Question & Answer

Assume that breaking news causes bond portfolio managers to suddenly expect much higher economic growth. How might bond prices be affected by this expectation? Explain. Now assume that breaking news causes bond portfolio managers to suddenly anticipate a recession. How might bond prices be affected? Explain. (LO2)

Assume that oil-producing countries have agreed to reduce their oil production by 30 percent. How would bond prices be affected by this announcement? Explain. (LO2)

Explain how bond prices may be affected by money supply growth, oil prices, and economic growth. (LO2)

When tensions rise or war erupts in the Middle East, bond prices in many countries tend to decline. What is the link between problems in the Middle East and bond prices? Would you expect bond prices to decline more in Japan or in the United Kingdom as a result of the crisis? (The answer is tied to how interest rates may change in those countries.) Explain. (LO2)

An analyst recently suggested that there will be a major economic expansion that will favorably affect the prices of highrated, fixed-rate bonds because the credit risk of bonds will decline as corporations improve their performance. Assuming that the economic expansion occurs, do you agree with the analyst’s conclusion? Explain. (LO2) 

Explain the concept of bond price elasticity. Would bond price elasticity suggest a higher price sensitivity for zero-coupon bonds or high-coupon bonds that are offering the same yield to maturity? Why? What does this suggest about the market value volatility of mutual funds containing zero-coupon Treasury bonds versus high-coupon Treasury bonds? (LO1, LO3)

Assume that inflation is expected to decline in the near future. How could this affect future bond prices? Would you recommend that financial institutions increase or decrease their concentration in long-term bonds based on this expectation? Explain. (LO2)

Why does the required rate of return for a particular bond change over time? (LO2)

Is the price of a long-term bond or the price of a short-term security more sensitive to a change in interest rates? Why? (LO1)

If a bond’s coupon rate is greater than the investor’s required rate of return on the bond, would the bond’s price be greater than or less than its par value? Explain. (LO1)

Since fixed-rate mortgages and bonds have similar payment flows, how is a financial institution with a large portfolio of fixed-rate mortgages affected by rising interest rates? Explain. LO(8-1)

How would a financial institution with a large bond portfolio be affected by falling interest rates? Would it be affected by a greater extent than a financial institution with a greater concentration of bonds (and fewer short-term securities)? Explain. (LO1)

Determine the direction of bond prices over the last year and explain the reason for it. (LO1, LO2) 

Why is the relationship between interest rates and bond prices important to financial institutions? (LO1) 

Explain the impact of a decline in interest rates on:

a. An investor’s required rate of return,

b. The present value of existing bonds,

c. The prices of existing bonds. (LO1).

Based on your forecast of interest rates, would you recommend that investors purchase bonds today? Explain. (LO1, LO2)

Write a short essay on the integration of bond markets. Explain why adverse conditions within one bond market (such as a particular country) commonly spread to other bond markets. 

Explain how the bond market facilitates a government’s fiscal policy. How do you think the bond market could discipline a government and discourage the government from borrowing (and spending) excessively? (LO1)

Explain why the market for auction-rate securities suffered in 2008. (LO4)

Explain what exchange-traded notes are and how they are used. Why are they risky? (LO4)

An insurance company purchased bonds issued by Hartnett Company two years ago. Today, Hartnett Company has begun to issue junk bonds and is using the funds to repurchase most of its existing stock. Why might the market value of those bonds held by the insurance company be affected by this action? (LO2)

Merrito Inc. is a large U.S. firm that issued bonds several years ago. Its bond ratings declined over time and, about a year ago, the bonds were rated in the junk bond classification. Nevertheless, investors continued to buy the bonds in the secondary market because of the attractive yield they offered. Last week, Merrito defaulted on its bonds, and the prices of most other junk bonds declined abruptly on the same day. Explain why news of Meritto’s financial problems could cause the prices of junk bonds issued by other firms to decrease, even when those firms had no business relationships with Merrito. Explain why the prices of those junk bonds with less liquidity declined more than those with a high degree of liquidity. (LO2)

Explain how the downgrading of bonds for a particular corporation affects the prices of those bonds, the return to investors who currently hold these bonds, and the potential return to other investors who may invest in the bonds in the near future. (LO2) 

Explain the conditions that led to the debt crisis in Greece. (LO3)

Explain the guidelines for credit rating agencies that resulted from the Financial Reform Act of 2010. (LO2)