Week 3: Risk, Return and Bond Valuation – Self Quiz

1. Which of the following bonds would have the greatest percentage increase in value if all interest rates fell by 1%? 10-year, zero coupon bond

20-year, 10% coupon bond

20-year, 5% coupon bond

1-year, 10% coupon bond

***20-year, zero coupon bond

2. Which of the following statements is most correct? Characteristic line is another name for the security market line.

The characteristic line is the regression line that results from plotting the returns on a particular stock versus the returns on a stock from a different industry. The slope of the characteristic line is the stock's standard deviation.

The distance of the plot points from the characteristic line is a measure of the stock's market risk. *** The distance of the plot points from the characteristic line is a measure of the stock's diversifiable risk.

3. Which of the following statements is most correct? E

A. Tests have shown that the betas of individual stocks are unstable over time, but that the betas of large portfolios are reasonably stable over time. B. Richard Roll has argued that it is not even possible to test the CAPM to see if it is correct. C. Tests have shown that the risk/return relationship appears to be linear, but the slope of the relationship is less than that predicted by the CAPM. D. Statements A and B are correct.

E. Statements A, B, and C are correct.

4. One of the basic relationships in interest rate theory is that, other things held constant, for a given change in the required rate of return, the _______ the time is to maturity, the _______ the change in price.

Student Answer: E A. All else equal, long-term bonds have more interest rate risk than short-term bonds. B.