Assess the following statements: I. Default risk is the risk that a security issuer will default on making its promised interest and principal payments to the buyer of a security. II. The higher the default risk, the higher the interest rate that will be demanded by the buyer of the security to compensate him or her for this default (or credit) risk exposure. III. A highly liquid asset is one that can be sold at a predictable price with low transaction costs and thus can be converted into its full market value at short notice. IV. The change in required interest rates as the maturity of a security changes is called the maturity premium (MP). Only one statement is correct. All statements are correct. Two statements are correct. Three statements are correct.

Assess the following statements: I. Default risk is the risk that a security issuer will default on making its promised interest and principal payments to the buyer of a security. II. The higher the default risk, the higher the interest rate that will be demanded by the buyer of the security to compensate him or her for this default (or credit) risk exposure. III. A highly liquid asset is one that can be sold at a predictable price with low transaction costs and thus can be converted into its full market value at short notice. IV. The change in required interest rates as the maturity of a security changes is called the maturity premium (MP). Only one statement is correct. All statements are correct. Two statements are correct. Three statements are correct.

Essentials Of Investments

11th Edition

ISBN:9781260013924

Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.

Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.

Chapter1: Investments: Background And Issues

Section: Chapter Questions

Problem 1PS

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Determine how the appropriate yield to be offered on a security is affected by a higher risk-free rate. Explain the logic of this relationship. . Determine how the appropriate yield to be offered on a security is affected by a higher default risk premium. Explain the logic of this relationship.
Counterparty credit risk is a function of the probability of default, exposure at default, and loss given default. Assuming that the individual exposure at default with a counterparty is fixed, which of the following statements is correct? A. The probability of default can be mitigated by collateral, and exposure at default can be mitigated by netting. B. The probability of default can be mitigated by netting, and exposure at default can be mitigated by collateral. C. Loss given default can be mitigated by collateral, and exposure at default can be mitigated by netting. D. Loss given default can be mitigated by netting, and exposure at default can be mitigated by collateral.
The maximum rate of return needed to induce an investor to purchase or hold a security is referred to as the investor's required rate of return. OTRUE. FALSE
Which is least likely correct about security valuation?a. The calculated or determined value considers the stream of future cash flows.b. The calculated or determined value equals the market price.c. The calculated or determined value considers the risks involved and the opportunity cost.d. The calculated or determined value allows the investors to evaluate whether a security isovervalued or undervalued.e. All of the above
An increase in the riskiness of a particular security would NOT affect: Select one: A. The risk premium for that security B. The premium for expected inflation C. The total required return for the security D. Investors' willingness to buy the security
(I) The market price of a security at a given time is the highest value any investor puts onthe security. (II) Superior information about a security increases its value by reducing its risk.a) (I) is true, (II) is false.b) (I) is false, (II) is true.c) Both are true.d) Both are false.
When market rates of interest rise after a fixed-rate security is purchased, the value of the now below-market, fixed-interest payments declines, so the market value of the investment falls. If that drop in fair value is viewed as giving rise to an other-than-temporary impairment, how would it be reflected in the investment account for a security classified as held-to-maturity?
If a security is underpriced (i.e., intrinsic value > price), then what is the relationship between its market capitalization rate and its expected rate of return?
In hedging, interest rate swap (IRS) can be used to hedge against rising rates, falling rates, manage asset-liability durationgaps, protecting revenue and lock-in cost of borrowing. True/False
When market rates of interest rise after a fixed-rate security is purchased, the value of the now-below-market, fixed-interest payments declines, so the market value of the investment falls. How would that drop in fair value be reflected in the investment account for a security classified as HTM? Would your answer change if the drop in fair value was due to worsened financial conditions at the investee?
Which is correct about security valuation? A. In an efficient market, several factors would affect the market and value is not necessarily equals the price. B. The value of the security is determined to compare it with the current market price and usually investor would buy when the value equals the price. C. Sellers would prefer the accept lower bid price than higher bid price to realize gains. D. Investors buy securities when securities are underpriced and sell them when it is overpriced. E. All of the above F. None of the above
Some characteristics of the determinants of nominal interest rates are listed as follows. Identify the components (determinants) and the symbols associated with each characteristic: Characteristic Component Symbol This is the premium that reflects the risk associated with changes in interest rates for a long-term security. It changes over time, depending on the expected rate of return on productive assets exchanged among market participants and people’s time preferences for consumption. This premium is added when a security lacks marketability, because it cannot be bought and sold quickly without losing value. It is calculated by adding the inflation premium to r*. Over the past several years, Germany, Japan, and Switzerland have had lower interest rates than the United States due to lower values of this premium. It is based on the bond’s rating; the higher the rating, the lower the premium added, thus lowering…

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