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Multiple Choice
Questions
1.
The term structure of
interest rates is:
A)
The relationship between the rates of
interest on all securities.
B)
The relationship between
the interest rate on a security and its time to
maturity.
C)
The relationship between the yield on a
bond and its default rate.
D)
All of the above.
E)
None of the
above.
Answer: B
Difficulty: Easy
Rationale: The term structure of
interest rates is the relationship between two
variables,
years and yield to maturity
(holding all else constant).
2.
The yield
curve shows at any point in time:
A)
The relationship between
the yield on a bond and the duration of the bond.
B)
The
relationship between the coupon rate on a bond and
time to maturity of the
bond.
C)
The
relationship between yield on a bond and the time
to maturity on the bond.
D)
All of the above.
E)
None of the
above.
Answer: C
Difficulty: Easy
3.
An inverted yield curve
implies that:
A)
Long-term interest rates are lower than
short-term interest rates.
B)
Long-term interest rates
are higher than short-term interest rates.
C)
Long-term
interest rates are the same as short-term interest
rates.
D)
Intermediate term interest rates are
higher than either short- or long-term interest
rates.
E)
none of the above.
Answer: A Difficulty: Easy
Rationale: The
inverted, or downward sloping, yield curve is one
in which short-term
rates are higher
than long-term rates. The inverted yield curve
has been observed
frequently, although
not as frequently as the upward sloping, or
normal, yield curve.
4.
An upward
sloping yield curve is a(n) _______ yield curve.
A)
normal.
B)
humped.
C)
inverted.
D)
flat.
E)
none of
the above.
Answer: A Difficulty:
Easy
Rationale: The
upward sloping yield curve is referred to as the
normal yield curve,
probably because,
historically, the upward sloping yield curve is
the shape that has been
observed most
frequently.
5.
According to
the expectations hypothesis, a normal yield curve
implies that
A)
interest
rates are expected to remain stable in the future.
B)
interest rates are
expected to decline in the future.
C)
interest rates are expected to increase
in the future.
D)
interest
rates are expected to decline first, then
increase.
E)
interest rates
are expected to increase first, then decrease.
Answer: C Difficulty: Easy
Rationale: An upward
sloping yield curve is based on the expectation
that short-term
interest rates will
increase.
6.
Which of the
following is not proposed as an explanation for
the term structure of
interest rates
A)
The expectations theory.
B)
The liquidity preference
theory.
C)
The market
segmentation theory.
D)
Modern portfolio theory.
E)
A, B, and C.
Answer: D
Difficulty: Easy
Rationale: A, B, and C are all theories
that have been proposed to explain the term
structure.
7.
The
expectations theory of the term structure of
interest rates states that
A)
forward rates are determined by
investors' expectations of future interest rates.
B)
forward rates exceed the
expected future interest rates.
C)
yields on long- and short-maturity
bonds are determined by the supply and demand
for the securities.
D)
all of the above.
E)
none of the above.
Answer:
A Difficulty: Easy
Rationale: The forward rate equals the
market consensus expectation of future short
interest rates.
8.
Which of the following theories state
that the shape of the yield curve is essentially
determined by the supply and demands
for long-and short-maturity bonds
A)
Liquidity preference theory.
B)
Expectations theory.
C)
Market segmentation
theory.
D)
All of the
above.
E)
None of the
above.
Answer: C Difficulty: Easy
Rationale: Market
segmentation theory states that the markets for
different maturities
are separate
markets, and that interest rates at the different
maturities are determined by
the
intersection of the respective supply and demand
curves.
9.
According to the
yield curve usually should be:
A)
inverted.
B)
normal.
C)
upward sloping
D)
A and B.
E)
B
and C.
Answer: E Difficulty: Easy
Rationale: According to the
liquidity preference theory, investors would
prefer to be
liquid rather than
illiquid. In order to accept a more illiquid
investment, investors
require a
liquidity premium and the normal, or upward
sloping, yield curve results.
Use the following to answer questions
10-13:
Suppose that all
investors expect that interest rates for the 4
years will be as follows:
10.
What is the
price of 3-year zero coupon bond with a par value
of $$1,000
A)
$$
B)
$$
C)
$$
D)
$$
E)
none of the
above
Answer: B
Difficulty: Moderate
Rationale: $$1,000 / = $$
11.
If you have
just purchased a 4-year zero coupon bond, what
would be the expected rate
of return on
your investment in the first year if the implied
forward rates stay the same
(Par value
of the bond = $$1,000)
A)
5%
B)
7%
C)
9%
D)
10%
E)
none of the above
Answer: A Difficulty: Moderate
Rationale: The
forward interest rate given for the first year of
the investment is given as
5% (see
table above).
12.
What is the price of a
2-year maturity bond with a 10% coupon rate paid
annually (Par
value = $$1,000)
A)
$$1,092
B)
$$1,054
C)
$$1,000
D)
$$1,073
E)
none of the
above
Answer: D
Difficulty: Moderate
Rationale: []
1/2
- 1 = 6%; FV = 1000, n = 2, PMT = 100, i = 6, PV =
$$1,
13.
What is the yield to maturity of a
3-year zero coupon bond
A)
%
B)
%
C)
%
D)
%
E)
none of the above
Answer: C Difficulty: Moderate
Rationale:
[]
1/3
- 1 = .
Use the following to answer questions
14-16:
The following is a
list of prices for zero coupon bonds with
different maturities and par value of
$$1,000.
14.
What is, according to the expectations
theory, the expected forward rate in the
third
year
A)
%
B)
%
C)
%
D)
%
E)
none of the
above
Answer: C
Difficulty: Moderate
Rationale: / - 1 = 9%
15.
What is the
yield to maturity on a 3-year zero coupon bond
A)
%
B)
%
C)
%
D)
%
E)
none of the
above
Answer: C
Difficulty: Moderate
Rationale: (1000 /
1/3
-1 = %
16.
What is the
price of a 4-year maturity bond with a 12% coupon
rate paid annually (Par
value =
$$1,000)
A)
$$
B)
$$1,
C)
$$1,
D)
$$1,
E)
none of the
above
Answer: D
Difficulty: Difficult
Rationale: (1000 /
1/4
-1 = %; FV = 1000, PMT =
120, n = 4, i = , PV = $$1,
17.
The market segmentation
theory of the term structure of interest rates
A)
theoretically
can explain all shapes of yield curves.
B)
definitely
holds in the
C)
assumes that markets for different
maturities are separate markets.
D)
A and B.
E)
A and C.
Answer: E Difficulty: Easy
Rationale:
Although this theory is quite tidy theoretically,
both investors and borrows
will depart
from their
attractive enough.
18.
An upward sloping yield curve
A)
may be an
indication that interest rates are expected to
increase.
B)
may incorporate a liquidity premium.
C)
may reflect
the confounding of the liquidity premium with
interest rate
expectations.
D)
all of the
above.
E)
none
of the above.
Answer: D
Difficulty: Easy
Rationale: One of the problems of the
most commonly used explanation of term
structure, the expectations hypothesis,
is that it is difficult to separate out the
liquidity
premium from interest rate
expectations.
19.
The
n
that equates the return on
an
n
-period
zero-
coupon bond to that of an
n-1
-period zero-coupon bond
rolled over into a one-year
bond in
year
n
is defined as
A)
the forward
rate.
B)
the
short rate.
C)
the yield to maturity.
D)
the discount rate.
E)
None of the
above.
Answer: A
Difficulty: Easy
Rationale: The forward rate for year n,
fn, is the
equates the return on an
n-period zero- coupon bond to that of an
n-1-period
zero-coupon bond rolled over
into a one-year bond in year n.
20.
When
computing yield to maturity, the implicit
reinvestment assumption is that the
interest payments are reinvested at
the:
A)
Coupon
rate.
B)
Current yield.
C)
Yield to maturity at the
time of the investment.
D)
Prevailing yield to maturity at the
time interest payments are received.
E)
The average yield to
maturity throughout the investment period.
Answer: C Difficulty:
Moderate
Rationale: In order to earn the yield
to maturity quoted at the time of the investment,
coupons must be reinvested at that
rate.
21.
Which one of the following statements
is
true
A)
The expectations
hypothesis indicates a flat yield curve if
anticipated future
short-term rates
exceed the current short-term rate.
B)
The basic conclusion of
the expectations hypothesis is that the long-term
rate is
equal to the anticipated long-
term rate.
C)
The liquidity preference hypothesis
indicates that, all other things being equal,
longer maturities will have lower
yields.
D)
The
segmentation hypothesis contends that borrows and
lenders are constrained to
particular
segments of the yield curve.
E)
None of the above.
Answer: D Difficulty:
Moderate
Rationale: A flat yield curve indicates
expectations of existing rates. Expectations
hypothesis states that the forward rate
equals the market consensus of expectations of
future short interest rates. The
reverse of C is true.
22.
The concepts of spot and
forward rates are most closely associated with
which one of
the following explanations
of the term structure of interest rates.
A)
Segmented
Market theory
B)
Expectations Hypothesis
C)
Preferred Habitat
Hypothesis
D)
Liquidity Premium theory
E)
None of the above
Answer: B Difficulty:
Moderate
Rationale: Only the expectations
hypothesis is based on spot and forward rates. A
and
C assume separate markets for
different maturities; liquidity premium assumes
higher
yields for longer maturities.
Use the following to answer
question 23:
23.
Given the bond described
above, if interest were paid semi-annually (rather
than
annually), and the bond continued
to be priced at $$850, the resulting effective
annual
yield to maturity would be:
A)
Less than 12%
B)
More than 12%
C)
12%
D)
Cannot be
determined
E)
None of the above
Answer: B Difficulty: Moderate
Rationale: FV =
1000, PV = -850, PMT = 50, n = 40, i = (semi-
annual);
2
- 1 = %.
24.
Interest rates might decline
A)
because real
interest rates are expected to decline.
B)
because the
inflation rate is expected to decline.
C)
because
nominal interest rates are expected to increase.
D)
A and B.
E)
B and C.
Answer: D Difficulty:
Easy
Rationale: The nominal rate is
comprised of the real interest rate plus the
expected
inflation rate.
25.
Forward rates ____________ future short
rates because ____________.
A)
are equal to; they are
both extracted from yields to maturity.
B)
are equal to;
they are perfect forecasts.
C)
differ from; they are
imperfect forecasts.
D)
differ from; forward rates are
estimated from dealer quotes while future short
rates
are extracted from yields to
maturity.
E)
are equal to; although they are
estimated from different sources they both are
used
by traders to make purchase
decisions.
Answer: C
Difficulty: Easy
Rationale: Forward rates are the
estimates of future short rates extracted from
yields to
maturity but they are not
perfect forecasts because the future cannot be
predicted with
certainty; therefore
they will usually differ.
26.
The
pure
yield curve
can be estimated
A)
by using
zero-coupon bonds.
B)
by using coupon bonds if each coupon is
treated as a separate
C)
by using corporate bonds with different
risk ratings.
D)
by estimating liquidity premiums for
different maturities.
E)
A and B.
Answer: E Difficulty: Moderate
Rationale: The
pure yield curve is calculated using zero coupon
bonds, but coupon
bonds may be used if
each coupon is treated as a separate
27.
The
on the run yield curve
is
A)
a plot of
yield as a function of maturity for zero-coupon
bonds.
B)
a
plot of yield as a function of maturity for
recently issued coupon bonds trading at
or near par.
C)
a plot of yield as a function of
maturity for corporate bonds with different risk
ratings.
D)
a plot of liquidity premiums for
different maturities.
E)
A and B.
Answer: B Difficulty: Moderate
28.
The market segmentation and preferred
habitat theories of term structure
A)
are identical.
B)
vary in that
market segmentation is rarely accepted today.
C)
vary in that
market segmentation maintains that borrowers and
lenders will not
depart from their
preferred maturities and preferred habitat
maintains that market
participants will
depart from preferred maturities if yields on
other maturities are
attractive enough.
D)
A and B.
E)
B and C.
Answer: E Difficulty:
Moderate
Rationale: Borrowers and lenders will
depart from their preferred maturity habitats if
yields are attractive enough; thus, the
market segmentation hypothesis is no longer
readily accepted.
29.
The yield
curve
A)
is a
graphical depiction of term structure of interest
rates.
B)
is
usually depicted for U. S. Treasuries in order to
hold risk constant across
maturities
and yields.
C)
is usually depicted for corporate bonds
of different ratings.
D)
A and B.
E)
A and C.
Answer: D Difficulty: Easy
Rationale: The
yield curve (yields vs. maturities, all else
equal) is depicted for U. S.
Treasuries
more frequently than for corporate bonds, as the
risk is constant across
maturities for
Treasuries.
Use the
following to answer questions 30-32:
30.
What should the purchase price of a
2-year zero coupon bond be if it is purchased at
the
beginning of year 2 and has face
value of $$1,000
A)
$$
B)
$$
C)
$$
D)
$$
E)
$$
Answer: A
Difficulty: Difficult
Rationale: $$1,000 / [] = $$
31.
What would
the yield to maturity be on a four-year zero
coupon bond purchased today
A)
%
B)
%
C)
%
D)
%
E)
none of the above.
Answer: C Difficulty:
Moderate
Rationale: [
]
1/4
- 1 = %
32.
Calculate
the price at the beginning of year 1 of a 10%
annual coupon bond with face
value
$$1,000 and 5 years to maturity.
A)
$$1,105
B)
$$1,132
C)
$$1,179
D)
$$1,150
E)
$$1,119
Answer: B Difficulty: Difficult
Rationale: i =
[ ]
1/5
- 1 = %; FV =
1000, PMT = 100, n = 5, i = , PV = $$1,