Exam 3 - Quizzes

Consider a 3-year TIPS of face value $1,000. The annual coupon rate is 4% with annual payment. If inflation rate during the first year is 3%, what is the first coupon payment?

$41.20 Adjusted Face Value at the End of First Year = Face Value*(1 + Inflation Rate) Adjusted Face Value at the End of First Year = $1,000*(1+3%) = $1,030 First Coupon Payment = Adjusted Face Value at the End of First Year * Coupon Rate First Coupon Payment = $1,030*4% = $ 41.2

Consider a 3-year TIPS of face value $1,000. The annual coupon rate is 5% with annual payment. It is expected that inflation rate during the first year is going to be 2%; however, there will be a 1% deflation annually during the second and third years. Calculate the coupon payments for all three years.

$51, $50.49, $49.99 Adjusted Face Value at the End of First Year = Face Value*(1 + Inflation Rate) Adjusted Face Value at the End of First Year = $1,000*(1 + 2%) = $1,020 First Coupon Payment = Adjusted Face Value at the End of First Year * Coupon Rate First Coupon Payment = $1,020 * 5% = $51 Adjusted Face Value at the End of Second Year = Adjusted Face Value at the End of First Year*(1 + Inflation Rate) Adjusted Face Value at the End of First Year = $1,020*(1 + 1%) = $1,009.80 Second Coupon Payment = Adjusted Face Value at the End of Second Year * Coupon Rate Second Coupon Payment = $1,009.80 * 5% = $50.49 Adjusted Face Value at the End of Third Year = Adjusted Face Value at the End of Second Year*(1 + Inflation Rate) Adjusted Face Value at the End of Third Year = $1,009.80*(1 + 1%) = $999.70 Third Coupon Payment = Adjusted Face Value at the End of Third Year * Coupon Rate Third Coupon Payment = $999.70 * 5% = $49.99

A 180-day T-bill is purchased at a 6% asked yield. If the bill has a face value of $10,000, calculate its price. (Hint: asked yield is quoted in discount yield).

$9,700 Discount yield = ((Par-Price)/Par)*(360/Days to maturity)*100% 6% = (($10,000-Price)/($10,000))*(360/180)*100% = $9,700

Suppose 7-day fed funds trade at 1.65 percent annually. What is the yield on fed funds on a bond-equivalent basis?

1.67% Bond-equivalent basis = 1.65%*(365/360) = 1.67%

A firm buys $1,000,000 of a 30-day commercial paper issue for $995,450. What is the bond equivalent yield on this commercial paper?

5.56% Bond-equivalent yield = ((Par-Price)/Price)*(365/Days to maturity)*100% Bond-equivalent yield = (($1,000,000-$995,450)/$995,450)*(365/30)*100% = 5.56%

What is a STRIPS security? What risks does it help investors manage?

A STRIPS security is a group of zero-coupon bonds created off of the different parts of a Treasury bond's cash flows. It makes it easier for investors to hedge against interest rate risks using the duration-matching strategy.

What is a credit spread? What does a "Flight to Safety" mean in long-term bonds market?

A credit spread is the difference between the yields of riskier bonds and those of safer bonds. "Flight to Safety" means that investors selling riskier bonds out of the fear of heightened default risks and replace these bonds with safer ones in their portfolio.

A T-bill trades at a 10% discount from par, maturing in 36 days. The discount yield is: A. 1.00% B. 1.39% C. 1.19% D. Need more information

A. 1.00% Discount yield = ((Par-Price)/Par)*(360/Days to maturity)*100% Discount yield = 10%*(360/36) = 1.00%

A T-bill trades at a 20% discount from par, maturing in 73 days. The bond-equivalent yield is: A. 1.25% B. 0.99% C. 1.01% D. Need more information

A. 1.25% Bond-equivalent yield = ((Par-Price)/Price)*(365/Days to maturity)*100% Bond-equivalent yield = ((Par-0.8*Par)/0.8*Par)*(365/73)*100% = 1.25%

Which of the following is not a mortgage-backed security? A. A jumbo mortgage B. A Ginnie Mae pass-through C. A collateralized mortgage obligation D. A stripped Fannie Mae pass-through

A. A jumbo mortgage

An increase in prepayment speed of a pass-through mortgage backed security (MBS) will result in: A. A reduction in interest earned over the life of the pass-through B. An increase in principal earned over the life of the pass-through C. An increase in the rate of return over the investor's original investment horizon D. No change in principal but an increase in interest earned over the life of the pass-through

A. A reduction in interest earned over the life of the pass-through

Suppose Fargood Corporation engages in a repurchase agreement with The National Bank of Nebraska. In the agreement, Fargood sells $9,987,950 worth of Treasury securities to the bank and agrees to repurchase the securities in 30 days for $10,000,000. A. Is this transaction a loan, and if so, who is the borrower and who is the lender? B. Is the loan collateralized? What is the collateral? Who holds the collateral during the term of the agreement? C. What interest rate (or yield) is earned by the lender?

A. A repo is essentially a loan. The borrower here is Fargood Corporation and lender is National Bank of Nebraska B. This loan is collateralized by the Treasury securities Fargood agrees to buy back. National Bank of Nebraska holds the collateral. C. Discount yield = ((Par-Price)/Price)*(360/Days to maturity)*100% Discount yield = (($10,000,000-$9,987,950)/$9,987,950)*(360/30)*100% Bond-equivalent yield = ((Par-Price)/Price)*(365/Days to maturity)*100% Bond-equivalent yield = (($10,000,000-$9,987,950)/$9,987,950)*(365/30)*100% Yield = 1.45% or 1.47%

The yield curve for AAA-rated municipal bonds should plot: A. Above that of U.S. Treasuries but below that of AAA-rated corporate bonds B. Below that of U.S. Treasuries but above that of AAA-rated corporate bonds C. Above that of both U.S. Treasuries and AAA corporates D. Below that of both U.S. Treasuries and AAA corporates

A. Above that of U.S. Treasuries but below that of AAA-rated corporate bonds

Which of the following is NOT one of money market instrument features: A. Small denominations B. Low default risk C. Low price risk D. High liquidity

A. Small denominations

If average corporate bond and tax-exempt municipal bond rates were 8.33% and 6.25% respectively, at what marginal tax rate would an investor be indifferent between the two? A. 18% B. 25% C. 30% D. 33%

B. 25%

The original purpose of the Federal Home Loan Mortgage Corporation (Freddie Mac) was to: A. Make home loans to low income individuals. B. Purchase conforming mortgages from mortgage originators. C. Purchase FHA insured mortgages from financial institutions. D. Purchase mortgages created by Ginnie Mae.

B. Purchase conforming mortgages from mortgage originators.

A contract designed to use the equity in a home for retirement income without making any required payments is called a(n): A. Rollover mortgage B. Reverse mortgage C. Adjustable-rate mortgage D. Home equity loan

B. Reverse mortgage

If negative amortization occurs on a mortgage this means that: A. The monthly payment due on the mortgage has fallen. B. The amount due on the loan has increased. C. The interest rate on the mortgage has risen. D. The interest rate on the mortgage has fallen.

B. The amount due on the loan has increased.

Mortgage refinancing activity varies: A. Not much over time B. Positively with mortgage rates C. Inversely with mortgage rates D. At random

C. Inversely with mortgage rates

T-bills are auctioned to the bidders who offer: A. Highest premiums over par B. Highest volumes of orders C. Lowest discounts from par D. Highest discounts from par

C. Lowest discounts from par In an auction, bidders with the highest price win. With T-bills, the highest price implies the lowest yield. Because T-bills are zero-coupon instruments, their yields only come from the capital gains originated by the discounted purchase prices. The lower a discount is, the smaller the difference between the purchase price and face value, therefore the lower capital fain and equivalently lower yield.

Major effects of the 2007-08 crisis on money markets included all the following except: A. Surge in demand for T-Bills B. Surge in excess reserves C. Widespread runs on banks D. Unprecedented Federal Reserve intervention

C. Widespread runs on banks

A "repo" transaction is essentially: A. An unsecured short-term loan B. An option transaction C. Riskless D. A secured short-term loan

D. A secured short-term loan

"Tranches" are not a way of: A. Allocating different levels of risk to different groups of investors B. Allocating different levels of return to different groups of investors C. Allocating the income from a securitized pool of assets D. Diversifying the holdings of a securitized pool of assets

D. Diversifying the holdings of a securitized pool of assets

Agency backed mortgage backed securities (MBSs) have interest rates above Treasury rates because MBSs: A. Are more liquid B. Have substantially more default risk C. Are tax advantaged investments D. Have prepayment risks

D. Have prepayment risks

Investors in Collateralized Mortgage Obligations (CMO) securities are not exposed to prepayment risk.

False

True/False: A STRIPS security is no longer subject to interest rate risks

False STRIPS securities make it easier for investors to immunize against interest rate risks. However, a STRIPS security itself is still exposed to interest rate risks.

True/False: Treasury notes and bonds are money market instruments.

False Treasury notes and bonds are long-term securities. Therefore, they are both capital money market instruments.

What features make municipal bonds attractive to certain groups of investors?

Municipals bonds are exempt from Federal Income tax

What is a TIPS security? What risks does it help investors hedge against?

TIPS is a special type of Treasury bonds whose principal and there coupon payment is adjusted with inflation.

True/False: Adjustable-Rate Mortgages alleviate interest rate risks for lenders by transferring them to the borrowers.

True

True/False: Agency backed CMOs are designed to help investors better choose the amount of prepayment risk they wish to face.

True

True/False: Credit Default Swaps can be used as an insurance against risks associated with Mortgage-Backed Securities.

True

True/False: Money market instruments are traded through dealer-broker networks.

True

True/False: Money market's main function is to satisfy participants' liquidity needs.

True

True/False: Mortgage interests are computed on the declining principal.

True

True/False: Mortgage-Backed Securities have promoted supply of home mortgages.

True

True/False: Mortgage-backed securities are more liquid than individual mortgages.

True

True/False: Pass-through mortgage securities have standard denominations but uncertain cash flow.

True

True/False: A TIPS security's yield is in real terms.

True The purpose of a TIPS is to strip inflation's effects on security yields.