FIN 510 CHPT 15

Suppose that this year's short rate is r1, next year's is known with certainty to be r2, and the two-year spot rate is y2. Which equation is correct? 1 + 2y2 = (1+r1)(1+r2) (1+y2)^½ = (1+r1)(1+r2) (1+y2)^2 = (1+r1)(1+r2) y2 = r1+r2

(1+y2)^2 = (1+r1)(1+r2) note: y2 = r1+r2 This holds as an approximation but is not correct.

If it were possible to risklessly profit by bond stripping or reconstitution, it would be a violation of the Law of __________ ____________ .

Blank 1: One Blank 2: Price

If you want to obtain a forward loan that begins in year 3 and ends in year 5, you would issue a __________-year zero-coupon bond and buy a _______________-year zero.

Blank 1: five or 5 Blank 2: 3 or three

The rate of interest for a future period, inferred from the term structure, that would equate the total return of holding a long-term bond with that of rolling over shorter-term bonds is the _______________ _____________ rate.

Blank 1: forward Blank 2: interest

When interest rates are uncertain, the interest rate that will actually be in effect for a given period that begins at a later time is termed the ______________ _____________ rate.

Blank 1: future Blank 2: short

The compensation for holding a less-traded bond, defined as the difference between the forward rate and the expected future short interest rate, is the ___________ ___________ .

Blank 1: liquidity Blank 2: premium

The pattern of interest rates appropriate for discounting cash flows of various maturities is the _____________ ______________ of interest rates.

Blank 1: term Blank 2: structure

Identify the shape of the yield curve. (Click to enlarge.) Rising (Normal) Yield Curve Inverted Yield Curve Flat Yield Curve Hump-shaped Yield Curve

Flat Yield Curve

Identify the shape of the yield curve. (Click to enlarge.) Rising (Normal) Yield Curve Inverted Yield Curve Hump-shaped Yield Curve Flat Yield Curve

Inverted Yield Curve

The idea that the forward rate differs from the expected short rate because of supply and demand issues, with the forward rate usually higher, is termed _______________ _______________ theory.

Liquidity preference

Select all that apply What would contribute to the negative slope of a yield curve? Increasing expected short rates Negative liquidity premium Decreasing expected short rates Positive liquidity premium

Negative liquidity premium Decreasing expected short rates

True or false: The analysis that accounts for patterns of interest rates for different-term assets and the term structure of interest rates focuses on the structure of interest rates for discounting cash flows at different maturities.

True

For an upward sloping yield curve, a(n) __________ average forward rate must be added to the other previously observed rates in order to increase the yield to maturity above- below- decreasing increasing

above-

According to the expectations hypothesis, an upward-sloping yield curve indicates that investors are expecting ______ in interest rates. an increase no change a decrease

an increase

According to the expectations hypothesis, the forward rate ________ the market consensus for the future short rate. does not have a definitive relationship with is less than is greater than equals

equals

A contract signed now for a loan that would not begin until a later date would be likely to use the ______. future short rate spot rate real interest rate forward interest rate

forward interest rate note: The future short rate will not be known until the future.

If there is a positive liquidity premium and expected short interest rates are constant, then the yield curve will have ______ slope. positive negative zero

positive

An interest rate for a period (often a year) available at different points in time is a(n) ______________ rate.

short

The liquidity premium compensates ______-______ investors for the uncertainty about the price at which they will be able to sell their ____-____ bonds at the end of the year. long-term; short-term short-term; long-term short-term; short-term long-term; long-term

short-term; long-term

The current interest rate appropriate for discounting a cash flow of some given maturity, in other words the rate that prevails today for a zero-coupon bond of that maturity, is the ________________ rate.

spot

Bond ______________ is the act of selling bond cash flows as stand-alone, zero-coupon securities.

stripping