Chapter 16

21. The duration of a perpetuity with a yield of 8% is A. 13.50 years. B. 12.11 years. C. 6.66 years. D. cannot be determined. E. None of these is correct.

1.08/0.08 = 13.50 years.

67. The duration of a perpetuity with a yield of 10% is A. 13.50 years. B. 11 years. C. 6.66 years. D. cannot be determined. E. None of these is correct.

11 years (D = 1.10/0.10)

68. The duration of a perpetuity with a yield of 6% is A. 13.50 years. B. 12.11 years. C. 17.67 years. D. cannot be determined. E. None of these is correct.

17.67 years

72. Which of the following bonds has the longest duration? A. A 12-year maturity, 0% coupon bond. B. A 12-year maturity, 8% coupon bond. C. A 4-year maturity, 8% coupon bond. D. A 4-year maturity, 0% coupon bond. E. Cannot tell from the information given.

A. A 12-year maturity, 0% coupon bond.

23. Par value bond XYZ has a modified duration of 6. Which one of the following statements regarding the bond is true? A. If the market yield increases by 1% the bond's price will decrease by $60. B. If the market yield increases by 1% the bond's price will increase by $50. C. If the market yield increases by 1% the bond's price will decrease by $50. D. If the market yield increases by 1% the bond's price will increase by $60. E. None of these is correct.

A. If the market yield increases by 1% the bond's price will decrease by $60.

69. Par value bond F has a modified duration of 9. Which one of the following statements regarding the bond is true? A. If the market yield increases by 1% the bond's price will decrease by $90. B. If the market yield increases by 1% the bond's price will increase by $90. C. If the market yield increases by 1% the bond's price will decrease by $60. D. If the market yield decreases by 1% the bond's price will increase by $60. E. None of these is true.

A. If the market yield increases by 1% the bond's price will decrease by $90.

40. Which one of the following is an incorrect statement concerning duration? A. The higher the yield to maturity, the greater the duration. B. The higher the coupon, the shorter the duration. C. The difference in duration is small between two bonds with different coupons each maturing in more than 15 years. D. The duration is the same as term to maturity only in the case of zero-coupon bonds. E. All of the statements are correct.

A. The higher the yield to maturity, the greater the duration.

66. The duration of a 20-year zero-coupon bond is A. equal to 20. B. larger than 20. C. smaller than 20. D. equal to that of a 20-year 10% coupon bond. E. None of these is correct.

A. equal to 20.

35. When interest rates decline, the duration of a 10-year bond selling at a premium A. increases. B. decreases. C. remains the same. D. increases at first, then declines. E. decreases at first, then increases.

A. increases.

50. A rate anticipation swap is an exchange of bonds undertaken to A. shift portfolio duration in response to an anticipated change in interest rates. B. shift between corporate and government bonds when the yield spread is out of line with historical values. C. profit from apparent mispricing between two bonds. D. change the credit risk of the portfolio. E. increase return by shifting into higher yield bonds.

A. shift portfolio duration in response to an anticipated change in interest rates.

39. The duration of a bond normally increases with an increase in A. term to maturity. B. yield to maturity. C. coupon rate. D. All of these are correct. E. None of these is correct.

A. term to maturity.

5. Holding other factors constant, the interest-rate risk of a coupon bond is higher when the bond's: A. term-to-maturity is higher. B. coupon rate is higher. C. yield to maturity is higher. D. All of these are correct. E. None of these is correct.

A. term-to-maturity is higher.

2. Ceteris paribus, the duration of a bond is positively correlated with the bond's A. time to maturity. B. coupon rate .C. yield to maturity. D. All of these are correct. E. None of these is correct.

A. time to maturity.

54. Which of the following are false about the interest-rate sensitivity of bonds? I) Bond prices and yields are inversely related.II) Prices of long-term bonds tend to be more sensitive to interest rate changes than prices of short-term bonds.III) Interest-rate risk is directly related to the bond's coupon rate.IV) The sensitivity of a bond's price to a change in its yield to maturity is inversely related to the yield to maturity at which the bond is currently selling. A. I B. III C. I, II, and IV D. II, III, and IV E. I, II, III, and IV

B. III

62. Which of the following two bonds is more price sensitive to changes in interest rates? 1) A par value bond, D, with a 2-year-to-maturity and a 8% coupon rate. 2) A zero-coupon bond, E, with a 2-year-to-maturity and a 8% yield-to-maturity. A. Bond D because of the higher yield to maturity. B. Bond E because of the longer duration. C. Bond D because of the longer time to maturity. D. Both have the same sensitivity because both have the same yield to maturity. E. None of these is correct.

B. Bond E because of the longer duration.

16. Which of the following is not true? A. Holding other things constant, the duration of a bond increases with time to maturity. B. Given time to maturity, the duration of a zero-coupon decreases with yield to maturity. C. Given time to maturity and yield to maturity, the duration of a bond is higher when the coupon rate is lower. D. Duration is a better measure of price sensitivity to interest rate changes than is time to maturity. E. All of these are correct.

B. Given time to maturity, the duration of a zero-coupon decreases with yield to maturity.

58. Two bonds are selling at par value and each has 17 years to maturity. The first bond has a coupon rate of 6% and the second bond has a coupon rate of 13%. Which of the following is true about the durations of these bonds? A. The duration of the higher-coupon bond will be higher. B. The duration of the lower-coupon bond will be higher. C. The duration of the higher-coupon bond will equal the duration of the lower-coupon bond. D. There is no consistent statement that can be made about the durations of the bonds. E. The bond's durations cannot be determined without knowing the prices of the bonds.

B. The duration of the lower-coupon bond will be higher.

38. One way that banks can reduce the duration of their asset portfolios is through the use of A. fixed rate mortgages. B. adjustable rate mortgages. C. certificates of deposit. D. short-term borrowing. E. None of these is correct.

B. adjustable rate mortgages.

6. Holding other factors constant, the interest-rate risk of a coupon bond is higher when the bond's: A. term-to-maturity is lower. B. coupon rate is lower. C. yield to maturity is higher. D. term-to-maturity is lower and yield to maturity is higher. E. None of these is correct.

B. coupon rate is lower.

11. The "modified duration" used by practitioners is equal to ______ divided by (one plus the bond's yield to maturity). A. current yield B. the Macaulay duration C. yield to call D. yield to maturity E. None of these is correct.

B. the Macaulay duration

13. The interest-rate risk of a bond is A. the risk related to the possibility of bankruptcy of the bond's issuer. B. the risk that arises from the uncertainty of the bond's return caused by changes in interest rates. C. the unsystematic risk caused by factors unique in the bond. D. the risk related to the possibility of bankruptcy of the bond's issuer and the risk that arises from the uncertainty of the bond's return caused by changes in interest rates. E. All of these are correct.

B. the risk that arises from the uncertainty of the bond's return caused by changes in interest rates.

32. Duration measures A. weighted average time until a bond's half-life. B. weighted average time until cash flow payment. C. the time required to make excessive profit from the investment. D. weighted average time until a bond's half-life and the time required to make excessive profit from the investment. E. weighted average time until cash flow payment and the time required to make excessive profit from the investment.

B. weighted average time until cash flow payment.

34. Identify the bond that has the longest duration (no calculations necessary). A. 20-year maturity with an 8% coupon. B. 20-year maturity with a 12% coupon. C. 20-year maturity with a 0% coupon. D. 10-year maturity with a 15% coupon. E. 12-year maturity with a 12% coupon.

C. 20-year maturity with a 0% coupon.

15. Holding other factors constant, which one of the following bonds has the smallest price volatility? A. 5-year, 0% coupon bond B. 5-year, 12% coupon bond C. 5 year, 14% coupon bond D. 5-year, 10% coupon bond E. Cannot tell from the information given.

C. 5 year, 14% coupon bond

22. A seven-year par value bond has a coupon rate of 9% and a modified duration of A. 7 years. B. 5.49 years. C. 5.03 years. D. 4.87 years. E. None of these is correct.

C. 5.03 years.

63. Holding other factors constant, which one of the following bonds has the smallest price volatility? A. 7-year, 0% coupon bond B. 7-year, 12% coupon bond C. 7 year, 14% coupon bond D. 7-year, 10% coupon bond E. Cannot tell from the information given.

C. 7 year, 14% coupon bond

61. Which of the following two bonds is more price sensitive to changes in interest rates? 1) A par value bond, A, with a 12-year-to-maturity and a 12% coupon rate.2) A zero-coupon bond, B, with a 12-year-to-maturity and a 12% yield-to-maturity. A. Bond A because of the higher yield to maturity. B. Bond A because of the longer time to maturity. C. Bond B because of the longer duration. D. Both have the same sensitivity because both have the same yield to maturity. E. None of these is correct.

C. Bond B because of the longer duration.

14. Which of the following two bonds is more price sensitive to changes in interest rates? 1) A par value bond, X, with a 5-year-to-maturity and a 10% coupon rate. 2) A zero-coupon bond, Y, with a 5-year-to-maturity and a 10% yield-to-maturity. A. Bond X because of the higher yield to maturity. B. Bond X because of the longer time to maturity. C. Bond Y because of the longer duration. D. Both have the same sensitivity because both have the same yield to maturity. E. None of these is correct.

C. Bond Y because of the longer duration.

53. Which of the following are true about the interest-rate sensitivity of bonds? I) Bond prices and yields are inversely related.II) Prices of long-term bonds tend to be more sensitive to interest rate changes than prices of short-term bonds.III) Interest-rate risk is directly related to the bond's coupon rate.IV) The sensitivity of a bond's price to a change in its yield to maturity is inversely related to the yield to maturity at which the bond is currently selling. A. I and II B. I and III C. I, II, and IV D. II, III, and IV E. I, II, III, and IV

C. I, II, and IV

70. Par value bond GE has a modified duration of 11. Which one of the following statements regarding the bond is true? A. If the market yield increases by 1% the bond's price will decrease by $55. B. If the market yield increases by 1% the bond's price will increase by $55. C. If the market yield increases by 1% the bond's price will decrease by $110. D. If the market yield increases by 1% the bond's price will increase by $110. E. None of these is true.

C. If the market yield increases by 1% the bond's price will decrease by $110.

26. Which one of the following statements is true concerning the duration of a perpetuity? A. The duration of 15% yield perpetuity that pays $100 annually is longer than that of a 15% yield perpetuity that pays $200 annually. B. The duration of a 15% yield perpetuity that pays $100 annually is shorter than that of a 15% yield perpetuity that pays $200 annually. C. The duration of a 15% yield perpetuity that pays $100 annually is equal to that of 15% yield perpetuity that pays $200 annually. D. The duration of a perpetuity cannot be calculated.E. None of these is true.

C. The duration of a 15% yield perpetuity that pays $100 annually is equal to that of 15% yield perpetuity that pays $200 annually.

52. Interest-rate risk is important to A. active bond portfolio managers. B. passive bond portfolio managers. C. both active and passive bond portfolio managers. D. neither active nor passive bond portfolio managers. E. obsessive bond portfolio managers.

C. both active and passive bond portfolio managers.

45. Cash flow matching on a multiperiod basis is referred to as A. immunization. B. contingent immunization. C. dedication. D. duration matching. E. rebalancing.

C. dedication

65. The duration of a 15-year zero-coupon bond is A. smaller than 15. B. larger than 15. C. equal to 15. D. equal to that of a 15-year 10% coupon bond. E. None of these is correct.

C. equal to 15.

18. The duration of a 5-year zero-coupon bond is A. smaller than 5. B. larger than 5. C. equal to 5. D. equal to that of a 5-year 10% coupon bond. E. None of these is correct.

C. equal to 5.

51. An analyst who selects a particular holding period and predicts the yield curve at the end of that holding period is engaging in A. a rate anticipation swap. B. immunization. C. horizon analysis. D. an intermarket spread swap. E. None of these is correct.

C. horizon analysis.

42. Immunization is not a strictly passive strategy because A. it requires choosing an asset portfolio that matches an index. B. there is likely to be a gap between the values of assets and liabilities in most portfolios. C. it requires frequent rebalancing as maturities and interest rates change. D. durations of assets and liabilities fall at the same rate. E. None of these is correct.

C. it requires frequent rebalancing as maturities and interest rates change.

9. Holding other factors constant, the interest-rate risk of a coupon bond is lower when the bond's: A. term-to-maturity is higher. B. coupon rate is lower. C. yield to maturity is higher. D. term-to-maturity is higher and coupon rate is lower. E. All of these are correct.

C. yield to maturity is higher.

4. Holding other factors constant, the interest-rate risk of a coupon bond is higher when the bond's: A. term-to-maturity is lower. B. coupon rate is higher. C. yield to maturity is lower. D. current yield is higher. E. None of these is correct.

C. yield to maturity is lower.

64. Holding other factors constant, which one of the following bonds has the smallest price volatility? A. 20-year, 0% coupon bond B. 20-year, 6% coupon bond C. 20 year, 7% coupon bond D. 20-year, 9% coupon bond E. Cannot tell from the information given.

D. 20-year, 9% coupon bond

20. The duration of a par value bond with a coupon rate of 8% and a remaining time to maturity of 5 years is A. 5 years. B. 5.4 years. C. 4.17 years. D. 4.31 years. E. None of these is correct.

D. 4.31 years.

24. Which of the following bonds has the longest duration? A. An 8-year maturity, 0% coupon bond. B. An 8-year maturity, 5% coupon bond. C. A 10-year maturity, 5% coupon bond. D. A 10-year maturity, 0% coupon bond. E. Cannot tell from the information given.

D. A 10-year maturity, 0% coupon bond.

71. Which of the following bonds has the longest duration? A. A 15-year maturity, 0% coupon bond. B. A 15-year maturity, 9% coupon bond. C. A 20-year maturity, 9% coupon bond. D. A 20-year maturity, 0% coupon bond. E. Cannot tell from the information given.

D. A 20-year maturity, 0% coupon bond.

1. The duration of a bond is a function of the bond's A. coupon rate. B. yield to maturity. C. time to maturity. D. All of these are correct. E. None of these is correct.

D. All of these are correct.

30. Indexing of bond portfolios is difficult because A. the number of bonds included in the major indexes is so large that it would be difficult to purchase them in the proper proportions. B. many bonds are thinly traded so it is difficult to purchase them at a fair market price. C. the composition of bond indexes is constantly changing. D. All of these are correct. E. None of these is correct.

D. All of these are correct.

60. Which of the following offers a bond index? A. Merrill Lynch B. Salomon C. Barclays Capital D. All of these are correct. E. All but Merrill Lynch

D. All of these are correct.

57. Duration is important in bond portfolio management because I) it can be used in immunization strategies.II) it provides a gauge of the effective average maturity of the portfolio.III) it is related to the interest rate sensitivity of the portfolio.IV) it is a good predictor of interest rate changes. A. I and II B. I and III C. III and IV D. I, II, and III E. I, II, III, and IV

D. I, II, and III

55. Which of the following researchers have contributed significantly to bond portfolio management theory? I) Sidney HomerII) Harry MarkowitzIII) Burton MalkielIV) Martin LiebowitzV) Frederick Macaulay A. I and II B. III and V C. III, IV, and V D. I, III, IV, and V E. I, II, III, IV, and V

D. I, III, IV, and V

12. Given the time to maturity, the duration of a zero-coupon bond is higher when the discount rate is A. higher. B. lower. C. equal to the risk free rate. D. The bond's duration is independent of the discount rate. E. None of these is correct.

D. The bond's duration is independent of the discount rate.

27. Which one of the following statements is false concerning the duration of a perpetuity? A. The duration of 15% yield perpetuity that pays $100 annually is longer than that of a 15% yield perpetuity that pays $200 annually. B. The duration of a 15% yield perpetuity that pays $100 annually is shorter than that of a 15% yield perpetuity that pays $200 annually. C. The duration of a 15% yield perpetuity that pays $100 annually is equal to that of 15% yield perpetuity that pays $200 annually. D. The duration of 15% yield perpetuity that pays $100 annually is longer than that of a 15% yield perpetuity that pays $200 annually, and the duration of a 15% yield perpetuity that pays $100 annually is shorter than that of a 15% yield perpetuity that pays $200 annually. E. All of these are false.

D. The duration of 15% yield perpetuity that pays $100 annually is longer than that of a 15% yield perpetuity that pays $200 annually, and the duration of a 15% yield perpetuity that pays $100 annually is shorter than that of a 15% yield perpetuity that pays $200 annually.

33. Duration A. assesses the time element of bonds in terms of both coupon and term to maturity. B. allows structuring a portfolio to avoid interest-rate risk. C. is a direct comparison between bond issues with different levels of risk. D. assesses the time element of bonds in terms of both coupon and term to maturity and allows structuring a portfolio to avoid interest-rate risk. E. assesses the time element of bonds in terms of both coupon and term to maturity and is a direct comparison between bond issues with different levels of risk.

D. assesses the time element of bonds in terms of both coupon and term to maturity and allows structuring a portfolio to avoid interest-rate risk.

47. The curvature of the price-yield curve for a given bond is referred to as the bond's A. modified duration. B. immunization. C. sensitivity. D. convexity. E. tangency.

D. convexity.

3. Ceteris paribus, the duration of a bond is negatively correlated with the bond's A. time to maturity. B. coupon rate. C. yield to maturity. D. coupon rate and yield to maturity. E. None of these is correct.

D. coupon rate and yield to maturity.

10. The "modified duration" used by practitioners is equal to the Macaulay duration A. times the change in interest rate. B. times (one plus the bond's yield to maturity). C. divided by (one minus the bond's yield to maturity). D. divided by (one plus the bond's yield to maturity). E. None of these is correct.

D. divided by (one plus the bond's yield to maturity).

44. If a bond portfolio manager believes A. in market efficiency, he or she is likely to be a passive portfolio manager. B. that he or she can accurately predict interest rate changes, he or she is likely to be an active portfolio manager. C. that he or she can identify bond market anomalies, he or she is likely to be a passive portfolio manager. D. in market efficiency, he or she is likely to be a passive portfolio manager; and that he or she can accurately predict interest rate changes, he or she is likely to be an active portfolio manager. E. in market efficiency, he or she is likely to be a passive portfolio manager; that he or she can accurately predict interest rate changes, he or she is likely to be an active portfolio manager; and that he or she can identify bond market anomalies, he or she is likely to be a passive portfolio manager.

D. in market efficiency, he or she is likely to be a passive portfolio manager; and that he or she can accurately predict interest rate changes, he or she is likely to be an active portfolio manager.

28. The two components of interest-rate risk are A. price risk and default risk. B. reinvestment risk and systematic risk. C. call risk and price risk. D. price risk and reinvestment risk. E. None of these is correct.

D. price risk and reinvestment risk.

49. A substitution swap is an exchange of bonds undertaken to A. change the credit risk of a portfolio. B. extend the duration of a portfolio. C. reduce the duration of a portfolio. D. profit from apparent mispricing between two bonds. E. adjust for differences in the yield spread.

D. profit from apparent mispricing between two bonds.

7. Holding other factors constant, the interest-rate risk of a coupon bond is lower when the bond's: A. term-to-maturity is lower. B. coupon rate is higher. C. yield to maturity is lower. D. term-to-maturity is lower and coupon rate is higher. E. All of these are correct.

D. term-to-maturity is lower and coupon rate is higher.

56. According to the duration concept A. only coupon payments matter. B. only maturity value matters. C. the coupon payments made prior to maturity make the effective maturity of the bond greater than its actual time to maturity. D. the coupon payments made prior to maturity make the effective maturity of the bond less than its actual time to maturity. E. coupon rates don't matter.

D. the coupon payments made prior to maturity make the effective maturity of the bond less than its actual time to maturity.

46. Immunization through duration matching of assets and liabilities may be ineffective or inappropriate because A. conventional duration strategies assume a flat yield curve. B. duration matching can only immunize portfolios from parallel shifts in the yield curve. C. immunization only protects the nominal value of terminal liabilities and does not allow for inflation adjustment. D. conventional duration strategies assume a flat yield curve; and immunization only protects the nominal value of terminal liabilities and does not allow for inflation adjustment. E. All of these are correct.

E. All of these are correct.

8. Holding other factors constant, the interest-rate risk of a coupon bond is lower when the bond's: A. term-to-maturity is lower. B. coupon rate is higher. C. yield to maturity is higher. D. term-to-maturity is lower and coupon rate is higher. E. All of these are correct.

E. All of these are correct.

17. Which of the following is true? A. Holding other things constant, the duration of a bond decreases with time to maturity. B. Given time to maturity, the duration of a zero-coupon increases with yield to maturity. C. Given time to maturity and yield to maturity, the duration of a bond is higher when the coupon rate is lower. D. Duration is a better measure of price sensitivity to interest rate changes than is time to maturity. E. Given time to maturity and yield to maturity, the duration of a bond is higher when the coupon rate is lower, and duration is a better measure of price sensitivity to interest rate changes than is time to maturity.

E. Given time to maturity and yield to maturity, the duration of a bond is higher when the coupon rate is lower, and duration is a better measure of price sensitivity to interest rate changes than is time to maturity.

29. The duration of a coupon bond A. does not change after the bond is issued. B. can accurately predict the price change of the bond for any interest rate change. C. will decrease as the yield to maturity decreases. D. All of these are correct. E. None of these is correct.

E. None of these is correct.

59. Two bonds are selling at par value and each has 17 years to maturity. The first bond has a coupon rate of 6% and the second bond has a coupon rate of 13%. Which of the following is most false about the durations of these bonds? A. The duration of the higher-coupon bond will be higher. B. The duration of the lower-coupon bond will be higher. C. The duration of the higher-coupon bond will equal the duration of the lower-coupon bond. D. There is no consistent statement that can be made about the durations of the bonds. E. The duration of the higher-coupon bond will be higher and will equal the duration of the lower-coupon bond; and there is no consistent statement that can be made about the durations of the bonds

E. The duration of the higher-coupon bond will be higher and will equal the duration of the lower-coupon bond; and there is no consistent statement that can be made about the durations of the bonds

41. Which one of the following is a correct statement concerning duration? A. The higher the yield to maturity, the greater the duration B. The higher the coupon, the shorter the duration. C. The difference in duration can be large between two bonds with different coupons each maturing in more than 15 years. D. The duration is the same as term to maturity only in the case of zero-coupon bonds. E. The higher the coupon, the shorter the duration; the difference in duration can be large between two bonds with different coupons each maturing in more than 15 years; and the duration is the same as term to maturity only in the case of zero-coupon bonds

E. The higher the coupon, the shorter the duration; the difference in duration can be large between two bonds with different coupons each maturing in more than 15 years; and the duration is the same as term to maturity only in the case of zero-coupon bonds

43. Some of the problems with immunization are A. duration assumes that the yield curve is flat. B. duration assumes that if shifts in the yield curve occur, these shifts are parallel. C. immunization is valid for one interest rate change only. D. durations and horizon dates change by the same amounts with the passage of time. E. duration assumes that the yield curve is flat, duration assumes that if shifts in the yield curve occur, these shifts are parallel, and immunization is valid for one interest rate change only.

E. duration assumes that the yield curve is flat, duration assumes that if shifts in the yield curve occur, these shifts are parallel, and immunization is valid for one interest rate change only.

19. The basic purpose of immunization is to A. eliminate default risk. B. produce a zero net interest-rate risk. C. offset price and reinvestment risk. D. eliminate default risk and produce a zero net interest-rate risk. E. produce a zero net interest-rate risk and offset price and reinvestment risk.

E. produce a zero net interest-rate risk and offset price and reinvestment risk.