Investments: Chapter 15

The "break-even" interest rate for year 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) None of the options are correct. D) the yield to maturity. E) the discount rate.

A) the forward rate.

The yield curve is a component of A) the index of leading economic indicators. B) the producer price index. C) the Dow Jones Industrial Average. D) the consumer price index. E) the inflation index.

A) the index of leading economic indicators.

Investors can use publicly available financial data to determine which of the following? I) The shape of the yield curve II) Expected future short-term rates (if liquidity premiums are ignored) III) The direction the Dow indexes are heading IV) The actions to be taken by the Federal Reserve A) I and II B) I and III C) I, II, and III D) I, III, and IV E) I, II, III, and IV

A) I and II I) The shape of the yield curve II) Expected future short-term rates (if liquidity premiums are ignored)

_____________________ are created from coupon paying treasuries, where the coupon and principal are separated. A) Stripped treasuries B) None of the options are correct. C) A yield curve D) Futures contracts E) Forward rates

A) Stripped treasuries

Which of the following are possible explanations for the term structure of interest rates? A) The expectations theory and the liquidity preference theory B) The liquidity preference theory C) Modern portfolio theory D) The expectations theory

A) The expectations theory and the liquidity preference theory

Bond stripping and bond reconstitution offer opportunities for ______, which can occur if the _________ is violated. A) arbitrage; law of one price B) huge losses; restrictive covenants C) huge losses; law of one price D) arbitrage; restrictive covenants

A) arbitrage; law of one price

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) All of the options are correct. C) yields on long- and short-maturity bonds are determined by the supply and demand for the securities. D) forward rates exceed the expected future interest rates. E) None of the options are correct.

A) forward rates are determined by investors' expectations of future interest rates.

When computing yield to maturity, the implicit reinvestment assumption is that the interest payments are reinvested at the A) yield to maturity at the time of the investment. B) the average yield to maturity throughout the investment period. C) prevailing yield to maturity at the time interest payments are received. D) current yield. E) coupon rate.

A) yield to maturity at the time of the investment.

______ can occur if _____. A) Arbitrage; the law of one price is violated B) Arbitrage and low-risk economic profit; the law of one price is violated C) Low-risk economic profit; the law of one price is not violated D) Arbitrage; the law of one price is not violated E) Low-risk economic profit; the law of one price is violated

B) Arbitrage and low-risk economic profit; the law of one price is violated

According to the expectations hypothesis, an upward-sloping yield curve implies that A) interest rates are expected to remain stable in the future. B) interest rates are expected to increase in the future. C) interest rates are expected to decline in the future. D) interest rates are expected to increase first, then decrease. E) interest rates are expected to decline first, then increase.

B) interest rates are expected to increase in the future.

The yield curve A) is usually depicted for corporate bonds of different ratings. B) is a graphical depiction of term structure of interest rates and is usually depicted for U.S. Treasuries in order to hold risk constant across maturities and yields. C) is a graphical depiction of term structure of interest rates and is usually depicted for corporate bonds of different ratings. D) is a graphical depiction of term structure of interest rates. E) is usually depicted for U.S. Treasuries in order to hold risk constant across maturities and yields.

B) is a graphical depiction of term structure of interest rates and is usually depicted for U.S. Treasuries in order to hold risk constant across maturities and yields.

An inverted yield curve is one A) with a hump in the middle. B) that slopes downward. C) constructed by using convertible bonds. D) that is relatively flat. E) that plots the inverse relationship between bond prices and bond yields.

B) that slopes downward.

If the value of a Treasury bond was higher than the value of the sum of its parts (STRIPPED cash flows), A) None of the options are correct. B) arbitrage would probably not occur. C) arbitrage would probably occur. D) the FED would adjust interest rates.

C) arbitrage would probably occur.

The value of a Treasury bond should A) All of the options are correct. B) be less than the sum of the value of STRIPS created from it. C) be equal to the sum of the value of STRIPS created from it. D) be greater than the sum of the value of STRIPS created from it.

C) be equal to the sum of the value of STRIPS created from it.

Treasury STRIPS are A) securities issued by the Treasury with very long maturities. B) created by pooling mortgage payments made to the Treasury. C) created by selling each coupon or principal payment from a whole Treasury bond as a separate cash flow. D) extremely risky securities.

C) created by selling each coupon or principal payment from a whole Treasury bond as a separate cash flow.

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

C) differ from; they are imperfect forecasts

An inverted yield curve implies that A) long-term interest rates are higher than short-term interest rates. B) long-term interest rates are the same as short-term interest rates. C) long-term interest rates are lower than short-term interest rates. D) intermediate-term interest rates are higher than either short- or long-term interest rates. E) None of the options are correct.

C) long-term interest rates are lower than short-term interest rates.

An upward sloping yield curve is a(n) _______ yield curve. A) inverted B) None of the options are correct. C) normal D) humped E) flat

C) normal

The ___________ yield curve is created from stripped treasuries. A) forward B) basic C) pure D) None of the options are correct. E) inverted

C) pure

An upward-sloping yield curve A) may be an indication that interest rates are expected to increase. B) None of the options are correct. C) may incorporate a liquidity premium. D) All of the options are correct. E) may reflect the confounding of the liquidity premium with interest rate expectations.

D) All of the options are correct.

What theory believes forward rates equals the market consensus of what the future short interest rate will be? A) Forward rate theory B) Market segmentation theory C) Short rate theory D) Expectations theory E) Liquidity preference theory

D) Expectations theory

What theory believes short-term investors dominate the market so that the forward rate will generally exceed the expected short rate? A) Expectations theory B) Forward rate theory C) Market segmentation theory D) Liquidity preference theory E) Short rate theory

D) Liquidity preference theory

The on the run yield curve is A) a plot of yield as a function of maturity for corporate bonds with different risk ratings. B) a plot of liquidity premiums for different maturities. C) a plot of yield as a function of maturity for zero-coupon bonds. D) a plot of yield as a function of maturity for recently-issued coupon bonds trading at or near par.

D) a plot of yield as a function of maturity for recently-issued coupon bonds trading at or near par.

If the value of a Treasury bond was lower than the value of the sum of its parts (STRIPPED cash flows), A) the FED would adjust interest rates. B) None of the options are correct. C) arbitrage would probably not occur. D) arbitrage would probably occur.

D) arbitrage would probably occur.

The pure yield curve can be estimated A) by using corporate bonds with different risk ratings. B) by using stripped Treasuries if each coupon is treated as a separate "zero." C) by estimating liquidity premiums for different maturities. D) by using zero-coupon Treasuries and by using stripped Treasuries if each coupon is treated as a separate "zero." E) by using zero-coupon Treasuries.

D) by using zero-coupon Treasuries and by using stripped Treasuries if each coupon is treated as a separate "zero."

The most recently issued Treasury securities are called A) off the market. B) on the market. C) off the run. D) on the run. E) None of the options are correct.

D) on the run.

Structure of interest rates is A) All of the options are correct. B) the relationship between the rates of interest on all securities. C) the relationship between the yield on a bond and its default rate. D) the relationship between the interest rate on a security and its time to maturity. E) None of the options are correct.

D) the relationship between the interest rate on a security and its time to maturity.

The graphic representation of the term structure of interest rates is the _______________. A) expectations table B) volatility index C) forward rate D) yield curve E) None of the options are correct.

D) yield curve

Which of the following combinations will result in a sharply-increasing yield curve? A) Constant future expected short rates and increasing liquidity premiums B) Decreasing future expected short rates and increasing liquidity premiums C) Increasing future expected short rates and constant liquidity premiums D) Increasing future expected short rates and decreasing liquidity premiums E) Increasing future expected short rates and increasing liquidity premiums

E) Increasing future expected short rates and increasing liquidity premiums

If the value of a Treasury bond was lower than the value of the sum of its parts (STRIPPED cash flows), you could A) not profit by buying the stripped cash flows and reconstituting the bond. B) None of the options are correct. C) profit by buying the stripped cash flows and reconstituting the bond. D) profit by buying the bond and creating STRIPS. E) not profit by buying the stripped cash flows and reconstituting the bond and profit by buying the bond and creating STRIPS.

E) not profit by buying the stripped cash flows and reconstituting the bond and profit by buying the bond and creating STRIPS.

If the value of a Treasury bond was higher than the value of the sum of its parts (STRIPPED cash flows), you could A) not profit by buying the stripped cash flows and reconstituting the bond. B) None of the options are correct. C) profit by buying the bond and creating STRIPS. D) not profit by buying the stripped cash flows and reconstituting the bond and profit by buying the bond and creating STRIPS. E) profit by buying the stripped cash flows and reconstituting the bond.

E) profit by buying the stripped cash flows and reconstituting the bond.

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) None of the options are correct. C) All of the options are correct. D) the relationship between the coupon rate on a bond and time to maturity of the bond. E) the relationship between yield on a bond and the time to maturity on the bond.

E) the relationship between yield on a bond and the time to maturity on the bond.