FINA 367 Multiple Choice Questions
For a mortgage pass-through security, which of the following risks most likely increases as interest rate declines? Contraction or extension
contraction
Immunization against liabilities is a set-and-forget strategy.
False
A corporate bond has a coupon rate of 5% (paid semi-annually), 10 years left to maturity, a face value of $1,000, and is trading at a YTM of 6%. In which range will you find this bond's Macaulay duration in years? (0,10) (10, infinity) (-infinity, 0)
(0,10)
Suppose we use the following spot rate curve to price a 2-year coupon-paying bond. 6-month: 1.5% 12-month: 2.2% 18-month: 2.5% 2-year: 2.7% In which range will you find this bond's YTM y?
1.5% < y < 2.7%
Which of the following statements about Macaulay duration is correct? -A bond's coupon rate is positively related to its Macaulay duration. --The Macaulay duration of a zero-coupon bond is less than its time-to-maturity. -A bond's Macaulay duration is inversely related to its yield-to-maturity
A bond's Macaulay duration is inversely related to its yield to maturity
You anticipate that the interest rates in the economy are about to fall significantly in the upcoming years, and you anticipate being able to pay off the mortgage before rates rise again. Which type of mortgage loan should you get when buying a house? Initial period fixed rate mortgage Fixed rate mortgage Adjustable rate mortgage
Adjustable rate mortgage
Empirical evidence suggests that historically, short-term T notes on average trade at higher yields relative to long term T-notes or T-bonds most of the time?
False
A measure that gives investors an indication of how long they can expect to hold the MBS before it is paid off is call the weighted average life, or WAL of the MBS. A mortgage pass-through security's WAL depends on the prepayment assumption. All else equal, how would an MBS's WAL under the prepayment assumption of 110 PSA compare to its WAL under the assumption of 165 PSA? WAL under 110 PSA > WAL under 165 PSA WAL under 110 PSA < WAL under 165 PSA WAL under 110 PSA = WAL under 165 PSA
WAL under 110 PSA > WAL under 165 PSA
A coupon-paying bond is trading below par. How does the bond's YTM compare to its current yield? YTM = current yield YTM < current yield YTM > current yield
YTM > current yield
A coupon-paying bond is trading below par. How does the bond's YTM compare to its current yield? YTM > current yield YTM = current yield YTM < current yield
YTM > current yield
All else equal, which of the following relations about bond values is true? Assume all bonds are based on the same underlying straight bond. callable = putable = straight callable = putable > straight Callable < straight < putable callable > straight > putable callable = putable < straight
callable < straight < putable
The price that the writer (seller) of a call option receives for the underlying asset when the option buyer exercises her option is called the spot price option premium option price strike price
strike price
Given two otherwise identical pools of mortgage contracts, contracts in pool A are expected to experience a higher prepayment rate relative to those in pool B. In an economic environment where interest rates are anticipated to rise, how does the value of the pass-through security A compare to that of B? Interest rate movement does not impact mortgage pass-through securities, so A = B A > B B> A
A > B
Under the liquidity premium theory, if the market is expecting the 6-month rate 6 months from now to remain the same as the current 6-month spot rate, then how does the current 1-year spot rate compare to the current 6-month spot rate? 12 month spot rate > 6 month spot rate 12 month spot rate < 6 month spot rate 12 month spot rate = 6 month spot rate
12 month spot rate > 6 month spot rate
As a winner of a local competition, you can choose one of the following prizes. If the annual interest rate is 12%, which prize is most valuable? 18,000 per year starting next year for 10 years 100,000 now 15,000 now and 15000 per year starting next year for 10 years 170000 at the end of 4 years
170000 at the end of 4 years
Which of the following statements about Macaulay duration is correct? -the Macaulay duration of a zero coupon bond is less than its yield to maturity -The Macaulay duration decreases with maturity -a bond's Macaulay duration is positively related to its coupon rate -a bond's Macaulay duration is inversely related to its yield to maturity -non of the others are correct
A bond's Macaulay duration is inversely related to its yield-to-maturity
An investor with a 10-year investment horizon put together a bond portfolio with a duration of 6 in years. Is this investor at risk of higher interest rate, lower interest rate, or perfectly hedged against interest rate risk? At risk of lower interest rate Perfectly hedged At risk of higher interest rate
At risk of lower interest rate
Bond A, B, and C share the same maturity date, coupon rate, and face value. Assume they all have high durations. Bond A is a straight bond; B is callable on date X in the future; C is putable on date X in the future. Which bond would most likely protect investors against a significant increase in interest rate? A B C
C
All else equal, bonds of which one of the following ratings typically trade at the highest credit spread? Ratings are on S&P's schedule. A- BB- BBB- CCC
CCC
All else equal, which of the following relation is true? Assume all bonds are based on the same underlying straight bond. If it does not say that a bond is callable or convertible, then assume that it is not. For example "callable" means a regular coupon-paying bond that is callable, but not convertible. Callable < straight < convertible Convertible < callable < convertible Straight < callable < convertible Callable < convertible < straight
Callable < straight < convertible
A company releases outstanding earnings numbers and raises guidance for the next fiscal year, and the stock price as a result jumps up 20%, then it is optimal to convert a convertible bond on this company into stocks right away. Assume that the stock pays no dividend.
False
In the case of a putable bond, it is up to the bond issuer whether the put option is exercised.
False
Investors prefer to receive payments early, so prepayment is viewed universally as a benefit to mortgage and MBS investors. True
False
It is to a bond issuer's benefit when an embedded put option on the bond is exercised.
False
True or false: Using Macaulay duration to approximate a bond price change when interest rate goes from 3% to 3.5% will produce results that are just as accurate as in the case when interest rate goes from 3% to 5.4%.
False
When buying a bond in between coupon payment dates, an investor pays the clean or (the quoted price)
False
Yield to maturity is the discount rate that equates the sum of the present values of a bond's future cash flows with its par value
False
Suppose an investor buys a bond with a settlement date in between coupon payment dates. Which price does the investor pay? Clean price or full price
Full price
Which term structure theory asserts that investors cannot be induced to hold debt securities whose maturities do to match their investment horizon? Expectations Theory Market Segmentation theory Liquidity theory preferred habitat theory
Market segmentation theory
You have a one-year investment horizon with $1,000,000 in hand, and are presented with two fixed-income investment options. Which one provides a higher return? Assume your goal is to maximize returns. 1. Lend at 10% for a year 2. Lend at 8% for the first 6 months, and then lend at 12% for the second 6 months All rates are expressed as bond-equivalent-yields, compounded semi annually. Option 1 provides a higher return Option 2 provides a higher return Cannot decide
Option 1 provides a higher return
All else equal, how does the price of a putable bond compare to the price of the underlying straight bond? Putable = straight putable > straight putable < striaght
Putable > straight
Assume annual compounding. Given only spot rates for one-, two-, and three-year zero coupon bonds, which of the following interest rates cannot be computed? The rate on two-year loan that begins at the end of Year 1 The rate on a one-year loan that starts at the end of Year 2 The rate on a two-year loan that begins at the end of Year 2 The rate on a one-year loan that begins at the end of Year 1
The rate on a two-year loan that begins at the end of Year 2
A residential mortgage is a secured loan where the house being purchased serves as the collateral.
True
In an efficient capital market, the price of a convertible cannot fall bellow the value of a comparable straight bond. Assume no credit risk.
True
In the case of a callable bond, it is up to the issuer whether the bond is called back at pre-specified dates.
True
Spot rate (of a certain horizon) is the YTM of a zero-coupon Treasury security (of the same maturity)
True
An investor with a 10-year investment horizon puts together a bond portfolio with a duration of 6 in years. Is this investor at risk of higher interest rate, lower interest rate, or perfectly hedged against interest rate risk? Perfectly hedged At risk of lower interest rate At risk of higher interest rate
at risk of lower interest rate
In the context of MBS, a conditional prepayment rate of 8% means that approximately 8% of an outstanding mortgage pool balance at the beginning of the year will be prepaid ______. Over the lifetime of the mortgages by the end of the year in the current month
by the end of the year
If forward rates implied under the no-arbitrage condition are lower than spot rates of matching maturities, then the spot rate curve is most likely downward sloping flat upward sloping
downward sloping
Which of the following credit risk measures is forward-looking? Altman's z-score debt to equity ratio expected default frequency
expected default frequency
Under liquidity theory of term structure of interest rates, an observed upward-sloping yield curve inevitably means that market is expecting future interest rates to increase
false
When the spot rate curve is upward sloping, the forward rate: is above the spot rate of the same maturity coincides with the spot rate of the same maturity is below the spot rate of the same maturity
is above the spot rate of the same maturity
The price that the buyer of a call option pays to acquire the option is called the exercise price execution price forward price strike price option premium
option premium
An investor who anticipates interest rates to fall significantly should invest in which tranche of a stripped CMO? interest only or principal only
principal only
Which of the following sources of return is most likely exposed to interest rate risk for an investor of a coupon-paying bond who holds the bond to maturity? Assume no credit risk. capital gain or loss reinvestment of coupon payments redemption of principal
reinvestment of coupon payments
Empirical evidence shows that forward rates derived from a spot rate curve are downward biased predictors of future spot rates unbiased predictors of future spot rates upward-biased predictors of future spot rates
upward-biased predictors of future spot rates
How does the value of a convertible bond relate to the value of the underlying straight bond? -Value of convertible = value of straight - value of call option on bond issuer's stock -value of convertible = value of straight - value of put option on bond issuer's stock -value of convertible = value of straight + value of call option on bond issuer's stock -value of convertible = value of straight + value of put option on bond issuer's stock
value of convertible = value of straight + value of call option on bond issuer's stock
All else equal, the interest rate risk of a coupon-paying bond is higher when the bond's coupon rate is higher time to maturity is lower yield to maturity is lower none of the others
yield to maturity is lower