Investments: Chapter 15

Maturity: 1, 2, 3, 4 Price: $943.40, $881.68, $808.88, $742.09 20. What is, according to the expectations theory, the expected forward rate in the third year? A. 7.00% B. 7.33% C. 9.00% D. 11.19% E. None of these is correct.

=(881.68 / 808.88) -1 =9% C. 9.00%

Year: 0 , 1 , 2 , 3 Forward Interest Rate:5%, 7%, 9%, 10% 16. What is the price of 3-year zero coupon bond with a par value of $1,000? A. $863.83 B. $816.58 C. $772.18 D. $765.55 E. None of these is correct.

=1000 / (1.05)(1.07)(1.09) =$816.58 B. $816.58

Maturity: 1, 2, 3, 4 Price: $943.40, $881.68, $808.88, $742.09 21. What is the yield to maturity on a 3-year zero coupon bond? A. 6.37% B. 9.00% C. 7.33% D. 10.00% E. None of these is correct.

=[ (1000 / 808.81) ^ 1/3 ] - 1 =7.33% C. 7.33%

Year: 0 , 1 , 2 , 3 Forward Interest Rate:5%, 7%, 9%, 10 19. What is the yield to maturity of a 3-year zero coupon bond? A. 7.00% B. 9.00% C. 6.99% D. 7.49% E. None of these is correct.

=[(1.05)(1.07)(1.09)]^ 1/3 =6.99% C. 6.99%

Year: 0 , 1 , 2 , 3 Forward Interest Rate:5%, 7%, 9%, 10% 17. If you have just purchased a 4-year zero coupon bond, what would be the expected rate of return on your investment in the first year if the implied forward rates stay the same? (Par value of the bond = $1,000) A. 5% B. 7% C. 9% D. 10% E. None of these is correct.

A. 5%

36. 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

11. An inverted yield curve implies that: A. Long-term interest rates are lower than short-term interest rates. B. Long-term interest rates are higher than short-term interest rates. C. Long-term interest rates are the same as short-term interest rates. D. Intermediate term interest rates are higher than either short- or long-term interest rates. E. None of these is correct.

A. Long-term interest rates are lower than short-term interest rates.

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

A. arbitrage would probably occur.

8. Bond stripping and bond reconstitution offer opportunities for ______, which can occur if the _________ is violated. A. arbitrage; Law of One Price B. arbitrage; restrictive covenants C. huge losses; Law of One Price D. huge losses; restrictive covenants E. both arbitrage; restrictive covenants and huge losses; restrictive covenants

A. arbitrage; Law of One Price

3. The value of a Treasury bond should A. be equal to the sum of the value of STRIPS created from it. B. be less than the sum of the value of STRIPS created from it. C. be greater than the sum of the value of STRIPS created from it. D. be greater than or less than the sum of the value of STRIPS created from it E. None of these is correct.

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

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

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

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

A. normal.

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

A. on the run.

24. 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. the yield to maturity. D. the discount rate. E. None of these is correct.

A. the forward rate.

1. The term structure of interest rates is: A. The relationship between the rates of interest on all securities. B. The relationship between the interest rate on a security and its time to maturity. C. The relationship between the yield on a bond and its default rate. D. All of these are correct. E. None of these is correct.

B. The relationship between the interest rate on a security and its time to maturity.

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

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

10. 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. The relationship between the coupon rate on a bond and time to maturity of the bond. C. The relationship between yield on a bond and the time to maturity on the bond. D. All of these are correct. E. None of these is correct.

C. The relationship between yield on a bond and the time to maturity on the bond.

25. When computing yield to maturity, the implicit reinvestment assumption is that the interest payments are reinvested at the: A. Coupon rate. B. Current yield. C. Yield to maturity at the time of the investment. D. Prevailing yield to maturity at the time interest payments are received. E. The average yield to maturity throughout the investment period.

C. Yield to maturity at the time of the investment.

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

27. 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.

13. 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 decline in the future. C. interest rates are expected to increase in the future. D. interest rates are expected to decline first, then increase. E. interest rates are expected to increase first, then decrease.

C. interest rates are expected to increase in the future.

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

C. the index of leading economic indicators.

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

D. All of these are correct.

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

5. If the value of a Treasury bond was lower than the value of the sum of its parts (STRIPPED cash flows) you could A. profit by buying the stripped cash flows and reconstituting the bond. B. not profit by buying the stripped cash flows and reconstituting the bond. 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. None of these is correct.

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

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

D. not profit by buying the stripped cash flows and reconstituting the bond but profit by buying the bond and creating STRIPS

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

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

E. that slopes downward.

Year: 0 , 1 , 2 , 3 Forward Interest Rate:5%, 7%, 9%, 10% 18. What is the price of a 2-year maturity bond with a 10% coupon rate paid annually? (Par value = $1,000) A. $1,092 B. $1,054 C. $1,000 D. $1,073 E. None of these is correct.

n = 2 i = [[(1.05)(1.07)] ^ (1/2)] -1 = 6% PV = ? PMT = (1,000 * 0.10) = 100 FV = 1,000 PV = $1,073.34 D. $1,073

Maturity: 1, 2, 3, 4 Price: $943.40, $881.68, $808.88, $742.09 22. What is the price of a 4-year maturity bond with a 12% coupon rate paid annually? (Par value = $1,000) A. $742.09 B. $1,222.09 C. $1,000.00 D. $1,141.92 E. None of these is correct.

n = 4 i = (1000 / 742.09)^(1/4) -1 = 7.74% PV = ? PMT = 120 FV = 1000 PV = $1,141.92 D. $1,141.92