Solved MCQs Term Structure Of Interest Rate
1. Investors can use publicly available financial date to determine which of the following?
I) the shape of the yield curve
II) future short-term rates
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
 |
| http://groups.google.com/group/vuZs |
| Visit this group |
Rationale: Only the shape of the yield curve and future inferred rates can be determined. The movement of the Dow Indexes and Federal Reserve policy are influenced by term structure but are determined by many other variables also.
2. Which of the following is a reason that bond prices do not conform exactly to the present value of the bond's cash flows?
I) A call feature affects the bond's price.
II) After-tax cash flows may be different for different investors.
III) The IRS may impute a "built-in" interest payment.
IV) Some investors might choose to sell the bond before its maturity date.
A) I and II
B) I, II, and III
C) I and IV
D) I, II, and IV
E) I, II, III and IV
Rationale: All of the items listed can affect the actual cash flows. It is not possible to know for sure whether a bond will be called, so cash flows after the call date may or may not be relevant. Investors have different tax brackets and situations and will therefore have different after-tax cash flows. Imputed interest income will apply to zero-coupon or OID bonds. And investors may choose different holding periods, for example, they may evaluate tax-timing options and make decisions based on tax consequences.
3. A liquidity premium
A) compensates long-term investors for the uncertainty about future selling prices.
B) compensates short-term investors for the uncertainty about future selling prices.
C) compensates long-term investors for the lack of liquidity in bond markets.
D) compensates short-term investors for the lack of liquidity in bond markets.
E) is almost never observed in the markets.
4. The Liquidity Preference Theory states that
A) stocks are preferred to bonds because they are generally more liquid.
B) treasury Bonds are preferred to corporate bonds because they are more liquid.
C) the liquidity premium is expected to be positive because short-term investors dominate the market.
D) bonds of large corporations are preferred because they have the highest liquidity.
E) liquidity premiums can be measured precisely.
Rationale: Short-term investors are not willing to hold long-term bonds unless they are compensated with a positive liquidity premium. The normal upward-sloping yield curve implies that f2 - E(r2), the liquidity premium, is expected to be positive.
5. Which of the following combinations will result in a sharply increasing yield curve?
A) increasing expected short rates and increasing liquidity premiums
B) decreasing expected short rates and increasing liquidity premiums
C) increasing expected short rates and decreasing liquidity premiums
D) increasing expected short rates and constant liquidity premiums
E) constant expected short rates and increasing liquidity premiums
Rationale: Both of the forces will act to increase the slope of the yield curve.
6. 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.
Rationale: Since the yield curve is often used to forecast the business cycle, it is used as one of the leading economic indicators.
7. 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 the above.
Use the following to answer questions 8-11:
Suppose that all investors expect that interest rates for the 4 years will be as follows:
| Year | Forward Interest Rate |
| 0 | (today)3% |
| 1 | 4% |
| 2 | 5% |
| 3 | 6% |
8. What is the price of 3-year zero coupon bond with a par value of $1,000?
A) $889.08
B) $816.58
C) $772.18
D) $765.55
E) none of the above
Rationale: $1,000 / (1.03)(1.04)(1.05) = $889.08
9. 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) 3%
C) 9%
D) 10%
E) none of the above
Rationale: The forward interest rate given for the first year of the investment is given as 3% (see table above).
10. What is the price of a 2-year maturity bond with a 5% coupon rate paid annually? (Par value = $1,000)
A) $1,092.97
B) $1,054.24
C) $1,028.51
D) $1,073.34
E) none of the above
Rationale: [(1.03)(1.04)]1/2 - 1 = 3.5%; FV = 1000, n = 2, PMT = 50, i = 3.5, PV = $1,028.51
for more contents visit
11. What is the yield to maturity of a 3-year zero coupon bond?
A) 7.00%
B) 9.00%
C) 6.99%
D) 4%
E) none of the above
Rationale: [(1.03)(1.04)(1.05)]1/3 - 1 = 4%.
Use the following to answer questions 12-15:
The following is a list of prices for zero coupon bonds with different maturities and par value of $1,000.
| Maturity (Years) | Price |
| 1 | $925.16 |
| 2 | $862.57 |
| 3 | $788.66 |
| 4 | $711.00 |
12. What is, according to the expectations theory, the expected forward rate in the third year?
A) 7.23
B) 9.37%
C) 9.00%
D) 10.9%
E) none of the above
Rationale: 862.57 / 788.66 - 1 = 9.37%
13. What is the yield to maturity on a 3-year zero coupon bond?
A) 6.37%
B) 9.00%
C) 7.33%
D) 8.24%
E) none of the above
Rationale: (1000 / 788.66)1/3 -1 = 8.24%
14. What is the price of a 4-year maturity bond with a 10% coupon rate paid annually? (Par value = $1,000)
A) $742.09
B) $1,222.09
C) $1,035.66
D) $1,141.84
E) none of the above
Rationale: (1000 / 711.00)1/4 -1 = 8.9%; FV = 1000, PMT = 100, n = 4, i = 8.9, PV = $1,035.66
15. You have purchased a 4-year maturity bond with a 9% coupon rate paid annually. The bond has a par value of $1,000. What would the price of the bond be one year from now if the implied forward rates stay the same?
A) $995.63
B) $1,108.88
C) $1,000
D) $1,042.78
E) none of the above
Rationale: (925.16 / 711.00)]1/3 - 1.0 = 9.17%; FV = 1000, PMT = 90, n = 3, i = 9.17, PV = $995.63
16. Given the following pattern of forward rates:
| Year | Forward Rate |
| 1 | 4% |
| 2 | 5% |
| 3 | 5.5% |
If one year from now the term structure of interest rates changes so that it looks exactly the same as it does today, what would be your holding period return if you purchased a 3-year zero coupon bond today and held it for one year?
A) 6%
B) 4%
C) 3%
D) 6%
E) none of the above
Rationale: $1,000 / (1.05)(1.055) = $902.73 (selling price); $1,000 / (1.04)(1.05)(1.055) = $868.01 (purchase price); ($902.73 - $868.01) / $868.01 = 4%.
17.
| Par Value | $1,000 |
| Time to Maturity | 18 years |
| Coupon | 9% (paid annually) |
| Current Price | $917.99 |
| Yield to Maturity | 10% |
Given the bond described above, if interest were paid semi-annually (rather than annually), and the bond continued to be priced at $917.99, the resulting effective annual yield to maturity would be:
A) Less than 10%
B) More than 10%
C) 10%
D) Cannot be determined
E) None of the above
Rationale: FV = 1000, PV = -917.99, PMT = 45, n = 36, i = 4.995325 (semi-annual); (1.4995325)2 - 1 = 10.24%.
Use the following to answer questions 18-20:
| Year | 1-Year Forward Rate |
| 1 | 5% |
| 2 | 5.5% |
| 3 | 6.0% |
| 4 | 6.5% |
| 5 | 7.0% |
18. What should the purchase price of a 2-year zero coupon bond be if it is purchased at the beginning of year 2 and has face value of $1,000?
A) $877.54
B) $888.33
C) $883.32
D) $894.21
E) $871.80
Rationale: $1,000 / [(1.055)(1.06)] = $894.21
19. What would the yield to maturity be on a four-year zero coupon bond purchased today?
A) 5.75%
B) 6.30%
C) 5.65%
D) 5.25%
E) none of the above.
Rationale: [(1.05) (1.055) (1.06) (1.065)]1/4 - 1 = 5.75%
20. Calculate the price at the beginning of year 1 of an 8% annual coupon bond with face value $1,000 and 5 years to maturity.
A) $1,105.47
B) $1,131.91
C) $1084.25
D) $1,150.01
E) $719.75
Rationale: i = [(1.05) (1.055) (1.06) (1.065) (1.07)]1/5 - 1 = 6%; FV = 1000, PMT = 80, n = 5, i = 6, PV = $1084.25
21. Given the yield on a 3 year zero-coupon bond is 7% and forward rates of 6% in year 1 and 6.5% in year 2, what must be the forward rate in year 3?
A) 7.2%
B) 8.6%
C) 8.5%
D) 6.9%
E) none of the above.
Rationale: f3 = (1.07)3 / [(1.06) (1.065)] - 1 = 8.5%
for more contents visit
--
Regards
Umeed
MBA 3rd Sem
