Question 1

Prior to the credit crisis that started in 2007 which of the following was the proxy used by derivatives traders for the risk-free rate?&#10;A)The Treasury rate&#10;B)The LIBOR rate&#10;C)The repo rate&#10;D)The overnight indexed swap rate

Accepted Answer

Prior to the credit crisis, the proxy used by derivatives traders for the risk-free rate was the LIBOR rate, which is the average rate at which a select group of banks can secure short-term loans from other banks. This was considered a reliable proxy for the risk-free rate as it represented the rate at which banks were willing to lend to each other, and therefore reflected the credit risk in the market. However, the credit crisis exposed weaknesses in the LIBOR rate and highlighted the need for a more robust benchmark, leading to the development of alternative rates such as the overnight indexed swap rate.

Question 2

The compounding frequency for an interest rate defines&#10;A)The frequency with which interest is paid&#10;B)A unit of measurement for the interest rate&#10;C)The relationship between the annual interest rate and the monthly interest rate&#10;D)None of the above

Accepted Answer

The compounding frequency is a unit of measurement.The frequency with which interest is paid may be different from the compounding frequency used for quoting the rate.

Question 3

An interest rate is 5% per annum with continuous compounding.What is the equivalent rate with semiannual compounding?&#10;A)5)06%&#10;B)5)03%&#10;C)4)97%&#10;D)4)94%

Accepted Answer

The equivalent rate with semiannual compounding is 2×(e^0.05/2−1)= 0.0506 or 5.06%.

Question 4

At what interest rate does a government borrow in its own currency?&#10;A)Treasury rate&#10;B)LIBOR&#10;C)LIBID&#10;D)Repo rate

Accepted Answer

Governments typically borrow in their own currency through the issuance of government bonds, which are sold to investors. The interest rate paid on these bonds is known as the Treasury rate, and it reflects the cost of borrowing for the government. The Treasury rate is set based on market demand for the bonds and is influenced by factors such as inflation expectations, economic growth, and global interest rates. Therefore, the best choice is A) Treasury rate.

Question 5

Which of the following is true?&#10;A)When interest rates in the economy increase.all bond prices increase&#10;B)As its coupon increases.a bond's price decreases&#10;C)Longer maturity bonds are always worth more that shorter maturity bonds when the coupon rates are the same&#10;D)None of the above

Accepted Answer

None of the statements are true. When interest rates increase, bond prices decrease; as the coupon rate increases, the bond price increases; and the value of longer maturity bonds is influenced by multiple factors including interest rates and credit risk.

Question 6

Under liquidity preference theory,which of the following is always true?&#10;A)The forward rate is higher than the spot rate when both have the same maturity&#10;B)Forward rates are unbiased predictors of expected future spot rates&#10;C)The spot rate for a certain maturity is higher than the par yield for that maturity&#10;D)Forward rates are higher than expected future spot rates

Accepted Answer

Liquidity preference theory argues that individuals like their borrowings to have a long maturity and their deposits to have a short maturity.To induce people to lend for long periods forward rates are raised relative to what expected future short rates would predict.

Question 7

The six month and one-year rates are 3% and 4% per annum with semiannual compounding.Which of the following is closest to the one-year par yield expressed with semiannual compounding?&#10;A)3)99%&#10;B)3)98%&#10;C)3)97%&#10;D)3)96%

Accepted Answer

The six month rate is 1.5% per six months.The one year rate is 2% per six months.The one year par yield is the coupon that leads to a bond being worth par.A is the correct answer because (3.99/2)/1.015+(100+3.99/2)/1.02² = 100.The formula in the text can also be used to give the par yield as [(100-100/1.02²)×2]/(1/1.015+1.02²)=3.99.

Question 8

The six-month zero rate is 8% per annum with semiannual compounding.The price of a one-year bond that provides a coupon of 6% per annum semiannually is 97.What is the one-year continuously compounded zero rate?

A)8)02%
B)8)52%
C)9)02%
D)9)52%

Accepted Answer

The answer of The six-month zero rate is 8% per...

Question 9

Bootstrapping involves&#10;A)Calculating the yield on a bond&#10;B)Working from short maturity instruments to longer maturity instruments determining zero rates at each step&#10;C)Working from long maturity instruments to shorter maturity instruments determining zero rates at each step&#10;D)The calculation of par yields

Accepted Answer

Bootstrapping is the process of determining zero rates for different maturities by using prices of various zero-coupon bonds with different maturities. The process starts with short-maturity instruments and moves towards longer-maturity instruments. Therefore, Option B is the correct answer. The other options are not related to bootstrapping.

Question 10

Which of the following is true of LIBOR?&#10;A)The LIBOR rate is free of credit risk&#10;B)A LIBOR rate is lower than the Treasury rate when the two have the same maturity&#10;C)It is a rate used when borrowing and lending takes place between banks&#10;D)It is subject to favorable tax treatment in the U.S.

Accepted Answer

LIBOR stands for London Interbank Offered Rate and is a benchmark interest rate used in interbank lending for short-term loans. It represents the average interest rate that major banks in London charge each other for borrowing money. It is not free of credit risk, as it is based on the perceived creditworthiness of the banks involved. A LIBOR rate is typically higher than the Treasury rate when the two have the same maturity, so B is incorrect. There is no evidence to suggest that LIBOR is subject to favorable tax treatment in the U.S., so D is also incorrect.

Question 11

The two-year zero rate is 6% and the three year zero rate is 6.5%.What is the forward rate for the third year? All rates are continuously compounded.&#10;A)6)75%&#10;B)7)0%&#10;C)7)25%&#10;D)7)5%

Accepted Answer

The answer of The two-year zero rate is 6% and...

Question 12

An interest rate is 6% per annum with annual compounding.What is the equivalent rate with continuous compounding?&#10;A)5)79%&#10;B)6)21%&#10;C)5)83%&#10;D)6)18%

Accepted Answer

The answer of An interest rate is 6% per annum...

Question 13

The zero curve is downward sloping.Define X as the 1-year par yield,Y as the 1-year zero rate and Z as the forward rate for the period between 1 and 1.5 year.Which of the following is true?&#10;A)X is less than Y which is less than Z&#10;B)Y is less than X which is less than Z&#10;C)X is less than Z which is less than Y&#10;D)Z is less than Y which is less than X

Accepted Answer

The answer of The zero curve is downward sloping.Define X...

Question 14

Since the credit crisis that started in 2007 which of the following have derivatives traders started to use as the risk-free rate for some transactions?&#10;A)The Treasury rate&#10;B)The LIBOR rate&#10;C)The repo rate&#10;D)The overnight indexed swap rate

Accepted Answer

The answer of Since the credit crisis that started in...

Question 15

The zero curve is upward sloping.Define X as the 1-year par yield,Y as the 1-year zero rate and Z as the forward rate for the period between 1 and 1.5 year.Which of the following is true?&#10;A)X is less than Y which is less than Z&#10;B)Y is less than X which is less than Z&#10;C)X is less than Z which is less than Y&#10;D)Z is less than Y which is less than X

Accepted Answer

The answer of The zero curve is upward sloping.Define X...

Question 16

Given a choice between 5-year and 1-year instruments most people would choose 5-year instruments when borrowing and 1-year instruments when lending.Which of the following is a theory consistent with this observation?

A)Expectations theory
B)Market segmentation theory
C)Liquidity preference theory
D)Maturity preference theory

Accepted Answer

The answer of Given a choice between 5-year and 1-year...

Question 17

The yield curve is flat at 6% per annum.What is the value of an FRA where the holder receives interest at the rate of 8% per annum for a six-month period on a principal of $1,000 starting in two years? All rates are compounded semiannually.

A)$9.12
B)$9.02
C)$8.88
D)$8.63

Accepted Answer

The answer of The yield curve is flat at 6%...

Question 18

A repo rate is&#10;A)An uncollateralized rate&#10;B)A rate where the credit risk is relatively high&#10;C)The rate implicit in a transaction where securities are sold and bought back at a higher price&#10;D)None of the above

Accepted Answer

The answer of A repo rate is&#10;A)An uncollateralized rate&#10;B)A rate...

Question 19

An interest rate is 12% per annum with semiannual compounding.What is the equivalent rate with quarterly compounding?&#10;A)11.83%&#10;B)11.66%&#10;C)11.77%&#10;D)11.92%

Accepted Answer

The answer of An interest rate is 12% per annum...

Question 20

Which of following describes forward rates?&#10;A)Interest rates implied by current zero rates for future periods of time&#10;B)Interest rate earned on an investment that starts today and last for n-years in the future without coupons&#10;C)The coupon rate that causes a bond price to equal its par (or principal)value&#10;D)A single discount rate that gives the value of a bond equal to its market price when applied to all cash flows

Accepted Answer

The answer of Which of following describes forward rates?&#10;A)Interest rates...

Deck 4: Interest Rates