Question 1

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 the options are correct.
E) None of the options are correct.

Accepted Answer

The forward rate equals the market consensus expectation of future short interest rates.

Question 2

Suppose that all investors expect that interest rates for the 4 years will be as follows: $\begin{array}{lr}
& \text { Forward } \
\text { Year } & \text { Interest Rate } \
\hline 0 & \text { (today) } 6 \% \
1 & 7 \% \
2 & 9 \% \
3 & 10 \%
\end{array}$ 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 the options are correct.

Accepted Answer

D

Question 3

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

Accepted Answer

The upward sloping yield curve is referred to as the normal yield curve, probably because, historically, the upward sloping yield curve is the shape that has been observed most frequently.

Question 4

Suppose that all investors expect that interest rates for the 4 years will be as follows: $\begin{array}{lr}
& \text { Forward } \
\text { Year } & \text { Interest Rate } \
\hline 0 & \text { (today) } 6 \% \
1 & 7 \% \
2 & 9 \% \
3 & 10 \%
\end{array}$ What is the price of a 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 the options are correct.

Accepted Answer

The answer of Suppose that all investors expect that interest...

Question 5

If the value of a Treasury bond was higher 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) None of the options are correct.

Accepted Answer

If the value of a Treasury bond was higher than the value of the sum of its parts (STRIPPED cash flows) arbitrage would probably occur.

Question 6

The following is a list of prices for zero-coupon bonds with different maturities and par values of $1,000. $\begin{array}{cc}
\text { Maturity }\
\text { (Years) } & \text { Price } \
1 & \$ 943.40 \
2 & 881.68 \
3 & 808.88 \
4 & 742.09
\end{array}$ According to the expectations theory, what is the expected forward rate in the third year?
A) 7.00%
B) 7.33%
C) 9.00%
D) 11.19%
E) None of the options are correct.

Accepted Answer

The answer of The following is a list of prices...

Question 7

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 the options are correct.
E) None of the options are correct.

Accepted Answer

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

Question 8

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.

Accepted Answer

An upward sloping yield curve is based on the expectation that short-term interest rates will increase.

Question 9

Suppose that all investors expect that interest rates for the 4 years will be as follows: $\begin{array}{lr}
& \text { Forward } \
\text { Year } & \text { Interest Rate } \
\hline 0 & \text { (today) } 6 \% \
1 & 7 \% \
2 & 9 \% \
3 & 10 \%
\end{array}$ What is the yield to maturity of a 3-year zero-coupon bond?
A) 7.03%
B) 9.00%
C) 6.99%
D) 7.49%
E) None of the options are correct.

Accepted Answer

The yield to maturity of a zero-coupon bond is the annual rate of return that equates the present value of the bond's future cash flows to its current price. In this case, the bond has a face value of $1,000 and will mature in 3 years. The present value of the bond's future cash flows is:$$PV = \frac{1000}{(1 + 0.06)^1} + \frac{1000}{(1 + 0.07)^2} + \frac{1000}{(1 + 0.09)^3}$$$$PV = 943.39 + 884.96 + 806.45 = 2634.80$$The current price of the bond is $2,634.80. Therefore, the yield to maturity is:$$YTM = \sqrt[3]{\frac{1000}{2634.80}} - 1 = 6.99%$$

Question 10

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 and profit by buying the bond and creating STRIPS.
E) None of the options are correct.

Accepted Answer

Only buying STRIPS and reconstituting the bond would be profitable.

Question 11

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

Accepted Answer

The expectations theory and the liquidity preference theory are theories that have been proposed to explain the term structure.

Question 12

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 the options are correct.

Accepted Answer

The inverted, or downward sloping, yield curve is one in which short-term rates are higher than long-term rates. The inverted yield curve has been observed frequently, although not as frequently as the upward sloping, or normal, yield curve.

Question 13

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) None of the options are correct.

Accepted Answer

If the value of a Treasury bond was lower than the value of the sum of its parts (STRIPPED cash flows) arbitrage would probably occur.

Question 14

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

Accepted Answer

Arbitrage (also known as riskless economic profit) can occur if the law of one price is violated.

Question 15

Suppose that all investors expect that interest rates for the 4 years will be as follows: $\begin{array}{lr}
& \text { Forward } \
\text { Year } & \text { Interest Rate } \
\hline 0 & \text { (today) } 6 \% \
1 & 7 \% \
2 & 9 \% \
3 & 10 \%
\end{array}$ 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 the options are correct.

Accepted Answer

The answer of Suppose that all investors expect that interest...

Question 16

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 the options are correct.
E) None of the options are correct.

Accepted Answer

The term structure of interest rates is the relationship between two variables, years and yield to maturity (holding all else constant).

Question 17

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

Accepted Answer

Bond stripping and bond reconstitution offer opportunities for arbitrage, which can occur if the law of one price is violated.

Question 18

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 the options are correct.

Accepted Answer

Buying and stripping the bond would be profitable so answer D is correct.

Question 19

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.

Accepted Answer

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

Question 20

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) All of the options are correct.

Accepted Answer

The value of a Treasury bond should be equal to the sum of the value of STRIPS created from it.

Quiz 15: The Term Structure of Interest Rates

The expectations theory of the term structure of interest rates states that

An upward sloping yield curve is a(n) _______ yield curve.

If the value of a Treasury bond was higher than the value of the sum of its parts (STRIPPED cash flows) ,

The yield curve shows at any point in time

According to the expectations hypothesis, an upward-sloping yield curve implies that

If the value of a Treasury bond was higher than the value of the sum of its parts (STRIPPED cash flows) , you could

Which of the following are possible explanations for the term structure of interest rates?

An inverted yield curve implies that

If the value of a Treasury bond was lower than the value of the sum of its parts (STRIPPED cash flows) ,

__ can occur if _.

Structure of interest rates is

Bond stripping and bond reconstitution offer opportunities for , which can occur if the ___ is violated.

If the value of a Treasury bond was lower than the value of the sum of its parts (STRIPPED cash flows) , you could

Treasury STRIPS are

The value of a Treasury bond should