Question #1 of 10 Question ID: 1281455

If 1-year rates are 5 percent, 1-year rates one year from now are expected to be 5.75

percent, and 1-year rates two years from now are expected to be 6.25 percent, then the
unbiased expectations theory of interest rates would indicate current 3-year rates should be
closest to:

A) 8.75%.

B) 5.67%.

C) 5.29%.

D) 6.37%.

Explanation

Current 3-year rates have to equal current 1-year rates compounded by 1-year forward
rates. Thus [1 + r(3)]3 = (1.05)(1.0575)(1.0625), which generates a current 3-year rate of
5.67 percent.

(Book 4, Module 53.2, LO 53.d)

Question #2 of 10 Question ID: 1281445

Suppose that the discount factor for the rst 180-day coupon period in Bond ABC is
0.91.What is the price of this bond if it pays $105 six months from today?

A) $115.38.

B) $14.00.

C) $95.55.

D) $54.97.

Explanation

Since $1 to be received in six months is worth $0.91 today, $105 received in six months is
worth 0.91 × $105 = $95.55 today.

(Book 4, Module 53.1, LO 53.a)

Question #3 of 10 Question ID: 1281448

Which of the following statements about zero-coupon bonds is not correct?

A) The lower the price, the greater the return for a given maturity.

B) All interest is earned at maturity.

A zero-coupon bond provides a single cash ow at maturity equal to its par

C)
value.

D) A zero coupon bond may sell at a premium to par when interest rates decline.

Explanation

Zero coupon bonds always sell below their par value, or at a discount prior to maturity.
The amount of the discount may change as interest rates change, but a zero coupon bond
will always be priced less than par.

(Book 4, Module 53.2, LO 53.d)

Question #4 of 10 Question ID: 1281449

When trading Treasury STRIPS, which of the following statement is correct regarding the

disadvantages of P-STRIPS and C-STRIPS?

A) Longer-term C-STRIPS tend to trade rich.

B) P-STRIPS typically trade at fair value.

C) Shorter-term C-STRIPS tend to trade cheap.

D) STRIPS are liquid assets.

Explanation

STRIPS have some disadvantages, which include the following:

They can be illiquid.

Shorter-term C-STRIPS tend to trade rich.
Longer-term C-STRIPS tend to trade cheap.
P-STRIPS typically trade at fair value.

(Book 4, Module 53.2, LO 53.d)

Use this table for the following questions.

Maturity
STRIPS Price Spot Rate Forward Rate
(Years)
0.5 98.7654 2.50% 2.50%
1.0 97.0662 3.00% 3.50%
 1.5 95.2652 3.26% 3.78%
2.0 93.2775 ????% ????%

Question #5 - 6 of 10 Question ID: 1281453

The 6-month forward rate in 1.5 years (ending in year 2.0) is closest to:

A) 4.04%.

B) 4.11%.

C) 4.57%.

D) 4.26%.

Explanation

First, calculate the spot rate in year 2.

2 × [(100 / 93.2775)(1/4) − 1] = 3.51%

Next, calculate the forward rate in year 2.

1
4 3
0.0351 0.0326 f(2.0)
(1 + ) = (1 + ) × (1 + )
2 2 2

⇒f (2.0) = 4.26%

(Book 4, Module 58.2, )

Question #6 - 6 of 10 Question ID: 1281454

The value of a 1.5-year, 6 percent semiannual coupon, $100 par value bond is closest to:

A) $102.19.

B) $104.00.

C) $105.66.

D) $103.42.

Explanation
 $3 $3 $103
bond price = + + = $104.00
1 2 3
0.0250 0.0300 0.0326
(1+ ) (1+ ) (1+ )
2 2 2

(Book 4, Module 53.2, LO 53.d)

Question #7 of 10 Question ID: 1281451

Which of the following statements concerning a forward rate is false? A forward rate is:

the interest rate that makes an investor indi erent to investing over a long time
A)
period or investing over two or more shorter time periods.

B) the market’s best guess as to an interest rate that will exist in the future.

the rate of interest an investor would earn from now until some point in the
C)
future.

D) an interest rate that can be locked in for some future time period.

Explanation

The rate of interest an investor could invest at today until some point in the future is the
spot rate. The other three statements correctly identify the three possible interpretations
of a forward rate. A forward rate can be interpreted as a break even rate, a locked-in rate
for some future period, or an expectation of future spot interest rates.

(Book 4, Module 53.2, LO 53.d)

Question #8 of 10 Question ID: 1281447

Which of the following is most accurate in relation to P-STRIPS and shorter term C-STRIPS?

A) P-STRIPS: Trade at fair value; C-STRIPS: Trade rich.

B) P-STRIPS: Trade rich; C-STRIPS: Trade rich.

C) P-STRIPS: Trade at fair value; C-STRIPS: Trade cheap.

D) P-STRIPS: Trade rich; C-STRIPS: Trade at fair value.

Explanation

Principal STRIPS typically trade at fair value. Shorter term coupon STRIPS typically trade
rich. Longer term coupon STRIPS tend to trade cheap.

(Book 4, Module 53.2, LO 53.d)

Question #9 of 10 Question ID: 1281446

Which of the following statements regarding U.S. Treasury issues is least accurate?

Investment bankers strip the coupons from Treasury notes and bonds to create
A)
zero-coupon securities.

B) A 5-year Treasury note can be stripped into 11 di erent zero coupon securities.

C) The U.S. Treasury issues zero coupon notes, but not bonds.

Due to the way Treasury STRIPS are taxed, U.S. investors may face negative cash
D)
ows before the maturity date.

Explanation

The Treasury does not issue zero-coupon notes or bonds. That is why STRIPS were
created. A 5-year Treasury note can be stripped into 11 zero coupon securities, consisting
of its 10 coupon payments and the principal repayment. The U.S. Internal Revenue Service
regards the accrued interest on a zero coupon security as income on which the security
holder must pay taxes even though he has not received a cash interest payment.

(Book 4, Module 53.2, LO 53.d)

Question #10 of 10 Question ID: 1281450

The Treasury spot rate yield curve is closest to which of the following curves?

A) Zero-coupon bond yield curve.

B) Par bond yield curve.

C) Reinvestment rate yield curve.

D) Forward yield curve rate.

Explanation

The spot rate yield curve shows the appropriate rates for discounting single cash ows
occuring at di erent times in the future. Conceptually, these rates are equivalent to yields
on zero-coupon bonds. The par bond yield curve shows the YTMs on coupon bonds by
maturity. Forward rates are expected future short-term rates. Reinvestment rates are not
part of the spot rate yield curve.

(Book 4, Module 53.2, LO 53.d)