Deck 19: The Term Structure of Interest Rates

Question 1

The relationship between yield and maturity is referred to as:

A) Yield curve.
B) Term structure of interest rates.
C) Term to maturity.
D) Yield spread.
E) None of the above.

Answer 1

Term structure of interest rates.

Question 2

The graphical depiction of the relationship between the yield on bonds of the same credit quality but different maturities is known as:

A) The yield curve.
B) The term to maturity.
C) The term structure of interest rates.
D) The yield spread.
E) None of the above.

Answer 2

The yield curve.

Question 3

Using spot rates, the theoretical value of a bond is calculated:

A) As the present value of all expected future cash flows.
B) By discounting a cash flow for a given period by the corresponding spot rate for that period.
C) By discounting all future cash flows at the riskfree rate.
D) By compounding all expected future cash flows.
E) None of the above.

Answer 3

By discounting a cash flow for a given period by the corresponding spot rate for that period.

Question 4

The current Treasury yield curve can be used to extrapolate the:

A) Theoretical spot rates.
B) The market's consensus of future interest rates.
C) Discount rate.
D) a and b only.
E) All of the above.

Question 5

A future interest rate calculated from either the spot rates or the yield curve is called:

A) An implicit forward rate.
B) A forward rate.
C) A theoretical future rate.
D) a and b only.
E) All of the above.

Question 6

The two elements of a forward rate are:

A) The length of time for the rate.
B) The implicit rate.
C) When in the future the rate begins.
D) a and c only.
E) a and b only.

Question 7

Forward rates are also referred to as:

A) Futures rates.
B) Hedgeable rates.
C) Implicit rates.
D) Future oriented rates.
E) None of the above.

Question 8

The shape of the yield curve can be explained by:

A) The expectations theory.
B) The liquidity theory.
C) The preferred habitat theory.
D) The market segmentation theory.
E) All of the above.

Question 9

Forward rates exclusively represent the expected future rates according to the:

A) Market segmentation theory.
B) Pure expectations theory.
C) The liquidity theory.
D) The preferred habitat theory.
E) None of the above.

Question 10

Price risk of a bond occurs when a bond must be sold prior to maturity at an uncertain price because the:

A) Yield is determined by the Federal Reserve.
B) Future return or yield is unknown.
C) Future yield is expected to be less than the coupon rate.
D) b and c only.
E) None of the above.

Question 11

If an investor has a six-month investment horizon, buying a 5-year, 10-year, or 20-year bond will produce the same six-month return. This interpretation of the pure expectations theory is referred to as the:

A) Return-to-maturity expectation.
B) Local expectations.
C) Broadest interpretation.
D) Liquidity theory.
E) None of the above.

Question 12

According to the liquidity theory of the term structure, the forward rate should reflect both interest rate expectations and:

A) A liquidity premium.
B) A risk premium.
C) A maturity premium.
D) A marketability premium.
E) None of the above.

Question 13

The theory which adopts the view that the term structure reflects the future path of interest rates as well as a risk premium is the:

A) The liquidity theory.
B) The pure expectations theory.
C) The preferred habitat theory.
D) The market segmentation theory.
E) None of the above.

Question 14

The market segmentation theory recognizes that investors have preferred habitats, which are dictated by:

A) Saving flows.
B) Investment flows.
C) Cash flows.
D) a and b only.
E) All of the above.

Question 15

Market participants tend to construct yield curves from observations of prices and yields in the:

A) Bond market.
B) Treasury market.
C) Agency securities market.
D) Money market.
E) None of the above.

Question 16

When the yield rises steadily as the maturity increases, the yield curve is said to be:

A) Positive.
B) Upward sloping.
C) Normal.
D) All of the above.
E) None of the above.

Question 17

When the yield declines as maturity increases, the yield curve is said to be:

A) Inverted.
B) Downward sloping.
C) Positive.
D) Negative.
E) a, b, and d only.

Question 18

Treasury securities are free of:

A) Price risk.
B) Default risk.
C) Reinvestment risk.
D) Yield variations.
E) None of the above.

Question 19

The risks that cause uncertainty about the return over some investment horizon are:

A) The uncertainty about the price of a bond at the end of the investment horizon.
B) The uncertainty about the rate at which the proceeds from a bond that matures prior to the maturity date can be reinvested until the maturity date.
C) The uncertainty about the movement of equity prices relative to debt instruments.
D) a and b only.
E) All of the above.

Question 20

As the largest and most active bond market, the Treasury market offers the fewest problems of illiquidity.

Question 21

The basic principle underlying the bootstrapping technique is that the value of the Treasury coupon security should be equal to the value of the package of zero-coupon Treasury securities that duplicates the coupon bond's cash flow.

Question 22

The yield of bonds of the same credit quality does not depend on their maturity alone.

Question 23

The pure expectations theory postulates that no systematic factors other than expected future short-term rates affect forward rates.

Question 24

The market segmentation theory proposes that the major reason for the shape of the yield curve lies in asset/liability management constraints.

Question 25

Differentiate between price risk and reinvestment risk.