Deck 21: Yields and Forward Rates

Question 1

Which of the following is NOT true with respect to duration?

A) All else constant,the larger is the bond's maturity,the smaller is the bond's duration.
B) Duration has an interpretation of the bond's average life.
C) Duration can be used to approximate the bond's price change when yields change.
D) The duration of a zero-coupon bond is the maturity of the bond.
E) Modified duration is the duration divided by (1 + y)where y is the bond's yield.

Answer 1

All else constant,the larger is the bond's maturity,the smaller is the bond's duration.

Question 2

When one puts on a trade to take advantage of an abnormal spread that one hopes will converge to the normal spread,which of the following is true?

A) Spread trades only work when the underlying prices of the two securities increase together.
B) A spread trade is always an arbitrage opportunity across time.
C) A spread trade works regardless of whether the underlying prices of the two securities increase or decrease.
D) A spread trade is always an arbitrage opportunity across space.
E) Spread trades always have a positive probability of losing money.

Answer 2

C

Question 3

Identify the correct statement.For an interest rate Eurodollar futures contract:

A) the quoted futures price equals the price used to determine daily settlement
B) the quoted futures price equals 100 minus the futures interest rate
C) the futures interest rate is a continuously compounded rate
D) the futures interest rate is the same as the FRA rate
E) interest rate futures have no cash flows until the futures delivery date

Answer 3

B

Question 4

The economy is booming.You believe that the Federal Reserve Bank is likely to raise short-term rates but keep long-term rates unchanged.To act on your belief,you decide to set up a spread strategy.Your initial trade should be as follows:

A) buy both the short-term bond and the long-term bond
B) sell both the short-term bond and the long-term bond
C) buy the short-term bond and sell the long-term bond
D) buy the long-term bond and sell the short-term bond
E) None of these answers are correct.

Question 5

Given the following zero-coupon bond prices,what is the forward rate agreement (FRA)rate for a contract maturing at time 2?

A) 0.0222
B) 0.0217
C) 0.0638
D) 0.0566
E) 0.02

Question 6

The TED spread is:

A) the difference between a bbalibor rate for Eurodollars and the interest rate on a similar maturity Treasury security
B) a measurement of a Treasury security's maturity adjusted for the coupon rate
C) the difference between the interest rate on a Treasury security and Euribor's dollar rate
D) the difference between the interest rate on a Treasury security and the euro's domestic rate
E) None of these answers are correct.

Question 7

Suppose two zero-coupon bonds are available for trading that have face values of $100 each.Current yields are 2 percent for the two-year bond and 5 percent for the ten-year bond.As the economy is expanding,you believe that the Federal Reserve Bank will raise short-term rates by 25 basis points (or 0.25 percent)to prevent the economy from overheating.The Fed has no influence over long-term interest rates and you expect them to remain unchanged.If you set up a spread strategy and it works as conjectured,then you will make a profit of:

A) $0.26
B) $0.33
C) $0.47
D) $0.94
E) None of these answers are correct.

Question 8

The yield on a coupon bond with face value L,coupon C per year,and maturity T is equal to:

A) the expected return on the bond
B) the forward rate for time T - 1
C) the forward rate for time T
D) the spot rate of interest
E) the internal rate of return on the coupon bond

Question 9

Which of the following is true with respect to modified duration hedging?

A) Modified duration hedging always works as a good approximation when yields change.
B) Modified duration hedging always works except when yields changes are large.
C) Modified duration hedging can only be applied to zero-coupon bonds.
D) Modified duration hedging always works if combined with convexity hedging.
E) Modified duration hedging works only for parallel shifts in the yield curve.

Question 10

Which of the following is NOT true?

A) Forward rate agreements (FRAs)and interest rate futures are contracts that bet on future movements of the spot rate of interest.
B) FRAs trade over the counter.
C) Interest rate futures trade on an organized exchange.
D) FRAs and interest rate futures are identical contracts in all respects,except that one trades over the counter and the other trades on an exchange.
E) FRAs have no intermediate cash flows before maturity,and interest rate futures have daily settlement cash flows.

Question 11

A newly issued two-year coupon bond has a par value of $100,a coupon rate of 5 percent ($5)and a yield y = 4 percent per year.If the yield goes up by 0.5 percent,then,according to the modified duration formula for a bond's price change,the bond price will:

A) go up by $0.90
B) go up by $1.90
C) go down by $0.96
D) go down by $1.90
E) None of these answers are correct.

Question 12

Given the following zero-coupon bond prices,what are the forward rates f(0,0),f(0,1),f(0,2)?

A) 0.0222,0.0217,0.0638
B) 0.0255,0.03222,0.0566
C) 0.0638,0.0217,0.0222
D) 0.0566,0.03222,0.0255
E) 0.02,0.04,0.06

Question 13

The yield on a zero-coupon bond of maturity T is equal to:

A) the expected return on the zero-coupon bond
B) the forward rate for time T -1
C) the forward rate for time T
D) the return on the bond each period,if the bond is held until maturity
E) the spot rate of interest

Question 14

A company buys a 5 * 11 (begins after five months,ends after eleven months),100-million-Eurodollar forward rate agreement (FRA)that has an FRA rate of 4 percent per year.If the six-month bbalibor rate announced after five months is 5.5 percent per year,then (assuming 182 days in the six-month period and 360 days in the year),the buyer will receive on the settlement date (after five months):

A) $491,878.60
B) $737,817.90
C) $758,333.33
D) $983,757.20
E) None of these answers are correct.

Question 15

Given the following zero-coupon bond prices,what is the forward rate agreement rate for a contract maturing at time 3?

A) 0.0222
B) 0.0217
C) 0.0638
D) 0.0566
E) 0.02

Question 16

Which of the following is true?

A) When investing in coupon bonds,holding constant for risk,the bond with the highest yield is preferred.
B) The yield measures the expected return on a coupon bond.
C) The yield should not be used as the sole determinate for selecting among bonds for investment purposes.
D) Bond yields are always increasing in the bond's maturity.
E) A coupon bond's yield always exceeds the spot rate of interest.

Question 17

Which of the following is true with respect to forward rates?

A) A forward rate is another name for a zero-coupon bond's yield.
B) A forward rate is equal to the expected return on a zero-coupon bond.
C) A forward rate is the rate one can contract today for riskless borrowing or lending at a future date.
D) Forward rates are always increasing in time to maturity.
E) Forward rates are always decreasing in time to maturity.