Term Structure of Interest Rates Essay Example

Term Structure of Interest Rates Paper Forward rate for a I-year bond in 2 years Forward rate for a 1 year bond in 3 years = 10% What is the price of a 3, year zero coupon bond with a face value of $100? Correct Answer: Question: Calculate the expected holding period return for an investor who p researches a 5. 5% two-year bond and plans to sell it after one year. The Burch ease price is $97,350, the expected market rate for a one year bond in one year is 7. 20% and the bond pays coupon interest annually. The bond has a SOCIO face value. Correct Answer: Question: An investor with a one- year investment horizon has chosen to invest in a four-year bond. Find the expected market rate of a three-year bond in one year if the forward rate, is 6. 4% with a liquidity premium of 50 basis points? Correct Answer: 5. 9% 6. 74% SIS_ASS Question: Compute the spot rate for a 2-year zero coupon bond given the i) I year 3. 5% coupon bond, ii) 2-year 11% coupon bond and iii) 3-year 10. 2% co upon bond are 11. 5%, 10. 5% and 10% respectively. All coupon bonds pay interest annually and have a face value of SOCIO. Correct Answer: Question: We use data to study the term Structure Of interest rates. Correct Answer: Question: The expectations theory of the term strut true of interest rates states that Correct Answer: Question: forward rates are market expectations of future interest rates. Cross sectional 10. 45% Calculate the expected holding period return for an investor who purchases a 7. 5 0% two-year bond and plans to sell it after one year. The purchase price in 5102. 0 00, the expected market rate for a one year bond in one year is 6. 25% Asses. shred. ND the bond pays coupon interest semi- annually. The bond has a $100 face value. Coupons can be reinvested at 6% p. A. Until the end Of the holding period. Correct Answer: 6. 57% Question: Which of the following statements are FALSE? Correct Answer: under the liquidity premium theory invest torso would demand a liquidity premium from a bond with a maturity that matches their investment horizon. Question: The yield curve shows the relationship between: Correct Answer: Question: Manchuria Bank purchased a large a mount of Commonwealth Government Bonds (CAB). We will write a custom essay sample on Term Structure of Interest Rates specifically for you for only $16.38 $13.9/page Order now We will write a custom essay sample on Term Structure of Interest Rates specifically for you FOR ONLY $16.38 $13.9/page Hire Writer We will write a custom essay sample on Term Structure of Interest Rates specifically for you FOR ONLY $16.38 $13.9/page Hire Writer They wish to strip and repackage the coupon interest as individual zero coupon bonds, According to their calculations, the term structure of interest rates suggests that the spot rate of a 2- year zero coupon bond is 10%. You would advise Manchuria to advertise a yield to on the 2-year zero coupon bond. Selected Answer: Correct Answer: Response Feedback: less than 10% In order for Manchuria Bank to earn a return on the IR coupon strapping they would need to offer a yield less than 10%. The yield on a bond and the time to maturity of the bond Asses. shred.. Online Quiz Questions for Week 4 Topic: Duration Question: When interest rates decline, the duration Of a II- year bond selling at a premium Correct Answer: Question: Who ICC Of the following is incorrect? Correct Answer: Question: The duration of a bond that pays coupon interest annually is 8. 05 yea The yield to maturity Of the bond is 10%. If the yield falls by 25 basis points , what is the percentage change in the price of the bond? Correct Answer: Question: The duration of a bond is positively correlated with the bonds Correct Answer: Question: Which of the following two bonds is more price SE incentives to changes in interest rates? A par value bond, X, with a 5-year- to;maturity and a yield to maturity. A zero;coupon bond, Y, with a S; year-to-maturity and a 10% yield to maturity. Selected Answer: Correct Answer: Response Feedback: Question: The two components of interest-rate risk are Correct Answer: Question: Holding other factors constant, the interest- ate risk of a coupon bond is higher when the bonds: Correct Answer: Question: Duration is important in bond portfolio management because l) it can be used in immunization strategies, II) it provides a gauge of the effective average maturity of the portfolio. Ill) it is related to the interest rate sensitivity of the portfolio. IV) it is a good predictor of interest rate changes. Selected Answer: Correct Answer: I and Ill , II, and Ill yield to maturity is lower. Price risk and reinvestment risk. Both have the same sensitivity because both have the same yield to maturity. Bond Y because Of the longer duration. Duration is the best mesas ere of bond price sensitivity; the longer the duration the higher the price sensitivity. Time to maturity. I . 83% The duration Of a zero- coupon bond decreases with an increase in time to maturity. Increases. Response Feedback: Duration can be used to calculate the approximate e effect of interest rate changes on prices, but is not used to forecast interest rates, Question: When interest rates decline, the duration of a II- year bond selling at a premium Selected Answer: Correct Answer: Question: Which of the following is incorrect? Correct Answer: Question: Compute the duration of a overvalue bond with a coupon rate of and a remaining time to maturity of 3 years. Assume coupon interest is paid annually and the bond has a face value $100. Correct Answer: Question: The duration of a bond that pays coupon interest annually is 8 . 05 years. The yield to maturity of the bond is 10%. If the yield falls by 25 basis points, What is the percentage change in the price Of the bond? Correct Answer: Question: Which of the following are true about the interest- rate sensitivity Of coupon bonds? Bond prices and yields are inversely related. II Prices of long-term bond s tend to be more sensitive to interest rate changes than prices Of short- term bonds. Ill Interest-rate risk is directly related to the bonds coupon rate. IV The sensitivity of a bonds price to a change in its yield to maturity is NV resell related to the yield to maturity at which the bond is currently selling. Correct Answer: Question: You have an obligation to pay $148 in f our years and 2 months. In which bond would you invest your $100 to accumulate this amount, with relative certainty, even if the yield d on the bond declines to 9. 5% immediately after you purchase the nod? All bonds pay interest annually and have a tact value of $100. Selected Answer: Correct Answer: Response Feedback: a 6- year; 10% coupon overvalue bond a 5-year; 10% coupon overvalue bond l, II, and I V I 2. 783 years. The duration of a zero- coupon bond decreases with an increase in time to maturity. Decreases. Increases, Response Feedback: The relationship between interest rates and duration is an i inverse one for coupon bonds. When duration = horizon date, one is minimized, or protected, against one interest rate change. The Zero coupon bond has a D = 5 and the 4- year bond has D e 4. Next choice should be the 5-year bond. Despite the change in yield to 9. 5%, the consequent duration = (10/1. 095)/ 100 100 = 4. 2 years months. Therefore select 5 year, 10% coupon bond. 4 years and 2 Online Quiz Questions for Week 5 Topic: Efficient Portfolios Question: Assume an investor has the following utility function, U E(RPR) O_Scoop, where her degree of risk aversion is 2. To maximize her expected utility, she would choose the asset with an expected return of and a standard deviation of returns of respectively. Correct Answer: Question: The variable A in the utility function represents the: Correct Answer: Question: Minimum variance portfolios of n risky securities are portfolios that: Correct Answer: Question: The expected return of a portfolio of risky securities: Correct Answer: Question: An indifference curve locates the risk re turn combinations Of a number Of portfolios that offer the same level of to an investor with a given degree of risk aversion. Correct Answer: hypothetical; utility Is a weighted average of the securities returns Have the smallest standard De aviation Of returns for a given level Of expected return Investors aversion to risk Question: The utility score an investor assigns to a particular pop Tivoli, other things equal, Selected Answer: Correct Answer: Will decrease as the variance of returns decreases none of the above Utility is enhanced by higher expected returns and diminished by higher risk. Question: In the absence of risk- tree lending and borrowing, the optimal risky portfolio (ARP) offers: Correct Answer: The largest utility Question When two risky securities that are not perfectly positively correlated are held in a portfolio, the portfolio standard deviation of returns will be the weight d average of the individual security standard deviations. Selected Answer: Correct Answer: Response Feedback: B or C less than Whenever we use two securities that are less than perfectly positively correlated to form a portfolio, the portfolio standard deviation Of returns Will be less than t he weighted average standard deviation of returns of the constituent securities. This risk reduction is the reason for diversification. Question: The standard deviation of returns of a portfolio of risky securities is: Correct Answer: The square root of the sum of weighted variances and covariant once of returns of the securities Question: Steve is more risk-averse than Edie. On a graph that shows Steve and Edi?s indifference curves, which of the following is true? Correct Answer: Staves indifference curves will have steeper slopes than Dies Question Other things equal, diversification is most effective when: Correct Answer: Securities returns are negatively correlated Question: Efficient portfolios of n risky securities are portfolios that: Correct Answer: Have the largest expected return for a given level of risk Question: A statistic that measures how the returns o f two risky assets moue together is: Correct Answer: C and D Question: When two risky securities that are not perfectly positively correlate d are held in a portfolio, the portfolio standard deviation Of returns Will be the weighted average of the individual security standard deviations. B Orca less than to form a portfolio, the portfolio standard deviation of returns will be less than t Online Quiz Questions for Week 6 Topic: Optimal Portfolios Question: An investors optimal balanced portfolio is the portfolio that: Correct Answer: Question: When using EXCEL to locate the optic mall balanced portfolio, the purpose is to: @When using EXCEL , the objective function is to identify the composition of the balanced portfolio (the allocation of funds between the ARP and the risk free as et) that gives rise to the highest utility, Correct Answer: Question: G even an optimal risky portfolio with expected return to 14% and standard deviation of returns of and a risk free rate of what is the SSL pope of the best feasible capital allocation line? Correct Answer: Question: Suppose your initial wealth is 51000, The risk free asset makes up of your optimal balanced portfolio. Tellers makes up 15% of you our optimal risky portfolio. How much do you invest in Tellers? $150 $210 Amount invested in your optimal risky portfolio = 51000 x 140% 51400; Amount invested in Tellers = $xx = $210 0. 36 Maximize the utility of the balanced portfolio by changing the weight allocated to the optimal risky portfolio Maximizes his utility Question: Other things being equal, when you combine a RI ask free asset With a portfolio Of risky assets, the larger these tankard deviation of return of the portfolio of risky assets. The larger the standard deviation of return of the balanced portfolio. Selected Answer: Correct Answer: Response Feedback: A and B This statement is always true The standard deviation of returns of the balanced portfolio is given by B = yap because the standard deviation of returns of the risk free asset and the variance of returns between the risk tree asset and the portfolio of risky assets are zero. Question: Which of the following statements regarding the capital allocation n line is false? Selected Answer: Correct Answer: Response Feedback: The slope Of the capital allocation line is obtained by dividing the expected return of a portfolio of risky assets by the standard deviation of returns of the portfolio Both A and C are true The capital allocation line shows the risk return combinations of a set of balanced portfolios that combine a risk-free asset With a portfolio Of risky assets in different proportions. Its slope is the reward to variability ratio and measured as the excess portfolio return per unit of (standard deviation) risk. Thus, both A and C are true. Question: The capital allocation line can be described as the: Correct Answer: Investment opportunity set formed with a risky asset and a risk-free asset Question: An investor invests of his wealth in a risky asset with an expected rate of return of 15% and a standard deviation of returns of 20% and 70% in a T- bill that pays His portfolios expected return and standard deviation n of returns are Question: The separation theorem says: Selected Answer: Correct Answer: Response Feedback: Two or more of the above are correct The choice of the optimal risky portfolio is independent of the investors degree of risk aversion The separation theorem States that in the presence Of a risk free asset, the decision regarding the choice of portfolios of risky assets is separate and independent Of the investors degree Of risk aversion. The degree Of risk aversion only affects the choice of balanced portfolios. The more risk averse you are, the less you allocate your capital to the optimal risky portfolio. Question: Which of the following securities would a risk- averse investor always choose as his sky asset in his balanced portfolio, given that a Treasury- bill has a rate of return of 5%? Correct Answer: security C: E(r)- 12%; standard deviation Question: Having a kinked capital allocation line can be a result of: Correct Answer: Question: Which of the following securities would a risk- risky asset in his balanced portfolio, given that a TreasurY bill has a rate of return of Selected Answer: Question: Suppose your initial wealth is 51000 The risk free asset makes up 40% four optimal balanced portfolio. Tellers makes up 15% of your optimal risky portfolio. HOW much do you invest in Tellers? Selected Answer: Correct Answer: Response Feedback: $240 $210 Amount invested in your optimal risky portfolio = 51000 x 140% = 51400; Amount invested in Tellers = $xx 15% = $210 Cannot be determined Security C: E(r) 1 Standard deviation = Security C has the highest reward to variability ratio. Reward to variability ratio (0. 12 0. 05)/0. 1 0. The borrowing rate exceeding the lending rate Question: Your optimal balanced portfolio consists of an optimal risky portfolio w tit expected return of 20% and standard deviation of returns of 10% and a risk; free asset with expected return off%. Your level to risk aversion is 8. What is the proportion of funds allocated to the optimal portfolio of risky assets (your)? Correct Answer: Question: It investors can borrow and lend at the same risk free rate, which one of the following statements is correct? Correct Answer: The capital allocation line sis straight line 200% Question: If the borrowing rate is higher than the lending g rate, which one of the following statements is correct? Investors with different degrees Of risk aversion Will always choose the same portfolio of risky assets Portfolios lying on different regions Of the capital allocation line have different reward to variability ratios If the borrowing rate is higher than the lending rate, this Will result in a kinked capital allocation line, meaning i) an investors degree of risk aversion affects the choice of the ARP, and ii) portfolios that lie on the CAL may have different reward to variability ratios. Question: Which of the following securities would a risk, bill has a rate of return of 5%? Selected Answer: Correct Answer: Response Feedback: Question: Which of the following statements regarding the capital a Location line is false? Selected Answer: Correct Answer: Response Feedback: The capital allocation line is also called the efficient frontier of risky assets n the absence of a risk-free asset Both A and C are true balanced portfolios that combine a risk-free asset with a portfolio of risky assets and C are true. Cannot be determined Security C: 12%; Standard deviation = ratio = (0. 12 0. 05)/0. 1 = 0. 7 Online Quiz for SIMI Question: As diversification increases, the toot I of a portfolio approaches Question: Which of the following is true regarding RE? Question: Which of the following is correct about the stocks alpha? Selected Answer: Correct Answer: Response Feedback: Question: The index MO del has been estimated for stocks A and g with the following results: RA- 0. 1 + 0. 02 + 1. ARM SMS -0. 20 s(EAI) s 0. 0 The standard deviation of returns of stock A is Correct Answer: Question: The Security Characteristic Line (SSL) Selected Answer: Correct Answer: Response setback: plots the excess return on a security as a function of the excess return on the market. All of the above. The security characteristic line, which plots the excess return of the security as a function of the excess return Of the market allows one to estimate both the alpha and the beta of the security. 0. 2335 under CAMP, alpha is zero at all times under CAMP, the value of alpha is zero when the market is at equilibrium Lender CAMP, the expected (equilibrium) value Of alpha is zero, although alpha could be positive, negative or zero the variance of the market portfolio Question: Analysts may use regression analysis to estimate the market model for a stock. When doing so, the intercept of the regression line is an estimate of . Selected Answer: the a of the asset Correct Answer: Response Feedback: Question: The Security Characteristic Line (SIC_) associated with the single- index model sis plot of Correct Answer: Question: The index model for stock k B has been estimated with the following result: ORB = 0,01 l, RIM ebb If MM 020 and RIB = 0. 50, the standard deviation to returns of stock B is Correct Answer: Question: Which of the following statements are true? Selected Answer: Correct Ensures: Response Feedback: the characteristic line is a regression output of the security market line. It is common to ignore the risk free rate and estimate the market model instead. A is incorrect because SMS shows you the relationship between the return Of a security in relation to its systematic risk (as measured by b) whereas the characteristics line shows the relationship between a stocks excess return to the markets excess return. B is also incorrect because a large alpha could be accompanied by a I-stats Of less than I . 96 (or 2 as per the rule Of thumb), hence making the output insignificantly different from O. RE measures the proportion of variation of the stocks excess return that is explained by the 0. 3111 the securitys excess returns on the vertical axis and the market indexs excess returns on the horizontal axis. None of the above The market model is a regression of total stock returns on total market returns. The intercept is neither b, s nor d, and is not the a to the asset, which is the intercept of the single index model which uses excess returns. As awe. shred.. Markets excess return, not the other way around. Hence C is incorrect. D is correct as practitioners typically use the market model instead of following the single index model strictly. Question: A single- index model uses as a proxy for the systematic risk factor. Correct Answer: Question: As diversification increases, the total variance Of a portfolio approaches . Selected Answer: none of the above Correct Answer: Response setback: Question: Analysts may use regression analysis to estimate the market model for a stock.