1.

The term structure of interest rates is:

Select one:

a. The relationship between the yield on a bond and its default rate.

b. The relationship between the interest rate on a security and its time to maturity.

c. All of these are correct.

d. None of these is correct.

e. The relationship between the rates of interest on all securities.

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The correct answer is: The relationship between the interest rate on a security and its time to maturity.

Question 2

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10. The yield curve shows at any point in time:

Select one:

a. None of these is correct.

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

c. All of these are correct.

d. The relationship between the yield on a bond and the duration of the bond.

e. The relationship between the coupon rate on a bond and time to maturity of the bond.

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The correct answer is: The relationship between yield on a bond and the time to maturity on the bond.

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11. An inverted yield curve implies that:

a. None of these is correct.

b. Long-term interest rates are higher than short-term interest rates.

c. Long-term interest rates are lower than short-term interest rates.

d. Long-term interest rates are the same as short-term interest rates.

e. Intermediate term interest rates are higher than either short- or long-term interest rates.

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The correct answer is: Long-term interest rates are lower than short-term interest rates.

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

Select one:

a. None of these is correct.

b. humped.

c. flat.

d. normal.

e. inverted.

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The correct answer is: normal.

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

Select one:
a. interest rates are expected to increase first, then decrease.

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 remain stable in the future.

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The correct answer is: interest rates are expected to increase in the future.

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14. Which of the following is not proposed as an explanation for the term structure of interest rates?

Select one:

a. Both the expectations theory and the liquidity preference theory.

b. The expectations theory.

c. Modern portfolio theory.

d. The liquidity preference theory.

e. The safety of principal theory.

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The correct answer is: Modern portfolio theory.

Question 7

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

Select one:

a. forward rates are determined by investors' expectations of future interest rates.

c. yields on long- and short-maturity bonds are determined by the supply and demand for the securities.

d. None of these is correct.

e. forward rates exceed the expected future interest rates.

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The correct answer is: forward rates are determined by investors' expectations of future interest rates.

Question 8

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16. What is the price of 3-year zero coupon bond with a par value of $1,000? Suppose that all investors
expect that interest rates for the 4 years will be as follows: Year 0 (today) 5%; year 1: 7%; year 2: 9%;
year 3: 10%.

Select one:

a. $765.55

b. $816.58

c. $772.18

d. None of these is correct.

e. $863.83

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The correct answer is: $816.58

Question 9

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17. 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). Suppose that all investors expect that interest rates for the 4 years will be as follows: Year 0
(today) 5%; year 1: 7%; year 2: 9%; year 3: 10%.

Select one:

a. None of these is correct.

b. 5%

c. 7%

d. 9%

e. 10%

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The correct answer is: 5%

Question 10

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18. What is the price of a 2-year maturity bond with a 10% coupon rate paid annually? (Par value =
$1,000). Suppose that all investors expect that interest rates for the 4 years will be as follows: Year 0
(today) 5%; year 1: 7%; year 2: 9%; year 3: 10%.

Select one:

a. $1,000

b. $1,073

c. $1,092

d. $1,054

e. None of these is correct.

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The correct answer is: $1,073

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19. What is the yield to maturity of a 3-year zero coupon bond? Suppose that all investors expect that
interest rates for the 4 years will be as follows: Year 0 (today) 5%; year 1: 7%; year 2: 9%; year 3: 10%.

Select one:

a. 6.99%

b. None of these is correct.

c. 9.00%

d. 7.00%

e. 7.49%

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The correct answer is: 6.99%

Question 12

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2. Treasury STRIPS are

Select one:

a. created by pooling mortgage payments made to the Treasury.

b. extremely risky securities.

c. securities issued by the Treasury with very long maturities.

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

e. created both by selling each coupon or principal payment from a whole Treasury bond as a separate
cash flow and by pooling mortgage payments made to the Treasury

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The correct answer is: created by selling each coupon or principal payment from a whole Treasury bond
as a separate cash flow.

Question 13

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20. What is, according to the expectations theory, the expected forward rate in the third year? The
following is a list of prices for zero coupon bonds with different maturities and par value of $1,000.
Maturity 1 year: Price $943.40; Maturity 2 years: Price $881.68; Maturity 3 years: Price $808.88;
Maturity 4 years: Price $742.09.

Select one:

a. None of these is correct.

b. 9.00%

c. 7.00%

d. 11.19%

e. 7.33%

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The correct answer is: 9.00%

Question 14

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21. What is the yield to maturity on a 3-year zero coupon bond? The following is a list of prices for zero
coupon bonds with different maturities and par value of $1,000. Maturity 1 year: Price $943.40;
Maturity 2 years: Price $881.68; Maturity 3 years: Price $808.88; Maturity 4 years: Price $742.09.

Select one:

a. 10.00%

b. 6.37%

c. 9.00%

d. None of these is correct.

e. 7.33%

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The correct answer is: 7.33%

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22. What is the price of a 4-year maturity bond with a 12% coupon rate paid annually? (Par value =
$1,000)The following is a list of prices for zero coupon bonds with different maturities and par value of
$1,000. Maturity 1 year: Price $943.40; Maturity 2 years: Price $881.68; Maturity 3 years: Price $808.88;
Maturity 4 years: Price $742.09.

Select one:

a. $1,000.00

b. $1,141.92

c. $1,222.09

d. None of these is correct.

e. $742.09

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The correct answer is: $1,141.92

Question 16

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23. An upward sloping yield curve

Select one:

a. may reflect the confounding of the liquidity premium with interest rate expectations.

b. All of these are correct.

c. None of these is correct.

d. may incorporate a liquidity premium.

e. may be an indication that interest rates are expected to increase.

The correct answer is: All of these are correct.

Question 17

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24. The "break-even" interest rate for year n that equates the return on an n-period zero-coupon bond
to that of an n-1-period zero-coupon bond rolled over into a one-year bond in year n is defined as

Select one:

a. the forward rate.

b. the short rate.

c. the discount rate.

d. the yield to maturity.

e. None of these is correct.

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The correct answer is: the forward rate.

Question 18

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25. When computing yield to maturity, the implicit reinvestment assumption is that the interest
payments are reinvested at the:

Select one:

a. Yield to maturity at the time of the investment.

b. The average yield to maturity throughout the investment period.

c. Prevailing yield to maturity at the time interest payments are received.

d. Coupon rate.
e. Current yield.

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The correct answer is: Yield to maturity at the time of the investment.

Question 19

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26. Given the bond described below, if interest were paid semi-annually (rather than annually), and the
bond continued to be priced at $850, the resulting effective annual yield to maturity would be: (Par
value 1000, Time to maturity 20 years, Coupon 10%, paid annually, Current price $850, YTM 12%)

Select one:

a. None of these is correct.

b. More than 12%

c. 12%

d. Less than 12%

e. Cannot be determined

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The correct answer is: More than 12%

Question 20

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27. Forward rates ____________ future short rates because ____________.

Select one:

a. are equal to; although they are estimated from different sources they both are used by traders to
make purchase decisions.

b. are equal to; they are perfect forecasts.

c. differ from; they are imperfect forecasts.

e. differ from; forward rates are estimated from dealer quotes while future short rates are extracted
from yields to maturity.

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The correct answer is: differ from; they are imperfect forecasts.

Question 21

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28. The pure yield curve can be estimated

Select one:

a. by using zero-coupon Treasuries and by using stripped Treasuries if each coupon is treated as a
separate "zero."

b. by estimating liquidity premiums for different maturities.

c. by using zero-coupon Treasuries.

d. by using corporate bonds with different risk ratings.

e. by using stripped Treasuries if each coupon is treated as a separate "zero."

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The correct answer is: by using zero-coupon Treasuries and by using stripped Treasuries if each coupon
is treated as a separate "zero."

Question 22

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29. The on the run yield curve is

Select one:

a. a plot of yield as a function of maturity for recently issued coupon bonds trading at or near par.
b. a plot of yield as a function of maturity for zero-coupon bonds and a plot of yield as a function of
maturity for recently issued coupon bonds trading at or near par.

c. a plot of yield as a function of maturity for corporate bonds with different risk ratings.

d. a plot of liquidity premiums for different maturities.

e. a plot of yield as a function of maturity for zero-coupon bonds.

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The correct answer is: a plot of yield as a function of maturity for recently issued coupon bonds trading
at or near par.

Question 23

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3. The value of a Treasury bond should

Select one:

a. be greater than or less than the sum of the value of STRIPS created from it

b. None of these is correct.

c. be greater than the sum of the value of STRIPS created from it.

d. be less than the sum of the value of STRIPS created from it.

e. be equal to the sum of the value of STRIPS created from it.

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The correct answer is: be equal to the sum of the value of STRIPS created from it.

Question 24

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30. The yield curve

Select one:
a. is a graphical depiction of term structure of interest rates.

b. is usually depicted for corporate bonds of different ratings.

c. is usually depicted for U. S. Treasuries in order to hold risk constant across maturities and yields.

d. is a graphical depiction of term structure of interest rates and is usually depicted for corporate bonds
of different ratings.

e. is a graphical depiction of term structure of interest rates and is usually depicted for U. S. Treasuries
in order to hold risk constant across maturities and yields.

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The correct answer is: is a graphical depiction of term structure of interest rates and is usually depicted
for U. S. Treasuries in order to hold risk constant across maturities and yields.

Question 25

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

Select one:

a. not profit by buying the stripped cash flows and reconstituting the bond but profit by buying the
bond and creating STRIPS

b. None of these is correct.

c. profit by buying the stripped cash flows and reconstituting the bond.

d. not profit by buying the stripped cash flows and reconstituting the bond.

e. profit by buying the bond and creating STRIPS.

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The correct answer is: not profit by buying the stripped cash flows and reconstituting the bond but
profit by buying the bond and creating STRIPS

Question 26

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

Select one:

a. None of these is correct.

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. profit by buying the stripped cash flows and reconstituting the bond.

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The correct answer is: not profit by buying the stripped cash flows and reconstituting the bond and
profit by buying the bond and creating STRIPS

Question 27

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

Select one:

a. None of these is correct.

b. arbitrage would probably occur.

c. arbitrage would probably not occur and the FED would adjust interest rates

d. arbitrage would probably not occur.

e. the FED would adjust interest rates.

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The correct answer is: arbitrage would probably occur.

Question 28

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

Select one:

a. the FED would adjust interest rates.

b. None of these is correct.

c. arbitrage would probably not occur.

d. arbitrage would probably not occur and the FED would adjust interest rates

e. arbitrage would probably occur.

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The correct answer is: arbitrage would probably occur.

Question 29

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

Select one:

a. arbitrage; restrictive covenants

b. huge losses; restrictive covenants

c. huge losses; Law of One Price

d. both arbitrage and huge losses; restrictive covenants

e. arbitrage; Law of One Price

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The correct answer is: arbitrage; Law of One Price

Question 30

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9. ______ can occur if _____.

Select one:

a. arbitrage; the Law of One Price is not violated

b. arbitrage; the Law of One Price is violated

c. riskless economic profit; the Law of One Price is violated

d. both arbitrage and riskless economic profit; the Law of One Price is violated

e. riskless economic profit; the Law of One Price is not violated

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The correct answer is: both arbitrage and riskless economic profit; the Law of One Price is violated