Chapter 15 – The Term Structure of Interest Rates
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Chapter 15
The Term Structure of Interest Rates
Multiple Choice Questions
1. The term structure of interest rates is:
A. The relationship between the rates of interest on all securities.
Difficulty: Easy
2. Treasury STRIPS are
A. securities issued by the Treasury with very long maturities
B. extremely risky securities
Difficulty: Easy
Chapter 15 – The Term Structure of Interest Rates
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3. The value of a Treasury bond should
D. A or B
E. B or C
Difficulty: Easy
4. If the value of a Treasury bond was higher than the value of the sum of its part (STRIPPED
cash flows) you could
D. B and C
E. none of the above
Difficulty: Moderate
5. If the value of a Treasury bond was lower than the value of the sum of its part (STRIPPED
cash flows) you could
A. profit by buying the stripped cash flows and reconstituting the bond.
B. not profit by buying the stripped cash flows and reconstituting the bond.
Difficulty: Moderate
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6. If the value of a Treasury bond was lower than the value of the sum of its part (STRIPPED
cash flows)
D. B and C
E. none of the above
Difficulty: Moderate
7. If the value of a Treasury bond was higher than the value of the sum of its part (STRIPPED
cash flows)
D. B and C
E. none of the above
Difficulty: Moderate
8. Bond stripping and bond reconstitution offer opportunities for ______, which can occur if
the _________ is violated.
D. huge losses; restrictive covenants
E. B and D
Difficulty: Moderate
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9. ______ can occur if _____.
A. arbitrage; the Law of One Price is not violated
B. arbitrage; the Law of One Price is violated
Difficulty: Moderate
10. The yield curve shows at any point in time:
A. The relationship between the yield on a bond and the duration of the bond.
B. The relationship between the coupon rate on a bond and time to maturity of the bond.
Difficulty: Easy
11. An inverted yield curve implies that:
D. Intermediate term interest rates are higher than either short- or long-term interest rates.
E. none of the above.
Difficulty: Easy
Chapter 15 – The Term Structure of Interest Rates
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12. An upward sloping yield curve is a(n) _______ yield curve.
D. flat.
E. none of the above.
Difficulty: Easy
13. According to the expectations hypothesis, a normal yield curve implies that
A. interest rates are expected to remain stable in the future.
B. interest rates are expected to decline in the future.
Difficulty: Easy
14. Which of the following is not proposed as an explanation for the term structure of interest
rates:
A. The expectations theory.
B. The liquidity preference theory.
Difficulty: Easy
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15. The expectations theory of the term structure of interest rates states that
D. all of the above.
E. none of the above.
Difficulty: Easy
16. Which of the following theories state that the shape of the yield curve is essentially
determined by the supply and demands for long-and short-maturity bonds?
A. Liquidity preference theory.
B. Expectations theory.
Difficulty: Easy
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17. According to the “liquidity preference” theory of the term structure of interest rates, the
yield curve usually should be:
A. inverted.
B. normal.
Difficulty: Easy
Suppose that all investors expect that interest rates for the 4 years will be as follows:
18. What is the price of 3-year zero coupon bond with a par value of $1,000?
A. $863.83
Difficulty: Moderate
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19. 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)
D. 10%
E. none of the above
Difficulty: Moderate
20. What is the price of a 2-year maturity bond with a 10% coupon rate paid annually? (Par
value = $1,000)
A. $1,092
B. $1,054
Difficulty: Moderate
21. What is the yield to maturity of a 3-year zero coupon bond?
A. 7.00%
B. 9.00%
Difficulty: Moderate
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The following is a list of prices for zero coupon bonds with different maturities and par value
of $1,000.
22. What is, according to the expectations theory, the expected forward rate in the third
year?
A. 7.00%
B. 7.33%
Difficulty: Moderate
23. What is the yield to maturity on a 3-year zero coupon bond?
A. 6.37%
B. 9.00%
Difficulty: Moderate
Chapter 15 – The Term Structure of Interest Rates
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24. What is the price of a 4-year maturity bond with a 12% coupon rate paid annually? (Par
value = $1,000)
A. $742.09
B. $1,222.09
Difficulty: Difficult
25. The market segmentation theory of the term structure of interest rates
A. theoretically can explain all shapes of yield curves.
B. definitely holds in the “real world”.
Difficulty: Easy
26. An upward sloping yield curve
A. may be an indication that interest rates are expected to increase.
B. may incorporate a liquidity premium.
Difficulty: Easy
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27. 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
D. the discount rate.
E. None of the above.
Difficulty: Easy
28. When computing yield to maturity, the implicit reinvestment assumption is that the
interest payments are reinvested at the:
A. Coupon rate.
B. Current yield.
Difficulty: Moderate
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29. Which one of the following statements is true?
A. The expectations hypothesis indicates a flat yield curve if anticipated future short-term
rates exceed the current short-term rate.
B. The basic conclusion of the expectations hypothesis is that the long-term rate is equal to
the anticipated long-term rate.
Difficulty: Moderate
30. Which one of the following statements is false?
A. The expectations hypothesis indicates a flat yield curve if anticipated future short-term
rates exceed the current short-term rate.
B. The basic conclusion of the expectations hypothesis is that the long-term rate is equal to
the anticipated long-term rate.
Difficulty: Moderate
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31. The concepts of spot and forward rates are most closely associated with which one of the
following explanations of the term structure of interest rates.
A. Segmented Market theory
Difficulty: Moderate
32. Given the bond described above, 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:
A. Less than 12%
Difficulty: Moderate
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33. Interest rates might decline
A. because real interest rates are expected to decline.
Difficulty: Easy
34. Forward rates ____________ future short rates because ____________.
A. are equal to; they are both extracted from yields to maturity.
B. are equal to; they are perfect forecasts.
Difficulty: Easy
35. The pure yield curve can be estimated
A. by using zero-coupon bonds.
B. by using coupon bonds if each coupon is treated as a separate “zero.”
Difficulty: Moderate
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36. The on the run yield curve is
A. a plot of yield as a function of maturity for zero-coupon bonds.
Difficulty: Moderate
37. The market segmentation and preferred habitat theories of term structure
A. are identical.
B. vary in that market segmentation is rarely accepted today.
Difficulty: Moderate
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38. The yield curve
A. is a graphical depiction of term structure of interest rates.
Difficulty: Easy
39. What should the purchase price of a 2-year zero coupon bond be if it is purchased at the
beginning of year 2 and has face value of $1,000?
D. $893.36
E. $871.80
Difficulty: Difficult