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. B) The relationship between the interest rate on a security and its time to maturity. C) The relationship between the yield on a bond and its default rate. D) All of the above. E) None of the above.
Answer: B Difficulty: Easy Rationale: The term structure of interest rates is the relationship between two variables,
years and yield to maturity (holding all else constant).
2. 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.
C) The relationship between yield on a bond and the time to maturity on the bond. D) All of the above. E) None of the above.
Answer: C Difficulty: Easy
3. An inverted yield curve implies that: A) Long-term interest rates are lower than short-term interest rates. B) Long-term interest rates are higher than short-term interest rates. C) Long-term interest rates are the same as short-term interest rates. D) Intermediate term interest rates are higher than either short- or long-term interest
rates.
E) none of the above.
Answer: A Difficulty: Easy Rationale: The inverted, or downward sloping, yield curve is one in which short-term
rates are higher than long-term rates. The inverted yield curve has been observed frequently, although not as frequently as the upward sloping, or normal, yield curve.
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Chapter 15 The Term Structure of Interest Rates
4. An upward sloping yield curve is a(n) _______ yield curve. A) normal. B) humped. C) inverted. D) flat.
E) none of the above.
Answer: A Difficulty: Easy
Rationale: The upward sloping yield curve is referred to as the normal yield curve, probably because, historically, the upward sloping yield curve is the shape that has been observed most frequently.
5. 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. 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 increase first, then decrease. Answer: C Difficulty: Easy
Rationale: An upward sloping yield curve is based on the expectation that short-term interest rates will increase.
6. 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. C) The market segmentation theory. D) Modern portfolio theory. E) A, B, and C. Answer: D Difficulty: Easy
Rationale: A, B, and C are all theories that have been proposed to explain the term structure.
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Chapter 15 The Term Structure of Interest Rates
7. The expectations theory of the term structure of interest rates states that
A) forward rates are determined by investors' expectations of future interest rates. B) forward rates exceed the expected future interest rates.
C) yields on long- and short-maturity bonds are determined by the supply and demand
for the securities. D) all of the above. E) none of the above. Answer: A Difficulty: Easy
Rationale: The forward rate equals the market consensus expectation of future short interest rates.
8. 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.
C) Market segmentation theory. D) All of the above. E) None of the above. Answer: C Difficulty: Easy
Rationale: Market segmentation theory states that the markets for different maturities are separate markets, and that interest rates at the different maturities are determined by the intersection of the respective supply and demand curves.
9. According to the \yield curve usually should be: A) inverted. B) normal.
C) upward sloping D) A and B. E) B and C. Answer: E Difficulty: Easy
Rationale: According to the liquidity preference theory, investors would prefer to be liquid rather than illiquid. In order to accept a more illiquid investment, investors require a liquidity premium and the normal, or upward sloping, yield curve results.
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Chapter 15 The Term Structure of Interest Rates
Use the following to answer questions 10-13:
Suppose that all investors expect that interest rates for the 4 years will be as follows:
10. What is the price of 3-year zero coupon bond with a par value of $1,000? A) $863.83 B) $816.58 C) $772.18 D) $765.55 E) none of the above
Answer: B Difficulty: Moderate Rationale: $1,000 / (1.05)(1.07)(1.09) = $816.58
11. 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) A) 5% B) 7% C) 9% D) 10% E) none of the above
Answer: A Difficulty: Moderate Rationale: The forward interest rate given for the first year of the investment is given as
5% (see table above).
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Chapter 15 The Term Structure of Interest Rates
12. 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 C) $1,000 D) $1,073 E) none of the above
Answer: D Difficulty: Moderate Rationale: [(1.05)(1.07)]1/2 - 1 = 6%; FV = 1000, n = 2, PMT = 100, i = 6, PV =
$1,073.34
13. What is the yield to maturity of a 3-year zero coupon bond? A) 7.00% B) 9.00% C) 6.99% D) 7.49% E) none of the above
Answer: C Difficulty: Moderate Rationale: [(1.05)(1.07)(1.09)]1/3 - 1 = 6.99.
Use the following to answer questions 14-16:
The following is a list of prices for zero coupon bonds with different maturities and par value of $1,000.
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