Chapter 15 The Term Structure of Interest Rates
28. The market segmentation and preferred habitat theories of term structure A) are identical. B) vary in that market segmentation is rarely accepted today. C) vary in that market segmentation maintains that borrowers and lenders will not
depart from their preferred maturities and preferred habitat maintains that market participants will depart from preferred maturities if yields on other maturities are attractive enough.
D) A and B. E) B and C.
Answer: E Difficulty: Moderate Rationale: Borrowers and lenders will depart from their preferred maturity habitats if
yields are attractive enough; thus, the market segmentation hypothesis is no longer readily accepted.
29. The yield curve A) is a graphical depiction of term structure of interest rates. B) is usually depicted for U. S. Treasuries in order to hold risk constant across
maturities and yields.
C) is usually depicted for corporate bonds of different ratings. D) A and B. E) A and C.
Answer: D Difficulty: Easy Rationale: The yield curve (yields vs. maturities, all else equal) is depicted for U. S.
Treasuries more frequently than for corporate bonds, as the risk is constant across maturities for Treasuries.
Use the following to answer questions 30-32:
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Chapter 15 The Term Structure of Interest Rates
30. 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? A) $877.54 B) $888.33 C) $883.32 D) $893.36 E) $871.80
Answer: A Difficulty: Difficult Rationale: $1,000 / [(1.064)(1.071)] = $877.54
31. What would the yield to maturity be on a four-year zero coupon bond purchased today? A) 5.80% B) 7.30% C) 6.65% D) 7.25% E) none of the above.
Answer: C Difficulty: Moderate Rationale: [(1.058) (1.064) (1.071) (1.073)]1/4 - 1 = 6.65%
32. Calculate the price at the beginning of year 1 of a 10% annual coupon bond with face
value $1,000 and 5 years to maturity. A) $1,105 B) $1,132 C) $1,179 D) $1,150 E) $1,119
Answer: B Difficulty: Difficult Rationale: i = [(1.058) (1.064) (1.071) (1.073) (1.074)]1/5 - 1 = 6.8%; FV = 1000, PMT =
100, n = 5, i = 6.8, PV = $1,131.91
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33. Given the yield on a 3 year zero-coupon bond is 7.2% and forward rates of 6.1% in year
1 and 6.9% in year 2, what must be the forward rate in year 3? A) 8.4% B) 8.6% C) 8.1% D) 8.9% E) none of the above.
Answer: B Difficulty: Moderate Rationale: f3 = (1.072)3 / [(1.061) (1.069)] - 1 = 8.6%
34. An inverted yield curve is one A) with a hump in the middle. B) constructed by using convertible bonds. C) that is relatively flat. D) that plots the inverse relationship between bond prices and bond yields. E) that slopes downward.
Answer: E Difficulty: Easy Rationale: An inverted yield curve occurs when short-term rates are higher than
long-term rates.
35. Investors can use publicly available financial date to determine which of the following?
I) the shape of the yield curve II) future short-term rates
III) the direction the Dow indexes are heading IV) the actions to be taken by the Federal Reserve A) I and II B) I and III C) I, II, and III D) I, III, and IV E) I, II, III, and IV
Answer: A Difficulty: Moderate Rationale: Only the shape of the yield curve and future inferred rates can be determined.
The movement of the Dow Indexes and Federal Reserve policy are influenced by term structure but are determined by many other variables also.
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36. Which of the following combinations will result in a sharply increasing yield curve? A) increasing expected short rates and increasing liquidity premiums B) decreasing expected short rates and increasing liquidity premiums C) increasing expected short rates and decreasing liquidity premiums D) increasing expected short rates and constant liquidity premiums E) constant expected short rates and increasing liquidity premiums
Answer: A Difficulty: Moderate Rationale: Both of the forces will act to increase the slope of the yield curve.
37. The yield curve is a component of A) the Dow Jones Industrial Average. B) the consumer price index. C) the index of leading economic indicators. D) the producer price index. E) the inflation index.
Answer: C Difficulty: Easy Rationale: Since the yield curve is often used to forecast the business cycle, it is used as
one of the leading economic indicators.
38. The most recently issued Treasury securities are called A) on the run. B) off the run. C) on the market. D) off the market. E) none of the above.
Answer: A Difficulty: Easy
Use the following to answer questions 39-42:
Suppose that all investors expect that interest rates for the 4 years will be as follows:
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39. What is the price of 3-year zero coupon bond with a par value of $1,000? A) $889.08 B) $816.58 C) $772.18 D) $765.55 E) none of the above
Answer: A Difficulty: Moderate Rationale: $1,000 / (1.03)(1.04)(1.05) = $889.08
40. 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) 3% C) 9% D) 10% E) none of the above
Answer: B Difficulty: Moderate Rationale: The forward interest rate given for the first year of the investment is given as
3% (see table above).
41. What is the price of a 2-year maturity bond with a 5% coupon rate paid annually? (Par
value = $1,000) A) $1,092.97 B) $1,054.24 C) $1,028.51 D) $1,073.34 E) none of the above
Answer: C Difficulty: Moderate Rationale: [(1.03)(1.04)]1/2 - 1 = 3.5%; FV = 1000, n = 2, PMT = 50, i = 3.5, PV =
$1,028.51
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