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1Copyright©2010PearsonEducationInc.PublishingasPrenticeHallFoundationsofFinancialMarketsandInstitutions,4e(Fabozzi/Modigliani/Jones)Chapter11TheTermStructureofInterestRatesMultipleChoiceQuestions1TheYieldCurveandtheTermStructure1)MarketparticipantshavetendedtoconstructyieldcurvesfromobservationsofpricesandyieldsintheTreasurymarket.Tworeasonsaccountforthistendency.WhichofthebelowisONEofthesereasons?A)Thesmallestandmostinactivebondmarket,theTreasurymarketoffersthefewestproblemsofilliquidityorfrequenttradingB)Treasurysecuritieshaveasmallamountsofdefaultrisk,anddifferencesincreditworthinessdoaffectyieldestimates.C)Thelargestandmostactivebondmarket,theTreasurymarketoffersthefewestproblemsofilliquidityorinfrequenttrading.D)Treasurysecuritiesarefullofdefaultrisk,anddifferencesincreditworthinessdonotaffectyieldestimates.Answer:CComment:MarketparticipantshavetendedtoconstructyieldcurvesfromobservationsofpricesandyieldsintheTreasurymarket.Tworeasonsaccountforthistendency.First,Treasurysecuritiesarefreeofdefaultrisk,anddifferencesincreditworthinessdonotaffectyieldestimates.Second,asthelargestandmostactivebondmarket,theTreasurymarketoffersthefewestproblemsofilliquidityorinfrequenttrading.Diff:2Topic:11.1TheYieldCurveandtheTermStructureObjective:11.4howatheoreticalspotratecurvecanbedeterminedfromtheTreasuryyieldcurve2)MorerecentlymarketparticipantshavecometorealizethatthetraditionallyconstructedTreasuryyieldcurveis________measureoftherelationbetweenrequiredyieldandmaturitywiththekeyreasonisthatsecuritieswiththesamematuritymayactuallyprovide________.A)anunsatisfactory;differentyieldsB)anunsatisfactory;verysimilaryieldsC)asatisfactory;differentyieldsD)asatisfactory;verysimilaryieldsAnswer:AComment:MorerecentlymarketparticipantshavecometorealizethatthetraditionallyconstructedTreasuryyieldcurveisanunsatisfactorymeasureoftherelationbetweenrequiredyieldandmaturitywiththekeyreasonisthatsecuritieswiththesamematuritymayactuallyprovidedifferentyields.Diff:2Topic:11.1TheYieldCurveandtheTermStructureObjective:11.1whattheyieldcurveis2Copyright©2010PearsonEducationInc.PublishingasPrenticeHall3)Becauseofthedifferentcashflowpatterns,itisnotappropriatetouse________todiscountallcashflowsbecauseeachcashflowshouldbediscountedat________thatisappropriateforthetimeperiodinwhichthecashflowwillbereceived.A)thesameinterestrate;adifferentinterestrateB)thesameinterestrate;auniqueinterestrateC)adifferentinterestrate;acommoninterestrateD)adifferentinterestrate;auniqueinterestrateAnswer:BComment:Becauseofthedifferentcashflowpatterns,itisnotappropriatetousethesameinterestratetodiscountallcashflowsbecauseeachcashflowshouldbediscountedatauniqueinterestratethatisappropriateforthetimeperiodinwhichthecashflowwillbereceived.Diff:2Topic:11.1TheYieldCurveandtheTermStructureObjective:11.4howatheoreticalspotratecurvecanbedeterminedfromtheTreasuryyieldcurve4)ThecorrectwaytothinkaboutbondsAandBisnotasbondsbutaspackagesof________.A)couponpayments.B)separatebondinstruments.C)zero-couponswithoutpayments.D)zero-couponinstruments.Answer:DComment:ThecorrectwaytothinkaboutbondsAandBisnotasbondsbutaspackagesofcashflows.Morespecifically,theyarepackagesofzero-couponinstruments.Diff:2Topic:11.1TheYieldCurveandtheTermStructureObjective:11.3whatismeantbyaspotrateandaspotratecurve5)WhichofthebelowstatementsisFALSE?A)Todeterminethevalueofeachzero-couponinstrument,itisnecessarytoknowtheyieldonazero-couponTreasurywiththatsamematurity─thisyieldiscalledtheforwardrate.B)Eachzero-couponinstrumentinthepackagehasamaturityequaltoitscouponpaymentdateor,inthecaseoftheprincipal,thematuritydate.C)Thevalueofthebondshouldequalthevalueofallthecomponentzero-couponinstruments.D)thegraphicaldepictionoftherelationshipbetweenthespotrateanditsmaturityiscalledthespotratecurve.Answer:AComment:Todeterminethevalueofeachzero-couponinstrument,itisnecessarytoknowtheyieldonazero-couponTreasurywiththatsamematurity─thisyieldiscalledthespotrate.Diff:2Topic:11.1TheYieldCurveandtheTermStructureObjective:11.2thedifferentshapesthatthetermstructurecantake3Copyright©2010PearsonEducationInc.PublishingasPrenticeHall6)ItisimportanttorememberthatthebasicprincipleunderlyingbootstrappingisthatthevalueoftheTreasurycouponsecurityshouldbeequaltothevalueofthepackageof________thatduplicatesthe________.A)couponpayingT-Bills;couponbond'scashflowB)zero-couponTreasurysecurities;couponbond'scashflowC)couponpayingT-Bills;discountbond'scashflowD)zero-couponTreasurysecurities;discountbond'scashflowAnswer:BDiff:2Topic:11.1TheYieldCurveandtheTermStructureObjective:11.4howatheoreticalspotratecurvecanbedeterminedfromtheTreasuryyieldcurve7)ATreasurybillisazero-couponinstrument.Therefore,itsannualizedyieldisequaltothespotrate.Similarly,fortheone-yearTreasury,itscitedyieldistheone-yearspotrate.Giventhesetwospotrates,wecancomputethespotratefor________.A)atheoretical0.5-yearzero-couponTreasury.B)atheoretical1.0-yearzero-couponTreasury.C)atheoretical1.5-yearzero-couponTreasury.D)atheoretical2.0-yearzero-couponTreasury.Answer:CDiff:2Topic:11.1Th