Question-Answer

Posted: August 27th, 2021

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1. A stripped bond is created by an Investment Dealer who “strips” the coupons from the Corpus (or Face or Body) to create a new security with just one cash flow at some future date.  What would you expect to pay for a $50,000 stripped bond with a maturity 25 years from today, given a YTM of 8%?

Select one: 

1. $14,662
2. $9,212
3. $8,776
4. $7,301
5. There are many different types of bonds, some of which are quite new.  Which of the following statements are true with respect to these different types of bonds?

Select one:

1. A CAT bond is usually issued by insurance companies to move the risk of large earthquakes and hurricanes off of their Balance Sheets and into the capital markets
2. A “death bond” or life settlement account gives an aging baby boomer a chance to monetize (or sell) an existing life insurance policy for immediate cash proceeds.
3. A convertible bond gives the investor both upside potential (from the conversion option) and downside protection (from the bond value).
4. A real return bond provides protection against inflation by grossing up the face value prior to the payment of each coupon.  At maturity, the investor receives the grossed up face value plus the final coupon.
5. All of the above are true statements.
6. It is very important that you understand how to read and interpret a bond quotation.  Let’s assume that you see a bond’s market price quoted at 98.90.  Which of the following statements are true with respect to this quotation?

Select one:

1. The bond is currently selling at 89.90% of its face value
2. The YTM is 98.90% of the coupon rate
3. The bond has 98.90% of its initial life (or term to maturity) remaining.
4. The bond is selling at $989.00 per $1,000 of face value. 
5. None of the above are true statements
6. The Fisher Equation is very important in helping us understand the relationship between the Nominal Rate, the Real Rate and the Expected Inflation Rate.  If the current Nominal Rate is 6% and the Expected Inflation Rate is 4%, the Real Rate (computed using the Approximation) must be?

Select one:

1. 8%
2. 6%
3. 4%
4. 2%
5. None of the above are correct

• If you were to use the Exact formula to solve for the Real Rate in the question above, it would be?

Select one:

a. 4.0%

b. 3.92%

c. 1.92%

d. 3.65%

e. None of the above are correct

6. You are advising a relative on the market’s expectation for future interest rates.  You have observed that current spot rates on 2-year money are 3.75% and current spot rates on 5-year money are 4.6%.  What is the market predicting for the rate on 3-year money, two years from now?

Select one:

a. 4.44%

b. 4.61%

c. 4.84%

d. 5.17%

e. 5.29%

7. Continue with the information provided in the Question above.  If you believe that the actual 3-year interest rate, two years from now, will be 5.0%, instead of the rate computed above, which of the following would be the appropriate course of action for the borrower to take?
Select one:

a. Lock in the long rate now

b. Borrow short (2 years) and then roll over into a three-year loan

c. You would be indifferent between locking in the long rate and borrowing short and rolling over

d. Both options are the same

e. None of the above are the correct course of action

8. Which of the following statements about the yield curve or term structure are correct?

Select one:

a. According to the unbiased expectations theory of the term structure, an upward sloping term structure suggests that future short rates should rise

b. The normal slope of the term structure is upward sloping (long rates are higher than short rates)

c. We normally expect to see the yield curve flatten and then invert as we approach the peak of the business cycle

d. The slope of the yield curve is a good predictor of future economic activity

e. All of the above statements are true

9. Yield spreads refer to the difference in yield between a safe government bond and a risky corporate bond of the same maturity.  Which of the following statements are true of the yield spread?
Select one:

a. The yield spread widens during recessions and narrows during expansions

b. The yield spread does not change over the business cycle

c. Yields on safe government bonds are always higher than yields on risky corporate bonds

d. All of the above statements are true

e. None of the above statements are true

10. A 5-year, $1,000 face bond with a 3.5% coupon, paid annually, is currently selling with a 4% YTM (yield to maturity).  What is the purchase price of the bond?

Select one:

a. $924.88

b. $955.48

c. $977.74

d. $1,000.00

e. $1,024.13

11. Now assume that you purchase a 5-year, $1,000 face bond with a 3.5% coupon, paid annually, currently selling with a 4% YTM (yield to maturity).  Immediately after you purchase the bond, the reinvestment rate in the market drops to 3%.  What is your realized yield on your bond investment?

Select one:

a. 4.11%

b. 4.00%

c. 3.93%

d. 3.80%

e. 3.27%

12. A 5-year, $1,000 face bond with a 3.5% coupon, paid annually, is currently selling with a 4% YTM (yield to maturity). What is the duration of the bond?

Select one:

a. 4.95

b. 4.88

c. 4.67

d. 4.00

e. 3.72

13. Continue with the bond in Question #10.  If market yields were to drop by 1%, what is the approximate percentage change in price you would expect, based on the bond’s duration?

Select one:

a. 4.95%

b. 4.88%

c. 4.67%

d. 4.00%

e. 3.72%

14. Continue with the bond in Question #10 and your duration calculation.  How long should you hold the bond, if you want to earn the 4% YTM that you thought you would get when you bought the bond?

Select one:

a. 4.95 Years

b. 4.88 Years

c. 4.67 Years

d. 4.00 Years

e. 3.72 Years

15. Continue with the bond in Question #10 and your duration calculation.  Assume that market yields rise by 40 basis points.  What do you expect to happen to the bond’s price, using modified duration?

Select one:

a. $45.12 fall in price

b. $36.75 rise in price

c. $28.99 fall in price

d. $17.56 fall in price

e. $17.56 rise in price