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Question 1

True or False?

A corporate bond of higher seniority should have a higher yield rate compared to a bond of lower seniority.

Answer 1

False

Question 2

True or False?

The lower the rating of a corporate bond, the lower the yield rate.

Answer 2

False

Question 3

True or False?

A corporate bond with a lower bid-ask spread should have a lower yield rate compared to a bond with a higher bid-ask spread.

Answer 3

True

Question 4

True or False?

A corporate bond with a call provision should have a lower yield rate compared to a bond with a put provision.

Answer 4

False

Question 5

True or False?

To achieve immunization, the convexity of the assets must equal the convexity of the liabilites.

Answer 5

False

Question 6

True or False?

The full immunization technique is designed to work for any change in the interest rate.

Answer 6

True

Question 7

True or False?

The theory of immunization was developed to protect against adverse effects created by changes in interest rates.

Answer 7

True

Question 8

What are the three assumptions that full and redington immunization strategies are based on?

Answer 8

1. Interest rates for all maturities are the same (flat yield curve)
2. When interest rates change, they change by the same amount for all maturities. This produces a parallel shift in the yield curve, thus maintaining a flat yield curve.
3. Cash flows do not change when interest rates change.

Question 9

The ___ theory states that interest rates differ by terms because lenders need enough/extra incentive to take risk in investing longer term investments.

Answer 9

Liquidity Preference / Opportunity Cost

Question 10

The ___ theory asserts that interest rates differ by terms because the pools of borrowers and lenders are different.

Answer 10

Market Segmentation

Question 11

The ___ is the compensation for the risk of lent money not fully repaid.

Answer 11

Default risk premium

Question 12

The ___ theory asserts that interest rates differ by terms because interest rates for longer term investments provide future expectations for interest rates on shorter term investments.

Answer 12

Expectations

Question 13

The ___ is the compensation for the extra cost of converting investments to cash.

Answer 13

Liquidity premium

Question 14

Name the 4 determinants of interest rates for corporate bonds.

Answer 14

• Liquidity
• Rating
• Seniority
• Call/put provisions

Question 15

The ___ theory states that interest rates differ by terms because if given enough compensation, lenders and borrowers are willing to move outside of their preferred term length.

Answer 15

Preferred Habitat

Question 16

The ___ is the compensation for accepting the risk of longer-term investments.

Answer 16

Maturity risk premium

Question 17

The ___ is the compensation for the loss of purchasing power of money.

Answer 17

Inflation premium

Question 18

The ___ is the tradeoff for current vs. future real consumption.

Answer 18

Real risk-free rate

Question 19

Name the 3 determinants of interest rates for lending products.

Answer 19

• Creditworthiness of borrower
• Type of loan
• Quality of security/guarantee

Question 20

Name the 3 determinants of interest rates for government bonds.

Answer 20

• Creditworthiness of issuer
• Tax treatment of interest payments
• Denomination of currency

Question 21

Name the 4 determinants of interest rates for savings products.

Answer 21

• Overhead costs
• Business environment
• Business strategy
• Perceived creditworthiness / credit rating

Question 22

True or False?

All else being equal, the rate on a secured loan should be greater than the rate on an unsecured loan.

Answer 22

False

Question 23

True or False?

All else being equal, the rate on a loan with guaranteed repayment should be greater than the rate on a loan without guaranteed repayment.

Answer 23

False

Question 24

True or False?

All else being equal, the rate on a loan for a borrower with high credit score should be lower compared to another borrower with low credit score.

Answer 24

True

Question 25

The Federal Open Market Committee (FOMC) has decided to decrease the target level of the federal funds rate. Determine the effect on the reserving and lending activity of U.S. banks. ## Footnote A. It becomes more expensive for banks to run a shortfall in their reserve accounts; thus, banks will be motivated to write fewer loans, and the interest rates charged on those loans will decrease. B. It becomes more expensive for banks to run a shortfall in their reserve accounts; thus, banks will be motivated to write fewer loans, and the interest rates charged on these loans will increase. C. It becomes more expensive for banks to run a shortfall in their reserve accounts; thus, banks will be motivated to write more loans, and the interest rates charged on these loans will decrease. D. It becomes less expensive for banks to run a shortfall in their reserve accounts; thus, banks will be motivated to write more loans, and the interest rates charged on these loans will increase. E. It becomes less expensive for banks to run a shortfall in their reserve accounts; thus, banks will be motivated to write more loans, and the interest rates charged on these loans will decrease.

Answer 25

E

Question 26

Which of the following types of loans is backed by a third party, where the third party covers the lender's losses if the borrower defaults? ## Footnote I. Secured Loan II. Guaranteed Loan III. Unsecured Loan

Answer 26

Guaranteed Loan

Question 27

Consider the formula for the dollar-weighted rate of return. Determine which of the following conditions produces i closest to the annual effective yield rate. ## Footnote A. When each cash flow is small relative to A B. When each cash flow is large relative to A C. When each cash flow is large relative to I (the numerator) D. When the cash flows all have the same sign E. When the timing of the cash flows is uniform throughout the year

Answer 27

A

Question 28

The rate at which banks with insufficient reserve funds borrow from another bank having excess reserve funds is the...

Answer 28

federal funds rate

Question 29

True or False? Maturity risk premium compensates investors for taking the risk of longer-term investments.

Answer 29

True

Question 30

True or False? All else being equal, an increase in the number of potential lenders increases the lending interest rate.

Answer 30

False

Question 31

True or False? The liquidity preference theory states that borrowers need to pay a higher interest rate to persuade lenders to lend for longer terms.

Answer 31

True

Question 32

True or False? If the cost for inflation protection and the compensation for unexpected inflation are high, the difference between the nominal interest rate and the real interest rate overestimates the inflation rate.

Answer 32

True

Question 33

True or False? All else being equal, a decrease in the number of potential borrowers decreases the lending interest rate.

Answer 33

True

Question 34

True or False? If a portfolio satisifes the conditions for full immunization, it satisfies the conditions for Redington immunization as well.

Answer 34

True

Question 35

True or False? If a portfolio satisfies the conditions for Redington immunization, it satisfies the conditions for full immunization as well.

Answer 35

False

Question 36

True or False? The Redington immunization strategy works well for any one-time shift in interest rates.

Answer 36

False

Question 37

True or False? The full immunization strategy works well for any one-time shift in interest rate.

Answer 37

True

Question 38

Which of the following types of interest premiums best helps explain why yield curves are typically upward-sloping? ## Footnote A. Maturity risk premium B. Inflation premium C. Default risk premium D. Liquidity premium E. Delayed consumption premium

Answer 38

A

Question 39

True or False? If long-term interest rates are lower than short-term interest rates, the need for immunization is reduced.

Answer 39

False

Question 40

True or False? Either Macaulay duration or Modified duration can be used to develop an immunization strategy.

Answer 40

True

Question 41

True or False? Both processes of matching the present values of the cash flows or the flows themselves will produce exact matching.

Answer 41

False

Question 42

Which of the following statements are false regarding banks and bonds? ## Footnote A. In general, commercial banks would prefer to loan money from other commercial banks rather than the central bank. B. Increasing the federal funds rate decreases the amount of money banks are willing to loan out. C. Customers receive the savings rate on their deposits into banks D. A callable bond bought at a discount would be priced lower than an otherwise equivalent bond bought at a discount without a call E. A putable bond bought at a discount would be priced higher than an otherwise equivalent bond bought at a discount without a put.

Answer 42

D

Question 43

In terms of components of interest rates, what is the difference between a real interest rate and a nominal interest rate?

Answer 43

A real interest rate includes inflation protection while a nominal interest rate does not.

Question 44

True or False? All else being equal, a corporate bond with a higher bid-ask spread has a higher yield rate compared to a bond with a lower bid-ask spread.

Answer 44

True A higher bid-ask spread indicates a lower level of liquidity. A bond with a lower liquidity would have a higher liquidity premium. Thus, bond holders need to be compensated with a higher yield rate.

Question 45

True or False? All else being equal, the lower the rating of a corporate bond, the lower the yield rate.

Answer 45

False A bond with a lower rating means that the bond issuer has a lower level of creditworthiness. The yield rate should be higher because the bond holders need to be compensated with extra risk.

Question 46

True or False? A call provision permits corporate bond holders to sell the bond back to the bond issuer before maturity, thus a bond with such provision has a lower yield rate.

Answer 46

False A call provision allows bond issuers to redeem the bond earlier than maturity. A put provision allows bond holders to sell the bond back to the bond issuer before maturity.

Question 47

True or False? All else being equal, a corporate bond of higher seniority has a lower yield rate.

Answer 47

True A bond with a higher seniority would have a higher price, thus, a lower yield rate.

Question 48

True or False? An advantage of the Redington immunization technique over the cash-flow matching technique is that the portfolio manager has more investment choices available.

Answer 48

True Cash-flow matching limits the number of investment choices available to the portfolio manager to a subset of the choices available for immunization.

Question 49

True or False? A cash-flow matched portfolio requires less rebalancing than a Redington immunized porfolio, but more rebalancing than a fully immunized portfolio.

Answer 49

False Cash-flow matched porfolio does not require any rebalancing.

Question 50

For loans with inflation protection, the interest rate charged is:

Answer 50

r - c + i_a

Question 51

For loans without inflation protection, the interest rate charged is:

Answer 51

r + i_e + i_u

Question 52

In an interest rate swap, the counterparty who agrees to pay the variable rate and receive the fixed rate is called the \_\_\_.

Answer 52

Receiver

Question 53

In an interest rate swap, the settlement period is...

Answer 53

the time between settlement dates

Question 54

True or False? Treasury bills have a term of one year or less

Answer 54

True

Question 55

True or False? ## Footnote Revenue bonds are bonds issued by governmental institutions that are repaid using funds collected, such as tax revenues.

Answer 55

False

Question 56

True or False? ## Footnote Bonds issued by state and local governments would have a lower-than-usual yield rate if the interest payments are taxed at a preferred rate.

Answer 56

True

Question 57

True or False? ## Footnote Real return bonds are bonds where interest payments and maturity values are adjusted for inflation.

Answer 57

True