Lecture 3: Basic Fixed Income Flashcards
The (no arbitrage) price of a bond is given by the present value of each of the future payments of the bond
True/ False
True
Before economic expansions, the yield curve (term structure of corporate and treasury bonds) tends to be (upward/ downward) _____ sloping.
Before economic recessions, the yield curve (term structure of corporate and treasury bonds) tends to be (upward/ downward) _____ sloping.
Before economic expansions, the yield curve (term structure of corporate and treasury bonds) tends to be UPWARD sloping.
Before economic recessions, the yield curve (term structure of corporate and treasury bonds) tends to be DOWNWARD sloping.
The yield curve/ term structure of
The yield curve/ term structure of interest rates illustrates the variation of the rate with _____
Fill in the blank word.
Maturity
How is net interest margin calculated?
Net Interest Margin = (Interest income - interest expenses) / Avg. interest earning assets
Which of the following statement(s) is/are true for net interest margins? (Select 1-4)
A) The NIM ranges between ~3-4% in US
B) NIM is typically higher for smaller banks
C) NIM is typically higher for larger banks
D) NIM tends to be lower in Europe relative to US
E) NIM tends to be stable
A) The NIM ranges between ~3-4% in US
B) NIM is typically higher for smaller banks
D) NIM tends to be lower in Europe relative to US
E) NIM tends to be stable
WRONG: C) NIM is typically higher for larger banks
–> Larger banks make more money from fees and service charges
Name the three main types of interest rates
Treasury rates
LIBOR rates
Overnight rates (ON rates)
Which of the following statements is/are FALSE about treasury rates? (Select 1-4)
A) They are the short term interbank rate
B) They are the rates an investor earns on Treasury bills and bonds
C) They are used by governments to borrow in its own currency
D) They are usually regarded as risk-free
A) They are the short term interbank rate
Which of the following statements is/are TRUE about LIBOR rates? (select 1-5)
A) It is a money-market interest rate
B) It is the unsecured short-term borrowing rate between banks (interbank rate)
C) It is calculated every business day for seven maturities (over-night to one year) and five currencies
D) It has local variations, e.g., EURIBOR, CIBOR, STIBOR, TIBOR, etc.
E) It is calculated as a trimmed average reported by banks from the LIBOR panel
All options are correct
What is the problem/ shortcoming of LIBOR rates?
Banks part of the LIBOR panel can report internally estimated quotes (non-binding). Banks can therefore lower the rates, allowing for lower borrowing rates and more profitable interest rate swap transactions
Which of the following statements is/are FALSE about overnight (ON) rates? (select 1-5)
A) They are the interest rates that large banks use to borrow and lend from each other (interbank) in the overnight market
B) Most countries have an official ON rate calculated as weighted average of actual transactions
C) ON rates have come to replace the LIBOR rates in many countries
D) They are used by governments to determine the rate by which banks can borrow from the central bank
D) They are used by governments to determine the rate by which banks can borrow from the central bank
____ equals the payment-weighted average of the time-to-maturity.
Fill in the blank.
A) Duration
B) Modified duration
C) Yield to maturity
D) Dollar duration
(A) DURATION equals the payment-weighted average of the time-to-maturity.
Which of the following statements are TRUE about modified duration?
A) It measures the percentage change in the bond price for a unit change in the yield
B) It is always equal to or lower than the duration
C) With continuous compounding, we get that the MD = D
D) It determines the change in the absolute value of the bond for a unit change in the yield
A) It measures the percentage change in the bond price for a unit change in the yield
B) It is always equal to or lower than the duration
C) With continuous compounding, we get that the MD = D
Which of the following statements are TRUE about dollar duration?
A) It determines the change in absolute value of the bond
B) It determines the percentage change in the value of the bond
C) The measure is equivalent to the delta of options
D) $D/100 tells us how much the portfolio will lose in value, if the yield increases by one percentage point
A) It determines the change in absolute value of the bond
C) The measure is equivalent to the delta of options
D) $D/100 tells us how much the portfolio will lose in value, if the yield increases by one percentage point
WRONG: B) It determines the percentage change in the value of the bond –> this is the modified duration
As the yield-to-maturity change increases in magnitude, how well does the duration-based approximation of bond value change work?
A) Increases in preciseness
B) Decreases in preciseness
B) Decreases in preciseness
The larger the yield change, the lower precision is provided by the duration-based approximation of bond price change given yield change.
See relation on graph on pp. 86 in lecture notes
