Question 1

Assuming the same coupon rate and maturity length,when the interest rate on a Treasury Inflation Protected Security is 3 percent,and the yield on a nonindexed Treasury bond is 8 percent,the expected rate of inflation is
A)3 percent.
B)5 percent.
C)8 percent.
D)11 percent.

Accepted Answer

The difference between the two yields, known as the breakeven inflation rate, is a measure of expected inflation. In this case, the breakeven inflation rate is 8%-3% = 5%. Therefore, the expected rate of inflation is 5%.

Question 2

The duration of a coupon bond increases
A)the longer is the bond's term to maturity.
B)when interest rates increase.
C)the higher the coupon rate on the bond.
D)the higher the bond price.

Accepted Answer

The duration of a coupon bond increases with an increase in the bond's term to maturity. This is because the longer the bond's term to maturity, the greater the impact of changes in interest rates on the bond's price. Therefore, the duration of the bond, which measures the sensitivity of the bond's price to changes in interest rates, increases.

Question 3

The interest rate on Treasury Inflation Protected Securities is a direct measure of
A)the real interest rate.
B)the nominal interest rate.
C)the rate of inflation.
D)the rate of deflation.

Accepted Answer

The interest rate on Treasury Inflation Protected Securities (TIPS) is a direct measure of the real interest rate because TIPS are designed to provide investors with a return that is adjusted for inflation. By subtracting the inflation rate from the TIPS yield, investors can calculate the real rate of return on their investment. Therefore, the TIPS interest rate reflects the actual return investors can expect to receive above inflation.

Question 4

Duration is
A)an asset's term to maturity.
B)the time until the next interest payment for a coupon bond.
C)the average lifetime of a debt security's stream of payments.
D)the time between interest payments for a coupon bond.

Accepted Answer

Duration is the measure of the average lifetime of a debt security's stream of payments, taking into account both the timing and amount of payments. It is a useful way to compare the interest rate risk of different securities as it gives a good estimate of how sensitive a bond's price is to changes in interest rates. Therefore, option C is the most appropriate answer. Options A, B, and D are related to specific aspects of bond terms and payment schedules, but are not comprehensive measures of interest rate risk.

Question 5

Comparing a discount bond and a coupon bond with the same maturity,
A)the coupon bond has the greater effective maturity.
B)the discount bond has the greater effective maturity.
C)the effective maturity cannot be calculated for a coupon bond.
D)the effective maturity cannot be calculated for a discount bond.

Accepted Answer

The answer of Comparing a discount bond and a coupon...

Question 6

Assuming the same coupon rate and maturity length,the difference between the yield on a Treasury Inflation Protected Security and the yield on a nonindexed Treasury security provides insight into
A)the nominal interest rate.
B)the real interest rate.
C)the nominal exchange rate.
D)the expected inflation rate.

Accepted Answer

The answer of Assuming the same coupon rate and maturity...

Question 7

If the nominal rate of interest is 2 percent,and the expected inflation rate is -10 percent,the real rate of interest is
A)2 percent.
B)8 percent.
C)10 percent.
D)12 percent.

Accepted Answer

The real rate of interest is calculated using the formula:

Real interest rate = Nominal interest rate - Inflation rate

Substituting the given values, we get:

Real interest rate = 2% - (-10%) = 2% + 10% = 12%

Therefore, the real rate of interest is 12 percent, which is option D.

Question 8

All else equal,the ________ the coupon rate on a bond,the ________ the bond's duration.
A)higher; longer
B)higher; shorter
C)lower; shorter
D)greater; longer

Accepted Answer

Duration measures the sensitivity of the bond's price to changes in interest rates. Higher coupon rates mean that the bond is paying out more cash flows, which reduces the bond's sensitivity to interest rate changes, therefore reducing duration.

Question 9

In which of the following situations would you prefer to be the lender?
A)The interest rate is 9 percent and the expected inflation rate is 7 percent.
B)The interest rate is 4 percent and the expected inflation rate is 1 percent.
C)The interest rate is 13 percent and the expected inflation rate is 15 percent.
D)The interest rate is 25 percent and the expected inflation rate is 50 percent.

Accepted Answer

In option B, the interest rate is higher than the expected inflation rate, which means that the lender will earn a real interest rate (interest rate - inflation rate) and their purchasing power will not decrease over time. In options A, C, and D, the inflation rate is either close to or higher than the interest rate, which means that the lender will either earn a very low real interest rate or even lose purchasing power over time.

Question 10

If you expect the inflation rate to be 4 percent next year and a one year bond has a yield to maturity of 7 percent,then the real interest rate on this bond is
A)-3 percent.
B)-2 percent.
C)3 percent.
D)7 percent.

Accepted Answer

The real interest rate can be approximated using the Fisher equation: real interest rate ≈ nominal interest rate - inflation rate. Therefore, 7% - 4% = 3%.

Question 11

If you expect the inflation rate to be 15 percent next year and a one-year bond has a yield to maturity of 7 percent,then the real interest rate on this bond is
A)7 percent.
B)22 percent.
C)-15 percent.
D)-8 percent.

Accepted Answer

The real interest rate is calculated as nominal interest rate - inflation rate.
Here, the nominal interest rate is the yield to maturity of 7% and the inflation rate is expected to be 15%.
Real interest rate = 7% - 15% = -8%
Therefore, the real interest rate on this bond is -8%, which means that the purchasing power of the principal amount invested in this bond will decrease by 8% after accounting for inflation.

Question 12

All else equal,when interest rates ________,the duration of a coupon bond ________.
A)rise; falls
B)rise; increases
C)falls; falls
D)falls; does not change

Accepted Answer

When interest rates rise, the present value of future cash flows decreases. As a result, the price of the bond falls. The longer the time to maturity, the greater the sensitivity of the bond's price to changes in interest rates. Duration captures this sensitivity, so as interest rates rise, duration falls.

Question 13

In the United States during the late 1970s,the nominal interest rates were quite high,but the real interest rates were negative.From the Fisher equation,we can conclude that expected inflation in the United States during this period was
A)irrelevant.
B)low.
C)negative.
D)high.

Accepted Answer

The Fisher equation states that nominal interest rate = real interest rate + expected inflation rate. Therefore, if nominal interest rates were high and real interest rates were negative, then expected inflation must have been high as well. This explains why investors demanded high nominal interest rates to compensate for the expected loss of purchasing power due to high inflation.

Question 14

The interest rate that describes how well a lender has done in real terms after the fact is called the
A)ex post real interest rate.
B)ex ante real interest rate.
C)ex post nominal interest rate.
D)ex ante nominal interest rate.

Accepted Answer

The term ex post means "after the event," so the ex post real interest rate is the rate that measures a lender's actual return after adjusting for inflation.

Question 15

If a financial institution has 50% of its portfolio in a bond with a five-year duration and 50% of its portfolio in a bond with a seven-year duration,what is the duration of the portfolio?
A)12 years
B)7 years
C)6 years
D)5 years

Accepted Answer

We can use the weighted average formula to calculate the duration of the portfolio:

Duration of portfolio = (weight of bond A * duration of bond A) + (weight of bond B * duration of bond B)

Plugging in the values:

Duration of portfolio = (0.5 * 5 years) + (0.5 * 7 years) 
= 2.5 years + 3.5 years 
= 6 years

Therefore, the duration of the portfolio is 6 years.

Question 16

When the ________ interest rate is low,there are greater incentives to ________ and fewer incentives to ________.
A)nominal; lend; borrow
B)real; lend; borrow
C)real; borrow; lend
D)market; lend; borrow

Accepted Answer

When the real interest rate is low, it means that inflation is high relative to the interest rate. As a result, there are greater incentives for individuals and businesses to borrow money at a lower cost and invest in various projects, which can help boost the overall economy. On the other hand, lenders will have fewer incentives to lend money because the returns on their investment will be relatively lower compared to when the interest rate is higher.

Question 17

The ________ states that the nominal interest rate equals the real interest rate plus the expected rate of inflation.
A)Fisher equation
B)Keynesian equation
C)Monetarist equation
D)Marshall equation

Accepted Answer

The Fisher equation states that the nominal interest rate equals the real interest rate plus the expected rate of inflation. This equation is named after economist Irving Fisher, who first presented it in his 1930 book "The Theory of Interest."

Question 18

If you expect the inflation rate to be 12 percent next year and a one-year bond has a yield to maturity of 7 percent,then the real interest rate on this bond is
A)-5 percent.
B)-2 percent.
C)2 percent.
D)12 percent.

Accepted Answer

The real interest rate can be approximated using the Fisher equation: real interest rate ≈ nominal interest rate - inflation rate. Here, it's 7% - 12% = -5%.

Question 19

In which of the following situations would you prefer to be the borrower?
A)The interest rate is 9 percent and the expected inflation rate is 7 percent.
B)The interest rate is 4 percent and the expected inflation rate is 1 percent.
C)The interest rate is 13 percent and the expected inflation rate is 15 percent.
D)The interest rate is 25 percent and the expected inflation rate is 50 percent.

Accepted Answer

The answer of In which of the following situations would...

Question 20

Would it make sense to buy a house when mortgage rates are 14% and expected inflation is 15%? Explain your answer.

Accepted Answer

The answer of Would it make sense to buy a...

Quiz 4: Understanding Interest Rates

Assuming the same coupon rate and maturity length,when the interest rate on a Treasury Inflation Protected Security is 3 percent,and the yield on a nonindexed Treasury bond is 8 percent,the expected rate of inflation is

The duration of a coupon bond increases

The interest rate on Treasury Inflation Protected Securities is a direct measure of

Duration is

Comparing a discount bond and a coupon bond with the same maturity,

Assuming the same coupon rate and maturity length,the difference between the yield on a Treasury Inflation Protected Security and the yield on a nonindexed Treasury security provides insight into

If the nominal rate of interest is 2 percent,and the expected inflation rate is -10 percent,the real rate of interest is

All else equal,the the coupon rate on a bond,the the bond's duration.

In which of the following situations would you prefer to be the lender?

If you expect the inflation rate to be 4 percent next year and a one year bond has a yield to maturity of 7 percent,then the real interest rate on this bond is

If you expect the inflation rate to be 15 percent next year and a one-year bond has a yield to maturity of 7 percent,then the real interest rate on this bond is

All else equal,when interest rates ,the duration of a coupon bond .

In the United States during the late 1970s,the nominal interest rates were quite high,but the real interest rates were negative.From the Fisher equation,we can conclude that expected inflation in the United States during this period was

The interest rate that describes how well a lender has done in real terms after the fact is called the

If a financial institution has 50% of its portfolio in a bond with a five-year duration and 50% of its portfolio in a bond with a seven-year duration,what is the duration of the portfolio?

When the interest rate is low,there are greater incentives to and fewer incentives to .

The ________ states that the nominal interest rate equals the real interest rate plus the expected rate of inflation.

If you expect the inflation rate to be 12 percent next year and a one-year bond has a yield to maturity of 7 percent,then the real interest rate on this bond is

In which of the following situations would you prefer to be the borrower?

Would it make sense to buy a house when mortgage rates are 14% and expected inflation is 15%? Explain your answer.