Question 1

The term convexity,
A) Quantifies the relationship between price risk and yield
B) Measures the rate of change of price elasticity with respect to yield
C) Measures how the investor's risk diminishes as interest rates rise
D) All of the above
E) None of the above

Accepted Answer

Convexity quantifies the relationship between bond price and yield, measures the rate of change of duration (which is related to price elasticity) with respect to yield, and also reflects how price sensitivity changes with yield changes, indirectly affecting investor's risk as interest rates move.

Question 2

The published or quoted rate of interest attached to a loan or security is called the:
A) Interest rate
B) Risk-free rate
C) Real rate
D) Promised rate
E) None of the above

Accepted Answer

The answer of The published or quoted rate of interest...

Question 3

Price deflation:
A) Tends to force both real and nominal interest rates lower
B) Tends to increase investment spending and the development of new jobs
C) Will cause borrowers to gain at the expense of lenders
D) All of the above
E) None of the above

Accepted Answer

Price deflation tends to increase the real burden of debt, as the value of money increases, making it harder for borrowers to pay back their loans. This can lead to decreased investment spending and potentially fewer new jobs, as businesses and consumers cut back on spending. Additionally, deflation can lead to higher real interest rates as nominal rates adjust downward less quickly than prices, making lending less attractive. Therefore, deflation does not tend to force both real and nominal interest rates lower, nor does it tend to increase investment spending and the development of new jobs. Instead, it causes borrowers to lose at the expense of lenders, as the real value of the money they have to pay back increases.

Question 4

In 1997, the U.S. Treasury issued inflation-indexed bonds, known as Treasury Inflation Protection Securities (TIPS). Reasons for doing so include:
A) The Treasury expected a protracted period of high inflation
B) To save the Treasury money
C) So that investors could separate exchange rate risk from interest-rate risk exposure
D) Choices A and B only
E) None of the above

Accepted Answer

The answer of In 1997, the U.S. Treasury issued inflation-indexed...

Question 5

When the risk that interest-rate changes will affect the total dollar return from a security portfolio is reduced to zero, this is referred to as:
A) Hedging
B) Portfolio protection
C) Duration
D) Zero price elasticity
E) None of the above

Accepted Answer

The answer of When the risk that interest-rate changes will...

Question 6

Yield curve studies of the yield spread between long-term and short-term government securities are being used to predict:
A) The probability of a recession
B) The near-term growth in profits
C) The size of government budget deficits
D) Choices A and C only
E) Choices A and B only

Accepted Answer

The yield curve, which plots the yields of short-term to long-term government securities, is a widely used tool to predict economic conditions. A normal yield curve (where long-term rates are higher than short-term rates) suggests economic expansion, while an inverted yield curve (where short-term rates are higher than long-term rates) is often seen as a predictor of economic recession. Therefore, the correct answer is A) The probability of a recession. The yield curve is not directly used to predict near-term growth in profits or the size of government budget deficits.

Question 7

Explain how the following effects connect inflation to changes in interest rates.
A. The inflation-caused income effect.
B. The inflation-caused wealth effect
C. The inflation-caused depreciation effect.
D. The inflation-caused tax effect.

Accepted Answer

The answer of Explain how the following effects connect inflation...

Question 8

Explain the difference between the expectations, market segmentation and liquidity premium views of the yield curve. What does each of these theories assume and what is the principal conclusion of each?

Accepted Answer

The answer of Explain the difference between the expectations, market...

Question 9

What are the implications for investors and for public policy of each of the yield-curve ideas mentioned in the preceding question?

Accepted Answer

The answer of What are the implications for investors and...

Question 10

What is the coupon effect? How does it relate to the concept of security price elasticity?

Accepted Answer

The answer of What is the coupon effect? How does...

Question 11

What is the relationship between the coupon rate on an asset and the volatility of its price as interest rates change?

Accepted Answer

The answer of What is the relationship between the coupon...

Question 12

What is portfolio immunization? How does it work?

Accepted Answer

The answer of What is portfolio immunization? How does it...

Question 13

Suppose the real rate is 4 percent and the nominal rate is 9 percent. Now investors expect a sudden doubling in the rate of inflation. According to the Fisher effect, what new rate of inflation is expected? If the depreciation, income and wealth effects are at work, what do you conclude is the new expected rate of inflation?

Accepted Answer

The answer of Suppose the real rate is 4 percent...

Question 14

Calculate the expected after-tax real rate of return for an investor in the 28 percent marginal income tax bracket if he or she purchases a bond whose nominal rate is 12 percent and the expected inflation rate is 4 percent.

Accepted Answer

The answer of Calculate the expected after-tax real rate of...

Question 15

Calculate the price elasticity of a 15-year bond around its $1,000 par value and 10-percent coupon rate if market interest rates on comparable securities drop to 6 percent. The market price of the bond is $1,392. Suppose now that the yield to maturity climbs to 14%. If the bond's price falls to $751.80, what is the bond's price elasticity?

Accepted Answer

The answer of Calculate the price elasticity of a 15-year...

Question 16

A government bond is scheduled to mature in 5 years. Its coupon rate is 10 percent, with interest paid to holders of record at the conclusion of each year. This $1,000 par value carries a current yield to maturity of 10 percent. What is its duration?

Accepted Answer

The answer of A government bond is scheduled to mature...

Question 17

A bank grants a loan to AXTEL Corporation for three years to cover repairs at one of its production units. The terms of this $10 million loan call for the accrual of interest by the bank at a compound interest rate of 9 percent. However, the interest and the principal owed on this loan are due and payable when the loan matures at the end of the third year. What is the duration of this loan?

Accepted Answer

The answer of A bank grants a loan to AXTEL...

Question 18

A TIPS issued 5 years ago for $1,000 with a 10 percent coupon rate and maturing today had the following inflation history:
  How did the nominal principal value and nominal interest payment associated with this bond change over its lifetime?

Accepted Answer

The answer of A TIPS issued 5 years ago for...

Question 19

Using each of the descriptions given below, identify the key term or concept that goes with them.
 a. Duration matches the length of the investor's planned holding period. 
b. Weighted average maturity of a financial asset. 
c. Ratio of changes in the price of a financial instrument relative to changes in its yield. 
d. The size of an asset's promised yield influences how rapidly its price changes as market interest rates move. 
 e. Investors prefer certain asset maturities due to such factors as their liquidity needs, tax exposure and risk.

Accepted Answer

The answer of Using each of the descriptions given below,...

Question 20

Using each of the descriptions given below, identify the key term or concept that goes with them.
 a. Maturity preferences of active investors divide up the financial markets into different sub-markets. 
b. Investors must receive an extra component of yield or return in order to accept the risk of longer-term financial instruments. 
c. Graphical representation of yield to maturity versus calendar time. 
d. Dominant determinant of a yield curve's shape is investors' anticipation of future interest rate movements. 
e. Adjusts payment of income to an investor based upon the actual rate of inflation.

Accepted Answer

The answer of Using each of the descriptions given below,...

Quiz 7: Effects of Inflation and Yield Curves on Stock Prices and Investments

The term convexity,

The published or quoted rate of interest attached to a loan or security is called the:

Price deflation:

In 1997, the U.S. Treasury issued inflation-indexed bonds, known as Treasury Inflation Protection Securities (TIPS) . Reasons for doing so include:

When the risk that interest-rate changes will affect the total dollar return from a security portfolio is reduced to zero, this is referred to as:

Yield curve studies of the yield spread between long-term and short-term government securities are being used to predict:

Explain how the following effects connect inflation to changes in interest rates. A. The inflation-caused income effect. B. The inflation-caused wealth effect C. The inflation-caused depreciation effect. D. The inflation-caused tax effect.