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A) Flat.

B) Humped.

C) Upward sloping.

D) Downward sloping.

The correct answer was D)

An inverted yield curve reflects the condition where long-term rates are less than short-term rates,

giving it a downward (negative) slope.

2.Which of the following best explains the slope of the yield curve?

A) The term spread between the yields of two maturities.

B) The credit spread between two securities with different maturities.

C) The nominal spread between two securities with different maturities.

D) The option adjusted spread between two securities with different maturities.

The correct answer was A)

Since the yield curve depicts the yield on securities with different maturities, the slope of the curve

between two maturities is a function of the maturity spread.

3.The concept of spot and forward rates is most closely associated with which of the following

explanations of the term structure of interest rates?

A) Segmented market theory.

B) Preferred habitat hypothesis.

C) Liquidity premium theory.

D) Expectations hypothesis.

The correct answer was D)

The pure expectations theory purports that forward rates are solely a function of expected future

spot rates. In other words, long-term interest rates equal the mean of future expected short-term

rates. This implies that an investor could earn the same return by investing in a 1-year bond or by

sequentially investing in two 6-month bonds. The implications for the shape of the yield curve under

the pure expectations theory are:

If the yield-curve is upward sloping, short-term rates are expected to rise.

If the curve is downward sloping, short-term rates are expected to fall.

A flat yield curve implies that the market expects short-term rates to remain constant.

4.If investors expect future rates will be higher than current rates, the yield curve should be:

A) upward sweeping.

B) downward sweeping.

C) flat.

D) vertical.

The correct answer was A)

When interest rates are expected to go up in the future the yield curve will be upward sweeping

because time is on the x-axis and rates are on the y-axis, thus forming an upward sweeping curve.

5.A downward sloping yield curve generally implies:

A) interest rates are expected to increase in the future.

B) longer-term bonds are riskier than short-term bonds.

C) interest rates are expected to decline in the future.

D) shorter-term bonds are less risky than longer-term bonds.

The correct answer was C)

Since a yield curve has time on the x-axis and rates on the y-axis, when the yield curve is

downward sloping it means that rates are expected to decline.

6.Which of the following yield curves represents a situation where long-term rates are less than

short-term rates?

A) Normal yield curve.

B) Inverted yield curve.

C) Flat yield curve.

D) Humped yield curve.

The correct answer was B)

A normal yield curve is one in which long-term rates are greater than short-term rates. A flat yield

curve represents a situation where the yield on all maturities is essentially the same. A humped

yield curve represents a situation where rates in the middle of the maturity spectrum are higher or

lower than those for both bonds with a short and long-term maturity.

7.A normally sloped yield curve has a:

A) positive slope.

B) zero slope.

C) negative slope.

D) an infinite slope.

The correct answer was A)

A normally shaped yield curve is one in which long-term rates are greater than short-term rates,

thus the curve exhibits a positive slope.

1.Jonathon Silver, CFA, has a client, Alyce Grossberg, whose only current investment requirement is that she

wants to buy a premium bond. The required market yield is currently 7.25 percent at all maturities. Which of the

following $1,000 face value bonds should Silver select for Grossbergs portfolio? A

A) 15-year, zero-coupon bond priced to yield 9.00%.

B) 10-year, 8.00% semi-annual coupon bond.

C) 5-year, 7.25% annual coupon bond.

D) 10-year, 7.00% semi-annual coupon bond.

The correct answer was B)

A bond sells at a premium when the coupon rate is greater than the required market yield. Here, the 10-year,

8.00% semi-annual coupon bond would sell above par, or at a premium.

The 15-year, zero-coupon bond priced to yield 9.00% would sell at a discount. Zero-coupon bonds sell at a

discount from par, because they pay no coupon. (Coupon rate = 0.00%.) The 10-year, 7.00% semi-annual

coupon bond would also sell at a discount, because the coupon rate is less than the required market yield. The

7.25% annual coupon bond would sell at par, because the coupon rate equals the required market yield. Note:

The information that this is an annual coupon bond is not relevant for this question.

Type of Bond Market Yield to Coupon Price to Par

Premium Market Yield < Coupon Price> Par

Par Market Yield = Coupon Price = Par

Discount Market Yield> Coupon Price < Par

2.Kirsten Thompson, CFA candidate, is studying the relationships between a bonds coupon rate and the

required market yield. One study question concerns a new-issue, 15-year, $1,000 face value 6.75 percent semi-

annual coupon bond priced at $1,075. Which of the following choices correctly describes the bond

and accurately represents the relationship of the bonds market yield to the coupon?

A) Premium bond, required market yield is less than 6.75%.

B) Premium bond, required market yield is greater than 6.75%.

C) Discount bond, required market yield is less than 6.75%.

D) Discount bond, required market yield is greater than 6.75%.

The correct answer was A)

When the issue price is greater than par, the bond is selling at a premium. We also know that the current market

required rate is less than the coupon rate of 6.75%, because the bond is selling at a premium.

For the examination, remember the following relationships:

Type of Bond Market Yield to Coupon Price to Par

Premium Market Yield < Coupon Price> Par

Par Market Yield = Coupon Price = Par

Discount Market Yield> Coupon Price < Par

3.Gabrielle Daniels and Edin Roth, CFA candidates, are discussing the relationship between a bonds coupon

rate and the required market yield. Looking through the local newspaper, they see a new-issue, 10-year, $1,000

face value 8.00 percent semi-annual coupon bond priced at $950. Daniels makes the following statements.

Which statement does Roth tell her is CORRECT?

A) The current market required rate is less than the coupon rate.

B) The bond is selling at a premium.

C) The bond is low-quality.

D) The bond is selling at a discount.

The correct answer was D)

When the issue price is less than par, the bond is selling at a discount.

We also know that the current market required rate is greater than the coupon rate because the bond is selling

at a discount. We cannot determine credit quality from the information provided.

4.Given that the information on the three bonds below is at issuance, which of the following choices correctly

identifies the bonds as premium, par, and discount.

Bond Market Rate Coupon Rate

1 8.00% 7.00%

2 7.25% 7.50%

3 6.75% 6.75%

Bond 1 Bond 2 Bond 3

B) discount premium par

C) par premium discount

D) par discount premium

The correct answer was B)

For the examination, remember the following relationships:

Type of Bond Market Yield to Coupon Price to Par

Premium Market Yield < Coupon Price> Par

Par Market Yield = Coupon Price = Par

Discount Market Yield> Coupon Price < Par

5.If the market rate of interest is greater than the coupon rate, the bond will be valued:

A) at par.

B) less than par.

C) greater than par.

D) cannot be determined.

The correct answer was B)

If the Coupon Rate > market yield, then bond will sell at a premium.

If the Coupon Rate < market yield, then bond will sell at a discount.

If the Coupon Rate = market yield, then bond will sell at par.

6.Given that the coupon rate of a bond is higher than the market interest rate on bonds with similar maturities

and payment structures, the bond will be trading:

A) at par value.

B) at a discount.

C) with a higher yield.

D) at a premium.

The correct answer was D)

If the bond provides investors with a higher coupon rate than the market interest rate the bond has to be trading

at a premium relative to its par value otherwise there is an arbitrage opportunity.

David Korotkin, CFA and a broker at an investment bank, has a client who is very concerned about

maintaining purchasing power over the next year. The investor is conservative, and to date has

been pleased with a consistent return of 8.00%. The banks research department has estimated

next years inflation rate at 2.0%. The client specifically wants to invest in a fixed-coupon bond.

Which of the following statements is most correct? If Korotkin purchases a bond with a 10.00%

coupon, the client:

Investors want to be compensated for the inflation they expect plus for the risk that inflation will

increase during the term of the investment. Here, the banks estimated inflation rate is just that an

estimate. Thus, we cannot say for certain that the investor will not lose purchasing power. Inflation

risk introduces uncertainty to the investment process.

: honeycfa : 2010-4-24 10:54

One year ago, Makato Omura purchased a 6.50% fixed coupon bond for 98.50. Recently, she

sold the bond for 99.25 and calculated her return at 7.4%. Her friend, Takanino Takemiya, CFA,

reminds Omura that this is the nominal return and that to calculate the real return, she needs to

factor in the inflation rate over the holding period. If the price index for the current year is 118.5

and the price index one year ago was 115.9, Omuras real return is closest to:

A) 9.6%.

B) 6.3%.

C) 5.2%.

Omuras real return is approximated by subtracting the inflation rate from the calculated

(nominal) return. As indicated in the preliminary reading for Study Session 4, LOS 1.B.e, the

inflation rate is calculated using the formula:

Inflation = (Price Indexthis year Price Indexlast year) / Price Indexlast year

A) The short term inflation premium is less than the long term premium.

The statement Treasury securities are considered immune to inflation and liquidity risk is partially

true Treasury securities are immune to liquidity risk, but fixed-coupon Treasury securities have

high inflation risk and generally low real returns.

The other choices are true. The inflation premium is less in the short term because investors are

better able to predict inflation in the short term inflation risk increases as time increases.

(Investors want to be compensated for this uncertainty.) An investors real return is not fixed- even

though an investor may hold a fixed-rate coupon bond, the real return depends on a variable

inflation. Higher inflation rates result in a reduction of the purchasing power of bond payments.

The holder of a 15-year bond with a coupon formula equal to the U.S. prime rate plus

B)

3.25%.

A 15-year bond with a coupon formula equal to the U.S. prime rate plus 3.25% is an example of

a floating rate bond. The holder of an adjustable rate asset is impacted less by inflation than the

holder of a fixed-rate asset because the increased cash flow (from the higher coupon payments

when the base rate increases) at least partially offsets the decreased purchasing power caused

by inflation.

The other two choices are examples of investors more susceptible to inflation - those who hold

long-term contracts in which they are to receive a fixed payment.

Which of the following investors faces the least inflation risk? An investor whose portfolio is

concentrated in:

C) equity securities.

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