FIXED INCOME - Quizz 5

Question 1

James McDonald and Veasna Lu were discussing different ways of valuing a Treasury security.
During their discussion Lu made the following statements:

Statement 1: It is inappropriate to discount the cash flows of a Treasury security by a single

discount rate because that is implicitly assuming that the yield curve is flat. Therefore, each
individual cash flow should be discounted by its corresponding spot rate.

Statement 2: The spot rates used for different time periods that produce a value equal to the
market price of a Treasury bond are called forward rates or future expected spot rates.

With regard to the statements made by Lu:

A) both are correct.
B) both are incorrect.
C) only one is correct.

Question 2

Which of the following statements about how the features of a bond impact interest rate risk is
NOT correct?
A) A lower-coupon bond is more sensitive to interest rate movements than a higher- coupon
bond (all else equal).
B) Bond price movements depend upon the direction and magnitude of changes in interest
rates.
C) An inverse relationship between interest rates and bond prices means that the greater
the change in interest rates, the less the change in fixed-coupon bond prices.

Question 3

A mortgage-backed security has the following characteristics:

 It was created by pooling a collection of more than a thousand mortgages
 Not all investors face the same prepayment risk
 Investors receive three distinct kinds of cash flows
 Freddie Mac issued the security
This security is a(n):
A) agency debenture.
B) collateralized mortgage obligation.
C) mortgage passthrough security.

Question 4

Which of the following five year bonds has the highest interest rate sensitivity?
A) Zero-coupon bond.
B) Floating rate bond.
C) Option-free 5% coupon bond.
Question 5

The most important LIBOR rate for funded investors is the:

A) 20 year rate.
B) 1 year or less rate.
C) 10 year rate.

Question 6

Which of the following is the most appropriate strategy for a fixed income portfolio manager under
the anticipation of an economic expansion?
A) Sell corporate bonds and purchase Treasury bonds.
B) Sell lower-rated corporate bonds and buy higher-rated corporate bonds.
C) Purchase corporate bonds and sell Treasury bonds.

Question 7

Which of the following statements regarding a sinking fund provision is most accurate?
A) It requires that the issuer set aside money based on a predefined schedule to
accumulate the cash to retire the bonds at maturity.
B) It permits the issuer to retire more than the stipulated sinking fund amount if they choose.
C) It requires that the issuer retire a portion of the principal through a series of principal
payments over the life of the bond.

Question 8

Which set of conditions will result in a bond with the greatest interest rate risk?
A) A low coupon and a long maturity.
B) A high coupon and a short maturity.
C) A high coupon and a long maturity.

Question 9

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
A) discount premium par
B) par premium discount
C) premium par discount
Question 10

Which of the following is the reason why credit spreads between high quality bonds and low
quality bonds widen during poor economic conditions?
A) indenture provisions.
B) interest risk.
C) default risk.

Question 11

Which of the following is a difference between an on-the-run and an off-the-run issue? An on-
the-run issue:
A) is publicly traded whereas an off-the-run issue is not.
B) is the most recently issued security of that type.
C) tends to sell at a lower price.

Question 12

Austin Traynor is considering buying a $1,000 face value, semi-annual coupon bond with a
quoted price of 104.75 and accrued interest since the last coupon of $33.50. If Traynor pays the
dirty price, how much will the seller receive at the settlement date?

A) $1,014.00.
B) $1,081.00.
C) $1,047.50.

Question 13

If investors expect greater uncertainty in the bond markets, you should see yield spreads
between AAA and B rates bonds:
A) slope downward.
B) widen.
C) narrow.