Lecture 12

Question 1

Term structure of interest rates =

Answer 1

Structure of interest rates for discounting cash flows of different maturities

Question 2

Yield curve displays

Answer 2

Relationship between yield and maturity > plots YTM as a function of time to maturity

Question 3

Yield curve implies

Answer 3

Information on the expected future short term rates

Question 4

Bonds of different maturities sell at

Answer 4

Different yield to maturities

Question 5

Long term bonds sold at

Answer 5

Higher yields than short term bonds

Question 6

As interest rates increase/ decrease, bondholders experience

Answer 6

Capital gains/ losses

Question 7

If the market rate falls below the coupon rate

Answer 7

The bond is attractive, therefore investors would pay > the par value

Question 8

If the market rate exceeds the coupon rate

Answer 8

Investors will pay below the par value

Question 9

Duration is a measure of

Answer 9

The average maturity of a bond’s promised cash flows. The number of years required to recover the true cost (price) of the bond.

Question 10

Duration is a guide for

Answer 10

The sensitivity of a bond to interest rate changes

Question 11

Duration =

Answer 11

The weighted average of times until each payment is received. Weights are proportional to the present value of each payment.

Question 12

Duration is shorter than the maturity for

Answer 12

All bonds, except zero coupon bonds (= for zero coupon)

Question 13

Long term bonds more sensitive to interest rate movements

Answer 13

Than short term. Duration quantifies this

Question 14

Duration rules (5)

Answer 14

• Duration of zero-coupon bond = time to maturity
• Holding maturity constant, a bond’s duration is higher when the coupon rate is lower
• Holding the coupon rate constant, a bond’s duration increases with time to maturity
• Holding other factors constant, the duration of a coupon bond is higher when the bond’d YTM is lower
• Duration of a level perpetuity = (1 + y) / y or 1 + (1/y)

Question 15

Duration is an independent coupon rate only for

Answer 15

Perpetuities

Question 16

Is there a linear relationship between bond prices and yield, as duration suggests?

Answer 16

No

Question 17

Duration rule is a good approximation when

Answer 17

There are only small changes in bond yields

Question 18

Bonds with greater convexity have

Answer 18

Increased curvature in the price-yield relationship

Question 19

Duration approximation (straight line) always

Answer 19

Understates the value of the bond
Underestimates the increase in bond price when yield falls
Overestimates the decline in the price when the yield increases

Question 20

Bonds with increased convexity see

Answer 20

Greater price increase and smaller price fall when interest rates fluctuate by large amounts

Question 21

If interest rates are volatile

Answer 21

Investors prefer convexity

Question 22

For greater convexity, investors must

Answer 22

Pay higher prices and accept lower yields to maturity