Quant Method - act1 - interest rate

Question 1

The nominal risk-free rate is most closely approximated by which of the following formulas?
A. Nominal rate = Real risk-free rate × Inflation premium
B. Nominal rate = Real risk-free rate + Inflation premium
C. Nominal rate = Default risk premium + Liquidity premium
D. Nominal rate = Real rate – Inflation premium

Answer 1

B. Nominal rate = Real risk-free rate + Inflation premium

Question 2

Which of the following components of interest rates compensates investors for the possibility of not receiving promised payments?
A. Liquidity premium
B. Default risk premium
C. Maturity premium
D. Inflation premium

Answer 2

B. Default risk premium

Question 3

What type of government-issued instrument is considered a good proxy for the nominal risk-free interest rate in the United States?
A. Municipal bonds
B. Corporate bonds
C. 90-day US Treasury bill
D. 30-year US Treasury bond

Answer 3

C. 90-day US Treasury bill

Question 4

The liquidity premium is likely to be highest for which of the following types of securities?
A. Large-cap equity shares
B. Short-term US Treasury bills
C. Thinly traded corporate bonds from small issuers
D. Central bank reserves

Answer 4

C. Thinly traded corporate bonds from small issuers

Question 5

Which premium compensates investors for the risk associated with converting an investment into cash quickly?
A. Inflation premium
B. Default risk premium
C. Maturity premium
D. Liquidity premium

Answer 5

D. Liquidity premium

Question 6

The maturity premium increases primarily due to which of the following risks?
A. Inflation variability
B. Market price sensitivity to interest rate changes
C. Creditworthiness of the issuer
D. Infrequent trading activity

Answer 6

B. Market price sensitivity to interest rate changes

Question 7

If the nominal risk-free rate is 5% and the expected inflation premium is 2%, what is the approximate real risk-free rate?
A. 2%
B. 3%
C. 5%
D. 7%

Answer 7

B. 3%

Question 8

Which of the following correctly expresses the relationship between nominal and real interest rates under compounding?
A. Nominal = Real – Inflation
B. (1 + Nominal) = (1 + Real)(1 + Inflation)
C. Nominal = Real × Inflation
D. Real = Nominal × Inflation

Answer 8

B. (1 + Nominal) = (1 + Real)(1 + Inflation)

Question 9

Which premium is most likely not included in the interest rate of a short-term US Treasury bill?
A. Real risk-free rate
B. Inflation premium
C. Default risk premium
D. Maturity premium

Answer 9

C. Default risk premium

Question 10

The inflation premium is included in interest rates primarily because:
A. It accounts for potential default of the borrower.
B. It compensates for reduced purchasing power over time.
C. It allows investors to benefit from unexpected inflation.
D. It provides compensation for illiquidity.

Answer 10

B. It compensates for reduced purchasing power over time.

Question 11

Which of the following statements is TRUE regarding risk premiums in interest rates?
A. All components are fixed over time.
B. Only the inflation premium fluctuates with economic expectations.
C. Each premium adjusts based on economic conditions and expectations.
D. The real risk-free rate is always higher than the nominal rate.

Answer 11

C. Each premium adjusts based on economic conditions and expectations.

Question 12

Interpretation of interest rate?

Answer 12

1. Discount Rate
2. Opportunity cost
3. Required rate or return

Question 13

Sum of interest rate

Answer 13

1. Norminal risk free interest rate
   1.1 Real risk free rate
   1.2 Inflation premium
2. Default risk premium
3. Liquidity premium
4. Maturity premium

Question 14

The real risk-free interest rate?

Answer 14

is the single-period interest rate for a completely risk-free security if no inflation were expected. In economic theory, the real risk-free rate reflects the time preferences of individuals for current versus future real consumption.

Question 15

The inflation premium?

Answer 15

compensates investors for expected inflation and reflects the average inflation rate expected over the maturity of the debt.
Inflation reduces the purchasing power of a unit of currency—the amount of goods and services one can buy with it.

Question 16

The default risk premium?

Answer 16

compensates investors for the possibility that the borrower will fail to make a promised payment at the contracted time and in the contracted amount.

Question 17

The liquidity premium?

Answer 17

compensates investors for the risk of loss relative to an investment’s fair value if the investment needs to be converted to cash quickly. US Treasury bills (T-bills), for example, do not bear a liquidity premium because large amounts of them can be bought and sold without
affecting their market price. Many bonds of small issuers, by contrast, trade infrequently after they are issued; the interest rate on such bonds includes a liquidity premium reflecting the relatively high costs (including the impact on price) of selling a position

Question 18

The maturity premium?

Answer 18

compensates investors for the increased sensitivity of the market value of debt to a change in market interest rates as maturity
is extended, in general (holding all else equal). The difference between the interest rate on longer-maturity, liquid Treasury debt and that on short-term Treasury debt typically reflects a positive maturity premium for the longer-term debt (and possibly different inflation premiums as well).

Question 19

Holding period return, Formular of signle period?

Answer 19

R = [(P1 - P0) + I1] / P0
which P is the price and I is the income

Question 20

Holding period return, Compute a one-year holding period return from n annual returns

Answer 20

R = [(1 + R1)(1 + R2)….(1 + Rn)] - 1

Question 21

Arithmetic or Mean Return
Most holding period returns are reported as daily, monthly, or annual returns.
When assets have returns for multiple holding periods,
It is necessary to normalize returns to a common period for ease
of comparison and understanding.

Formular of arithmetic average?

Answer 21

R = (R1 + R2 +…+ Rn) / T

Question 22

Geometric mean returne

Answer 22

[(1+R1)(1+R2)…(1+Rn)]^(1/n) - 1

Question 23

What is the primary difference between gross return and net return?
a) Gross return includes taxes, while net return does not.
b) Gross return is before deductions for management expenses, while net return accounts for them.
c) Gross return is adjusted for inflation, while net return is not.
d) Gross return is after-tax, while net return is pre-tax.

Answer 23

b) Gross return is before deductions for management expenses, while net return accounts for them.

Question 24

Why are trading expenses deducted from the gross return?
a) They are unrelated to the generation of returns.
b) They contribute directly to the return earned by the manager.
c) They vary with the tax status of the investor.
d) They are fixed administrative costs.

Answer 24

b) They contribute directly to the return earned by the manager.

Question 25

Which type of return is most relevant to individual investors? a) Gross return b) Pre-tax nominal return c) Net return d) Real return

Answer 25

c) Net return

Question 26

Why do small mutual funds often waive part of their expenses? a) To reduce taxes for investors b) To remain competitive with larger funds c) To increase gross returns d) To avoid custodial fees

Answer 26

b) To remain competitive with larger funds

Question 27

What does the term "pre-tax nominal return" indicate? a) Returns adjusted for inflation but not taxes b) Returns before adjustments for taxes or inflation c) Returns after taxes but before inflation d) Returns after both taxes and inflation

Answer 27

b) Returns before adjustments for taxes or inflation

Question 28

How can an investment manager minimize tax liability for investors? a) By increasing trading turnover b) By selecting securities with less favorable taxation c) By reducing trading turnover and selecting tax-favored securities d) By ignoring capital gains taxes

Answer 28

c) By reducing trading turnover and selecting tax-favored securities

Question 29

Which type of income is typically taxed as ordinary income in most countries? a) Dividend income b) Long-term capital gains c) Interest income d) Short-term capital gains

Answer 29

c) Interest income

Question 30

What is a key advantage of larger mutual funds over smaller ones? a) They have lower trading expenses. b) They can spread fixed administrative expenses over a larger asset base. c) They are exempt from taxes. d) They always generate higher gross returns.

Answer 30

b) They can spread fixed administrative expenses over a larger asset base.

Question 31

How are bonds issued at a discount to par value typically taxed? a) Based on realized gains b) Based on accrued gains c) As ordinary income d) They are tax-exempt

Answer 31

b) Based on accrued gains

Question 32

Why is gross return a good measure for evaluating asset managers? a) It includes all management and administrative fees. b) It reflects the investor’s actual return after expenses. c) It excludes fees related to management and administration. d) It accounts for inflation and taxes.

Answer 32

c) It excludes fees related to management and administration.