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CHP 4 MCQ

The document contains 10 multiple choice questions testing knowledge of interest rates, yield curves, and derivatives. Key points covered include: 1) The compounding frequency defines how often interest is paid. 2) Converting between interest rates with different compounding frequencies, such as continuous vs. semiannual. 3) Calculating forward rates from given zero rates. 4) Valuing a forward rate agreement using the relevant formulas. 5) Properties of yield curves such as the relationship between zero rates, par yields, and forward rates on an upward sloping curve.

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46 views

CHP 4 MCQ

The document contains 10 multiple choice questions testing knowledge of interest rates, yield curves, and derivatives. Key points covered include: 1) The compounding frequency defines how often interest is paid. 2) Converting between interest rates with different compounding frequencies, such as continuous vs. semiannual. 3) Calculating forward rates from given zero rates. 4) Valuing a forward rate agreement using the relevant formulas. 5) Properties of yield curves such as the relationship between zero rates, par yields, and forward rates on an upward sloping curve.

Uploaded by

fena
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd
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1.

(0 points)

The compounding frequency for an interest rate defines

A. The frequency with which interest is paid

*B. A unit of measurement for the interest rate

C. The relationship between the annual interest rate and the monthly interest rate

D. None of the above

2. (0 points)

An interest rate is 5% per annum with continuous compounding. What is the equivalent rate with
semiannual compounding?

*A. 5.06%

B. 5.03%

C. 4.97%

D. 4.94%

3. (0 points)

The two-year zero rate is 6% and the three year zero rate is 6.5%. What is the forward rate for the third
year? All rates are continuously compounded.

A. 6.75%

B. 7.0%

C. 7.25%

*D. 7.5%
4. (0 points)

The risk-free yield curve is flat at 6% per annum. What is the value of an FRA where the holder receives
LIBOR at the rate of 9% per annum for a six-month period on a principal of $1,000 starting in two years?
The forward LIBOR rate is 7%. All rates are compounded semiannually.

A. $9.12

B. $9.02

C. $8.88

*D. $8.63

5. (0 points)

(ATTENTION: THE MATERIAL COVERED BY THIS QUESTION IS NOT AT THE EXAM) The zero curve is
upward sloping. Define X as the 1-year par yield, Y as the 1-year zero rate and Z as the forward rate for
the period between 1 and 1.5 year. Which of the following is true?

*A. X is less than Y which is less than Z

B. Y is less than X which is less than Z

C. X is less than Z which is less than Y

D. Z is less than Y which is less than X

6. (0 points)

Since the credit crisis that started in 2007 which of the following have derivatives traders used as the
risk-free rate

A. The Treasury rate

B. The LIBOR rate

C. The repo rate

*D. The overnight indexed swap rate


7. (0 points)

Which of the following is true of LIBOR

A. The LIBOR rate is free of credit risk

B. A LIBOR rate is lower than the Treasury rate when the two have the same maturity

*C. It is a rate used when borrowing and lending takes place between banks

D. It is subject to favorable tax treatment in the U.S.

8. (0 points)

(ATTENTION: THE MATERIAL COVERED BY THIS QUESTION IS NOT AT THE EXAM) Given a choice
between 5-year and 1-year instruments most people would choose 5-year instruments when borrowing
and 1-year instruments when lending. Which of the following is a theory consistent with this
observation?

A. Expectations theory

B. Market segmentation theory

*C. Liquidity preference theory

D. Maturity preference theory

9. (0 points)

Bootstrapping involves

A. Calculating the yield on a bond

*B. Working from short maturity instruments to longer maturity instruments determining zero rates
at each step

C. Working from long maturity instruments to shorter maturity instruments determining zero rates
at each step

D. The calculation of par yields


10. (0 points)

Which of the following is true?

A. When interest rates in the economy increase, all bond prices increase

B. As its coupon increases, a bond’s price decreases

C. Longer maturity bonds are always worth more that shorter maturity bonds when the coupon
rates are the same

*D. None of the above

Solutions :

1-b, 2-a, 3-d, 4-d, 5-a, 6-d, 7-c, 8-c, 9-b, 10-d

The detailed solution of question 4 is on the following pages


Detailed solution, question #4:

As mentioned in your manual and course notes, the value of the FRA can be assessed with (equation 4.9
of your manual on page 97)

𝑉 = 𝐿 × (𝑅𝐾 − 𝑅𝐹 )(𝑇2 − 𝑇1 )𝑒 −𝑅2 𝑇2


with

• 𝑇1 = 2.0: the start date of the hypothetical loan associated with the FRA (2 years)
• 𝑇2 = 2.5: the end date of the hypothetical loan associated with the FRA (2.5 years)
• 𝑅𝐾 = 0.09: FRA rate (annual semi-annual compounding because the hypothetical loan underlying
the FRA is 6 months)
• 𝑅𝐹 = 0.07: LIBOR forward rate (annual semi-annual compounding because the hypothetical loan
underlying the FRA is 6 months)
• 𝑅2 = continuously compounded risk-free rate
• Since the statement states that all rates are semi-funded, the given rate for the risk-free spot rate
futures structure must be converted to a continuous capitalization rate with
𝑅2,𝑠𝑒𝑚𝑖𝑎𝑛𝑛𝑢𝑎𝑙
𝑅2 = 2 × ln (1 + )
2
0.06
= 2 × ln (1 + ) = 0.0591
2

• La valeur du FRA :
𝑉 = 𝐿 × (𝑅𝐾 − 𝑅𝐹 )(𝑇2 − 𝑇1 )𝑒 −𝑅2 𝑇2

= 1000 × (0.09 − 0.07)(2.5 − 2.0)𝑒 −0.0591×2.5

= 8.6265

which becomes $8.63 after rounding. The correct answer is D.

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