Online Quiz 3 Duration Q&A

Online Quiz Questions for Week 4 Topic: Duration Question: When interest rates decline, the duration of a 10-year bond selling at a premium Correct Answer:

increases.

Question: Which of the following is incorrect? Correct Answer:

The duration of a zero-coupon bond decreases with an increase in time to maturity.

Question: The duration of a bond that pays coupon interest annually is 8.05 years. The yield to maturity of the bond is 10%. If the yield falls by 25 basis points, what is the percentage change in the price of the bond? Correct Answer:

1.83%

Question: The duration of a bond is positively correlated with the bond's Correct Answer:

time to maturity.

Question: Which of the following two bonds is more price sensitive to changes in interest rates? · A par value bond, X, with a 5-year-to-maturity and a 10% yield to maturity. · A zero-coupon bond, Y, with a 5-year-to-maturity and a 10% yield to maturity. Selected Answer: Correct Answer: Response Feedback:

Both have the same sensitivity because both have the same yield to maturity. Bond Y because of the longer duration. Duration is the best measure of bond price sensitivity; the longer the duration the higher the price sensitivity.

Question: The two components of interest-rate risk are Correct Answer:

price risk and reinvestment risk.

Question: Holding other factors constant, the interest-rate risk of a coupon bond is higher when the bond's: Correct Answer:

yield to maturity is lower.

Question: Duration is important in bond portfolio management because I) it can be used in immunization strategies. II) it provides a gauge of the effective average maturity of the portfolio. III) it is related to the interest rate sensitivity of the portfolio. IV) it is a good predictor of interest rate changes.

Selected Answer:

I and III

Correct Answer:

I, II, and III

Response Feedback:

Duration can be used to calculate the approximate effect of interest rate changes on prices, but is not used to forecast interest rates.

Question: When interest rates decline, the duration of a 10-year bond selling at a premium Selected Answer:

decreases.

Correct Answer:

increases.

Response Feedback:

The relationship between interest rates and duration is an inverse one for coupon bonds.

Question: Which of the following is incorrect? Correct Answer:

The duration of a zero-coupon bond decreases with an increase in time to maturity.

Question: Compute the duration of a par value bond with a coupon rate of 8% and a remaining time to maturity of 3 years. Assume coupon interest is paid annually and the bond has a face value $100. Correct Answer:

2.783 years.

Question: The duration of a bond that pays coupon interest annually is 8.05 years. The yield to maturity of the bond is 10%. If the yield falls by 25 basis points, what is the percentage change in the price of the bond? Correct Answer:

1.83%

Question: Which of the following are true about the interest-rate sensitivity of coupon bonds? I Bond prices and yields are inversely related. II Prices of long-term bonds tend to be more sensitive to interest rate changes than prices of short-term bonds. III Interest-rate risk is directly related to the bond's coupon rate. IV The sensitivity of a bond's price to a change in its yield to maturity is inversely related to the yield to maturity at which the bond is currently selling. Correct Answer:

I, II, and IV

Question: You have an obligation to pay $148 in four years and 2 months. In which bond would you invest your $100 to accumulate this amount, with relative certainty, even if the yield on the bond declines to 9.5% immediately after you purchase the bond? All bonds pay interest annually and have a face value of $100. Selected Answer:

a 6-year; 10% coupon par value bond

Correct Answer:

a 5-year; 10% coupon par value bond

Response When duration = horizon date, one is immunized, or protected, against one

Feedback :

interest rate change. The zero coupon bond has a D = 5 and the 4-year bond has D < 4. Next choice should be the 5-year bond. Despite the change in yield to 9.5%, the consequent duration = (10/1.095)/100 *1 + (10/1.095 2)/100 *2 +(10/1.0953)/100 *3 +(10/1.0954)/100 *4 +(110/1.0955)/100 *5 = 4.2 years 4 years and 2 months. Therefore select 5 year, 10% coupon bond.