Question 101

Which of these statements about central bank policy in an environment of global financial markets is most accurate?

A)    In an environment where consumers and businesses base their decisions largely on long-term interest rates, the central bank must bring long-term rates under its direct control in order to influence financial markets and the economy.

B)   By communicating a credible and transparent monetary policy to the financial markets, a central bank can bypass the private banking system as a means of influencing the economy.

C)   Because financial markets are subject to fads and bubbles, often overreact, and exhibit herding behavior, central banks should not look to them for information when making policy decisions.

D)   To minimize instability in the financial markets, the central bank should communicate its policy intentions clearly so the markets will anticipate how the central bank will respond to threats to price stability.

The correct answer was D) To minimize instability in the financial markets, the central bank should communicate its policy intentions clearly so the markets will anticipate how the central bank will respond to threats to price stability.

How the financial markets react to new information that suggests a threat to price stability depends on how accurately they can predict the central bank’s reaction to that information. Policy decisions that are communicated poorly or surprise the markets will lead to greater instability.

Long-term rates are beyond central banks’ direct control, but central banks can influence them by committing themselves to long-term price stability and thus controlling inflation expectations in the economy. Central banks control short-term interest rates by adding or removing systemic liquidity in the commercial banking system. Thus, private banks are the mechanism through which the central bank influences financial markets and the economy. Despite the irrationality that financial markets can sometimes exhibit, they can provide useful information about expected interest rates and economic growth to a central bank.

This question tested from Session 15, Reading 66, LOS a

Question 102

Which of the following statements regarding sovereign debt is least accurate?

A)    Sovereign debt denominated in a foreign currency may have a different rating than sovereign debt denominated in the home currency.

B)   Sovereign debt must be issued in a country’s own bond market.

C)   U.S. Treasury securities are sovereign debt of the U.S. government and are considered free of default risk.

D)   Bonds issued by the government of any country are sovereign debt.

The correct answer was B) Sovereign debt must be issued in a country’s own bond market.

Sovereign debt can be issued in a country’s own domestic market, another country’s bond market, or in the Eurobond market. The other statements are accurate.

This question tested from Session 15, Reading 64, LOS a

Question 103

Four years ago, at the advice of J.T. Lindseth, her financial planner, T.J. Ali paid $906.50 to purchase a $1,000 face value, 5.7%, semiannual coupon bond with four years to maturity priced to yield 8.50%. Now the bond has matured, and Lindseth calls Ali and informs her that he had reinvested the coupons at an annual rate of 10.0%. Given this return on coupon reinvestment, Ali's realized rate of return on the bond investment is closest to:

A)    8.65%.

B)   8.50%.

C)   10.00%.

D)   8.35%.

The correct answer was A) 8.65%.

You can answer this question without doing any calculations. Because the coupon reinvestment rate was greater than the original YTM, the realized rate of return will be greater than the YTM. This narrows down the choices to 8.65% and 10.00%. The rate of 10.00% is an unlikely choice because the coupon payments do not comprise 100% of the return of the bond. Thus, the realized rate will be greater than 8.50%, but less than 10.00%. The only choice that meets this criterion is 8.65%.

For those of you who want to work through the calculations: We first need to calculate the FV_{coupon annuity}, then calculate the Total Future Value of the Bond, and finally calculate the realized return.

Step 1: Calculate the FV_{coupon annuity}

Alternatively, N = 8; I/Y = 5; PMT = 28.5; PV = 0; CPT → FV = -272.15

Step 2: Calculate the Bond’s Total Future Value (TFV)

TFV = Face Value + FV_{coupon annuity} = $1,000 + $272.15 = $1,272.15.

Step 3: Calculate the Realized Annual Return

Here, Realized Return_{Annualized Basis} = [ (1,272.15 / 906.70)^1/8 – 1] × 2 = 0.08648, or 8.65%.

This question tested from Session 16, Reading 68, LOS c, (Part 1)

Question 104

The price value of a basis point for a 7% coupon, semiannual pay, 10-year bond with a $1,000 par value, currently trading at par, is closest to:

A)    $1.42.

B)   $0.71.

C)   $67.10.

D)   $33.55.

The correct answer was B) $0.71.

The price value of a basis point is the price given a 1 basis point change in the discount rate.
N = 20; PMT = 35; FV = 1,000; I/Y = 7.01/2 = 3.505; CPT → PV = 999.29
$1,000 – $999.29 = $0.71.

This question tested from Session 16, Reading 69, LOS i

Question 105

Randy Harris is contemplating whether to add a bond to his portfolio. It is a semiannual, 6.5% bond with 7 years to maturity. He is concerned about the change in value due to interest rate fluctuations and would like to know the bond’s value given various scenarios. At a yield to maturity of 7.5% or 5.0%, the bond’s fair value is closest to:

7.5%         5.0%

A)    946.30     1,087.68

B)   1,032.67       959.43

C)   974.03     1,052.36

D)   1,046.98      982.79

The correct answer was A) 946.30    1,087.68

Given a YTM of 7.5%, calculate the value of the bond as follows:
N = 14; I/Y = 7.5/2 = 3.75%; PMT = 32.50; FV = 1,000; CPT → PV = 946.30

Given a YTM of 5.0%, calculate the value of the bond as follows:
N = 14; I/Y = 5/2 = 2.5%; PMT = 32.50; FV = 1,000; CPT → PV = 1,087.68

This question tested from Session 16, Reading 67, LOS c

Question 101

Which of these statements about central bank policy in an environment of global financial markets is most accurate?

A)    In an environment where consumers and businesses base their decisions largely on long-term interest rates, the central bank must bring long-term rates under its direct control in order to influence financial markets and the economy.

B)   By communicating a credible and transparent monetary policy to the financial markets, a central bank can bypass the private banking system as a means of influencing the economy.

C)   Because financial markets are subject to fads and bubbles, often overreact, and exhibit herding behavior, central banks should not look to them for information when making policy decisions.

D)   To minimize instability in the financial markets, the central bank should communicate its policy intentions clearly so the markets will anticipate how the central bank will respond to threats to price stability.

Question 102

Which of the following statements regarding sovereign debt is least accurate?

A)    Sovereign debt denominated in a foreign currency may have a different rating than sovereign debt denominated in the home currency.

B)   Sovereign debt must be issued in a country’s own bond market.

C)   U.S. Treasury securities are sovereign debt of the U.S. government and are considered free of default risk.

D)   Bonds issued by the government of any country are sovereign debt.

Question 103

Four years ago, at the advice of J.T. Lindseth, her financial planner, T.J. Ali paid $906.50 to purchase a $1,000 face value, 5.7%, semiannual coupon bond with four years to maturity priced to yield 8.50%. Now the bond has matured, and Lindseth calls Ali and informs her that he had reinvested the coupons at an annual rate of 10.0%. Given this return on coupon reinvestment, Ali's realized rate of return on the bond investment is closest to:

A)    8.65%.

B)   8.50%.

C)   10.00%.

D)   8.35%.

Question 104

The price value of a basis point for a 7% coupon, semiannual pay, 10-year bond with a $1,000 par value, currently trading at par, is closest to:

A)    $1.42.

B)   $0.71.

C)   $67.10.

D)   $33.55.

Question 105

Randy Harris is contemplating whether to add a bond to his portfolio. It is a semiannual, 6.5% bond with 7 years to maturity. He is concerned about the change in value due to interest rate fluctuations and would like to know the bond’s value given various scenarios. At a yield to maturity of 7.5% or 5.0%, the bond’s fair value is closest to:

7.5%         5.0%

A)    946.30     1,087.68

B)   1,032.67       959.43

C)   974.03     1,052.36

D)   1,046.98      982.79

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Thanks a LOT

8cuo!

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