Reading 55: Term Structure and Volatility of Interest Rates- 2011, advantages, center, style

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Session 14: Fixed Income: Valuation Concepts
Reading 55: Term Structure and Volatility of Interest Rates

LOS c: Explain the various universes of Treasury securities that are used to construct the theoretical spot rate curve, and evaluate their advantages and disadvantages.

 

 

Which of the following Treasury issues is typically NOT a candidate used to construct the theoretical spot rate curve?

A) Treasury coupon strips.

B) All Treasury coupon securities and bills.

C) Treasury principal strips.

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The following Treasury securities can be used to construct a default-free theoretical spot rate curve:

1)   On-the-Run Treasury - the newest Treasury issues of a given maturity:

• T-Bills:  zero-coupon securities with 3-month, 6-month, and 1-year maturities.
• Treasury Notes:  coupon instruments with 2-year, 5-year, and 10-year maturities.
• Treasury Bonds: coupon instruments with 30-year maturities.

2)   On-the-run Treasury issues and selected off-the-run Treasury issues.
3)   All Treasury coupon securities and Bills.
4)   Treasury coupon strips.

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Which of the following is a disadvantage of using all of the Treasury coupon securities to construct the theoretical spot rate curve?

A) The spot rate curve will be overfitted.

B) Real-time information is not available for all issues.

C) The off-the-run Treasury securities tend to be mispriced.

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A disadvantage of using all Treasury securities and bills to develop the theoretical spot rate curve is that current information is not available for all issues.

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To construct a theoretical spot-rate curve using Treasury securities, the class of securities that provides the most accurate prices but has the disadvantage of large maturity gaps is:

A) strips.

B) off-the-run securities.

C) on-the-run securities.

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On-the-run securities have the greatest trading volume; therefore, they should be the most accurately priced issues. The Treasury only issues bonds of specified maturities, however, and large gaps exist between the maturities.