Baran

 

The correct answer is C

The easiest way to do this given the discount factors is to use the formula

 

where z(t) is the spot rate associated with the discount factors d(t). The first spot rate, which pertains to the bond maturing in December 2003, is equal to (1/0.9657 – 1) × 2 = 7.10%. The second spot rate, which pertains to the payment being made in June 2004, is equal to ((1/0.9225)^0.5 – 1) × 2 = 8.23%.

Baran

 

Given the spot rates for the 6-month and 1-year maturing bond, the forward rate inherent in those figures is closest to:

A) 9.37%.

B) 4.68%.

C) 5.74%.

D) 6.96%.

Baran

 

The correct answer is A

 

The key to calculating forward rates is to understand that the longer spot rate has to be equivalent to the product of the two shorter rates. In this case, an investment in a 1-year rate held over the year has to generate the same cash flow as investing for the first six months and then reinvesting in another 6-month bond. Therefore, the forward rate implied by the annual and the 6-month spot rate is equal to:

 [attach]13889[/attach]

= 4.6831%

4.6831 x 2 = 9.37% annualized return

Baran

 

3、Which of the following statements concerning a forward rate is FALSE? A forward rate is:

A) the market’s best guess as to an interest rate that will exist in the future.

B) an interest rate that can be locked in for some future time period.

C) the interest rate that makes an investor indifferent to investing over a long time period or investing over two or more shorter time periods.

D) the rate of interest an investor would earn from now until some point in the future.

Baran

 

The correct answer is D

 

The rate of interest an investor could invest at today until some point in the future is the spot rate. The other three statements correctly identify the three possible interpretations of a forward rate. A forward rate can be interpreted as a break even rate, a locked-in rate for some future period, or an expectation of future spot interest rates.

Baran

 

4、If the one-year spot rate is 7 percent and the one-year forward rate is 7.4 percent, what is the two-year spot rate?

A) 7.12 %.

B) 7.27%.

C) 7.40%.

D) 7.20%.

Baran

 

The correct answer is D

The two-year spot rate: ((1+0.07)(1+0.074)).5 - 1 = 0.072, or 7.2 percent.

Baran

 

5、Assume the one-year spot rate is 4 percent, the two-year spot rate is 4.5 percent, and the three-year spot rate is 5 percent. Which of the following statements is TRUE?

A) The one-year rate that will exist one year from today is 5.5 percent.

B) The one-year rate that will exist two years from today is 5 percent.

C) The two-year rate that will exist one year from today is 5.5 percent.

D) The rate that an investor can earn on a sum invested today for the next three years is 5.5 percent.

Baran

 

The correct answer is C

It might be best to draw a set of timelines for this problem.

The one-year rate that will exist one year from today is:

(1.045)2/(1.04) ? 1 = 0.05, or 5%.

The one-year rate that will exist two years from today is:

(1.05)3/(1.045)2 ? 1 = 0.06, or 6%.

The two-year rate that will exist one year from today is:

(1.05)3/(1.04)) = (1.113)0.5 = 1.055 ? 1 = 0.055, or 5.5%.

Note that the rate that an investor could earn on a sum invested today for the next three years would be equal to the three-year spot rate of 5%.

Baran

 

6、If the five-year spot rate is 6.1 percent and the four-year spot rate is 5.9 percent, what is the only rate that can be computed?

A) The four-year forward rate starting one year from today is 6.9%.

B) The one-year forward rate starting four years from today is 6.9%.

C) The one-year forward rate starting four years from today is 7.4%.

D) The four-year forward rate starting one year from today is 7.4%.