Identify a problem associated with using the Black-Šcholes model to value bond options. а. It assumes short-term interest rates are constant. b. It assumes that commissions are charged. С. It assumes fluctuating variance of returns on the underlying asset. d. It assumes that the variance of bond prices is nonconstant over time. е. All of the above.
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- If the yield curve in the bond market shows a flat curve, what do you think about the prediction of the liquidity premium in explaining this phenomenon? Then do you prefer the prediction of expectation theory in explaining this phenomenon?Which one of the following statements about the term structure of interest rates is true?a. The expectations hypothesis indicates a flat yield curve if anticipated future short-term rates exceed current short-term rates.b. The expectations hypothesis contends that the long-term rate is equal to the anticipated short-term rate.c. The liquidity premium theory indicates that, all else being equal, longer maturities will have lower yields.d. The liquidity preference theory contends that lenders prefer to buy securities at the short end of the yield curve.Which one of the following statements about the term structure of interest rates is true? A) The expectations hypothesis predicts a flat yield curve if anticipated future short-term rates exceed current short-term rates. B) The liquidity premium theory contends that lenders prefer to buy securities at the ghort-term end of the curve. C) The expectations hypothesis contends that the long-term spot rate is equal to the short-term rate. D) The liquidity premium theory indicates that, all else being equal, longer maturity bonds will have lower yields.
- Which of the following statements is correct? A.) A flat yield curve occurs when the yield-to-maturity is virtually unaffected by the term-to-maturity. B.) Real interest rates are generally lower than nominal interest rates. C.) Liquidity risk is the risk that a security may be difficult to sell on short notice for its true value. D.) All of these statements are correct.Which of the following is correct with regards to Theories of Term Structure? When the shape of the yield curve depends on investors’ expectations about prospective prevailing interest rates, the Pure Exception Theory is being applied. When the economic outlook is improving, the yield curve inverts as it reflects no changes in inflation premium. The liquidity preference theory suggests that long-term rates are generally higher than short-term rates since investors perceive more liquidity in long-term investments. Under the Market segmentation theory, there is an apparent relationship between the yield curve and the prevailing rate of returns in each market segment.Which of the following statements is false? A. Other things being equal, an increase in a bond’s maturity will increase its interest rate risk. B. Other things being equal, an increase in the coupon rate of a bond will decrease its interest rate risk. C. Other things being equal, an increase in a bond’s YTM will decrease its interest rate risk. D. Effective duration is calculated as Macaulay duration divided by one plus the bond’s yield to maturity.
- The inverted yield curve predicts that bond prices will fall. Select one: True OR FalseThe yield curve varies over time based the relative riskiness of buying a single long-term bond versus purchasing multiple short-term bonds. This explanation of the yield curve is most consistent with A.the Fisher Effect theoryB.the market segmentation theoryC.the unbiased expectations theoryD.the liquidity preference theoryCheck all that are true with respect to the yield to maturity (YTM) and the expected return for a bond. Group of answer choices The expected return is based on the contractly obligated payments whereas the YTM is based on what the investors expect to receive The YTM is based on the promised payments whereas the expected return is based on the expected cash flows Higher YTMs always mean higher expected returns In the presence of non-zero default risk, the YTM will be higher than the expected return YTM is just another name for the expected return
- The security market line (SML) is an equation that shows the relationship between risk as measured by beta and the required rates of return on individual securities. The SML equation is given below: If a stock's expected return plots on or above the SML, then the stock's return is sufficient to compensate the investor for risk. If a stock's expected return plots below the SML, the stock's return is insufficient to compensate the investor for risk.The SML line can change due to expected inflation and risk aversion. If inflation changes, then the SML plotted on a graph will shift up or down parallel to the old SML. If risk aversion changes, then the SML plotted on a graph will rotate up or down becoming more or less steep if investors become more or less risk averse. A firm can influence market risk (hence its beta coefficient) through changes in the composition of its assets and through changes in the amount of debt it uses. Quantitative Problem: You are given the following…Which of the following statements is CORRECT about the yield curve? A) The yield curve shows the behaviour of interest rate forecasts. B) When short-term rates are lower than long-term rates, there is a downward-sloping yield curve. C) A downward-sloping yield curve shows that investors demand an additional risk premium for lending money over the long term. D) A downward-sloping yield curve indicates that the market expects a future rise in interest rates.Some characteristics of the determinants of nominal interest rates are listed as follows. Identify the components (determinants) and the symbols associated with each characteristic: Characteristic Component Symbol This is the premium added to the real risk-free rate to compensate for a decrease in purchasing power over time. It is based on the bond’s rating; the higher the rating, the lower the premium added, thus lowering the interest rate. It is calculated by adding the inflation premium to r*. It changes over time, depending on the expected rate of return on productive assets exchanged among market participants and people’s time preferences for consumption. As interest rates rise, bond prices fall, and as interest rates fall, bond prices rise. Because interest rate changes are uncertain, this premium is added as a compensation for this uncertainty. This premium is added when a security lacks marketability,…