Question

1. Which of following security offer inflation protection for coupon payment?

A. TIPS Only

B. Fixed Rate Bonds and TIPS

C. TIPS and Floating Rate Notes

2. When the trading volume of a bond increases and thus the trading cost goes down, the liquidity premium charge on this bond?

A. Increased

B. Decreased

C. Unchanged

3. Which of the following statement is true about the benefit of holding bonds:

A. High correlation with Stock Mkt makes bonds desirable for diversify

B. Some types of bonds help investors preserve purchasing power

C. Central Bank increase interest rate when the economy is weak

D. A & B

Answer 1

(1)

Fixed Rated Bonds give the fixed amount of return irrespective of whether market interest rates rise or fall.

Floating rated notes are genrally for those type of investors where they dont want to bear interest rate risks.

Both above type of bonds do not protect from Inflation risk.

Only Treasury Inflation Protection Bonds provides inflation protection of coupon payment.

Hence option A is the correct answer.

(2)

Liquidity Premium changes with the volume of bonds that are traded in the market.

Whenever there is high liquidity in the market for the bond, the liquidity premium of the bond will be less and vice versa.

In the given case it is said that trading volume increased, Hence Liquidity Premium will be decreased.

Option B is the correct answer.

(3)

In order to maintain a diversified portfolio, the corelation between the assets that are in portfolio should have negative corelation because decrease in value of one asset and there will automatically increase in value of other asset thus the portfolio wont be in any losses.

High corelation results in losses in between both the assets.

Yes some type of bonds such as inflation linked bonds help investor preserve purchasing power.

Central Bank Decreases rates when economy is weak.

Hence option B is the correct answer.