Question

1. Prices of zero-coupon bonds rise over time, providing a rate of appreciation equal to the internal, compounded rate of return. Zero coupon bonds are also the vehicles of choice in constructing a yield curve and are oftentimes estimated, when a zero is not readily available, by a treasury strip.

True

False

2.Holding maturity constant, a bond’s duration is higher when the coupon rate is higher; generally decreases with its time to maturity; is lower when the bond’s yield to maturity is higher; and equals its time to maturity when no coupon is paid (i.e., a zero coupon bond).

True

False

3.Collateralized debt obligations (CDOs) are used to reallocate (via tranches) the general risk of a pool of loans. Each tranche is given a different level of security in terms of its claims on the underlying loan pool cash flows and each can be sold as a stand-alone security. Some of the largest collateralized pools are portfolios of mortgages, credit cards, auto loans, and student loans.

True

False

4.The risk premium of the market portfolio is related to its variance by its average degree of risk aversion. With CAPM specifically, the risk premium on a risky asset is proportional to its CAPM beta.

True

False

Answer 1

1) True.

Zero coupon bonds are issued at discount to their face value and they rise over a period of time as their maturity period approaches in order to reach the face value at the end. Treasury strip are used to estimate the spot rate.

2) False

Holding maturity constant, the bond duration would be lower if the coupon rate is higher because higher coupon rate than yield curve means the bond is a premium bond and premium bonds have low duration.

3) True

Collateralized loan can be used to distribute risk where each tranche is given a different level of security in terms of its claims on the underlying loan pool cash flows and each can be sold as a stand-alone security. Some of the largest collateralized pools are portfolios of mortgages, credit cards, auto loans, and student loans.

4) True

The risk premium of the market portfolio is proportional to the degree of its risk aversion and the risk premium on a risky asset is proportional to its CAPM beta.