CFA Practice Question

There are 490 practice questions for this study session.

CFA Practice Question

Which of these coupon structures will provide increasing coupon payments in the event that the slope of the term structure becomes steeper (i.e., long-term rates increase relative to short-term rates)?

R = 10-year U.S. Treasury note rate
r = six-month Treasury bill rate
g = six-month LIBOR rate

A. 5% + Maximum [(0.60 x (15% - r)) or 0]
B. 3% + Maximum [(3.5 x (R-r)) or 0]
C. Maximum [(7.25 x (r-g)) or 0]
D. Maximum [(18% - 2.5R) or 0]
Correct Answer: B

This coupon rate specification increases when the 10-year Treasury note rate, R, increases relative to the six-month Treasury bill rate, r.

User Contributed Comments 7

User Comment
SSPatel Which interest rate structure pays more if long-term interest rates increase compared to short-term rates. In answer choice B, the (R-r) would increase yielding a higher rate.
ljamieson B is the only one that is a function of both a short rate and long rate
magicchip nothing but B mentions long term rates, therefore B
Donnaiola long term rates are mentioned in D as well. However, in that formula, rising long term rates will have an inverse effect on the coupon.
Oarona Good observations Donnaiola
slipleft The mention of long term rates matters not. If B did not have the 3.5 multiplier, then B would be only be true under certain conditions. Best bet, insert rates consistent with an upward sloping yield curve for r, g and R, then solve each equation.
philerup Just read the question, when it says relative to something, there has to be at least two variables.
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