- CFA Exams
- CFA Level I Exam
- Study Session 14. Fixed Income (1)
- Reading 42. Fixed-Income Securities: Defining Elements
- Subject 4. Structure of a Bond's Cash Flows

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**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 = six-month Treasury bill rate

g = six-month LIBOR rate

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]

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.

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**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. |