Chapter 4

Fundamentals of Futures and Options Markets, 8e (Hull)
Chapter 4 Interest Rates
1) The compounding frequency for an interest rate defines

A) The frequency with which interest is paid
B) A unit of measurement for the interest rate
C) The relationship between the annual interest rate and the monthly interest rate
D) None of the above
Answer: B
2) An interest rate is 6% per annum with annual compounding. What is the equivalent rate with
continuous compounding?
A) 5.79%
B) 6.21%
C) 5.83%
D) 6.18%
Answer: C
3) An interest rate is 5% per annum with continuous compounding. What is the equivalent rate
with semiannual compounding?
A) 5.06%
B) 5.03%
C) 4.97%
D) 4.94%
Answer: A
4) An interest rate is 12% per annum with semiannual compounding. What is the equivalent rate
with quarterly compounding?
A) 11.83%
B) 11.66%
C) 11.77%
D) 11.92%
Answer: A
5) The two-year zero rate is 6% and the three year zero rate is 6.5%. What is the forward rate for
the third year? All rates are continuously compounded.
A) 6.75%
B) 7.0%
C) 7.25%
D) 7.5%
Answer: D
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6) The six-month zero rate is 8% per annum with semiannual compounding. The price of a one-
year bond that provides a coupon of 6% per annum semiannually is 97. What is the one-year
continuously compounded zero rate?
A) 8.02%
B) 8.52%
C) 9.02%
D) 9.52%
Answer: C
7) The yield curve is flat at 6% per annum. What is the value of an FRA where the holder
receives interest at the rate of 8% per annum for a six-month period on a principal of $1,000
starting in two years? All rates are compounded semiannually.
A) $9.12
B) $9.02
C) $8.88
D) $8.63
Answer: D
8) Under liquidity preference theory, which of the following is always true?

A) The forward rate is higher than the spot rate when both have the same maturity
B) Forward rates are unbiased predictors of expected future spot rates
C) The spot rate for a certain maturity is higher than the par yield for that maturity
D) Forward rates are higher than expected future spot rates
Answer: D
9) The zero curve is upward sloping. Define X as the 1-year par yield, Y as the 1-year zero rate
and Z as the forward rate for the period between 1 and 1.5 year. Which of the following is true?
A) X is less than Y which is less than Z
B) Y is less than X which is less than Z
C) X is less than Z which is less than Y
D) Z is less than Y which is less than X
Answer: A
10) Prior to the credit crisis that started in 2007 which of the following was the proxy used by
derivatives traders for the risk-free rate?
A) The Treasury rate
B) The LIBOR rate
C) The repo rate
D) The overnight indexed swap rate
Answer: B
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11) Since the credit crisis that started in 2007 which of the following have derivatives traders
started to use as the risk-free rate for some transactions?
A) The Treasury rate
B) The LIBOR rate
C) The repo rate
D) The overnight indexed swap rate
Answer: D
12) At what interest rate does a government borrow in its own currency?
A) Treasury rate
B) LIBOR
C) LIBID
D) Repo rate
Answer: A
13) Which of the following is true of LIBOR?

A) The LIBOR rate is free of credit risk
B) A LIBOR rate is lower than the Treasury rate when the two have the same maturity
C) It is a rate used when borrowing and lending takes place between banks
D) It is subject to favorable tax treatment in the U.S.
Answer: C
14) Which of following describes forward rates?

A) Interest rates implied by current zero rates for future periods of time
B) Interest rate earned on an investment that starts today and last for n-years in the future without
coupons
C) The coupon rate that causes a bond price to equal its par (or principal) value
D) A single discount rate that gives the value of a bond equal to its market price when applied to
all cash flows
Answer: A
15) Given a choice between 5-year and 1-year instruments most people would choose 5-year
instruments when borrowing and 1-year instruments when lending. Which of the following is a
theory consistent with this observation?
A) Expectations theory
B) Market segmentation theory
C) Liquidity preference theory
D) Maturity preference theory
Answer: C
16) A repo rate is

A) An uncollateralized rate
B) A rate where the credit risk is relatively high
C) The rate implicit in a transaction where securities are sold and bought back at a higher price
Answer: C
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17) Bootstrapping involves
A) Calculating the yield on a bond
B) Working from short maturity instruments to longer maturity instruments determining zero
rates at each step
C) Working from long maturity instruments to shorter maturity instruments determining zero
rates at each step
D) The calculation of par yields
Answer: B
18) The zero curve is downward sloping. Define X as the 1-year par yield, Y as the 1-year zero
rate and Z as the forward rate for the period between 1 and 1.5 year. Which of the following is
true?
A) X is less than Y which is less than Z
B) Y is less than X which is less than Z
C) X is less than Z which is less than Y
D) Z is less than Y which is less than X
Answer: D
19) Which of the following is true?

A) When interest rates in the economy increase, all bond prices increase
B) As its coupon increases, a bond's price decreases
C) Longer maturity bonds are always worth more that shorter maturity bonds when the coupon
rates are the same
Answer: D
20) The six month and one-year rates are 3% and 4% per annum with semiannual compounding.
Which of the following is closest to the one-year par yield expressed with semiannual
compounding?
A) 3.99%
B) 3.98%
C) 3.97%
D) 3.96%
Answer: A
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Fundamentals of Futures and Options Markets, 8e (Hull)

Chapter 4 Interest Rates

1) The compounding frequency for an interest rate defines

8) Under liquidity preference theory, which of the following is always true?

13) Which of the following is true of LIBOR?

14) Which of following describes forward rates?

16) A repo rate is

19) Which of the following is true?

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