1) FRM EXAM 2002—QUESTION 48

An investor buys a Treasury bill maturing in 1 month for $987. On the maturity date the investor
collects $1,000. Calculate effective annual rate (EAR).

a. 17.0%
b. 15.8%
c. 13.0%
d. 11.6%

Solution:

a. The EAR is defined by FV/PV = (1 + EAR)T. So EAR = (FV/PV)1/T − 1. Here, T = 1/12. So,

EAR = (1,000/987)12 − 1 = 17.0%.

2) FRM EXAM 2002—QUESTION 51

Consider a savings account that pays an annual interest rate of 8%. Calculate the amount of
time it would take to double your money. Round to the nearest year.

a. 7 years

b. 8 years

c. 9 years

d. 10 years

Solution:

c. The time T relates the current and future values such that FV/PV = 2 =

(1 + 8%)T. Taking logs of both sides, this gives T = ln(2)/ln(1.08) = 9.006.

3) FRM EXAM 2006—QUESTION 75

A zero-coupon bond with a maturity of 10 years has an annual effective yield of 10%. What is
the closest value for its modified duration?

a. 9

b. 10

c. 99

d. 100

Solution:
a. Without doing any computation, the Macaulay duration must be 10 years
because this is a zero-coupon bond. With annual compounding, modified duration
is D∗ = 10/(1 + 10%), or close to 9 years.

4) FRM EXAM 2007—QUESTION 115

A portfolio manager has a bond position worth USD 100 million. The position has a modified
duration of eight years and a convexity of 150 years. Assume that the term structure is flat. By
how much does the value of the position change if interest rates increase by 25 basis points?

a. USD -2,046,875

b. USD -2,187,500

c. USD -1,953,125

d. USD -1,906,250

Solution:
c. The change in price is given by P = −[D∗ × P](y) + 1/2 x[C × P](y)2

= −[8 × 100](0.0025) + 0.5[150 × 100](0.0025)2 = −2.000000 + 0.046875 =

−1.953125.

5) FRM EXAM 2003—QUESTION 13

Suppose the face value of a three-year option-free bond is USD 1,000 and the annual coupon is
10%. The current yield to maturity is 5%. What is the modified duration of this bond?

a. 2.62
b. 2.85
c. 3.00
d. 2.75

Solution:

d. As in Table bellow, we lay out the cash flows and find

Period Payment Yield PVt = Ct/(1 + y) t tPVt

1 100 5.00 95.24 95.24
2 100 5.00 90.71 181.41
3 1100 5.00 950.22 2850.66
Sum: 1136.16 3127.31
Duration is then 2.75, and modified duration 2.62.

6) FRM EXAM 2002—QUESTION 118

A Treasury bond has a coupon rate of 6% per annum (the coupons are paid semiannually) and
a semiannually compounded yield of 4% per annum. The bond matures in 18 months and the
next coupon will be paid 6 months from now. Which number below is closest to the bond’s
Macaulay duration?

a. 1.023 years
b. 1.457 years
c. 1.500 years
d. 2.915 years

Solution:
b. For coupon-paying bonds, Macaulay duration is slightly less than the maturity, which is 1.5 year here.
So, b. would be a good guess. Otherwise, we can compute duration exactly.

7) DURATION AND COUPON

A and B are two perpetual bonds, that is, their maturities are infinite. A has a coupon of 4% and
B has a coupon of 8%. Assuming that both are trading at the same yield, what can be said
about the duration of these bonds?

a. The duration of A is greater than the duration of B.

b. The duration of A is less than the duration of B.

c. A and B both have the same duration.

d. None of the above.

Solution

c. Going back to the duration equation for the consol, we see that it does not depend on the coupon but
only on the yield. Hence, the durations must be the same. The price of bond A, however, must be half that
of bond B.

8) FRM EXAM 2006—QUESTION 61

Consider the following portfolio of bonds (par amounts are in millions of USD).

Bond Price Par amount held Modified Duration

A 101.43 3 2.36
B 84.89 5 4.13
C 121.87 8 6.27

What is the value of the portfolio’s DV01 (dollar value of 1 basis point)?
a. 8,019
b. 8,294
c. 8,584
d. 8,813

Solution:

c. First, the market value of each bond is obtained by multiplying the par amount by the ratio of
the market price divided by 100. Next, this is multiplied by D∗ to get the dollar duration DD.
 Summing, this gives $85.841 million. We multiply by 1,000,000 to get dollar amounts and by
0.0001 to get the DV01, which gives $8,584.

Bond Price Par Mkt value D∗ DD

A 101.43 3 3.043 2.36 7.181
B 84.89 5 4.245 4.13 15.530
C 121.87 8 9.750 6.27 61.130
Sum 8 85.841

9) FRM EXAM 2007—QUESTION 32

The price of a three-year zero-coupon government bond is 85.16. The price of a similar four-
year bond is 79.81. What is the one-year implied forward rate from year 3 to year 4?

a. 5.4%

b. 5.5%

c. 5.8%

d. 6.7%

Solution:

d. The forward rate can be inferred from P4 = P3/(1 + F3,4), or (1 + R4)4 = (1 +R3)3(1 + F3,4). Solving, this

gives F3,4 = (85.16/79.81) − 1 = 0.067.

10) FRM EXAM 2005—QUESTION 57

ABC, Inc., entered a forward rate agreement (FRA) to receive a rate of 3.75% with continuous
compounding on a principal of USD 1 million between the end of year 1 and the end of year 2.
The zero rates are 3.25% and 3.50% for one and two years. What is the value of the FRA when
the deal is just entered?

a. USD 35,629
b. USD 34,965
c. USD 664
d. USD 0

Solution:

d. The market-implied forward rate is given by exp(−R2 × 2) = exp(−R1 × 1 −F1,2 × 1), or F1,2 = 2 × 3.50

− 1 × 3.25 = 3.75%. Given that this is exactly equalv to the quoted rate, the value must be zero. If

instead this rate was 3.50%, for example, the value would be V = $1,000,000 × (3.75% − 3.50%) × (2 −

1) exp(−3.50% × 2) = 2,331.
11) FRM EXAM 2001—QUESTION 70
Consider the buyer of a 6 × 9 FRA. The contract rate is 6.35% on a notional amount of $10
million. Calculate the settlement amount of the seller if the settlement rate is 6.85%. Assume a
30/360 day count basis.
a. −12,500
b. −12,290
c. +12,500
d. +12,290

Solution:

b. The seller of an FRA agrees to receive fixed. Since rates are now higher than the contract rate, this
contract must show a loss for the seller. The loss is $10,000,000 × (6.85% − 6.35%) × (90/360) =
$12,500 when paid in arrears, i.e., in nine months. On the settlement date, i.e., brought forward by three
months, the loss is $12,500/(1 + 6.85% × 0.25) = $12,290.

12) FRM EXAM 2010 -The table below gives the closing prices and yields of a particular liquid
bond over the past few days

Day Price Yield

Monday 106.3 4.25%

Tuesday 105.8 4.20%

Wednesday 106.1 4.23%

What is the approximate duration of the bond?

a. 18.8
b. 9.4
c. 4.7
d. 1.9

Solution:
b. The duration can be approximated from the price changes
(106.3 – 105.8)/106.3/0.0005 = 9.4

13) FRM EXAM 2011 – Consider a bond with par value of EUR1000, maturity in 3 years
and that pays a coupon of 5% annually. The spot rate curve is as follows.

Term Annual Spot Interest Rates

1 6%
2 7%
3 8%

The value of the bond is closest to:

 a. EUR 904
b. EUR 924
c. EUR 930
d. EUR 950

Solution:
b. Using spot rates, the value of the bond is:
50/(1.06) + 50/[(1.07)^2] + 1050/[(1.08)^3] = 924.37

14) FRM EXAM 2012 – A trading portfolio consists of two bonds, A and B. Both have
modified duration of three years and a face value of USD 1000, but A is a zero-coupon bond
and its current price is USD 900, and bond B pays annual coupons and is priced at par. What
do you expect will happen to the market prices of A and B if risk-free yield curve moves up by 1
basis point?

a. Both bond prices will move up by roughly the same amount

b. Both bond prices will move up, but bond B will gain more than bond A

c. Both bond prices will move down by roughly equal amouts

d. Both bond prices will move down, but bond B will lose more than bond A

Solution:

d. Assuming parallel movements to the yield curve, the expected price change is: P =
- P y * D where

P is the current price or net present value

y is the yield change

D is the duration

All else equal, a negative impact of yield curve move is stronger in absolute terms at
the bond which is currently priced higher. Upward parallel curve movements makes bonds
cheaper.

15) FRM EXAM 2013 - You have been asked to check for arbitrage opportunities in the
Treasury bond market by comparing the flows of selected bonds with the cash flows of
combinations of other bonds. If a 1-year zero-coupon bond is priced at USD 96.12 and a 1-year
bond paying a 10% coupon semi-annually is priced at USD 106.20, what should be the price of
1-year Treasury bond that pays a coupon of 8% semi-annually?

a. USD 98.10

b. USD 101.23
 c. USD 103.35

d. USD 104.18

Solution:

d. The solution is to replicate the 1 year 8% bond using the other two treasury bonds.
In order to replicate the cash flows of the 8% bond, you could solve a system of equations to
determine the weight factors, F1 and F2, which correspond to the proportion of the zero and
the 10% bond to be held, respectively:

The two equations are as follows:

100 F1 + 105 F2 = 104 (replicating the cash flow including principal and interest
payments at the end of 1 year)

5 F2 = 4 (replicating the cash flow from the coupon payment in 6 months)

Solving the two equations gives us F1 = 0.2 and F2 = 0.8 . Thus, the price of 8% bond
should be 0.2 (96.12) + 0.8 (106.2) = 104.18

16) CFA practice question

a) What is the present value of a 5-year security with a coupon rate of 7% that pays
annually assuming a discount rate of 5%

b) A 5-year amortizing security with a par value of $10000 and a coupon rate of 5% has
an expected cash flow of $2309.75 per year assuming that there are no prepayments. The
annual cash flow includes interest and principal repayment. What is the present value of this
amortizing security assuming a discount rate of 6%?

17) CFA practice question

a) What is the value of a 5-year 7% coupon bond when the discount rate is (i) 6%, (ii)
7%, and (iii) 8%

b) Show that the results obtained in part a are consistent with the relationship between
the coupon rate, discount rate and price relative to par value

18) CFA practice question

a) Suppose that a bond is purchased between coupon periods. The days between the
settlement date and the next coupon period is 58. There are 183 days in the coupon period.
Suppose that the bond purchased has a coupon rate of 7% and there are 10 semiannual
coupon payments remaining. What is the full price for this bond if a 5% annual discount rate is
used?

b) What is the accrued interest and the clean price for the bond whose full price is
computed in a?