Question #27
Reading: Reading 25 The Term Structure and Interest Rate Dynamics
PDF File: Reading 25 The Term Structure and Interest Rate Dynamics.pdf
Page: 10
Status: Correct
Correct Answer: A
Question
If an active bond portfolio manager believes future spot rates will be lower than indicated by today's forward rates, then she will most likely:
Answer Choices:
A. be indifferent because her holding period return will be unaffected
B. sell bonds because the market appears to be discounting future cash flows at “too high” of a discount rate
C. purchase bonds because the market is discounting future cash flows at “too high” of a discount rate
Explanation
If an investor believes future spot rates will be lower than indicated by today's forward
rates, then she should purchase bonds (at a presumably attractive price) because the
market appears to be discounting future cash flows at "too high" of a discount rate.