Question #29
Reading: Reading 25 The Term Structure and Interest Rate Dynamics
PDF File: Reading 25 The Term Structure and Interest Rate Dynamics.pdf
Page: 11
Status: Incorrect
Correct Answer: A
Your Answer: C
Question
Suppose the government spot rate curve is flat at 3%. An active manager is planning on purchasing a five-year government bond at par. The realized return on this bond will most likely be:
Answer Choices:
A. more than 3% if the bond is held to maturity while the yield curve remains flat but decreases below 3%
B. 3% if the bond is held to maturity provided that the yield curve remains flat at 3%
C. 3% if the bond is held to maturity regardless of the shape of the yield curve
Explanation
There is no price risk for a default-free bond held to maturity. However, there is
reinvestment risk for the coupon payments received during the life of the bond (in this
instance, the bond is a par bond and hence has the same coupon rate as its yield). If the
yield curve shifts down, the reinvestment rate would be lower and the realized holding
period return would be lower than 3%.