Question

(I) Because interest rates on Treasury bills are more volatile than rates on long-term securities, the return on short-term Treasury securities is usually above that on longer-term Treasury securities.
(II) A Treasury STRIP separates the periodic interest payments from the final principal repayment.
A) (I) is true, (II) false.
B) (I) is false, (II) true.
C) Both are true.
D) Both are false.

Answer 1

Answer:

B) (I) is false, (II) true.

Explanation:

The interest rate of longer-term securities is usually higher than the interest rate of short-term securities because more risk is associated with the longer-term securities. An example of the risks associated with long-term securities is that it possible for inflation to make value of the payment to fall. Another risk is when there is a rise in the interest rate which usually lead to a fall in the bond prices.  

Treasury STRIPS refers to bonds that are offered for sale at a discount to their face value. Their major attribute is that they do not pay interest to investors but the full face value of the bonds is paid to the investor when the bonds mature. This means the bonds mature at par.

The full meaning of STRIPS is Separate Trading of Registered Interest and Principal of Securities, and they are types of bonds that are commonly referred to as zero-coupon bonds because no interest or coupon is paid by them.

From the above, we can see that (B) is the correct option in the question. That is, (I) is false, (II) true.