Exam 5: The Cost of Money Interest Rates

Assume that the current interest rate on a 1-year bond is 8 percent, the current rate on a 2-year bond is 10 percent, and the current rate on a 3-year bond is 12 percent. If the expectations theory of the term structure is correct, what is the 1-year interest rate expected during Year 3? (Base your answer on an arithmetic rather than geometric average.)

Andrew purchased a stock for $175 and sold it for $250. If he earned a dividend income of $30, the stock's yield is:

Other things held constant,:

Interest rates on 1-year, 2-year, and 3-year Treasury bills are 5%, 6%, and 7% respectively. Assume that the pure expectations theory holds and that the market is in equilibrium. Which of the following statements is correct?

If you have information that a recession is ending, and the economy is about to enter a boom, and your firm needs to borrow money, it should probably issue long-term rather than short-term debt.

_____ can be negative if the value of the investment decreases during the period it is held.

Which of the following rates indicate the rate that will exist in an inflation-free world?

The change in the market value of an asset over some time period is called the _____.

The real rate of interest is composed of a risk-free rate of interest plus the default premium and liquidity premium that reflects the riskiness of the security

You read in The Wall Street Journal that 30-day T-bills are currently yielding 8 percent. Your brother-in-law, a broker at Kyoto Securities, has given you the following estimates of current interest rate premiums: Inflation premium 5% Liquidity premium 1% Maturity risk premium 2% Default risk premium 2% Based on these data, the real risk-free rate of return is:

_____ is the tendency of prices to increase over time.

If a stock pays a dividend of $10 and the investors need 8% return on their investment, then the investors should pay _____ for the stock.

A foreign trade deficit occurs when a country's:

If the expectations theory of the term structure of interest rates is correct, and if the other term structure theories are invalid, and we observe a downward sloping yield curve, which of the following is a true statement?

Assume that the real risk-free rate, r*, is 4 percent, and that inflation is expected to be 9% in Year 1, 6% in Year 2, and 4% thereafter. Also, assume that all Treasury bonds are highly liquid and free of default risk. If 2-year and 5-year Treasury bonds both yield 12%, what is the difference in the maturity risk premiums (MRPs) on the two bonds, i.e., what is MRP5 - MRP2?

Bonds with higher liquidity have to offer higher interest rates in the market since they can be easily converted into cash on short notice at or near the fair market value for that bond.

Which of the following bonds have the highest default risk for a given return?

A normal yield curve that is upward sloping implies that:

During or near peaks of business activity, yield curves that are flat or downward sloping (possibly with humps) are prevalent.

Production opportunity is one of the four fundamental factors that affect the: