Exam 6: Understanding Financial Markets and Institutions

This is a security formalizing an agreement between two parties to exchange a standard quantity of an asset at a predetermined price on a specified date in the future.

Which of the following statements is correct?

A particular security's default risk premium is 3%. For all securities, the inflation risk premium is 1.75% and the real interest rate is 4.2%. The security's liquidity risk premium is 0.35% and maturity risk premium is 0.95%. The security has no special covenants. Calculate the security's equilibrium rate of return.

If the yield curve is downward sloping, what is the yield to maturity on a 30-year Treasury bond relative to a 10-year Treasury bond?

Unbiased Expectations Theory One-year Treasury bills currently earn 5.50 percent. You expect that one year from now, one-year Treasury bill rates will increase to 5.75 percent. If the unbiased expectations theory is correct, what should the current rate be on two-year Treasury securities?

How do Financial Intermediaries (FIs) act as asset transformers?

The Wall Street Journal reports that the rate on 4-year Treasury securities is 7.50% and the rate on 5-year Treasury securities is 9.15%. According to the unbiased expectations hypotheses, what does the market expect the 1-year Treasury rate to be four years from today, E(₅r₁)?

You note the following yield curve in The Wall Street Journal. According to the unbiased expectations hypothesis, what is the one-year forward rate for the period beginning one year from today, ₂f₁?

Unbiased Expectations Theory The Wall Street Journal reports that the rate on 4-year Treasury securities is 4.75 percent and the rate on 5-year Treasury securities is 5.95 percent. According to the unbiased expectations hypotheses, what does the market expect the 1-year Treasury rate to be four years from today, E(₅r₁)?

Based on economists' forecasts and analysis, one-year Treasury bill rates and liquidity premiums for the next four years are expected to be as follows: R₁ = 5.95% E(r₂) = 6.25% L₂ = 0.05% E(r₃) = 6.75% L₃ = 0.10% E(r₄) = 7.15% L₄ = 0.12% Using the liquidity premium hypothesis, what should be the current rate on four-year Treasury securities?

One-year Treasury bills currently earn 4.5 percent. You expect that one year from now, one-year Treasury bill rates will increase to 6.65 percent. The liquidity premium on two-year securities is 0.05 percent. If the liquidity theory is correct, what should the current rate be on two-year Treasury securities?

Which of these does NOT perform vital functions to securities markets of all sorts by channeling funds from those with surplus funds to those with shortages of funds?

Once firms issue financial instruments in primary markets, these same stocks and bonds are then traded in which of these?

These capital market instruments are long-term loans to individuals or businesses to purchase homes, pieces of land, or other real property.

Primary market financial instruments include stock issues from firms allowing their equity shares to be publicly traded on stock market for the first time. We usually refer to these first-time issues as which of the following?

This is the interest rate that would exist on a default-free security if no inflation were expected.

The Wall Street Journal reports that the rate on 3-year Treasury securities is 7.00%, and the 6-year Treasury rate is 6.20%. From discussions with your broker, you have determined that expected inflation premium is 2.25% next year, 2.50% in Year 2, and 2.50% in Year 3 and beyond. Further, you expect that real interest rates will be 4.4% annually for the foreseeable future. Calculate the maturity risk premium on the 3-year Treasury security.

You are considering an investment in 30-year bonds issued by Moore Corporation. The bonds have no special covenants. The Wall Street Journal reports that 1-year T-bills are currently earning 3.55%. Your broker has determined the following information about economic activity and Moore Corporation bonds: Real interest rate = 2.75% Default risk premium = 1.05% Liquidity risk premium = 0.50% Maturity risk premium = 1.85% What is the inflation premium?

The Wall Street Journal reports that the rate on 3-year Treasury securities is 6.50%, and the 6-year Treasury rate is 6.80%. From discussions with your broker, you have determined that expected inflation premium is 2.25% next year, 2.50% in Year 2, and 2.60% in Year 3 and beyond. Further, you expect that real interest rates will be 3.4% annually for the foreseeable future. Calculate the maturity risk premium on the 3-year and the 6-year Treasury security.

Liquidity Premium Hypothesis The Wall Street Journal reports that the rate on 3-year Treasury securities is 4.75 percent and the rate on 4-year Treasury securities is 5.00 percent. The one-year interest rate expected in three years is E(₄r₁), 5.25 percent. According to the liquidity premium hypotheses, what is the liquidity premium on the 4-year Treasury security, L₄?