Exam 5: The Cost of Money Interest Rates

The fundamental factors that affect the cost of money include

The ____ premium is compensation for possibility that the borrower will not be able to debt's interest and principal on time.

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

The market segmentation theory of the term structure is, essentially, the expectations theory with the addition of maturity risk premiums.

Which of the following statements is most correct? Other things held constant,

The difference between the nominal risk-free rate and the real risk-free rate is that the real risk-free includes inflation and the nominal risk-free rate does not include inflation.

Assume that a 3-year Treasury note has no maturity premium, and that the real, risk-free rate of interest is 3 percent.If the T-note carries a yield to maturity of 13 percent, and if the expected average inflation rate over the next 2 years is 11 percent, what is the implied expected inflation rate during Year 3?

A downward sloping yield curve is considered normal.

Assume that the expectations theory of term structure holds.If the rate on a two-year Treasury bond is 8% and the rate on a three-year Treasury bond is 7%, what is the expected rate on a one-year Treasury bond in year three?

If the Fed increases the money supply interest rates will generally increase.

What is the yield on a one-year corporate bond with a $1,000 face value that pays a 12% annual dividend if it was purchased for $950 and held until maturity?

The existence of an upward sloping yield curve proves that the liquidity preference theory is correct, because an upward sloping curve necessarily implies that firms must offer a maturity risk premium in order to induce investors to lend for longer periods.

Suppose your firm must raise funds immediately, and it has decided to use debt financing to do so.If you believe that the economy is at the peak of a boom, but it is just about to enter a recession, your firm would probably be better off if it issued long-term debt rather than short-term debt.

Default risk premiums

Assume that the expectations theory holds, and that liquidity and maturity risk premiums are zero.If the annual rate of interest on a 2-year Treasury bond is 10.5 percent and the rate on a 1-year Treasury bond is 12 percent, what rate of interest should you expect on a 1-year Treasury bond one year from now?

The price of a bond bought at a discount cannot go down in the financial markets.

Suppose that the annual expected rates of inflation over each of the next five years are 5 percent, 6 percent, 9 percent, 13 percent, and 12 percent, respectively.What is the average expected rate of inflation over the 5-year period?

The nominal rate of interest is defined as the sum of the nominal risk-free rate of return and the expected inflation rate.

If the Federal Reserve sells $50 billion of short-term U.S.Treasury securities to the public, other things held constant, what will this tend to do to short-term security prices and interest rates?

Assume that r* = 2.0%; the maturity risk premium is found as MRP = 0.1%(t − 1) where t = years to maturity; the default risk premium for corporate bonds is found as DRP = 0.05%(t − 1); the liquidity premium is 1.0% for corporate bonds only; and inflation is expected to be 3%, 4%, and 5% during the next three years and then 6% thereafter.What is the difference in interest rates between 10-year corporate and Treasury bonds?