Question 1

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?

Accepted Answer

A)  12.0% 
B)  12.6% 
C)  17.0% 
D)  17.9%

Question 2

Assume investors demand a real rate of return equal to 3 percent and that there is no maturity risk premium associated with Treasury securities.According to the Wall Street Journal,the average nominal yields on risk-free Treasury securities with different maturities are:
Type of security
Yield1-year
4)5%2-year
4)63-year
4)84-year
5)0What is the one-year nominal interest rate and the inflation premium that is expected in Year 4?

Accepted Answer

A)  5.0%;2.0% 
B)  4.5%;1.5% 
C)  3.0%;1.8% 
D)  5.6%;2.6% 
E)  There is not enough information to answer this question.

Question 3

The two reasons most experts give for the existence of a positive maturity risk premium are (1)because investors are assumed to be risk averse,and (2)because investors prefer to lend long while firms prefer to borrow short.

Accepted Answer

A) True 
 B)False

Question 4

Investors with a high time preference for current consumption would be willing to pay a higher price for the same investment than investors with a low time preference for current consumption.

Accepted Answer

A) True 
 B)False

Question 5

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?

Accepted Answer

A)  9.0% 
B)  9.5% 
C)  10.0% 
D)  10.5% 
E)  11.0%

Question 6

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.

Accepted Answer

A) True 
 B)False

Question 7

Which of the following statements is most correct?

Accepted Answer

A)  The more highly developed a nation's financial system is,the more likely funds are to flow from savers to borrowers by direct transfers as opposed to through financial intermediaries. 
B)  If people in the aggregate have a strong time preference for current consumption as opposed to future consumption,this factor will cause interest rates to be lower than if preferences were more toward future consumption. 
C)  If investors expect the rate of inflation to increase in the future,this would tend to cause the current short-term interest rate to be higher than current long-term rates. 
D)  The existence of maturity risk premiums is due to the fact that a change in interest rates has more effect on the prices of short-term than long-term bonds. 
E)  If a 1-year Treasury bond has a yield of 5 percent,if the expected rate of inflation during the coming year is 3 percent,and if the maturity risk and liquidity premiums on 1-year bonds are zero,then the real risk-free rate r* must be 2 percent.

Question 8

Given the following data,find the expected rate of inflation during the next year. r* = real risk-free rate = 3%.
Maturity risk premium on 10-year T-bonds = 2%.It is zero on 1-year bonds,and a linear relationship exists.
Default risk premium on 10-year,A-rated bonds = 1.5%.
Liquidity premium = 0%.
Going interest rate on 1-year T-bonds = 8.5%.

Accepted Answer

A)  3.5% 
B)  4.5% 
C)  5.5% 
D)  6.5% 
E)  7.5%

Question 9

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?

Accepted Answer

A)  Prices and interest rates will both rise. 
B)  Prices will rise and interest rates will decline. 
C)  Prices and interest rates will both decline. 
D)  Prices will decline and interest rates will rise. 
E)  There will be no changes in either prices or interest rates.

Question 10

Long-term interest rates reflect expectations about future inflation.Inflation has varied significantly from year to year in the past,and as a result,long-term rates can be expected to fluctuate more than short-term rates.

Accepted Answer

A) True 
 B)False

Question 11

Assume that expected rates of inflation over the next 5 years are 4 percent,7 percent,10 percent,8 percent,and 6 percent,respectively.What is the average expected inflation rate over this 5-year period?

Accepted Answer

A)  6.5% 
B)  7.5% 
C)  8.0% 
D)  6.0% 
E)  7.0%

Question 12

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

Accepted Answer

A) True 
 B)False

Question 13

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.

Accepted Answer

A) True 
 B)False

Question 14

Long-term bonds are more vulnerable to reinvestment rate risk than short-term bonds.

Accepted Answer

A) True 
 B)False

Question 15

An investor with a six-year investment horizon believes that interest rates are determined only by expectations about future interest rates, (i.e. ,this investor believes in the expectations theory).This investor should expect to earn the same rate of return over the 6-year time horizon if he or she buys a 6-year bond or a 3-year bond now and another 3-year bond three years from now (ignore transaction costs).

Accepted Answer

A) True 
 B)False

Question 16

You are given the following data:
R* = real risk-free rate
= 4%Constant inflation premium
= 7%Maturity risk premium
= 1%Default risk premium for AAA bonds
= 3%Liquidity premium for long-term T-bonds
= 2%Assume that a highly liquid market does not exist for long-term T-bonds,and the expected rate of inflation is a constant.Given these conditions,the nominal risk-free rate for T-bills is ____,and the rate on long-term Treasury bonds is ____.

Accepted Answer

A)  4%;14% 
B)  4%;15% 
C)  11%;14% 
D)  11%;15% 
E)  11%;17%

Question 17

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. )

Accepted Answer

A)  12.0% 
B)  16.0% 
C)  13.5% 
D)  10.5% 
E)  14.0%

Question 18

Your uncle would like to restrict his interest rate risk and his default risk,but he still would like to invest in corporate bonds.Which of the possible bonds listed below best satisfies your uncle's criteria?

Accepted Answer

A)  AAA bond with 10 years to maturity. 
B)  BBB perpetual bond. 
C)  BBB bond with 10 years to maturity. 
D)  AAA bond with 5 years to maturity. 
E)  BBB bond with 5 years to maturity.

Question 19

Treasury securities that mature in 6 years currently have an interest rate of 8.5%.Inflation is expected to be 5% each of the next three years and 6% each year after the third year.The maturity risk premium is estimated to be 0.1%(t − 1),where t is equal to the maturity of the bond (i.e. ,the maturity risk premium of a one-year bond is zero).The real risk-free rate is assumed to be constant over time.What is the real risk-free rate of interest?

Accepted Answer

A)  0.25% 
B)  0.50% 
C)  1.00% 
D)  1.75% 
E)  2.50%

Question 20

Which of the following statements is correct?

Accepted Answer

A)  The maturity premiums embedded in the interest rates on U.S.Treasury securities are due primarily to the fact that the probability of default is higher on long-term bonds than on short-term bonds. 
B)  Reinvestment rate risk is lower,other things held constant,on long-term than on short-term bonds. 
C)  According to the market segmentation theory of the term structure of interest rates,we should normally expect the yield curve to slope downward. 
D)  The expectations theory of the term structure of interest rates states that borrowers generally prefer to borrow on a long-term basis while savers generally prefer to lend on a short-term basis,and that as a result,the yield curve normally is upward sloping. 
E)  If the maturity risk premium was zero and the rate of inflation was expected to decrease in the future,then the yield curve for U.S.Treasury securities would,other things held constant,have an upward slope.

Exam 5: The Cost of Money Interest Rates

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 two reasons most experts give for the existence of a positive maturity risk premium are (1)because investors are assumed to be risk averse,and (2)because investors prefer to lend long while firms prefer to borrow short.

Investors with a high time preference for current consumption would be willing to pay a higher price for the same investment than investors with a low time preference for current consumption.

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.

Which of the following statements is most correct?

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?

Long-term interest rates reflect expectations about future inflation.Inflation has varied significantly from year to year in the past,and as a result,long-term rates can be expected to fluctuate more than short-term rates.

Assume that expected rates of inflation over the next 5 years are 4 percent,7 percent,10 percent,8 percent,and 6 percent,respectively.What is the average expected inflation rate over this 5-year period?

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

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.

Long-term bonds are more vulnerable to reinvestment rate risk than short-term bonds.

Your uncle would like to restrict his interest rate risk and his default risk,but he still would like to invest in corporate bonds.Which of the possible bonds listed below best satisfies your uncle's criteria?

Which of the following statements is correct?