Question 1

On May 23, 20XX, the existing or current (spot) one-year, two-year, three-year, and four-year zero-coupon Treasury security rates were as follows: 
 $${ } _ { 1 } R _ { 1 } = 5.25 \% , \quad { } _ { 1 } R _ { 2 } = 5.75 \% , \quad { } _ { 1 } R _ { 3 } = 6.25 \% , \quad { } _ { 1 } R _ { 4 } = 6.45 \%$$ Using the unbiased expectations theory, what is the one-year forward rate on zero-coupon Treasury bonds for year 4 as of May 23, 20XX?

Accepted Answer

A) 5.925 percent 
B) 6.45 percent 
C) 7.05 percent 
D) 10.32 percent

Question 2

The Wall Street Journal reports that the rate on three-year Treasury securities is 4.75 percent and the rate on four-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 theory, what is the liquidity premium on the four-year Treasury security, L4?

Accepted Answer

A) 0.0375 percent 
B) 0.504 percent 
C) 5.01 percent 
D) 5.04 percent

Question 3

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

Accepted Answer

A) 0.00 percent 
B) 0.10 percent 
C) 4.50 percent 
D) 2.60 percent

Question 4

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. The liquidity premium on two-year securities is 0.075 percent. If the liquidity theory is correct, what should the current rate be on two-year Treasury securities?

Accepted Answer

A) 3.775 percent 
B) 5.625 percent 
C) 5.662 percent 
D) 11.325 percent

Question 5

One-year Treasury bills currently earn 2.95 percent. You expected that one year from now, one-year Treasury bill rates will increase to 3.15 percent and that two years from now, one-year Treasury bill rates will increase to 3.35 percent. The liquidity premium on two-year securities is 0.05 percent and on three-year securities is 0.15 percent. If the liquidity theory is correct, what should the current rate be on three-year Treasury securities?

Accepted Answer

A) 2.95 percent 
B) 3.15 percent 
C) 3.22 percent 
D) 3.35 percent

Question 6

According to this theory of term structure of interest rates, at any given point in time, the yield curve reflects the market's current expectations of future short-term rates.

Accepted Answer

A) Expectations theory 
B) Future short-term rates theory 
C) Term structure of interest rates theory 
D) Unbiased expectations theory

Question 7

Suppose that the current one-year rate (one-year spot rate) and expected one-year T-bill rates over the following three years (i.e., years 2, 3, and 4, respectively) are as follows: 1R1 = 5 percent, E(2r1) = 6 percent, E(3r1) = 7.5 percent E(4r1) = 6.85 percent
Using the unbiased expectations theory, calculate the current (long-term) rates for one-, two-, three-, and four-year-maturity Treasury securities.

Accepted Answer

A) 5.00 percent; 5.50 percent; 6.16 percent; 6.33 percent 
B) 5.00 percent; 5.25 percent; 6.10 percent; 6.27 percent 
C) 5.00 percent; 5.50 percent; 6.10 percent; 6.23 percent 
D) 5.00 percent; 5.25 percent; 6.16 percent; 6.49 percent

Question 8

A recent edition of The Wall Street Journal reported interest rates of 3.10 percent, 3.50 percent, 3.75 percent, and 3.95 percent for three-year, four-year, five-year, and six-year Treasury security yields, respectively. According to the unbiased expectation theory of the term structure of interest rates, what are the expected one-year rates for year 6?

Accepted Answer

A) 3.575 percent 
B) 3.95 percent 
C) 4.96 percent 
D) 5.33 percent

Question 9

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: $$\begin{array} { l l } 
R _ { 1 } = 6.65 \% & \
E \left( r _ { 2 } \right) = 7.75 \% & L _ { 2 } = 0.10 \% \
E \left( r _ { 3 } \right) = 7.85 \% & L _ { 3 } = 0.20 \% \
E \left( r _ { 4 } \right) = 8.15 \% & L _ { 4 } = 0.25 \%
\end{array}$$ Using the liquidity premium theory, what is the current rate on a four-year Treasury security?

Accepted Answer

A) 7.736 percent 
B) 7.600 percent 
C) 7.738 percent 
D) 8.400 percent

Question 10

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 percent
E(r2) = 6.25 percent L2 = 0.05 percent
E(r3) = 6.75 percent L3 = 0.10 percent
E(r4) = 7.15 percent L4 = 0.12 percent
Using the liquidity premium theory, what should be the current rate on four-year Treasury securities?

Accepted Answer

A) 6.59 percent 
B) 6.75 percent 
C) 6.82 percent 
D) 7.13 percent

Question 11

Assume the current interest rate on a one-year Treasury bond (1R1) is 5.00 percent, the current rate on a two-year Treasury bond (1R2) is 5.75 percent, and the current rate on a three-year Treasury bond (1R3) is 6.25 percent. If the unbiased expectations theory of the term structure of interest rates is correct, what is the one-year interest rate expected on Treasury bills during year 3, 3f1?

Accepted Answer

A) 5.00 percent 
B) 5.67 percent 
C) 7.26 percent 
D) 8.00 percent

Question 12

Which of the following statements is incorrect?

Accepted Answer

A) The over-the-counter market operates in a fixed location to conduct trades for local stocks. 
B) Liquidity is the ease with which an asset can be converted into cash. 
C) An initial public offering is an example of a primary market transaction. 
D) Money market instruments have maturities of less than one year.

Question 13

In 20XX, the 10-year Treasury rate was 4.5 percent while the average 10-year Aaa corporate bond debt carried an interest rate of 6.0 percent. What is the average default risk premium on Aaa corporate bonds?

Accepted Answer

A) 0.75 percent 
B) 1.5 percent 
C) 1.95 percent 
D) 2.25 percent

Question 14

All of the following are secondary market transactions EXCEPT:

Accepted Answer

A) GE sells $30 million of new preferred stock. 
B) Microsoft sells $2 million of IBM preferred stock out of its marketable securities portfolio. 
C) the Magellan Fund buys $100 million of Apple previously issued bonds. 
D) Allstate Insurance Co. sells $5 million in IBM bonds.

Question 15

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 one-year T-bills are currently earning 3.55 percent. Your broker has determined the following information about economic activity and Moore Corporation bonds: Real interest rate = 2.75 percent
Default risk premium = 1.05 percent
Liquidity risk premium = 0.50 percent
Maturity risk premium = 1.85 percent
What is the inflation premium?

Accepted Answer

A) 0.80 percent 
B) 1.25 percent 
C) 6.25 percent 
D) 8.00 percent

Question 16

You are considering an investment in 30-year bonds issued by a corporation. The bonds have no special covenants. The Wall Street Journal reports that one-year T-bills are currently earning 3.50 percent. Your broker has determined the following information about economic activity and the corporation bonds: Real interest rate = 2.50 percent
Default risk premium = 1.75 percent
Liquidity risk premium = 0.70 percent
Maturity risk premium = 1.50 percent
What is the inflation premium? What is the fair interest rate on the corporation's 30-year bonds?

Accepted Answer

A) 1 percent and 1.49 percent, respectively 
B) 1 percent and 6.45 percent, respectively 
C) 1 percent and 7.45 percent, respectively 
D) 3.50 percent and 9.95 percent, respectively

Question 17

One-year Treasury bill rates in 20XX averaged 5.15 percent and inflation for the year was 7.3 percent. If investors had expected the same inflation rate as that realized, calculate the real interest rate for 20XX according to the Fisher effect.

Accepted Answer

A) 0.00 percent 
B) -2.15 percent 
C) 2.15 percent 
D) 3.95 percent

Question 18

In the United States, which of these financial institutions arrange most primary market transactions for businesses?

Accepted Answer

A) Investment banks 
B) Asset transformer 
C) Direct transfer agents 
D) Over-the-counter agents

Question 19

The Wall Street Journal reports that the current rate on 5-year Treasury bonds is 6.50 percent and on 10-year Treasury bonds is 6.75 percent. Assume that the maturity risk premium is zero. Calculate the expected rate on a 5-year Treasury bond purchased five years from today, E(5r1).

Accepted Answer

A) 6.625 percent 
B) 6.75 percent 
C) 7.00 percent 
D) 7.58 percent

Question 20

Which of these markets trade currencies for immediate or for some future stated delivery?

Accepted Answer

A) Money markets 
B) Primary markets 
C) Foreign exchange markets 
D) Over-the-counter stocks

Exam 6: Understanding Financial Markets and Institutions

According to this theory of term structure of interest rates, at any given point in time, the yield curve reflects the market's current expectations of future short-term rates.

Which of the following statements is incorrect?

In 20XX, the 10-year Treasury rate was 4.5 percent while the average 10-year Aaa corporate bond debt carried an interest rate of 6.0 percent. What is the average default risk premium on Aaa corporate bonds?

All of the following are secondary market transactions EXCEPT:

One-year Treasury bill rates in 20XX averaged 5.15 percent and inflation for the year was 7.3 percent. If investors had expected the same inflation rate as that realized, calculate the real interest rate for 20XX according to the Fisher effect.

In the United States, which of these financial institutions arrange most primary market transactions for businesses?

The Wall Street Journal reports that the current rate on 5-year Treasury bonds is 6.50 percent and on 10-year Treasury bonds is 6.75 percent. Assume that the maturity risk premium is zero. Calculate the expected rate on a 5-year Treasury bond purchased five years from today, E(₅r₁) .

Which of these markets trade currencies for immediate or for some future stated delivery?

Exam 6: Understanding Financial Markets and Institutions

According to this theory of term structure of interest rates, at any given point in time, the yield curve reflects the market's current expectations of future short-term rates.

Which of the following statements is incorrect?

In 20XX, the 10-year Treasury rate was 4.5 percent while the average 10-year Aaa corporate bond debt carried an interest rate of 6.0 percent. What is the average default risk premium on Aaa corporate bonds?

All of the following are secondary market transactions EXCEPT:

One-year Treasury bill rates in 20XX averaged 5.15 percent and inflation for the year was 7.3 percent. If investors had expected the same inflation rate as that realized, calculate the real interest rate for 20XX according to the Fisher effect.

In the United States, which of these financial institutions arrange most primary market transactions for businesses?

The Wall Street Journal reports that the current rate on 5-year Treasury bonds is 6.50 percent and on 10-year Treasury bonds is 6.75 percent. Assume that the maturity risk premium is zero. Calculate the expected rate on a 5-year Treasury bond purchased five years from today, E(5r1) .

Which of these markets trade currencies for immediate or for some future stated delivery?

The Wall Street Journal reports that the current rate on 5-year Treasury bonds is 6.50 percent and on 10-year Treasury bonds is 6.75 percent. Assume that the maturity risk premium is zero. Calculate the expected rate on a 5-year Treasury bond purchased five years from today, E(₅r₁) .