Question 1

The real risk-free rate is expected to remain constant at 3% in the future, a 2% rate of inflation is expected for the next 2 years, after which inflation is expected to increase to 4%, and there is a positive maturity risk premium that increases with years to maturity. Given these conditions, which of the following statements is CORRECT?

Accepted Answer

A)   The yield on a 2-year T-bond must exceed that on a 5-year T-bond.
B)   The yield on a 5-year Treasury bond must exceed that on a 2-year Treasury bond.
C)   The yield on a 7-year Treasury bond must exceed that of a 5-year corporate bond.
D)   The conditions in the problem cannot all be true--they are internally inconsistent.
E)   The Treasury yield curve under the stated conditions would be humped rather than have a consistent positive or negative slope.F) A) and B)
G) A) and C)

Question 2

Short Corp just issued bonds that will mature in 10 years, and Long Corp issued bonds that will mature in 20 years. Both bonds promise to pay a semiannual coupon, they are not callable or convertible, and they are equally liquid. Further assume that the Treasury yield curve is based only on the pure expectations theory. Under these conditions, which of the following statements is CORRECT?

Accepted Answer

A)   If the yield curve for Treasury securities is flat, Short's bond must under all conditions have the same yield as Long's bonds.
B)   If the yield curve for Treasury securities is upward sloping, Long's bonds must under all conditions have a higher yield than Short's bonds.
C)   If Long's and Short's bonds have the same default risk, their yields must under all conditions be equal.
D)   If the Treasury yield curve is upward sloping and Short has less default risk than Long, then Short's bonds must under all conditions have a lower yield than Long's bonds.
E)   If the Treasury yield curve is downward sloping, Long's bonds must under all conditions have the lower yield.F) B) and E)
G) C) and D)

Question 3

Assume that the rate on a 1-year bond is now 6%, but all investors expect 1-year rates to be 7% one year from now and then to rise to 8% two years from now. Assume also that the pure expectations theory holds, hence the maturity risk premium equals zero. Which of the following statements is CORRECT?

Accepted Answer

A)   The yield curve should be downward sloping, with the rate on a 1-year bond at 6%.
B)   The interest rate today on a 2-year bond should be approximately 6%.
C)   The interest rate today on a 2-year bond should be approximately 7%.
D)   The interest rate today on a 3-year bond should be approximately 7%.
E)   The interest rate today on a 3-year bond should be approximately 8%.F) C) and E)
G) A) and C)

Question 4

If the Treasury yield curve is downward sloping, how should the yield to maturity on a 10-year Treasury coupon bond compare to that on a 1-year T-bill?

Accepted Answer

A)   The yield on a 10-year bond would be less than that on a 1-year bill.
B)   The yield on a 10-year bond would have to be higher than that on a 1 year bill because of the maturity risk premium.
C)   It is impossible to tell without knowing the coupon rates of the bonds.
D)   The yields on the two securities would be equal.
E)   It is impossible to tell without knowing the relative risks of the two securities.F) D) and E)
G) C) and D)

Question 5

The four most fundamental factors that affect the cost of money are (1) production opportunities, (2) time preferences for consumption, (3) risk, and (4) the skill level of the economy's labor force.

Accepted Answer

A) True 
 B)False

Question 6

Suppose the federal deficit increased sharply from one year to the next, and the Federal Reserve kept the money supply constant. Other things held constant, we would expect to see interest rates decline.

Accepted Answer

A) True 
 B)False

Question 7

Suppose the real risk-free rate is 3.50% and the future rate of inflation is expected to be constant at 2.20%. What rate of return would you expect on a 1-year Treasury security, assuming the pure expectations theory is valid? Disregard cross-product terms, i.e., if averaging is required, use the arithmetic average.

Accepted Answer

A)   5.14%
B)   5.42%
C)   5.70%
D)   5.99%
E)   6.28%F) B) and C)
G) C) and E)

Question 8

One of the four most fundamental factors that affect the cost of money as discussed in the text is the expected rate of inflation. If inflation is expected to be relatively high, then interest rates will tend to be relatively low, other things held constant.

Accepted Answer

A) True 
 B)False

Question 9

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)   The pure expectations theory of the term structure states that borrowers generally prefer to borrow on a long-term basis while savers generally prefer to lend on a short-term basis, and as a result, the yield curve is normally upward sloping.
D)   If the maturity risk premium were zero and interest rates were expected to decrease in the future, then the yield curve for U.S. Treasury securities would, other things held constant, have an upward slope.
E)   Liquidity premiums are generally higher on Treasury than on corporate bonds.F) D) and E)
G) A) and B)

Question 10

Kay Corporation's 5-year bonds yield 6.20% and 5-year T-bonds yield 4.40%. The real risk-free rate is r* = 2.5%, the inflation premium for 5-year bonds is IP = 1.50%, the default risk premium for Kay's bonds is DRP = 1.30% versus zero for T-bonds, and the maturity risk premium for all bonds is found with the formula MRP = (t - 1)  × 0.1%, where t = number of years to maturity. What is the liquidity premium (LP)  on Kay's bonds?

Accepted Answer

A)   0.36%
B)   0.41%
C)   0.45%
D)   0.50%
E)   0.55%F) D) and E)
G) A) and B)

Question 11

Assuming that the term structure of interest rates is determined as posited by the pure expectations theory, which of the following statements is CORRECT?

Accepted Answer

A)   In equilibrium, long-term rates must be equal to short-term rates.
B)   An upward-sloping yield curve implies that future short-term rates are expected to decline.
C)   The maturity risk premium is assumed to be zero.
D)   Inflation is expected to be zero.
E)   Consumer prices as measured by an index of inflation are expected to rise at a constant rate.F) B) and D)
G) B) and E)

Question 12

The risk that interest rates will decline, and that decline will lead to a decline in the income provided by a bond portfolio as interest and maturity payments are reinvested, is called "reinvestment rate risk."

Accepted Answer

A) True 
 B)False

Question 13

Suppose the real risk-free rate is 2.50% and the future rate of inflation is expected to be constant at 4.10%. What rate of return would you expect on a 5-year Treasury security, assuming the pure expectations theory is valid? Disregard cross-product terms, i.e., if averaging is required, use the arithmetic average.

Accepted Answer

A)   5.38%
B)   5.66%
C)   5.96%
D)   6.27%
E)   6.60%F) B) and D)
G) All of the above

Question 14

Which of the following statements is CORRECT?

Accepted Answer

A)   The yield on a 3-year Treasury bond cannot exceed the yield on a 10 year Treasury bond.
B)   The real risk-free rate is higher for corporate than for Treasury bonds.
C)   Most evidence suggests that the maturity risk premium is zero.
D)   Liquidity premiums are higher for Treasury than for corporate bonds.
E)   The pure expectations theory states that the maturity risk premium for long-term Treasury bonds is zero and that differences in interest rates across different Treasury maturities are driven by expectations about future interest rates.F) A) and B)
G) None of the above

Question 15

Which of the following statements is CORRECT?

Accepted Answer

A)   Even if the pure expectations theory is correct, there might at times be an inverted Treasury yield curve.
B)   If the yield curve is inverted, short-term bonds have lower yields than long-term bonds.
C)   The higher the maturity risk premium, the higher the probability that the yield curve will be inverted.
D)   Inverted yield curves can exist for Treasury bonds, but because of default premiums, the corporate yield curve cannot become inverted.
E)   The most likely explanation for an inverted yield curve is that investors expect inflation to increase in the future.F) D) and E)
G) A) and E)

Question 16

Suppose the real risk-free rate is 3.50% and the future rate of inflation is expected to be constant at 2.20%. What rate of return would you expect on a 1-year Treasury security, assuming the pure expectations theory is valid? Include cross-product terms, i.e., if averaging is required, use the geometric average.

Accepted Answer

A)   5.21%
B)   5.49%
C)   5.78%
D)   6.07%
E)   6.37%F) A) and E)
G) A) and D)

Question 17

Which of the following factors would be most likely to lead to an increase in nominal interest rates?

Accepted Answer

A)   Households reduce their consumption and increase their savings.
B)   A new technology like the Internet has just been introduced, and it increases investment opportunities.
C)   There is a decrease in expected inflation.
D)   The economy falls into a recession.
E)   The Federal Reserve decides to try to stimulate the economy.F) C) and E)
G) B) and E)

Question 18

The four most fundamental factors that affect the cost of money are (1) production opportunities, (2) time preferences for consumption, (3) risk, and (4) weather conditions.

Accepted Answer

A) True 
 B)False

Question 19

Suppose the real risk-free rate is 3.00%, the average expected future inflation rate is 2.25%, and a maturity risk premium of 0.10% per year to maturity applies, i.e., MRP = 0.10%(t) , where t is the years to maturity. What rate of return would you expect on a 1-year Treasury security, assuming the pure expectations theory is NOT valid? Include the cross-product term, i.e., if averaging is required, use the geometric average.

Accepted Answer

A)   5.15%
B)   5.42%
C)   5.69%
D)   5.97%
E)   6.27%F) C) and D)
G) A) and B)

Question 20

Since yield curves are based on a real risk-free rate plus the expected rate of inflation, at any given time there can be only one yield curve, and it applies to both corporate and Treasury securities.

Accepted Answer

A) True 
 B)False

Exam 6: Interest Rates

Which of the following statements is CORRECT?

Correct Answer
verified

The four most fundamental factors that affect the cost of money are (1) production opportunities, (2) time preferences for consumption, (3) risk, and (4) weather conditions.

Correct Answer
verified

Which of the following statements is CORRECT?

Correct Answer
verified

Assuming that the term structure of interest rates is determined as posited by the pure expectations theory, which of the following statements is CORRECT?

Correct Answer
verified

Correct Answer
verified

Since yield curves are based on a real risk-free rate plus the expected rate of inflation, at any given time there can be only one yield curve, and it applies to both corporate and Treasury securities.

Correct Answer
verified

Correct Answer
verified

The risk that interest rates will decline, and that decline will lead to a decline in the income provided by a bond portfolio as interest and maturity payments are reinvested, is called "reinvestment rate risk."

Correct Answer
verified

Correct Answer
verified

If the Treasury yield curve is downward sloping, how should the yield to maturity on a 10-year Treasury coupon bond compare to that on a 1-year T-bill?

Correct Answer
verified

Correct Answer
verified

One of the four most fundamental factors that affect the cost of money as discussed in the text is the expected rate of inflation. If inflation is expected to be relatively high, then interest rates will tend to be relatively low, other things held constant.

Correct Answer
verified

Correct Answer
verified

The four most fundamental factors that affect the cost of money are (1) production opportunities, (2) time preferences for consumption, (3) risk, and (4) the skill level of the economy's labor force.

Correct Answer
verified

Correct Answer
verified

Which of the following statements is CORRECT?

Correct Answer
verified

Correct Answer
verified

Suppose the federal deficit increased sharply from one year to the next, and the Federal Reserve kept the money supply constant. Other things held constant, we would expect to see interest rates decline.

Correct Answer
verified

Assume that the rate on a 1-year bond is now 6%, but all investors expect 1-year rates to be 7% one year from now and then to rise to 8% two years from now. Assume also that the pure expectations theory holds, hence the maturity risk premium equals zero. Which of the following statements is CORRECT?

Correct Answer
verified

Which of the following factors would be most likely to lead to an increase in nominal interest rates?

Correct Answer
verified

Exam 6: Interest Rates

Which of the following statements is CORRECT?

Correct AnswerverifiedShow Answer

The four most fundamental factors that affect the cost of money are (1) production opportunities, (2) time preferences for consumption, (3) risk, and (4) weather conditions.

Correct AnswerverifiedShow Answer

Which of the following statements is CORRECT?

Correct AnswerverifiedShow Answer

Assuming that the term structure of interest rates is determined as posited by the pure expectations theory, which of the following statements is CORRECT?

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

Since yield curves are based on a real risk-free rate plus the expected rate of inflation, at any given time there can be only one yield curve, and it applies to both corporate and Treasury securities.

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

The risk that interest rates will decline, and that decline will lead to a decline in the income provided by a bond portfolio as interest and maturity payments are reinvested, is called "reinvestment rate risk."

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

If the Treasury yield curve is downward sloping, how should the yield to maturity on a 10-year Treasury coupon bond compare to that on a 1-year T-bill?

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

One of the four most fundamental factors that affect the cost of money as discussed in the text is the expected rate of inflation. If inflation is expected to be relatively high, then interest rates will tend to be relatively low, other things held constant.

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

The four most fundamental factors that affect the cost of money are (1) production opportunities, (2) time preferences for consumption, (3) risk, and (4) the skill level of the economy's labor force.

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

Which of the following statements is CORRECT?

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

Suppose the federal deficit increased sharply from one year to the next, and the Federal Reserve kept the money supply constant. Other things held constant, we would expect to see interest rates decline.

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

Which of the following factors would be most likely to lead to an increase in nominal interest rates?

Correct AnswerverifiedShow Answer

Correct Answer
verified

Correct Answer
verified

Correct Answer
verified

Correct Answer
verified

Correct Answer
verified

Correct Answer
verified

Correct Answer
verified

Correct Answer
verified

Correct Answer
verified

Correct Answer
verified

Correct Answer
verified

Correct Answer
verified

Correct Answer
verified

Correct Answer
verified

Correct Answer
verified

Correct Answer
verified

Correct Answer
verified

Correct Answer
verified

Correct Answer
verified

Correct Answer
verified