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Exam 7: Interest Rates

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Question 41

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Which of the following statements is CORRECT?

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) B) and C)
G) A) and B)

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Question 42

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Suppose 10-year T-bonds have a yield of 5.30% and 10-year corporate bonds yield 7.10%.Also,corporate bonds have a 0.25% liquidity premium versus a zero liquidity premium for T-bonds,and the maturity risk premium on both Treasury and corporate 10-year bonds is 1.15%.What is the default risk premium on corporate bonds?

A) 1.64%
B) 1.55%
C) 1.19%
D) 1.35%
E) 1.38%

F) B) and D)
G) A) and B)

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Question 43

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Suppose the real risk-free rate is 3.00%,the average expected future inflation rate is 6.60%,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.(Round your final answer to 2 decimal places. )

If the Treasury yield curve were downward sloping,the yield to maturity on a 10-year Treasury coupon bond would be higher than that on a 1-year T-bill.

An upward-sloping yield curve is often call a "normal" yield curve,while a downward-sloping yield curve is called "abnormal."

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.

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

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?

Which of the following statements is CORRECT?

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?

If 10-year T-bonds have a yield of 6.2%,10-year corporate bonds yield 11.9%,the maturity risk premium on all 10-year bonds is 1.3%,and corporate bonds have a 0.4% liquidity premium versus a zero liquidity premium for T-bonds,what is the default risk premium on the corporate bond?

Suppose 1-year T-bills currently yield 7.00% and the future inflation rate is expected to be constant at 5.80% per year.What is the real risk-free rate of return,r*? The cross-product term should be considered ,i.e. ,if averaging is required,use the geometric average.(Round your final answer to 2 decimal places. )

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

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?

5-year Treasury bonds yield 6.1%.The inflation premium (IP) is 1.9%,and the maturity risk premium (MRP) on 5-year T-bonds is 0.4%.There is no liquidity premium on these bonds.What is the real risk-free rate,r*?

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."