Question 1

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

Question 2

Which of the following statements is CORRECT, other things held constant?

Accepted Answer

A)   If companies have fewer good investment opportunities, interest rates are likely to increase.
B)   If individuals increase their savings rate, interest rates are likely to increase.
C)   If expected inflation increases, interest rates are likely to increase.
D)   Interest rates on all debt securities tend to rise during recessions because recessions increase the possibility of bankruptcy, hence the riskiness of all debt securities.
E)   Interest rates on long-term bonds are more volatile than rates on short-term debt securities like T-bills.F) A) and C)
G) A) and E)

Question 3

Suppose 1-year Treasury bonds yield 4.00% while 2-year T-bonds yield 5.10%. Assuming the pure expectations theory is correct, and thus the maturity risk premium for T-bonds is zero, what is the yield on a 1-year T-bond expected to be one year from now?

Accepted Answer

A)   5.90%
B)   6.21%
C)   6.52%
D)   6.85%
E)   7.19%F) None of the above
G) B) and D)

Question 4

Suppose the rate of return on a 10-year T-bond is 6.55%, the expected average rate of inflation over the next 10 years is 2.0%, the MRP on a 10-year T-bond is 0.9%, no MRP is required on a TIPS, and no liquidity premium is required on any Treasury security. Given this information, what should the yield be on a 10-year TIPS? Disregard cross-product terms, i.e., if averaging is required, use the arithmetic average.

Accepted Answer

A)   2.97%
B)   3.13%
C)   3.29%
D)   3.47%
E)   3.65%F) B) and C)
G) C) and D)

Question 5

Suppose 1-year T-bills currently yield 7.00% and the future inflation rate is expected to be constant at 3.20% per year. What is the real risk-free rate of return, r*? Disregard any cross-product terms, i.e., if averaging is required, use the arithmetic average.

Accepted Answer

A)   3.80%
B)   3.99%
C)   4.19%
D)   4.40%
E)   4.62%F) C) and D)
G) A) and C)

Question 6

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) A) and C)
G) A) and E)

Question 7

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

Question 8

If the pure expectations theory is correct (that is, the maturity risk premium is zero) , which of the following is CORRECT?

Accepted Answer

A)   An upward-sloping Treasury yield curve means that the market expects interest rates to decline in the future.
B)   A 5-year T-bond would always yield less than a 10-year T-bond.
C)   The yield curve for corporate bonds may be upward sloping even if the Treasury yield curve is flat.
D)   The yield curve for stocks must be above that for bonds, but both yield curves must have the same slope.
E)   If the maturity risk premium is zero for Treasury bonds, then it must be negative for corporate bonds.F) A) and D)
G) B) and D)

Question 9

5-year Treasury bonds yield 5.5%. 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*?

Accepted Answer

A)   2.59%
B)   2.88%
C)   3.20%
D)   3.52%
E)   3.87%F) C) and E)
G) B) and C)

Question 10

Assume that the current corporate bond yield curve is upward sloping, or normal. Under this condition, we could be sure that

Accepted Answer

A)   Long-term interest rates are more volatile than short-term rates.
B)   Inflation is expected to decline in the future.
C)   The economy is not in a recession.
D)   Long-term bonds are a better buy than short-term bonds.
E)   Maturity risk premiums could help to explain the yield curve's upward slope.F) All of the above
G) A) and B)

Question 11

The real risk-free rate is 3.55%, inflation is expected to be 3.15% this year, and the maturity risk premium is zero. Taking account of the cross-product term, i.e., not ignoring it, what is the equilibrium rate of return on a 1-year Treasury bond?

Accepted Answer

A)   5.840%
B)   6.148%
C)   6.471%
D)   6.812%
E)   7.152%F) C) and D)
G) B) and E)

Question 12

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 C)
G) C) and D)

Question 13

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) C) and E)
G) None of the above

Question 14

Suppose the interest rate on a 1-year T-bond is 5.00% and that on a 2 year T-bond is 6.00%. Assume that the pure expectations theory is NOT valid, and the MRP is zero for a 1-year T-bond but 0.40% for a 2-year bond. What is the yield on a 1-year T-bond expected to be one year from now?

Accepted Answer

A)   5.32%
B)   5.60%
C)   5.89%
D)   6.20%
E)   6.51%F) A) and B)
G) C) and D)

Question 15

Inflation is expected to increase steadily over the next 10 years, there is a positive maturity risk premium on both Treasury and corporate bonds, and the real risk-free rate of interest is expected to remain constant. Which of the following statements is CORRECT?

Accepted Answer

A)   The yield on 10-year Treasury securities must exceed the yield on 7 year Treasury securities.
B)   The yield on any corporate bond must exceed the yields on all Treasury bonds.
C)   The yield on 7-year corporate bonds must exceed the yield on 10-year Treasury bonds.
D)   The stated conditions 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 E)
G) A) and D)

Question 16

One of the four most fundamental factors that affect the cost of money as discussed in the text is the time preference for consumption. The higher the time preference, the lower the cost of money, other things held constant.

Accepted Answer

A) True 
 B)False

Question 17

The risk that interest rates will increase, and that increase will lead to a decline in the prices of outstanding bonds, is called "interest rate risk," or "price risk."

Accepted Answer

A) True 
 B)False

Question 18

Which of the following statements is CORRECT?

Accepted Answer

A)   Downward-sloping yield curves are inconsistent with the expectations theory.
B)   The actual shape of the yield curve depends only on expectations about future inflation.
C)   If the pure expectations theory is correct, a downward-sloping yield curve indicates that interest rates are expected to decline in the future.
D)   If the yield curve is upward sloping, the maturity risk premium must be positive and the inflation rate must be zero.
E)   Yield curves must be either upward or downward sloping--they cannot first rise and then decline.F) D) and E)
G) C) and E)

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) B) and E)
G) B) and C)

Question 20

In the foreseeable future, the real risk-free rate of interest, r*, is expected to remain at 3%, inflation is expected to steadily increase, and the maturity risk premium is expected to be 0.1(t − 1) %, where t is the number of years until the bond matures. Given this information, which of the following statements is CORRECT?

Accepted Answer

A)   The yield on 2-year Treasury securities must exceed the yield on 5 year Treasury securities.
B)   The yield on 5-year Treasury securities must exceed the yield on 10 year corporate bonds.
C)   The yield on 5-year corporate bonds must exceed the yield on 8-year Treasury bonds.
D)   The yield curve must be "humped."
E)   The yield curve must be upward sloping.F) C) and D)
G) A) and E)

Exam 6: Interest Rates

Which of the following statements is CORRECT?

Correct Answer
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One of the four most fundamental factors that affect the cost of money as discussed in the text is the time preference for consumption. The higher the time preference, the lower the cost of money, other things held constant.

Correct Answer
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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
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Suppose 1-year Treasury bonds yield 4.00% while 2-year T-bonds yield 5.10%. Assuming the pure expectations theory is correct, and thus the maturity risk premium for T-bonds is zero, what is the yield on a 1-year T-bond expected to be one year from now?

Correct Answer
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The real risk-free rate is 3.55%, inflation is expected to be 3.15% this year, and the maturity risk premium is zero. Taking account of the cross-product term, i.e., not ignoring it, what is the equilibrium rate of return on a 1-year Treasury bond?

Correct Answer
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Correct Answer
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Which of the following statements is CORRECT?

Correct Answer
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Correct Answer
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Suppose 1-year T-bills currently yield 7.00% and the future inflation rate is expected to be constant at 3.20% per year. What is the real risk-free rate of return, r*? Disregard any cross-product terms, i.e., if averaging is required, use the arithmetic average.

Correct Answer
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Suppose the interest rate on a 1-year T-bond is 5.00% and that on a 2 year T-bond is 6.00%. Assume that the pure expectations theory is NOT valid, and the MRP is zero for a 1-year T-bond but 0.40% for a 2-year bond. What is the yield on a 1-year T-bond expected to be one year from now?

Correct Answer
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Assume that the current corporate bond yield curve is upward sloping, or normal. Under this condition, we could be sure that

Correct Answer
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5-year Treasury bonds yield 5.5%. 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*?

Correct Answer
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Correct Answer
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Inflation is expected to increase steadily over the next 10 years, there is a positive maturity risk premium on both Treasury and corporate bonds, and the real risk-free rate of interest is expected to remain constant. Which of the following statements is CORRECT?

Correct Answer
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Correct Answer
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If the pure expectations theory is correct (that is, the maturity risk premium is zero) , which of the following is CORRECT?

Correct Answer
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Which of the following statements is CORRECT, other things held constant?

Correct Answer
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The risk that interest rates will increase, and that increase will lead to a decline in the prices of outstanding bonds, is called "interest rate risk," or "price risk."

Correct Answer
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Which of the following statements is CORRECT?

Correct Answer
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Correct Answer
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Exam 6: Interest Rates

Which of the following statements is CORRECT?

Correct AnswerverifiedShow Answer

One of the four most fundamental factors that affect the cost of money as discussed in the text is the time preference for consumption. The higher the time preference, the lower the cost of money, other things held constant.

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

Suppose 1-year Treasury bonds yield 4.00% while 2-year T-bonds yield 5.10%. Assuming the pure expectations theory is correct, and thus the maturity risk premium for T-bonds is zero, what is the yield on a 1-year T-bond expected to be one year from now?

Correct AnswerverifiedShow Answer

The real risk-free rate is 3.55%, inflation is expected to be 3.15% this year, and the maturity risk premium is zero. Taking account of the cross-product term, i.e., not ignoring it, what is the equilibrium rate of return on a 1-year Treasury bond?

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

Which of the following statements is CORRECT?

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

Suppose 1-year T-bills currently yield 7.00% and the future inflation rate is expected to be constant at 3.20% per year. What is the real risk-free rate of return, r*? Disregard any cross-product terms, i.e., if averaging is required, use the arithmetic average.

Correct AnswerverifiedShow Answer

Suppose the interest rate on a 1-year T-bond is 5.00% and that on a 2 year T-bond is 6.00%. Assume that the pure expectations theory is NOT valid, and the MRP is zero for a 1-year T-bond but 0.40% for a 2-year bond. What is the yield on a 1-year T-bond expected to be one year from now?

Correct AnswerverifiedShow Answer

Assume that the current corporate bond yield curve is upward sloping, or normal. Under this condition, we could be sure that

Correct AnswerverifiedShow Answer

5-year Treasury bonds yield 5.5%. 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*?

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

Inflation is expected to increase steadily over the next 10 years, there is a positive maturity risk premium on both Treasury and corporate bonds, and the real risk-free rate of interest is expected to remain constant. Which of the following statements is CORRECT?

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

If the pure expectations theory is correct (that is, the maturity risk premium is zero) , which of the following is CORRECT?

Correct AnswerverifiedShow Answer

Which of the following statements is CORRECT, other things held constant?

Correct AnswerverifiedShow Answer

The risk that interest rates will increase, and that increase will lead to a decline in the prices of outstanding bonds, is called "interest rate risk," or "price risk."

Correct AnswerverifiedShow Answer

Which of the following statements is CORRECT?

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

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