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Exam 7: Interest Rates

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Question 1

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The real risk-free rate is 3.05%,inflation is expected to be 5.95% this year,and the maturity risk premium is zero.Ignoring any cross-product terms,i.e. ,if averaging is required,use the arithmetic average,what is the equilibrium rate of return on a 1-year Treasury bond?

A) 8.37%
B) 9.00%
C) 8.82%
D) 10.80%
E) 9.09%

F) B) and D)
G) D) and E)

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Question 2

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Suppose the real risk-free rate is 3.50%,the average future inflation rate is 2.50%,a maturity premium of 0.20% per year to maturity applies,i.e. ,MRP = 0.20%(t) ,where t is the number of years to maturity.Suppose also that a liquidity premium of 0.50% and a default risk premium of 1.30% applies to A-rated corporate bonds.What is the difference in the yields on a 5-year A-rated corporate bond and on a 10-year Treasury bond? Here we assume that the pure expectations theory is NOT valid,and disregard any cross-product terms,i.e. ,if averaging is required,use the arithmetic average.

A) ​0.66
B) 0.80​
C) 0.92​
D) 0.93​
E) 0.86​

F) A) and E)
G) A) and B)

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Question 3

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Because the maturity risk premium is normally positive,the yield curve is normally upward sloping.

Suppose the interest rate on a 1-year T-bond is 5.00% and that on a 2-year T-bond is 7.90%.Assuming the pure expectations theory is correct,what is the market's forecast for 1-year rates 1 year from now? Round the intermediate calculations to 4 decimal places and final answer to 2 decimal places.

One of the four most fundamental factors that affect the cost of money as discussed in the text is the current state of the weather.If the weather is dark and stormy,the cost of money will be higher than if it is bright and sunny,other things held constant.

Suppose the rate of return on a 10-year T-bond is 4.05%,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.

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.

Suppose the real risk-free rate is 2.50% and the future rate of inflation is expected to be constant at 2.80%.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.

Suppose the real risk-free rate is 3.50% and the future rate of inflation is expected to be constant at 4.60%.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.

One of the four most fundamental factors that affect the cost of money as discussed in the text is the availability of production opportunities and their expected rates of return.If production opportunities are relatively good,then interest rates will tend to be relatively high,other things held constant.

The real risk-free rate is 3.55%,inflation is expected to be 2.85% 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? (Round your final answer to 3 decimal places. )

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

Which of the following statements is CORRECT?

The real risk-free rate of interest is expected to remain constant at 3% for the foreseeable future.However,inflation is expected to increase steadily over the next 30 years,so the Treasury yield curve has an upward slope.Assume that the pure expectations theory holds.You are also considering two corporate bonds,one with a 5-year maturity and one with a 10-year maturity.Both have the same default and liquidity risks.Given these assumptions,which of these statements is CORRECT?

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.

If the pure expectations theory holds,which of the following statements is CORRECT?

Suppose 1-year Treasury bonds yield 4.00% while 2-year T-bonds yield 4.40%.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? Round the intermediate calculations to 4 decimal places and final answer to 2 decimal places.

During periods when inflation is increasing,interest rates tend to increase,while interest rates tend to fall when inflation is declining.

Which of the following would be most likely to lead to a higher level of interest rates in the economy?

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?