Chapter 6 Fin man
Which of the following would be most likely to lead to a higher level of interest rates in the economy?
Corporations step up their expansion plans and thus increase their demand for capital.
Assume that interest rates on 20-year Treasury and corporate bonds are as follows: T-bond = 7.72% AAA = 8.72% A = 9.64% BBB = 10.18% The differences in these rates were probably caused primarily by:
Default and Liquidity risk differences.
Because the maturity risk premium is normally positive, the yield curve must have an upward slope. If you measure the yield curve and find a downward slope, you must have done something wrong
False
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
False
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.
False
If the pure expectations theory of the term structure is correct, which of the following statements would be CORRECT?
Interest rate (price) risk is higher on long-term bonds, but reinvestment rate risk is higher on short-term bonds
Assume that the current corporate bond yield curve is upward sloping. Under this condition, then we could be sure that
Maturity risk premiums could help to explain the yield curve's upward slope
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 10-year corporate bond must have a higher yield than the 5-year corporate bond
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?
The interest rate today on a 3-year bond should be approximately 7%.
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 maturity risk premium is assumed to be zero.
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.
True
One of the four most fundamental factors that affect the cost of money as discussed in the text is the risk inherent in a given security. The higher the risk, the higher the security's required return, other things held constant.
True
The "yield curve" shows the relationship between bonds' maturities and their yields.
True
The Federal Reserve tends to take actions to increase interest rates when the economy is very strong and to decrease rates when the economy is weak.
True
The most likely explanation for an inverted yield curve is that investors expect inflation to decrease.
True
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."
True
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."
True
The yield on a 2-year corporate bond should always exceed the yield on a 2-year Treasury bond.
True
Assuming the pure expectations theory is correct, which of the following statements is CORRECT?
If 2-year Treasury bond rates exceed 1-year rates, then the market must expect interest rates to rise.
If the pure expectations theory is correct, a downward-sloping yield curve indicates that interest rates are expected to decline in the future.
True
A bond trader observes the following information: • The Treasury yield curve is downward sloping. • Empirical data indicate that a positive maturity risk premium applies to both Treasury and corporate bonds. • Empirical data also indicate that there is no liquidity premium for Treasury securities but that a positive liquidity premium is built into corporate bond yields. On the basis of this information, which of the following statements is most CORRECT?
A 5-year corporate bond must have a higher yield than a 10-year Treasury bond
Which of the following factors would be most likely to lead to an increase in nominal interest rates?
A new technology like the Internet has just been introduced, and it increases investment opportunities.
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.
False
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.
False
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.
False
Which of the following statements is CORRECT, other things held constant?
If expected inflation increases, interest rates are likely to increase.
Which of the following statements is CORRECT? Yield Curve
If inflation is expected to increase in the future and the maturity risk premium (MRP) is greater than zero, the Treasury bond yield curve must be upward sloping.
Assume that inflation is expected to decline steadily in the future, but that the real risk-free rate, r*, will remain constant. Which of the following statements is CORRECT, other things held constant?
If the pure expectations theory holds, the Treasury yield curve must be downward sloping.
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?
The yield curve must be upward sloping.
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?
The yield on a 10-year bond would be less than that on a 1-year bill.
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?
The yield on a 5-year Treasury bond must exceed that on a 2-year Treasury bond
Assume the following: The real risk-free rate, r*, is expected to remain constant at 3%. Inflation is expected to be 3% next year and then to be constant at 2% a year thereafter. The maturity risk premium is zero. Given this information, which of the following statements is CORRECT?
This problem assumed a zero maturity risk premium, but that is probably not valid in the real world.
An upward-sloping yield curve is often call a "normal" yield curve, while a downward-sloping yield curve is called "abnormal."
True
Because the maturity risk premium is normally positive, the yield curve is normally upward sloping.
True
During periods when inflation is increasing, interest rates tend to increase, while interest rates tend to fall when inflation is declining
True
If inflation is expected to increase in the future, and if the maturity risk premium (MRP) is greater than zero, then the Treasury yield curve will have an upward slope.
True
If investors expect a zero rate of inflation, then the nominal rate of return on a very short-term U.S. Treasury bond should be equal to the real risk-free rate, r*.
True
If investors expect the rate of inflation to increase sharply in the future, then we should not be surprised to see an upward-sloping yield curve.
True
If the demand curve for funds increased but the supply curve remained constant, we would expect to see the total amount of funds supplied and demanded increase and interest rates in general also increase
True
The four most fundamental factors that affect the cost of money are
1)Production opportunities 2)time preferences for consumption 3)Risk 4)Inflation
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.
False
