Financial Management Chapter 6

True

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

b.) Default and liquidity risk differences.

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: a.)Tax effects. b.)Default and liquidity risk differences. c.)Maturity risk differences. d.)Inflation differences. e.)Real risk-free rate differences.

e.) Maturity risk premiums could help to explain the yield curve's upward slope.

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

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.

e.) 1.00%

Suppose 1-year T-bills currently yield 7.00% and the future inflation rate is expected to be constant at 6.00% per year. What is the real risk-free rate of return, r*? a.)0.82% b.)1.15% c.)0.97% d.)0.85% e.)1.00%

b.) 1.10%

Suppose 10-year T-bonds have a yield of 5.30% and 10-year corporate bonds yield 6.65%. 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.)1.22% b.)1.10% c.)1.34% d.)0.86% e.)1.20%

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.

a.) 9.50%

Suppose the real risk-free rate is 2.50% and the future rate of inflation is expected to be constant at 7.00%. What rate of return would you expect on a 5-year Treasury security, assuming the pure expectations theory is valid? a.)9.50% b.)11.59% c.)7.70% d.)7.41% e.)8.46%

True

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

b.) 1.30%

If 10-year T-bonds have a yield of 6.2%, 10-year corporate bonds yield 7.9%, 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? a.)1.46% b.)1.30% c.)1.60% d.)1.51% e.)1.40%

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*.

False

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.

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.

b.) A new technology like the Internet has just been introduced, and it increased investment opportunities.

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

b.) The yield on a 2-year corporate bond should always exceed the yield on a 2-year Treasury bond.

Which of the following statements is CORRECT? a.)The yield on a 3-year Treasury bond cannot exceed the yield on a 10-year Treasury bond. b.)The yield on a 2-year corporate bond should always exceed the yield on a 2-year Treasury bond. c.)The yield on a 3-year corporate bond should always exceed the yield on a 2-year corporate bond. d.)The yield on a 10-year AAA-rated corporate bond should always exceed the yield on a 5-year AAA-rated corporate bond. e.)The following represents a "possibly reasonable" formula for the maturity risk premium on bonds: MRP = -0.1%(t), where t is the years to maturity.