Ch. 6 Financial Management
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
A bond trader observes the following information: - The Treasury yield curve is downward sloping. - Empirical data indicated that a positive maturity risk premium applies to both Treasury and corporate bonds. - Empirical data also indicated 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 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-bonds = 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
Which of the following statements is CORRECT?
Even if the pure expectation theory is correct , there might at times be an inverted Treasury yield curve
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
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
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
False
One of the four most fundamental factors that affect the cost of money as discussed in the text is the current state of weather. If the weather is dark and stormy, the cost of money will be higher that if its 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
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
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
False
The four most fundamental factors that affect the cost of money are (1) production opportunities, (2) time preferences for consumption,,, (3) risk, (4) weather conditions
False
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.
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?
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
Which of the following statements is CORRECT?
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
Short Corp just issued bonds that will mature in 10 years, and Long Corp issued bonds that will mature in 20 years. Both bonds promise to pay a semiannual coupon, they are not callable or convertible, and they are equally liquid. Further assume that the Treasury yield curve is based only on the pure expectations theory. Under these conditions, which of the following statements is CORRECT?
If the Treasury yield curve is upward sloping and short has less default risk than long, then shorts bonds must be under all conditions have a lower yield than longs bond
Assume that inflation is expected to decline steadily in the future, but that the real risk free rate will remain constant. Which of the following statements is CORRECT , other things held constant?
If the pure expectation theory holds, the Treasury yield curve must be downward sloping
Which of the following statements is CORRECT?
If the pure expectation theory is correct, a downward sloping yield curve indicates that interest rates are expected to decline in the future
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 or normal. Under this condition , we can be sure that
Maturity risk premium could help to explain the yield curves upward slope
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.
Suppose the U.S. Treasury issued $50 billion of short-term securities and sold them to the public. Other things held constant, what would be the most likely effect on short-term securities' prices and interest rates?
Prices would decline and interest rates would rise.
Which of the following statements is CORRECT?
Reinvestment rate risk is lower, other things held constant, on long term than on short term bonds
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
If the pure expectations theory holds, which of the following statements is CORRECT?
The MRP would be zero
Assume that he 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 the 3 year bond should be approximately 7%
Assuming that the term structure of interest rates is determined as posited by the pure expectation theory, which of the following statements is CORRECT?
The maturity risk premium is assumed to be zero
Which of the following statements is CORRECT?
The most likely explanation for an inverted yield curve is that investors expect inflation to decrease
Which of the following statements is CORRECT?
The pure expectation theory states that the MRP 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
If the pure expectations theory is correct (that is, the maturity risk premium is zero), which of the following is CORRECT?
The yield curve for corporate bonds may be upward sloping even if the Treasury yield curve is flat.
In the foreseeable future, the real risk free rate of interest is excepted to remain at 3%, inflations is expected to steadily increase, and the maturity risk premium is expected to be 00.1(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
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?
The yield on 10-year Treasury securities must exceed the yield on 7-year Treasury securities.
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.
Which of the following statements is CORRECT?
The yield on a 2 year corporate bond should always exceed the yield on a 2 year Treasury bond
If the pure expectations theory is correct, a downward sloping yield curve indicates that interest rates are expected to decline in the future
True
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% & there's 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 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's probably not valid in the real world
An upward sloping yield curve is often called 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 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
True
If investors expect the rate of inflation to increase sharply in the future, then we shouldn't 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
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 four most fundamental factors that affect the cost of money are (1) production opportunities, (2) time preferences for consumption, (3) risk, and (4) inflation.
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 is" or "price risk"
True