Finance quiz 2 chapter

5-year Treasury bonds yield 4.4%. 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*?

2.10%

Suppose 1-year Treasury bonds yield 4.00% while 2-year T-bonds yield 4.10%. 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? Round the intermediate calculations to 4 decimal places and final answer to 2 decimal places.

4.20

Suppose the real risk-free rate is 3.00%, the average expected future inflation rate is 5.90%, and a maturity risk premium of 0.10% per year to maturity applies, i.e., MRP = 0.10%(t), where t is the number of years to maturity. What rate of return would you expect on a 1-year Treasury security, assuming the pure expectations theory is NOT valid? Disregard cross-product terms, i.e., if averaging is required, use the arithmetic average.

9.00%

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? Disregard cross-product terms, i.e., if averaging is required, use the arithmetic average.

9.50%

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

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

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

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

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 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

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

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

Suppose the interest rate on a 1-year T-bond is 5.00% and that on a 2-year T-bond is 6.90%. 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.

​8.83

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.

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.

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

True