Interest Rates

False

An individual living at the margin with just enough money to get by likely has a low time preference for consumption.

0.3%; lower; 1.2%

Below are interest rates for different long-term bonds maturing on the same date. The default risk premium for the AA corporate bond is _____________ which is ___________ than the default risk premium of ______________ for the BBB corporate bond. U.S. Treasury 4.7% AAA Corporate 4.9% AA Corporate 5.0% A Corporate 5.3% BBB Corporate 5.9%

High; high

Company X is in trouble and might face bankruptcy within the next three years. It needs a loan to survive. In order for an investor to give Company X a loan, that investor would likely charge a _______________ interest rate, hoping for a ______________ rate of return.

True

Generally speaking, higher levels of expected future inflation lead to higher interest rates.

False

Generally speaking, inflation tends to fall during periods of economic expansion and rise during periods of economic recession. This is because demand for goods and services is stronger during expansions and lower during recessions.

2.1%

If a U.S. Treasury Bill has an interest rate of 3.2% and inflation over the Treasury Bill's maturity is expected to average 1.1%, then what is the real risk-free rate?

The yield curve must be upward sloping.

In the future, the real risk-free rate is expected to remain at 4%, inflation is expected to steadily increase, and the maturity risk premium is expected to be 0.2(T-1)% where T is the number of years to maturity. Given this information, which of the following statements is correct?

True

Interest rates fluctuate over time as supply and demand conditions change

more; reinvestment rate risk

Long-term bondholders face ______________ interest rate risk than short-term bondholders. However, short-term bondholders face ____________________ which is the risk that interest rates are lower when the short-term bond matures.

3%; fall; rise

Market A deals in low-risk securities with an average interest rate of 4%. Market B deals in high-risk securities with an average interest rate of 7%. Suddenly there is a financial crisis and the economy enters recession. Before the recession, the risk premium for securities in Market B over securities in Market A was ____________ . As a result of the recession, one would expect the demand for securities in Market B to _____________ and interest rates to _____________ .

There was no risk premium; rise; fall

Market A deals in low-risk securities with an average interest rate of 5%. Market B deals in high-risk securities with an average interest rate of 7%. Suddenly there is a financial crisis and the economy enters recession. Before the recession, the risk premium for securities in Market A over securities in Market B was ____________ . As a result of the recession, one would expect the demand for securities in Market A to _____________ and interest rates to _____________ .

4.51%

Suppose 1-year Treasury bonds yield 3.00% while 2-year T-bonds yield 3.75%. 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?

5.1%

Suppose the rate of return on a 10-year Treasury bond is 7.1%, the expected average rate of inflation over the next 10 years is 1.5%, the maturity risk premium on a Treasury bond is 0.5%, no maturity risk premium is required on a TIPS, and no liquidity premium is required on any Treasury. Given this information, what should the yield be on a 10-year TIPS? Disregard cross-product terms; if averaging is required, use the arithmetic average.

False

The Federal Reserve tends to take actions to decrease interest rates when the economy is very strong and to increase rates when the economy is weak.

False

The real risk-free rate of interest (r*) is widely known and published in financial publications, such as the Wall Street Journal.

maturities; yields

The yield curve shows the relationship between bond _____________ and their ______________ .

That Treasury Bonds have no maturity risk premiums.

What key assumption underlies the pure expectations theory?

decreases; increased

When an economy enters recession and demand for risky securities decreases, the ability to sell such securities quickly at a good price _____________ leading to a(n) ___________ liquidity premium.

True

When interest rates rise, the price (value) of existing bonds goes down.

The yield on a 3-year corporate bond should always exceed the yield on a 3-year Treasury.

Which of the following statements is correct?