Question 1

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?

Accepted Answer

A)   The yield curve for U.S. Treasury securities will be upward sloping.
B)   A 5-year corporate bond must have a lower yield than a 5-year Treasury security.
C)   A 5-year corporate bond must have a lower yield than a 7-year Treasury security.
D)   The real risk-free rate cannot be constant if inflation is not expected to remain constant.
E)   This problem assumed a zero maturity risk premium, but that is probably not valid in the real world.F) B) and D)
G) All of the above

Question 2

Kelly Inc's 5-year bonds yield 7.50% and 5-year T-bonds yield 4.90%. The real risk-free rate is r* = 2.5%, the default risk premium for Kelly's bonds is DRP = 0.40%, the liquidity premium on Kelly's bonds is LP = 2.2% versus zero on T-bonds, and the inflation premium (IP)  is 1.5%. What is the maturity risk premium (MRP)  on all 5-year bonds?

Accepted Answer

A)   0.73%
B)   0.81%
C)   0.90%
D)   0.99%
E)   1.09%F) D) and E)
G) B) and E)

Question 3

If the pure expectations theory is correct, a downward sloping yield curve indicates that interest rates are expected to decline in the future.

Accepted Answer

A) True 
 B)False

Question 4

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.

Accepted Answer

A) True 
 B)False

Question 5

Which of the following statements is CORRECT?

Accepted Answer

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.F) B) and D)
G) A) and E)

Question 6

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.

Accepted Answer

A) True 
 B)False

Question 7

Which of the following statements is CORRECT?

Accepted Answer

A)   If the maturity risk premium (MRP)  is greater than zero, the Treasury bond yield curve must be upward sloping.
B)   If the maturity risk premium (MRP)  equals zero, the Treasury bond yield curve must be flat.
C)   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.
D)   If the expectations theory holds, the Treasury bond yield curve will never be downward sloping.
E)   Because long-term bonds are riskier than short-term bonds, yields on long-term Treasury bonds will always be higher than yields on short-term T-bonds.F) C) and E)
G) B) and E)

Question 8

If 10-year T-bonds have a yield of 6.2%, 10-year corporate bonds yield 8.5%, 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?

Accepted Answer

A)   1.90%
B)   2.09%
C)   2.30%
D)   2.53%
E)   2.78%F) All of the above
G) A) and B)

Question 9

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.

Accepted Answer

A) True 
 B)False

Question 10

Which of the following statements is CORRECT, other things held constant?

Accepted Answer

A)   If companies have fewer good investment opportunities, interest rates are likely to increase.
B)   If individuals increase their savings rate, interest rates are likely to increase.
C)   If expected inflation increases, interest rates are likely to increase.
D)   Interest rates on all debt securities tend to rise during recessions because recessions increase the possibility of bankruptcy, hence the riskiness of all debt securities.
E)   Interest rates on long-term bonds are more volatile than rates on short-term debt securities like T-bills.F) All of the above
G) B) and C)

Question 11

If the pure expectations theory holds, which of the following statements is CORRECT?

Accepted Answer

A)   The yield curve for both Treasury and corporate bonds should be flat.
B)   The yield curve for Treasury securities would be flat, but the yield curve for corporate securities might be downward sloping.
C)   The yield curve for Treasury securities cannot be downward sloping.
D)   The maturity risk premium would be zero.
E)   If 2-year bonds yield more than 1-year bonds, an investor with a 2-year time horizon would almost certainly end up with more money if he or she bought 2-year bonds.F) A) and B)
G) A) and C)

Question 12

Suppose the real risk-free rate is 3.00%, the average expected future inflation rate is 2.25%, and a maturity risk premium of 0.10% per year to maturity applies, i.e., MRP = 0.10%(t) , where t is the years to maturity. What rate of return would you expect on a 1-year Treasury security, assuming the pure expectations theory is NOT valid? Include the cross-product term, i.e., if averaging is required, use the geometric average.

Accepted Answer

A)   5.15%
B)   5.42%
C)   5.69%
D)   5.97%
E)   6.27%F) A) and B)
G) A) and C)

Question 13

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?

Accepted Answer

A)   A 10-year corporate bond must have a higher yield than a 5-year Treasury bond.
B)   A 10-year Treasury bond must have a higher yield than a 10-year corporate bond.
C)   A 5-year corporate bond must have a higher yield than a 10-year Treasury bond.
D)   The corporate yield curve must be flat.
E)   Since the Treasury yield curve is downward sloping, the corporate yield curve must also be downward sloping.F) B) and D)
G) B) and C)

Question 14

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.

Accepted Answer

A) True 
 B)False

Question 15

Suppose the real risk-free rate is 4.20%, the average expected future inflation rate is 3.10%, and a maturity risk premium of 0.10% per year to maturity applies, i.e., MRP = 0.10%(t) , where t is the years to maturity, hence the pure expectations theory is NOT valid. What rate of return would you expect on a 4-year Treasury security? Disregard cross-product terms, i.e., if averaging is required, use the arithmetic average.

Accepted Answer

A)   6.60%
B)   6.95%
C)   7.32%
D)   7.70%
E)   8.09%F) A) and D)
G) A) and E)

Question 16

Kay Corporation's 5-year bonds yield 6.20% and 5-year T-bonds yield 4.40%. The real risk-free rate is r* = 2.5%, the inflation premium for 5-year bonds is IP = 1.50%, the default risk premium for Kay's bonds is DRP = 1.30% versus zero for T-bonds, and the maturity risk premium for all bonds is found with the formula MRP = (t - 1)  × 0.1%, where t = number of years to maturity. What is the liquidity premium (LP)  on Kay's bonds?

Accepted Answer

A)   0.36%
B)   0.41%
C)   0.45%
D)   0.50%
E)   0.55%F) C) and D)
G) A) and B)

Exam 6: Bonds and Their Valuation

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.

Correct Answer
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If the pure expectations theory is correct, a downward sloping yield curve indicates that interest rates are expected to decline in the future.

Correct Answer
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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.

Correct Answer
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Correct Answer
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If the pure expectations theory holds, which of the following statements is CORRECT?

Correct Answer
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If 10-year T-bonds have a yield of 6.2%, 10-year corporate bonds yield 8.5%, 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?

Correct Answer
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Which of the following statements is CORRECT, other things held constant?

Correct Answer
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Correct Answer
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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?

Correct Answer
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Correct Answer
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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.

Correct Answer
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Which of the following statements is CORRECT?

Correct Answer
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Which of the following statements is CORRECT?

Correct Answer
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Correct Answer
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Exam 6: Bonds and Their Valuation

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.

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

If the pure expectations theory is correct, a downward sloping yield curve indicates that interest rates are expected to decline in the future.

Correct AnswerverifiedShow Answer

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.

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

If the pure expectations theory holds, which of the following statements is CORRECT?

Correct AnswerverifiedShow Answer

If 10-year T-bonds have a yield of 6.2%, 10-year corporate bonds yield 8.5%, 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?

Correct AnswerverifiedShow Answer

Which of the following statements is CORRECT, other things held constant?

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

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?

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

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.

Correct AnswerverifiedShow Answer

Which of the following statements is CORRECT?

Correct AnswerverifiedShow Answer

Which of the following statements is CORRECT?

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Correct AnswerverifiedShow Answer

Correct Answer
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