Question 1 10 points Save



Question 1     10 points      Save

     For at least the next 10 years, the real risk-free rate of interest, r*, is expected to remain at 3%, inflation is expected to steadily increase steadily, 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 on 2-year Treasury securities must exceed the yield on 5-year Treasury securities.

          The yield on 5-year Treasury securities must exceed the yield on 10-year corporate bonds.

          The yield on 5-year corporate bonds must exceed the yield on 8-year Treasury bonds.

          The yield curve must be "humped."

          The yield curve must be upward sloping.

   

Question 2     10 points      Save

     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%, and there is 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 2-year T-bond must exceed that on a 5-year T-bond.

          The yield on a 5-year Treasury bond must exceed that on a 2-year Treasury bond.

          The yield on a 7-year Treasury bond must exceed that of a 5-year corporate bond.

          The conditions in the problem cannot all be true-they are internally inconsistent.

          The Treasury yield curve under the stated conditions would be humped rather than have a consistent positive or negative slope.

  

 Question 3     10 points      Save

     Assume that inflation is expected to decline steadily in the future, but that the real risk-free rate, r*, will remain constant. Which of the following statements is CORRECT?

          If the expectations theory holds, the Treasury yield curve must be downward sloping.

          If the expectations theory holds, the corporate yield curve must be downward sloping.

          If there is a positive maturity risk premium, the Treasury yield curve must be upward sloping.

          If inflation is expected to decline, there can be no maturity risk premium.

          The expectations theory cannot hold if inflation is decreasing.

   

Question 4     10 points      Save

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

          The yield curve for both Treasury and corporate bonds would be flat.

          The yield curve for Treasury securities would be flat, but the yield curve for corporate securities might be downward sloping.

          The yield curve for Treasury securities cannot be downward sloping.

          The maturity risk premium would be zero.

          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.

   

Question 5     10 points      Save

     Assume that the rate on a 1-year bond is now 6%, but all investors in the market 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 yield curve would be downward sloping, with the rate on a 1-year bond at 6%.

          The interest rate today on a 2-year bond would be 6%.

          The interest rate today on a 2-year bond would be 7%.

          The interest rate today on a 3-year bond would be 7%.

          The interest rate today on a 3-year bond would be 8%.

 

  Question 6     10 points      Save

     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?

          The yield curve for U.S. Treasury securities will be upward sloping.

          A 5-year corporate bond will have a lower yield than a 5-year Treasury security.

          A 5-year corporate bond will have a lower yield than a 7-year Treasury security.

          The real risk-free rate cannot be constant if inflation is not expected to remain constant.

          This problem's assumption of a zero maturity risk premium is probably not valid in the real world.

 

 Question 7     10 points      Save

     Which of the following statements is CORRECT?

          If companies have fewer good investment opportunities, interest rates are likely to increase.

          If individuals increase their savings rate, interest rates are likely to increase.

          If expected inflation increases, interest rates are likely to increase.

          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.

          Interest rates on long-term bonds are more volatile than rates on short-term debt securities like T-bills.

  

 Question 8     10 points      Save

     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.

          The yield on a 3-year corporate bond should always exceed the yield on a 2-year corporate bond.

          The yield on a 3-year Treasury bond should always exceed the yield on a 2-year Treasury bond.

          If inflation is expected to increase, then the yield on a 2-year bond will exceed that on a 3-year bond.

          The real risk-free rate increases if people expect inflation to increase.

   

Question 9     10 points      Save

     Which of the following statements is CORRECT?

          The maturity premiums embedded in the interest rates on U.S. Treasury securities are due primarily to the fact that the probability of default is higher on long-term bonds than on short-term bonds.

          Reinvestment rate risk is lower, other things held constant, on long-term than on short-term bonds.

          The pure expectations theory of the term structure states that borrowers generally prefer to borrow on a long-term basis while savers generally prefer to lend on a short-term basis, and that as a result, the yield curve is normally upward sloping.

          If the maturity risk premium were zero and interest rates were expected to decrease in the future, then the yield curve for U.S. Treasury securities would, other things held constant, have an upward slope.

          Liquidity premiums are generally higher on Treasury than corporate bonds.

   

Question 10     10 points      Save

     Which of the following statements is CORRECT?

          If the maturity risk premium (MRP) is greater than zero, the yield curve must be upward sloping.

          If the maturity risk premium (MRP) equals zero, the yield curve must be flat.

          If inflation is expected to increase in the future and the maturity risk premium (MRP) is greater than zero, the yield curve will be upward sloping.

          If the expectations theory holds, the yield curve will never be downward sloping.

          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.

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