Question 1

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

Accepted Answer

A) True 
 B)False  True

Question 2

Suppose 1-year Treasury bonds yield 4.00% while 2-year T-bonds yield 5.10%. 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?

Accepted Answer

A)  5.90% 
B)  6.21% 
C)  6.52% 
D)  6.85% 
E)  7.19% 
A)  5.90% 
B)  6.21% 
C)  6.52% 
D)  6.85% 
E)  7.19% B

Question 3

The real risk-free rate is 3.55%, inflation is expected to be 3.15% this year, and the maturity risk premium is zero. Taking account of the cross-product term, i.e., not ignoring it, what is the equilibrium rate of return on a 1-year Treasury bond?

Accepted Answer

A)  5.840% 
B)  6.148% 
C)  6.471% 
D)  6.812% 
E)  7.152% 
A)  5.840% 
B)  6.148% 
C)  6.471% 
D)  6.812% 
E)  7.152% D

Question 4

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.

Accepted Answer

A) True 
 B)False

Question 5

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 6

Suppose the real risk-free rate is 3.50% and the future rate of inflation is expected to be constant at 2.20%. What rate of return would you expect on a 1-year Treasury security, assuming the pure expectations theory is valid? Include cross-product terms, i.e., if averaging is required, use the geometric average.

Accepted Answer

A)  5.21% 
B)  5.49% 
C)  5.78% 
D)  6.07% 
E)  6.37% 
A)  5.21% 
B)  5.49% 
C)  5.78% 
D)  6.07% 
E)  6.37%

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. 
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.

Question 8

Suppose 1-year T-bills currently yield 7.00% and the future inflation rate is expected to be constant at 3.20% per year. What is the real risk-free rate of return, r*? The cross-product term should be considered, i.e., if averaging is required, use the geometric average.

Accepted Answer

A)  3.68% 
B)  3.87% 
C)  4.06% 
D)  4.26% 
E)  4.48% 
A)  3.68% 
B)  3.87% 
C)  4.06% 
D)  4.26% 
E)  4.48%

Question 9

Which of the following statements is CORRECT?

Accepted Answer

A)  The higher the maturity risk premium, the higher the probability that the yield curve will be inverted. 
B)  The most likely explanation for an inverted yield curve is that investors expect inflation to increase. 
C)  The most likely explanation for an inverted yield curve is that investors expect inflation to decrease. 
D)  If the yield curve is inverted, short-term bonds have lower yields than long-term bonds. 
E)  Inverted yield curves can exist for Treasury bonds, but because of default premiums, the corporate yield curve can never be inverted. 
A)  The higher the maturity risk premium, the higher the probability that the yield curve will be inverted. 
B)  The most likely explanation for an inverted yield curve is that investors expect inflation to increase. 
C)  The most likely explanation for an inverted yield curve is that investors expect inflation to decrease. 
D)  If the yield curve is inverted, short-term bonds have lower yields than long-term bonds. 
E)  Inverted yield curves can exist for Treasury bonds, but because of default premiums, the corporate yield curve can never be inverted.

Question 10

Kern Corporation's 5-year bonds yield 7.30% and 5-year T-bonds yield 4.10%. The real risk-free rate is r* = 2.5%, the default risk premium for Kern's bonds is DRP = 1.90% versus zero for T-bonds, the liquidity premium on Kern's bonds is LP = 1.3%, 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 inflation premium (IP) on all 5-year bonds?

Accepted Answer

A)  1.20% 
B)  1.32% 
C)  1.45% 
D)  1.60% 
E)  1.68% 
A)  1.20% 
B)  1.32% 
C)  1.45% 
D)  1.60% 
E)  1.68%

Question 11

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, r*.

Accepted Answer

A) True 
 B)False

Question 12

Suppose 1-year T-bills currently yield 7.00% and the future inflation rate is expected to be constant at 3.20% per year. What is the real risk-free rate of return, r*? Disregard any cross-product terms, i.e., if averaging is required, use the arithmetic average.

Accepted Answer

A)  3.80% 
B)  3.99% 
C)  4.19% 
D)  4.40% 
E)  4.62% 
A)  3.80% 
B)  3.99% 
C)  4.19% 
D)  4.40% 
E)  4.62%

Question 13

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. 
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.

Question 14

If the pure expectations theory of the term structure is correct, which of the following statements would be CORRECT?

Accepted Answer

A)  An upward-sloping yield curve would imply that interest rates are expected to be lower in the future. 
B)  If a 1-year Treasury bill has a yield to maturity of 7% and a 2-year Treasury bill has a yield to maturity of 8%, this would imply the market believes that 1-year rates will be 7.5% one year from now. 
C)  The yield on a 5-year corporate bond should always exceed the yield on a 3-year Treasury bond. 
D)  Interest rate (price) risk is higher on long-term bonds, but reinvestment rate risk is higher on short-term bonds. 
E)  Interest rate (price) risk is higher on short-term bonds, but reinvestment rate risk is higher on long-term bonds. 
A)  An upward-sloping yield curve would imply that interest rates are expected to be lower in the future. 
B)  If a 1-year Treasury bill has a yield to maturity of 7% and a 2-year Treasury bill has a yield to maturity of 8%, this would imply the market believes that 1-year rates will be 7.5% one year from now. 
C)  The yield on a 5-year corporate bond should always exceed the yield on a 3-year Treasury bond. 
D)  Interest rate (price) risk is higher on long-term bonds, but reinvestment rate risk is higher on short-term bonds. 
E)  Interest rate (price) risk is higher on short-term bonds, but reinvestment rate risk is higher on long-term bonds.

Question 15

Assume that the current corporate bond yield curve is upward sloping. Under this condition, then we could be sure that

Accepted Answer

A)  Inflation is expected to decline in the future. 
B)  The economy is not in a recession. 
C)  Long-term bonds are a better buy than short-term bonds. 
D)  Maturity risk premiums could help to explain the yield curve's upward slope. 
E)  Long-term interest rates are more volatile than short-term rates. 
A)  Inflation is expected to decline in the future. 
B)  The economy is not in a recession. 
C)  Long-term bonds are a better buy than short-term bonds. 
D)  Maturity risk premiums could help to explain the yield curve's upward slope. 
E)  Long-term interest rates are more volatile than short-term rates.

Question 16

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?

Accepted Answer

A)  The yield on 10-year Treasury securities must exceed the yield on 7-year Treasury securities. 
B)  The yield on any corporate bond must exceed the yields on all Treasury bonds. 
C)  The yield on 7-year corporate bonds must exceed the yield on 10-year Treasury bonds. 
D)  The stated conditions cannot all be true-they are internally inconsistent. 
E)  The Treasury yield curve under the stated conditions would be humped rather than have a consistent positive or negative slope. 
A)  The yield on 10-year Treasury securities must exceed the yield on 7-year Treasury securities. 
B)  The yield on any corporate bond must exceed the yields on all Treasury bonds. 
C)  The yield on 7-year corporate bonds must exceed the yield on 10-year Treasury bonds. 
D)  The stated conditions cannot all be true-they are internally inconsistent. 
E)  The Treasury yield curve under the stated conditions would be humped rather than have a consistent positive or negative slope.

Question 17

If the pure expectations theory is correct (that is, the maturity risk premium is zero), which of the following is CORRECT?

Accepted Answer

A)  An upward-sloping Treasury yield curve means that the market expects interest rates to decline in the future. 
B)  A 5-year T-bond would always yield less than a 10-year T-bond. 
C)  The yield curve for corporate bonds may be upward sloping even if the Treasury yield curve is flat. 
D)  The yield curve for stocks must be above that for bonds, but both yield curves must have the same slope. 
E)  If the maturity risk premium is zero for Treasury bonds, then it must be negative for corporate bonds. 
A)  An upward-sloping Treasury yield curve means that the market expects interest rates to decline in the future. 
B)  A 5-year T-bond would always yield less than a 10-year T-bond. 
C)  The yield curve for corporate bonds may be upward sloping even if the Treasury yield curve is flat. 
D)  The yield curve for stocks must be above that for bonds, but both yield curves must have the same slope. 
E)  If the maturity risk premium is zero for Treasury bonds, then it must be negative for corporate bonds.

Question 18

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?

Accepted Answer

A)  Prices and interest rates would both rise. 
B)  Prices would rise and interest rates would decline. 
C)  Prices and interest rates would both decline. 
D)  Prices would decline and interest rates would rise. 
E)  There is no reason to expect a change in either prices or interest rates. 
A)  Prices and interest rates would both rise. 
B)  Prices would rise and interest rates would decline. 
C)  Prices and interest rates would both decline. 
D)  Prices would decline and interest rates would rise. 
E)  There is no reason to expect a change in either prices or interest rates.

Question 19

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."

Accepted Answer

A) True 
 B)False

Question 20

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

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

Suppose 1-year Treasury bonds yield 4.00% while 2-year T-bonds yield 5.10%. 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?

The real risk-free rate is 3.55%, inflation is expected to be 3.15% this year, and the maturity risk premium is zero. Taking account of the cross-product term, i.e., not ignoring it, what is the equilibrium rate of return on a 1-year Treasury bond?

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.

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.

Which of the following statements is CORRECT?

Suppose 1-year T-bills currently yield 7.00% and the future inflation rate is expected to be constant at 3.20% per year. What is the real risk-free rate of return, r*? The cross-product term should be considered, i.e., if averaging is required, use the geometric average.

Which of the following statements is CORRECT?

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, r*.

Suppose 1-year T-bills currently yield 7.00% and the future inflation rate is expected to be constant at 3.20% per year. What is the real risk-free rate of return, r*? Disregard any cross-product terms, i.e., if averaging is required, use the arithmetic average.

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

If the pure expectations theory of the term structure is correct, which of the following statements would be CORRECT?

Assume that the current corporate bond yield curve is upward sloping. Under this condition, then we could be sure that

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?

If the pure expectations theory is correct (that is, the maturity risk premium is zero), which of the following is CORRECT?

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?

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."

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.

An Overview of Financial Management

Financial Markets and Institutions

Financial Statements, Cash Flow, and Taxes

Analysis of Financial Statements

The Value of Money

Bonds and Their Valuation

Risk and Rates of Return

Stocks and Their Valuation

The Cost of Capital

The Basics of Capital Budgeting

Cash Flow Estimation and Risk Analysis

Capital Structure and Leverage

Distributions to Shareholders: Dividends and Share Repurchases

Working Capital Management

Financial Planning and Forecasting

Multinational Financial Management

Financial and Operating Leverage: Analysis and Calculation

Filters

Exam 6: Interest Rates

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

Suppose 1-year Treasury bonds yield 4.00% while 2-year T-bonds yield 5.10%. 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?

The real risk-free rate is 3.55%, inflation is expected to be 3.15% this year, and the maturity risk premium is zero. Taking account of the cross-product term, i.e., not ignoring it, what is the equilibrium rate of return on a 1-year Treasury bond?

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.

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.

Which of the following statements is CORRECT?

Suppose 1-year T-bills currently yield 7.00% and the future inflation rate is expected to be constant at 3.20% per year. What is the real risk-free rate of return, r*? The cross-product term should be considered, i.e., if averaging is required, use the geometric average.

Which of the following statements is CORRECT?

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, r*.

Suppose 1-year T-bills currently yield 7.00% and the future inflation rate is expected to be constant at 3.20% per year. What is the real risk-free rate of return, r*? Disregard any cross-product terms, i.e., if averaging is required, use the arithmetic average.

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

If the pure expectations theory of the term structure is correct, which of the following statements would be CORRECT?

Assume that the current corporate bond yield curve is upward sloping. Under this condition, then we could be sure that

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?

If the pure expectations theory is correct (that is, the maturity risk premium is zero), which of the following is CORRECT?

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?

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."

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.

An Overview of Financial Management

Financial Markets and Institutions

Financial Statements, Cash Flow, and Taxes

Analysis of Financial Statements

The Value of Money

Bonds and Their Valuation

Risk and Rates of Return

Stocks and Their Valuation

The Cost of Capital

The Basics of Capital Budgeting

Cash Flow Estimation and Risk Analysis

Capital Structure and Leverage

Distributions to Shareholders: Dividends and Share Repurchases

Working Capital Management

Financial Planning and Forecasting

Multinational Financial Management

Financial and Operating Leverage: Analysis and Calculation

Filters