Question 1

The expectations theory postulates that the term structure of interest rates is based on expectations regarding future inflation rates.

Accepted Answer

A) True 
 B)False  True

Question 2

Assume that the real risk-free rate,r*,is 4 percent,and that inflation is expected to be 9% in Year 1,6% in Year 2,and 4% thereafter.Assume also that all Treasury bonds are highly liquid and free of default risk.If 2-year and 5-year Treasury bonds both yield 12%,what is the difference in the maturity risk premiums (MRPs)on the two bonds,i.e.,what is MRP5 - MRP2?

Accepted Answer

A)  2.1% 
B)  1.8% 
C)  5.0% 
D)  3.0% 
E)  2.5% 
A)  2.1% 
B)  1.8% 
C)  5.0% 
D)  3.0% 
E)  2.5% A

Question 3

You read in The Wall Street Journal that 30-day T-bills currently are yielding 8 percent.Your brother-in-law,a broker at Kyoto Securities,has given you the following estimates of current interest rate premiums:   Based on these data,the real risk-free rate of return is

Accepted Answer

A)  0% 
B)  1% 
C)  2% 
D)  3% 
E)  4% 
A)  0% 
B)  1% 
C)  2% 
D)  3% 
E)  4% D

Question 4

The liquidity preference theory states that each borrower and lender has a preferred maturity and that the slope of the yield curve depends on supply and demand for funds in the long-term market relative to the short-term market.

Accepted Answer

A) True 
 B)False

Question 5

An investor with a six-year investment horizon believes that interest rates are determined only by expectations about future interest rates,(i.e.,this investor believes in the expectations theory).This investor should expect to earn the same rate of return over the 6-year time horizon if he or she buys a 6-year bond or a 3-year bond now and another 3-year bond three years from now (ignore transaction costs).

Accepted Answer

A) True 
 B)False

Question 6

A 9 percent coupon bond issued by the State of Pennsylvania sells for $1,000 and thus provides a 9 percent yield to maturity.What yield on a Synthetic Chemical Company bond would cause the two bonds to provide the same after-tax rate of return to an investor in the 28 percent tax bracket?

Accepted Answer

A)  12.50% 
B)  17.50% 
C)  7.00% 
D)  14.00% 
E)  9.00% 
A)  12.50% 
B)  17.50% 
C)  7.00% 
D)  14.00% 
E)  9.00%

Question 7

Treasury securities that mature in 6 years currently have an interest rate of 8.5%.Inflation is expected to be 5% each of the next three years and 6% each year after the third year.The maturity risk premium is estimated to be 0.1%(t - 1),where t is equal to the maturity of the bond (i.e.,the maturity risk premium of a one-year bond is zero).The real risk-free rate is assumed to be constant over time.What is the real risk-free rate of interest?

Accepted Answer

A)  0.25% 
B)  0.50% 
C)  1.00% 
D)  1.75% 
E)  2.50% 
A)  0.25% 
B)  0.50% 
C)  1.00% 
D)  1.75% 
E)  2.50%

Question 8

Assume that the expectations theory holds,and that liquidity and maturity risk premiums are zero.If the annual rate of interest on a 2-year Treasury bond is 10.5 percent and the rate on a 1-year Treasury bond is 12 percent,what rate of interest should you expect on a 1-year Treasury bond one year from now?

Accepted Answer

A)  9.0% 
B)  9.5% 
C)  10.0% 
D)  10.5% 
E)  11.0% 
A)  9.0% 
B)  9.5% 
C)  10.0% 
D)  10.5% 
E)  11.0%

Question 9

Which of the following statements is correct?

Accepted Answer

A)  For the most part, our federal tax rates are progressive, because higher incomes are taxed at higher average rates. 
B)  Bonds issued by a municipality such as the city of Miami would carry a lower interest rate than bonds with the same risk and maturity issued by a private corporation such as Florida Power & Light. 
C)  Our federal tax laws tend to encourage corporations to finance with debt rather than with equity securities. 
D)  Our federal tax laws encourage the managers of corporations with surplus cash to invest it in stocks rather than in bonds. However, other factors may offset tax considerations. 
E)  All of the above statements are true. 
A)  For the most part, our federal tax rates are progressive, because higher incomes are taxed at higher average rates. 
B)  Bonds issued by a municipality such as the city of Miami would carry a lower interest rate than bonds with the same risk and maturity issued by a private corporation such as Florida Power & Light. 
C)  Our federal tax laws tend to encourage corporations to finance with debt rather than with equity securities. 
D)  Our federal tax laws encourage the managers of corporations with surplus cash to invest it in stocks rather than in bonds. However, other factors may offset tax considerations. 
E)  All of the above statements are true.

Question 10

Which of the following is not one of the four fundamental factors that affect the cost of money?

Accepted Answer

A)  production opportunities 
B)  time preferences for consumption 
C)  risk 
D)  liquidity 
E)  inflation 
A)  production opportunities 
B)  time preferences for consumption 
C)  risk 
D)  liquidity 
E)  inflation

Question 11

If the tax laws stated that $0.50 out of every $1.00 of interest paid by a corporation was allowed as a tax-deductible expense,it would probably encourage companies to use more debt financing than they presently do,other things held constant.

Accepted Answer

A) True 
 B)False

Question 12

If the expectations theory of the term structure of interest rates is correct,and if the other term structure theories are invalid,and we observe a downward sloping yield curve,which of the following is a true statement?

Accepted Answer

A)  Investors expect short-term rates to be constant over time. 
B)  Investors expect short-term rates to increase in the future. 
C)  Investors expect short-term rates to decrease in the future. 
D)  It is impossible to say unless we know whether investors require a positive or negative maturity risk premium. 
E)  The maturity risk premium must be positive. 
A)  Investors expect short-term rates to be constant over time. 
B)  Investors expect short-term rates to increase in the future. 
C)  Investors expect short-term rates to decrease in the future. 
D)  It is impossible to say unless we know whether investors require a positive or negative maturity risk premium. 
E)  The maturity risk premium must be positive.

Question 13

Interest rates on 1-year,2-year,and 3-year Treasury bills are 5%,6%,and 7% respectively.Assume that the pure expectations theory holds and that the market is in equilibrium.Which of the following statements is most correct?

Accepted Answer

A)  The maturity risk premium is positive. 
B)  Interest rates are expected to rise over the next two years. 
C)  The market expects one-year rates to be 5.5% one year from today. 
D)  Answers a, b, and c are all correct. 
E)  Only answers b and c are correct. 
A)  The maturity risk premium is positive. 
B)  Interest rates are expected to rise over the next two years. 
C)  The market expects one-year rates to be 5.5% one year from today. 
D)  Answers a, b, and c are all correct. 
E)  Only answers b and c are correct.

Question 14

If the Federal Reserve tightens the money supply,other things held constant,short-term interest rates will be pushed upward,and this increase probably will be greater than the increase in rates in the long-term market.

Accepted Answer

A) True 
 B)False

Question 15

The real rate of interest is composed of a risk-free rate of interest plus a premium that reflects the riskiness of the security.

Accepted Answer

A) True 
 B)False

Question 16

If the yield curve is downward sloping,what is the yield to maturity on a 10-year Treasury coupon bond,relative to that on a 1-year T-bond?

Accepted Answer

A)  The yield on the 10-year bond is less than the yield on a 1-year bond. 
B)  The yield on a 10-year bond will always be higher than the yield on a 1-year bond because of maturity premiums. 
C)  It is impossible to tell without knowing the coupon rates of the bonds. 
D)  The yields on the two bonds are equal. 
E)  It is impossible to tell without knowing the relative risks of the two bonds. 
A)  The yield on the 10-year bond is less than the yield on a 1-year bond. 
B)  The yield on a 10-year bond will always be higher than the yield on a 1-year bond because of maturity premiums. 
C)  It is impossible to tell without knowing the coupon rates of the bonds. 
D)  The yields on the two bonds are equal. 
E)  It is impossible to tell without knowing the relative risks of the two bonds.

Question 17

Firms with the most profitable investment opportunities are willing and able to pay the most for capital,so they tend to attract it away from less efficient firms or from those whose products are not in demand.

Accepted Answer

A) True 
 B)False

Question 18

The fact that a percentage of the interest income received by one corporation is excluded from taxable income has encouraged firms to use more debt financing relative to equity financing.

Accepted Answer

A) True 
 B)False

Question 19

Assume that the current yield curve is upward sloping,or normal.This implies that

Accepted Answer

A)  Short-term interest rates are more volatile than long-term rates. 
B)  Inflation is expected to subside in the future. 
C)  The economy is at the peak of a business cycle. 
D)  Long-term bonds are a better buy than short-term bonds. 
E)  None of the above statements is necessarily implied by the yield curve given. 
A)  Short-term interest rates are more volatile than long-term rates. 
B)  Inflation is expected to subside in the future. 
C)  The economy is at the peak of a business cycle. 
D)  Long-term bonds are a better buy than short-term bonds. 
E)  None of the above statements is necessarily implied by the yield curve given.

Question 20

Allen Corporation can (1)build a new plant which should generate a before-tax return of 11 percent,or (2)invest the same funds in the preferred stock of FPL,which should provide Allen with a before-tax return of 9%,all in the form of dividends.Assume that Allen's marginal tax rate is 25 percent,and that 70 percent of dividends received are excluded from taxable income.If the plant project is divisible into small increments,and if the two investments are equally risky,what combination of these two possibilities will maximize Allen's effective return on the money invested?

Accepted Answer

A)  All in the plant project. 
B)  All in FPL preferred stock. 
C)  60% in the project; 40% in FPL. 
D)  60% in FPL; 40% in the project. 
E)  50% in each. 
A)  All in the plant project. 
B)  All in FPL preferred stock. 
C)  60% in the project; 40% in FPL. 
D)  60% in FPL; 40% in the project. 
E)  50% in each.

The expectations theory postulates that the term structure of interest rates is based on expectations regarding future inflation rates.

You read in The Wall Street Journal that 30-day T-bills currently are yielding 8 percent.Your brother-in-law,a broker at Kyoto Securities,has given you the following estimates of current interest rate premiums: Based on these data,the real risk-free rate of return is

The liquidity preference theory states that each borrower and lender has a preferred maturity and that the slope of the yield curve depends on supply and demand for funds in the long-term market relative to the short-term market.

A 9 percent coupon bond issued by the State of Pennsylvania sells for $1,000 and thus provides a 9 percent yield to maturity.What yield on a Synthetic Chemical Company bond would cause the two bonds to provide the same after-tax rate of return to an investor in the 28 percent tax bracket?

Which of the following statements is correct?

Which of the following is not one of the four fundamental factors that affect the cost of money?

If the tax laws stated that $0.50 out of every $1.00 of interest paid by a corporation was allowed as a tax-deductible expense,it would probably encourage companies to use more debt financing than they presently do,other things held constant.

If the expectations theory of the term structure of interest rates is correct,and if the other term structure theories are invalid,and we observe a downward sloping yield curve,which of the following is a true statement?

Interest rates on 1-year,2-year,and 3-year Treasury bills are 5%,6%,and 7% respectively.Assume that the pure expectations theory holds and that the market is in equilibrium.Which of the following statements is most correct?

If the Federal Reserve tightens the money supply,other things held constant,short-term interest rates will be pushed upward,and this increase probably will be greater than the increase in rates in the long-term market.

The real rate of interest is composed of a risk-free rate of interest plus a premium that reflects the riskiness of the security.

If the yield curve is downward sloping,what is the yield to maturity on a 10-year Treasury coupon bond,relative to that on a 1-year T-bond?

Firms with the most profitable investment opportunities are willing and able to pay the most for capital,so they tend to attract it away from less efficient firms or from those whose products are not in demand.

The fact that a percentage of the interest income received by one corporation is excluded from taxable income has encouraged firms to use more debt financing relative to equity financing.

Assume that the current yield curve is upward sloping,or normal.This implies that

An Overview of Managerial Finance

Analysis of Financial Statements

The Financial Environment: Markets, institutions, and Investment Banking

The Time Value of Money

Bonds Debt-Characteristics and Valuation

Stocks Equity-Characteristics and Valuation

Risk and Rates of Return

Capital Budgeting Techniques

Project Cash Flows and Risk

The Cost of Capital

Capital Structure

Distribution of Retained Earnings: Dividends and Stock Repurchases

Working Capital Policy

Managing Short-Term Assets

Managing Short-Term Liabilities Financing

Financial Planning and Control

project Cash Flows and Risk

Filters

Exam 5: The Cost of Money

The expectations theory postulates that the term structure of interest rates is based on expectations regarding future inflation rates.

You read in The Wall Street Journal that 30-day T-bills currently are yielding 8 percent.Your brother-in-law,a broker at Kyoto Securities,has given you the following estimates of current interest rate premiums: Based on these data,the real risk-free rate of return is

The liquidity preference theory states that each borrower and lender has a preferred maturity and that the slope of the yield curve depends on supply and demand for funds in the long-term market relative to the short-term market.

A 9 percent coupon bond issued by the State of Pennsylvania sells for $1,000 and thus provides a 9 percent yield to maturity.What yield on a Synthetic Chemical Company bond would cause the two bonds to provide the same after-tax rate of return to an investor in the 28 percent tax bracket?

Which of the following statements is correct?

Which of the following is not one of the four fundamental factors that affect the cost of money?

If the tax laws stated that $0.50 out of every $1.00 of interest paid by a corporation was allowed as a tax-deductible expense,it would probably encourage companies to use more debt financing than they presently do,other things held constant.

If the expectations theory of the term structure of interest rates is correct,and if the other term structure theories are invalid,and we observe a downward sloping yield curve,which of the following is a true statement?

Interest rates on 1-year,2-year,and 3-year Treasury bills are 5%,6%,and 7% respectively.Assume that the pure expectations theory holds and that the market is in equilibrium.Which of the following statements is most correct?

If the Federal Reserve tightens the money supply,other things held constant,short-term interest rates will be pushed upward,and this increase probably will be greater than the increase in rates in the long-term market.

The real rate of interest is composed of a risk-free rate of interest plus a premium that reflects the riskiness of the security.

If the yield curve is downward sloping,what is the yield to maturity on a 10-year Treasury coupon bond,relative to that on a 1-year T-bond?

Firms with the most profitable investment opportunities are willing and able to pay the most for capital,so they tend to attract it away from less efficient firms or from those whose products are not in demand.

The fact that a percentage of the interest income received by one corporation is excluded from taxable income has encouraged firms to use more debt financing relative to equity financing.

Assume that the current yield curve is upward sloping,or normal.This implies that

An Overview of Managerial Finance

Analysis of Financial Statements

The Financial Environment: Markets, institutions, and Investment Banking

The Time Value of Money

Bonds Debt-Characteristics and Valuation

Stocks Equity-Characteristics and Valuation

Risk and Rates of Return

Capital Budgeting Techniques

Project Cash Flows and Risk

The Cost of Capital

Capital Structure

Distribution of Retained Earnings: Dividends and Stock Repurchases

Working Capital Policy

Managing Short-Term Assets

Managing Short-Term Liabilities Financing

Financial Planning and Control

project Cash Flows and Risk

Filters