Deck 6: Understanding Financial Markets and Institutions

Question 1

Which of these refer to the ease with which an asset can be converted into cash?

A) direct transfer
B) liquidity
C) primary market
D) secondary market

Answer 1

liquidity

Question 2

Which of these markets trade currencies for immediate or for some future stated delivery?

A) money markets
B) primary markets
C) foreign exchange markets
D) over-the-counter stocks

Answer 2

foreign exchange markets

Question 3

Which of these provide a forum in which demanders of funds raise funds by issuing new financial instruments, such as stocks and bonds?

A) investment banks
B) money markets
C) primary markets
D) secondary markets

Answer 3

primary markets

Question 4

Which of the following is NOT a capital market instrument?

A) U.S. Treasury notes and bonds
B) U.S. Treasury bills
C) U.S. government agency bonds
D) corporate stocks and bonds

Question 5

Which of these feature debt securities or instruments with maturities of one year or less?

A) money markets
B) primary markets
C) secondary markets
D) over-the-counter stocks

Question 6

Which of the following are money market securities to obtain short-term funds?

A) U.S. Treasury notes and bonds
B) U.S. Treasury bills
C) Commercial paper
D) Both b and c

Question 7

Once firms issue financial instruments in primary markets, these same stocks and bonds are then traded in which of these?

A) initial public offerings
B) direct transfers
C) secondary markets
D) over-the-counter stocks

Question 8

Which of these does NOT perform vital functions to securities markets of all sorts by channelling funds from those with surplus funds to those with shortages of funds?

A) commercial banks
B) secondary markets
C) insurance companies
D) mutual funds

Question 9

Which of the following is/are NOT a capital market security

A) Corporate bonds
B) Banker's acceptances
C) Corporate stocks
D) State and local government bonds

Question 10

Which of the following is the risk that a security issuer will miss an interest or principal payment or continue to miss such payments?

A) default risk
B) liquidity risk
C) maturity risk
D) price risk

Question 11

Primary market financial instruments include stock issues from firms allowing their equity shares to be publicly traded on the stock market for the first time. We usually refer to these first-time issues as which of the following?

A) initial public offerings
B) direct transfers
C) money market transfers
D) over-the-counter stocks

Question 12

In the United States, which of these financial institutions arrange most primary market transactions for businesses?

A) investment banks
B) asset transformer
C) direct transfer agents
D) over-the-counter agents

Question 13

Which of these capital market instruments are long-term loans to individuals or businesses to purchase homes, pieces of land, or other real property?

A) treasury notes and bonds
B) mortgages
C) mortgage-backed securities
D) corporate bonds

Question 14

Which of the following is NOT a money market instrument?

A) treasury bills
B) commercial paper
C) corporate bonds
D) bankers' acceptances

Question 15

Which of these money market instruments are short-term funds transferred between financial institutions, usually for no more than one day?

A) treasury bills
B) federal funds
C) commercial paper
D) banker acceptances

Question 16

Which of these is the interest rate that is actually observed in financial markets?

A) nominal interest rates
B) real interest rates
C) real risk-free rate
D) market premium

Question 17

Which of these is the interest rate that would exist on a default-free security if no inflation were expected?

A) nominal interest rate
B) real interest rate
C) default premium
D) market premium

Question 18

Which of the following is the risk that an asset's sale price will be lower than its purchase price?

A) default risk
B) liquidity risk
C) price risk
D) trading risk

Question 19

Financial intermediaries provide which of the following?

A) Purchase the financial claims that fund users issue.
B) Finance purchases by selling financial claims to household investors and other fund suppliers.
C) Both a and b
D) None of the above

Question 20

Which of these formalizes an agreement between two parties to exchange a standard quantity of an asset at a predetermined price on a specified date in the future?

A) derivative security
B) initial public offering
C) liquidity asset
D) trading volume

Question 21

How is the shadow banking system the same as the traditional banking system?

A) It intermediates the flow of funds between net savers and net borrowers.
B) It serves as a middle man.
C) The complete credit intermediation is performed through a series of steps involving many nonbank financial service firms.
D) The complete credit intermediation is performed by a single bank.

Question 22

A corporation's 10-year bonds have an equilibrium rate of return of 7 percent. For all securities, the inflation risk premium is 1.50 percent and the real interest rate is 3.0 percent. The security's liquidity risk premium is 0.15 percent and maturity risk premium is 0.70 percent. The security has no special covenants. What is the bond's default risk premium?

A) 1.40 percent
B) 1.65 percent
C) 5.35 percent
D) 9.35 percent

Question 23

Which of these is NOT a participant in the shadow banking system?

A) structured investment vehicles (SIVs)
B) special purpose vehicles (SPVs)
C) limited-purpose finance companies
D) credit unions

Question 24

Which of these is a comparison of market yields on securities, assuming all characteristics except maturity are the same?

A) liquidity risk
B) market risk
C) maturity risk
D) term structure of interest rates

Question 25

One-year Treasury bills currently earn 5.50 percent. You expect that one year from now, one-year Treasury bill rates will increase to 5.75 percent. The liquidity premium on two-year securities is 0.075 percent. If the liquidity theory is correct, what should the current rate be on two-year Treasury securities?

A) 3.775 percent
B) 5.625 percent
C) 5.662 percent
D) 11.325 percent

Question 26

A two-year Treasury security currently earns 5.25 percent. Over the next two years, the real interest rate is expected to be 3.00 percent per year and the inflation premium is expected to be 2.00 percent per year. What is the maturity risk premium on the two-year Treasury security?

A) 0.25 percent
B) 1.00 percent
C) 1.05 percent
D) 5.00 percent

Question 27

Suppose that the current one-year rate (one-year spot rate) and expected one-year T-bill rates over the following three years (i.e., years 2, 3, and 4, respectively) are as follows:
₁R₁ = 5%,
E(₂r₁) = 5.5%,
E(₃r₁) = 6.5%,
E(₄r₁) = 7.0%
Using the unbiased expectations theory, what is the current (long-term) rate for four-year-maturity Treasury securities?

A) 6.00 percent
B) 6.33 percent
C) 6.75 percent
D) 7.00 percent

Question 28

Based on economists' forecasts and analysis, one-year Treasury bill rates and liquidity premiums for the next four years are expected to be as follows: Using the liquidity premium theory, what is the current rate on a four-year Treasury security?
$$\begin{array} { l l } R _ { 1 } & = 6.65 \% \\E \left( r _ { 2 } \right) & = 7.75 \% L _ { 2 } = 0.10 \% \\E \left( r _ { 3 } \right) & = 7.85 \% L _ { 3 } = 0.20 \% \\E \left( r _ { 4 } \right) & = 8.15 \% L _ { 4 } = 0.25 \%\end{array}$$

A) 7.736 percent
B) 7.600 percent
C) 7.738 percent
D) 8.400 percent

Question 29

Which of these is the expected or "implied" rate on a short-term security that will originate at some point in the future?

A) current yield
B) forward rate
C) spot rate
D) yield to maturity

Question 30

One-year Treasury bills currently earn 3.15 percent. You expect that one year from now, 1-year Treasury bill rates will increase to 3.65 percent and that two years from now, one-year Treasury bill rates will increase to 4.05 percent. If the unbiased expectations theory is correct, what should the current rate be on three-year Treasury securities?

A) 3.40 percent
B) 3.62 percent
C) 3.75 percent
D) 3.85 percent

Question 31

Which statement is NOT true of the loanable funds theory?

A) Views the level of interest rates as resulting from factors that affect the supply and demand for loanable funds.
B) Categorizes financial market participants as net suppliers or demanders of funds.
C) Is a model that is rarely used to explain interest rates and interest rate movement.
D) Is a theory of interest rate determination that views equilibrium interest rates in financial markets as a result of the supply and demand for loanable funds.

Question 32

You are considering an investment in 30-year bonds issued by a corporation. The bonds have no special covenants. The Wall Street Journal reports that one-year T-bills are currently earning 3.50 percent. Your broker has determined the following information about economic activity and the corporation's bonds:
Real interest rate = 2.50 percent
Default risk premium = 1.75 percent
Liquidity risk premium = 0.70 percent
Maturity risk premium = 1.50 percent
What is the inflation premium? What is the fair interest rate on the corporation's 30-year bonds?

A) 1 percent and 1.49 percent, respectively
B) 1 percent and 6.45 percent, respectively
C) 1 percent and 7.45 percent, respectively
D) 3.50 percent and 9.95 percent, respectively

Question 33

Which of these is NOT a theory that explains the shape of the term structure of interest rates?

A) liquidity theory
B) market segmentation theory
C) short-term structure of interest rates theory
D) unbiased expectations theory

Question 34

Which of the following theories argues that individual investors and financial institutions have specific maturity preferences, and to encourage buyers to hold securities with maturities other than their most preferred requires a higher interest rate?

A) liquidity premium hypothesis
B) market segmentation theory
C) supply and demand theory
D) unbiased expectations theory

Question 35

A particular security's default risk premium is 3 percent. For all securities, the inflation risk premium is 2 percent and the real interest rate is 2.25 percent. The security's liquidity risk premium is 0.75 percent and maturity risk premium is 0.90 percent. The security has no special covenants. What is the security's equilibrium rate of return?

A) 1.78 percent
B) 3.95 percent
C) 8.90 percent
D) 17.8 percent

Question 36

Which of these statements is true?

A) The higher the default risk, the higher the interest rate that securities buyers will demand.
B) The lower the default risk, the higher the interest rate that securities buyers will demand.
C) The higher the default risk, the lower the interest rate that securities buyers will demand.
D) The default risk does not impact the interest rate that securities buyers will demand.

Question 37

According to this theory of term structure of interest rates, at any given point in time, the yield curve reflects the market's current expectations of future short-term rates.

A) expectations theory
B) future short-term rates theory
C) term structure of interest rates theory
D) unbiased expectations theory

Question 38

Which of the following is the continual increase in the price level of a basket of goods and services?

A) deflation
B) inflation
C) recession
D) stagflation

Question 39

One-year Treasury bills currently earn 5.50 percent. You expect that one year from now, one-year Treasury bill rates will increase to 5.75 percent. If the unbiased expectations theory is correct, what should the current rate be on two-year Treasury securities?

A) 5.50 percent
B) 5.625 percent
C) 5.75 percent
D) 11.25 percent

Question 40

Which statement(s) are true regarding the liquidity premium theory:

A) States that long-term rates are equal to geometric averages of current and expected short-term rates.
B) Liquidity premiums that increase with maturity result in upward sloping yield curves.
C) An upward sloping yield curve may reflect investor's expectations that future short-term rates will be flat.
D) All of the above.

Question 41

The Wall Street Journal reports that the rate on three-year Treasury securities is 7.00 percent, and the six-year Treasury rate is 7.25 percent. From discussions with your broker, you have determined that the expected inflation premium will be 1.75 percent next year, 2.25 percent in year 2, and 2.40 percent in year 3 and beyond. Further, you expect that real interest rates will be 3.75 percent annually for the foreseeable future. What is the maturity risk premium on the six-year Treasury security?

A) 0.83 percent
B) 0.983 percent
C) 1.10 percent
D) 1.233 percent

Question 42

You note the following yield curve in The Wall Street Journal. According to the unbiased expectations hypothesis, what is the one-year forward rate for the period beginning one year from today, ₂f₁?
$$\begin{array}{l}\begin{array} { l l } \text {Maturity }&\text {Yield}\\\text {One day }&3.00\%\\\text {One year }&5.00\\\text {Two years }&6.25\\\text {three years }&8.00\\\end{array}\end{array}$$

A) 1.01 percent
B) 1.19 percent
C) 5.625 percent
D) 7.51 percent

Question 43

Suppose we observe the following rates: ₁R₁ = 6 percent, ₁R₂ = 7.5 percent. If the unbiased expectations theory of the term structure of interest rates holds, what is the one-year interest rate expected one year from now, E(₂r₁)?

A) 6.75 percent
B) 7.50 percent
C) 9.02 percent
D) 13.5 percent

Question 44

The Wall Street Journal reports that the current rate on 10-year Treasury bonds is 6.75 percent, on 20-year Treasury bonds is 7.25 percent, and on a 20-year corporate bond is 8.50 percent. Assume that the maturity risk premium is zero. If the default risk premium and liquidity risk premium on a 10-year corporate bond is the same as that on the 20-year corporate bond, what is the current rate on a 10-year corporate bond.

A) 7.50 percent
B) 8.00 percent
C) 8.50 percent
D) 8.75 percent

Question 45

Assume the current interest rate on a one-year Treasury bond (₁R₁) is 5.00 percent, the current rate on a two-year Treasury bond (₁R₂) is 5.75 percent, and the current rate on a three-year Treasury bond (₁R₃) is 6.25 percent. If the unbiased expectations theory of the term structure of interest rates is correct, what is the one-year interest rate expected on Treasury bills during year 3, ₃f₁?

A) 5.00 percent
B) 5.67 percent
C) 7.26 percent
D) 8.00 percent

Question 46

A corporation's 10-year bonds are currently yielding a return of 7.75 percent. The expected inflation premium is 3.0 percent annually and the real interest rate is expected to be 3.00 percent annually over the next 10 years. The liquidity risk premium on the corporation's bonds is 0.50 percent. The maturity risk premium is 0.25 percent on two-year securities and increases by 0.10 percent for each additional year to maturity. What is the default risk premium on the corporation's 10-year bonds?

A) 0.18 percent
B) 0.20 percent
C) 0.22 percent
D) 0.27 percent

Question 47

One-year Treasury bills currently earn 2.95 percent. You expect that one year from now, one-year Treasury bill rates will increase to 3.15 percent and that two years from now, one-year Treasury bill rates will increase to 3.35 percent. The liquidity premium on two-year securities is 0.05 percent and on three-year securities is 0.15 percent. If the liquidity theory is correct, what should the current rate be on three-year Treasury securities?

A) 2.95 percent
B) 3.15 percent
C) 3.22 percent
D) 3.35 percent

Question 48

The Wall Street Journal reports that the current rate on 5-year Treasury bonds is 6.50 percent and on 10-year Treasury bonds is 6.75 percent. Assume that the maturity risk premium is zero. Calculate the expected rate on a 5-year Treasury bond purchased five years from today, E(₅r₁).

A) 6.625 percent
B) 6.75 percent
C) 7.00 percent
D) 7.58 percent

Question 49

Suppose we observe the three-year Treasury security rate (₁R₃) to be 6 percent, the expected one-year rate next year E(₂r₁) to be 3 percent, and the expected one-year rate the following year E(₃r₁) to be 5 percent. If the unbiased expectations theory of the term structure of interest rates holds, what is the one-year Treasury security rate, ₁R₁?

A) 3.00 percent
B) 10.13 percent
C) 14.00 percent
D) 19.88 percent

Question 50

On May 23, 20XX, the existing or current (spot) one-year, two-year, three-year, and four-year zero-coupon Treasury security rates were as follows:
₁R₁ = 5.25%,
₁R₂ = 5.75%,
₁R₃ = 6.25%,
₁R₄ = 6.45%
Using the unbiased expectations theory, what is the one-year forward rate on zero-coupon Treasury bonds for year 4 as of May 23, 20XX?

A) 5.925 percent
B) 6.45 percent
C) 7.05 percent
D) 10.32 percent

Question 51

The Wall Street Journal reports that the rate on four-year Treasury securities is 4.75 percent and the rate on five-year Treasury securities is 5.95 percent. According to the unbiased expectations hypotheses, what does the market expect the one-year Treasury rate to be four years from today, E(₅r₁)?

A) 1.11 percent
B) 5.95 percent
C) 10.70 percent
D) 10.89 percent

Question 52

One-year Treasury bills currently earn 3.25 percent. You expect that one year from now, one-year Treasury bill rates will increase to 3.45 percent and that two years from now, one-year Treasury bill rates will increase to 3.95 percent. The liquidity premium on two-year securities is 0.05 percent and on three-year securities is 0.15 percent. If the liquidity theory is correct, what should the current rate be on three-year Treasury securities?

A) 3.25 percent
B) 3.55 percent
C) 3.62 percent
D) 4.10 percent

Question 53

You are considering an investment in 30-year bonds issued by Moore Corporation. The bonds have no special covenants. The Wall Street Journal reports that one-year T-bills are currently earning 3.55 percent. Your broker has determined the following information about economic activity and Moore Corporation bonds:
Real interest rate = 2.75 percent
Default risk premium = 1.05 percent
Liquidity risk premium = 0.50 percent
Maturity risk premium = 1.85 percent
What is the fair interest rate on Moore Corporation 30-year bonds?

A) 3.80 percent
B) 6.45 percent
C) 6.95 percent
D) 9.70 percent

Question 54

A recent edition of The Wall Street Journal reported interest rates of 3.10 percent, 3.50 percent, 3.75 percent, and 3.95 percent for three-year, four-year, five-year, and six-year Treasury security yields, respectively, According to the unbiased expectation theory of the term structure of interest rates, what are the expected one-year rates for year 6?

A) 3.575 percent
B) 3.95 percent
C) 4.96 percent
D) 5.33 percent

Question 55

You are considering an investment in 30-year bonds issued by Moore Corporation. The bonds have no special covenants. The Wall Street Journal reports that one-year T-bills are currently earning 3.55 percent. Your broker has determined the following information about economic activity and Moore Corporation bonds:
Real interest rate = 2.75 percent
Default risk premium = 1.05 percent
Liquidity risk premium = 0.50 percent
Maturity risk premium = 1.85 percent
What is the inflation premium?

A) 0.80 percent
B) 1.25 percent
C) 6.25 percent
D) 8.00 percent

Question 56

The Wall Street Journal reports that the rate on three-year Treasury securities is 6.25 percent and the rate on five-year Treasury securities is 6.45 percent. According to the unbiased expectations hypothesis, what does the market expect the two-year Treasury rate to be three years from today, E(₄r₂)?

A) 6.35 percent
B) 6.75 percent
C) 7.25 percent
D) 7.45 percent

Question 57

One-year Treasury bills currently earn 2.55 percent. You expect that one year from now, one-year Treasury bill rates will increase to 2.85 percent and that two years from now, one-year Treasury bill rates will increase to 3.15 percent. If the unbiased expectations theory is correct, what should the current rate be on 3-year Treasury securities?

A) 2.55 percent
B) 2.85 percent
C) 2.93 percent
D) 3.15 percent

Question 58

A particular security's default risk premium is 3 percent. For all securities, the inflation risk premium is 1.75 percent and the real interest rate is 4.2 percent. The security's liquidity risk premium is 0.35 percent and maturity risk premium is 0.95 percent. The security has no special covenants. Calculate the security's equilibrium rate of return.

A) 8.50 percent
B) 6.05 percent
C) 10.25 percent
D) 9.90 percent

Question 59

Suppose we observe the following rates: ₁R₁ = 8 percent, ₁R₂ = 10 percent, and E(₂r₁) = 8 percent. If the liquidity premium theory of the term structure of interest rates holds, what is the liquidity premium for year 2, L₂?

A) 1.02 percent
B) 4.04 percent
C) 6.15 percent
D) 12.03 percent

Question 60

The Wall Street Journal reports that the rate on three-year Treasury securities is 4.75 percent and the rate on four-year Treasury securities is 5.00 percent. The one-year interest rate expected in three years is E(₄r₁), 5.25 percent. According to the liquidity premium theory, what is the liquidity premium on the four-year Treasury security, L₄?

A) 0.0375 percent
B) 0.504 percent
C) 5.01 percent
D) 5.04 percent

Question 61

Suppose we observe the following rates: ₁R₁ = 13 percent, ₁R₂ = 16 percent, and E(₂r₁) = 10 percent. If the liquidity premium theory of the term structure of interest rates holds, what is the liquidity premium for year 2, L₂?

A) 8.7 percent
B) 9.1 percent
C) 9.7 percent
D) 10.0 percent

Question 62

A two-year Treasury security currently earns 5.13 percent. Over the next two years, the real interest rate is expected to be 2.15 percent per year and the inflation premium is expected to be 1.75 percent per year. Calculate the maturity risk premium on the two-year Treasury security.

A) 5.13 percent
B) 3.38 percent
C) 2.98 percent
D) 1.23 percent

Question 63

Suppose that the current one-year rate (one-year spot rate) and expected one-year T-bill rates over the following three years (i.e., years 2, 3, and 4, respectively) are as follows:
₁R₁ = 5 percent,
E(₂r₁) = 7 percent,
E(₃r₁) = 7.5 percent
E(₄r₁) = 7.85 percent
Using the unbiased expectations theory, calculate the current (long-term) rates for one-year and two-year-maturity Treasury securities.

A) one-year: 5.00 percent,two-year: 5.50 percent
B) one-year: 5.00 percent, two-year: 6.00 percent
C) one-year: 5.50 percent, two-year: 6.15 percent
D) one-year: 5.50 percent, two-year: 5.75 percent

Question 64

The Wall Street Journal reports that the rate on four-year Treasury securities is 7.50 percent and the rate on five-year Treasury securities is 9.15 percent. According to the unbiased expectations hypothesis, what does the market expect the one-year Treasury rate to be four years from today, E(₅r₁)?

A) 16.0 percent
B) 18.4 percent
C) 15.9 percent
D) 13.7 percent

Question 65

The Wall Street Journal reports that the current rate on 10-year Treasury bonds is 6.25 percent, on 20-year Treasury bonds is 7.95 percent, and on a 20-year corporate bond is 10.75 percent. Assume that the maturity risk premium is zero. If the default risk premium and liquidity risk premium on a 10-year corporate bond is the same as that on the 20-year corporate bond, calculate the current rate on a 10-year corporate bond.

A) 9.05 percent
B) 6.15 percent
C) 7.60 percent
D) 8.70 percent

Question 66

Suppose we observe the three-year Treasury security rate (₁R₃) to be 11 percent, the expected one-year rate next year E(₂r₁) to be 4 percent, and the expected one-year rate the following year E(₃r₁) to be 5 percent. If the unbiased expectations theory of the term structure of interest rates holds, what is the one-year Treasury security rate, ₁R₁?

A) 18.57 percent
B) 10.19 percent
C) 23.19 percent
D) 25.24 percent

Question 67

You note the following yield curve in The Wall Street Journal. According to the unbiased expectations hypothesis, what is the one-year forward rate for the period beginning one year from today, ₂f₁?
$$\begin{array}{l}\begin{array} { l l } \text {Maturity }&\text {Yield}\\\text {One day }&2.00\%\\\text {One year }&6.00\\\text {Two years }&7.50\\\text {three years }&9.00\\\end{array}\end{array}$$

A) 7.6 percent
B) 8.6 percent
C) 9.0 percent
D) 10.2 percent

Question 68

One-year Treasury bills currently earn 3.75 percent. You expect that one year from now, one-year Treasury bill rates will increase to 4.15 percent. If the unbiased expectations theory is correct, what should the current rate be on two-year Treasury securities?

A) 4.25 percent
B) 3.85 percent
C) 3.95 percent
D) 4.35 percent

Question 69

The Wall Street Journal reports that the current rate on five-year Treasury bonds is 6.45 percent and on 10-year Treasury bonds is 7.75 percent. Assume that the maturity risk premium is zero. Calculate the expected rate on a five-year Treasury bond purchased five years from today, E(₅r₅).

A) 7.25 percent
B) 8.12 percent
C) 9.07 percent
D) 10.16 percent

Question 70

Dakota Corporation 15-year bonds have an equilibrium rate of return of 9 percent. For all securities, the inflation risk premium is 1.95 percent and the real interest rate is 3.65 percent. The security's liquidity risk premium is 0.35 percent and maturity risk premium is 0.95 percent. The security has no special covenants. Calculate the bond's default risk premium.

A) 2.10 percent
B) 3.05 percent
C) 3.40 percent
D) 2.45 percent

Question 71

One-year Treasury bills currently earn 4.5 percent. You expect that one year from now, one-year Treasury bill rates will increase to 6.65 percent. The liquidity premium on two-year securities is 0.05 percent. If the liquidity theory is correct, what should the current rate be on two-year Treasury securities?

A) 5.24 percent
B) 5.59 percent
C) 5.65 percent
D) 5.95 percent

Question 72

On May 23, 20XX, the existing or current (spot) one-year, two-year, three-year, and four-year zero-coupon Treasury security rates were as follows:

₁R₁ = 4.55 percent,
₁R₂ = 4.75 percent,
₁R₃ = 5.25 percent,
₁R₄ = 5.95 percent
Using the unbiased expectations theory, calculate the one-year forward rates on zero-coupon Treasury bonds for years two, three, and four as of May 23, 20XX.

A) year 1: 4.95 percent, Year 2: 6.26 percent, Year 3: 8.08 percent
B) year 1: 3.75 percent, Year 2: 6.02 percent, Year 3: 9.00 percent
C) year 1: 4.95 percent, Year 2: 7.26 percent, Year 3: 8.08 percent
D) year 1: 3.65 percent, Year 2: 6.32 percent, Year 3: 11.08 percent

Question 73

The Wall Street Journal reports that the rate on three-year Treasury securities is 6.50 percent, and the six-year Treasury rate is 6.80 percent. From discussions with your broker, you have determined that the expected inflation premium will 2.25 percent next year, 2.50 percent in year 2, and 2.60 percent in year 3 and beyond. Further, you expect that real interest rates will be 3.4 percent annually for the foreseeable future. Calculate the maturity risk premium on the three-year and the six-year Treasury security.

A) 3-year: 0.6 percent, 6-year: 0.80 percent
B) 3-year: 0.5 percent, 6-year: 0.90 percent
C) 3-year: 0.6 percent, 6-year: 1.20 percent
D) 3-year: 0.5 percent, 6-year: 0.80 percent

Question 74

Suppose we observe the following rates: ₁R₁ = 12 percent, ₁R₂ = 15 percent. If the unbiased expectations theory of the term structure of interest rates holds, what is the one-year interest rate expected one year from now, E(₂r₁)?

A) 13.5 percent
B) 14.2 percent
C) 15.6 percent
D) 18.0 percent

Question 75

The Wall Street Journal reports that the rate on three-year Treasury securities is 7.25 percent and the rate on four-year Treasury securities is 8.50 percent. The one-year interest rate expected in three years is E(₄r₁), 4.10 percent. According to the liquidity premium theory, what is the liquidity premium on the four-year Treasury security, L₄?

A) 6.7 percent
B) 7.1 percent
C) 8.2 percent
D) 9.6 percent

Question 76

Suppose that the current one-year rate (one-year spot rate) and expected one-year T-bill rates over the following three years (i.e., years 2, 3, and 4, respectively) are as follows:
₁R₁ = 5 percent,
E(₂r₁) = 6 percent,
E(₃r₁) = 7.5 percent
E(₄r₁) = 6.85 percent
Using the unbiased expectations theory, calculate the current (long-term) rates for one-, two-, three-, and four-year-maturity Treasury securities.

A) 5.00 percent, 5.50 percent, 6.16 percent, 6.33 percent
B) 5.00 percent, 5.25 percent, 6.10 percent, 6.27 percent
C) 5.00 percent, 5.50 percent, 6.10 percent, 6.23 percent
D) 5.00 percent, 5.25 percent, 6.16 percent, 6.49 percent

Question 77

Based on economists' forecasts and analysis, one-year Treasury bill rates and liquidity premiums for the next four years are expected to be as follows:
$$\begin{array} { l } R _ { 1 } \quad = \quad 5.95 p e r c e n t \\E \left( r _ { 2 } \right) = 6.25 p \text { ercent } L _ { 2 } = 0.05 \text { percent } \\E \left( r _ { 3 } \right) = 6.75 p \mathrm { percent } \quad L _ { 3 } = 0.10 \text { percent } \\E \left( r _ { 4 } \right) = \quad 7.15 \text { percent } \quad L _ { 4 } = 0.12 p e r c e n t \\\end{array}$$
Using the liquidity premium theory, what should be the current rate on four-year Treasury securities?

A) 6.59 percent
B) 6.75 percent
C) 6.82 percent
D) 7.13 percent

Question 78

The Wall Street Journal reports that the rate on three-year Treasury securities is 7.00 percent, and the six-year Treasury rate is 6.20 percent. From discussions with your broker, you have determined that the expected inflation premium will be 2.25 percent next year, 2.50 percent in year 2, and 2.50 percent in year 3 and beyond. Further, you expect that real interest rates will be 4.4 percent annually for the foreseeable future. Calculate the maturity risk premium on the 3-year Treasury security.

A) 0.00 percent
B) 0.10 percent
C) 4.50 percent
D) 2.60 percent

Question 79

Nikki G's Corporation's 10-year bonds are currently yielding a return of 9.25 percent. The expected inflation premium is 2.0 percent annually and the real interest rate is expected to be 3.10 percent annually over the next 10 years. The liquidity risk premium on Nikki G's bonds is 0.1 percent. The maturity risk premium is 0.10 percent on two-year securities and increases by 0.05 percent for each additional year to maturity. Calculate the default risk premium on Nikki G's 10-year bonds.

A) 2.55 percent
B) 5.65 percent
C) 3.55 percent
D) 1.85 percent

Question 80

Suppose that the current one-year rate (one-year spot rate) and expected one-year T-bill rates over the following three years (i.e., years 2, 3, and 4 respectively) are as follows:
₁R₁ = 5 percent,
E(₂r₁) = 6 percent,
E(₃r₁) = 7.5 percent
E(₄r₁) = 7.85 percent
Using the unbiased expectations theory, calculate the current (long-term) rates for three-year- and four-year-maturity Treasury securities.

A) one-year: 6.16 percent, two-year: 6.58 percent
B) one-year: 6.16 percent, two-year: 6.78 percent
C) one-year: 6.25 percent, two-year: 6.45 percent
D) one-year: 5.95 percent, two-year: 6.45 percent