Question 1

Which of the following statements is CORRECT?

Accepted Answer

A)   The yield on a 2-year corporate bond should always exceed the yield on a 2-year Treasury bond.
B)   The yield on a 3-year corporate bond should always exceed the yield on a 2-year corporate bond.
C)   The yield on a 3-year Treasury bond should always exceed the yield on a 2-year Treasury bond.
D)   If inflation is expected to increase, then the yield on a 2-year bond should exceed that on a 3-year bond.
E)   The real risk-free rate should increase if people expect inflation to increase.F) C) and E)
G) All of the above

Question 2

Crockett Corporation's 5-year bonds yield 6.35%, and 5-year T-bonds yield 4.75%. The real risk-free rate is r* = 3.60%, the default risk premium for Crockett's bonds is DRP = 1.00% versus zero for T-bonds, the liquidity premium on Crockett's bonds is LP = 0.90% 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 inflation premium (IP)  is built into 5-year bond yields?

Accepted Answer

A)   0.68%
B)   0.75%
C)   0.83%
D)   0.91%
E)   1.00%F) C) and D)
G) A) and E)

Question 3

Assume that interest rates on 20-year Treasury and corporate bonds are as follows: T-bond = 7.72% AAA = 8.72% A = 9.64% BBB = 10.18%
The differences in these rates were probably caused primarily by:

Accepted Answer

A)   Tax effects.
B)   Default risk differences.
C)   Maturity risk differences.
D)   Inflation differences.
E)   Real risk-free rate differences.F) All of the above
G) A) and D)

Question 4

Suppose the interest rate on a 1-year T-bond is 5.0% and that on a 2-year T-bond is 7.0%. Assuming the pure expectations theory is correct, what is the market's forecast for 1-year rates 1 year from now?

Accepted Answer

A)   7.36%
B)   7.75%
C)   8.16%
D)   8.59%
E)   9.04%F) None of the above
G) B) and C)

Question 5

Assuming that the term structure of interest rates is determined as posited by the pure expectations theory, which of the following statements is CORRECT?

Accepted Answer

A)   In equilibrium, long-term rates must be equal to short-term rates.
B)   An upward-sloping yield curve implies that future short-term rates are expected to decline.
C)   The maturity risk premium is assumed to be zero.
D)   Inflation is expected to be zero.
E)   Consumer prices as measured by an index of inflation are expected to rise at a constant rate.F) A) and B)
G) A) and C)

Question 6

The real risk-free rate is 3.05%, inflation is expected to be 2.75% this year, and the maturity risk premium is zero. Ignoring any cross-product terms, what is the equilibrium rate of return on a 1-year Treasury bond?

Accepted Answer

A)   5.51%
B)   5.80%
C)   6.09%
D)   6.39%
E)   6.71%F) None of the above
G) A) and B)

Question 7

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

Question 8

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 9

The real risk-free rate of interest is expected to remain constant at 3% for the foreseeable future. However, inflation is expected to increase steadily over the next 30 years, so the Treasury yield curve has an upward slope. Assume that the pure expectations theory holds. You are also considering two corporate bonds, one with a 5-year maturity and one with a 10-year maturity. Both have the same default and liquidity risks. Given these assumptions, which of these statements is CORRECT?

Accepted Answer

A)   Since the pure expectations theory holds, the 10-year corporate bond must have the same yield as the 5-year corporate bond.
B)   Since the pure expectations theory holds, all 5-year Treasury bonds must have higher yields than all 10-year Treasury bonds.
C)   Since the pure expectations theory holds, all 10-year corporate bonds must have the same yield as 10-year Treasury bonds.
D)   The 10-year Treasury bond must have a higher yield than the 5-year corporate bond.
E)   The 10-year corporate bond must have a higher yield than the 5-year corporate bond.F) A) and E)
G) D) and E)

Question 10

Which of the following factors would be most likely to lead to an increase in nominal interest rates?

Accepted Answer

A)   Households reduce their consumption and increase their savings.
B)   A new technology like the Internet has just been introduced, and it increases investment opportunities.
C)   There is a decrease in expected inflation.
D)   The economy falls into a recession.
E)   The Federal Reserve decides to try to stimulate the economy.F) C) and D)
G) None of the above

Question 11

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

Question 12

Keys 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 liquidity premium for Keys' bonds is LP = 0.5% 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 default risk premium (DRP)  on Keys' bonds?

Accepted Answer

A)   1.17%
B)   1.30%
C)   1.43%
D)   1.57%
E)   1.73%F) D) and E)
G) A) and B)

Question 13

One of the four most fundamental factors that affect the cost of money as discussed in the text is the expected rate of inflation. If inflation is expected to be relatively high, then interest rates will tend to be relatively low, other things held constant.

Accepted Answer

A) True 
 B)False  False

Question 14

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 real risk-free rate is higher for corporate than for Treasury bonds.
C)   Most evidence suggests that the maturity risk premium is zero.
D)   Liquidity premiums are higher for Treasury than for corporate bonds.
E)   The pure expectations theory states that the maturity risk premium for long-term Treasury bonds is zero and that differences in interest rates across different Treasury maturities are driven by expectations about future interest rates.F) B) and D)
G) A) and D)

Question 15

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? Disregard cross-product terms, i.e., if averaging is required, use the arithmetic average.

Accepted Answer

A)   5.14%
B)   5.42%
C)   5.70%
D)   5.99%
E)   6.28%F) All of the above
G) A) and E)

Question 16

The "yield curve" shows the relationship between bonds' maturities and their yields.

Accepted Answer

A) True 
 B)False

Question 17

Short Corp just issued bonds that will mature in 10 years, and Long Corp issued bonds that will mature in 20 years. Both bonds promise to pay a semiannual coupon, and they are non-callable, so they cannot be retired early. Also, they are equally liquid, and we assume that the Treasury yield curve is based on the pure expectations theory. Under these conditions, which of the following statements is CORRECT?

Accepted Answer

A)   If the yield curve for Treasury securities is flat, Short's bond must under all conditions have the same yield as Long's bonds.
B)   If the yield curve for Treasury securities is upward sloping, Long's bonds must under all conditions have a higher yield than Short's bonds.
C)   If Long's and Short's bonds have the same default risk, their yields must under all conditions be equal.
D)   If the Treasury yield curve is upward sloping and Short has less default risk than Long, then Short's bonds must under all conditions have a lower yield than long's bonds.
E)   If the Treasury yield curve is downward sloping, Long's bonds must under all conditions have the lower yield.F) A) and B)
G) All of the above D

Question 18

Since yield curves are based on a real risk-free rate plus the expected rate of inflation, at any given time there can be only one yield curve, and it applies to both corporate and Treasury securities.

Accepted Answer

A) True 
 B)False

Question 19

The four most fundamental factors that affect the cost of money are (1) production opportunities, (2) time preferences for consumption, (3) risk, and (4) weather conditions.

Accepted Answer

A) True 
 B)False

Question 20

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%F) All of the above
G) B) and C)

Exam 6: Bonds and Their Valuation

Which of the following statements is CORRECT?

Correct Answer
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Correct Answer
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Assume that interest rates on 20-year Treasury and corporate bonds are as follows: T-bond = 7.72% AAA = 8.72% A = 9.64% BBB = 10.18% The differences in these rates were probably caused primarily by:

Correct Answer
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Suppose the interest rate on a 1-year T-bond is 5.0% and that on a 2-year T-bond is 7.0%. Assuming the pure expectations theory is correct, what is the market's forecast for 1-year rates 1 year from now?

Correct Answer
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Assuming that the term structure of interest rates is determined as posited by the pure expectations theory, which of the following statements is CORRECT?

Correct Answer
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The real risk-free rate is 3.05%, inflation is expected to be 2.75% this year, and the maturity risk premium is zero. Ignoring any cross-product terms, what is the equilibrium rate of return on a 1-year Treasury bond?

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

Correct Answer
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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.

Correct Answer
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Correct Answer
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Which of the following factors would be most likely to lead to an increase in nominal interest rates?

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

Correct Answer
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D

Correct Answer
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One of the four most fundamental factors that affect the cost of money as discussed in the text is the expected rate of inflation. If inflation is expected to be relatively high, then interest rates will tend to be relatively low, other things held constant.

Correct Answer
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False

Which of the following statements is CORRECT?

Correct Answer
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Correct Answer
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The "yield curve" shows the relationship between bonds' maturities and their yields.

Correct Answer
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Correct Answer
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D

Since yield curves are based on a real risk-free rate plus the expected rate of inflation, at any given time there can be only one yield curve, and it applies to both corporate and Treasury securities.

Correct Answer
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The four most fundamental factors that affect the cost of money are (1) production opportunities, (2) time preferences for consumption, (3) risk, and (4) weather conditions.

Correct Answer
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Correct Answer
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Exam 6: Bonds and Their Valuation

Which of the following statements is CORRECT?

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

Assume that interest rates on 20-year Treasury and corporate bonds are as follows: T-bond = 7.72% AAA = 8.72% A = 9.64% BBB = 10.18% The differences in these rates were probably caused primarily by:

Correct AnswerverifiedShow Answer

Suppose the interest rate on a 1-year T-bond is 5.0% and that on a 2-year T-bond is 7.0%. Assuming the pure expectations theory is correct, what is the market's forecast for 1-year rates 1 year from now?

Correct AnswerverifiedShow Answer

Assuming that the term structure of interest rates is determined as posited by the pure expectations theory, which of the following statements is CORRECT?

Correct AnswerverifiedShow Answer

The real risk-free rate is 3.05%, inflation is expected to be 2.75% this year, and the maturity risk premium is zero. Ignoring any cross-product terms, what is the equilibrium rate of return on a 1-year Treasury bond?

Correct AnswerverifiedShow Answer

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

Correct AnswerverifiedShow Answer

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.

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

Which of the following factors would be most likely to lead to an increase in nominal interest rates?

Correct AnswerverifiedShow Answer

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

Correct AnswerverifiedD

Correct AnswerverifiedShow Answer

One of the four most fundamental factors that affect the cost of money as discussed in the text is the expected rate of inflation. If inflation is expected to be relatively high, then interest rates will tend to be relatively low, other things held constant.

Correct AnswerverifiedFalse

Which of the following statements is CORRECT?

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

The "yield curve" shows the relationship between bonds' maturities and their yields.

Correct AnswerverifiedShow Answer

Correct AnswerverifiedD

Since yield curves are based on a real risk-free rate plus the expected rate of inflation, at any given time there can be only one yield curve, and it applies to both corporate and Treasury securities.

Correct AnswerverifiedShow Answer

The four most fundamental factors that affect the cost of money are (1) production opportunities, (2) time preferences for consumption, (3) risk, and (4) weather conditions.

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

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D

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False

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D

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