Answer Choices:
a. True
b. False
Answer: b. False
Question: 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?
Answer Choices:
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.
Answer: e. The Treasury yield curve under the stated conditions would be humped rather than have a consistent positive or negative slope.
Question: Which of the following statements is CORRECT?
Answer Choices:
a. The yield curve for both Treasury and corporate bonds should be flat.
b. The yield curve for Treasury securities would be flat, but the yield curve for corporate securities might be downward sloping.
c. The yield curve for Treasury securities cannot be downward sloping.
d. The maturity risk premium would be zero.
e. 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.
Answer: e. 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: 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.
Answer Choices:
a. True
b. False
Answer: b. False
Question: 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*.
Answer Choices:
a. True
b. False
Answer: a. True
Question: 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.
Answer Choices:
a. 3.80%
b. 3.99%
c. 4.19%
d. 4.40%
e. 4.62%
Answer: b. 3.99%
Question: 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.
Answer Choices:
a. True
b. False
Answer: a. True
Question: Which of the following would be most likely to lead to a higher level of interest rates in the economy?
Answer Choices:
a. Households start saving a larger percentage of their income.
b. Corporations step up their expansion plans and thus increase their demand for capital.
c. The level of inflation begins to decline.
d. The economy moves from a boom to a recession.
e. The Federal Reserve decides to try to stimulate the economy.
Answer: b. Corporations step up their expansion plans and thus increase their demand for capital.
Question: If the demand curve for funds increased but the supply curve remained constant, we would expect to see the total amount of funds supplied and demanded increase and interest rates in general also increase.
Answer Choices:
a. True
b. False
Answer: a. True
Question: One of the four most fundamental factors that affect the cost of money as discussed in the text is the risk inherent in a given security. The higher the risk, the higher the security’s required return, other things held constant.
Answer Choices:
a. True
b. False
Answer: a. True
Question: Which of the following statements is CORRECT?
Answer Choices:
a. If inflation is expected to increase in the future, and if the maturity risk premium (MRP) is greater than zero, then the Treasury yield curve will have an upward slope.
b. If the maturity risk premium (MRP) is greater than zero, then the yield curve must have an upward slope.
c. 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.
d. If the maturity risk premium (MRP) equals zero, the yield curve must be flat.
e. The yield curve can never be downward sloping.
Answer: a. If inflation is expected to increase in the future, and if the maturity risk premium (MRP) is greater than zero, then the Treasury yield curve will have an upward slope.
Question: 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?
Answer Choices:
a. The yield on a 2-year T-bond must exceed that on a 5-year T-bond.
b. The yield on a 5-year Treasury bond must exceed that on a 2-year Treasury bond.
c. The yield on a 7-year Treasury bond must exceed that of a 5-year corporate bond.
d. The conditions in the problem 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.
Answer: b. The yield on a 5-year Treasury bond must exceed that on a 2-year Treasury bond.
Question: One of the four most fundamental factors that affect the cost of money as discussed in the text is the current state of the weather. If the weather is dark and stormy, the cost of money will be higher than if it is bright and sunny, other things held constant.
Answer Choices:
a. True
b. False
Answer: b. False
Question: One of the four most fundamental factors that affect the cost of money as discussed in the text is the availability of production opportunities and their expected rates of return. If production opportunities are relatively good, then interest rates will tend to be relatively high, other things held constant.
Answer Choices:
a. True
b. False
Answer: a. True
Question: 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.
Answer Choices:
a. True
b. False
Answer: b. False
Question: Assume that the current corporate bond yield curve is upward sloping. Under this condition, then we could be sure that
Answer Choices:
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.
Answer: d. Maturity risk premiums could help to explain the yield curve’s upward slope.
Question: 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?
Answer Choices:
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.
Answer: e. The 10-year corporate bond must have a higher yield than the 5-year corporate bond.
Question: Assuming that the term structure of interest rates is determined as posited by the pure expectations theory, which of the following statements is CORRECT?
Answer Choices:
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.
Answer: b. An upward-sloping yield curve implies that future short-term rates are expected to decline.
Question: Assume that the current corporate bond yield curve is upward sloping, or normal. Under this condition, we could be sure that
Answer Choices:
a. Long-term interest rates are more volatile than short-term rates.
b. Inflation is expected to decline in the future.
c. The economy is not in a recession.
d. Long-term bonds are a better buy than short-term bonds.
e. Maturity risk premiums could help to explain the yield curve’s upward slope.
Answer: e. Maturity risk premiums could help to explain the yield curve’s upward slope.
Question: The Federal Reserve tends to take actions to increase interest rates when the economy is very strong and to decrease rates when the economy is weak.
Answer Choices:
a. True
b. False
Answer: a. True
Question: If the pure expectations theory is correct, a downward-sloping yield curve indicates that interest rates are expected to decline in the future.
Answer Choices:
a. True
b. False
Answer: a. True