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Suppose 1-year T-bills currently yield 7.00% and the future inflation rate is expected to be constant at 4.70% 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.


A) 2.81%
B) 2.48%
C) 2.23%
D) 2.12%
E) 2.30%

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A bond trader observes the following information: The Treasury yield curve is downward sloping. Empirical data indicate that a positive maturity risk premium applies to both Treasury and corporate bonds. Empirical data also indicate that there is no liquidity premium for Treasury securities but that a positive liquidity premium is built into corporate bond yields. On the basis of this information,which of the following statements is most CORRECT?


A) A 10-year corporate bond must have a higher yield than a 5-year Treasury bond.
B) A 10-year Treasury bond must have a higher yield than a 10-year corporate bond.
C) A 5-year corporate bond must have a higher yield than a 10-year Treasury bond.
D) The corporate yield curve must be flat.
E) Since the Treasury yield curve is downward sloping,the corporate yield curve must also be downward sloping.

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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.

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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:


A) Tax effects.
B) Default and liquidity risk differences.
C) Maturity risk differences.
D) Inflation differences.
E) Real risk-free rate differences.

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

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Because the maturity risk premium is normally positive,the yield curve must have an upward slope.If you measure the yield curve and find a downward slope,you must have done something wrong.

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Which of the following statements is CORRECT?


A) The yield on a 3-year Treasury bond cannot exceed the yield on a 10-year Treasury bond.
B) The yield on a 2-year corporate bond should always exceed the yield on a 2-year Treasury bond.
C) The yield on a 3-year corporate bond should always exceed the yield on a 2-year corporate bond.
D) The yield on a 10-year AAA-rated corporate bond should always exceed the yield on a 5-year AAA-rated corporate bond.
E) The following represents a "possibly reasonable" formula for the maturity risk premium on bonds: MRP = -0.1%(t) ,where t is the years to maturity.

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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,they are not callable or corvertible,and they are equally liquid.Further assume that the Treasury yield curve is based only on the pure expectations theory.Under these conditions,which of the following statements is CORRECT?


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.

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Suppose the interest rate on a 1-year T-bond is 5.00% and that on a 2-year T-bond is 6.10%.Assume that the pure expectations theory is NOT valid,and the MRP is zero for a 1-year T-bond but 0.40% for a 2-year bond.What is the yield on a 1-year T-bond expected to be one year from now? Round the intermediate calculations to 4 decimal places and final answer to 2 decimal places.


A) 7.30
B) 7.81
C) 5.89
D) 6.40
E) 5.64

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If the pure expectations theory is correct,a downward sloping yield curve indicates that interest rates are expected to decline in the future.

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


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.

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Suppose the real risk-free rate is 3.00%,the average expected future inflation rate is 6.60%,and a maturity risk premium of 0.10% per year to maturity applies,i.e. ,MRP = 0.10%(t) ,where t is the number of years to maturity.What rate of return would you expect on a 1-year Treasury security,assuming the pure expectations theory is NOT valid? Disregard cross-product terms,i.e. ,if averaging is required,use the arithmetic average.


A) 8.83%
B) 7.47%
C) 9.12%
D) 9.70%
E) 8.54%

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Kelly Inc's 5-year bonds yield 7.50% and 5-year T-bonds yield 4.70%.The real risk-free rate is r* = 2.5%,the default risk premium for Kelly's bonds is DRP = 0.40%,the liquidity premium on Kelly's bonds is LP = 2.4% versus zero on T-bonds,and the inflation premium (IP) is 1.5%.What is the maturity risk premium (MRP) on all 5-year bonds?


A) 0.73%
B) 0.70%
C) 0.55%
D) 0.74%
E) 0.57%

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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?


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.

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Suppose the real risk-free rate is 4.20%,the average expected future inflation rate is 4.20%,and a maturity risk premium of 0.10% per year to maturity applies,i.e. ,MRP = 0.10%(t) ,where t is the number of years to maturity,hence the pure expectations theory is NOT valid.What rate of return would you expect on a 4-year Treasury security? Disregard cross-product terms,i.e. ,if averaging is required,use the arithmetic average.


A) 8.54%
B) 8.80%
C) 8.01%
D) 7.92%
E) 7.22%

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Suppose the federal deficit increased sharply from one year to the next,and the Federal Reserve kept the money supply constant.Other things held constant,we would expect to see interest rates decline.

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Assume that inflation is expected to decline steadily in the future,but that the real risk-free rate,r*,will remain constant.Which of the following statements is CORRECT,other things held constant?


A) If the pure expectations theory holds,the Treasury yield curve must be downward sloping.
B) If the pure expectations theory holds,the corporate yield curve must be downward sloping.
C) If there is a positive maturity risk premium,the Treasury yield curve must be upward sloping.
D) If inflation is expected to decline,there can be no maturity risk premium.
E) The expectations theory cannot hold if inflation is decreasing.

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Which of the following statements is CORRECT?


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.

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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?


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.

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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.

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