1. 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 risk differences.c.Maturity risk differencesd.Inflation differencese.Real risk-free rate differences2. 5-year Treasury bonds yield 6.4%. The inflation premium (IP) is 1.9%, and the maturity risk premium (MRP) on 5-year T-bonds is 0.4%. There is no liquidity premium on these bonds. What is the real risk-free rate, r*? a. 3.90%b. 3.77%c. 5.04%d. 5.13%e. 4.10%3. Suppose the yield on a 10-year T-bond is currently 5.05% and that on a 10-year Treasury Inflation Protected Security (TIPS) is 2.85%. Suppose further that the MRP on a 10-year T-bond is 0.90%, that no MRP is required on a TIPS, and that no liquidity premium is required on any T-bond. Given this information, what is the expected rate of inflation over the next 10 years? Disregard cross-product terms, i.e., if averaging is required, use the arithmetic average.a. 1.55%b. 1.30%c. 1.60%d. 1.35%e. 1.08%4. 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*. True/False5. The real risk-free rate is 3.05%, inflation is expected to be 2.60% 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?a. 6.44%b. 5.25%c. 5.37%d. 5.65%e. 7.06%6. If the Treasury yield curve is downward sloping, how should the yield to maturity on a 10-year Treasury coupon bond compare to that on a 1-year T-bill?a. The yield on a 10-year bond would be less than that on a 1-year bill.b. The yield on a 10-year bond would have to be higher than that on a 1-year bill because of the maturity risk premium.c. It is impossible to tell without knowing the relative risks of the two securities.d. The yields on the two securities would be equal.e. It is impossible to tell without knowing the coupon rates of the bonds.7. Which of the following statements is CORRECT? a. The real risk-free rate should increase if people expect inflation to increase.b. The yield on a 3-year Treasury bond should always exceed the yield on a 2-year Treasury bond.c. If inflation is expected to increase, then the yield on a 2-year bond should exceed that on a 3-year bondd. The yield on a 3-year corporate bond should always exceed the yield on a 2-year corporate bond.e. The yield on a 2-year corporate bond should always exceed the yield on a 2-year Treasury bond.8. If investors expect the rate of inflation to increase sharply in the future, then we should not be surprised to see an upward sloping yield curve.True/False9. Which of the following statements is CORRECT? a. 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.b. If the maturity risk premium (MRP) is greater than zero, the Treasury bond yield curve must be upward sloping.c. If the maturity risk premium (MRP) equals zero, the Treasury bond yield curve must be flat.d. If the expectations theory holds, the Treasury bond yield curve will never be downward slopinge. If inflation is expected to increase in the future and the maturity risk premium (MRP) is greater than zero, the Treasury bond yield curve must be upward sloping10. Kop Corporation’s 5-year bonds yield 6.50%, and T-bonds with the same maturity yield 4.70%. The default risk premium for Kop’s bonds is DRP = 0.40%, the liquidity premium on Kop’s bonds is LP = 1.40% versus zero on T-bonds, the inflation premium (IP) is 1.50%, and the maturity risk premium (MRP) on 5-year bonds is 0.40%. What is the real risk-free rate, r*? a. 2.35%b. 2.80%c. 2.91%d. 3.16%e. 2.72%
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