1. The one-year interest rate over the next three years is expected to be 5.00%, 7.00% 10.00%. The liquidity premium for one- to three-year bonds: 0%, 0.25%, 0.75%. What is the interest rate on the three year bond?

A. 7.75%

B. 8.33%

C. 8.08%

D. 7.67%

2. The current one year interest rate is 5.00% on a T-bill. The current two year interest is 7.00% on the T-note. What is the market predicting about the interest rate on a one year bond in year 2(one year from now) solely based on the expectations theory?

A. 6.00%

B. 7.75%

C. 9.00%

D. 12.00%

3ased on Table 1 which issue (s) has (have) an error in the reported prices.

Table 1

Issue Coupon Maturity Yield Price

A 7.00% 16 8.00% 104.02

B 7.00% 4 3.02% 99.14

C 5.00% 10 3.00% 102.5

D 5.50% 20 3.00% 104.15

A. A

B. B

C. C

D. D

E. A and B

4. A 10-year, 9.00% coupon bond with a face value of $1,000 is currently selling for $900. Compute your rate of return if you sell the bond next year for $936.

A. 4.00%

B. 14.00%

C. 11.11%

D. 16.45%

5. Based on Table 3, what is the liquidity risk premium?

Table 3

Investment Maturity Liquidity Default Risk Interest Rate

1 2 High Low 2.00%

2 2 Low Low 2.52%

3 7 Low Low 3.52%

4 8 High Low 4.03%

5 8 Low High 5.53%

A. 1.50%

B. 1.52%

C. 2.26%

D. 0.52%

Based on Table 3, what is the default risk premium?

A. 0.51%

B. 1.50%

C. 0.98%

D. 1.03%

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