Objective type Question Bond Yield and Valuation

Identify the choice that best completes the statement or answers the question.

1. If 10-year T-bonds have a yield of 5.2%, 10-year corporate bonds yield 7.5%, the maturity risk premium on all 10-year bonds is 1.1%, and corporate bonds have a 0.2% liquidity premium versus a zero liquidity premium for T-bonds, what is the default risk premium on the corporate bond?

a. 1.00%
b. 1.10%
c. 1.20%
d. 1.30%
e. 1.40%

2. The real risk-free rate is 3%, inflation is expected to be 2% 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. 4.90%
b. 5.00%
c. 5.10%
d. 5.20%
e. 5.30%

3. Suppose the interest rate on a 1-year T-bond is 5.0% and that on a 2-year T-bond is 6.0%. Assume that the pure expectations theory is NOT valid, and the MRP is zero for a 1-year T-bond but 0.4% for a 2-year bond. What is the equilibrium market forecast for 1-year rates 1 year from now?

a. 6.28%
b. 6.39%
c. 6.50%
d. 6.61%
e. 6.72%

4. Assume the following: The real risk-free rate, r*, is expected to remain constant at 3%. Inflation is expected to be 3% next year and then to be constant at 2% a year thereafter. The maturity risk premium is zero. Given this information, which of the following statements is CORRECT?

a. The yield curve for U.S. Treasury securities will be upward sloping.
b. A 5-year corporate bond will have a lower yield than a 5-year Treasury security.
c. A 5-year corporate bond will have a lower yield than a 7-year Treasury security.
d. The real risk-free rate cannot be constant if inflation is not expected to remain constant.
e. This problem\\\'s assumption of a zero maturity risk premium is probably not valid in the real world.

5. Assume that the rate on a 1-year bond is now 6%, but all investors in the market expect 1-year rates to be 7% one year from now and then to rise to 8% two years from now. Assume also that the pure expectations theory holds, hence the maturity risk premium equals zero. Which of the following statements is CORRECT?

a. The yield curve would be downward sloping, with the rate on a 1-year bond at 6%.
b. The interest rate today on a 2-year bond would be 6%.
c. The interest rate today on a 2-year bond would be 7%.
d. The interest rate today on a 3-year bond would be 7%.
e. The interest rate today on a 3-year bond would be 8%.

6. If the pure expectations theory of the term structure is correct, which of the following statements is 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.

7. Which of the following is CORRECT?

a. Even if the pure expectations theory is correct, there might at times be an inverted Treasury yield curve.
b. If the yield curve is inverted, short-term bonds have lower yields than long-term bonds.
c. The higher the maturity risk premium, the higher the probability that the yield curve will be inverted.
d. Inverted yield curves can exist for Treasury bonds, but because of default premiums, the corporate yield curve cannot become inverted.
e. The most likely explanation for an inverted yield curve is that investors expect inflation to increase in the future.

8. 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 all corporate bonds 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.

9. Three-year treasury securities yield 5%, 5-year treasury securities yield 6%, and 8-year treasury securities yield 7%. If the expectations theory is correct, what is the expected yield on 5-year Treasury securities three years from now?

a. 5.09%
b. 7.00%
c. 6.71%
d. 8.22%
e. 6.03%

10. You read in The Wall Street Journal that 30-day T-bills are currently yielding 8%. Your brother-in-law, a broker at Kyoto Securities, has given you the following estimates of current interest rate premiums:

a. Inflation premium 5%.
b. Liquidity premium 1%.
c. Maturity risk premium 2%.
d. Default risk premium 2%.

11.Disregard cross-product terms, i.e., if averaging is required, use the arithmetic average. On the basis of these data, the real risk-free rate of return is

a. 0%
b. 1%
c. 2%
d. 3%
e. 4%