problem1: Suppose 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] A 5-year corporate bond will have a lower yield than a seven year Treasury security.

[B] The real risk-free rate cannot be constant if inflation is not expected to remain constant.

[C] This problem's assumption of a zero maturity risk premium is probably not valid in the real world.

[D] The yield curve for U.S. Treasury securities will be upward sloping.

[E] A 5-year corporate bond will have a lower yield than a 5-year Treasury security.

problem2: Suppose that the rate on a 1-year bond is now 6%, but all investors in the market expect 1-year rates to be 7 percent one year from now and then to rise to 8 percent 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 interest rate today on a 2-year bond would be 7 percent.

[B] The interest rate today on a 3-year bond would be 7 percent.

[C] The interest rate today on a 3-year bond would be 8 percent.

[D] The yield curve would be downward sloping, with the rate on a 1-year bond at 6 percent.

[E] The interest rate today on a 2-year bond would be 6 percent.

problem3: Inflation is expected to increase steadily over the next ten 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 7-year corporate bonds must exceed the yield on 10-year Treasury bonds.

[B] The stated conditions cannot all be true they are internally inconsistent.

[C] The Treasury yield curve under the stated conditions would be humped rather than have a consistent positive or negative slope.

[D] The yield on 10-year Treasury securities must exceed the yield on 7-year Treasury securities.

[E] The yield on all corporate bonds must exceed the yields on all Treasury bonds.

problem4:  You read in The Wall Street Journal that thirty day T-bills are currently yielding 8 percent. Your brother-in-law, a broker at Kyoto Securities, has given you the following estimates of current interest rate premiums:

[A] Maturity risk premium 2%

[B] Default risk premium 2%

[C] Inflation premium 5%

[D] Liquidity premium 1%

problem5: Disregard cross-product terms, i.e., if averaging is required, use the arithmetic average. On the basis of these data, determine the real risk-free rate of return

[A] 4%

[B] 0%

[C] 1%

[D] 2%

[E] 3%