Deck 4: The Term Structure of Interest Rates

Question 1

If the real risk-free rate is 112 basis points, the maturity risk premium is 177 basis points and the one-year inflation premium is 263 basis points, what is the nominal risk-free rate?

A) 2.63%.
B) 2.89%.
C) 3.75%.
D) 4.40%.
E) 5.52%.

Answer 1

3.75%.

Question 2

Which of the following items reflects the size of the market for the security in question?

A) Real risk-free rate.
B) Inflation premium.
C) Default risk premium.
D) Liquidity premium.
E) Maturity risk premium.

Answer 2

Liquidity premium.

Question 3

Which of the following items reflects the time value of money?

A) Real risk-free rate.
B) Inflation premium.
C) Default risk premium.
D) Liquidity premium.
E) Maturity risk premium.

Answer 3

Real risk-free rate.

Question 4

Which of the following items reflects the financial stability of the company that issued the security in question?

A) Real risk-free rate.
B) Inflation premium.
C) Default risk premium.
D) Liquidity premium.
E) Maturity risk premium.

Question 5

Which of the following items reflects the expected changes in purchasing power over the life of the security in question?

A) Real risk-free rate.
B) Inflation premium.
C) Default risk premium.
D) Liquidity premium.
E) Maturity risk premium.

Question 6

Which of the following rules regarding interest rate premiums are true?

A) All bonds with maturities longer than one year must have maturity risk premiums.
B) All securities must have the real risk-free rate and an appropriate inflation premium.
C) US government securities do not have default risk or liquidity risk premiums.
D) All of the above are true.
E) None of the above is true.

Question 7

The yield curve represents:

A) The relationship between bond yields and stock returns.
B) The relationship between default risk and time to maturity.
C) The relationship between short-term and long-term interest rates.
D) The relationship between risk and return.
E) The relationship between yield and price.

Question 8

Use the following data to answer questions below
Assume the following premiums reflect current market conditions:
r^* = 3.15%;
IP (1-year bonds) = 2.35%;
IP (3-year bonds) = 2.65%;
IP (5-year bonds) = 2.90%;
DRP (AAA corporate bonds) = 0.60%;
DRP (AA+ corporate bonds) = 0.85%;
LP (AAA corporate bonds) = 0.22%;
LP (AA+ corporate bonds) = 0.30%;
MRP = 0.1% × (t − 1) where t is the number of years to maturity.
-Calculate the interest rate for a 1-year AA+ corporate bond.

Question 9

Use the following data to answer questions below
Assume the following premiums reflect current market conditions:
r^* = 3.15%;
IP (1-year bonds) = 2.35%;
IP (3-year bonds) = 2.65%;
IP (5-year bonds) = 2.90%;
DRP (AAA corporate bonds) = 0.60%;
DRP (AA+ corporate bonds) = 0.85%;
LP (AAA corporate bonds) = 0.22%;
LP (AA+ corporate bonds) = 0.30%;
MRP = 0.1% × (t − 1) where t is the number of years to maturity.
-Calculate the interest rate for a 3-year AA+ corporate bond.

Question 10

Use the following data to answer questions below
Assume the following premiums reflect current market conditions:
r^* = 3.15%;
IP (1-year bonds) = 2.35%;
IP (3-year bonds) = 2.65%;
IP (5-year bonds) = 2.90%;
DRP (AAA corporate bonds) = 0.60%;
DRP (AA+ corporate bonds) = 0.85%;
LP (AAA corporate bonds) = 0.22%;
LP (AA+ corporate bonds) = 0.30%;
MRP = 0.1% × (t − 1) where t is the number of years to maturity.
-Calculate the interest rate for a 5-year AA+ corporate bond.

Question 11

Use the following data to answer questions below
Assume the following premiums reflect current market conditions:
r^* = 3.15%;
IP (1-year bonds) = 2.35%;
IP (3-year bonds) = 2.65%;
IP (5-year bonds) = 2.90%;
DRP (AAA corporate bonds) = 0.60%;
DRP (AA+ corporate bonds) = 0.85%;
LP (AAA corporate bonds) = 0.22%;
LP (AA+ corporate bonds) = 0.30%;
MRP = 0.1% × (t − 1) where t is the number of years to maturity.
-Calculate the interest rate for a 1-year AAA corporate bond.

Question 12

Use the following data to answer questions below
Assume the following premiums reflect current market conditions:
r^* = 3.15%;
IP (1-year bonds) = 2.35%;
IP (3-year bonds) = 2.65%;
IP (5-year bonds) = 2.90%;
DRP (AAA corporate bonds) = 0.60%;
DRP (AA+ corporate bonds) = 0.85%;
LP (AAA corporate bonds) = 0.22%;
LP (AA+ corporate bonds) = 0.30%;
MRP = 0.1% × (t − 1) where t is the number of years to maturity.
-Calculate the interest rate for a 3-year AAA corporate bond.

Question 13

Use the following data to answer questions below
Assume the following premiums reflect current market conditions:
r^* = 3.15%;
IP (1-year bonds) = 2.35%;
IP (3-year bonds) = 2.65%;
IP (5-year bonds) = 2.90%;
DRP (AAA corporate bonds) = 0.60%;
DRP (AA+ corporate bonds) = 0.85%;
LP (AAA corporate bonds) = 0.22%;
LP (AA+ corporate bonds) = 0.30%;
MRP = 0.1% × (t − 1) where t is the number of years to maturity.
-Calculate the interest rate for a 5-year AAA corporate bond.

Question 14

Use the following data to answer questions below
Assume the following premiums reflect current market conditions:
r^* = 3.15%;
IP (1-year bonds) = 2.35%;
IP (3-year bonds) = 2.65%;
IP (5-year bonds) = 2.90%;
DRP (AAA corporate bonds) = 0.60%;
DRP (AA+ corporate bonds) = 0.85%;
LP (AAA corporate bonds) = 0.22%;
LP (AA+ corporate bonds) = 0.30%;
MRP = 0.1% × (t − 1) where t is the number of years to maturity.
-Calculate the interest rate for a 1-year Treasury security.

Question 15

Use the following data to answer questions below
Assume the following premiums reflect current market conditions:
r^* = 3.15%;
IP (1-year bonds) = 2.35%;
IP (3-year bonds) = 2.65%;
IP (5-year bonds) = 2.90%;
DRP (AAA corporate bonds) = 0.60%;
DRP (AA+ corporate bonds) = 0.85%;
LP (AAA corporate bonds) = 0.22%;
LP (AA+ corporate bonds) = 0.30%;
MRP = 0.1% × (t − 1) where t is the number of years to maturity.
-Calculate the interest rate for a 3-year Treasury security.

Question 16

Use the following data to answer questions below
Assume the following premiums reflect current market conditions:
r^* = 3.15%;
IP (1-year bonds) = 2.35%;
IP (3-year bonds) = 2.65%;
IP (5-year bonds) = 2.90%;
DRP (AAA corporate bonds) = 0.60%;
DRP (AA+ corporate bonds) = 0.85%;
LP (AAA corporate bonds) = 0.22%;
LP (AA+ corporate bonds) = 0.30%;
MRP = 0.1% × (t − 1) where t is the number of years to maturity.
-Calculate the interest rate for a 5-year Treasury security.

Question 17

The current 1-year interest rate is 6.40%, while the current 2-year interest rate is 5.80%. Given these rates, what is the expected 1-year interest rate one year from now?

Question 18

The current 1-year interest rate is 4.74% and the expected 1-year interest rate one year from now is 5.12%. If the current 3-year interest rate is 5.22%, what is the expected 1-year rate two years from now?