Question 1

Suppose the following rates are averages for banks in your area: interest checking accounts pay 1%,savings accounts pay 2%,and one-year certificates of deposit pay 3%.All accounts are federally insured by the FDIC.The difference in rates can be explained mainly by

Accepted Answer

Liquidity premiums are the extra interest paid to compensate for the loss of liquidity associated with longer-term investments. In this case, checking accounts are the most liquid, followed by savings accounts, and then one-year certificates of deposit. Therefore, checking accounts pay the lowest interest rate, savings accounts pay a higher interest rate, and one-year certificates of deposit pay the highest interest rate.

Question 2

During the period 1990 to 2014,the average yield on 3-month U.S.Treasury bills was 3.04%,the average inflation rate was 2.64%,the average yield on 30-year Treasury bonds was 5.49%,and the average return on 30-year Aaa-rated corporate bonds was 6.35%.The real risk-free short-term interest rate is

Accepted Answer

The real risk-free short-term interest rate can be approximated by subtracting the average inflation rate from the average yield on 3-month U.S. Treasury bills. Thus, 3.04% - 2.64% = 0.40%.

Question 3

In response to the banking crisis and economic collapse of 2007 and 2008,the U.S.government moved to increase interest rates in order to attract foreign capital seeking high returns in U.S.banks.

Accepted Answer

In response to the banking crisis and economic collapse of 2007 and 2008, the U.S. government actually lowered interest rates in order to stimulate borrowing and spending by consumers and businesses. The goal was to jumpstart economic growth and prevent a further recession.

Question 4

The term structure of interest rates usually indicates that longer terms to maturity have higher expected returns.

Accepted Answer

This is because longer terms to maturity involve greater risks, such as inflation and default risks, and investors require a higher return to compensate for these risks.

Question 5

Which of the following securities will likely have the highest default risk premium?

Accepted Answer

The default risk premium is the additional compensation that investors demand for bearing the risk of default. The higher the default risk of a security, the higher the default risk premium. Among the given choices, the Bbb-rated corporate bond (Option B) has the highest default risk as it is not considered as investment grade and has a higher probability of default. The U.S. Treasury bond and bill (Options A and D) are considered risk-free as they are backed by the government, while the Aaa-rated corporate bond (Option C) is of the highest credit quality and has a lower default risk compared to the Bbb-rated bond.

Question 6

A real interest rate is the interest rate on a fixed-income security that has no risk in an economic environment of high inflation.

Accepted Answer

A real interest rate is the nominal interest rate adjusted for inflation, not specifically related to risk-free or high inflation environments.

Question 7

Examine the securities below and identify the security with the highest liquidity premium,the highest default risk premium,and the highest maturity premium.
a.30-year U.S.Government Treasury bond maturing in 2025
b.25-year Bbb-rated corporate bond maturing in 2030,actively traded on the New York Exchange
c.10-year Aaa-rated corporate bond maturing in 2020,thinly traded on a regional exchange
d.3-month U.S.Treasury bill

Accepted Answer

The answer of Examine the securities below and identify the...

Question 8

What was the average annual rate of return on long-term corporate bonds during the period 1926 to 2014?

Accepted Answer

The answer of What was the average annual rate of...

Question 9

A liquidity-risk premium is the additional return required by investors in longer-term securities to compensate them for the greater risk of price fluctuation on those securities caused by interest rate changes.

Accepted Answer

A liquidity-risk premium compensates investors for the risk associated with the difficulty of selling an asset quickly without a significant price concession, not for interest rate changes.

Question 10

Which of the following represents the correct ordering of returns over the period 1926 to 2014 (from lowest to highest return)?

Accepted Answer

Historically, common stocks have offered the highest return among these investment options, followed by long-term corporate bonds, then long-term government bonds, with Treasury bills typically providing the lowest return. This ordering reflects the risk-return trade-off, where higher risk investments like stocks offer higher potential returns compared to lower risk investments like Treasury bills.

Question 11

Distinguish between the concepts of the inflation premium and the default-risk premium.

Accepted Answer

The answer of Distinguish between the concepts of the inflation...

Question 12

What was the average annual rate of return on long-term government bonds (30-year Treasury bonds)during the period 1990 to 2014?

Accepted Answer

According to historical data from the Federal Reserve Bank of St. Louis, the average annual rate of return on long-term government bonds (30-year Treasury bonds) during the period 1990 to 2014 was 5.49%. This can be calculated by taking the average of the annual yields for each year during that period.

Question 13

Over the period 1926 to 2014,the standard deviation of returns has been the greatest for which of the following?

Accepted Answer

Common stocks have historically exhibited the highest standard deviation of returns compared to other investment options such as Treasury bills, corporate bonds, and government bonds. This is due to their higher volatility and risk compared to other asset classes.

Question 14

Which of the following statements is false?

Accepted Answer

Brokers act as intermediaries between buyers and sellers of securities and do not purchase securities for their own account. Instead, they earn commissions on the transactions they facilitate.

Question 15

What was the average annual rate of return on 3-month U.S.Treasury bills during the period 1990 to 2014?

Accepted Answer

According to historical data from the Federal Reserve Bank of St. Louis, the average annual rate of return on 3-month U.S. Treasury bills during the period 1990 to 2014 was 3.04%. Therefore, choice C is the correct answer. The other options are not supported by the data.

Question 16

Which of the following represents the correct ordering of standard deviation of returns over the period 1926 to 2014 (from highest to lowest standard deviation of returns)?

Accepted Answer

Common stocks have historically had the highest standard deviation of returns, followed by long-term government bonds, long-term corporate bonds, and then Treasury bills. Choice A and C have the correct order except for the placement of long-term corporate bonds and long-term government bonds. Choice D has the incorrect order.

Question 17

What was the average annual rate of return on common stocks during the period 1926 to 2014?

Accepted Answer

The average annual rate of return on common stocks during the period 1926 to 2014 was approximately 10.1%, as per historical data provided by Ibbotson SBBI Classic Yearbook (2015 edition).

Question 18

Which of the following securities will likely have the highest liquidity premium?

Accepted Answer

Liquidity premium is higher for securities that are less frequently traded or have a smaller market, making them harder to buy or sell without affecting the price. A Aaa-rated corporate bond maturing in 2015 that is not actively traded would likely have a higher liquidity premium due to its lower market activity compared to the other options, which are either more liquid government securities or actively traded corporate bonds.

Question 19

The risk premium would be greater for an investment in an oil and gas exploration in unproven fields than an investment in preferred stock because

Accepted Answer

Oil and gas exploration in unproven fields typically involves higher variability in returns due to the uncertain nature of finding viable resources, and such investments are less liquid compared to preferred stocks, which can generally be sold more easily in the market.

Question 20

Distinguish between the concepts of the maturity-risk premium and the liquidity-risk premium.

Accepted Answer

The answer of Distinguish between the concepts of the maturity-risk...

Quiz 2: The Financial Markets and Interest Rates