Question 1

We assign a very low probability of default to the U.S. Treasury and thus assume that all Treasury bills will be paid in full at maturity and thus have a zero default premium.

Accepted Answer

This statement is true. The U.S. Treasury is considered to have a very low probability of default, so there is no default premium for Treasury bills.

Question 2

Which of the statements below is FALSE?

Accepted Answer

The statement in D is false because typically, the longer the loan period, the higher the interest rate demanded by the lender. This is due to the increased risk of nonpayment over a longer period, which lenders compensate for by charging higher interest rates.

Question 3

Which of the statements below is FALSE?

Accepted Answer

The statement about inflation varying from a low of 5% to a high of slightly over 13% is false, as inflation rates have been lower than 5% at times.

Question 4

We can get an average real rate if we assume expected inflation and actual inflation are on average the same ________.

Accepted Answer

Looking over a relatively long period of time allows for expected inflation and actual inflation to average out, thereby giving us an average real rate. Short-term variations in inflation can skew the real rate calculation. Different or neighboring countries may have differing levels of inflation, making it difficult to assume that expected and actual inflation are the same.

Question 5

Differences in borrowing rates can generally be explained by the level of risk of the investment or loan and by the length of the investment or loan.

Accepted Answer

This is generally true because lenders will charge higher interest rates for riskier investments or loans, and longer-term investments or loans generally carry higher interest rates to compensate for inflation and other risks over time. However, there may be other factors that influence borrowing rates such as market conditions, economic policies, and the creditworthiness of the borrower.

Question 6

The most common shape for a yield curve is upward sloping.

Accepted Answer

The most common shape for a yield curve is upward sloping, also known as normal curve. This suggests that longer-term interest rates are higher than shorter-term interest rates due to expectations of economic growth and inflation. However, there are also other shapes of yield curves such as flat, inverted, humped and irregular.

Question 7

In constructing a yield curve you place interest rates on the vertical axis, and risk on the horizontal axis.

Accepted Answer

In constructing a yield curve, interest rates are placed on the horizontal axis and maturity or time to maturity is placed on the vertical axis. Risk is not typically included as a factor in constructing a yield curve.

Question 8

Inflation in the United States has ________ since 1950.

Accepted Answer

Inflation in the United States has varied over time since 1950. It has gone through periods of high inflation, such as in the 1970s and early 1980s, as well as periods of low inflation, such as in the 2010s.

Question 9

The default risk premium for U.S. corporate bonds was greater in the last 50 years of the 20th century than in the first decade if the 21st century.

Accepted Answer

The default risk premium for U.S. corporate bonds was higher in the first decade of the 21st century than in the last 50 years of the 20th century, mainly due to the 2008 financial crisis.

Question 10

Which of the statements below is TRUE?

Accepted Answer

The maturity premium, which compensates investors for the increased risk of holding longer-term securities, has averaged around 1.28% for twenty-year maturity differences over the past 50 years.

Question 11

Which of the below is NOT a major component of interest rates?

Accepted Answer

Historical interest rates may have an impact on current interest rates, but they are not a major component of interest rates. The other options (real rate, inflation premium, default premium) are all major components of interest rates.

Question 12

Which of the four interest rate components had the smallest average percentage in the period from 1950-1999?

Accepted Answer

The answer of Which of the four interest rate components...

Question 13

Which of the statements below is FALSE?

Accepted Answer

The default premium does not have a consistent average over the past 50 years and can vary widely depending on economic conditions and other factors.

Question 14

Why are there different interest rates on loans and securities?

Accepted Answer

The answer of Why are there different interest rates on...

Question 15

A yield curve constructed using Treasury securities has each of the following components embedded in the nominal interest rates:

Accepted Answer

The nominal interest rates used to construct the yield curve are composed of the real interest rate (which represents the return on an investment after accounting for inflation), expected inflation, and a maturity premium (which compensates investors for the risks associated with holding longer-term investments). There is no default risk premium included in Treasury securities, as they are considered to be free from default risk.

Question 16

The borrowing rate for real estate is more than the borrowing rates for autos, boats, and VISA Reward credit cards.

Accepted Answer

The borrowing rate for real estate is typically lower than the rates for autos, boats, and especially VISA Reward credit cards because mortgages are secured by the property, which reduces the lender's risk.

Question 17

James is a rational investor wishing to maximize his return over a 20-year period. The current yield curve is inverted with one-year rates at 5.00% and 20-year rates at 3.50%. James will invest in the lower-rate 20-year bonds if:

Accepted Answer

James should invest in the lower-rate 20-year bonds if he thinks rates will fall in the future and locking in long-term rates today may provide the highest long-run average return. This is because, in an inverted yield curve, long-term rates are expected to decrease in the future. By investing in the lower-rate 20-year bonds now, James can lock in the current lower rate and potentially benefit from the future decrease in rates, resulting in a higher return over the 20-year period.

Question 18

The rates on Treasury bills in the United States has been lower on average in the most recent decade than in the 50 years from 1950 - 1999.

Accepted Answer

According to data from the Federal Reserve Bank of St. Louis, the average rates on Treasury bills for the most recent decade (2010-2019) was 1.47%, while the average rates for the period from 1950-1999 was 4.75%, indicating that rates on Treasury bills have been lower on average in the most recent decade compared to the previous 50 years.

Question 19

Which of the four interest rate components had the greatest average percentage in the period from 1950-1999?

Accepted Answer

According to historical data, the inflation premium had the highest average percentage in the period from 1950-1999.

Question 20

If we want to get some idea about a(n) ________ over time between two specific assets, we can compare the returns on top-rated corporate bonds and U.S. government bonds.

Accepted Answer

The default premium is the additional yield that investors require to hold a bond with credit risk compared to a risk-free bond. Comparing returns on top-rated corporate bonds (which have some credit risk) and U.S. government bonds (considered risk-free) helps assess the default premium over time.

Quiz 5: Interest Rates

We assign a very low probability of default to the U.S. Treasury and thus assume that all Treasury bills will be paid in full at maturity and thus have a zero default premium.

Which of the statements below is FALSE?

Which of the statements below is FALSE?

We can get an average real rate if we assume expected inflation and actual inflation are on average the same ________.

Differences in borrowing rates can generally be explained by the level of risk of the investment or loan and by the length of the investment or loan.

The most common shape for a yield curve is upward sloping.

In constructing a yield curve you place interest rates on the vertical axis, and risk on the horizontal axis.

Inflation in the United States has ________ since 1950.

The default risk premium for U.S. corporate bonds was greater in the last 50 years of the 20th century than in the first decade if the 21st century.

Which of the statements below is TRUE?

Which of the below is NOT a major component of interest rates?

Which of the four interest rate components had the smallest average percentage in the period from 1950-1999?

Which of the statements below is FALSE?

Why are there different interest rates on loans and securities?

A yield curve constructed using Treasury securities has each of the following components embedded in the nominal interest rates:

The borrowing rate for real estate is more than the borrowing rates for autos, boats, and VISA Reward credit cards.

James is a rational investor wishing to maximize his return over a 20-year period. The current yield curve is inverted with one-year rates at 5.00% and 20-year rates at 3.50%. James will invest in the lower-rate 20-year bonds if:

The rates on Treasury bills in the United States has been lower on average in the most recent decade than in the 50 years from 1950 - 1999.

Which of the four interest rate components had the greatest average percentage in the period from 1950-1999?

If we want to get some idea about a(n) ________ over time between two specific assets, we can compare the returns on top-rated corporate bonds and U.S. government bonds.