Question 1

The one-year interest rate is 4%.The interest rate for a two-year security is 6%.The one-year interest rate one year from now is 8.34%.According to the liquidity preference theory,the risk premium for the second one-year investment is

Accepted Answer

The answer of The one-year interest rate is 4%.The interest...

Question 2

The one-year interest rate is 4%.The interest rate for a two-year security is 6%.According to the unbiased expectations theory,the one-year interest rate one year from now must be equal to

Accepted Answer

According to the unbiased expectations theory, the expected one-year interest rate one year from now should equal the current two-year interest rate, which is 6%. However, since the current one-year interest rate is only 4%, it is expected to increase by 2% over the next year. Therefore, the expected one-year interest rate one year from now is 6% + 2% = 8%.

Question 3

Which of the following represents the correct ordering of returns over the period 1926 to 2011 (from lowest to highest return)?

Accepted Answer

Historically, over the period 1926 to 2011, Treasury bills had the lowest returns, followed by long-term corporate bonds, then common stocks, and small firm common stocks had the highest returns.

Question 4

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

The U.S. government actually lowered interest rates during this time in order to stimulate borrowing and spending, which it hoped would boost the economy.

Question 5

You are considering an investment in a AAA-rated U.S.corporate bond but you are not sure what rate of interest it should pay.Assume that the real risk-free rate of interest is 1.0%; inflation is expected to be 1.5%; the maturity risk premium is 2.5%; and,the default risk premium for AAA-rated corporate bonds is 3.5%.What rate of interest should the U.S.corporate bond pay?

Accepted Answer

The interest rate can be calculated by adding up all the given premiums and rates: 1.0% (real risk-free rate) + 1.5% (inflation) + 2.5% (maturity risk premium) + 3.5% (default risk premium) = 8.5%.

Question 6

Which of the following represents the correct ordering of standard deviation of returns over the period 1926 to 2011 (from highest to lowest standard deviation of returns)?

Accepted Answer

The correct order of standard deviation of returns over the period 1926 to 2011 is: small firm common stocks (standard deviation of 32.9%), common stocks (standard deviation of 20.2%), long-term corporate bonds (standard deviation of 9.3%), and Treasury bills (standard deviation of 3.3%). Therefore, option B represents the correct ordering of standard deviation of returns from highest to lowest.

Question 7

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

Accepted Answer

The default risk premium is the additional return an investor requires for bearing the risk of default. BB-rated corporate bonds are considered junk bonds and have a higher probability of default compared to other securities listed. The other options are either issued by the government (with very low probability of default) or are highly rated and have lower default risk premiums.

Question 8

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

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The answer of Suppose the following rates are averages for...

Question 9

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

Accepted Answer

The maturity risk premium is the additional return that investors typically require to hold long-term bonds rather than shorter-term bonds. Therefore, of the options given, the U.S. Treasury Bond maturing in 2027 will likely have the highest maturity risk premium as it has the longest maturity period.

Question 10

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 are associated with higher risk due to uncertainty over future market conditions, inflation, and credit risk. Therefore, investors demand higher returns to compensate for this added risk.

Question 11

What was the average annual rate of return on common stocks of small firms during the period 1926 to 2011?

Accepted Answer

This figure comes from the analysis of data by the Center for Research in Security Prices (CRSP) at the University of Chicago. The data covers the period from 1926 to 2011 and includes annual returns of small firms that are part of the CRSP database. While the annual rate of return on small stocks can be volatile and subject to a degree of uncertainty, the 11.9% average annual rate of return is considered to be a reliable estimate based on a long history of data.

Question 12

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 13

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

Accepted Answer

The AAA-rated corporate bond maturing in 2015 that is not actively traded will likely have the highest liquidity premium because it is not actively traded, making it harder to sell quickly without a price concession.

Question 14

A liquidity-risk premium is the additional return required by investors for securities that cannot quickly be converted into cash at a reasonably predictable price.

Accepted Answer

This statement is true. A liquidity-risk premium is the additional return required by investors to compensate for the risk of not being able to sell a security quickly and at a fair market price, which increases the uncertainty and potential for loss in holding the security.

Question 15

What is the term for a graphical representation of the relationship between interest rates and the maturities of debt securities?

Accepted Answer

The term for a graphical representation of the relationship between interest rates and the maturities of debt securities is yield curve.

Question 16

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

The answer of A liquidity-risk premium is the additional return...

Question 17

Over the period 1926 to 2011 the standard deviation of returns has been the greatest for which of the following?

Accepted Answer

Common stocks of small firms generally have higher volatility and risk, leading to a greater standard deviation of returns compared to other investment options like treasury bills, corporate bonds, and larger common stocks.

Question 18

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 19

You are considering an investment in a U.S.Treasury bond but you are not sure what rate of interest it should pay.Assume that the real risk-free rate of interest is 1.0%; inflation is expected to be 1.5%; the maturity risk premium is 2.5%; and,the default risk premium for AAA-rated corporate bonds is 3.5%.What rate of interest should the U.S.Treasury bond pay?

Accepted Answer

The interest rate on a U.S. Treasury bond can be calculated by adding the real risk-free rate of interest (1.0%) to the expected inflation (1.5%), since U.S. Treasury bonds are considered free of default risk and the maturity risk premium applies to them. Therefore, the rate of interest should be 1.0% + 1.5% = 2.5%. However, the inclusion of the maturity risk premium (2.5%) should also be considered for longer-term bonds, making the correct calculation 1.0% + 1.5% + 2.5% = 5.0%. The default risk premium for AAA rated corporate bonds is not relevant for U.S. Treasury bonds.

Question 20

During the period 1987 to 2011,the average yield on 3-Month U.S.Treasury bills was 3.85%,the average inflation rate was 2.92%,the average yield on 30-year Treasury bonds was 6.14%,and the average return on 30-year AAA-Rated Corporate Bonds was 7.00%.The real risk-free short-term interest rate is

Accepted Answer

The real risk-free short-term interest rate is calculated by subtracting the average inflation rate from the average yield on 3-Month U.S. Treasury bills: 3.85% - 2.92% = 0.93%, which is approximately 0.90%.

Quiz 2: The Financial Markets and Interest Rates