# Multiple choice questions on bonds, yields

13. Hanratty Inc.'s stock and the stock market have generated the following returns over the past five years:

Year Hanratty Market (kM)

1 13% 9%

2 18 15

3 -5 -2

4 23 19

5 6 12

On the basis of these historical returns, what is the estimated beta of Hanratty Inc.'s stock?

a. 0.7839

b. 0.9988

c. 1.2757

d. 1.3452

e. 1.5000

14. The one-year spot rate is 10% and the two-year spot rate is 8%. If the one-

year spot rate expected in one year is 6%, according to the liquidity

preference theory, what must be the one -year liquidity premium

commencing one year from now?

a. .0353 b. .0373 c. .0363 d .0463

15. A 10-year Treasury bond currently yields 8 percent. The real risk-free rate of interest, k*, is 4 percent. The maturity risk premium has been estimated to be 0.1(t)%, where t = the maturity of the bond. Inflation is expected to average 2 percent a year for each of the next five years. What is the expected average rate of inflation between years five and ten?

a. 4% b. 4.5% c. 5% d. 5.5% e. 6%

16. The 10-year bonds of Gator Corporation are yielding 9 percent per year. Treasury bonds with the same maturity are yielding 7.5 percent per year. The real risk-free rate (k*) has not changed in recent years and is 3 percent. The average inflation premium is 2.5 percent and the maturity risk premium takes the form: MRP = 0.l(t - l)%, where t = number of years to maturity. If the liquidity premium is 0.6 percent, what is the default risk premium on the corporate bond?

a. 1% b. .9% c. .8% d. 0.7% e. .6%

17. Which of the following statements is most correct?

a. Downward sloping yield curves are inconsistent with the expectations theory.

b. The shape of the yield curve depends only on expectations about future inflation.

c. If the expectations theory is correct, a downward sloping yield curve indicates that interest rates are expected to decline in the future.

d. Statements a and c are correct.

e. None of the statements above is correct.

18. The real risk-free rate of interest is expected to remain constant at 3 percent for the foreseeable future. However, inflation is expected to steadily increase over the next 20 years, so the Treasury yield curve is upward sloping. Assume that the expectations theory holds. You are considering two corporate bonds: a 5-year corporate bond and a 10-year corporate bond, each of which has the same default risk and liquidity risk. Given this information, which of the following statements is most correct?

a. Since the expectations theory holds, this implies that 10-year Treasury bonds must have the same yield as 5-year Treasury bonds.

b. Since the expectations theory holds, this implies that the 10-year corporate bonds must have the same yield as the 5-year corporate bonds.

c. Since the expectations theory holds, this implies that the 10-year corporate bonds must have the same yield as 10-year Treasury bonds.

d. The 10-year Treasury bond must have a higher yield than the 5-year corporate bond.

e. The 10-year corporate bond must have a higher yield than the 5-year corporate bond.

19. Which of the following statements is most correct?

a. The yield on a 2-year corporate bond will always exceed the yield on a 2-year Treasury bond.

b. The yield on a 3-year corporate bond will always exceed the yield on a 2-year corporate bond.

c. The yield on a 3-year Treasury bond will always exceed the yield on a 2-year Treasury bond.

d. All of the statements above are correct.

e. Statements a and c are correct.

20. You are given the following data:

k* = real risk-free rate: 4%

Constant inflation premium: 7%

Maturity risk premium: 1%

Default risk premium for AAA bonds: 3%

Liquidity premium for long-term T-bonds: 2%

Assume that a highly liquid market does not exist for long-term T-bonds, and the expected rate of inflation is a constant. Given these conditions, the nominal risk-free rate for T-bills (SHORT-TERM) is , and the rate on long-term Treasury bonds is .

a. 4%; 14%

b. 4%; 15%

c. 11%; 14%

d. 11%; 15%

e. 11%; 17%

21. You observe the following yields on Treasury securities of various maturities:

Maturity Yield

1 year 6.0%

3 years 6.4

6 years 6.5

9 years 6.8

12 years 7.0

15 years 7.2

Using the expectations theory, forecast the interest rate on 9-year Treasuries, six years from now. (That is, what will be the yield on 9-year Treasuries, issued in 6 years' time?)

a. 6.50%

b. 6.65%

c. 6.80%

d. 7.67%

e. 8.00%

22. The real risk-free rate is expected to remain at 3 percent. Inflation is expected to be 3 percent this year and 4 percent next year. The maturity risk premium is estimated to be equal to 0.1(t - 1)%, where t = the maturity of a bond (in years). All Treasury securities are highly liquid, and therefore have no liquidity premium. Three-year Treasury bonds yield 0.5 percentage points (0.005) more than 2-year Treasury bonds (that is, 2-year bond yield plus 0.5%). What is the expected level of inflation in Year 3?

a. 4.5%

b. 4.7%

c. 5.0%

d. 5.6%

e. 6.3%

23. If the Federal Reserve sells $50 billion of short-term U. S. Treasury securities to the public, other things held constant, what will this tend to do to short-term security prices and interest rates?

a. Prices and interest rates will both rise.

b. Prices will rise and interest rates will decline.

c. Prices and interest rates will both decline.

d. Prices will decline and interest rates will rise.

e. There will be no changes in either prices or interest rates.

#### Solution Preview

...% b. .9% c. .8% d. 0.7% e. .6%

The difference in rate is because of default risk and liquidity premium

(9-7.5)= default risk+ 0.6

default risk= 1.5-0.6=0.9%

Answer b is correct.

17. Which of the following statements is most correct?

a. Downward sloping yield curves are inconsistent with the expectations theory.

b. The shape of the yield curve depends only on expectations about future inflation.

c. If the expectations theory is correct, a downward sloping yield curve indicates that interest rates are expected to decline in the future.

d. Statements a and c are correct.

e. None of the statements above is correct.

a is wrong as downward sloping yield curve is possible if expectation for future is for lower interest rate. C is correct by this logic.

Answer c is correct.

18. The real risk-free rate of interest is expected to remain constant at 3 percent for the foreseeable future. However, inflation is expected to steadily increase over the next 20 years, so the Treasury yield curve is upward sloping. Assume that the expectations theory holds. You are considering two corporate bonds: a 5-year corporate bond and a 10-year corporate bond, each of which has the same default risk and liquidity risk. Given this information, which of the following statements is most correct?

a. Since the expectations theory holds, this implies that 10-year Treasury bonds must have the same yield as 5-year Treasury bonds.

b. Since the expectations theory holds, this implies that the 10-year corporate bonds must have the same yield as the 5-year corporate bonds.

c. Since the expectations theory holds, this implies that the 10-year corporate bonds must have the same yield as 10-year Treasury bonds.

d. The 10-year Treasury bond must have a higher yield than the 5-year corporate bond.

e. The 10-year corporate bond must have a higher yield than the 5-year corporate bond.

Answer e is correct.

10 yr yields cannot be less than 5 yr yields for the ...