Reference no: EM132261867
BUSN 422
Assignment
[1 - 3] Fill in the blank or choose one of the choices below.
1. ________ represents the relationship between yield and term-to-maturity of financial instruments. It may be upward sloping, downward sloping, flat, or humped.
2. The shapes of the yield curve are explained by several theories: The expectations theory suggests that if interest rates are expected to (Choose one: increase, decrease) in the future, long-term rates will be higher than short-term rates, and the yield curve will slope upward.
A downward-sloping curve occurs if market participants expect interest rates to (Choose one: incline, decline).
Liquidity premium theory suggests that risk-averse investors require yield premiums to hold (Choose one: longer-term, short-term) securities because of greater price or liquidity risk. These yield premiums cause an upward bias in the slope of the yield curve.
The _________________ theory suggests that the shape of the yield curve is determined by the supply of and demand for securities within narrow maturity ranges.
3. The greater a security's default risk, the higher is the interest rate that must be paid to investors as compensation for potential financial loss and risk bearing. ______________ can be measured as the difference between the yield on a risky security and that of a risk-free security with the same term-to- maturity. Yields on the _______________ are the best proxies for risk-free interest rates.
4. The one year spot interest rate is 5.50% and the one-year forward rate next year is 6.0%. According to the expectations theory, what is the current two-year rate?
1) Write the equation which expresses term structure of interest. From the equation, plug in numbers based on the above information.
2) What is the computed current two-year rate?
A) The rate cannot be calculated from the information above.
B) 5.50%
C) 5.66%
D) 5.75%
5. According to the expectations theory, what is the one-year forward rate three years from now if three and four-year spot rates are 5.50% and 5.80%, respectively?
1) Write the equation which expresses term structure of interest. From the equation, plug in numbers based on the above information.
2) What is the computed one-year forward rate three years from now?
A) The rate cannot be calculated from the information above.
B) 6.2%
C) 6.7%
D) 5.6%
6. A two-year interest rate is 7% and a one-year forward rate one year from now is 8%. According to the expectations theory, what is the current one-year rate?
1) Write the equation which expresses term structure of interest. From the equation, plug in numbers based on the above information.
2) What is the computed what is the current one-year rate?
A) 6.0%
B) 6.5%
C) 7.0%
D) 8.0%
7. If three-year securities are yielding 6% and two-year securities are yielding 5.5%, what is the expected one-year rate two years from now as implied by the two actual rates above?
1) Write the equation which expresses term structure of interest. From the equation, plug in numbers based on the above information.
2) What is the computed what is the current one-year rate?
A) 4.7%
B) 5.8%
C) 6.5%
D) 7.0%
8. Define default risk. How does the default risk premium vary over the business cycle? Explain.
9. According to the expectations theory of the term structure of interest rates, if the yield curve slopes _______, the markets expect short-term interest rates to _______ in the future.
A) upward; increase
B) downward; decrease
C) upward; decrease
D) both a and b
10. The major determinant of the bond ratings assigned by Moody's, Standard and Poors, or Fitchs is
A) marketability.
B) tax treatment.
C) term to maturity.
D) default risk.
11. The relationship between maturity and yield to maturity is called the ________________.
A) term structure
B) loan covenant
C) bond indenture
D) Fisher effect
12. According to the expectation theory
A) markets are segmented and buyers stay in their own segment
B) the long term spot rate is an average of the current and expected future short term interest rates
C) the term structure will most often be downward sloping
D)liquidity premiums are negative and time varying
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90-day
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Treasury bills
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8.36 percent
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180-day
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Treasury bills
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8.48 percent
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2-year
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Treasury notes
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9.10 percent
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3-year
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Treasury notes
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9.25 percent
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90-day
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Commercial paper
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9.15 percent
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3-year
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Corporate bonds (AA)
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10.10 percent
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3-year
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Municipal (AA)
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7.07 percent
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Expected 2-year inflation rate
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3.50 percent
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13. With reference to the data above, what is the default risk premium on commercial paper?
A) 5.65%
B) 0.95%
C) 0.79%
D) 0.55%
14. With reference to the data above, what is the one-year forward rate on Treasury securities two years from now according to the expectations theory?
A) 9.10%
B) 9.18%
C) 9.40%
D) 9.55%
15. With reference to the data above, at what tax rate would an investor be indifferent between holding the 3-year municipal or 3-year corporate bond?
A) 15%
B) 20%
C) 25%
D) 30%
16. With reference to the data above, what is the default risk premium on 3-year AA-rated corporate bonds?
A) 0.85%
B) 0.95%
C) 3.03%
D) 6.60%
17. If the pure expectations yield curve is flat, the actual yield curve with liquidity premiums would be
A) flat.
B) upward sloping.
C) downward sloping.
D) upward at first, then downward sloping.
18. What actions by bond investors, given their expectations of increasing interest rates, result in an upward sloping yield curve?
A) selling long-term securities and buying short-term securities.
B) buying long-term securities and selling short-term securities.
C) selling short-term securities and holding cash.
D) selling long-term securities and holding cash.
19. A bondholder in the 30 percent tax bracket owns a $1000 par Treasury bond with an 8 percent coupon rate. What is the after-tax return on the bond? Show your work.
A) 8 percent
B) 2.4 percent
C) 5.6 percent
D) 5 percent
20. The yield differentials between an AAA-rated corporate bond and an otherwise similar BBB-rated corporate bond may be explained by
A) marketability.
B) tax treatment.
C) default risk.
D) term to maturity.
21. Which of the following statements explains the liquidity premium theory of the term structure of interest rates?
A) Investors will pay higher prices for longer-term securities.
B) Investors demand a lower yield for securities that cannot be sold quickly at high prices.
C) Investors demand a higher return on longer-term securities with greater price risk and less marketability.
D) Investors will pay higher prices for securities with greater price risk and less marketability.
22. Commercial banks, savings and loan associations, and finance companies traditionally have better profits when
A) the level of interest rates were expected to fall sharply.
B) the yield curve had a downward slope.
C) the yield curve had an upward slope.
D) loan losses were increasing.
23. Historically, high default premiums have been associated with
A) economic recessions.
B) economic boom periods.
C) generally rising interest rates.
D) the number of bonds rated by Moody's and Standard & Poor's.
24. A conversion option gives a valuable right to a bond's _______; a put option gives a valuable right to a bond's _______.
A) issuer; issuer
B) issuer; holder
C) holder; issuer
D) holder; holder
25. Bond A is not callable; bond B is callable. Investors will require a higher yield on bond __ and will pay ____ for the bond.
A) A; less
B) A; more
C) B; less
D) B; more
26. Bond A is not putable; bond B is putable. Investors will require a lower yield on bond __ and will pay ____ for the bond.
A) A; less
B) A; more
C) B; less
D) B; more