Chapter 06: Interest Rates
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68. Kay Corporation’s 5-year bonds yield 7.50% and 5-year T-bonds yield 4.40%. The real risk-free rate is r* = 2.5%, the
inflation premium for 5-year bonds is IP = 1.50%, the default risk premium for Kay’s bonds is DRP = 1.30% versus zero
for T-bonds, and the maturity risk premium for all bonds is found with the formula MRP = (t – 1) 0.1%, where t =
number of years to maturity. What is the liquidity premium (LP) on Kay’s bonds?
a. 1.55%
b. 1.87%
c. 1.62%
d. 1.80%
e. 1.94%
69. Niendorf Corporation’s 5-year bonds yield 11.25%, and 5-year T-bonds yield 4.80%. The real risk-free rate is r* =
2.75%, the inflation premium for 5-year bonds is IP = 1.65%, the default risk premium for Niendorf’s bonds is DRP =
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1.20% versus zero for T-bonds, and the maturity risk premium for all bonds is found with the formula MRP = (t – 1)
0.1%, where t = number of years to maturity. What is the liquidity premium (LP) on Niendorf’s bonds?
a. 4.41%
b. 3.99%
c. 4.36%
d. 5.25%
e. 6.09%
70. Kern Corporation’s 5-year bonds yield 6.60% and 5-year T-bonds yield 3.40%. The real risk-free rate is r* = 2.5%, the
default risk premium for Kern’s bonds is DRP = 1.90% versus zero for T-bonds, the liquidity premium on Kern’s bonds is
LP = 1.3%, and the maturity risk premium for all bonds is found with the formula MRP = (t – 1) 0.1%, where t =
number of years to maturity. What is the inflation premium (IP) on all 5-year bonds?
a. 0.50%
b. 0.48%
c. 0.54%
d. 0.38%
e. 0.51%
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75. Suppose 1-year T-bills currently yield 7.00% and the future inflation rate is expected to be constant at 5.80% per year.
What is the real risk-free rate of return, r*? The cross-product term should be considered , i.e., if averaging is required, use
the geometric average. (Round your final answer to 2 decimal places.)
a. 1.25%
b. 1.41%
c. 1.13%
d. 1.04%
e. 1.27%
76. Suppose the real risk-free rate is 3.50% and the future rate of inflation is expected to be constant at 4.20%. What rate
of return would you expect on a 1-year Treasury security, assuming the pure expectations theory is valid? Include cross-
product terms, i.e., if averaging is required, use the geometric average. (Round your final answer to 2 decimal places.)
a. 7.30%
b. 7.85%
c. 7.69%
d. 6.91%
e. 5.96%
Chapter 06: Interest Rates
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80. Suppose the real risk-free rate is 3.25%, the average future inflation rate is 4.35%, and a maturity risk premium of
0.07% per year to maturity applies to both corporate and T-bonds, i.e., MRP = 0.07%(t), where t is the number of years to
maturity. Suppose also that a liquidity premium of 0.50% and a default risk premium of 1.20% apply to A-rated corporate
bonds but not to T-bonds. How much higher would the rate of return be on a 10-year A-rated corporate bond than on a 5-
year Treasury bond? Here we assume that the pure expectations theory is NOT valid. Disregard cross-product terms, i.e.,
if averaging is required, use the arithmetic average.
a. 1.89
b. 2.28
c. 2.05
d. 2.07
e. 1.72
81. Suppose the real risk-free rate is 3.50%, the average future inflation rate is 2.50%, a maturity premium of 0.20% per
year to maturity applies, i.e., MRP = 0.20%(t), where t is the number of years to maturity. Suppose also that a liquidity
premium of 0.50% and a default risk premium of 1.30% applies to A-rated corporate bonds. What is the difference in the
yields on a 5-year A-rated corporate bond and on a 10-year Treasury bond? Here we assume that the pure expectations
theory is NOT valid, and disregard any cross-product terms, i.e., if averaging is required, use the arithmetic average.
a. 0.66
b. 0.80
c. 0.92
d. 0.93
e. 0.86
