Chapter 06: Interest Rates
68. Kay Corporation’s 5-year bonds yield 5.90% 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.
0.23%
b.
0.25%
c.
0.19%
d.
0.20%
e.
0.17%
2.50%
1.50%
1.30%
b.
c.
d.
e.
MODERATE
Chapter 06: Interest Rates
69. Niendorf Corporation’s 5-year bonds yield 7.75%, 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 =
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.
1.42%
b.
2.10%
c.
2.17%
d.
1.75%
e.
1.56%
MRP
0.40%
1.65%
2.75%
1.20%
b.
c.
d.
e.
MODERATE
70. Kern Corporation’s 5-year bonds yield 7.50% and 5-year T-bonds yield 4.30%. 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.
1.40%
b.
1.64%
c.
1.32%
d.
1.06%
e.
1.19%
a
a.
Maturity
Chapter 06: Interest Rates
71. Crockett Corporation’s 5-year bonds yield 6.35%, and 5-year T-bonds yield 4.45%. The real risk-free rate is r* =
2.80%, the default risk premium for Crockett’s bonds is DRP = 1.00% versus zero for T-bonds, the liquidity premium on
Crockett’s bonds is LP = 0.90% 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 inflation premium (IP) is built into 5-year
bond yields?
a.
1.40%
b.
1.10%
c.
1.11%
d.
1.33%
e.
1.25%
e
0.90%
1.00%
2.80%
0.40%
7.50%
4.30%
2.50%
1.30%
1.90%
0.1%
1.40%
1.40%
b.
c.
d.
e.
MODERATE
Chapter 06: Interest Rates
72. Kelly Inc’s 5-year bonds yield 7.50% and 5-year T-bonds yield 5.80%. The real risk-free rate is r* = 2.5%, the default
risk premium for Kelly’s bonds is DRP = 0.40%, the liquidity premium on Kelly’s bonds is LP = 1.3% versus zero on T-
bonds, and the inflation premium (IP) is 1.5%. What is the maturity risk premium (MRP) on all 5-year bonds?
a.
1.51%
b.
1.80%
c.
2.00%
d.
1.46%
e.
2.12%
Maturity
2.50%
1.30%
0.40%
1.50%
b.
c.
d.
e.
MODERATE
b.
c.
d.
e.
MODERATE
Chapter 06: Interest Rates
73. Kop Corporation’s 5-year bonds yield 6.50%, and T-bonds with the same maturity yield 5.90%. The default risk
premium for Kop’s bonds is DRP = 0.40%, the liquidity premium on Kop’s bonds is LP = 0.20% versus zero on T-bonds,
the inflation premium (IP) is 1.50%, and the maturity risk premium (MRP) on 5-year bonds is 0.40%. What is the real
risk-free rate, r*?
a.
3.64%
b.
3.48%
c.
3.00%
d.
4.96%
e.
4.00%
e
Maturity
0.40%
0.20
1.50%
MRP
0.40%
b.
c.
d.
e.
MODERATE
74. 5-year Treasury bonds yield 4.4%. The inflation premium (IP) is 1.9%, and the maturity risk premium (MRP) on 5-
year T-bonds is 0.4%. There is no liquidity premium on these bonds. What is the real risk-free rate, r*?
a.
2.10%
Chapter 06: Interest Rates
b.
2.39%
c.
2.21%
d.
2.58%
e.
1.91%
a
1.90%
MRP
0.40%
0.00%
b.
c.
d.
e.
MODERATE
75. Suppose 1-year T-bills currently yield 7.00% and the future inflation rate is expected to be constant at 2.00% 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.
4.51%
b.
4.85%
c.
4.90%
d.
3.87%
e.
3.77%
c
Inflation
2.00%
b.
c.
d.
MODERATE
Chapter 06: Interest Rates
76. Suppose the real risk-free rate is 3.50% and the future rate of inflation is expected to be constant at 4.10%. 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.
6.58%
b.
7.74%
c.
9.37%
d.
6.50%
e.
7.90%
3.50%
Inflation
4.10%
7.74%
b.
c.
d.
e.
MODERATE
77. Suppose the real risk-free rate is 3.00%, the average expected future inflation rate is 4.00%, and a maturity risk
premium of 0.10% per year to maturity applies, i.e., MRP = 0.10%(t), where t is the years to maturity. What rate of return
would you expect on a 1-year Treasury security, assuming the pure expectations theory is NOT valid? Include the cross-
product term, i.e., if averaging is required, use the geometric average. (Round your final answer to 2 decimal places.)
a.
8.88%
b.
7.15%
c.
7.22%
d.
7.80%
e.
8.95%
Chapter 06: Interest Rates
78. Suppose the interest rate on a 1-year T-bond is 5.00% and that on a 2-year T-bond is 6.90%. Assuming the pure
expectations theory is correct, what is the market’s forecast for 1-year rates 1 year from now? Round the intermediate
calculations to 4 decimal places and final answer to 2 decimal places.
a.
7.16
b.
8.83
c.
6.63
d.
7.42
e.
8.04
a
1.1428
MODERATE
c
3.00%
Inflation
4.00%
MRP
0.10%
7.22%
b.
c.
d.
e.
MODERATE
Chapter 06: Interest Rates
79. Suppose 1-year Treasury bonds yield 4.00% while 2-year T-bonds yield 4.10%. Assuming the pure expectations
theory is correct, and thus the maturity risk premium for T-bonds is zero, what is the yield on a 1-year T-bond expected to
be one year from now? Round the intermediate calculations to 4 decimal places and final answer to 2 decimal places.
a.
4.20
b.
4.49
c.
3.82
d.
3.57
e.
4.41
a
4.00%
4.10%
c.
e.
MODERATE
6-6 Using the Yield Curve to Estimate Future Interest Rates
Multiple Choice
United States – OH – DISC.FOFM.BRIG.17.02 – Financial markets and interest rates
Estimating forward rate
Bloom’s: Evaluation
6/23/2015 3:25 PM
6/23/2015 3:25 PM
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 2.50% apply to A-rated corporate
Multiple Choice
United States – OH – DISC.FOFM.BRIG.17.02 – Financial markets and interest rates
Estimating forward rate
Bloom’s: Evaluation
6/23/2015 3:25 PM
6/23/2015 3:25 PM
Chapter 06: Interest Rates
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.
1.90
b.
3.05
c.
2.50
d.
2.60
e.
a
3.25%
4.35%
0.07%
2.50%
T-bond yield
7.95%
Difference
2.50%
CHALLENGING
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 2.70% 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.
1.91
b.
2.20
Chapter 06: Interest Rates
c.
2.27
d.
2.13
e.
1.78
b.
c.
d.
e.
CHALLENGING
82. Suppose the interest rate on a 1-year T-bond is 5.00% and that on a 2-year T-bond is 4.10%. Assume that the pure
expectations theory is NOT valid, and the MRP is zero for a 1-year T-bond but 0.40% for a 2-year bond. What is the yield
on a 1-year T-bond expected to be one year from now? Round the intermediate calculations to 4 decimal places and final
answer to 2 decimal places.
a.
2.80
b.
2.37
c.
2.88
d.
2.42
e.
2.03
5.00
1.0754
Chapter 06: Interest Rates