EBK INVESTMENTS
11th Edition
ISBN: 9781259357480
Author: Bodie
Publisher: MCGRAW HILL BOOK COMPANY
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Chapter 15, Problem 2CP
Summary Introduction
Introduction : The uncertainty in the interest rate varies or increases with time and based on this concept Liquidity Preference is proposed.
To Explain: The true statement is to be determined about the term structure of the interest rates.
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Which one of the following statements about the term structure of interest rates is true?
A) The expectations hypothesis predicts a flat yield curve if anticipated future short-term rates exceed current short-term rates.
B) The liquidity premium theory contends that lenders prefer to buy securities at the ghort-term end of the curve.
C) The expectations hypothesis contends that the long-term spot rate is equal to the short-term rate.
D) The liquidity premium theory indicates that, all else being equal, longer maturity bonds will have lower yields.
Which one of the following statements about the term structure of interest rates is true?a. The expectations hypothesis indicates a flat yield curve if anticipated future short-term rates exceed current short-term rates.b. The expectations hypothesis contends that the long-term rate is equal to the anticipated short-term rate.c. The liquidity premium theory indicates that, all else being equal, longer maturities will have lower yields.d. The liquidity preference theory contends that lenders prefer to buy securities at the short end of the yield curve.
Determine whether the following statements are TRUE or FALSE.
Briefly explain your answers.
(a) “When a consol is priced above its par value, the yield to maturity equals coupon rate.”
(b) "If the actual inflation rate is higher than expected, both borrowers and lenders will
lose"
Chapter 15 Solutions
EBK INVESTMENTS
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- At any point in time forward rates computed by the yield curve represent the market's best estimates about the future course of short-term interest rates. Hence, for an individual investor who has a one-period investment horizon, it makes no difference what the term to maturity is on the individual security purchased. True/false?arrow_forwardWhich of the following best explains an upward sloping Treasury yield curve? A. Maturity risk is expected to decline in the future B. Long-term interest rates are more volatile than short-term rates C. Inflation risk premiums are higher for longer terms to maturity D. Default risk is higher for longer terms to maturityarrow_forwardWhich of the following statements is CORRECT about the yield curve? A) The yield curve shows the behaviour of interest rate forecasts. B) When short-term rates are lower than long-term rates, there is a downward-sloping yield curve. C) A downward-sloping yield curve shows that investors demand an additional risk premium for lending money over the long term. D) A downward-sloping yield curve indicates that the market expects a future rise in interest rates.arrow_forward
- Assuming the pure expectations theory is correct, an upward-sloping yield curve implies:a. Interest rates are expected to increase in the future.b. Longer-term bonds are riskier than short-term bonds.c. Interest rates are expected to decline in the future.arrow_forwardUnder the expectations hypothesis, if the yield curve is upward-sloping, the market must expect an increase in short-term interest rates. True/false/uncertain? Why?arrow_forwardSuppose the real risk-free rate is 3.00%, the average expected future inflation rate is 6.60%, and a maturity risk premium of 0.10% per year to maturity applies, i.e., MRP = 0.10%(t), where t is the number of years to maturity. What rate of return would you expect on a 1-year Treasury security, assuming the pure expectations theory is NOT valid? Disregard cross-product terms, i.e., if averaging is required, use the arithmetic average.arrow_forward
- Some characteristics of the determinants of nominal interest rates are listed as follows. Identify the components (determinants) and the symbols associated with each characteristic: Characteristic Component Symbol This is the premium that reflects the risk associated with changes in interest rates for a long-term security. It changes over time, depending on the expected rate of return on productive assets exchanged among market participants and people’s time preferences for consumption. This premium is added when a security lacks marketability, because it cannot be bought and sold quickly without losing value. It is calculated by adding the inflation premium to r*. Over the past several years, Germany, Japan, and Switzerland have had lower interest rates than the United States due to lower values of this premium. It is based on the bond’s rating; the higher the rating, the lower the premium added, thus lowering…arrow_forwardWhich of the following is correct with regards to Theories of Term Structure? When the shape of the yield curve depends on investors’ expectations about prospective prevailing interest rates, the Pure Exception Theory is being applied. When the economic outlook is improving, the yield curve inverts as it reflects no changes in inflation premium. The liquidity preference theory suggests that long-term rates are generally higher than short-term rates since investors perceive more liquidity in long-term investments. Under the Market segmentation theory, there is an apparent relationship between the yield curve and the prevailing rate of returns in each market segment.arrow_forwardSuppose 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.)arrow_forward
- Assess the following statements: The traditional liquidity premium theory states that long term interest rates are greater than the average of expected future interest rates. According to the market segmentation theory short term investors will not normally switch to intermediate or long term investments. The liquidity premium theory of interest rates states that the term structure must always be upward sloping. The liquidity premium theory of interest rates states that investors are indifferent between different maturities if the long term spot rates are equal to the average of current and expected future short term rates. a. Two statements are correct. b. Three statements are correct. c. Only one statement is correct. d. Four statements are correct.arrow_forwardIs it true or false? The inflation risk premium theory implies that, in normal circumstances, we can expect an upwards-sloping yield curve in the fixed-interest bond market.arrow_forward22. If the expectations theory of the term structure of interest rates is correct, and if the otherterm structure theories are invalid, and we observe a downward sloping yield curve, which ofthe following is a true statement?a.Investors expect short-term rates to be constant over time.b.Investors expect short-term rates to increase in the future.c.Investors expect short-term rates to decrease in the future.d.It is impossible to say unless we know whether investors require a positive ornegative maturity risk premium.e.The maturity risk premium must be positive 23. Other things held constant, which of the following will not affect the quick ratio? (Assumethat current assets equal current liabilities.)a.Fixed assets are sold for cash.b.Cash is used to purchase inventories.c.Cash is used to pay off accounts payable.d.Accounts receivable are collected.e.Long-term debt is issued to pay off a short-term bank loan.arrow_forward
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