ookmarks Window Help Quiz: Exam 2 m.instructure.com/courses/1323846/quizzes/1748
ID: 2614085 • Letter: O
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ookmarks Window Help Quiz: Exam 2 m.instructure.com/courses/1323846/quizzes/1748642/take Quiz MyUSF Question 19 5 pts In the foreseeable future, the real risk-free rate of interest, r*, is expected to remain at 3%, inflation is expected to steadily increase, and the maturity risk premium is expected to be 0.10% (t 1), where t is the number of years until the bond matures. Given this information, which of the following statements is correct? O The yield on 2-year Treasury securities must exceed the yield on 5 year Treasury securities. O The yield on 5-year Treasury securities must exceed the yield on 10- year corporate bonds. O The yield on 5-year corporate bonds must exceed the yield on 8 year Treasury bonds. O The yield curve must be humped O The yield curve must be upward sloping. D Question 20 5 pts 12Explanation / Answer
Answer is - Yield curve must be upward sloping
Nominal Interest rate on Bond = Real risk free rate r* + Inflation risk premium + default risk premium + liquidity premium + Maturity risk premium
Now, based on the question, inflation is expected to increase over time. This implies inflation risk premium would be higher for higher maturity bonds. Moreover, maturity risk, expected to be 0.10% * {t - 1}, which implies higher the maturity higher would be maturity risk premium. Hence, with the impact of maturity risk premium and inflation risk premium, bond yield would be higher for higher end maturities and hence, it will be an upward sloping curve.
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