1.) Suppose 1-year T-bills currently yield 7.00% and the future inflation rate i

Question

1.) Suppose 1-year T-bills currently yield 7.00% and the future inflation rate is expected to be constant at 3.20% per year. What is the real risk-free rate of return, r*? Disregard any cross-product terms, i.e., if averaging is required, use the arithmetic average.

a. 3.80%

b. 3.99%

c. 4.19%

d. 4.40%

e. 4.62%

2.) Suppose the real risk-free rate is 3.50% and the future rate of inflation is expected to be constant at 2.20%. What rate of return would you expect on a 1-year Treasury security, assuming the pure expectations theory is valid? Disregard cross-product terms, i.e., if averaging is required, use the arithmetic average.

a. 5.14%

b. 5.42%

c. 5.70%

d. 5.99%

e. 6.28%

3.) If the discount (or interest) rate is positive, the present value of an expected series of payments will always exceed the future value of the same series.

a. True

b. False

4.) Disregarding risk, if money has time value, it is impossible for the present value of a given sum to exceed its future value.

a. True

b. False

5.) A 12-year bond has an annual coupon of 9%. The coupon rate will remain fixed until the bond matures. The bond has a yield to maturity of 7%. Which of the following statements is CORRECT?

a. If market interest rates decline, the price of the bond will also decline.

b. The bond is currently selling at a price below its par value.

c. If market interest rates remain unchanged, the bond’s price one year from now will be lower than it is today.

d. The bond should currently be selling at its par value.

e. If market interest rates remain unchanged, the bond’s price one year from now will be higher than it is today.

Explanation / Answer

r = T nOte yield - IP r =7-3.2 r = 3.8 The correct answer is a. 3.80% 2 (1+r)(1+I)-1 = Yile don 1 year T Bond = (1+3.5)(1+2.20)-1 = 5.78% The correct option is C. 5.70% 3 FALSE The Future value will exceed FV = pV(PVAF, rate, life) 4 TRUE The time value increase the value of money therefore the present value cannot be more than the future value

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