FINANCE 3
1. Which of the following is likely to result in a lower nominal risk free rate?
a) More good investment opportunities
b) Higher time preference for consumption
c) An increase in the supply of money
d) An increase in the demand for money
answer: An increase in the supply of money
2. A(n) ___________ yield curve is often taken as a sign of a possible future recession.
a) Backward c) Upward
b) Normal d) Inverted
Answer: Inverted
3. Investors do not have to pay federal income taxes on interest earned on ______________ securities.
a) Corporate
b) Foreign
c) Municipal
d) Treasury
answer: Treasury
4. Suppose the current one-year Treasury Bill rate is 6%, the current three-year Treasury Bond rate is
5.8%, and the current five-year Treasury Bond rate is 5.7%. According to the expectations theory of
interest rates, what would you expect the two-year Treasury bond rate to be three years from now?
a) 5.25% b) 5.4% c) 5.55% d) 5.75%
, answer: c) 5.55%
5. Which type of security is likely to have the lowest required return?
a) Treasury Bills
b) Common Stock
c) High-Yield (Junk) Bonds
d) Preferred Stock
answer: Common Stock
6. If a bond is selling at a discount, then it's current yield will be _______ than it’s yield to maturity and
________ than it’s coupon rate.
a) Higher; Higher
b) Higher; Lower
c) Lower; Higher
d) Lower; Lower
answer: Higher; Lower
Use the following information for questions 7 and 8: Assume the real risk free rate is 2% and expected
inflation is 4% for the next 2 years and 3% for every year after that. The Maturity risk premium is .1% for
every year until maturity. The Default risk premium increases by .5% for every drop in a bond’s rating
(Treasury securities have a 0% premium, AAA bonds have a .5% premium, AA bonds have a 1%
premium, A bonds have a 1.5% premium, and so on). Junior or Subordinated bonds have a 1% Seniority
risk premium (Senior or Unsubordinated bonds have a 0% risk premium along with Treasury Securities).
Finally, the Liquidity risk premium is 2% for small companies and 1% for large companies, and 0% for
Treasury Securities.
7. What is the interest rate on an 8-year, BB-rated, Subordinated bond issued by a large company?
1. Which of the following is likely to result in a lower nominal risk free rate?
a) More good investment opportunities
b) Higher time preference for consumption
c) An increase in the supply of money
d) An increase in the demand for money
answer: An increase in the supply of money
2. A(n) ___________ yield curve is often taken as a sign of a possible future recession.
a) Backward c) Upward
b) Normal d) Inverted
Answer: Inverted
3. Investors do not have to pay federal income taxes on interest earned on ______________ securities.
a) Corporate
b) Foreign
c) Municipal
d) Treasury
answer: Treasury
4. Suppose the current one-year Treasury Bill rate is 6%, the current three-year Treasury Bond rate is
5.8%, and the current five-year Treasury Bond rate is 5.7%. According to the expectations theory of
interest rates, what would you expect the two-year Treasury bond rate to be three years from now?
a) 5.25% b) 5.4% c) 5.55% d) 5.75%
, answer: c) 5.55%
5. Which type of security is likely to have the lowest required return?
a) Treasury Bills
b) Common Stock
c) High-Yield (Junk) Bonds
d) Preferred Stock
answer: Common Stock
6. If a bond is selling at a discount, then it's current yield will be _______ than it’s yield to maturity and
________ than it’s coupon rate.
a) Higher; Higher
b) Higher; Lower
c) Lower; Higher
d) Lower; Lower
answer: Higher; Lower
Use the following information for questions 7 and 8: Assume the real risk free rate is 2% and expected
inflation is 4% for the next 2 years and 3% for every year after that. The Maturity risk premium is .1% for
every year until maturity. The Default risk premium increases by .5% for every drop in a bond’s rating
(Treasury securities have a 0% premium, AAA bonds have a .5% premium, AA bonds have a 1%
premium, A bonds have a 1.5% premium, and so on). Junior or Subordinated bonds have a 1% Seniority
risk premium (Senior or Unsubordinated bonds have a 0% risk premium along with Treasury Securities).
Finally, the Liquidity risk premium is 2% for small companies and 1% for large companies, and 0% for
Treasury Securities.
7. What is the interest rate on an 8-year, BB-rated, Subordinated bond issued by a large company?
