1. If inflation is expected to be relatively low, then interest rates will tend to be relatively high, other things held constant.

a. True b. False

2. Which of the following statements is CORRECT?

a. If the maturity risk premium (MRP) is greater than zero, the Treasury bond yield curve

must be upward sloping.

b. If the maturity risk premium (MRP) equals zero, the Treasury bond yield curve must be flat.

c. If inflation is expected to decrease in the future and the maturity risk premium (MRP) is

greater than zero, the Treasury bond yield curve must be downward sloping.

d. If the expectations theory holds, the Treasury bond yield curve will never be downward

sloping.

e. If inflation is expected to increase in the future and the maturity risk premium (MRP) is

greater than zero, the Treasury bond yield curve must be upward sloping.

3. Ms Parker found two opportunities of investment A (rate of return 4%, standard deviation 4%) and investment B (rate of return 6%, standard deviation 3%). Which one is better for her? (hints: calculate each CV and then compare each other)

a. A b. B c. none

4. Johnson Corporation has 5-year bonds. Inflation premium (IP) on a 5 year bond is 1.00%. The real risk-free rate is r* = 2.80%, the default risk premium for Johnson's bonds is DRP = 0.85% versus zero for T-bonds, the liquidity premium on Johnson's bonds is LP = 1.25%, and the maturity risk premium for all bonds is found with the formula MRP = (t 1) x 0.1%, where t = number of years to maturity. What is the yield on Johnson Corporations 5-year bonds?

a. 1.40% b. 6.85% c. 1.71% d. 6.30% e. 2.06%

5. Le Corporation's 5-year bonds yield 6.30%, 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 Le'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)x0.1%, where t =number of years to maturity. What is the liquidity premium (LP) on Le's bonds?

a. 0.49% b. 0.55% c. 0.61% d. 0.50% e. 0.30%

6. Suppose the interest rate on a 1-year T-bond is 4.0% and that on a 2-year T-bond is 5.0%. Assuming the pure expectations theory is correct, what is the market's forecast for 1-year rates 1 year from now?

a. 7.36% b. 7.01% c. 8.16% d. 6.01% e. 9.04%

7. Bellocks Corporation's bonds have a 10-year maturity, a 5.00% semiannual coupon, and a par value of $1,000. The going interest rate (rd) is 4.00%, based on semiannual compounding. What is the bonds price?

a.1,163.51 b.1,090.35 c.1,118.31 d.1,146.27 e.1,081.75

8. A 15-year bond with a face value of $1,000 currently sells for $900. Which of the following statements is CORRECT?

a. The bond's coupon rate exceeds its current yield.

b. The bond's yield to maturity or discount rate is more than its coupon rate.

c. The bond's yield to maturity or discount rate is less than its coupon rate.

d. The bond's current yield is equal to its coupon rate.

e. If the yield to maturity stays constant until the bond matures, the bond's price will remain at $900.

This is the information for the problems 9, 10, 11, 12 and 13. Alexander Inc.'s bonds currently sell for $800 and have a par value of $1,000. They pay a $50 annual coupon and have a 20-year maturity, but they can be called in 5 years at $1,200.

9. What is their yield to maturity (YTM)?

a. 5.78% b. 7.64% c. 6.39% d. 8.04% e. 6.87%

10. What is their Expected Current Yield (CY)?

a. 5.78% b. 6.09% c. 6.39% d. 7.50% e. 6.25%

11. What is their Capital Gain Yield (CGY)?

a. 0.54% b. 6.09% c. 0.42% d. 0.65% e. 0.62%

12. This bond is a discount bond.

a. True b. False

13. What is their yield to Call (YTC)?

a. 5.78% b. 14.93% c. 6.39% d. 9.43% e. 13.84%

14. Kimberly Motors has a beta of 1.40, the T-bill rate is 3.00%, and the T-bond rate is 7.0%. The annual return on the stock market during the past 3 years was 15.00%, but investors expect the annual future stock market return to be 13.00%. Based on the SML, what is the firm's required return?

a. 13.51% b. 13.86% c. 14.80% d. 14.58% e. 15.40%

15. Newsomes stock has a beta of 1.20, its required return is 11.50%, and the risk-free rate is 4.30%. What is the required rate of return on the market? (Hint: First find the market risk premium.)

a. 10.30% b. 10.62% c. 10.88% d. 10.15% e. 11.43%

16. 5-year Treasury bonds yield 5.0%. The inflation premium (IP) is 1.9%, and the maturity risk premium (MRP) on 5-year bonds is 0.3%. What is the real risk-free rate, r*?

a. 2.59% b. 2.70% c. 3.20% d. 3.52% e. 2.80%

Short answer question (20 points):

1. What are the four micro factors which affect the level of interest rates? Explain. (hint: not macro factors)
2. A 10-year, 10% semiannual coupon bond selling for $1,135.90 can be called in 4 years for $1,050 (hint: par value is $1,000).

Draw the Time line? Show your work

What is its yield to maturity (YTM)? Show your work

What s its current yield (CY)? Show your work

What is its yield to call (YTC)? Show your work.

3. What are the five key features of bonds? Explain.
4. Show your work. If the pure expectations theory holds, what does the market expect will be the intrest rate on one-year securities, four years from now (1 year maturity yield is 6.0%; 2 year maturity yield is 6.1%; 3 year maturity yield is 6.2%; 4 year maturity yield is 6.5 %; 5 year maturity yield is 6.5%)? (Hints: Draw the time line and then calculate the interest rate.

Can you help with ALL QUESTIONS THAT REQUIRE MANUAL WORK THROUGH'S #4-16