# FINANCE

22. This theory argues that individual investors and financial institutions have specific maturity preferences, and to encourage buyers to hold securities with maturities other than their most preferred requires a higher interest rate.

A. Liquidity Premium Hypothesis

B. Market Segmentation Theory

C. Supply and Demand Theory

D. Unbiased Expectations Theory

23. This is the expected or “implied” rate on a short-term security that will originate at some point in the future.

A. Current yield

B. Forward rate

C. Spot rate

D. Yield to maturity

24. Which of these is NOT a theory that explains the shape of the term structure of interest rates?

A. liquidity theory

B. market segmentation theory

C. short-term structure of interest rates theory

D. unbiased expectations theory

25. **Interest rates** A particular security’s default risk premium is 3 percent. For all securities, the inflation risk premium is 2 percent and the real interest rate is 2.25 percent. The security’s liquidity risk premium is 0.75 percent and maturity risk premium is 0.90 percent.

The security has no special covenants. What is the security’s equilibrium rate of return?

A. 1.78%

B. 3.95%

C. 8.90%

D. 17.8%

26. **Interest rates** You are considering an investment in 30-year bonds issued by a corporation. The bonds have no special covenants. *The Wall Street Journal* reports that 1-year T-bills are currently earning 3.50 percent. Your broker has determined the following information about economic activity and the corporation bonds:

Real interest rate = 2.50%

Default risk premium = 1.75%

Liquidity risk premium = 0.70%

Maturity risk premium = 1.50%

What is the inflation premium? What is the fair interest rate on the corporation’s 30-year bonds?

A. 1% and 1.49%, respectively

B. 1% and 6.45%, respectively

C. 1% and 7.45%, respectively

D. 3.50% and 9.95%, respectively

27. **Interest rates** A corporation’s 10-year bonds have an equilibrium rate of return of 7 percent. For all securities, the inflation risk premium is 1.50 percent and the real interest rate is 3.0 percent. The security’s liquidity risk premium is 0.15 percent and maturity risk premium is 0.70 percent. The security has no special covenants. What is the bond’s default risk premium?

A. 1.40%

B. 1.65%

C. 5.35%

D. 9.35%

28. **Interest rates** A 2-year Treasury security currently earns 5.25 percent. Over the next two years, the real interest rate is expected to be 3.00 percent per year and the inflation premium is expected to be 2.00 percent per year. What is the maturity risk premium on the 2-year Treasury security?

A. 0.25%

B. 1.00%

C. 1.05%

D. 5.00%

29. **Unbiased Expectations Theory** Suppose that the current one-year rate (one-year spot rate) and expected one-year T-bill rates over the following three years (i.e., years 2, 3, and 4, respectively) are as follows:

Using the unbiased expectations theory, what is the current (long-term) rate for four-year-maturity Treasury securities?

A. 6.00%

B. 6.33%

C. 6.75%

D. 7.00%

30. **Unbiased Expectations Theory** One-year Treasury bills currently earn 5.50 percent. You expect that one year from now, one-year Treasury bill rates will increase to 5.75 percent. If the unbiased expectations theory is correct, what should the current rate be on two-year Treasury securities?

A. 5.50%

B. 5.625%

C. 5.75%

D. 11.25%

31. **Liquidity Premium Hypothesis** One-year Treasury bills currently earn 5.50 percent. You expect that one year from now, one-year Treasury bill rates will increase to 5.75 percent. The liquidity premium on two-year securities is 0.075 percent. If the liquidity theory is correct, what should the current rate be on two-year Treasury securities?

A. 3.775%

B. 5.625%

C. 5.662%

D. 11.325%

32. **Liquidity Premium Hypothesis** Based on economists’ forecasts and analysis, one-year Treasury bill rates and liquidity premiums for the next four years are expected to be as follows: