Chapter 02 Determinants of Interest Rates

Figure 2-1

YIELD CURVE FOR ZERO COUPON BONDS RATED AA



Assume that there are no liquidity premiums.

27. To the nearest basis point, what is the expected interest rate on a four-year maturity AA zero coupon bond purchased six years from today?
A. 10.41%
B. 10.05%
C. 9.16%
D. 10.56%
E. 9.96%

28. You just bought a fifteen-year maturity Xerox corporate bond rated AA with a 0% coupon. You expect to sell the bond in eight years. Find the expected interest rate at the time of sale (watch out for rounding error).
A. 11.00%
B. 8.85%
C. 12.49%
D. 12.80%
E. 13.92%

29. According to the liquidity premium theory of interest rates,
A. long-term spot rates are higher than the average of current and expected future short-term rates
B. investors prefer certain maturities and will not normally switch out of those maturities
C. investors are indifferent between different maturities if the long-term spot rates are equal to the average of current and expected future short-term rates
D. the term structure must always be upward sloping
E. long-term spot rates are totally unrelated to expectations of future short-term rates

30. Of the following, the most likely effect of an increase in income tax rates would be to
A. decrease the savings rate
B. decrease the supply of loanable funds
C. increase interest rates
D. all of the above

31. Upon graduating from college this year you expect to earn $25,000 per year. If you get your MBA, in one year you can expect to start at $35,000 per year. Over the year, inflation is expected to be 5%. In today's dollars, how much additional (less) money will you make from getting your MBA (to the nearest dollar) in your first year?
A. -$2,462
B. $8,333
C. $8,750
D. $9,524
E. $10,000

32. Investment A pays 8% simple interest for 10 years. Investment B pays 7.75% compound interest for 10 years. Both require an initial $10,000 investment. The future value of A minus the future value of B is equal to ______________ (to the nearest penny).
A. $2,500.00
B. -$2,500.00
C. $1,643.32
D. $3,094.67
E. -$3,094.67

33. You buy a car for $38,000. You agree to a 60-month loan with a monthly interest rate of 0.55%. What is your required monthly payment?
A. $634.24
B. $745.29
C. $605.54
D. $764.07
E. none of the above

34. You buy an investment today for $9,000. You sell the investment in 120 days for $9,500. The effective annual rate on this investment is
A. 13.76%
B. 14.35%
C. 15.56%
D. 16.90%
E. 17.87%