Write out an equation for the nominal interest rate on any security.
Distinguish between the real risk-free rate of interest, r*, and the
nominal, or quoted, risk-free rate of interest, r RF.
How do investors deal with inflation when they determine interest
rates in the financial markets?
Does the interest rate on a T-bond include a default risk premium?
Explain.
Distinguish between liquid and illiquid assets, and list some assets
that are liquid and some that are illiquid.
Briefly explain the following statement: “Although long-term bonds
are heavily exposed to interest rate risk, short-term T-bills are heav-
ily exposed to reinvestment rate risk. The maturity risk premium
reflects the net effects of these two opposing forces.”
Assume that the real risk-free rate is r* 2% and the average
expected inflation rate is 3 percent for each future year. The DRP
and LP for Bond X are each 1 percent, and the applicable MRP is
2 percent. What is Bond X’s interest rate? Is Bond X (1) a Treasury
bond or a corporate bond and (2) more likely to have a 3-month or a
20-year maturity?
What is a yield curve, and what information would you need to
draw this curve?
Distinguish among the shapes of a “normal” yield curve, an
“abnormal” curve, and a “humped” curve.
If the interest rates on 1-, 5-, 10-, and 30-year bonds are 4, 5, 6, and
7 percent, respectively, how would you describe the yield curve? If
the rates were reversed, how would you describe it?
