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1) If one expects the inflation premium to be 2%, the default risk premium to be 1%, and the real interest rate to be 4%, what interest rate would you expect to observe in the market place under the simplest form of market rates?
a) 4% b) 7 % c) 2% d) 1%

2) What is the real rate of interest if the nominal rate of interest is 15%, the inflation premium is 3%, the default is 3%, and the maturity risk premium is 3%, and the liquidity premium is 2%
a) 3% b) 4% c) 5% d) none of the above.

3) When investors expect ______ inflation rates, they will require ______
nominal interest rates so that a real rate of return will remain after the inflation.
a) higher, higher. b) higher, lower. c) lower higher d) none of the above.

4) Assume that these current yields exist: long term government securities yield 9%, 5 year treasury securities yield 8.5%, and 1 year treasury bills yield 8%. What type of yield curve is depicted?
a) downward sloping b) flat or level c) upward sloping d) u shaped

5) What yield curve shape is depicted if intermediate term tresury securities yield 10%, short term treasuries yield 10.5%, and long term treasuries yield 9.5% ?
a) downward sloping b) flat or level c) upward sloping d) u shaped.

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Solution Preview

1) If one expects the inflation premium to be 2%, the default risk premium to be 1%, and the real interest rate to be 4%, what interest rate would you expect to observe in the market place under the simplest form of market rates?
a) 4% b) 7 % c) 2% d) 1%

Formula of market Return:
k = k* + IP + DRP + LP + MRP
where, k* = real interest rate = 4%
IP = inflation premium = 2%
DRP = default risk premium = 1%
LP = liquidity premium = 0
MRP= maturity risk premium = 0
Then:
k = k* + ...

Solution Summary

Explicate the yield curve.

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Yield Curve Predictor

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2. Discuss ways in which an investor can take advantage of a flat or inverted yield curve. Give three current, specific real-world examples in your discussion.

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