FiltersDone

Question type

Essay

Multiple Choice

Short Answer

True False

Matching

Exam 5: The Cost of Money Interest Rates

Show Answer

Share

---

All types

Filters

Study FlashcardsPractice ExamLearn

Question 1

Multiple Choice

Review LaterAdd Note

Review Later

As a corporate investor paying a marginal tax rate of 34 percent, if 70 percent of dividends are excludable, what would be your after-tax dividend yield on preferred stock with a 16 percent before-tax dividend yield?

A) 6.36%
B) 7.36%
C) 12.19%
D) 13.01%
E) 14.37%

Correct Answer

verified

Show Answer

Question 2

True/False

Review LaterAdd Note

Review Later

Investors with a higher time preference for consumption will demand a lower rate of return to forego current consumption and save than investors with a lower time preference for consumption.

Correct Answer

verified

False

Question 3

Multiple Choice

Review LaterAdd Note

Allen Corporation can (1) build a new plant which should generate a before-tax return of 11 percent, or (2) invest the same funds in the preferred stock of FPL, which should provide Allen with a before-tax return of 9%, all in the form of dividends.Assume that Allen's marginal tax rate is 25 percent, and that 70 percent of dividends received are excluded from taxable income.If the plant project is divisible into small increments, and if the two investments are equally risky, what combination of these two possibilities will maximize Allen's effective return on the money invested?

Bonds with higher liquidity will demand higher interest rates in the market since they can be easily converted into cash on short notice at or near the fair market value for that bond.

If the expectations theory of the term structure of interest rates is correct, and if the other term structure theories are invalid, and we observe a downward sloping yield curve, which of the following is a true statement?

The fact that a percentage of the interest income received by one corporation is excluded from taxable income has encouraged firms to use more debt financing relative to equity financing.

You read in The Wall Street Journal that 30-day T-bills currently are yielding 8 percent.Your brother-in-law, a broker at Kyoto Securities, has given you the following estimates of current interest rate premiums: $\begin{array}{llcc} \text { Inflation premium } &5\%\\ \text { Liquidity premium } &1\%\\ \text { Maturity risk premium } &2\%\\ \text { Default risk premium } &2\%\\\end{array}$ Based on these data, the real risk-free rate of return is

If the Federal Reserve tightens the money supply, other things held constant, short-term interest rates will be pushed upward, and this increase probably will be greater than the increase in rates in the long-term market.

Assume that the real risk-free rate, r*, is 4 percent, and that inflation is expected to be 9% in Year 1, 6% in Year 2, and 4% thereafter.Assume also that all Treasury bonds are highly liquid and free of default risk.If 2-year and 5- year Treasury bonds both yield 12%, what is the difference in the maturity risk premiums (MRPs) on the two bonds, i.e., what is MRP5 − MRP2?

During or near peaks of business activity, yield curves that are flat or downward sloping (possibly with humps) often are prevalent.

Treasury securities that mature in 6 years currently have an interest rate of 8.5%.Inflation is expected to be 5% each of the next three years and 6% each year after the third year.The maturity risk premium is estimated to be 0) 1%(t − 1) , where t is equal to the maturity of the bond (i.e., the maturity risk premium of a one-year bond is zero) .The real risk-free rate is assumed to be constant over time.What is the real risk-free rate of interest?

If the Federal Reserve sells $50 billion of short-term U.S.Treasury securities to the public, other things held constant, what will this tend to do to short-term security prices and interest rates?

If you have information that a recession is ending, and the economy is about to enter a boom, and your firm needs to borrow money, it should probably issue long-term rather than short-term debt.

The liquidity preference theory states that each borrower and lender has a preferred maturity and that the slope of the yield curve depends on supply and demand for funds in the long-term market relative to the short-term market.

The normal yield curve is upward sloping implying that

Your uncle would like to restrict his interest rate risk and his default risk, but he still would like to invest in corporate bonds.Which of the possible bonds listed below best satisfies your uncle's criteria?

An investor with a six-year investment horizon believes that interest rates are determined only by expectations about future interest rates, (i.e., this investor believes in the expectations theory).This investor should expect to earn the same rate of return over the 6-year time horizon if he or she buys a 6-year bond or a 3-year bond now and another 3-year bond three years from now (ignore transaction costs).

Assume that the current interest rate on a 1-year bond is 8 percent, the current rate on a 2-year bond is 10 percent, and the current rate on a 3-year bond is 12 percent.If the expectations theory of the term structure is correct, what is the 1-year interest rate expected during Year 3? (Base your answer on an arithmetic rather than geometric average.)

You are given the following data: $\begin{array}{llcc} \text {r*= real risk-free rate } &4\%\\ \text {Constant inflation premium } &7\%\\ \text {Maturity risk premium } &1\%\\ \text { Default risk premium for AAA bonds } &3\%\\ \text { Liquidity premium for long-term T-bonds } &2\%\\\end{array}$ Assume that a highly liquid market does not exist for long-term T-bonds, and the expected rate of inflation is a Constant.Given these conditions, the nominal risk-free rate for T-bills is , and the rate on long-term Treasury Bonds is .

The term structure is defined as the relationship between interest rates and maturities of similar securities.