FINC 514 EXAM QUESTIONS AND
CORRECT ANSWERS VERIFIED
2025/2026.
Chapter 6
Which tend to be more volatile, short- or long-term interest rates? - ANS Short-term interest
rates
If the inflation rate was 3.00% and the nominal interest rate was 4.60% over the last year, what
was the real rate of interest over the last year? Disregard cross-product terms; that is, if
averaging is required, use the arithmetic average. - ANS The nominal interest rate consists of
the real rate of interest and inflation. In this case, the nominal interest rate is 4.60%, and the
inflation rate is 3.00%.
So the real rate of interest is 4.60% - 3.00% = 1.60%.
Based on your understanding of the determinants of interest rates, if everything else remains
the same, which of the following will be true?
- The yield on U.S. Treasury securities always remains static.
- In theory, the yield on a bond with a longer maturity will be higher than the yield on a bond
with a shorter maturity. - ANS In theory, the yield on a bond with a longer maturity will be
higher than the yield on a bond with a shorter maturity.
1 @COPYRIGHT 2025/2026 ALLRIGHTS RESERVED.
,Suppose the real risk-free rate and inflation rate are expected to remain at their current levels
throughout the foreseeable future. Consider all factors that affect the yield curve. Then identify
which of the following shapes that the US Treasury yield curve can take. Check all that apply.
- Inverted yield curve
- Upward-sloping yield curve
- Downward-sloping yield curve - ANS - Inverted yield curve
- Upward-sloping yield curve
- Downward-sloping yield curve
If inflation is expected to decrease in the future and the real rate is expected to remain steady,
then the Treasury yield curve is downward sloping. (Assume MRP = 0.) - ANS True
The default risk on Walmart's short-term debt will be higher than the default risk on its long-
term debt. - ANS False
The yield curve for a BBB-rated corporate bond is expected to be above the US Treasury bond
yield curve. - ANS True
Yield curves of highly liquid assets will be lower than yield curves of relatively illiquid assets. -
ANS True
The pure expectations theory assumes that a one-year bond purchased today will have the
same return as a one-year bond purchased five years from now. - ANS False
The pure expectations theory assumes that the maturity risk premium is zero (MRP = 0). This
suggests that investing consecutively in short-term bonds will provide the same return as a long-
term bond.
This premium is added when a security lacks marketability, because it cannot be bought and
sold quickly without losing value. - ANS Liquidity risk premium (LP)
2 @COPYRIGHT 2025/2026 ALLRIGHTS RESERVED.
, As interest rates rise, bond prices fall, and as interest rates fall, bond prices rise. Because
interest rate changes are uncertain, this premium is added as a compensation for this
uncertainty. - ANS Maturity risk premium (MRP)
This is the difference between the interest rate on a US Treasury bond and a corporate bond of
the same profile—that is, the same maturity and marketability. - ANS Default risk premium
(DRP)
This is the rate on short-term US Treasury securities, assuming there is no inflation. -
ANS Real risk-free rate (r*)
Over the past several years, Germany, Japan, and Switzerland have had lower interest rates than
the United States due to lower values of this premium. - ANS Inflation premium (IP)
It is calculated by adding the inflation premium to r*. - ANS Nominal risk-free rate (Rrf)
Countries with strong balance sheets and declining budget deficits tend to have lower interest
rates. - ANS True
If the Fed injects a huge amount of money into the markets, inflation is expected to decline, and
long-term interest rates are expected to rise. - ANS False
During the credit crisis of 2008, investors around the world were fearful about the collapse of
real estate markets, shaky stock markets, and illiquidity of several securities in the United States
and several other nations. The demand for US Treasury bonds increased, which led to a rise in
their price and a decline in their yields. - ANS True
The Federal Reserve's ability to use monetary policy to control economic activity in the United
States is limited because US interest rates are highly dependent on interest rates in other parts
of the world. - ANS True
3 @COPYRIGHT 2025/2026 ALLRIGHTS RESERVED.
CORRECT ANSWERS VERIFIED
2025/2026.
Chapter 6
Which tend to be more volatile, short- or long-term interest rates? - ANS Short-term interest
rates
If the inflation rate was 3.00% and the nominal interest rate was 4.60% over the last year, what
was the real rate of interest over the last year? Disregard cross-product terms; that is, if
averaging is required, use the arithmetic average. - ANS The nominal interest rate consists of
the real rate of interest and inflation. In this case, the nominal interest rate is 4.60%, and the
inflation rate is 3.00%.
So the real rate of interest is 4.60% - 3.00% = 1.60%.
Based on your understanding of the determinants of interest rates, if everything else remains
the same, which of the following will be true?
- The yield on U.S. Treasury securities always remains static.
- In theory, the yield on a bond with a longer maturity will be higher than the yield on a bond
with a shorter maturity. - ANS In theory, the yield on a bond with a longer maturity will be
higher than the yield on a bond with a shorter maturity.
1 @COPYRIGHT 2025/2026 ALLRIGHTS RESERVED.
,Suppose the real risk-free rate and inflation rate are expected to remain at their current levels
throughout the foreseeable future. Consider all factors that affect the yield curve. Then identify
which of the following shapes that the US Treasury yield curve can take. Check all that apply.
- Inverted yield curve
- Upward-sloping yield curve
- Downward-sloping yield curve - ANS - Inverted yield curve
- Upward-sloping yield curve
- Downward-sloping yield curve
If inflation is expected to decrease in the future and the real rate is expected to remain steady,
then the Treasury yield curve is downward sloping. (Assume MRP = 0.) - ANS True
The default risk on Walmart's short-term debt will be higher than the default risk on its long-
term debt. - ANS False
The yield curve for a BBB-rated corporate bond is expected to be above the US Treasury bond
yield curve. - ANS True
Yield curves of highly liquid assets will be lower than yield curves of relatively illiquid assets. -
ANS True
The pure expectations theory assumes that a one-year bond purchased today will have the
same return as a one-year bond purchased five years from now. - ANS False
The pure expectations theory assumes that the maturity risk premium is zero (MRP = 0). This
suggests that investing consecutively in short-term bonds will provide the same return as a long-
term bond.
This premium is added when a security lacks marketability, because it cannot be bought and
sold quickly without losing value. - ANS Liquidity risk premium (LP)
2 @COPYRIGHT 2025/2026 ALLRIGHTS RESERVED.
, As interest rates rise, bond prices fall, and as interest rates fall, bond prices rise. Because
interest rate changes are uncertain, this premium is added as a compensation for this
uncertainty. - ANS Maturity risk premium (MRP)
This is the difference between the interest rate on a US Treasury bond and a corporate bond of
the same profile—that is, the same maturity and marketability. - ANS Default risk premium
(DRP)
This is the rate on short-term US Treasury securities, assuming there is no inflation. -
ANS Real risk-free rate (r*)
Over the past several years, Germany, Japan, and Switzerland have had lower interest rates than
the United States due to lower values of this premium. - ANS Inflation premium (IP)
It is calculated by adding the inflation premium to r*. - ANS Nominal risk-free rate (Rrf)
Countries with strong balance sheets and declining budget deficits tend to have lower interest
rates. - ANS True
If the Fed injects a huge amount of money into the markets, inflation is expected to decline, and
long-term interest rates are expected to rise. - ANS False
During the credit crisis of 2008, investors around the world were fearful about the collapse of
real estate markets, shaky stock markets, and illiquidity of several securities in the United States
and several other nations. The demand for US Treasury bonds increased, which led to a rise in
their price and a decline in their yields. - ANS True
The Federal Reserve's ability to use monetary policy to control economic activity in the United
States is limited because US interest rates are highly dependent on interest rates in other parts
of the world. - ANS True
3 @COPYRIGHT 2025/2026 ALLRIGHTS RESERVED.
