Exam2F07
Multiple Choice
Identify the choice that best completes the statement or answers the question.
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1.
One-year interest rates are 6 percent. The market expects 1-year rates to be 7 percent one year from now. The
market also expects 1-year rates will be 8 percent two years from now. Assume that the expectations theory
holds regarding the term structure (that is, the maturity risk premium equals zero). Which of the following
statements is most correct?
a.
The yield curve is downward sloping.
b.
Today's 2-year interest rate is 8 percent.
c.
Today's 2-year interest rate is 7 percent.
d.
Today's 3-year interest rate is 7 percent.
e.
Today's 3-year interest rate is 9 percent.
____
2.
Assume that the current yield curve is upward sloping, or normal. This implies that
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3.
The real risk-free rate of interest, r*, equals 2 percent. Inflation is expected to be 2 percent per year over the
next five years and then 3 percent per year thereafter. The maturity risk premium (MRP) equals 0.05%(t - 1),
where t = the maturity of the bond. A 10-year corporate bond has a yield of 7.8 percent. The default risk
premium is 2.85% and the liquidity premium is 0.
What is the yield on the 12-year bond?
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4.
You observe the following yield curve for Treasury securities:
Maturity
Yield
1 year
5.6%
2 years
5.8
5 years
6.2
7 years
6.6
9 years
6.8
Assuming that the expectations theory holds, what does the market expect the yield on 2-year Treasury
securities to be five years from today?

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5.
Bob has a $50,000 stock portfolio with a beta of 1.2, an expected return of 10.8 percent, and a standard
deviation of 25 percent. Becky has a $50,000 portfolio with a beta of 0.8, an expected return of 9.2 percent,
and a standard deviation of 25 percent. The correlation coefficient, r, between Bob's and Becky's portfolios is
0. Bob and Becky are engaged to be married. Which of the following best describes their combined $100,000
portfolio?
a.
The combined portfolio's expected return is a simple average of the expected returns of the
two individual portfolios (10%).
b.
The combined portfolio's beta is a simple average of the betas of the two individual
portfolios (1.0).
c.
The combined portfolio's standard deviation is less than a simple average of the two
portfolios' standard deviations (25%), even though there is no correlation between the
returns of the two portfolios.
d.
All of these statements are correct.
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