ps3_sln - METU, FEAS ECON 311 TA: Nutiye Sekin SA: Hatice...

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METU, FEAS ECON 311 Fall 2009 TA: Nutiye Seçkin SA: Hatice İ pek Inst: Elif Akbostanc ı PROBLEM SET III 1. What factors affect interest rate that is paid on bond? 2. Explain the reason behind the spread between the interest rates on bonds of the same maturity but different default risks. 3. Risk premiums on corporate bonds are usually anticyclical; that is they decrease during business cycle expansions and increase during business cycle recessions. Explain why this is so? 4. Discuss the effect of the effect of a lowering of income tax rates on municipal bonds interest rates? Would interest rates on Treasury bonds be affected, and if so, how? Demonstrate your answer with diagrams. 5. Which theory about the term structure of interest rates assumes that the bonds with different maturities are perfect substitutes? What are the consequences of this assumption? 6. Which theory about the term structure of interest rates assumes that the bonds with different maturities are not substitutes at all? What are the consequences of this assumption? 7. Which theory about the term structure of interest rates assumes that the bonds with different maturities are substitutes but not perfect substitutes? What are the consequences of this assumption? 8. Can liquidity Premium theory explain all three of our conclusions about the term structure of interest rate? 9. Discuss the following statements. Are they true or false? a) If bonds with different maturities are perfect substitutes the expected return on these bonds must be equal. b) Yield curve of the liquidity premium theory has steeper slope than expectations theory. c) If the interest rates of corporate bonds and government treasury bonds are the same in a country, then it is likely that government treasury bonds are default-free bonds.
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d) The U-shaped yield curve in the figure above indicates that short-term interest rates are expected to fall moderately in the near-term and rise later on and that the inflation rate is expected to fall sharply in the near-term and rise later on. e) The statement, “people compare the maturity of the different bonds with their returns in decision of making a bond demand”, contradicts with segmented market hypothesis but not with the liquidity premium theory. 10. Use the following diagram to answer the question: a) Suppose that the short term yields of the above asset are expected to rise. Which term structure theories (expectation theory, segmented market theory, and liquidity premium theory) could explain the expected increase in the short term yields and the upward sloped yield curve phenomena of the above asset? Which ones could not? Explain.
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ps3_sln - METU, FEAS ECON 311 TA: Nutiye Sekin SA: Hatice...

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