Question 37 Suppose the real risk-free rate is 3.00%, the average expected futur

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Question 37 Suppose the real risk-free rate is 3.00%, the average expected future inflation rate is 4.10%, and a maturity risk premium of 0.10% per year to maturity applies, i.e., MRP = 0.10%(t), where t is the years to maturity. What rate of return would you expect on a 1-year Treasury security, assuming the pure expectations theory is NOT valid? Include the cross-product term, i.e., if averaging is required, use the geometric average. Answer 7.98% 5.93% 7.32% 5.64% 7.10% 2 points Question 38 Your girlfriend just won the Florida lottery. She has the choice of $16,600,000 today or a 20-year annuity of $1,050,000, with the first payment coming one year from today. What rate of return is built into the annuity? Answer 2.75% 2.73% 2.52% 2.35% 2.54% 2 points Question 39 Assume that the rate on a 1-year bond is now 6%, but all investors expect 1-year rates to be 7% one year from now and then to rise to 8% two years from now. Assume also that the pure expectations theory holds, hence the maturity risk premium equals zero. Which of the following statements is CORRECT? Answer The yield curve should be downward sloping, with the rate on a 1-year bond at 6%. The interest rate today on a 2-year bond should be approximately 6%. The interest rate today on a 2-year bond should be approximately 7%. The interest rate today on a 3-year bond should be approximately 7%. The interest rate today on a 3-year bond should be approximately 8%.

Explanation / Answer

37)(1+r) =(1+r*)*(1+IP) + MRP

r = 1.03 * 1.041-1 +0.10 = 7.32%

38)

39) the interest rate on a 3-year bond would be approximately 7%

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