Question

4.Which of the following statements is (are) correct?(x)A 2-year Treasury security has a higher liquidity risk premium than a 2-year corporate bond because the current White House administration is in the process of melting down (liquifying).(y)AAA corporate bonds have a lower interest rate than BBB corporate bonds because the default risk premium is higher on a BBB corporate bond than a AAA corporate bond.(z)The higher the default risk, the higher the interest rate that security buyers will demand.

A.(x), (y) and (z)

B. (x) and (y) only

C.(x) and (z) only

D.(y) and (z) only

E.(z) only

5.Which of the following statements is (are) correct?(x)Suppose Saradeposits money in a bank account that pays anannual nominal interest rate of 2.75 percent. If the real rate of interest is 1.5 percent, then, at the end of one year the purchasing power ofSara’s account has increased less than the number of dollars in the account.(y)If the nominal rate of interest is 4.25percentand the expected inflation rate is 1.50percent, then the real rate ofinterestis 2.75 percent.(z)If a particular bond does not have liquidity risk, maturity risk, or default risk then the nominal rate would be less than the real rate in the scenario where deflation exists.

A.(x), (y) and (z)

B. (x) and (y) only

C.(x) and (z) only

D.(y) and (z) only

E.(z) only

Answer 1

4. ANSWER:

D.(y) and (z) only

Because AAA corporate bonds offer more security and naturally comparatively lesser returns to the investor than a BBB corporate bond, which is more risky & hence offer higher returns.

5. ANSWER:

A.(x), (y) and (z)

X--Yes.the Purchasing power ofSara’s account would have increased --but not to the extent of the number of dollars in her account-- but reduced to the extent of the rate of inflation.ie. 2.75%-1.5%= 1.25%

Y-YES ---Nominal rate-Inflation rate= Real rate, ie. 4.25%-1.5%=2.75%

Z-YES---Deflation is decreasing price levels--in the absence of all the risks mentioned, real rate will be more than the nominal rate.