Deck 5: Time-Varying Rates of Return and the Yield Curve

Question 1

Which of the following terms refers to a decrease in price levels?

A)inflation
B)hyperinflation
C)deflation
D)disinflation

Answer 1

deflation

Question 2

A "nominal return" is

A)a return that has not been adjusted for inflation.
B)the type of return that is quoted for securities by the financial press.
C)the return that a security would have earned had there been no inflation.
D)both A and B.

Answer 2

both A and B.

Question 3

You bought a piece of art from a Starving Artist's sale in early 1990 for $50.00. In early 2008, it is worth $500.00. What is the annualized rate of return on your investment, rounded to the
Nearest tenth of a percent?

A)13.6%
B)25.0%
C)50.0%
D)12.5%

Answer 3

13.6%

Question 4

Investors Mutual Fund reported a total 10-year return of 326%. This translates to an annualized rate of return, rounded to the nearest tenth of a percent, of

A)15.6%.
B)78.4%.
C)12.5%.
D)32.6%.

Question 5

You invested $70,000 in a piece of real estate four years ago. Today it is worth $100,000. What is the annualized rate of return on this investment, rounded to the nearest tenth of a percent?

A)9.3%
B)7.5%
C)10.7%
D)none of the above

Question 6

A project will cost $12,000 and will provide cash flows of $3,000, $5,000, and $5,600 at
the end of the following three years. The annualized interest rate is 8% per annum
over one year, 8.5% per annum over two years, and 9.2% per annum over three years.
Should you undertake this project? Explain your answer.

Question 7

If you make an investment that returns 10% the first year, 20% the second year, and 12% the third year, what is your total 3-year return? Round your answer to the nearest tenth of a
Percent.

A)21.6%
B)42.0%
C)47.8%
D)none of the above

Question 8

In the United States, most contracts are written in

A)nominal terms.
B)deflated terms.
C)real terms.
D)inflation-indexed terms.

Question 9

A "real return" is

A)a return that has not been adjusted for inflation.
B)the return that a security would have earned had there been no inflation.
C)the type of return that is quoted for securities by the financial press.
D)both A and B.

Question 10

The term "inflation" refers to

A)an increase in gross domestic product.
B)an increase in real interest rates.
C)an increase in nominal interest rates.
D)an increase in general price levels.

Question 11

Your total return on an investment was -12% over an eight-year holding period. What was your annualized rate of return, rounded to the nearest tenth of a percent?

A)-1.6%
B)-9.84%
C)-0.98%
D)-1.5%

Question 12

If you make an investment that earns 10% the first year, -5% the second year, -2% the third year, and 12% the fourth year, what is your total 4-year return? Round your answer to the
Nearest tenth of a percent.

A)15.0%
B)14.7%
C)31.9%
D)none of the above

Question 13

According to a 1996 study, the CPI tends to

A)be manipulated frequently by the government for political purposes.
B)understate the general increase in price levels.
C)overstate the general increase in price levels.
D)Both A and C are true.

Question 14

A mutual fund reported the following quarterly returns for the year: 2%, -0.5%, 1.5%, 5%. What was its total return for the year? Round your answer to the nearest tenth of a percent.

A)3.3%
B)37%.
C)8.0%
D)8.2%

Question 15

What range of inflation rates do many economists currently believe is healthy?

A)2% to 4%
B)0% to 1%
C)3% to 5%
D)1% to 3%

Question 16

You paid $75,000 for 13 acres of land in 2005 and sold the land four years later for $120,000. What was the annualized rate of return on your investment, rounded to the nearest tenth of a
Percent?

A)9.9%
B)12.5%
C)15.0%
D)none of the above

Question 17

In the United States, the inflation rate is measured by calculating the change in

A)the public price index.
B)short-term interest rates.
C)long-term interest rates.
D)the consumer price index.

Question 18

If you make an investment that earns 10% the first year and loses 10% the second year, what is your total 2-year return?

A)+1%
B)0%
C)+5%
D)-1%

Question 19

The Trinity Mutual Fund reported a total 5-year return of 200%. What was its annualized rate of return? Round your answer to the nearest tenth of a percent.

A)40.0%
B)14.9%
C)31.6%
D)24.6%

Question 20

Your total return on a certain investment was -25% for a five-year holding period. What was your annualized rate of return, rounded to the nearest tenth of a percent?

A)+9.4%
B)-9.4%
C)-5.0%
D)-5.6%

Question 21

Which of the following statements regarding real and nominal interest rates is true?

A)Although real interest rates may be either positive or negative, nominal interest rates will always be positive.
B)Although nominal interest rates may be either positive or negative, real interest rates will always be positive.
C)If a security has a positive nominal return, then its real return will also be positive.
D)Both real and nominal interest rates may be either positive or negative.

Question 22

Abraham invests only in Treasury securities because he read that they are risk-free.
Comment on Abraham's investment strategy.

Question 23

If yields on long-term bonds are lower than the yields on short-term bonds, the term structure is said to be

A)humped.
B)downward sloping.
C)flat.
D)upward sloping.

Question 24

Assume that the following data on U.S. Treasury securities is current:
Refer to the information above. How much will a $10,000 investment in 5-year Treasury notes return if the investment is held to
Maturity? Round your answer to the nearest $10.

A)$52,180
B)$10,440
C)$52,160
D)$12,380

Question 25

Assume that the following data on U.S. Treasury securities is current:
Refer to the information above. How much will a $20,000 investment in 10-year Treasury bonds return if the investment is held to maturity? Round your answer to the nearest $10.

A)$209,180
B)$208,640
C)$20,920
D)$31,330

Question 26

If an investment offered a nominal return of 10%, and inflation was 15.8% over the period, what was the real return on this investment? Round your answer to the nearest tenth of a
Percent.

A)+4.8%
B)+0.9%
C)-13.6%
D)-5.0%

Question 27

Your savings account yielded 1.5% last year. The inflation rate was 2%. What real return did you earn on this account? Round your answer to the nearest tenth of a percent.

A)-0.5%
B)+1.0%
C)-1.0%
D)+0.1%

Question 28

If the nominal interest rate is 14%, and inflation is 4%, what is the real interest rate? Round your answer to the nearest tenth of a percent.

A)9.1%
B)9.6%
C)-8.8%
D)11.9%

Question 29

The real interest rate is 2% a year, and the inflation rate is 3.4% a year. What is the present value of a $10,000 nominal payment next year? Round your answer to the nearest $10.

A)$10,140
B)$8,992
C)$9,480
D)$9,860

Question 30

The term structure of interest rates depicts the relationship between yield to maturity and

A)forward rates.
B)default risk.
C)time to maturity.
D)coupon rates.

Question 31

The inflation rate is a constant 3% a year and the nominal interest rate is a constant 6% a year. How much must you have in your retirement account today if you want to make withdrawals
Of $60,000 a year, quoted in today's dollars, each year for the next 30 years? Round your answer
To the nearest $10,000.

A)$830,000
B)$1,190,000
C)$1,940,000
D)$1,750,000

Question 32

What is inflation and how is it usually measured? Be specific.

Question 33

The real interest rate is 1.8% per annum, and the inflation rate is 3% a year. What is the present value of a nominal payment of $5,000 next year? Round your answer to the nearest $10.

A)$4,910
B)$4,550
C)$4,770
D)none of the above

Question 34

A project's cash flows will grow 1.5% faster than the rate of inflation forever. The first cash flow will be $100 and will occur at the end of the year. The inflation rate is a constant 3.2%,
And the nominal interest rate is 10%. What is the value of this project?

A)$1,887
B)$2,941
C)$5,263
D)$1,471

Question 35

The inflation rate is 3.5% a year, and the real interest rate is -2% a year. If a project will provide a perpetual nominal cash flow of $1,000 a year, what is the project's value? Round
Answers to the nearest hundredth of a percent and to the nearest $10.

A)$69,930
B)$17,950
C)$10,200
D)none of the above

Question 36

The inflation rate is a constant 3% a year, and the real interest rate is a constant 1% a year. How much must you have in your retirement account today if you want to make a withdrawal
Of $50,000 a year, quoted in today's dollars, each year after retirement for 25 years. Assume your
First withdrawal will be at the end of this year, and round your answer to the nearest thousand
Dollars.

A)$5,150,000
B)$780,000
C)$1,290,000
D)$1,105,000

Question 37

Assume that the following data on U.S. Treasury securities is current:
Refer to the information above. What is the implied interest rate on a one-year Treasury issued at the end of one year?

A)1.92%
B)0.96%
C)4.36%
D)none of the above

Question 38

The inflation rate is 3.5% a year, and the real interest rate is 2% a year. If a project will provide a perpetual real cash flow of $1,000 a year, what is the project's value?

A)$50,000
B)$17,953
C)$9,804
D)$10,101

Question 39

A bond investment yielded 8%. If inflation was 3%, what real return did the bond offer? Round your answer to the nearest tenth of a percent.

A)+4.9%
B)+5.2%
C)+1.0%
D)-4.6%

Question 40

An investment earned an average return of 20% per year. During the investment period, the real interest rate averaged 1.8% a year. To the nearest tenth of a percent, the implied average
Annual inflation rate was

A)17.9%.
B)1.2%.
C)1.8%.
D)22.2%.

Question 41

What is an inverted yield curve? What do many people think it signals?

Question 42

True, false, or uncertain: Given that the yield curve is generally upward sloping,
longer-term bonds are better investments than shorter-term bonds because they offer
higher returns.

Question 43

TIPS are

A)bonds issued by the U.S. government that are indexed to inflation.
B)bonds issued by the U.S. government that earn interest that is free from federal taxation.
C)bonds issued by the U.S. government with initial maturities of 12 months or less.
D)zero-coupon bonds that represent coupon or principal payments stripped from a level-coupon bond.

Question 44

Define: Term structure of interest rates. What term structure is considered "normal"?

Question 45

Which of the following statements is true?

A)Longer-term projects must offer higher expected rates of return, which translate into higher NPVs.
B)Short-term projects usually have lower costs of capital than long-term projects.
C)Because shorter-term borrowing is cheaper than long-term borrowing, short-term projects are more likely to be positive NPV projects.
D)All of the above are true statements.

Question 46

True, false, or uncertain: Longer-term projects have higher costs of capital than
short-term projects.

Question 47

An upward sloping yield curve means that

A)long-term bonds are a better investment than short-term bonds.
B)deflation is expected in the future.
C)short-term interest rates are more volatile than long-term interest rates.
D)none of the above.

Question 48

Assume that the following data on U.S. Treasury securities is current:
Refer to the information above. You purchase a $1,000, zero-coupon, Treasury bond that matures in five years. Assume the term structure remains constant and that you sell the bond
After holding it only three years. For what price can you sell it?

A)$917.66
B)$958.41
C)$1,135.71
D)none of the above

Question 49

The following yields were reported for Treasury securities on May 12, 2008:
Refer to the information above. Calculate the implied annualized inflation rate over the next 10 years.

A)1.05%
B)0.44%
C)5.24%
D)none of the above

Question 50

Assume that the following data on U.S. Treasury securities is current:
Refer to the information above. What is the implied annualized interest rate on a 2-year bond that is issued at the end of year 5?

A)23.79%
B)11.30%
C)4.57%
D)9.35%

Question 51

Assume that the following data on U.S. Treasury securities is current:
Refer to the information above. You purchase a $1,000, zero-coupon, Treasury bond that matures in seven years. Assume the term structure remains constant and that your sell the
Bond after having held it only 5 years. At what price should you be able to sell it?

A)$1,237.86
B)$914.50
C)$807.85
D)$958.22

Question 52

Assume that the following data on U.S. Treasury securities is current:
Refer to the information above. What is the implied interest rate on a one-year Treasury issued two years from today?

A)2.15%
B)4.34%
C)0.00%
D)0.96%

Question 53

The following yields were reported for Treasury securities on May 12, 2008:
Refer to the information above. Calculate the implied annualized inflation rate over the next 7 years.

A)+0.98%
B)-2.17%
C)+4.48%
D)+2.21%

Question 54

Assume that the following data on U.S. Treasury securities is current:
Refer to the information above. According to the term structure, what would you have to pay for a $1,000, zero-coupon, Treasury bond that matures in five years?

A)$958.22
B)$808.62
C)$807.85
D)none of the above

Question 55

Assume that the following data on U.S. Treasury securities is current:
Refer to the information above. What is the implied annualized interest rate on a 10-year bond that is issued 10 years from today.

A)1.82%
B)4.97%
C)6.24%
D)9.08%

Question 56

A 1-year bond is yielding 7.4%, and the 1-year forward rate at the beginning of year
two is 8.2%. What is the annualized return on a two-year bond?

Question 57

The following yields were reported for Treasury securities on May 12, 2008:
Refer to the information above. Calculate the implied annualized inflation rate over the next five years.

A)-3.73%
B)+2.28%
C)+1.47%
D)none of the above

Question 58

Empirical evidence suggests that the reason that the yield curve is usually upward sloping is that

A)long-term bonds are a better buy than short-term bonds.
B)investors are expecting higher interest rates due to anticipated changes in the economy.
C)investors are expecting higher inflation in the future.
D)long-term bonds are perceived as riskier than short-term bonds.

Question 59

The following yields were reported for Treasury securities on May 12, 2008:
Refer to the information above. Calculate the implied annualized inflation rate over the next 20 years.

A)2.52%
B)6.56%
C)0.74%
D)none of the above

Question 60

In which of the following two bonds would you prefer to invest if you expect interest
rates to decrease by 50 basis points in the near future? Why?
Bond A: A zero-coupon, 10-year Treasury bond
Bond B: A zero-coupon, 15-year Treasury bond

Question 61

A $10,000 Treasury bill that matures in 9 months (270 days)is currently selling at an
ask discount yield of 2.5%. What effective annual return is it offering?

Question 62

What is the Macaulay duration of a $1,000, zero-coupon bond that has a maturity of 10 years if its yield-to-maturity is 6%?

A)10.00 years
B)9.50 years
C)9.43 years
D)Duration is a meaningless number when dealing with zero-coupon bonds.

Question 63

What continuously compounded rate is equivalent to a simple rate of return of 10%?

A)9.53%
B)28.33%
C)10.52%
D)none of the above

Question 64

Calculate the Macaulay duration of a $1,000, level-coupon, 8% bond that matures in three years . The bond makes annual interest payments and repays its principal at the end of the
Third year, and the yield curve is a flat 10%.

A)2.81 years
B)0.59 years
C)2.78 years
D)3.41 years

Question 65

Consider the following term structure: Assume you expect the interest rate on a 1-year Treasury security issued one year
from today to be 4.0%. Describe the trades that you would make to earn a profit if you
are correct, assuming you are able to short sell securities and invest the proceeds from
the short sale immediately. Give an example.

Question 66

If you invest $1,000 at 6%, compounded continuously, how much will you have at the end of the year? Round your answer to the nearest dollar.

A)$1,016
B)$1,058
C)$1,062
D)$1,060