Question

1. If a company experiences a decrease in their credit rating, what is the likely effect on the yield on their long term bonds?

The yield will increase due to the default risk premium

The yield will increase due to the maturity risk premium

The yield will decrease due to the default risk premium

The yield will decrease due to the maturity risk premium

2. The real risk-free rate of interest is 3%. Inflation is expected to be 2% this year and 4% next year. Assume that the maturity risk premium is zero. What is the yield on a 2-year Treasury security? (express your answer as a percentage. Do not include the % symbol)

3. What will happen to a yield curve if there is an increase in the real risk free rate of interest?

The yield curve will shift up

The yield curve will shift down

The yield curve slope will decrease

The yield curve slope will increase

Answer 1

1)Rating is based on corporations ability and willingness to pay interest and repay principal as schedued .As credit rating decreases ,the possibility of default increases.

correct option is "A" -The yield will increase due to the default risk premium

2)yield on a 2-year Treasury security =Risk free rate+ Average inflation+MRP

              = 3+3+0

             = 6%

**Average infation= [2+4]/2 = 6/2 = 3%

3)correct option is "A" -

since there is a increase in real risk free rate of interest ,the yield curve will shift up .