The Real Risk-Free Rate Is Expected to Remain Constant at 3

question 9

Multiple Choice

The real risk-free rate is expected to remain constant at 3% in the future,a 2% rate of inflation is expected for the next 2 years,after which inflation is expected to increase to 4%,and there is a positive maturity risk premium that increases with years to maturity.Given these conditions,which of the following statements is CORRECT?

• A) The yield on a 2-year T-bond must exceed that on a 5-year T-bond.
• B) The yield on a 5-year Treasury bond must exceed that on a 2-year Treasury bond.
• C) The yield on a 7-year Treasury bond must exceed that of a 5-year corporate bond.
• D) The conditions in the problem cannot all be true--they are internally inconsistent.
• E) The Treasury yield curve under the stated conditions would be humped rather than have a consistent positive or negative slope.

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Definitions:

Atrial Natriuretic Peptide

A hormone secreted by the heart's atria that regulates blood pressure by decreasing sodium ion concentration and therefore reducing blood volume.

Osmoconformer

An animal in which the salt concentration of body fluids varies along with changes in the surrounding sea water so that it stays in osmotic equilibrium with its surroundings.

Osmoregulator

An organism that regulates its internal osmotic pressure, maintaining fluid and electrolyte balance despite external conditions.

Antidiuretic Hormone

A hormone released by the pituitary gland that regulates water retention in the body by increasing the concentration of solutes in the blood.