Financial Markets and Institutions (2-downloads)

Year

1-year rate (%)

1

4.25

2

5.15

3

5.50

4

6.25

5

7.10

8. What effect would reducing income tax rates have on

the interest rates of municipal bonds? Would interest

rates of Treasury securities be affected and, if so, how?

Predicting the Future

9. Predict what will happen to interest rates on a cor-

poration’s bonds if the federal government guarantees

today that it will pay creditors if the corporation goes

bankrupt in the future. What will happen to the inter-

est rates on Treasury securities?

10. Predict what would happen to the risk premiums on

corporate bonds if brokerage commissions were low-

ered in the corporate bond market.

11. If the income tax exemption on municipal bonds were

abolished, what would happen to the interest rates on

these bonds? What effect would it have on interest

rates on U.S. Treasury securities?

Q U A N T I TAT I V E   P R O B L E M S

1. Assuming that the expectations theory is the correct

theory of the term structure, calculate the interest

rates in the term structure for maturities of one to five

years, and plot the resulting yield curves for the fol-

lowing series of one-year interest rates over the next

five years: