Tutorial Exercises – Practise more!

1. A financial adviser has just given you the following advice: “Long-term bonds are a great investment
because their interest rate is over 20%”. Is the financial advisor right?

2. If bonds of different maturities are close substitutes, their interest rates are more likely to move
together.” Is this statement true, false?

3. In the fall of 2008, AIG, the largest insurance company in the world at the time, was at
risk of defaulting due to the severity of the global financial crisis. As a result, the U.S.
government stepped in to support AIG with large capital injections and an ownership stake. How
would this affect, if at all, the yield and risk premium on AIG corporate debt?

4. If a yield curve looks like the one shown in the figure below, what might the yield curve indicate
about the market’s predictions for the inflation rate in the future?
5. The table below shows current and expected future one-year interest rates, as well as current interest
rates on multiyear bonds. Use the table to calculate the liquidity premium for each multiyear bond.

One-Year Bond Multiyear Bond

Year
Rate Rate
1 2% 2%
2 5% 4%
3 7% 5%
4 8% 7%
5 10% 10%
The liquidity premiums for each year are given as: (enter your responses rounded to two decimal places.)