1 In general, an upward-sloping term structure implies that investors expect future short-term interest rates to?

2

The CAPM shows that the expected return for an asset depends on three things:

I. the risk-free rate of return

II. the reward for bearing idiosyncratic risk

III. the amount of systematic risk

IV. the reward for bearing systematic risk

V. the reward for bearing unique risk

3 The expectations theory of the term structure of interest implies:

a that investors can expect to achieve the same return over any future period, regardless of the security in which they invest.

b there is a risk that borrowers may default on the payment of the principal

c that interest received on securities is in accordance with term to maturity

d there is a premium due to uncertainty about the future level of interest rates

4 Liquidity premium theory suggests that

a the market for some securities may be thinly traded; hence, investors require a reward for this risk

b there is a premium on longer maturities versus shorter maturities due to increasing uncertainty about the future level of interest rates as maturity increases

c there is a downward bias in the yield curve.

d there is an upward bias in the yield curve because interest rate risk decreases with term to maturity

5 The following one-year "forward" rates exist for each of the years 2012-2016

1/1/12 - 31/12/12 20.00%

1/1/13 - 31/12/13 25.00%

1/1/14 - 31/12/14 20.00%

1/1/15 - 31/12/15 20.00%

1/1/16 - 31/12/16 11.11%

Calculate the 1, 2, 3, 4, and 5 year spot rates as at 1/1/12