1. Assume that inflation is expected to decline steadily in the future, but that the real risk-free rate, r*, will remain constant. Which of the following statements is CORRECT, other things held constant?
If inflation is expected to decline, there can be no maturity risk premium.
If the pure expectations theory holds, the corporate yield curve must be downward sloping.
If there is a positive maturity risk premium, the Treasury yield curve must be upward sloping.
If the pure expectations theory holds, the Treasury yield curve must be downward sloping.
The expectations theory cannot hold if inflation is decreasing.
2. If the Treasury yield curve is downward sloping, how should the yield to maturity on a 20-year Treasury coupon bond compare to that on a 5-year Treasury coupon bond?
It is impossible to tell without knowing the relative risks of the two securities.
The yield on a 20-year bond would be less than that on a 5-year bond.
The yield on a 20-year bond would have to be higher than that on a 5 year bond because of the maturity risk premium.
It is impossible to tell without knowing the coupon rates of the bonds.
The yields on the two securities would be equal.