Question

Which of the following statement is CORRECT?

a.	The better the bond rating, the more default risk associated with the bond, the higher is the nominal interest rate.
	b.	Real risk free is added to protect investors against loss of purchasing power for goods.
	c.	The higher inflation rate expected in the future, the lower is the nominal interest rate.
	d.	Maturity risk premiums are generally higher on short-term bonds than on long-term bonds
	e.	Other things held constant, the more liquid is a bond, the lower is the nominal interest rate

Answer 1

Solution

Option E is correct i.e"Other things held constant, the more liquid is a bond, the lower is the nominal interest rate"

If the bond is illiquid then the liquidity risk premium is added to bond increasing the risk premium. On the other hand, if the bond is more liquid, the bond will have lower liquidity risk thus lower interest rate

The better the bond rating, the more default risk associated with the bond, the higher is the nominal interest rate.( This is incorrect as better the rating lesser is default risk thus lesser the risk premium, thus lesser interest

The higher the inflation rate expected in the future, the lower is the nominal interest rate . This statement is wrong as inflation and nominal interest rates are directly proportional

Maturity risk premiums are generally higher on short-term bonds than on long-term bonds . This is incorrect as the short term bonds have lower risk premiums as they have lower risk of intrest rate fluctuations while risk premiums are higher on long term bonds due to intrest rate fluctuation risks being more