Question

Which of the following statements 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

a) The better the bond rating, the more default risk associated with the bond, the higher is the nominal interest rate- False, the better the bond rating the less default risk associated with the bond.

b) Real risk free is added to protect investors against loss of purchasing power for goods. - False

An inflation premium premium is added to the real risk free rate to protect investors against loss of purcahsing power

c) The higher inflation rate expected in the future, the lower is the nominal interest rate.- False

Nominal Rate = Real Rate + Inflation Rate, if inflation rate is expected to be higher than nominal rate should also be higher

d) Maturity risk premiums are generally higher on short-term bonds than on long-term bonds.- False

A risk premium for maturity compensates investors for holding securities over time. Thus, longer term bonds have higher maturity risk premiums

e) Other things held constant, the more liquid is a bond, the lower is the nominal interest rate -True

Thus, the correct answer is option e i.e. Other things held constant, the more liquid is a bond, the lower is the nominal interest rate

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