Financial Markets, 6 Questions, 2 hours

1.      If expected inflation is 3% and the nominal interest rate is 6%, what is the real rate of interest? If actual inflation turns out to be only 2%, explain who benefits and who loses.

2.      The economy is suffering from a recession, explain what will happen to the yield spread between a Treasury bond and a BBB rated corporate bond. 

3.      What is the difference between preferred and common stock?  If you want higher expected returns, which would you purchase? Which is riskier; why?

4.      All else equal, which would offer a higher interest rate: a seven-year Treasury note or a fifteen-year Treasury bond?  Explain.

5.      Assume that the city of Chicago issues both general obligation and revenue municipal bonds.  Do the bonds have equal risk? Why or why not?

6.      Two securities of equal risk are available for investment—a money market security and a capital market security.  Assuming a normal yield curve, which security should be purchased to achieve the highest yield?  Why?