Chapter 6

Suppose that your marginal tax rate is 40​%. Your​ after-tax return from holding​ (to maturity) a​ one-year corporate bond with a yield to maturity of 5​% is ---- ​ Suppose your marginal income tax rate is 35​%. If a corporate bond pays 10%, then the interest rate that an otherwise identical municipal bond have to pay in order for you to be indifferent between holding the corporate bond and the municipal bond is ------​ In which of the following situations would you choose to hold the corporate bond over the municipal​ bond, assuming that corporate and municipal bonds have the same​ maturity, liquidity, and default​ risk? A. The corporate bond pays​ 10%, the municipal bond pays​ 9%, and your marginal income tax rate is​ 20%. B. The corporate bond pays​ 10%, the municipal bond pays​ 8%, and your marginal income tax rate is​ 25%. C. The corporate bond pays​ 10%, the municipal bond pays​ 7%, and your marginal income tax rate is​ 35%. D. The corporate bond pays​ 10%, the municipal bond pays​ 7%, and your marginal income tax rate is​ 25%.

3​%. 7%. D

According to the liquidity premium theory of the term structure of interest​ rates, if the​ one-year bond rate is expected to be 3​%, 6​%, and 9​% over each of the next three​ years, and if the liquidity premium on a​ three-year bond is 11​%, then the interest rate on a​ three-year bond is ------- According to the liquidity premium and preferred habitat theories of the term structure of interest​ rates, a flat yield curve indicates that A. future​ short-term interest rates are expected to stay the same. B. future​ short-term interest rates are expected to fall. C. bondholders no longer prefer​ short-term bonds to​ long-term bonds. D. future​ short-term interest rates are expected to rise.

7​%. B

Will a U.S. Treasury bill have a risk premium that is higher​ than, lower​ than, or the same as that of a similar security​ (in terms of maturity and​ liquidity) issued by the government of​ Colombia? A. A U.S. Treasury bill will have a lower risk premium since U.S. government issued securities are usually considered to be default free. B. A U.S. Treasury bill will have the same risk premium as that of a similar security issued by the government of Colombia. C. A U.S. Treasury bill may have a higher risk premium depending on the fiscal imbalances that each country exhibits at a given point in time.

A

What would happen to the risk premiums of municipal bonds if the federal government guarantees today that it will pay creditors if municipal governments default on their payments. A. Risk premium on municipal bonds will stay the same. B. Risk premium on municipal bonds will decrease. C. Risk premium on municipal bonds will increase. D. There is not enough information to tell. Do you think that it will then make sense for municipal bonds to be exempt from income​ taxes? A. No. If this were to​ happen, then municipal bonds will be even better than U.S. government bonds. B. Yes. Municipal bonds will continue to have higher risk premium than Treasury bonds and will need​ "help" to gain access to funds.

B A

Which of the following statements is not true​? A. When​ short-term interest rates are​ high, yield curves tend to be downward sloping. B. When short−term interest rates are low, yield curves tend to be inverted. C. Yield curves almost always slope upward D. Interest rates on bonds of different maturities tend to move together over time According to the segmented markets theory of the term structure of interest​ rates, if bondholders prefer​ short-term bonds to​ long-term bonds, the yield curve will be ------- .

B upward sloping

If junk bonds are​ "junk," then why would investors buy​ them? A. Some junk bonds may have a rating of​ AA- by the​ credit-rating agencies. B. Junk bonds have lower default risk. C. Junk bonds can provide high yields. D. The theory of portfolio choice predicts that portfolios with junk bonds are more diversified.

C

What will happen to interest rates on a​ corporation's bonds if the federal government guarantees today that it will pay creditors if the corporation goes bankrupt in the​ future? Interest rates on corporate bonds will ----- .

decrease

If expectations of future​ short-term interest rates suddenly​ fall, what would happen to the slope of the yield​ curve? The yield curve would become ----- .

flatter

If the income tax exemption on municipal bonds were​ abolished, the interest rates on these bonds would ----- .

increase

If a yield curve looks like the one shown in the figure to the​ right, what is the market predicting about the movement of future​ short-term interest​ rates? The market is predicting that future​ short-term interest rates will ---- . What might the yield curve indicate about the​ market's predictions for the inflation rate in the​ future? The​ market's predictions indicate that inflation will be ---- in the future.

increase higher

If the yield curve suddenly becomes​ steeper, how would you revise your predictions of interest rates in the​ future? You would --- your predictions of future interest rates.

raise

You are given the following series of​ one-year interest​ rates: 33​%, 55​%, 1313​%, 1515​% Assuming that the expectations theory is the correct theory of the term​ structure, calculate the interest rates in the term structure for maturities of one to four​ years, and plot the resulting yield curve. 1. Using the point drawing​ tool, plot the interest rate​ (calculated using the data​ above) for each of the four terms to maturity. Properly label each point according to its corresponding term. 2. Using the​ 4-point curved line drawing tool​, connect these points. Label your curve​ 'yield curve'. Carefully follow the instructions​ above, and only draw the required objects. How would your yield curve change if people preferred​ shorter-term bonds over​ longer-term bonds? The yield curve would become ------ .

steeper

The spread between the interest rate on a​ one-year U.S. Treasury bond and a​ 20-year U.S. Treasury bond is known as the ------ . According to the expectations theory of the term structure of interest​ rates, if the​ one-year bond rate is 3​%, and the​ two-year bond rate is 4​%, next​ year's one-year rate is expected to be A. 3%. B. 5​%. C. 4%. D. 6%.

term premium B