EC Chapter 6

25) Which of the following securities has the lowest interest rate? A) Junk bonds B) Canada bonds C) Investment-grade bonds D) Corporate Baa bonds

B

10) If a corporation begins to suffer large losses, then the default risk on the corporate bond will ________. A) increase and the bond's return will become more uncertain, meaning the expected return on the corporate bond will fall B) increase and the bond's return will become less uncertain, meaning the expected return on the corporate bond will fall C) decrease and the bond's return will become less uncertain, meaning the expected return on the corporate bond will fall D) decrease and the bond's return will become less uncertain, meaning the expected return on the corporate bond will rise

A

18) The spread between interest rates on low quality corporate bonds and Canada bonds ________. A) widens significantly during recessions B) narrows significantly during recessions C) narrows moderately during recessions D) does not change during recessions interest rates

A

24) Which of the following long-term bonds has the highest interest rate? A) Corporate Baa bonds B) Canada bonds C) Corporate Aaa bonds D) Provincial bonds

A

31) During a "flight to quality" ________. A) the spread between Canada bonds and Baa bonds increases B) the spread between Canada bonds and Baa bonds decreases C) the spread between Canada bonds and Baa bonds is not affected D) the change in the spread between Canada bonds and Baa bonds cannot be predicted

A

32) Which of the following statements is true? A) A liquid asset is one that can be quickly and cheaply converted into cash. B) The demand for a bond declines when it becomes less liquid, decreasing the interest rate spread between it and relatively more liquid bonds. C) The differences in bond interest rates reflect differences in default risk only. D) The corporate bond market is the most liquid bond market.

A

33) Corporate bonds are not as liquid as Canada bonds because ________. A) fewer corporate bonds for any one corporation are traded, making them more costly to sell B) the corporate bond rating must be calculated each time they are traded C) corporate bonds are not callable D) corporate bonds cannot be resold

A

36) An increase in the liquidity of corporate bonds will ________ the price of corporate bonds and ________ the yield of Canada bonds, everything else held constant. A) increase; increase B) reduce; reduce C) increase; reduce D) reduce; increase

A

37) The risk premium on corporate bonds reflects the fact that corporate bonds have a higher default risk and are ________ Canada bonds. A) less liquid than B) less speculative than C) tax-exempt unlike D) lower-yielding than

A

39) Which of the following statements is true? A) Because coupon payments on tax-exempt bonds are exempt from federal income tax, the expected after-tax return on them will be higher for individuals in higher income tax brackets. B) An increase in tax rates will decrease the demand for tax-exempt bonds, lowering their interest rates. C) Interest rates on tax-exempt bonds will be higher than comparable bonds without the tax exemption. D) Because coupon payments on tax-exempt are exempt from federal income tax, the expected after-tax return on them will be lower for individuals in higher income tax brackets.

A

40) Which of the following statements is true? A) Because coupon payments on tax-exempt bonds are exempt from federal income tax, the expected after-tax return on them will be higher for individuals in higher income tax brackets. B) An decrease in tax rates will increase the demand for U.S Treasury bonds, lowering their interest rates. C) Interest rates on tax-exempt bonds will be higher than comparable bonds without the tax exemption. D) An decrease in tax rates will increase the supply of U.S Treasury bonds, lowering their interest rates.

A

45) If income tax rates were lowered, then ________. A) the prices of tax-exempt bonds would fall B) the interest rate on tax-exempt bonds would fall C) the interest rate on U.S. Treasury bonds would rise D) the prices of tax-exempt bonds would rise

A

46) If income tax rates were lowered, then ________. A) the interest rate on tax-exempt bonds would rise B) the interest rate on U.S. Treasury bonds would rise C) the interest rate on tax-exempt bonds would fall D) the interest rate on tax-exempt bonds would stay the same

A

47) Three factors explain the risk structure of interest rates: ________. A) liquidity, default risk, and the income tax treatment of a security B) maturity, default risk, and the income tax treatment of a security C) maturity, liquidity, and the income tax treatment of a security D) maturity, default risk, and the liquidity of a security

A

6) The spread between the interest rates on bonds with default risk and default-free bonds is called the ________. A) risk premium B) junk margin C) bond margin D) default premium

A

9) A bond with default risk will always have a ________ risk premium and an increase in its default risk will ________ the risk premium. A) positive; raise B) positive; lower C) negative; raise D) negative; lower

A

11) If the possibility of a default increases because corporations begin to suffer losses, then the default risk on corporate bonds will ________, and the bonds' returns will become ________ uncertain, meaning that the expected return on these bonds will decrease, everything else held constant. A) increase; less B) increase; more C) decrease; less D) decrease; more

B

15) An increase in default risk on corporate bonds ________ the demand for these bonds, but ________ the demand for default-free bonds, everything else held constant. A) increases; lowers B) lowers; increases C) does not change; greatly increases D) moderately lowers; does not change

B

17) Which of the following statements is true? A) A decrease in default risk on corporate bonds lowers the demand for these bonds, but increases the demand for default-free bonds. B) The expected return on corporate bonds decreases as default risk increases. C) A corporate bond's return becomes less uncertain as default risk increases. D) As their relative riskiness increases, the expected return on corporate bonds increases relative to the expected return on default-free bonds.

B

19) As their relative riskiness ________, the expected return on corporate bonds ________ relative to the expected return on default-free bonds, everything else held constant. A) increases; increases B) increases; decreases C) decreases; decreases D) decreases; does not change

B

21) Bonds with relatively high risk of default are called ________. A) Brady bonds B) junk bonds C) zero coupon bonds D) investment grade bonds

B

22) Bonds with relatively low risk of default are called ________ securities and have a rating of Baa (or BBB) and above; bonds with ratings below Baa (or BBB) have a higher default risk and are called ________. A) investment grade; lower grade B) investment grade; junk bonds C) high quality; lower grade D) high quality; junk bonds

B

3) Canadian government bonds have no default risk because ________. A) they are backed by the full faith and credit of the federal government B) the federal government can increase taxes to pay its obligations C) they are backed with gold reserves D) they can be exchanged for silver at any time

B

41) The interest rate on tax-exempt bonds falls relative to the interest rate on U.S. Treasury securities when ________. A) there is a major default in the tax-exempt bond market B) income tax rates are raised C) tax-exempt bonds become less widely traded D) corporate bonds become riskier

B

20) Everything else held constant, if the federal government were to guarantee today that it will pay creditors if a corporation goes bankrupt in the future, the interest rate on corporate bonds will ________ and the interest rate on government securities will ________. A) increase; increase B) increase; decrease C) decrease; increase D) decrease; decrease

C

27) Risk premiums on corporate bonds tend to ________ during business cycle expansions and ________ during recessions, everything else held constant. A) increase; increase B) increase; decrease C) decrease; increase D) decrease; decrease

C

30) The collapse of the subprime mortgage market increased the spread between Baa and default-free Canada bonds. This is due to ________. A) a reduction in risk B) a reduction in maturity C) a flight to quality D) a flight to liquidity

C

34) When Canada bonds become more liquid, other things equal, the demand curve for corporate bonds shifts to the ________ and the demand curve for Canada bonds shifts to the ________. A) right; right B) right; left C) left; right D) left; left

C

38) Bonds with relatively low risk of default are called ________. A) zero coupon bonds B) junk bonds C) investment grade bonds D) fallen angels

C

44) If income tax rates were lowered, then ________. A) the interest rate on tax-exempt bonds would fall B) the interest rate on U.S. Treasury bonds would rise C) the interest rate on tax-exempt bonds would rise D) the price of Canada bonds would fall

C

5) Bonds with no default risk are called ________. A) flower bonds B) no-risk bonds C) default-free bonds D) zero-risk bonds

C

8) Which of the following bonds are considered to be default-risk free? A) Municipal bonds B) Investment-grade bonds C) Canadian government bonds D) Junk bonds

C

16) As default risk increases, the expected return on corporate bonds ________, and the return becomes ________ uncertain, everything else held constant. A) increases; less B) increases; more C) decreases; less D) decreases; more

D

2) The risk that interest payments will not be made, or that the face value of a bond is not repaid when a bond matures is ________. A) interest rate risk B) inflation risk C) moral hazard D) default risk

D

23) Which of the following bonds would have the highest default risk? A) Provincial bonds B) Investment-grade bonds C) Canada bonds D) Junk bonds

D

26) During the Great Depression years 1930-1933 there was a very high rate of business failures and defaults, we would expect the risk premium for ________ bonds to be very high. A) federal government B) corporate Aaa C) provincial D) corporate Baa

D

28) If you have a very low tolerance for risk, which of the following bonds would you be least likely to hold in your portfolio? A) A federal government bond B) A provincial bond C) A corporate bond with a rating of Aaa D) A corporate bond with a rating of Baa

D

29) The collapse of the subprime mortgage market ________. A) did not affect the corporate bond market B) increased the perceived riskiness of Treasury securities C) reduced the Baa-Aaa spread D) increased the Baa-Aaa spread

D

35) A decrease in the liquidity of corporate bonds, other things being equal, shifts the demand curve for corporate bonds to the ________ and the demand curve for Canada bonds shifts to the ________. A) right; right B) right; left C) left; left D) left; right

D

7) If the probability of a bond default increases because corporations begin to suffer large losses, then the default risk on corporate bonds will ________ and the expected return on these bonds will ________, everything else held constant. A) decrease; increase B) decrease; decrease C) increase; increase D) increase; decrease

D

12) Other things being equal, an increase in the default risk of corporate bonds shifts the demand curve for corporate bonds to the ________ and the demand curve for Canada bonds to the ________. A) right; right B) right; left C) left; right D) left; left

C

13) An increase in the riskiness of corporate bonds will ________ the price of corporate bonds and ________ the price of Canada bonds, everything else held constant. A) increase; increase B) reduce; reduce C) reduce; increase D) increase; reduce

C

14) An increase in the riskiness of corporate bonds will ________ the yield on corporate bonds and ________ the yield on government securities, everything else held constant. A) increase; increase B) reduce; reduce C) increase; reduce D) reduce; increase

C

43) Tax-exempt bond interest rates increase relative to corporate bond interest rates when ________. A) income taxes are increased B) corporate bonds become riskier C) U.S. Treasury securities become more widely traded D) there is a major default in the tax-exempt bond market

D

4) Default risk is the risk that ________. A) a bond issuer is unable to make interest payments B) a bond issuer is unable to make a profit C) a bond issuer is unable to pay the face value at maturity D) Both A and C above

D

42) The interest rate on tax-exempt bonds rises relative to the interest rate on U.S. Treasury securities when ________. A) income tax rates are raised B) tax-exempt bonds become more widely traded C) corporate bonds become riskier D) income tax rates are lowered

D

1) The risk structure of interest rates is ________. A) the structure of how interest rates move over time B) the relationship among interest rates of different bonds with the same maturity C) the relationship among the term to maturity of different bonds D) the relationship among interest rates on bonds with different maturities

B