FI 301 Ch. 3

False

Other things being equal, an expected decrease in interest rates will increase the demand for long-term funds by borrowers.

less than

Other things equal, the yield required on A-rated bonds should be ____ the yield required on B-rated bonds whose other characteristics are exactly the same.

lower; higher

Securities that offer ____ liquidity will offer a ____ yield to be preferred.

investment-grade bonds.

Some financial institutions such as commercial banks are required by law to invest only in

True

Some types of debt securities always offer a higher yield than others.

overestimates

If liquidity influences the yield curve, but is not considered when deriving the forward interest rate, the forward interest rate ____ the market's expectation of the future interest rate.

False

If liquidity influences the yield curve, the forward rate underestimates the market's expectation of the future interest rate.

segmented markets theory.

If research showed that all investors attempt to purchase securities that perfectly match their time in which they will have available funds, this would specifically support the argument made by the

Expectations theory

If research showed that anticipation about future interest rates was the only important factor for all investors in choosing short-term or long-term securities, this would support the argument made by the

is downward sloping.

If shorter term securities have higher annualized yields than longer term securities, the yield curve

long-term; upward

If the Treasury uses a relatively large proportion of ____ debt to finance a budget deficit, this would place ____ pressure on long-term yields.

long-term; long-term

If the Treasury uses a relatively large proportion of ____ debt to finance the deficit, this may place upward pressure on ____ interest rates, and corporations may reduce their investment in fixed assets.

upward sloping.

If the liquidity premium theory completely describes the term structure of interest rates, then, on the average, the yield curve should be

True

If the yield curve is upward sloping, some investors may attempt to benefit from the higher yields on longer-term securities, even when they have funds for only a short period of time. This strategy is known as riding the yield curve.

favorable; lower

In general, securities with ____ characteristics will offer ____ yields.

15.1

The annualized yield on a three-year security is 13 percent; the annualized two-year interest rate is 12 percent, while the one-year interest rate is 9 percent. The forward rate one-year ahead is ____ percent.

True

The forward rate is commonly used to represent the market's forecast of the future interest rate.

False

The graphic comparison of maturities and annualized yields is known as the interest rate

True

The higher a bond rating, the lower the perceived default risk.

False

The preference for more liquid short-term securities places downward pressure on the slope of the yield curve.

False

The segmented markets theory suggests that although investors and borrowers may normally concentrate on a particular natural maturity market, certain events may cause them to wander from it.

between maturity and yield.

The term structure of interest rates defines the relationship

True

The term structure of interest rates defines the relationship between maturity and annualized yielding, holding other factors such as risk constant.

expectations theory

In some time periods there is evidence that corporations initially financed long-term projects with short-term funds. They planned to borrow long-term funds once interest rates were lower. This specifically supports the ____ for explaining the term structure of interest rates.

False

Interest income from municipal bonds is exempt from state taxes but is subject to federal taxes.

False

Investors will always prefer the purchase of risk-free Treasury securities, since other securities have a higher level of risk.

taxable securities; a higher before-tax yield than tax-exempt securities

If all other characteristics are similar, ____ would have to offer ____.

preferred habitat

The ____ theory suggests that although investors and borrowers may normally concen- trate on a particular natural maturity market, certain events may cause them to wander from it.

False

Yield curves are always upward sloping.

a slight decrease

If the liquidity premium exists, a flat yield curve would be interpreted as the market expecting ____ in interest rates.

15.0

The annualized yield on a three-year security is 13 percent; the annualized two-year interest rate is 12 percent, while the one-year interest rate is 9 percent. The forward rate two years ahead is ____ percent.

maturity markets are segmented.

The degree to which the Treasury's debt management policy could affect the term structure of interest rates is greatest if

greater; greater, less; less

24. According to the pure expectations theory of the term structure of interest rates, the ____ the difference between the implied one-year forward rate and today's one-year interest rate, the ____ is the expected change in the one-year interest rate.

longer; lower, shorter; higher

A downward-sloping yield curve indicates that Treasury securities with ____ maturities offer ____ annualized yields.

10.8 percent.

A firm in the 35 percent tax bracket is aware of a tax-exempt security that is paying a yield of 7 percent. To match this yield, taxable securities must offer a before-tax yield of

preferred habitat theory.

A theory states that while investors and borrowers may normally concentrate on a particular natural maturity market, conditions may cause them to change maturity markets. This theory is called the

small; large

According to expectations theory, the sudden expectation of lower interest rates in the future will cause a ____ supply of short-term funds provided by investors, and a ____ supply of long-term funds.

upward; downward

According to pure expectations theory, if interest rates are expected to decrease, there will be ____ pressure on the demand for short-term funds by borrowers and ____ pressure on the demand for long-term funds issued by borrowers.upward; downward

downward; downward

According to segmented markets theory, if investors have mostly long-term funds available and borrowers want short-term funds, this will place ____ pressure on the demand for long-term funds issued by borrowers and the yield curve will be ____ sloping.

upward; downward

According to segmented markets theory, if investors have mostly long-term funds available and borrowers want short-term funds, this will place ____ pressure on the demand for short- term funds by borrowers and the yield curve will be ____ sloping.

upward; upward

According to segmented markets theory, if investors have mostly short-term funds available and borrowers want long-term funds, there would be ____ pressure on the supply of short-term funds provided by investors and ____ pressure on the yield of long-term securities.

be greater than

According to the liquidity premium theory, the expected yield on a two-year security will ____ the expected yield from consecutive investments in one-year securities.

upward pressure on the price of short-term securities.

According to the segmented markets theory, if most investors suddenly preferred to invest in short-term securities and most borrowers suddenly preferred to issue long-term securities there would be

False

According to the segmented markets theory, the term structure of interest rates is determined solely by expectations of future interest rates.

lower; higher

All other characteristics being equal, securities with ____ liquidity would have to offer a ____ yield to be preferred.

15.71 percent

An investor's tax rate is 30 percent. What must the before-tax yield on a security be to have an after-tax yield of 11 percent?

longer; higher, shorter; lower

An upward-sloping yield curve indicates that Treasury securities with ____ maturities offer ____ annualized yields.

9.00 percent

Assume an investor's tax rate is 25 percent. The before-tax yield on a security is 12 percent. What is the after-tax yield?

15.08 percent

Assume investors are indifferent among security maturities. Today, the annualized 2-year interest rate is 12 percent, and the 1-year interest rate is 9 percent. What is the forward rate according to the pure expectations theory?

slight downward slope

Assume that a yield curve is influenced by interest rate expectations and a liquidity premium. Assume the yield curve is initially flat. If liquidity suddenly was no longer important, the yield curve would now have a ____ (assuming no other changes).

become upward sloping.

Assume that annualized yields of short-term and long-term securities are equal. If investors believe interest rates will increase, their actions may cause the yield curve to

greater than

Assume that the Treasury bond yield today is 2% higher than it was one year ago. Also assume that the credit (default) risk premium of an A-rated bond declined by 0.4% since one year ago. A newly issued A-rated bond will likely offer a yield today that is ____ the yield that was offered on an A- rated bond issued one year ago.

decrease; upward

Assume that the Treasury experiences a large decrease in the budget deficit and purchases a large number of T-bills. This action will ____ the supply of T-bills in the market and places ____ pressure on the yield of T-bills.

increase; downward

Assume that the Treasury experiences a large increase in the budget deficit and issues a large number of T-bills. This action will ____ the supply of T-bills in the market and place ____ pressure on the yield of T-bills.

7.6 percent.

Assume that the current yield on one-year securities is 6 percent, and that the yield on a two-year security is 7 percent. If the liquidity premium on a two-year security is 0.4 percent, then the one- year forward rate is

become upward sloping.

Assume the yield curve is flat. If investors flood the short-term market and avoid the long-term market, they may cause the yield curve to

True

Credit ratings are most commonly used to indicate which financial institutions have available funds that they can lend to borrowers.

BBB corporate securities.

Default risk is likely to be highest for

term structure of interest rates.

Holding other factors such as risk constant, the relationship between the maturity and annualized yield of securities is called the

is liquid.

If a security can easily be converted to cash without a loss in value, it

riding the yield curve.

If a yield curve is upward sloping, the investment strategy of buying long-term securities, then selling them after a short period (say, one year) is called

increase; downward

If interest rates are expected to decrease, the yield on new short-term securities may be expected to ____, and the yield curve should be ____ sloping.

None of the above

If issuers of securities (borrowers) and investors suddenly expect interest rates to decrease, their actions to benefit from their expectations should cause

pure expectations theory.

The theory for the term structure of interest rates that says the shape of the yield curve is determined solely by expectations of future interest rates is called the

segmented markets theory.

The theory of the term structure of interest rates, which states that investors and borrowers choose securities with maturities that satisfy their forecasted cash needs, is the

typically has the same slope as the Treasury yield curve.

The yield curve for corporate bonds.

positively; positively

The yield offered on a debt security is ____ related to the prevailing risk-free rate and ____ related to the security's risk premium.

False

Treasury securities are exempt from federal and state income taxes.

7.6

Vaughn Corporation is considering the issue of commercial paper and would like to know the yield it should offer on its commercial paper. The corporation believes that a 0.2 percent default risk premium, a 0.1 percent liquidity premium, and a 0.3 percent tax adjustment are necessary to sell its commercial paper to investors. Furthermore, annualized T-bill rates are 7 percent. Based on this information, Vaughn should offer ____ percent on its commercial paper.

False

When expectations theory is combined with the liquidity theory, the yield on a security will always be equal to the yield from consecutive investments in shorter-term securities over the same investment horizon.

All effect debt yield: default risk, liquidity, tax status, term to maturity

Which of the following is not a characteristic affecting the yields on debt securities?

In general, securities with favorable characteristics will offer higher yields to entice investors.

Which of the following statements is not true with respect to debt securities?

lowest; above that

Within the category of capital market securities, municipal bonds have the ____ before-tax yield, and their after-tax yield is typically ____ of Treasury bonds from the perspective of investors in high tax brackets.

14 percent.

You are considering the purchase of a tax-exempt security that is paying a yield of 10.08 percent. You are in the 28 percent tax bracket. To match this after-tax yield, you would consider taxable securities that pay.