homework 3

According to the segmented markets theory of the term structure

interest rates on bonds of different maturities do not move together over time.

According to the expectations theory of the term structure

interest rates on bonds of different maturities move together over time.

The mound-shaped yield curve in the figure above indicates that short-term interest rates are expected to

rise in the near-term and fall later on.

The spread between the interest rates on bonds with default risk and default-free bonds is called the

risk premium.

An increase in the liquidity of corporate bonds, other things being equal, shifts the demand curve for corporate bonds to the ________ and the demand curve for Treasury bonds shifts to the ________.

right; left

According to the liquidity premium theory of the term structure, a steeply upward sloping yield curve indicates that short-term interest rates are expected to

rise in the future.

The additional incentive that the purchaser of a Treasury security requires to buy a long-term security rather than a short-term security is called the

term premium.

U.S. government bonds have no default risk because

the federal government can increase taxes to pay its obligations.

According to the segmented markets theory of the term structure

the interest rate for each maturity bond is determined by supply and demand for that maturity bond.

Everything else held constant, if the tax-exempt status of municipal bonds were eliminated, then

the interest rate on municipal bonds would exceed the rate on Treasury bonds.

The term structure of interest rates is

the relationship among interest rates on bonds with different maturities

An inverted yield curve predicts that short-term interest rates

will fall in the future.

The risk structure of interest rates is

the relationship among interest rates of different bonds with the same maturity

If 1-year interest rates for the next five years are expected to be 4, 2, 5, 4, and 5 percent, and the 5-year term premium is 1 percent, than the 5-year bond rate will be

5 percent.

If the expected path of one-year interest rates over the next five years is 4 percent, 5 percent, 7 percent, 8 percent, and 6 percent, then the expectations theory predicts that today's interest rate on the five-year bond is

6 percent.

Typically, yield curves are

gently upward sloping.

If the yield curve is flat for short maturities and then slopes downward for longer maturities, the liquidity premium theory (assuming a mild preference for shorter-term bonds) indicates that the market is predicting.

a decline in short-term interest rates in the near future and an even steeper decline further out in the future.

A plot of the interest rates on default-free government bonds with different terms to maturity is called

a yield curve.

A key assumption in the segmented markets theory is that bonds of different maturities

are not substitutes at all.

According to the expectations theory of the term structure, the interest rate on a long-term bond will equal the ________ of the short-term interest rates that people expect to occur over the life of the long-term bond.

average

According to the liquidity premium theory of the term structure, a flat yield curve indicates that short-term interest rates are expected to

decline moderately in the future.

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 Treasury securities will ________.

decrease; increase

Risk premiums on corporate bonds tend to ________ during business cycle expansions and ________ during recessions, everything else held constant.

decrease; increase

If a corporation begins to suffer large losses, then the default risk on the corporate bond will

increase and the bond's return will become more uncertain, meaning the expected return on the corporate bond will fall.

A(n) ________ in the liquidity of corporate bonds will ________ the price of corporate bonds and ________ the yield on corporate bonds, all else equal.

increase; increase; decrease

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 Treasury bonds to the ________.

left; right

When the Treasury bond market becomes more liquid, other things equal, the demand curve for corporate bonds shifts to the ________ and the demand curve for Treasury bonds shifts to the ________.

left; right

The preferred habitat theory of the term structure is closely related to the

liquidity premium theory of the term structure

Three factors explain the risk structure of interest rates:

liquidity, default risk, and the income tax treatment of a security.

An increase in default risk on corporate bonds ________ the demand for these bonds, but ________ the demand for default-free bonds, everything else held constant.

lowers; increases

According to the liquidity premium theory of the term structure, a slightly upward sloping yield curve indicates that short-term interest rates are expected to

remain unchanged in the future.

Which of the following statements is true?

A liquid asset is one that can be quickly and cheaply converted into cash.

The U-shaped yield curve in the figure above indicates that the inflation rate is expected to

fall sharply in the near-term and rise later on.

Everything else held constant, the interest rate on municipal bonds rises relative to the interest rate on Treasury securities when

income tax rates are lowered.

According to the liquidity premium theory of the term structure

the interest rate on long-term bonds will equal an average of short-term interest rates that people expect to occur over the life of the long-term bonds plus a term premium.