ECON 301 - Ch 5

Assume that a bond had its rating lowered. What is the likely effect on this bond in the bond​ market?

Demand for the bond will decrease

The ________ _________ states that interest rates on​ long-term bonds are an average of the interest rates investors expect on​ short-term bonds over the lifetime of the​ long-term bond.

Expectations theory (Pure Expectations Theory)

What are the major credit agencies

Fitch Ratings, Standard and Poor's, Moody's Investment Service

What are the two types of income an investor can earn on a bond?

Interest income from coupon payments and capital gains from price changes

____ is taxed at the same rate as wage and salary income while a ____ is taxed at a lower rate

Interest income, a capital gain

The term structure of interest rates is the relationship among the _____ ______ on bonds that are otherwise similar but differ in ______ . The most common way to analyze the term structure is by using a graph known as the ______ ______ _____ .

Interest rates, maturity, Treasury Yield Curve

The _____ ______ ______ holds that the interest rate on a bond of a particular maturity is determined only by the demand and supply of bonds of that maturity.

Segmented Markets Theory

What is meant by a bond​ issuer's creditworthiness?

The ability for the bond issuer to make the required payments on its bonds

What is the tax treatment of the coupons on a bond issued by the city of​ Houston?

The bond is not subject to the​ federal, state, or local taxes.

What is the tax treatment of the coupons on a bond issued by the U.S.​ Treasury?

The bond is subject to federal tax only

What is the tax treatment of the coupons on a bond issued by​ GE?

The bond is subject to​ federal, state, and local taxes.

What is a carry trade?

The term is sometimes used to refer to borrowing at a low​ short-term interest rate and then using the borrowed funds to invest at a higher​ long-term interest rate.

What is a bond rating?

a single statistic summarizing a rating agency's view of the bond issuer's likely creditworthiness

The _____ _____ _____ holds that interest rates on​ long-term bonds are averages of the expected interest rates on​ short-term bonds plus a term premium.

liquidity premium theory

The difference between the yields on​ high-grade corporate bonds and on junk bonds was ____ during periods of growth in the economy and _____ as the economy neared recessions. After the​ recession, the difference ______ to​ pre-recession levels.

low, increased, decreased

An upward shift in the yield curve indicates

unanticipated increase in inflation expectations

Why might a carry trade end badly?

A - Because the average of expected​ short-term interest rates should be almost equal to the interest rate of the​ long-term investment, thus wiping out potential profits from the carry trade. B - Because if interest rates rise more rapidly than​ expected, the price of the​ long-term investment will decrease and create a capital loss for the investor.

Can you use yield curves to draw any conclusion about what investors in the bond market expect will happen to the interest rates in the​ future?

An upward sloping normal yield curve implies that investors expect future short-term rates to rise above the current levels.