Econ 353 Chapter 6

left; right

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 ________.

average

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.

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

According to the liquidity premium theory of the term structure

decline sharply in the future

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

rise in the future

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

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

According to the segmented markets theory of the term structure

segmented markets theory

According to this theory of the term structure, bonds of different maturities are not substitutes for one another.

right; left

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 ________.

default-free bonds

Bonds with no default risk are called

junk bonds

Bonds with relatively high risk of default are called

investment grade; junk bonds

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 ________.

time to maturity

Differences in ________ explain why interest rates on Treasury securities are not all the same.

increase the interest rate on municipal bonds

Everything else held constant, abolishing the individual income tax will

expected return

If bonds with different maturities are perfect substitutes, then the ________ on these bonds must be equal.

lower; higher

The Obama administration increased the tax on the top income tax bracket from 35% to 39%. Supply and demand analysis predicts the impact of this change was a ________ interest rate on municipal bonds and a ________ interest rate on Treasury bonds, all else the same.

risk premium

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

positive; raise

A bond with default risk will always have a ________ risk premium and an increase in its default risk will ________ the risk premium.

decrease; increase

A decrease in the riskiness of corporate bonds will ________ the yield on corporate bonds and ________ the yield on Treasury securities, everything else held constant

are not substitutes at all

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

increase; increase; decrease

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

segmented markets theory

In actual practice, short-term interest rates and long-term interest rates usually move together; this is the major shortcoming of the

high-yield bonds

Junk bonds, bonds with a low bond rating, are also known as

5 percent

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

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

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

five years

If the expected path of 1-year interest rates over the next five years is 1 percent, 2 percent, 3 percent, 4 percent, and 5 percent, the expectations theory predicts that the bond with the highest interest rate today is the one with a maturity of

one year

If the expected path of 1-year interest rates over the next five years is 2 percent, 4 percent, 1 percent, 4 percent, and 3 percent, the expectations theory predicts that the bond with the lowest interest rate today is the one with a maturity of

3 percent

If the expected path of 1-year interest rates over the next four years is 5 percent, 4 percent, 2 percent, and 1 percent, then the expectations theory predicts that today's interest rate on the four-year bond is

6 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

decrease; increase

If the federal government were to guarantee payment on municipal bonds, the yield on municipal bonds would ________ and the yield on U.S. Treasury bonds would ________, all else equal

increase; more

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.

increase; decrease

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.

constant short-term interest rates in the near future and further out in the future

If the yield curve has a mild upward slope, the liquidity premium theory (assuming a mild preference for shorter-term bonds) indicates that the market is predicting

expectations theory

The ________ of the term structure of interest rates states that the interest rate on a long-term bond will equal the average of short- term interest rates that individuals expect to occur over the life of the long-term bond, and investors have no preference for short-term bonds relative to long-term bonds.

the liquidity premium theory

The expectations theory and the segmented markets theory do not explain the facts very well, but they provide the groundwork for the most widely accepted theory of the term structure of interest rates

rise in the near-term and fall later on

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

rise moderately in the near-term and fall later on

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

less liquid than

The risk premium on corporate bonds reflects the fact that corporate bonds have a higher default risk and are ________ U.S. Treasury bonds.

short-term interest rates are expected to rise in the future

The steeply upward sloping yield curve in the figure above indicates that

short-term; rise

The steeply upward sloping yield curve in the figure above indicates that ________ interest rates are expected to ________ in the future.

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

Three factors explain the risk structure of interest rates

the federal government can increase taxes or print money to pay its obligations.

U.S. government bonds have no default risk because

be inverted

When short-term interest rates are expected to fall sharply in the future, the yield curve will

right; left

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

short-term interest rates are about the same as long-term interest rates

When yield curves are flat

long-term interest rates are above short-term interest rates

When yield curves are steeply upward sloping

U.S. Treasury bonds

Which of the following bonds are considered to be default-risk free?

corporate Baa bonds

Which of the following long-term bonds has the highest interest rate?

Because the tax-exempt status of municipal bonds was of little benefit to bond holders when tax rates were low, they had higher interest rates than U.S. government bonds before World War II

Which of the following statements are TRUE?

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

Which of the following statements is TRUE?

Bonds issued by state and local governments are called municipal bonds

Which of the following statements is TRUE?