Ch. 4

The risk that a bond issuer will not be able to live up to the promise they make when they issue a bond is known as ____ risk

default

A person who believes the pure expectations theory of interest rates would explain a steeply upward-sloping yield curve is suggesting that

higher inflation is in the future, or more rapid economic growth is on the horizon

An inverted yield occurs when

long-term interest rates are higher than short-term interest rates

You hear a report on the news by a well-respected financial analyst who says that the currently inverted yield curve is irrelevant to borrowing and lending decisions because yield curves are not an accurate reflection of the situation in bond markets. This analyst most likely is a proponent of the ___ theory of interest rates.

segmented market

You are having a conversation with your friend Belinda about the upward-sloping yield curve that currently exists in the bond market. She explains this to you by saying that the upward slope to the yield curve is because longer term bond are less desire-able than shorter-term bonds so that the issuers of longer term bonds must offer a higher interest rate as an incentive to attract buyers. Her observation means that she is a proponent of the ___ theory of interest rates

term premium

A yield curve illustrates the relationship between the

term to maturity of bonds and the interest rate they pay, at a particular point of time

You are having a conversation with your friend Yvonne about the upward-sloping yield curve that currently exists in the bond market. She explains this to you by saying that the upward slope to the yield curve is because the market expects future interest rates to be higher than current interest rates. Her observation means that she is a proponent of the ___ theory of interest rates.

pure expectations

According to the pure expectations theory, a flat yield curve means the market

thinks that future interest rates will be exactly the same as current interest rates

Emmel is the CFO for ABC Corp. Ten years ago, under Emmel's instructions, the company invested in 10-year US Treasury bonds that paid 3% interest. At the time, Emmel's projection was that inflation over the 10-year period would be 0.5% per year. As it turns out, the annual rate of inflation over the 10-year period was 1.5%. As a result, the ex-post of return on ABC Corp. investment was ___, innstead of the ____ return that Emmel expected ex-ante.

1.5%; 2.5%

Armand buys a 10-year, $10,000 bond that pays him $500 every year for 10 years and repays the face value in year 10. During the 10-year period, the rate of inflation holds steady at 3% per year. The real rate of return on Armand's investment is

2%

Daniella is considering the purchase of a 10-year, $10,000 bond being issued by Disreputable, Inc. The bond offers an interest rate of 5.5%. The rate on a similar US Treasury bond is 2.5%. All else equal, Daniella will be getting a default premium of _____, if she purchases the Disreputable, Inc. bond.

3.0%

Emily is in the 10% marginal income tac bracket and earned a 4.5% return on the corporate bonds that just matured. The nominal interest rate period on these bonds was

5%

Saladin is willing to lend her friend Astro $500 to buy a new smart phone. Saladin wants a 3% real rate of return on the loan when it is paid back at the end of the year. She believes that during the year the general level of prices will rise by 2%, so she should charge her friend Astro a nominal interest rate of

5%

Gwen is considering buying either a corporate bond or a municipal bond that are exactly the same except for their yield. Gwen is in the 33% marginal tax bracket, and the municipal bond she is considering pays a 6% interest rate. To make Gwen indifferent between the two bonds, the corporate bond must offer an interest rate of

8.96%

Diedre works for a pension fund and is thinking of buying some bonds that have a nominal interest rate of 6%. She believes that the inflation rate over the life of the bond will be 2%. The ex-post real interest rate on this bond is

unknown

Suppose that the interest rate on a one-year bond is currently 3% and the market believes that the rate on a one-year bond one year year from now will be 5%. If you follow the pure expectations theory of interest rates, then you would expect to see a(n) ____ yield curve.

upward-sloping

Harper just got a big raise at work, which pushed her from the 15% federal marginal tax bracket to the 25% marginal tax bracket. Which of the following best describes how this might affect her decision to buy municipal bonds?

This will make her more likely to buy municipal bonds because it will increase the difference between the nominal interest rate paid on the bonds and the after-tax interest rate she will receive relative to corporate bonds

Inflation is a benefit to

borrowers