chapter 4
Which of the following explain why financial instruments, such as bonds or loans, carry a default risk?
-A natural disaster -A household that took out a mortgage loan lives beyond its means -A firm that issued bonds expanded too quickly and its revenue fell
Which of the following are properties of yield curves?
-Generally, a yield curve slopes upward. -A yield curve shows yields of bonds of different maturities at one point in time -Yield curves are subject to frequent parallel shifts
Which of the following is consistent with the pure expectations theory of the yield curve?
-Long-term interest rates are based on expectations of what short-term interest rates will be in the future. -An upward-sloping yield curve implies that the market thinks short-term interest rates are going to be higher in the future than they currently are. -A flat yield curve suggests that the market thinks interest rates in the future will be the same as they are today. -An inverted yield curve suggests that the market thinks short-term interest rates in the future will be lower than they are today.
If Kari is the 35% income tax bracket and is thinking about buying a corporate bond that yields 2.5%, what yield must a muni bond pay to make her indifferent between the two bonds, ceteris paribus?
0.25x0.65=1.625
Suppose that in July 2015, Tokarev & Sons Corporation issues a bond that pays 6%. At the same time, the US Treasury, when it issues debt, pays an interest rate of 2.5%. Based on the formula for the default risk premium, 1)_____ must pay a 2)____ because the rate on 3)_____ is considered the risk-free rate.
1) Tokarev & Sons Corporation 2) 3.5% 3)US Treasury securities
Based on the graphs, the price of the US Treasury securities is 1)____than the price of the corporate bond, which implies that the interest rate on US Treasury securities is 2)____than the interest rate on the corporate bond.
1) higher 2) lower
Suppose the sales volumes of Caddell & Sons Corporation increase. This will likely 1)______ the default risk associated with its bonds and cause a 2)_____
1)decrease 2)reversal of the flight to quality effect
Julia is in the 10% marginal income tax bracket and earned a 4.5% return on the municipal bonds that just matured. The nominal interest rate paid on these bonds was
4.5
If the ex ante real interest rate is less than the ex post real interest rate, which of the following happened?
Actual inflation rate is greater than the expected inflation rate.
Proponents of segmented market theory disagree with which of the following?
Bondholders are indifferent between holding a long-term bond and a series of short-term bonds.
What does an inverted yield curve usually signal?
Current or future recession.
Which of the following represents the default risk premium (DRP)
DRPi,t=IRmarket,i,t−IRrisk-free,t
Which of the following accurately describes a principal argument of the term premium theory of the yield curve?
Everything else constant, bondholders prefer short-term bonds to long-term bonds.
The term structure of interest rates shows:
How securities that are similar in every other way but have different maturities have different yields.
ex post real IR =
Nominal IR - actual inflation rate
Under which theory might a steep yield curve suggest market participants are worried that inflation will increase in the future?
Pure expectations theory
An inverted yield curve occurs when:
Short term bonds pay higher yields than longer term bonds.
According to the Segmented Markets Theory, which markets are unrelated to each other?
Short term debt and long term debt markets.
According to the Pure Expectations Theory, an upward sloping yield curve signals markets to believe what?
Short term interest rates will be higher in the future than what they are today.
How do different models explain an inverted yield curve?
The economy is headed for a slowdown or a recession
According to the Pure Expectations Theory, long term yields are determined by:
The expected yield on short term bonds in the future.
According to the Segmented Markets Theory, traditional monetary policy impacts only:
The short term end of the yield curve
Which of the following is a key argument for the segmented market theory?
The short-term, medium-term, and long-term bond markets are all different markets, characterized by market players who have different objectives in participating in these market.
The term structure of interest rates is shown graphically with the:
Yield Curve.
You read in the financial press that the recent flight to quality is reversing. What will happen in the bond market? Select all that apply.
Yields of US Treasury bonds will decrease relative to the yields of corporate bonds.Prices of US Treasury bonds will increase relative to the prices of corporate bonds
inverted yield curve
downwards
ex ante real IR =
nominal IR - expected inflation rate
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
the real realized rate of return is
the ex post real interest rate.
The three theories that economists have developed to explain the shape of the yield curve are
the pure expectations theory, the term premium theory, and the segmented market theory.
As the marginal tax rate increases, the after-tax rate of return decreases.
true
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.
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
An inverted yield occurs when
long-term interest rates are lower than short-term interest rates.
