Econ 330 Chapter 6

According to the expectations theory of the term​ structure, the interest rate on a longminus−term bond will equal the​ ________ of the shortminus−term interest rates that people expect to occur over the life of the longminus−term bond. A. average B. sum C. difference D. multiple

A

According to the liquidity premium theory of the term structure A. if yield curves are downward​ sloping, then shortminus−term interest rates are expected to fall by so much​ that, even when the positive term premium is​ added, longminus−term rates fall below shortminus−term rates. B. interest rates on bonds of different maturities do not move together over time. C. bonds of different maturities are not substitutes. D. yield curves should never slope downward.

A

According to the liquidity premium theory of the term​ structure, a steeply upward sloping yield curve indicates that shortminus−term interest rates are expected to A. rise in the future. B. remain unchanged in the future. C. decline moderately in the future. D. decline sharply in the future.

A

If the expected path of 1minus−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 A. one year. B. two years. C. three years. D. four years.

A

The term structure of interest rates is A. the relationship among interest rates on bonds with different maturities. B. the structure of how interest rates move over time. C. the relationship among interest rates of different bonds with the same maturity. D. the relationship among the term to maturity of different bonds.

A

When yield curves are steeply upward​ sloping, A. longminus−term interest rates are above shortminus−term interest rates. B. mediumminus−term interest rates are above both shortminus−term and longminus−term interest rates. C. shortminus−term interest rates are above longminus−term interest rates. D. shortminus−term interest rates are about the same as longminus−term interest rates.

A

Why do U.S. Treasury bills have lower interest rates than​ large-denomination negotiable bank​ CDs? A. Treasuries are considered to be​ risk-free debt instruments. B. Bank CDs are affected by inflation differently than are Treasury bills. C. Treasury bills are​ short-term debt​ instruments, whereas CDs are​ medium-term debt instruments. D. Treasury rates are set by the Federal Reserve at a greater rate than the​ market-determined CD rate.

A

According to the liquidity premium theory of the term​ structure, a slightly upward sloping yield curve indicates that shortminus−term interest rates are expected to A. rise in the future. B. remain unchanged in the future. C. decline moderately in the future. D. decline sharply in the future.

B

Bonds with no default risk are called A. flower bonds. B. defaultminus−free bonds. C. nominus−risk bonds. D. zerominus−risk bonds.

B

A decrease in the liquidity of corporate bonds will​ ________ the price of corporate bonds and​ ________ the yield of Treasury​ bonds, everything else held constant. A. ​increase; decrease B. ​decrease; decrease C. ​increase; increase D. ​decrease; increase

B

Following a policy meeting on March​ 19, 2009, the Federal Reserve made an announcement that it would purchase up to​ $300 billion of​ longer-term Treasury securities over the following six months. What effect might this policy have on the yield​ curve? A. The yield curve would jump with​ medium- and​ long-term rates and remain unchanged with​ short-term rates. B. The yield curve would shift​ down, but mostly on​ medium- and​ long-term maturities. C. The yield curve would steepen at the end and flatten somewhere along the rest of the curve. D. The yield curve would steadily shift​ up, with slightly more increase in​ short-term rates.

B

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. A. ​increase; less B. ​increase; more C. ​decrease; less D. ​decrease; more

B

The U.S. Treasury offers some of its debt as Treasury Inflation Protected​ Securities, or​ TIPS, in which the price of bonds is adjusted for inflation over the life of the debt instrument. TIPS bonds are traded on a much smaller scale than nominal U.S. Treasury bonds of equivalent maturity. What can you conclude about the liquidity premium between TIPS and nominal U.S.​ bonds? A. The liquidity premium for a TIPS bond is​ high, so it is more profitable than a nominal U.S. bond of equal maturity. B. The liquidity premium for a TIPS bond is usually smaller than inflation compensation in nominal U.S. bond yields of equal maturity. C. Both TIPS and nominal U.S. bonds are equally​ liquid, so there is no liquidity premium. D. The difference in the liquidity premium between TIPS and nominal U.S. bonds usually results in a higher yield on nominal U.S. bonds.

B

What effect would reducing income tax rates have on the interest rates of municipal​ bonds? A. Interest rates would fall because Treasury securities are now less valuable and more people will want to hold municipal bonds. B. Interest rates would rise because the reduction in income tax rates would make the​ tax-exempt privilege for municipal bonds less valuable and reduce the demand for municipal bonds. C. Interest rates would fall because the reduction in income tax rates would make the​ tax-exempt privilege for municipal bonds less valuable and reduce the demand for municipal bonds. D. Interest rates would rise because Treasury securities are now less valuable and more people will want to hold municipal bonds.

B

Everything else held​ constant, the interest rate on municipal bonds rises relative to the interest rate on Treasury securities when A. municipal bonds become more widely traded. B. corporate bonds become riskier. C. income tax rates are lowered. D. income tax rates are raised.

C

If you have a very low tolerance for​ risk, which of the following bonds would you be least likely to hold in your​ portfolio? A. a corporate bond with a rating of Aaa B. a municipal bond C. a corporate bond with a rating of Baa D. a U.S. Treasury bond

C

According to the liquidity premium theory of the term structure A. because of the positive term​ premium, the yield curve will not be observed to be downward sloping. B. because buyers of bonds may prefer bonds of one maturity over​ another, interest rates on bonds of different maturities do not move together over time. C. the interest rate on longminus−term bonds will equal an average of shortminus−term interest rates that people expect to occur over the life of the longminus−term bonds plus a term premium. D. the interest rate for each maturity bond is determined by supply and demand for that maturity bond.

C

According to the segmented markets theory of the term structure A. because of the positive term​ premium, the yield curve will not be observed to be downwardminus−sloping. B. ​investors' strong preferences for shortminus−term relative to longminus−term bonds explains why yield curves typically slope downward. C. the interest rate for each maturity bond is determined by supply and demand for that maturity bond. D. bonds of one maturity are close substitutes for bonds of other​ maturities, therefore, interest rates on bonds of different maturities move together over time.

C

A​ ________ yield curve predicts a future increase in inflation. A. downward sloping B. flat C. steeply upward sloping D. slight upward sloping

C

Bonds with relatively high risk of default are called A. zero coupon bonds. B. investment grade bonds. C. junk bonds. D. Brady bonds.

C

Corporate bonds are not as liquid as government bonds because A. corporate bonds are not callable. B. the corporate bond rating must be calculated each time they are traded. C. fewer corporate bonds for any one corporation are​ traded, making them more costly to sell. D. corporate bonds cannot be resold.

C

During​ 2008, the difference in yield​ (the yield spread​) between​ 3-month AA-rated financial commercial paper and​ 3-month AA-rated nonfinancial commercial paper steadily increased from its usual level of close to​ zero, spiking to over a full percentage point at its peak in October 2008. Which of the following explains this sudden​ increase? A. Increased yield spreads tend to occur because of the inefficient nature of nonfinancial commercial paper when economic instability is present. B. The increase in the yield spread was caused by an increase in the supply of financial commercial paper to fund future real estate investments. C. The increase in the yield spread was a result of the decrease in demand for financial commercial paper due to the uncertainty and soundness of financial companies and banks. D. The increase in the yield spread was due to government efforts to ease the debt burden for financial companies during the financial crisis.

C

Suppose the interest rates on​ one-, five-, and​ ten-year U.S. Treasury bonds are currently​ 3%, 6%, and​ 6%, respectively. Investor A chooses to hold only​ one-year bonds, and Investor B is indifferent with regard to holding​ five- and​ ten-year bonds. Which theories best explain the behavior of Investors A and​ B? A. Both Investors A and B exhibit preferences that are consistent with expectations theory. B. Both Investors A and B exhibit preferences that are consistent with the segmented markets theory. C. Investor​ A's preferences are best explained by the segmented markets​ theory, while Investor​ B's preferences are more consistent with the expectations theory. D. Investor​ A's preferences are best explained by the liquidity premium​ theory, while Investor​ B's preferences are more consistent with the segmented markets theory.

C

When yield curves are downward​ sloping, A. mediumminus−term interest rates are above both shortminus−term and longminus−term interest rates. B. longminus−term interest rates are above shortminus−term interest rates. C. shortminus−term interest rates are above longminus−term interest rates. D. shortminus−term interest rates are about the same as longminus−term interest rates.

C

Would interest rates of Treasury securities be affected by the tax rate​ change? A. ​Yes, because the increase in interest rates would increase the desire to hold more municipal bonds and less Treasury securities. B. ​Yes, because municipal bonds are less risky than Treasury​ securities, the demand for Treasury securities will decrease. C. ​Yes, because the reduction in the​ tax-exempt privilege in municipal bonds would raise the relative value of Treasury​ securities, making Treasury securities more desirable. D. ​No, there would be no impact on the market for Treasury securities.

C

According to the segmented markets theory of the term structure A. buyers require an additional incentive to hold longminus−term bonds. B. the interest rate on longminus−term bonds will equal an average of shortminus−term interest rates that people expect to occur over the life of the longminus−term bonds. C. buyers of bonds do not prefer bonds of one maturity over another. D. interest rates on bonds of different maturities do not move together over time.

D

An increase in default risk on corporate bonds​ ________ the demand for these​ bonds, but​ ________ the demand for defaultminus−free ​bonds, everything else held constant. A. moderately​ lowers; does not change B. ​increases; lowers C. does not​ change; greatly increases D. ​lowers; increases

D

An increase in the riskiness of corporate bonds will​ ________ the price of corporate bonds and​ ________ the price of Treasury​ bonds, everything else held constant. A. ​increase; increase B. ​increase; reduce C. ​reduce; reduce D. ​reduce; increase

D

If bond investors decide that​ 30-year bonds are no longer as desirable an​ investment, the yield curve​ would: A. result in a jump in the 30 minus year rate comma with the remainder of the yield curve unchangedresult in a jump in the 30−year rate, with the remainder of the yield curve unchanged. B. flatten near the​ 30-year rate and steepen slightly along the smaller rates. C. slope less steeply upward toward the​ 30-year rate and remain the same after it. D. steepen at the end of the yield curve and flatten somewhere along the rest of the curvesteepen at the end of the yield curve and flatten somewhere along the rest of the curve.

D

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. A. ​decrease; decrease B. ​increase; increase C. ​decrease; increase D. ​increase; decrease

D

Risk premiums on corporate bonds are usually anticyclical​; that​ is, they decrease during business cycle expansions and increase during recessions. Why is this​ so? A. In anticipation of a​ recession, the Federal Reserve will begin to lower interest rates. B. During an economic​ expansion, there is greater inflationary pressure driving interest rates upward. C. As an economy enters a​ recession, business firms are less likely to default on their debt. D. As the economy enters an​ expansion, there is greater likelihood that borrowers will be able to service their debt.

D

The additional incentive that the purchaser of a Treasury security requires to buy a longminus−term security rather than a shortminus−term security is called the A. tax premium. B. market premium. C. risk premium. D. term premium.

D

The preferred habitat theory of the term structure is closely related to the A. the inverted yield curve theory of the term structure. B. segmented markets theory of the term structure. C. expectations theory of the term structure. D. liquidity premium theory of the term structure.

D

The segmented markets theory can explain A. why interest rates on bonds of different maturities tend to move together. B. why yield curves have been used to forecast business cycles. C. why yield curves tend to slope upward when shortminus−term interest rates are low and to be inverted when shortminus−term interest rates are high. D. why yield curves usually tend to slope upward.

D

The spread between the interest rates on bonds with default risk and default−free bonds is called the A. default premium. B. bond margin. C. junk margin. D. risk premium.

D

Which of the following bonds would have the highest default​ risk? A. Investmentminus−grade bonds B. U.S. Treasury bonds C. Municipal bonds D. Junk bonds

D

Which of the following statements is​ true? A. All government issued bonds long dash— ​local, state, and federal long dash— are federal income tax exempt. B. State and local governments cannot default on their bonds. C. The coupon payment on municipal bonds is usually higher than the coupon payment on Treasury bonds. D. Bonds issued by state and local governments are called municipal bonds.

D

​A(n) ________ in the riskiness of corporate bonds will​ ________ the price of corporate bonds and​ ________ the yield on corporate​ bonds, all else equal. A. ​decrease; decrease;decrease B. ​increase; increase; increase C. ​decrease; increase; increase D. ​increase; decrease; increase

D

"According to the expectations theory of the term​ structure, it is better to invest in​ one-year bonds, reinvested over two​ years, than to invest in a​ two-year bond, if interest rates on​ one-year bonds are expected to be the same in both​ years." Is this statement​ true, false, or​ uncertain?

False: These investments are almost of the same profitability.

Segmented markets

The interest rate for each bond with a different maturity is determined by the supply of and demand for that​ bond, with no effects from expected returns on other bonds with other maturities.

Expectations theory

The interest rate on a​ long-term bond will equal an average of the​ short-term interest rates that people expect to occur over the life of the​ long-term bond.

Preferred habitat

The interest rate on a​ long-term bond will equal an average of​ short-term interest rates expected to occur over the life of the​ long-term bond plus a liquidity premium​ (also referred to as a term​ premium) that responds to supply and demand conditions for that bond.

Suppose you observe a change in the relationship between​ short-term and​ long-term bonds.​ Specifically, you note that although interest rates on both​ short-term and​ long-term bond are rising​ together, as​ expected, the rate on​ long-term bonds is not rising by as much as has been observed in the past. Assuming the liquidity premium theory of term​ structure, you conclude that the liquidity premium is As a​ result, the yield curve becomes

decreasing flatten