ECON 330 week 3

If stock prices are expected to climb next year, everything else held constant, the ________ curve for bonds shifts ________ and the interest rate ________.

demand; left; rises

Corporate bonds are not as liquid as government bonds because

fewer corporate bonds for any one corporation are traded, making them more costly to sell.

Typically, yield curves are

gently upward sloping

Everything else held constant, the interest rate on municipal bonds rises relative to the interest rate on Treasury securities when

income tax rates are lowered

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

increase; decrease; increase

A business cycle expansion increases income, causing money demand to ________ and interest rates to ________, everything else held constant.

increase; increase

A rise in the price level causes the demand for money to ________ and the interest rate to ________, everything else held constant.

increase; increase

A ____ in the liquidity of corporate bonds will ____ the price of corporate bonds and ____ the yield on corporate bonds, all else equal

increase; increase; decrease

Higher government deficits ________ the supply of bonds and shift the supply curve to the ________, everything else held constant.

increase; right

In the Keynesian liquidity preference framework, a rise in the price level causes the demand for money to ________ and the demand curve to shift to the ________, everything else held constant.

increase; right

As their relative riskiness ________, the expected return on corporate bonds ________ relative to the expected return on default-free bonds, everything else held constant.

increases; decreases

If the expected return on bonds increases, all else equal, the demand for bonds increases, the price of bonds ________, and the interest rate ________.

increases; decreases

The interest rate falls when either the demand for bonds ____ or the supply of bonds ____

increases; decreases

As default risk decreases, the expected return on corporate bonds ________, and the return becomes ________ uncertain, everything else held constant.

increases; less

When the Fed ________ the money stock, the money supply curve shifts to the ________ and the interest rate ________, everything else held constant.

increases; right; falls

If there is an excess supply of money

individuals buy bonds, causing interest rates to fall

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 ________.

investment grade; junk bonds

Bonds with relatively high risk of default are called

junk bonds.

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 ________.

left; right

When the Fed decreases the money stock, the money supply curve shifts to the ________ and the interest rate ________, everything else held constant.

left; rises

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

less liquid than

Of the four effects on interest rates from an increase in the money supply, the one that works in the opposite direction of the other three is the

liquidity effect

When yield curves are upward sloping,

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

An inverted yield curve

slopes down.

In a business cycle expansion, the ________ of bonds increases and the ________ curve shifts to the ________ as business investments are expected to be more profitable.

supply; supply; right

The additional incentive that the purchaser of a Treasury security requires to buy a long-term security rather than a short-term security is called the

term premium

Municipal bonds have default risk, yet their interest rates are lower than the rates on default-free Treasury bonds. This suggests that

the benefit from the tax-exempt status of municipal bonds exceeds their default risk

According to the segmented markets theory of the term structure

the interest rate for each maturity bond is determined by supply and demand for that maturity bond.

According to the liquidity premium theory of the term structure

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.

Everything else held constant, if the tax-exempt status of municipal bonds were eliminated, then

the interest rate on municipal bonds would exceed the rate on Treasury bonds.

When the growth rate of the money supply increases, interest rates end up being permanently lower if

the liquidity effect is larger than the other effects.

The risk structure of interest rates is

the relationship among interest rates of different bonds with the same maturity.

During a "flight to quality"

the spread between Treasury bonds and Baa bonds increases

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

time to maturity

The bond supply curve is ________ sloping, indicating a(n) ________ relationship between the price and quantity supplied of bonds.

upward; direct

The segmented markets theory can explain

why yield curves usually tend to slope upward.

A plot of the interest rates on default-free government bonds with different terms to maturity is called

yield curve

The risk that interest payments will not be made, or that the face value of a bond is not repaid when a bond matures is

default risk.

If 1-year interest rates for the next three years are expected to be 4, 2, and 3 percent, and the 3-year bond rate is 4 percent, then the 3-year term premium is

1 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

3 percent

If a 1-year interest rate or the next three years are expected to be 4, 2, and 3 percent, and the 3-year term premium is 1 percent, then the 3-year bond rate will be

4 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, then the 5-year bond rate will be

5 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

6 percent

________ in the money supply creates excess ________ money, causing interest rates to ________, everything else held constant.

A decrease; demand for; rise

Which of the following statements is true?

Bonds issued by state and local governments are called municipal bonds.

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

U.S. Treasury bonds

Which of the following securities has the lowest interest rate if all other characteristics are the same?

U.S. Treasury bonds

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.

average

When the price of a bond is ________ the equilibrium price, there is an excess demand for bonds and price will ________.

below; rise

A movement along the bond demand or supply curve occurs when ________ changes.

bond price

Everything else held constant, an increase in expected inflation, lowers the expected return on ________ compared to ________ assets.

bonds; real

Everything else held constant, if the federal government were to guarantee today that it will pay creditors if a corporation goes bankrupt in the future, the interest rate on corporate bonds will ________ and the interest rate on Treasury securities will ________.

decrease; increase

Risk premiums on corporate bonds tend to ____ during business cycle expansions and ____ during recessions, everything else held constant

decrease; increase

An asset's interest rate risk ________ as the duration of the asset ________.

decreases; decreases

When the economy slips into a recession, normally the demand for bonds ________, the supply of bonds ________, and the interest rate ________, everything else held constant.

decreases; decreases; falls

When the expected inflation rate increases, the demand for bonds ________, the supply of bonds ________, and the interest rate ________, everything else held constant.

decreases; increases; rises

Holding the expected payments on bonds constant, an increase in the expected return on common stocks would ________ the demand for bonds, shifting the demand curve to the ________.

decreases; left

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

positive; raise

The economist Irving Fisher, after whom the Fisher effect is named, explained why interest rates ________ as the expected rate of inflation ________, everything else held constant.

rise; increases

During business cycle expansions when income and wealth are rising, the demand for bonds ________ and the demand curve shifts to the ________, everything else held constant.

rises; right

Everything else held constant, if interest rates are expected to fall in the future, the demand for long-term bonds today ________ and the demand curve shifts to the ________.

rises; right

When real income ________, the demand curve for money shifts to the ________ and the interest rate ________, everything else held constant.

rises; right; rises

When the price level ________, the demand curve for money shifts to the ________ and the interest rate ________, everything else held constant.

rises; right; rises

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

risk premium.

When yield curves are flat,

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

The figure above illustrates the effect of an increased rate of money supply growth at time period T0. From the figure, one can conclude that the

Fisher effect is dominated by the liquidity effect and interest rates adjust slowly to changes in expected inflation.

An increase in income

In the figure above, one factor not responsible for the decline in the demand for money is

a decline in the expected price level.

In the figure above, the decrease in the interest rate from i1 to i2 can be explained by

An increase in the money supply

In the figure above, the factor responsible for the decline in the interest rate is

Which of the following bonds would have the highest after-tax yield for an investor in the 25% marginal tax bracket?

Tax exempt municipal bond with a 3.5% yield.

In Keynes's liquidity preference framework,

an excess supply of bonds implies an excess demand for money

Factors that can cause the supply curve for bonds to shift to the right include

an expansion in overall economic activity

When the interest rate is above the equilibrium interest rate, there is an excess ____ money and the interest rate will ____

supply of; fall

When the price of a bond is above the equilibrium price, there is an excess ____ bonds and price will ____

supply of; fall

Everything else held constant, if income tax rates were lowered, then

the interest rate on municipal bonds would rise