Econ 353 Chap 6

Q6) Which of the following long-term bonds has the highest interest rate? A) corporate Baa bonds B) U.S. Treasury bonds C) corporate Aaa bonds D) municipal bonds

A) corporate Baa bonds

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

A) increase; increase; decrease

Which of the following statements is TRUE? A) A liquid asset is one that can be quickly and cheaply converted into cash. B) The demand for a bond declines when it becomes less liquid, decreasing the interest rate spread between it and relatively more liquid bonds. C) The differences in bond interest rates reflect differences in default risk only. D) The corporate bond market is the most liquid bond market

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

A bond with default risk will always have a ________ risk premium and an increase in its default risk will ________ the risk premium. A) positive; raise B) positive; lower C) negative; raise D) negative; lower

A) positive; raise

The segmented markets theory of the term structure of interest rates fails to explain characteristics of the yield curve because it cannot explain why: A. Interest rates on bonds with different maturities move together over time B. Yields on longer-term Treasury bonds exceed those on short-term Treasury bills C. The normal yield curve slopes upward

A. Interest rates on bonds with different maturities move together over time

5. True or False: This decreases the equilibrium price of Initech bonds.

Ans: A, True

True or False: The risk premium on corporate bonds increases when the default risk increases. A. True B. False

Ans: A, True

Suppose that the U.S. Treasury issues bonds to finance a budget deficit, increasing the volume of Treasury securities in the market. This makes Treasury bonds relatively easier to buy and sell in the future. How does this affect the markets for 30-year Treasury bonds vs. 30-year corporate bonds? The risk premium for corporate bonds: A. Increases because of higher default risk B. Increases because Treasury bonds are more liquid relative to corporate bonds C. Decreases because the default risk for corporate bonds rises D. Decreases because most corporate bonds have income tax breaks E. Decreases because the liquidity of Treasury bonds falls

Ans: B

True or False: An increase in Initech's default risk decreases the equilibrium bond yield. A. True B. False

Ans: B, False

Which of the following combinations of bonds provides the best situation to study the risk structure of interest rates? (Hint: Best answer may not be perfect.) A. A three-month Treasury bill vs. a 30-year Treasury bond B. A six-month Treasury bill vs. a corporate Aaa bond C. Three-month commercial paper vs. a corporate Baa bond D. A 30-year Treasury bond vs. a corporate Aaa bond E. Six-month commercial paper vs. a seven-year Treasury note

Ans: D

Risk premiums on corporate bonds tend to ________ during business cycle expansions and ________ during recessions, everything else held constant. A) increase; increase B) increase; decrease C) decrease; increase D) decrease; decrease

Answer: C Explanation: Default risks are lower during expansions because businesses make more profits. They are higher during recessions for analogous reasons. Suppose that Moody's Investors Service, Inc., downgrades Initech's bonds from an Aa (high quality) to an A (upper-medium grade) rating.

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

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

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 A) a rise in short-term interest rates in the near future and a decline further out in the future. B) constant short-term interest rates in the near future and further out in the future. C) a decline in short-term interest rates in the near future and a rise further out in the future. D) a decline in short-term interest rates in the near future and an even steeper decline further out in the future.

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

Q5) A(n) ________ in the riskiness of corporate bonds will ________ the price of corporate bonds and ________ the yield on corporate bonds, all else equal. A) increase; increase; increase B) increase; decrease; increase C) decrease; increase; increase D) decrease; decrease;decrease

B) increase; decrease; increase

According to the liquidity premium theory of the term structure, a slightly upward sloping yield curve indicates that short-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) remain unchanged in the future.

According to the liquidity premium theory of the term structure A) 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. B) 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. C) because of the positive term premium, the yield curve will not be observed to be downward sloping. D) the interest rate for each maturity bond is determined by supply and demand for that maturity bond.

B) 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.

1) Which of the following bonds are considered to be default-risk free? A) Municipal bonds B) Investment-grade bonds C) U.S. Treasury bonds D) Junk bonds

C) U.S. Treasury bonds

If the yield curve slope is flat for short maturities and then slopes steeply upward for longer maturities, the liquidity premium theory (assuming a mild preference for shorter-term bonds) indicates that the market is predicting A) a rise in short-term interest rates in the near future and a decline further out in the future. B) constant short-term interest rates in the near future and further out in the future. C) a decline in short-term interest rates in the near future and a rise further out in the future. D) constant short-term interest rates in the near future and a decline further out in the future.

C) a decline in short-term interest rates in the near future and a rise further out in the future.

15) According to the liquidity premium theory of the term structure, a flat yield curve indicates that short-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.

C) decline moderately in the future.

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 ________. A) increase; increase B) increase; decrease C) decrease; increase D) decrease; decrease

C) decrease; increase Explanation: The default risk on corporate bonds go down as a result of the guarantee. The demand for corporate bonds increases, the demand for the substitute, T-bonds, decreases. The price of the corporate bond goes up, the interest rate goes down. The price of the Tbond goes down, the interest rate goes up. Note that this implies a narrowing of the risk premium of corporate bonds over T-bonds.

Municipal bonds have default risk, yet their interest rates are lower than the rates on default-free Treasury bonds. This suggests that A) the benefit from the tax-exempt status of municipal bonds is less than their default risk. B) the benefit from the tax-exempt status of municipal bonds equals their default risk. C) the benefit from the tax-exempt status of municipal bonds exceeds their default risk. D) Treasury bonds are not default-free.

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

According to the liquidity premium theory of the term structure, a downward sloping yield curve indicates that short-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.

D) decline sharply in the future.

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 A) two years. B) three years. C) four years. D) five years.

D) five years.

The collapse of the subprime mortgage market A) did not affect the corporate bond market. B) increased the perceived riskiness of Treasury securities. C) reduced the Baa-Aaa spread. D) increased the Baa-Aaa spread.

D) increased the Baa-Aaa spread. Explanation: The Baa-Aaa spread is equal to (YTM on Baa bonds - YTM on Aaa bonds). Panics and financial market collapses increase default risk.

According to the expectations theory of the term structure A) when the yield curve is steeply upward sloping, short-term interest rates are expected to remain relatively stable in the future. B) when the yield curve is downward sloping, short-term interest rates are expected to remain relatively stable in the future. C) investors have strong preferences for short-term relative to long-term bonds, explaining why yield curves typically slope upward. D) yield curves should be equally likely to slope downward as slope upward.

D) yield curves should be equally likely to slope downward as slope upward.