ECON HW 3

The segmented markets theory can explain

A) why yield curves usually tend to slope upward.

In actual practice, short-term interest rates and long-term interest rates usually move together; this is the major shortcoming of the

A) segmented markets theory.

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

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

A key assumption in the segmented markets theory is that bonds of different maturities

A) are not substitutes at all.

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

A) less liquid than

Three factors explain the risk structure of interest rates

A) liquidity, default risk, and the income tax treatment of a security.

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

According to the liquidity premium theory of the term structure, a steeply upward sloping yield curve indicates that short-term interest rates are expected to

A) rise in the future.

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

A) risk premium.

An increase in the riskiness of corporate bonds will ________ the price of corporate bonds and ________ the price of Treasury bonds, everything else held constant.

C) reduce; increase

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

C) U.S. Treasury bonds

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, than the 5-year bond rate will be

D) 5 percent.

According to the liquidity premium theory of the term structure, a downward sloping yield curve indicates that short-term interest rates are expected to

D) decline sharply in the future.

A decrease in the liquidity of corporate bonds, other things being equal, shifts the demand curve for corporate bonds to the ________ and the demand curve for Treasury bonds shifts to the ________.

D) left; right

The term structure of interest rates is

D) the relationship among interest rates on bonds with different maturities.

An inverted yield curve predicts that short-term interest rates

D) will fall in the future.

According to the expectations theory of the term structure

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

An increase in the riskiness of corporate bonds will ________ the yield on corporate bonds and ________ the yield on Treasury securities, everything else held constant.

increase; reduce

Which of the following statements are TRUE?

B) The expected return on corporate bonds decreases as default risk increases.

The U-shaped yield curve in the figure above indicates that short-term interest rates are expected to

B) fall sharply in the near-term and rise later on.

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

B) remain unchanged in the future.

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

B) term premium.

According to the liquidity premium theory of the term structure

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.

The risk structure of interest rates is

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

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

C) 6 percent.

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

C) a yield curve.

According to the liquidity premium theory of the term structure, a flat yield curve indicates that short-term interest rates are expected to

C) decline moderately in the future.

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

C) decrease; increase

If bonds with different maturities are perfect substitutes, then the ________ on these bonds must be equal.

expected return

The typical shape for a yield curve is

gently upward sloping

When the yield curve is flat or downward-sloping, it suggest that the economy is more likely to enter

A) a recession.

Which of the following statements is true?

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

According to the segmented markets theory of the term structure

C) investors' strong preferences for short-term relative to long-term bonds explains why yield curves typically slope downward.

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 ________.

C) left; right

A particularly attractive feature of the ________ is that it tells you what the market is predicting about future short-term interest rates by just looking at the slope of the yield curve.

C) liquidity premium theory