Economics midterm 2

Which of the following securities has the lowest interest rate? A) Junk bonds B) U.S. Treasury bonds C) Investment-grade bonds D) Corporate Baa bonds

US Treasury bonds

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

US Treasury bonds

If the federal government where to raise the income tax rates, would this have any impact on a state's cost of borrowing funds? Explain.

Yes, if the federal government raises income tax rates, demand for municipal bonds which are federal income tax exempt would increase. This would lower the interest rate on the municipal bonds thus lowering the cost to the state of borrowing funds.

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

Which of the following statements are true? A) An increase in tax rates will increase the demand for Treasury bonds, lowering their interest rates. B) Because the tax-exempt status of municipal bonds was of little benefit to bond holders when tax rates were low, they had higher interest rates than U.S. government bonds before World War II. C) Interest rates on municipal bonds will be higher than comparable bonds without the tax exemption. D) Because coupon payments on municipal bonds are exempt from federal income tax, the expected after-tax return on them will be higher for individuals in lower income tax brackets.

because the tax-exempt status of municipal bonds was of little benefit to bond holders when tax rates were low, they had higher interest rates than US gov bonds before WW2

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.

bonds issued by state and local governments are called municipal bonds

During the Great Depression years 1930-1933 there was a very high rate of business failures and defaults, we would expect the risk premium for ________ bonds to be very high. A) U.S. Treasury B) corporate Aaa C) municipal D) corporate Baa

corporate BAA

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

corporate BAA bonds

The spread between the interest rates on Baa corporate bonds and U.S. government bonds is very large during the Great Depression years 1930-1933. Explain this difference using the bond supply and demand analysis.

During the Great Depression many businesses failed. The default risk for the corporate bond increased compared to the default-free Treasury bond. The demand for corporate bonds decreased while the demand for Treasury bonds increased resulting in a larger risk premium.

A decrease in the liquidity of corporate bonds will ________ the price of corporate bonds and ________ the yield of Treasury bonds, everything else held constant.

decrease, decrease

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

decrease, increase

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

decrease, increase

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

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

decreases, more

Everything else held constant, a decrease in marginal tax rates would likely have the effect of ________ the demand for municipal bonds, and ________ the demand for U.S. government bonds.

decreasing, increasing

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 A) interest rate risk. B) inflation risk. C) moral hazard. D) default risk.

default risk

bonds with no default risk are called A) flower bonds. B) no-risk bonds. C) default-free bonds. D) zero-risk bonds.

default-free bonds

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

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

The Bush tax cut reduced the top income tax bracket from 39% to 35% over a ten-year period. Supply and demand analysis predicts the impact of this change was a ________ interest rate on municipal bonds and a ________ interest rate on Treasury bonds.

higher, lower

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

income tax rates are lowered

If a corporation begins to suffer large losses, then the default risk on the corporate bond will A) increase and the bond's return will become more uncertain, meaning the expected return on the corporate bond will fall. B) increase and the bond's return will become less uncertain, meaning the expected return on the corporate bond will fall. C) decrease and the bond's return will become less uncertain, meaning the expected return on the corporate bond will fall. D) decrease and the bond's return will become less uncertain, meaning the expected return on the corporate bond will rise.

increase and the bonds return will become more uncertain, meaning the expected return on the corporate bond will fall.

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

increase reduce

Everything else held constant, abolishing all taxes will A) increase the interest rate on corporate bonds. B) reduce the interest rate on municipal bonds. C) increase the interest rate on municipal bonds. D) increase the interest rate on Treasury bonds.

increase the interest rate on municipal bonds

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; increase B) decrease; decrease C) increase; increase D) increase; decrease

increase, decrease

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

increase, increase

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

increase, increase, decrease

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

increase, more

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

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.

increased the BAA-AAA spread

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

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

increases, less

A decrease in default risk on corporate bonds ________ the demand for these bonds, and ________ the demand for default-free bonds, everything else held constant.

increases, lowers

Everything else held constant, an increase in marginal tax rates would likely have the effect of ________ the demand for municipal bonds, and ________ the demand for U.S. government bonds.

increasing, decreasing

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 ________. A) investment grade; lower grade B) investment grade; junk bonds C) high quality; lower grade D) high quality; junk bonds

investment grade, junk bonds

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

junk bonds

Which of the following bonds would have the highest default risk? A) Municipal bonds B) Investment-grade bonds C) U.S. Treasury bonds D) Junk bonds

junk bonds

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 ________.

left, right

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 Treasury bond market becomes more liquid, other things equal, the demand curve for corporate bonds shifts to the ________ and the demand curve for Treasury bonds shifts to the ________.

left, right

Three factors explain the risk structure of interest rates: A) liquidity, default risk, and the income tax treatment of a security. B) maturity, default risk, and the income tax treatment of a security. C) maturity, liquidity, and the income tax treatment of a security. D) maturity, default risk, and the liquidity of a security.

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

An increase in default risk on corporate bonds ________ the demand for these bonds, but ________ the demand for default-free bonds, everything else held constant.

lower, increase

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

positive, raise

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

reduce, increase

An increase 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 ________.

right, left

Other things being equal, a decrease 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 ________.

right, left

When the Treasury bond market becomes less liquid, other things equal, the demand curve for corporate bonds shifts to the ________ and the demand curve for Treasury bonds shifts to the ________.

right, left

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

risk premium

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.

the benefit from the tax-exempt status of municipal bonds is less than their default risk

Which of the following statements are true? A) A decrease in default risk on corporate bonds lowers the demand for these bonds, but increases the demand for default-free bonds. B) The expected return on corporate bonds decreases as default risk increases. C) A corporate bond's return becomes less uncertain as default risk increases. D) As their relative riskiness increases, the expected return on corporate bonds increases relative to the expected return on default-free bonds.

the expected return on corporate bonds decreases as default risk increases

The US government bonds have no default risk because A) they are backed by the full faith and credit of the federal government. B) the federal government can increase taxes to pay its obligations. C) they are backed with gold reserves. D) they can be exchanged for silver at any time.

the federal government can increase taxes to pay its obligations

Everything else held constant, if the tax-exempt status of municipal bonds were eliminated, then A) the interest rates on municipal bonds would still be less than the interest rate on Treasury bonds. B) the interest rate on municipal bonds would equal the rate on Treasury bonds. C) the interest rate on municipal bonds would exceed the rate on Treasury bonds. D) the interest rates on municipal, Treasury, and corporate bonds would all increase.

the interest rate on municipal bonds would = the rate on Treasury bonds

Everything else held constant, if income tax rates were lowered, then A) the interest rate on municipal bonds would fall. B) the interest rate on Treasury bonds would rise. C) the interest rate on municipal bonds would rise. D) the price of Treasury bonds would fall.

the interest rate on municipal bonds would fall

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

the relationship among interest rates of different bonds with same maturity

During a "flight to quality" A) the spread between Treasury bonds and Baa bonds increases. B) the spread between Treasury bonds and Baa bonds decreases. C) the spread between Treasury bonds and Baa bonds is not affected. D) the change in the spread between Treasury bonds and Baa bonds cannot be predicted.

the spread between treasury bonds and BAA bonds increase

The spread between interest rates on low quality corporate bonds and U.S. government bonds A) widened significantly during the Great Depression. B) narrowed significantly during the Great Depression. C) narrowed moderately during the Great Depression. D) did not change during the Great Depression.

widened significantly during the great depression

The collapse of the subprime mortgage market increased the spread between Baa and default-free U.S. Treasury bonds. This is due to A) a reduction in risk. B) a reduction in maturity. C) a flight to quality. D) a flight to liquidity.

a flight to quality

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 B) less speculative than C) tax-exempt unlike D) lower-yielding than

a less liquid than

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 U.S. Treasury bond B) a municipal bond C) a corporate bond with a rating of Aaa D) a corporate bond with a rating of Baa

a corporate bond with a rating of BAA