FIN 341 Exam 1 (ch 3)

Ben Affleck is considering the purchase of a taxable security that offers a before-tax yield of 15 percent. Ben's marginal tax rate is 30 percent. Based on this information, Ben's after-tax yield on the security will be ________ percent.

10.5%

The annualized yield on a three-year security is 13 percent; the annualized two-year interest rate is 12 percent, while the one-year interest rate is 9 percent. The two-year ahead forward rate is ________ percent.

15.0

According to the pure expectations theory, expectations of increasing interest rates indicate an upward-sloping yield curve.

True

Although different securities may exhibit different yields, market forces cause the yields of all securities to move in the same direction.

True

If liquidity influences the yield curve, the forward rate overestimates the market's expectation of the future interest rate.

True

The higher a bond rating, the lower the perceived default risk.

True

The term structure of interest rates defines the relationship between maturity and annualized yield, holding other factors such as risk constant.

True

In response to criticism of the ratings they assigned before the credit crisis, credit rating agencies now

are depending more on sensitivity analysis in which they assess how creditworthiness may change in response to abrupt changes in the economy. and are not allowing employees who work in the agency's sales and marketing departments to influence the ratings that the agency assigns.

Assume that annualized yields of short-term and long-term securities are equal. If investors suddenly believe interest rates will decrease, their actions may cause the yield curve to

become inverted

The ________ theory suggests that although investors and borrowers may normally concentrate on a particular natural maturity market, certain events may cause them to wander from it.

preferred habitat

According to the ________ theory, the term structure of interest rates is determined solely by expectations of future interest rates.

pure expectations

The annualized yield on a three-year security is 13 percent; the annualized two-year interest rate is 12 percent, while the one-year interest rate is 9 percent. The one-year ahead forward rate is ________ percent.

15.1

Vaughn Corporation is considering the issue of commercial paper and would like to know the yield it should offer on its commercial paper. The corporation believes that a 0.5 percent default risk premium, a 0.1 percent liquidity premium, and a 0.4 percent tax adjustment are necessary to sell its commercial paper to investors. Furthermore, annualized T-bill rates are 7 percent. Based on this information, Vaughn should offer ________ percent on its commercial paper.

8.0

Assume an investor's tax rate is 20 percent. The before-tax yield on a security is 10 percent. What is the after-tax yield?

8.00%

Burke Co. is considering the issue of commercial paper and would like to know the yield it should offer on its commercial paper. It believes that a 0.3 percent credit risk premium and a 0.2 percent liquidity premium are necessary to sell its commercial paper to investors. Furthermore, annualized T-bill rates are 8 percent. Based on this information, Burke should offer ____ percent on its commercial paper.

8.5

According to the segmented markets theory, the term structure of interest rates is determined solely by expectations of future interest rates.

False

Investors will always prefer the purchase of risk-free Treasury securities, since other securities have a higher level of risk.

False

The greater the difference between the implied one-year forward rate and today's one-year interest rate, the smaller the expected change in the one-year interest rate.

False

The preference for more liquid short-term securities places downward pressure on the slope of the yield curve.

False

When expectations theory is combined with the liquidity theory, the yield on a security will always be equal to the yield from consecutive investments in shorter-term securities over the same investment horizon.

False

If liquidity influences the yield curve, the forward rate ________ the market's expectation of the future interest rate.

overestimates

According to the segmented markets theory, if most investors suddenly preferred to invest in long-term securities and most borrowers suddenly preferred to issue short-term securities, there would be

downward pressure on the yield of long-term securities.

If the pure expectations theory completely describes the term structure of interest rates, then, on the average, the yield curve should be

flat

In general, securities with ____ credit risk and _______ liquidity will offer higher yields.

higher;lower

The ________ the bond rating, the ________ the perceived default risk.

higher;lower or lower;higher

Assume that the Treasury experiences a large increase in the budget deficit and issues a large number of T-bills. This action will ________ the supply of T-bills in the market and place ________ pressure on the yield of T-bills.

increase;downward

If interest rates are expected to decrease, the yield on new short-term securities may be expected to ________, and the yield curve should be ________ sloping

increase;downward

Assume that the Treasury issues a large number of Treasury bonds. This action will ____ the demand for funds in the market and place ____ pressure on the yield of Treasury bonds.

increase;upward

If the Treasury uses a relatively large proportion of ________ debt to finance a budget deficit, this would place ________ pressure on long-term yields.

long-term;upward

A downward-sloping yield curve indicates that Treasury securities with ________ maturities offer ________ annualized yields.

longer;lower or shorter;higher

Assume that you derive the one-year forward interest rate without considering liquidity. Assuming that liquidity affects the yield, the forward interest rate that you derived would _____________ the market's expectation of the future interest rate.

overestimate

Assume that a yield curve is influenced by interest rate expectations and a liquidity premium. Assume the yield curve is initially flat. If liquidity suddenly became more important, the yield curve would now have a(n) ____ (assuming no other changes).

upward slope

If the liquidity premium theory completely describes the term structure of interest rates, then, on the average, the yield curve should be

upward sloping

According to segmented markets theory, if investors have mostly long-term funds available and borrowers want short-term funds, this will place ________ pressure on the demand for short-term funds by borrowers and the yield curve will be ________ sloping.

upward;downward

The ___________curve represents the relationship between the maturity and the annualized yield of Treasury debt securities.

yield