Chapter 6
Suppose that your marginal tax rate is 40%. Your after-tax return from holding (to maturity) a one-year corporate bond with a yield to maturity of 5% is ---- Suppose your marginal income tax rate is 35%. If a corporate bond pays 10%, then the interest rate that an otherwise identical municipal bond have to pay in order for you to be indifferent between holding the corporate bond and the municipal bond is ------ In which of the following situations would you choose to hold the corporate bond over the municipal bond, assuming that corporate and municipal bonds have the same maturity, liquidity, and default risk? A. The corporate bond pays 10%, the municipal bond pays 9%, and your marginal income tax rate is 20%. B. The corporate bond pays 10%, the municipal bond pays 8%, and your marginal income tax rate is 25%. C. The corporate bond pays 10%, the municipal bond pays 7%, and your marginal income tax rate is 35%. D. The corporate bond pays 10%, the municipal bond pays 7%, and your marginal income tax rate is 25%.
3%. 7%. D
According to the liquidity premium theory of the term structure of interest rates, if the one-year bond rate is expected to be 3%, 6%, and 9% over each of the next three years, and if the liquidity premium on a three-year bond is 11%, then the interest rate on a three-year bond is ------- According to the liquidity premium and preferred habitat theories of the term structure of interest rates, a flat yield curve indicates that A. future short-term interest rates are expected to stay the same. B. future short-term interest rates are expected to fall. C. bondholders no longer prefer short-term bonds to long-term bonds. D. future short-term interest rates are expected to rise.
7%. B
Will a U.S. Treasury bill have a risk premium that is higher than, lower than, or the same as that of a similar security (in terms of maturity and liquidity) issued by the government of Colombia? A. A U.S. Treasury bill will have a lower risk premium since U.S. government issued securities are usually considered to be default free. B. A U.S. Treasury bill will have the same risk premium as that of a similar security issued by the government of Colombia. C. A U.S. Treasury bill may have a higher risk premium depending on the fiscal imbalances that each country exhibits at a given point in time.
A
What would happen to the risk premiums of municipal bonds if the federal government guarantees today that it will pay creditors if municipal governments default on their payments. A. Risk premium on municipal bonds will stay the same. B. Risk premium on municipal bonds will decrease. C. Risk premium on municipal bonds will increase. D. There is not enough information to tell. Do you think that it will then make sense for municipal bonds to be exempt from income taxes? A. No. If this were to happen, then municipal bonds will be even better than U.S. government bonds. B. Yes. Municipal bonds will continue to have higher risk premium than Treasury bonds and will need "help" to gain access to funds.
B A
Which of the following statements is not true? A. When short-term interest rates are high, yield curves tend to be downward sloping. B. When short−term interest rates are low, yield curves tend to be inverted. C. Yield curves almost always slope upward D. Interest rates on bonds of different maturities tend to move together over time According to the segmented markets theory of the term structure of interest rates, if bondholders prefer short-term bonds to long-term bonds, the yield curve will be ------- .
B upward sloping
If junk bonds are "junk," then why would investors buy them? A. Some junk bonds may have a rating of AA- by the credit-rating agencies. B. Junk bonds have lower default risk. C. Junk bonds can provide high yields. D. The theory of portfolio choice predicts that portfolios with junk bonds are more diversified.
C
What will happen to interest rates on a corporation's bonds if the federal government guarantees today that it will pay creditors if the corporation goes bankrupt in the future? Interest rates on corporate bonds will ----- .
decrease
If expectations of future short-term interest rates suddenly fall, what would happen to the slope of the yield curve? The yield curve would become ----- .
flatter
If the income tax exemption on municipal bonds were abolished, the interest rates on these bonds would ----- .
increase
If a yield curve looks like the one shown in the figure to the right, what is the market predicting about the movement of future short-term interest rates? The market is predicting that future short-term interest rates will ---- . What might the yield curve indicate about the market's predictions for the inflation rate in the future? The market's predictions indicate that inflation will be ---- in the future.
increase higher
If the yield curve suddenly becomes steeper, how would you revise your predictions of interest rates in the future? You would --- your predictions of future interest rates.
raise
You are given the following series of one-year interest rates: 33%, 55%, 1313%, 1515% Assuming that the expectations theory is the correct theory of the term structure, calculate the interest rates in the term structure for maturities of one to four years, and plot the resulting yield curve. 1. Using the point drawing tool, plot the interest rate (calculated using the data above) for each of the four terms to maturity. Properly label each point according to its corresponding term. 2. Using the 4-point curved line drawing tool, connect these points. Label your curve 'yield curve'. Carefully follow the instructions above, and only draw the required objects. How would your yield curve change if people preferred shorter-term bonds over longer-term bonds? The yield curve would become ------ .
steeper
The spread between the interest rate on a one-year U.S. Treasury bond and a 20-year U.S. Treasury bond is known as the ------ . According to the expectations theory of the term structure of interest rates, if the one-year bond rate is 3%, and the two-year bond rate is 4%, next year's one-year rate is expected to be A. 3%. B. 5%. C. 4%. D. 6%.
term premium B