Homework Ch 6.

positive; raise

A bond with default risk will always have a ________ risk premium and an increase in its default risk will ________ the risk premium.

Increase; decrease; increase

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

Perfect

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

one

If the expected path of 1-year interest rates over the next five years is 2 percent, 4 percent, 1 percent, 4 percent, and 3 percent, the expectations theory predicts that the bond with the lowest interest rate today is the one with a maturity of ________ year(s).

3%

If the expected path of 1-year interest rates over the next four years is 5 percent, 4 percent, 2 percent, and 1 percent, then the expectations theory predicts that today's interest rate on the four-year bond is _________ percent.

expectations theory

The ________ of the term structure of interest rates states that the interest rate on a long-term bond will equal the average of short-term interest rates that individuals expect to occur over the life of the long-term bond, and investors have no preference for short-term bonds relative to long-term bonds.

liquidity premium theory

The ________ of the term structure states the following: the interest rate on a long-term bond will equal an average of short-term interest rates expected to occur over the life of the long-term bond plus a term premium that responds to supply and demand conditions for that bond.

Term Premium

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 ________.

The federal government can increase taxes to pay its obligations

U.S. government bonds have no default risk because ________.

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 ________.

short-term interest rates are above long-term interest rates

When yield curves are downward sloping, ________.

short-term interest rates are about the same as long-term interest rates

When yield curves are flat, ________.

long-term interest rates are above short-term interest rates

When yield curves are steeply upward sloping, ________.

Junk Bonds

Which of the following bonds would have the highest default risk?

U.S. Treasury bonds

Which of the following securities has the lowest interest rate?

increase; reduce

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

are not substitutes at all

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

a yield curve

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

increase; increase; decrease

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

remain unchanged

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 ___________ in the future.

Rise

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 ___________ in the future.

interest rates on bonds of different maturities do not move together over time

According to the segmented markets theory of the term structure _______.

Default - Free Bonds

Bonds with no default risk are called __________.

investment grade; junk bonds

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 ________.

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

Corporate bonds are not as liquid as government bonds because _______.

time to maturity

Differences in ________ explain why interest rates on Treasury securities are not all the same.

Increases

During a "flight to quality" the spread between Treasury bonds and Baa bonds ________.

the relationship among interest rates on bonds with different maturities

The term structure of interest rates is ________.

increasing; decreasing

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.

the interest rate on municipal bonds would rise

Everything else held constant, if income tax rates were lowered, then _______.

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

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

income tax rates are lowered

Everything else held constant, the interest rate on municipal bonds rises relative to the interest rate on Treasury securities when ______.

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

Municipal bonds have default risk, yet their interest rates are lower than the rates on default-free Treasury bonds. This suggests that ______.

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 ________.

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 ________.

2%

Over the next three years, the expected path of 1-year interest rates is 4, 1, and 1 percent. The expectations theory of the term structure predicts that the current interest rate on 3-year bond is ______ percent.

decrease; increase

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

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

Three factors explain the risk structure of interest rates: ______

U.S Treasury Bonds

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

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

Which of the following statements is TRUE?

Bonds issued by state and local governments are called municipal bonds

Which of the following statements is TRUE?

increase; decrease

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

Left; right

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 ________.

interest rates on bonds of different maturities move together over time

According to the expectations theory of the term structure _____.

yield curves should be equally likely to slope downward as slope upward

According to the expectations theory of the term structure ________.

Average

According to the expectations theory of the term structure, the interest rate on a long-term bond will equal the ________ of the short-term interest rates that people expect to occur over the life of the long-term bond.

if yield curves are downward sloping, then short-term interest rates are expected to fall by so much that, even when the positive term premium is added, long-term rates fall below short-term rates

According to the liquidity premium theory of the term structure _______.

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

According to the liquidity premium theory of the term structure ________.

decline sharply

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

decline moderately

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

the interest rate for each maturity bond is determined by supply and demand for that maturity bond

According to the segmented markets theory of the term structure __________.

segmented markets theory

According to this theory of the term structure, bonds of different maturities are not substitutes for one another.

increase; reduce

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

slopes down

An inverted yield curve _______.

5%

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 ________ percent.

6%

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 ________ percent.

increase; decrease

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.

segmented markets theory

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

high-yield

Junk bonds, bonds with a low bond rating, are also known as _______ bonds.

lower; higher

The Obama administration increased the tax on the top income tax bracket from 35% to 39%. Supply and demand analysis predicts the impact of this change was a ________ interest rate on municipal bonds and a ________ interest rate on Treasury bonds, all else the same.

A flight to quality

The collapse of the subprime mortgage market increased the spread between Baa and default-free U.S. Treasury bonds. This is due to ___________.

Less liquid than

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

The relationship among interest rates of different bonds with the same maturity

The risk structure of interest rates is ________.

Default Risk

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 ______.

why yield curves usually tend to slope upward

The segmented markets theory can explain _________.

Widened

The spread between interest rates on low quality corporate bonds and U.S. government bonds __________ significantly during the Great Depression.

Risk Premium

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