Money and Banking Chapter 5 Questions

According to the expectations theory of the term structure, a. A) when the yield curve is steeply upward-sloping, short-term interest rates are expected to rise in the future. b. B) when the yield curve is downward-sloping, short-term interest rates are expected to remain relatively stable in the future. c. C) investors have strong preferences for short-term relative to long-term bonds, explaining why yield curves typically slope upward. d. D) all of the above. e. E) only A and B of the above.

A

Corporate bonds are not as liquid as government bonds because a. A) fewer bonds for any one corporation are traded, making them more costly to sell. b. B) the corporate bond rating must be calculated each time they are traded. c. C) corporate bonds are not callable. d. D) all of the above. e. E) only A and B of the above.

A

Economists' attempts to explain the term structure of interest rates a. A) illustrate how economists modify theories to improve them when they are inconsistent with the empirical evidence. b. B) illustrate how economists continue to accept theories that fail to explain observed behavior of interest rate movements. c. C) prove that the real world is a special case that tends to get short shrift in theoretical models. d. D) have proved entirely unsatisfactory to date

A

Of the four theories that explain how interest rates on bonds with different terms to maturity are related, the one that views long-term interest rates as equaling the average of future short-term rates expected to occur over the life of the bond is the a. A) pure expectations theory. b. B) preferred habitat theory. c. C) liquidity premium theory. d. D) segmented markets theory.

A

A corporation suffering big losses might be more likely to suspend interest payments on its bonds, thereby a. A) raising the default risk and causing the demand for its bonds to rise. b. B) raising the default risk and causing the demand for its bonds to fall. c. C) lowering the default risk and causing the demand for its bonds to rise. d. D) lowering the default risk and causing the demand for its bonds to fall.

B

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. a. A) increasing; increasing b. B) increasing; decreasing c. C) decreasing; increasing d. D) decreasing; decreasing

B

As a result of the subprime collapse, the demand for low -quality corporate bonds ________, the demand for high-quality Treasury bonds ________, and the risk spread ________. a. A) increased; decreased; was unchanged b. B) decreased; increased; increased c. C) increased; decreased; decreased d. D) decreased; increased; was unchanged

B

If a corporation's earnings rise, then the default risk on its bonds will ________ and the equilibrium interest rate on these bonds will ________. a. A) increase; decrease b. B) decrease; decrease c. C) increase; increase d. D) decrease; increase

B

In actual practice, short-term interest rates are just as likely to fall as to rise; this is the major shortcoming of the a. A) market segmentation theory. b. B) expectations theory. c. C) liquidity premium theory. d. D) separable markets theory.

B

When the corporate 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 ________. a. A) right; right b. B) right; left c. C) left; left d. D) left; right

B

Holding everything else constant, if a corporation begins to suffer large losses, then the default risk on its bonds will ________ and the expected return on those bonds will ________. a. A) increase: increase b. B) decrease; increase c. C) increase; decrease d. D) decrease; decrease

C

If the yield curve slope is flat, the liquidity premium theory indicates that the market is predicting a. A) a mild rise in short-term interest rates in the near future and a mild decline further out in the future. b. B) constant short-term interest rates in the near future and further out in the future. c. C) a mild decline in short-term interest rates in the near future and a continuing mild decline further out in the future. d. D) constant short-term interest rates in the near future and a mild decline further out in the future.

C

The relationship among interest rates on bonds with identical default risk but different maturities is called the a. A) time-risk structure of interest rates. b. B) liquidity structure of interest rates. c. C) yield curve. d. D) bond demand curve.

C

According to the liquidity premium theory of the term structure, a downward-sloping yield curve indicates that short-term interest rates are expected to a. A) rise in the future. b. B) remain unchanged in the future. c. C) decline moderately in the future. d. D) decline sharply in the future.

D

According to the market segmentation theory of the term structure, a. A) the interest rate for bonds of one maturity is determined by the supply and demand for bonds of that maturity. b. B) bonds of one maturity are not substitutes for bonds of other maturities; therefore, interest rates on bonds of different maturities do not move together over time. c. C) investors' strong preference for short-term relative to long-term bonds explains why yield curves typically slope upward. d. D) all of the above. e. E) none of the above.

D

If the expected path of one-year interest rates over the next four years is 5 percent, 4 percent, 2 percent, and 1 percent, then the pure expectations theory predicts that today's interest rate on the four-year bond is a. A) 1 percent. b. B) 2 percent. c. C) 4 percent. d. D) none of the above.

D

The liquidity premium theory of the term structure a. A) indicates that today's long-term interest rate equals the average of short-term interest rates that people expect to occur over the life of the long-term bond. b. B) assumes that bonds of different maturities are perfect substitutes. c. C) suggests that markets for bonds of different maturities are completely separate because people have different preferences. d. D) does none of the above.

D

The term structure of interest rates is a. A) the relationship among interest rates of different bonds with the same risk and maturity. b. B) the structure of how interest rates move over time. c. C) the relationship among the terms to maturity of different bonds from different issuers. d. D) the relationship among interest rates on bonds with different maturities but similar risk.

D

Since yield curves are usually upward sloping, the ________ indicates that, on average, people tend to prefer holding short-term bonds to long-term bonds. a. A) market segmentation theory b. B) expectations theory c. C) liquidity premium theory d. D) both A and B of the above e. E) both A and C of the above

E

The risk premium on corporate bonds becomes smaller if a. A) the riskiness of corporate bonds increases. b. B) the liquidity of corporate bonds increases. c. C) the liquidity of corporate bonds decreases. d. D) the riskiness of corporate bonds decreases. e. E) either B or D of the above occur.

E