Chapter 6

A ________ yield curve predicts a future increase in inflation. A) steeply upward sloping B) slight upward sloping C) flat D) downward sloping

A

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

A

A decrease in default risk on corporate bonds ________ the demand for these bonds, and ________ the demand for default-free bonds, everything else held constant. A) increases; lowers B) lowers; increases C) does not change; greatly increases D) moderately lowers; does not change

A

A key assumption in the segmented markets theory is that bonds of different maturities A) are not substitutes at all. B) are perfect substitutes. C) are substitutes only if the investor is given a premium incentive. D) are substitutes but not perfect substitutes.

A

An increase in the liquidity of corporate bonds will ________ the price of corporate bonds and ________ the yield of Treasury bonds, everything else held constant. A) increase; increase B) reduce; reduce C) increase; reduce D) reduce; increase

A

As default risk decreases, the expected return on corporate bonds ________, and the return becomes ________ uncertain, everything else held constant. A) increases; less B) increases; more C) decreases; less D) decreases; more

A

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.

A

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.

A

If bonds with different maturities are perfect substitutes, then the ________ on these bonds must be equal. A) expected return B) surprise return C) surplus return D) excess return

A

In actual practice, short-term interest rates and long-term interest rates usually move together; this is the major shortcoming of the A) segmented markets theory. B) expectations theory. C) liquidity premium theory. D) separable markets theory.

A

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

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

A

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.

A

Typically, yield curves are A) gently upward sloping. B) mound shaped. C) flat. D) bowl shaped.

A

When yield curves are steeply upward sloping, A) long-term interest rates are above short-term interest rates. B) short-term interest rates are above long-term interest rates. C) short-term interest rates are about the same as long-term interest rates. D) medium-term interest rates are above both short-term and long-term interest rates.

A

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

A

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

B

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

B

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. A) increasing; increasing B) increasing; decreasing C) decreasing; increasing D) decreasing; decreasing

B

If the yield curve has a mild upward slope, the liquidity premium theory (assuming a mild preference for shorter-term bonds) indicates that the market is predicting A) a rise in short-term interest rates in the near future and a decline further out in the future. B) constant short-term interest rates in the near future and further out in the future. C) a decline in short-term interest rates in the near future and a rise further out in the future. D) a decline in short-term interest rates in the near future and an even steeper decline further out in the future.

B

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. A) segmented markets theory B) expectations theory C) liquidity premium theory D) separable markets theory

B

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 A) risk premium. B) term premium. C) tax premium. D) market premium.

B

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.

B

When yield curves are downward sloping, A) long-term interest rates are above short-term interest rates. B) short-term interest rates are above long-term interest rates. C) short-term interest rates are about the same as long-term interest rates. D) medium-term interest rates are above both short-term and long-term interest rates.

B

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

B

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.

B

A plot of the interest rates on default-free government bonds with different terms to maturity is called A) a risk-structure curve. B) a default-free curve. C) a yield curve. D) an interest-rate curve.

C

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

C

According to the segmented markets theory of the term structure A) 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. B) buyers of bonds do not prefer bonds of one maturity over another. C) interest rates on bonds of different maturities do not move together over time. D) buyers require an additional incentive to hold long-term bonds.

C

An increase in the riskiness of corporate bonds will ________ the price of corporate bonds and ________ the price of Treasury bonds, everything else held constant. A) increase; increase B) reduce; reduce C) reduce; increase D) increase; reduce

C

An increase in the riskiness of corporate bonds will ________ the yield on corporate bonds and ________ the yield on Treasury securities, everything else held constant. A) increase; increase B) reduce; reduce C) increase; reduce D) reduce; increase

C

An inverted yield curve A) slopes up. B) is flat. C) slopes down. D) has a U shape.

C

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

C

Differences in ________ explain why interest rates on Treasury securities are not all the same. A) risk B) liquidity C) time to maturity D) tax characteristics

C

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.

C

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 A) 4 percent. B) 5 percent. C) 6 percent. D) 7 percent.

C

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 ________. A) right; right B) right; left C) left; right D) left; left

C

Risk premiums on corporate bonds tend to ________ during business cycle expansions and ________ during recessions, everything else held constant. A) increase; increase B) increase; decrease C) decrease; increase D) decrease; decrease

C

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.

C

The preferred habitat theory of the term structure is closely related to the A) expectations theory of the term structure. B) segmented markets theory of the term structure. C) liquidity premium theory of the term structure. D) the inverted yield curve theory of the term structure.

C

When yield curves are flat, A) long-term interest rates are above short-term interest rates. B) short-term interest rates are above long-term interest rates. C) short-term interest rates are about the same as long-term interest rates. D) medium-term interest rates are above both short-term and long-term interest rates.

C

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

C

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 ________. A) right; right B) right; left C) left; left D) left; right

D

If 1-year interest rates for the next three years are expected to be 4, 2, and 3 percent, and the 3-year term premium is 1 percent, than the 3-year bond rate will be A) 1 percent. B) 2 percent. C) 3 percent. D) 4 percent.

D

If investors expect interest rates to fall significantly in the future, the yield curve will be inverted. This means that the yield curve has a ________ slope. A) steep upward B) slight upward C) flat D) downward

D

If the expected path of 1-year interest rates over the next five years is 1 percent, 2 percent, 3 percent, 4 percent, and 5 percent, the expectations theory predicts that the bond with the highest interest rate today is the one with a maturity of A) two years. B) three years. C) four years. D) five years.

D

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

D

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.

D

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.

D

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

D