Ch5
(I) if a corporation suffers big losses, the demand for its bonds will rise because of the higher interest rates the firm must pay. (II) The spread between the interest rates on bonds with the default risk and default-free bonds is called the risk premium.
(I) is false, (II) is true.
If the expected path of 1-year interest rates over the next five years is 2%, 4%, 1%, 4%, and 3%, then the pure expectations theory predicts that the bond with the lowest interest rate today is the one with the maturity of
1 year
If the expected path of 1-year interest rates over the next four years is 5%, 4%, 2% and 1%, then the pure expectations theory predicts that today's interest rate on the 4-year bond is
3%
(I) The risk premium widens as the default risk on corporate bonds increases. (II) The risk premium widens as corporate bonds become less liquid.
Both are true
A positive liquidity premium indicates that investors prefer long-term bonds over short-term bonds
False
The expectations theory is able to explain why yield curves are usually upward-sloping
False
The market segmentations theory is able to explain why inters rates on bonds of different maturities move together over time.
False
The risk premium on corporate bonds becomes smaller as the liquidity of bonds falls
False
The term structure of interest rates describes how interest rates move over time.
False
When yield curves are downward-sloping, long-term interest rates are above short-term interest rates.
False
Which of the following long-term bonds should have the lowest interest rate?
Municipal bonds
A mildly upward-sloping yield curve suggests that the market is predicting constant short-term interest rates.
True
According to the expectations theory, the interest rate on a long-term bond is the average of the short-term interest rates expected of the life of the long-term bond.
True
An increase in income tax rates will cause the inters rates on tax-exempt municipal bonds to fall relative to the inters rate on taxable corporate securities.
True
The interest rates on bonds of different maturities tend to move together over time.
True
The risk structure of interest rates describes the relationship between the interest rates of different bonds with the same maturities
True
If the yield curve slope is flat, the liquidity premium theory indicates that the market is predicting
a mild decline in short-term interest rates in the near future and a continuing mild decline further out in the future.
According to the liquidity premium theory of the term structure, a downward-sloping yield curve indicates that short-term interest rates are expected to
decline sharply in the future
If Moody's or Standard and Poor's downgrades its rating on a corporate bond, the demand for the bond ______ and its yield _____.
decreases; increases
A decrease in marginal tax rates would likely have the effect of ______ the demand for municipal bonds and ______ the demand for U.S. government bonds.
decreasing; increasing
The risk structure of interest rates is explained by
default risk; liquidity; tax considerations.
The liquidity premium theory of the term structure
does none of the above...
The risk premium on corporate bonds becomes smaller if
either the liquidity of corporate bonds increases or the riskiness of corporate bonds decrease.
In actual practice, short-term interest rates are just as likely to fall as to rise; this is the major shortcoming of the
expectations theory
Typically, yield curves are
gently upward-sloping.
Holding everything else the same, if a corporation's earnings rise, then the default risk on its bonds will ______ and the expected return on those bonds will ______.
increase; decrease
According to the expectations theory of the term structure,
interest rates on bonds of different maturities move together over time.
Bonds with relatively low risk of default are called
investment-grade bonds.
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 ______.
left; right
The _______ theory is the most widely accepted theory of the term structure of interest rates because it explains the major empirical facts about the term structure so well.
liquidity premium
When yield curves are steeply upward-sloping,
long-term interest rates are above short-term interest rates
When the default risk on corporate bonds decreases, other things equal, the demand curve for corporate bonds shifts to the ______ and the demand curve for Treasury bonds shifts to the ______.
right; left.
Of the four theories that explain how interest rates on bonds with different terms to maturity are related, the one that assumes that bonds of different maturities are not substitutes for one another is the
segmented markets theory
According to the market segmentation theory of the term structure,
the interest rate for bonds o one maturity is determined by the supply and demand for bonds of that maturity; bonds of one maturity are not substitutes fro bonds of other maturities - therefore, interest rates on bonds of different maturities do not move together over time; investors' strong preference for short-term relative to long-term bonds explains why yield curves typically slope upward.
If income tax rates were lowered, then
the interest rate on municipal bonds would rise.
The risk structure of interest rate is
the relationship among interest rates of different bonds with the same maturity
The term structure of interest rates is
the relationship among interest rates on bonds with different maturities but similar risk.
Yield curves can be classified as
upward-sloping; downward-sloping; flat
According to the expectations theory of the term structure,
when the yield curve is steeply upward-sloping, short-term interest rates are expected to rise in the future; when the yield curve is downward-sloping, short-term interest rates are expected to decline in the future.
The relationship among interest rates on bonds with identical default risk but different maturities is called the
yield curve
