Chapter 6

the economy is coming out of a recession

A Flat yield curve generally occurs when ______

are the same as short-term rates

A Flat yield curve means that long-term rates are ______

risk free

A Treasury instrument (Treasury bill, Treasury note, or Treasury bond) is considered to be ______ in that the federal government has the ability to service its debt at any market-determined interest rate or, failing that, the power to coin the currency (i.e., print money).

decrease increase

A _______ in the tax rate causes an ______ in the interest rate on tax-exempt bonds (municipals), which can be considered an increase in the risk premium on municipals.

increase raise

A bond with default risk will always have a positive risk premium, and an ______ in its default risk will _____ the risk premium

An increase

A decrease in the tax rate causes ____ in the interest rate on tax exempt bonds, such as municipal bonds.

increase

A decrease in the tax rate causes an increase in the interest rate on tax-exempt bonds (municipals), which can be considered an _____ in the risk premium on municipals.

rise in the near term and fall later on

A mound shaped yield curve indicates that short term interest rates are expected to _______

rise moderately in the near term and fall later on

A mound shaped yield curve indicates that the inflation rate is expected to ________

will rise in the future

An Upward-sloping yield curve means that interest rates _______

above short term rates

An Upward-sloping yield curve means that long-term rates are.....

left

An increase in default risk shifts the demand curve for corporate bonds to the _____

right

An increase in default risk shifts the demand curve for treasury bonds to the _____

will be low and continue to fall

An inverted yield curve mean that interest rates ________

below short-term rates end up in a recession,

An inverted yield curve means that long-term rates are ________. The economy will ________

more risky higher interest rate

Bonds that are _____ are less attractive, the seller has to offer incentives to make you buy them, normally the incentive would be the bond having a _____

positive

Bonds with default risk have a ______ risk premium.

time remaining to maturity

Bonds with identical risk, liquidity, and tax characteristics may have different interest rates because the ______ is different

higher

Bonds with longer yield to maturity have____ interest rates

" Default risk " Liquidity " Tax considerations

Bonds with the same maturity have different interest rates due to:

Interest rates spread

Concerning long term bond yields for Municipal, US government long term bonds, corporate Baa, and corporate Aaa bonds: " The _____ move together but they differ from one another slightly: so the _____ varies over time

unable or unwilling to make interest payments or pay off the face value

Default risk is the probability that the issuer of the bond is _________

falls left

If corporate bonds become less liquid, demand for corporate bonds ______, the Demand curve shifts to the ______, meaning price falls and interest rates increase

falls increase

If corporate bonds become less liquid, demand for corporate bonds falls, the Demand curve shifts to the left, meaning price _____ and interest rates _____

Increase

If the income tax exemption on municipal bonds were abolished, the interest rates on these bonds would _________

You would raise your predictions of future interest rates

If the yield curve suddenly becomes steeper, how would you revise your predictions of interest rates in the future?

less interest rate risk

In The SEGMENTED MARKETS THEORY If investors (more specifically, risk averse investors) generally prefer bonds with shorter maturities that have _______ then this explains why yield curves usually slope upward (fact 3).

opposite directions

In response to an increase in default risk on corporate bonds, The change in prices leads to a change in interest rates, they move in _______

lowers raises

In response to an increase in default risk on corporate bonds, the price of treasury bonds rise and the price of corporate bonds decrease. This _____ the interest rate on treasury bonds and _____ the interest rates on corporate bonds.

EXPECTATIONS THEORY

In the _______ the interest rate on a long-term bond will equal an average of the short-term interest rates that people expect to occur over the life of the long-term bond.

municipal bonds

Interest payments on _____ are exempt from federal income taxes.

together over time

Interest rates on bonds with different maturities move ________

an average of short-term interest rates expected to occur over the life of the long-term bond plus

Liquidity Premium Theory says that the interest rate on a long-term bond will equal ________ plus a liquidity premium that responds to supply and demand conditions for that bond.

liquidity premium that responds to supply and demand conditions for that bond.

Liquidity Premium Theory says that 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 ___________

partial (not perfect) substitutes.

Liquidity Premium Theory states that Bonds of different maturities are _________

not default free

Municipal bonds are _______: local governments have and do default on them unlike treasury bonds

tax exempt interest payments right. left

Municipal bonds are not as liquid as treasury bills but they also have lower rates than T-bonds, why? Municipal bonds have ______, making them more attractive to buyers. This leads to an increase in demand and the demand curve shifts _____ Relatively, demand curve for US treasury bonds shifts _____

lower

Municipal bonds have _____ interest rates than US Treasury bills.

expected inflation

Nominal rates and _______ move together

yield curves usually slope upward (fact 3)

The Expectations theory cannot explain why _________

move together over time (fact 1)

The Expectations theory explains why interest rates on bonds with different maturities _______

different times.

The Expectations theory explains why the term structure of interest rates change at ________

low high

The Expectations theory explains why yield curves tend to slope up when short-term rates are _____ and slope down when short-term rates are ______ (fact 2).

bonds with different maturities to be perfect substitutes

The Key assumption of the EXPECTATIONS THEORY is that Bond holders consider __________

interest rates

The RISK STRUCTURE OF INTEREST RATES is why different bonds with the same maturity have different ________

substitutes at all

The SEGMENTED MARKETS THEORY says that bonds of different maturities are not _______, there are segmented markets.

Risk premium

The ______ is the spread between the interest rates on bonds default risk and the interest rates on (same maturity) default free bonds Ex: Treasury bonds

Term Structure of Interest Rates

The _______ Is the relationship among interest rates on bonds with different terms to maturity There is no difference in liquidity, interest rates, etc.

Liquidity Premium Theory

The _________ combines the first two theories to explain all the facts.

SEGMENTED MARKETS THEORY

The _________ says that Investors have preferences for bonds with a specific holding period in mind. They have a specific demand for a specific type of bond

additional interest people must earn

The risk premium Indicates how much _______ to be willing to hold a more risky bond

default risk liquidity.

The spread between interest rates on corporate bonds and Treasury bonds reflect not only the _____ of a corporate bond but also ______

the risk premium

The spread between the corporate bonds and default free bonds = _________

Term premium

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 ____

difference between 2 interest rates

The spread is the ___________

term structure of interest rates for particular types of bonds

The yield curve describes the ________

higher

The yield from Municipal bonds are not subject to federal taxation. Therefore, their effective returns are ____ than that of Treasury bonds.

default free

U.S. Treasury bonds are considered ______ (Government can raise taxes)

Decrease

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 _______

raises lowers

When an increase in default risk shifts the demand curve for corporate bonds to the left and shifts the demand curve for treasury bonds to the right, this ______ the price of treasury bonds and _____ the price of corporate bonds.

downward slope inverted.

When short term interest rates are high, yield curves are more likely to have a ______ and be _____

upward slope.

When short term interest rates are low, yield curves are more likely to have an _________

differing terms to maturity

Yield curve is a plot of the yield on bonds with ______ but the same risk, liquidity and tax considerations

upwards

Yield curves almost always slope _____

Corporate bonds

______ are not as widely traded as U.S. Government bonds, so they are not as liquid.

US Government Bonds

_______ are the most risk free bond

Corporate Aaa bonds

________ are the best corporate bonds

U.S. Government bonds

________ are the most liquid of all long-term bonds since they are the most widely traded, the cost of selling is low