ECO 414 CH 6

The typical shape for a yield curve is A) gently upward sloping. B) mound shaped. C) flat. D) bowl shaped.

A) gently upward sloping.

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

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

According to this theory of the term structure, bonds of different maturities are not substitutes for one another. A) segmented markets theory B) expectations theory C) liquidity premium theory D) separable markets theory

A) segmented markets theory

The segmented markets theory can explain A) why yield curves usually tend to slope upward. B) why interest rates on bonds of different maturities tend to move together. C) why yield curves tend to slope upward when short-term interest rates are low and to be inverted when short-term interest rates are high. D) why yield curves have been used to forecast business cycles.

A) why yield curves usually tend to slope upward.

Which of the following statements are TRUE? A) A decrease in default risk on corporate bonds lowers the demand for these bonds, but increases the demand for default-free bonds. B) The expected return on corporate bonds decreases as default risk increases. C) A corporate bond's return becomes less uncertain as default risk increases. D) As their relative riskiness increases, the expected return on corporate bonds increases relative to the expected return on default-free bonds.

B) The expected return on corporate bonds decreases as default risk increases.

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) U.S. Treasury bonds

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) expectations theory

According to the liquidity premium theory of the term structure A) bonds of different maturities are not substitutes. B) 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. C) yield curves should never slope downward. D) interest rates on bonds of different maturities do not move together over time.

B) 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.

U.S. government bonds have no default risk because A) they are issued in strictly limited quantities. B) the federal government can increase taxes or print money to pay its obligations. C) they are backed with gold reserves. D) they can be exchanged for silver at any time.

B) the federal government can increase taxes or print money to pay its obligations.

According to the segmented markets theory of the term structure A) bonds of one maturity are close substitutes for bonds of other maturities, therefore, interest rates on bonds of different maturities move together over time. B) the interest rate for each maturity bond is determined by supply and demand for that maturity bond. C) investors' strong preferences for short-term relative to long-term bonds explains why yield curves typically slope downward. D) because of the positive term premium, the yield curve will not be observed to be downward-sloping.

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

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) the relationship among interest rates of different bonds with the same maturity.

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 A) 1 percent. B) 2 percent. C) 3 percent. D) 4 percent.

C) 3 percent.

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) decrease; increase

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

C) liquidity premium theory

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

Municipal bonds have default risk, yet their interest rates are lower than the rates on default-free Treasury bonds. This suggests that A) the benefit from the tax-exempt status of municipal bonds is less than their default risk. B) the benefit from the tax-exempt status of municipal bonds equals their default risk. C) the benefit from the tax-exempt status of municipal bonds exceeds their default risk. D) Treasury bonds are not default-free.

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

If you have a very low tolerance for risk, which of the following bonds would you be least likely to hold in your portfolio? A) a U.S. Treasury bond B) a municipal bond C) a corporate bond with a rating of Aaa D) a corporate bond with a rating of Baa

D) a corporate bond with a rating of Baa

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) the relationship among interest rates on bonds with different maturities.

If a higher inflation is expected, what would you expect to happen to the shape of the yield curve? Why?

The yield curve should have a steep upward slope. Nominal interest rates will increase if the inflation rate increases, therefore, bond purchasers will require a higher term premium to hold the riskier long-term bond.