Money and Banking: Module 4 - Chapter 4

The rate at which a lender needs to be compensated for taking on greater risk is known as a(n) __________ premium.

default risk

As the federal marginal tax rate rises, the advantage of municipal bonds over corporate bonds

increases

According to the pure expectations theory, a flat yield curve means the market

thinks that future interest rates will be exactly the same as current interest rates.

​Diedre works for a pension fund and is thinking of buying some bonds that have a nominal interest rate of 6%. She believes that the inflation rate over the life of the bond will be 2%. The ex-post real interest rate on this bond is

unknown

Armand buys a 10-year, $10,000 bond that pays him $500 every year for 10 years and repays the face value in year 10. During the 10-year period, the rate of inflation holds steady at 3% per year. The real rate of return on Armand's investment is

​2%.

​Daniella is considering the purchase of a 10-year, $10,000 bond being issued by Disreputable, Inc. The bond offers an interest rate of 5.5%. The rate on a similar US Treasury bond is 2.5%. All else equal, Daniella will be getting a default premium of _____, if she purchases the Disreputable, Inc. bond.

​3.0%

Julia is in the 10% marginal income tax bracket and earned a 4.5% return on the municipal bonds that just matured. The nominal interest rate paid on these bonds was

​4.5%.

Consider Figure 4-1, which shows the supply and demand for US Treasury Securities (S US and D US ) and for Charter Corp. bonds (S C and D C ), as well as the corresponding equilibrium price (P US and P C ). What is the most likely reason that the market price for US Treasury Securities is higher than the market price for Charter Corp. bonds?

​There is a higher risk that Charter Corp. will default on its obligation.

​Harper just got a big raise at work, which pushed her from the 15% federal marginal tax bracket to the 25% marginal tax bracket. Which of the following best describes how this might affect her decision to buy municipal bonds?

​This will make her more likely to buy municipal bonds because it will increase the difference between the nominal interest rate paid on the bonds and the after-tax interest rate she will receive relative to corporate bonds.

​The best way to measure the default risk premium that a borrower is paying is to

​compare the interest rate the borrower pays with the risk-free premium, usually represented by the rate on US Treasury Securities.

A major advantage that municipal bonds have over corporate bonds for investors is that

​the income earned on municipal bonds is not subject to federal income tax.

​The three theories that economists have developed to explain the shape of the yield curve are

​the pure expectations theory, the term premium theory, and the segmented market theory.

​Inflation is a benefit to

borrowers

​The risk that a bond issuer will not be able to live up to the promise they make when they issue a bond is known as __________ risk.

default