Question 1

A company that retains a high bond rating during a recession in which many other companies see their bond ratings cut will experience

Accepted Answer

A) an increased flow of funds into the market for its securities. 
B) an increased demand for its securities, driving up the expected return on them. 
C) a decreased demand for its securities, driving down the expected return on them. 
D) a decreased flow of funds into the market for its securities. 
A) an increased flow of funds into the market for its securities. 
B) an increased demand for its securities, driving up the expected return on them. 
C) a decreased demand for its securities, driving down the expected return on them. 
D) a decreased flow of funds into the market for its securities.

Question 2

The preferred habitat theory holds that investors

Accepted Answer

A) always choose the bond with the highest expected return, regardless of maturity. 
B) require a term premium to compensate them for investing in a less preferred maturity. 
C) view bonds of different maturities as perfect substitutes. 
D) view bonds of different maturities as completely unsubstitutable. 
A) always choose the bond with the highest expected return, regardless of maturity. 
B) require a term premium to compensate them for investing in a less preferred maturity. 
C) view bonds of different maturities as perfect substitutes. 
D) view bonds of different maturities as completely unsubstitutable.

Question 3

Steve Forbes has run for president twice on a program of a "flat tax." Under a flat tax, there would be only one tax bracket for the federal income tax and most tax deductions and tax exemptions would be eliminated. Suppose that Forbes wins the 2008 presidential election. What would be the likely impact on the market for municipal bonds?

Accepted Answer

If interest on municipal bonds were no l

Question 4

The default of the Penn Central Railroad in the early 1970s

Accepted Answer

A) led indirectly to a fall in the price of U.S. Treasury securities. 
B) strongly affected the market for municipal bonds. 
C) resulted from the lack of liquidity in the U.S. Treasury bill market. 
D) resulted in an increase in the default-risk premium in the commercial paper market. 
A) led indirectly to a fall in the price of U.S. Treasury securities. 
B) strongly affected the market for municipal bonds. 
C) resulted from the lack of liquidity in the U.S. Treasury bill market. 
D) resulted in an increase in the default-risk premium in the commercial paper market.

Question 5

Under the preferred habitat theory, the expectation that future short-term rates will be constant results in a yield curve that

Accepted Answer

A) is flat. 
B) slopes upward. 
C) slopes downward. 
D) is flat, slopes upward, or slopes downward, depending on the size of the term premium at each maturity. 
A) is flat. 
B) slopes upward. 
C) slopes downward. 
D) is flat, slopes upward, or slopes downward, depending on the size of the term premium at each maturity.

Question 6

Default risk

Accepted Answer

A) is the probability that a borrower will not pay in full the promised interest or principal. 
B) exists only for the bonds of small corporations. 
C) is also known as market risk. 
D) is zero for bonds issued by cities and states. 
A) is the probability that a borrower will not pay in full the promised interest or principal. 
B) exists only for the bonds of small corporations. 
C) is also known as market risk. 
D) is zero for bonds issued by cities and states.

Question 7

Which of the following statements about junk (high-risk) bonds is true?

Accepted Answer

A) They never outperform treasury bonds since they're too risky. 
B) The price of junk bonds increase as their perceived risk increases. 
C) They tend to perform best during recessions. 
D) One can profit by owning them if market perceptions of their risk decline. 
A) They never outperform treasury bonds since they're too risky. 
B) The price of junk bonds increase as their perceived risk increases. 
C) They tend to perform best during recessions. 
D) One can profit by owning them if market perceptions of their risk decline.

Question 8

Interest on most bonds issued by state governments is

Accepted Answer

A) exempt from state and federal income taxes. 
B) exempt from state, but not from federal, income taxes. 
C) exempt from federal, but not from state, income taxes. 
D) subject to both state and federal income taxes. 
A) exempt from state and federal income taxes. 
B) exempt from state, but not from federal, income taxes. 
C) exempt from federal, but not from state, income taxes. 
D) subject to both state and federal income taxes.

Question 9

The key assumption of the preferred habitat theory is that investors

Accepted Answer

A) view bonds of different maturities as perfect substitutes. 
B) view bonds of different maturities as completely unsubstitutable. 
C) always choose the bond with the highest expected return, regardless of maturity. 
D) care about both expected returns and maturity. 
A) view bonds of different maturities as perfect substitutes. 
B) view bonds of different maturities as completely unsubstitutable. 
C) always choose the bond with the highest expected return, regardless of maturity. 
D) care about both expected returns and maturity.

Question 10

Which of the following bond ratings by Moody's Investors Service would NOT be considered to be below investment grade?

Accepted Answer

A) Baa 
B) Ba 
C) B 
D) All of these ratings are considered below investment grade. 
A) Baa 
B) Ba 
C) B 
D) All of these ratings are considered below investment grade.

Question 11

U.S. Treasury securities

Accepted Answer

A) are considered risk free because their prices never change. 
B) have been defaulted on several time in U.S. history. 
C) are considered default-risk-free instruments. 
D) have a large default risk premium. 
A) are considered risk free because their prices never change. 
B) have been defaulted on several time in U.S. history. 
C) are considered default-risk-free instruments. 
D) have a large default risk premium.

Question 12

The implication of the expectations theory that expected returns for a holding period must be the same for bonds of different maturities depends on the assumption that

Accepted Answer

A) yield curves usually slope upward. 
B) yield curves usually slope downward. 
C) instruments with different maturities are perfect substitutes. 
D) savers are usually risk averse. 
A) yield curves usually slope upward. 
B) yield curves usually slope downward. 
C) instruments with different maturities are perfect substitutes. 
D) savers are usually risk averse.

Question 13

If a country has a poorly functioning risk structure of corporate bond yields,

Accepted Answer

A) yields on long-term bonds will be relatively low. 
B) the country's tax code will have to be adjusted to reflect this. 
C) low interest rates will lead to rapid rates of growth in physical capital. 
D) corporations will rely more heavily on bank loans and on new equity issues. 
A) yields on long-term bonds will be relatively low. 
B) the country's tax code will have to be adjusted to reflect this. 
C) low interest rates will lead to rapid rates of growth in physical capital. 
D) corporations will rely more heavily on bank loans and on new equity issues.

Question 14

In which of the following periods was the yield curve inverted?

Accepted Answer

A) Spring 1989 
B) Fall 1990 
C) Early 1991 
D) The yield curve was not inverted during any of these periods. 
A) Spring 1989 
B) Fall 1990 
C) Early 1991 
D) The yield curve was not inverted during any of these periods.

Question 15

Suppose that your marginal federal income tax rate is 30%, the sum of your marginal state and local tax rates is 5%, and the yield on a thirty-year corporate bond is 10%. You would be indifferent between buying this corporate bond and buying a thirty-year municipal bond (ignoring differences in liquidity, risk, and costs of information) if the municipal bond has a yield of

Accepted Answer

A) 6.5%. 
B) 7.0%. 
C) 9.5%. 
D) 10.0%. 
A) 6.5%. 
B) 7.0%. 
C) 9.5%. 
D) 10.0%.

Question 16

The risk premium

Accepted Answer

A) is slightly higher on U.S. Treasury securities than on the bonds of large corporations. 
B) is not subject to federal income tax. 
C) compensates savers both for default risk and for illiquidity of assets. 
D) falls whenever illiquidity rises. 
A) is slightly higher on U.S. Treasury securities than on the bonds of large corporations. 
B) is not subject to federal income tax. 
C) compensates savers both for default risk and for illiquidity of assets. 
D) falls whenever illiquidity rises.

Question 17

The segmented markets theory

Accepted Answer

A) explains upward-sloping yield curves as resulting from the demand for long-term bonds being high relative to the demand for short-term bonds. 
B) explains upward-sloping yield curves as resulting from the demand for long-term bonds being low relative to the demand for short-term bonds. 
C) explains upward-sloping yield curves as resulting from the favorable tax treatment of long-term bonds. 
D) is unable to account for upward-sloping yield curves. 
A) explains upward-sloping yield curves as resulting from the demand for long-term bonds being high relative to the demand for short-term bonds. 
B) explains upward-sloping yield curves as resulting from the demand for long-term bonds being low relative to the demand for short-term bonds. 
C) explains upward-sloping yield curves as resulting from the favorable tax treatment of long-term bonds. 
D) is unable to account for upward-sloping yield curves.

Question 18

The default risk premium fluctuates mainly

Accepted Answer

A) because bond rating agencies tend to be inconsistent in their ratings of bonds. 
B) because risk-neutral investors will often become risk-averse as time passes. 
C) because taxes tend to rise over the long run. 
D) as new information about a borrower's creditworthiness becomes available. 
A) because bond rating agencies tend to be inconsistent in their ratings of bonds. 
B) because risk-neutral investors will often become risk-averse as time passes. 
C) because taxes tend to rise over the long run. 
D) as new information about a borrower's creditworthiness becomes available.

Question 19

Under the expectations theory, an upward-sloping yield curve indicates that investors expect future short-term rates to

Accepted Answer

A) fall. 
B) rise. 
C) remain constant. 
D) either rise or remain constant. 
A) fall. 
B) rise. 
C) remain constant. 
D) either rise or remain constant.

Question 20

According to the National Bureau of Economic Research an increase in risk premiums is

Accepted Answer

A) a leading indicator of the business cycle. 
B) a lagging indicator of the business cycle. 
C) a coincident indicator of the business cycle. 
D) unrelated to the business cycle. 
A) a leading indicator of the business cycle. 
B) a lagging indicator of the business cycle. 
C) a coincident indicator of the business cycle. 
D) unrelated to the business cycle.

Exam 7: Risk Structure and Term Structure of Interest Rates

A company that retains a high bond rating during a recession in which many other companies see their bond ratings cut will experience

The preferred habitat theory holds that investors

The default of the Penn Central Railroad in the early 1970s

Under the preferred habitat theory, the expectation that future short-term rates will be constant results in a yield curve that

Default risk

Which of the following statements about junk (high-risk) bonds is true?

Interest on most bonds issued by state governments is

The key assumption of the preferred habitat theory is that investors

Which of the following bond ratings by Moody's Investors Service would NOT be considered to be below investment grade?

U.S. Treasury securities

The implication of the expectations theory that expected returns for a holding period must be the same for bonds of different maturities depends on the assumption that

If a country has a poorly functioning risk structure of corporate bond yields,

In which of the following periods was the yield curve inverted?

The risk premium

The segmented markets theory

The default risk premium fluctuates mainly

Under the expectations theory, an upward-sloping yield curve indicates that investors expect future short-term rates to

According to the National Bureau of Economic Research an increase in risk premiums is

Introducing Money and the Financial System

Money and the Payments System

Overview of the Financial System

Interest Rates and Rates of Return

The Theory of Portfolio Allocation

Determining Market Interest Rates

The Foreign-Exchange Market and Exchange Rates

Derivative Securities and Derivative Markets

Information and Financial Market Efficiency

Reducing Transactions Costs and Information Costs

What Financial Institutions Do

The Business of Banking

The Banking Industry

Banking Regulation: Crisis and Response

Banking in the International Economy

The Money Supply Process

Changes in the Monetary Base

Organization of Central Banks

Monetary Policy Tools

The Conduct of Monetary Policy

The International Financial System and Monetary Policy

The Demand for Money

Linking the Financial System and the Economy: the Is-Lm-Fe Model

Aggregate Demand and Aggregate Supply

Money and Output in the Short Run

Information Problems and Channels for Monetary Policy

Inflation: Causes and Consequences

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