Exam 6: The Risk and Term Structure of Interest Rates

Over the next three years, the expected path of 1-year interest rates is 4, 1, and 1 percent. The expectations theory of the term structure predicts that the current interest rate on 3-year bond is ________.

Explain using a diagram how the "flight to quality" after the Subprime collapse lead to a rising spread between lower-quality (BBB-rated) and highest-quality (AAA-rated) bonds.

Explain the factors that determine the risk structure of interest rates. Explain how a change of each factor changes interest rates.

Which of the following bonds are considered to be default-risk free?

A bond with default risk will always have a ________ risk premium and an increase in its default risk will ________ the risk premium.

The risk that interest payments will not be made, or that the face value of a bond is not repaid when a bond matures is ________.

An increase in the riskiness of corporate bonds will ________ the yield on corporate bonds and ________ the yield on government securities, everything else held constant.

According to the segmented markets theory of the term structure ________.

The risk premium on corporate bonds reflects the fact that corporate bonds have a higher default risk and are ________ Canada bonds.

-The U-shaped yield curve in the figure above indicates that short-term interest rates are expected to ________.

If the probability of a bond default increases because corporations begin to suffer large losses, then the default risk on corporate bonds will ________ and the expected return on these bonds will ________, everything else held constant.

Which of the following statements is true?

According to the liquidity premium theory, a yield curve that is flat means that ________.

If the U.S. government where to raise the income tax rates, would this have any impact on a state's cost of borrowing funds? Explain.

According to the segmented markets theory of the term structure ________.

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

According to the liquidity premium theory of the term structure ________.

The spread between the interest rates on Baa corporate bonds and Canada bonds was very large during the Great Depression years 1930-1933. Explain this difference using the bond supply and demand analysis.

The collapse of the subprime mortgage market increased the spread between Baa and default-free Canada bonds. This is due to ________.

If 1-year interest rates for the next three years are expected to be 4, 2, and 3 percent, and the 3-year term premium is 1 percent, than the 3-year bond rate will be ________.