Question 1

Under the expectations hypothesis, a downward-sloping yield curve suggests:

Accepted Answer

A)  investors expect future short-term interest rates to fall. 
B)  investors expect future short-term interest rates to rise. 
C)  this is a trick question, the yield curve always slopes upward. 
D)  investors expect future short-term interest rates to remain constant. 
A)  investors expect future short-term interest rates to fall. 
B)  investors expect future short-term interest rates to rise. 
C)  this is a trick question, the yield curve always slopes upward. 
D)  investors expect future short-term interest rates to remain constant.

Question 2

Under the expectations hypothesis, bonds of different maturities are assumed to be perfect substitutes because:

Accepted Answer

A)  the risk premium is assumed to be negative. 
B)  market forces would always have long-term interest rates equal the average of the current and expected short-term rate. 
C)  expectations of future interest rates are uncertain and therefore cannot be included in the analysis. 
D)  bond markets are very liquid. 
A)  the risk premium is assumed to be negative. 
B)  market forces would always have long-term interest rates equal the average of the current and expected short-term rate. 
C)  expectations of future interest rates are uncertain and therefore cannot be included in the analysis. 
D)  bond markets are very liquid.

Question 3

Which fact about the term structure is the expectations theory able to explain?

Accepted Answer

A)  Why interest rates on bonds with different terms to maturity tend to move together over time. 
B)  Why yields on short-term bonds are more volatile than yields on long-term bonds. 
C)  Why longer-term yields tend to be higher than shorter-term yields. 
D)  Why long-term bonds usually are less liquid than short-term bonds with the same default risk. 
A)  Why interest rates on bonds with different terms to maturity tend to move together over time. 
B)  Why yields on short-term bonds are more volatile than yields on long-term bonds. 
C)  Why longer-term yields tend to be higher than shorter-term yields. 
D)  Why long-term bonds usually are less liquid than short-term bonds with the same default risk.

Question 4

Municipal bonds are usually purchased by:

Accepted Answer

A)  retired investors who have no other taxable income. 
B)  investors looking for securities to buy for their IRA accounts. 
C)  investors who live in cities with high municipal tax rates. 
D)  investors who are in high marginal tax brackets. 
A)  retired investors who have no other taxable income. 
B)  investors looking for securities to buy for their IRA accounts. 
C)  investors who live in cities with high municipal tax rates. 
D)  investors who are in high marginal tax brackets.

Question 5

The risk structure of interest rates refers to the:

Accepted Answer

A)  relationship among the interest rates of bonds with different maturities. 
B)  relationship among the interest rates of bonds from different issuers with the same maturities. 
C)  relationship among the interest rates of bonds from the same issuer but different maturities. 
D)  additional interest required to compensate the buyer for the longer maturity of the bond. 
A)  relationship among the interest rates of bonds with different maturities. 
B)  relationship among the interest rates of bonds from different issuers with the same maturities. 
C)  relationship among the interest rates of bonds from the same issuer but different maturities. 
D)  additional interest required to compensate the buyer for the longer maturity of the bond.

Question 6

Holding liquidity and default risk constant, an investor earning 4% from a tax-exempt bond who is in a 20% tax bracket would be indifferent between that bond and a taxable bone with a(n):

Accepted Answer

A)  7.5% yield. 
B)  8.0% yield. 
C)  5% yield. 
D)  6% yield. 
A)  7.5% yield. 
B)  8.0% yield. 
C)  5% yield. 
D)  6% yield.

Question 7

A proposed increase in the federal income tax rate should:

Accepted Answer

A)  have no impact on the slope of the yield curve since the tax laws impact all maturities the same. 
B)  cause the slope of the yield curve to become negative. 
C)  increase the slope of the yield curve since it increases the risk premium of longer maturities. 
D)  flatten the yield curve. 
A)  have no impact on the slope of the yield curve since the tax laws impact all maturities the same. 
B)  cause the slope of the yield curve to become negative. 
C)  increase the slope of the yield curve since it increases the risk premium of longer maturities. 
D)  flatten the yield curve.

Question 8

When the growth rate of the economy slows we would expect:

Accepted Answer

A)  the risk to increase for U.S. Treasury securities. 
B)  the risk spread to increase more between U.S. Treasury Securities and Aaa securities than between Aaa and Baa securities. 
C)  the risk spread to increase more between Aaa and Baa securities than U.S. Treasuries and Aaa securities. 
D)  investors to purchase more junk bonds in search of a higher yield. 
A)  the risk to increase for U.S. Treasury securities. 
B)  the risk spread to increase more between U.S. Treasury Securities and Aaa securities than between Aaa and Baa securities. 
C)  the risk spread to increase more between Aaa and Baa securities than U.S. Treasuries and Aaa securities. 
D)  investors to purchase more junk bonds in search of a higher yield.

Question 9

When the yield curve slope is more upward sloping than usual, people are expecting:

Accepted Answer

A)  an economic slowdown. 
B)  the U.S. Treasury may default on its obligations. 
C)  the Federal Reserve is going to ease monetary policy. 
D)  a future rise in short-term interest rates. 
A)  an economic slowdown. 
B)  the U.S. Treasury may default on its obligations. 
C)  the Federal Reserve is going to ease monetary policy. 
D)  a future rise in short-term interest rates.

Question 10

During economic slowdowns why would you expect the risk premium to increase the most between U.S. Treasury bonds and junk bonds?

Accepted Answer

While it is true that during economic sl

Question 11

The term structure of interest rates:

Accepted Answer

A)  always results in an upward sloping yield curve. 
B)  represents the variation in yields for securities differing in maturities. 
C)  usually results in a flat yield curve. 
D)  usually results in a downward sloping yield curve. 
A)  always results in an upward sloping yield curve. 
B)  represents the variation in yields for securities differing in maturities. 
C)  usually results in a flat yield curve. 
D)  usually results in a downward sloping yield curve.

Question 12

Imagine a scandal that finds the officers of bond rating agencies have been taking bribes to inflate the rating of specific bonds. This should:

Accepted Answer

A)  have no impact on the bond market since bond markets are highly efficient. 
B)  decrease the demand for all bonds. 
C)  increase the demand for U.S. Treasury securities and decrease the demand for corporate bonds. 
D)  decrease the risk spread. 
A)  have no impact on the bond market since bond markets are highly efficient. 
B)  decrease the demand for all bonds. 
C)  increase the demand for U.S. Treasury securities and decrease the demand for corporate bonds. 
D)  decrease the risk spread.

Question 13

The yield curve for U.S. Treasury securities allows us to draw the following conclusions, except that:

Accepted Answer

A)  long-term yields tend to higher than short term yields. 
B)  interest rates of different maturities tend to move. 
C)  long-term rates tend to equal short-term rates. 
D)  yields on short-term securities are more volatile than yields on long-term bonds. 
A)  long-term yields tend to higher than short term yields. 
B)  interest rates of different maturities tend to move. 
C)  long-term rates tend to equal short-term rates. 
D)  yields on short-term securities are more volatile than yields on long-term bonds.

Question 14

Consider the following four investors. Rank each according to who has the most to gain from investing in 30-year tax-exempt municipal bonds. Each investor has $1,000 in a savings account that he/she plans to use to buy bonds. Explain briefly why you ranked the investors this way.
(a) A 20-year old college student who earns low income through working over summers and breaks. The student plans to graduate next year.
(b) The CEO of a large company who is currently in the highest tax bracket. (c) A middle-income household saving up to move into a larger home.
(d) A 60-year old nurse who plans to retire at age 62. He uses a tax-exempt pension fund for all of his savings.

Accepted Answer

(b), (c), (a), (d)
The CEO has the most

Question 15

A borrower who has to pay an interest rate of 8% rather than 6% due to risk spread will pay:

Accepted Answer

A)  $20 more in interest annually for every $100 borrowed. 
B)  33.3% higher interest in dollar terms. 
C)  2% in net interest. 
D)  less interest in total over the life of the loan. 
A)  $20 more in interest annually for every $100 borrowed. 
B)  33.3% higher interest in dollar terms. 
C)  2% in net interest. 
D)  less interest in total over the life of the loan.

Question 16

If a local government eliminates the tax exemption on municipal bonds, we'd expect to see:

Accepted Answer

A)  an increase in the yield on taxable bonds. 
B)  a decrease in the gap in yields on taxable and tax-exempt bonds. 
C)  a decrease in the yield on municipal bonds. 
D)  municipal bonds will become more attractive to investors. 
A)  an increase in the yield on taxable bonds. 
B)  a decrease in the gap in yields on taxable and tax-exempt bonds. 
C)  a decrease in the yield on municipal bonds. 
D)  municipal bonds will become more attractive to investors.

Question 17

Explain why most retired individuals are not likely to be heavily invested in municipal bonds.

Accepted Answer

Most retired individuals are not working

Question 18

When the yield curve is downward sloping:

Accepted Answer

A)  people are expecting an economic slowdown. 
B)  short-term yields are lower than long term yields. 
C)  people are expecting higher inflation in the future. 
D)  people could be expecting a tightening in monetary policy. 
A)  people are expecting an economic slowdown. 
B)  short-term yields are lower than long term yields. 
C)  people are expecting higher inflation in the future. 
D)  people could be expecting a tightening in monetary policy.

Question 19

Any theory of the yield curve must be able to explain what three general conditions?

Accepted Answer

#1) The interest rates of different matu

Question 20

What is the equivalent tax-exempt bond yield for a taxable bond with an 8% yield and a bondholder in a 35% marginal tax rate? Explain.

Accepted Answer

5.20%. The tax-exempt bond yie

Exam 7: The Risk and Term Structure of Interest Rates

Under the expectations hypothesis, a downward-sloping yield curve suggests:

Under the expectations hypothesis, bonds of different maturities are assumed to be perfect substitutes because:

Which fact about the term structure is the expectations theory able to explain?

Municipal bonds are usually purchased by:

The risk structure of interest rates refers to the:

Holding liquidity and default risk constant, an investor earning 4% from a tax-exempt bond who is in a 20% tax bracket would be indifferent between that bond and a taxable bone with a(n):

A proposed increase in the federal income tax rate should:

When the growth rate of the economy slows we would expect:

When the yield curve slope is more upward sloping than usual, people are expecting:

During economic slowdowns why would you expect the risk premium to increase the most between U.S. Treasury bonds and junk bonds?

The term structure of interest rates:

Imagine a scandal that finds the officers of bond rating agencies have been taking bribes to inflate the rating of specific bonds. This should:

The yield curve for U.S. Treasury securities allows us to draw the following conclusions, except that:

A borrower who has to pay an interest rate of 8% rather than 6% due to risk spread will pay:

If a local government eliminates the tax exemption on municipal bonds, we'd expect to see:

Explain why most retired individuals are not likely to be heavily invested in municipal bonds.

When the yield curve is downward sloping:

Any theory of the yield curve must be able to explain what three general conditions?

What is the equivalent tax-exempt bond yield for a taxable bond with an 8% yield and a bondholder in a 35% marginal tax rate? Explain.

An Introduction to Money and the Financial System

Money and the Payments System

Financial Instruments, Financial Markets, and Financial Institutions

Future Value, Present Value and Interest Rates

Understanding Risk

Bonds, Bond Prices, and the Determination of Interest Rates

Stocks, Stock Markets and Market Efficiency

Derivatives: Futures, Options, and Swaps

Foreign Exchange

The Economics of Financial Intermediation

Depository Institutions: Banks and Bank Management

Financial Industry Structure

Regulating the Financial System

Central Banks in the World Today

The Structure of Central Banks: The Federal Reserve and the European Central Bank

The Central Bank Balance Sheet and the Money Supply Process

Monetary Policy: Stabilizing the Domestic Economy

Exchange Rate Policy and the Central Bank

Money Growth, Money Demand and Modern Monetary Policy

Output, Inflation, and Monetary Policy

Understanding Business Cycle Fluctuations

Modern Monetary Policy and the Challenges Facing Central Bankers

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