Deck 6: The Structure of Interest Rates

Question 1

Which of the following may be true?

A)All interest rates generally move up and down together.
B)All interest rates may not move the exact same amount.
C)Sometimes interest rates may not move in the same direction as others.
D)All of the above are true.

Answer 1

D

Question 2

Which of the following is/are primarily responsible for determining the relationships among interest rates?

A)term to maturity
B)credit risk
C)liquidity
D)tax treatment
E)All of the above are correct.

Answer 2

E

Question 3

What is the major characteristic distinguishing one type of Treasury security from another?

A)term to maturity
B)yield curve
C)inflationary index
D)Both b and c are correct.

Answer 3

A

Question 4

The yield curve is a graphical relationship between

A)the spreads among interest rates and their tax treatment.
B)interest rates (yields) on a particular security and its risk.
C)interest rates (yields) on a particular structure and its after-tax return.
D)interest rates (yields) on a particular security and its term to maturity.

Question 5

The pattern or spread among interest rates determined by the term to maturity, credit risk, and tax treatment is best described as the

A)term structure of interest rates.
B)geometric average theory.
C)expectations theory.
D)preferred habitat theory.

Question 6

__________ suggests that the long-term interest rate is the geometric average of the present short-term rate and the short-term rates expected to prevail over the term to maturity of the long-term security.

A)The term structure of interest rates
B)The geometric average theory
C)The expectations theory
D)The preferred habitat theory

Question 7

What happens to the shape of the yield curve if, ceteris paribus, expectations about future interest rates change such that future short term interest rates are expected to be higher than previously expected?

A)the slope (shape) of the yield curve remains the same but the curve shifts up.
B)the differences among various yield curves narrows.
C)the yield curve becomes steeper.
D)Both a and b are correct.

Question 8

What happens to the shape of the yield curve if expectations about future interest rates change such that future short term interest rates are expected to be lower than previously expected?

A)the slope (shape) of the yield curve remains the same but the curve shifts down.
B)the differences among various yield curves narrows.
C)If positively sloped, the yield curve becomes flatter; if negatively sloped, the yield curve becomes more negatively sloped.
D)Both a and b are correct.

Question 9

If the slope of the yield curve is positive, this means which of the following?

A)Yields decline as the term to maturity increases.
B)Yields decline as the term to maturity decreases.
C)Yields rise as the term to maturity increases.
D)Yields rise as the term to maturity decreases.

Question 10

According to the expectations theory, if next year's expected short-term rate is above the current short-term rate, the yield curve will be

A)horizontal.
B)vertical.
C)upward sloping.
D)downward sloping.

Question 11

Ceteris paribus, when borrowers increase their current supply of long-term securities, then

A)short-term interest rates will rise.
B)long-term interest rates will rise.
C)long-term interest rates will fall.
D)All of the above

Question 12

Ceteris paribus, when borrowers decrease their current supply of long-term securities, then

A)short-term interest rates will rise.
B)long-term interest rates will rise.
C)long-term interest rates will fall.
D)All of the above

Question 13

According to the expectations theory, when the yield curve is rising, market participants expect

A)future long-term interest rates to rise above current short-term rates.
B)future long-term interest rates to fall below current long-term rates.
C)future short-term interest rates to rise above current short-term rates.
D)future short-term interest rates to fall below current short-term rates.

Question 14

According to the expectations theory, when the yield curve is falling, market participants expect

A)future long-term interest rates to rise above current short-term rates.
B)future long-term interest rates to fall below current long-term rates.
C)future short-term interest rates to rise above current short-term rates.
D)future short-term interest rates to fall below current short-term rates.

Question 15

Expectations about future short-term interest rates depend on expectations about which of the following?

A)future income
B)the money supply and inflation
C)long-term interest rates
D)both a and b are true

Question 16

The expected short-term interest rate is inversely related to expectations about future

A)national income.
B)money supply.
C)surpluses.
D)inflation.

Question 17

If the yield curve was negatively sloped, this would most likely reflect expectations of a combination of future

A)declines in the money supply and income.
B)declines in income and inflation.
C)increases in income and inflation.
D)increases in income and money supply.

Question 18

When market participants see the economy going into an expansion, they most likely expect

A)falling interest rates.
B)stabilizing future interest rates.
C)rising future interest rates.
D)falling future interest rates.

Question 19

During the late part of the business expansion, interest rates will most likely do which of the following?

A)fall
B)rise
C)remain the same
D)fall slightly, then plateau

Question 20

According to the expectations theory, a negatively sloped yield curve usually reflects

A)an increase in expected income.
B)an increase in expected future prices.
C)a decrease in expected future prices.
D)a decrease in the money supply.

Question 21

According to the expectations theory, a positively sloped yield curve usually reflects

A)an increase in expected future income.
B)a decrease in expected future income.
C)a decrease in expected future prices.
D)an increase in the money supply.

Question 22

Some researchers believe the expectations theory needs to be modified in order to reflect

A)liquidity premiums.
B)that lenders may have some preference for either long- or short-term securities and hence not be indifferent between the two.
C)the tendency of borrowers to prefer longer term securities so they don't have to issue and reissue short term securities.
D)All of the above are true.

Question 23

Preferred habitats refers to

A)preferring stocks over bonds.
B)minimal allowance for write-offs.
C)preferred maturities for borrowers and lenders that may lead to market segmentation.
D)investment in newly constructed housing.

Question 24

The __________ is the extra return required to induce lenders to lend long term rather than short term.

A)risk premium
B)liquidity premium
C)credit risk
D)liquidity risk

Question 25

A liquidity premium is used to

A)lure lenders to lend short term.
B)lure lenders to lend long term.
C)lure lenders to lend greater amounts.
D)None of the above

Question 26

If expected future short-term interest rates are equal to current short-term rates, the liquidity premium will

A)make long-term rates lower than current short-term rates.
B)make long-term rates higher than current short-term rates.
C)make long-term rates equal to current short-term rates.
D)make have no effect.

Question 27

__________ is the probability of a debtor not paying the principal and/or interest due on an outstanding debt

A)Risk premium
B)Liquidity premium
C)Credit risk
D)Liquidity risk

Question 28

The __________ is the extra return or interest with which a lender is compensated for accepting more risk.

A)risk premium
B)liquidity premium
C)credit risk
D)liquidity risk

Question 29

Which of these is a major corporate credit-rating agency that evaluates a borrower's probability of default and assigns the borrower to a particular risk class?

A)Dow Jones Industrial Average (DJIA)
B)Moody's Investors Services
C)FDIC
D)Dow Jones Investor Service (DJIS)

Question 30

Changes in interest rates may be caused by which of the following?

A)Changes in liquidity premiums
B)Changes in preferred habitats
C)Changes in the supply of funds driven by changes in expectations
D)All of the above may cause interest rates to change.

Question 31

The current long-term interest rate is a function of all of the following except

A)the current short-term rate.
B)the short-term rates expected in the future.
C)last year's long-term rate.
D)the liquidity premium.

Question 32

The current long-term interest rate is a function of which of the following?

A)the current short-term rate.
B)the short-term rates expected in the future.
C)the liquidity premium.
D)All of the above are correct.

Question 33

Which of the following is a measure of the credit worthiness of the issuer of a security?

A)the liquidity premium
B)the discount from par
C)the money illusion
D)the credit risk

Question 34

Which security has the least credit risk?

A)Common stock
B)Treasury securities
C)Preferred stock
D)Equities

Question 35

The rate paid on the last dollar of income the tax payer earns is called

A)the after-tax yield
B)the average tax rate
C)the marginal tax rate
D)the marginal after-tax yield

Question 36

If Maureen lives in a country where no taxes are levied on the first $20,000 of income and a 10% tax is levied on all income above $20,000, what is her marginal tax rate if she has an average tax rate of 5%?

A)5%
B)10%
C)15%
D)25%

Question 37

Assume a corporate marginal tax rate of 38%. What yield on a municipal bond would leave a corporation indifferent between a 9% corporate bond and a municipal bond?

A)4.8%
B)5.58%
C)6.03%
D)7.2%

Question 38

If security purchasers found the after-tax yield on municipal bonds higher than that of corporate bonds, leading to an increase in municipal bond purchases and an increase in corporate bond sales, this would cause the

A)yields on municipals to increase.
B)prices on corporate bonds to increase.
C)yields on corporate bonds to decrease.
D)yields on municipals to decrease.

Question 39

The main advantage of municipal securities is that

A)their credit risk is usually very low.
B)the interest income earned is exempt from federal income tax and taxes in the issuing state.
C)they are the most liquid type of securities.
D)Both a and b are correct.

Question 40

Typically, the yields on municipal securities are

A)well above the yields on other securities with similar credit ratings and similar terms to maturity.
B)well below the yields on other securities with similar credit ratings and similar terms to maturity.
C)taxed at both the state and federal level.
D)about the same as the yields on other securities with similar credit ratings and similar terms to maturity.

Question 41

Which of the following is false?

A)The buying and selling by investors results in the yield on municipals being approximately equal to the yield on similarly rated taxable securities, such as corporate bonds, minus the portion of the yield that is taxed away.
B)Taxpayers, depending on their individual incomes, are in different marginal tax brackets, some high and some low, and there is an average marginal tax rate somewhere between the high and the low marginal tax brackets.
C)The interest rate on municipal securities will gravitate to the rate that makes the "average" taxpayer (in the average marginal tax bracket) indifferent between municipals and similarly rated corporate securities.
D)Banks and rich individuals are attracted to municipals because they are subject to a tax rate equal to the average marginal rate.

Question 42

The hypothesis that the markets for short- and long-term securities are completely separate markets is called the

A)stationary equilibrium hypothesis
B)preferred habitat hypothesis
C)the liquidity premium hypothesis
D)segmented market hypothesis

Question 43

-According to expectations theory, which of the figures above reflects expectations of a rise in the interest rate on short-term securities?

A)Figure A
B)Figure B
C)Figure C
D)Both a and b

Question 44

-Refer to Figures A, B, and C. According to expectations theory, which of the figures above reflects expectations of a fall in the interest rate on short-term securities?

A)Figure A
B)Figure B
C)Figure C
D) Both a and b

Question 45

-Refer to Figures A, B, and C. According to expectations theory, which of the figures is most likely to be associated with expected growth in income, expected increases in prices, and slower growth of money supply?

A)Figure A
B)Figure B
C)Figure C
D) Both a and b

Question 46

-Refer to Figures A, B, and C. According to expectations theory, which of the figures is most likely to be associated with business cycle peaks, including the late part of an expansion and the early part of a recession?

A)Figure A
B)Figure B
C)Figure C
D) Both a and b

Question 47

-Refer to Figures A, B, and C. According to expectations theory, which of the figures reflects expectations that the short-term interest rate is expected to remain constant in the future?

A)Figure A
B)Figure B
C)Figure C
D) Both a and b

Question 48

-Refer to Figures A, B, and C. According to expectations theory, which of the figures reflects expectations that the short-term interest rate is expected to remain constant in the future but that borrowers and lenders also must be compensated with a liquidity premium for lending long?

A)Figure A
B)Figure B
C)Figure C
D) Both a and b

Question 49

-Refer to Figures A, B, and C. According to expectations theory, which of the figures best reflects a situation where i_s > i_s^e?

A)Figure A
B)Figure B
C)Figure C
D) None of the above

Question 50

The expected future short-term interest rate is determined by all of the following except?

A)expectations about the future money supply
B)expectations about future income
C)expectations about the future price level
D)the current short-term interest rate

Question 51

The theory that short and long term securities are not substitutes for each other but rather that there are separate markets for each is

A)the preferred habitat theory.
B)the modified expectations theory.
C)the segmented markets hypothesis.
D)the expectations theory modified by the preferred habitats theory.

Question 52

Treasury bills (T-bills) carry maturities of

A)less than 6 months.
B)1 year or less.
C)less than 2 years.
D)less than 5 years.

Question 53

__________ postulates that many borrowers and lenders favor securities that have maturities of a particular length. This favoritism creates a degree of market segmentation between the short-term and long-term securities markets.

A)The term structure of interest rates
B)The geometric average theory
C)The expectations theory
D)The preferred habitat theory

Question 54

The sweetener or bribe required to induce lenders to abandon their preferred habitats is referred to as

A)a risk premium.
B)a habitat premium.
C)taxability.
D)a liquidity premium.

Question 55

The expectations theory posits that

A)the long-term rate is the geometric average of the current short-term rate and short-term rates expected to prevail over the term to maturity of the long-term security.
B)the short-term rate is the geometric average of the current long-term rate and long-term rates expected to prevail over the term to maturity of the short-term security.
C)the long-term rate is the geometric average of the current long-term rate and short-term rates expected to prevail over the term to maturity of the long-term security.
D)the long-term rate is the geometric average of the current short-term rate and the rate of inflation expected to prevail over the term to maturity of the long-term security.

Question 56

The pattern or spread among interest rates is usually referred to as the

A)term to maturity.
B)credit risk.
C)term structure of interest rates.
D)yield to maturity.

Question 57

The tax rate paid on the last dollar of income that the taxpayer earns is the

A)IRS discount rate.
B)average tax rate.
C)average marginal tax rate.
D)marginal tax rate.

Question 58

A graphic representation of the relationship between interest rates on a particular security and different terms to maturity for that security is called the

A)term structure of interest rates.
B)yield curve.
C)geometric average.
D)discount basis.

Question 59

The__________ takes into account the effects of compounding; it is used to calculate the long-term rate from the short rate and the short-term rates expected to prevail over the term to maturity of the long-term security.

A)marginal average rate
B)marginal rate
C)average marginal rate
D)geometric average

Question 60

Which of these is a major corporate credit-rating agency that evaluates a borrower's probability of default and assigns the borrower to a particular risk class?

A)Dow Jones Industrial Average (DJIA)
B)Standard & Poor's
C)the FDIC
D)the Federal Reserve System

Question 61

The risk that funds may have to be reinvested at a lower rate in the future is the _______________. It is generally _____________ than the ___________________.

A)reinvestment risk, less, liquidity premium.
B)liquidity risk, less, reinvestment premium.
C)reinvestment risk, more, liquidity premium.
D)liquidity premium, more, reinvestment risk.

Question 62

The pattern among interest rates and their maturity is generally referred to as which of the following?

A)Nominal interest rates
B)Term structure of interest rates
C)Implicit interest rates
D)Effective structure of rates

Question 63

Treasury notes and bonds are issued with an original maturity of which of the following?

A)1 to 3 months
B)3 to 6 months
C)6 to 12 months
D)more than one year

Question 64

Changes in the slope of the yield curve

A)reflect only changes in the demand for securities, since lenders dominate the securities markets.
B)reflect only changes in the supply of securities, since borrowers dominate the securities markets.
C)reflect changes in the supply of and demand for securities which are induced by changes in interest rate expectations.
D)come about magically.

Question 65

A yield curve graphically depicts the relationship between which of these pairs?

A)Term to maturity and interest rates
B)Term to maturity and structure of stock options
C)Term to maturity and tax treatment
D)Term to maturity and credit risk

Question 66

Typically, an individual asset is depicted on

A)a single yield curve.
B)two yield curves combined.
C)three yield curves combined.
D)several yield curves.

Question 67

On a yield curve, term to maturity is shown

A)as downward sloping.
B)as upward sloping.
C)on the horizontal axis.
D)on the vertical axis.

Question 68

The slope and the position of the yield curve depicts

A)the term structure of interest rates.
B)the term structure of tax treatment.
C)the term structure of stock options.
D)the term structure of credit risk.

Question 69

When the yield curve is upward sloping, this means which of the following?

A)Short-term securities yield more than long-term securities.
B)Short-term securities yield less than long-term securities.
C)Short-term securities yield the same as long-term securities.
D)None of the above are correct.

Question 70

When the yield curve is downward sloping or inverted, this means

A)Short-term securities yield more than long-term securities.
B)Short -term securities yield less than long-term securities.
C)Short -term securities yield the same as long-term securities.
D)None of the above are correct.

Question 71

When the yield curve is flat, this means which of the following?

A)Short-term securities yield more than long-term securities.
B)Short-term securities yield less than long-term securities.
C)Short-term securities yield the same as long-term securities.
D)None of the above is correct.

Question 72

According to the expectations theory, if next year's expected short-term rate is below the current short-term rate, the yield curve will be

A)horizontal.
B)vertical.
C)upward sloping.
D)downward sloping.

Question 73

The term structure of interest rates is determined by

A)interest rate expectations.
B)the supply of securities.
C)the demand for securities.
D)All of the above are correct.

Question 74

According to the expectations theory, if the 1-year rate is 2.5% and the 2-year rate is 3.64%, the expected 1-year rate would be

A)3.80%.
B)4.80%.
C)5.80%.
D)6.80%.

Question 75

According to the expectations theory, a negatively sloped yield curve usually reflects

A)an increase in expected income.
B)an increase in expected future prices.
C)a decrease in expected future prices.
D)a decrease in the money supply.

Question 76

Generally, the relationship between the liquidity premium and term to maturity is

A)inverse.
B)direct.
C)negative.
D)None of the above

Question 77

Long-term interest rates are affected by

A)interest rate expectations.
B)preferred habitats.
C)liquidity premiums.
D)All of the above are correct.

Question 78

Which of the following best describes the type of relationship between the term to maturity and interest rates in the last 20 years?

A)inverse
B)direct
C)negative
D)There is no consistent relationship.

Question 79

Which of the following is not considered a major credit-rating agency?

A)Standard & Poor's
B)Moody's Investors Service
C)New York Exchange Service
D)All of the above are major credit-rating agencies.

Question 80

Credit-rating agencies do which of the following?

A)evaluate a borrower's probability of default
B)assign the borrower to a particular risk class
C)help lenders determine the credit worthiness of a borrower
D)All of the above are correct.