Deck 6: The Risk and Term Structure of Interest Rates

Question 1

A(n)________ in the riskiness of corporate bonds will ________ the price of corporate bonds and ________ the yield on corporate bonds,all else equal.

A)increase;increase;increase
B)increase;decrease;increase
C)decrease;increase;increase
D)decrease;decrease;decrease

Answer 1

increase;decrease;increase

Question 2

An increase in default risk on corporate bonds ________ the demand for these bonds,but ________ the demand for default-free bonds,everything else held constant.

A)increases;lowers
B)lowers;increases
C)does not change;greatly increases
D)moderately lowers;does not change

Answer 2

lowers;increases

Question 3

If a corporation begins to suffer large losses,then the default risk on the corporate bond will

A)increase and the bond's return will become more uncertain,meaning the expected return on the corporate bond will fall.
B)increase and the bond's return will become less uncertain,meaning the expected return on the corporate bond will fall.
C)decrease and the bond's return will become less uncertain,meaning the expected return on the corporate bond will fall.
D)decrease and the bond's return will become less uncertain,meaning the expected return on the corporate bond will rise.

Answer 3

increase and the bond's return will become more uncertain,meaning the expected return on the corporate bond will fall.

Question 4

Other things being equal,a decrease in the default risk of corporate bonds shifts the demand curve for corporate bonds to the ________ and the demand curve for Treasury bonds to the ________.

A)right;right
B)right;left
C)left;right
D)left;left

Question 5

As default risk increases,the expected return on corporate bonds ________,and the return becomes ________ uncertain,everything else held constant.

A)increases;less
B)increases;more
C)decreases;less
D)decreases;more

Question 6

The risk structure of interest rates is

A)the structure of how interest rates move over time.
B)the relationship among interest rates of different bonds with the same maturity.
C)the relationship among the term to maturity of different bonds.
D)the relationship among interest rates on bonds with different maturities.

Question 7

If the possibility of a default increases because corporations begin to suffer losses,then the default risk on corporate bonds will ________,and the bonds' returns will become ________ uncertain,meaning that the expected return on these bonds will decrease,everything else held constant.

A)increase;less
B)increase;more
C)decrease;less
D)decrease;more

Question 8

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

A)municipal bonds
B)investment-grade bonds
C)U.S.Treasury bonds
D)junk bonds

Question 9

The spread between the interest rates on bonds with default risk and default-free bonds is called the

A)risk premium.
B)junk margin.
C)bond margin.
D)default premium.

Question 10

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

A)increase;increase
B)reduce;reduce
C)increase;reduce
D)reduce;increase

Question 11

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

A)positive;raise
B)positive;lower
C)negative;raise
D)negative;lower

Question 12

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

A)interest rate risk.
B)inflation risk.
C)liquidity risk.
D)default risk.

Question 13

A decrease in the riskiness of corporate bonds will ________ the yield on corporate bonds and ________ the yield on Treasury securities,everything else held constant.

A)increase;increase
B)decrease;decrease
C)increase;decrease
D)decrease;increase

Question 14

Other things being equal,an increase in the default risk of corporate bonds shifts the demand curve for corporate bonds to the ________ and the demand curve for Treasury bonds to the ________.

A)right;right
B)right;left
C)left;right
D)left;left

Question 15

A decrease in default risk on corporate bonds ________ the demand for these bonds,and ________ the demand for default-free bonds,everything else held constant.

A)increases;lowers
B)lowers;increases
C)does not change;greatly increases
D)moderately lowers;does not change

Question 16

Bonds with no default risk are called

A)flower bonds.
B)no-risk bonds.
C)default-free bonds.
D)zero-risk bonds.

Question 17

A decrease in the riskiness of corporate bonds will ________ the price of corporate bonds and ________ the price of Treasury bonds,everything else held constant.

A)increase;increase
B)reduce;reduce
C)reduce;increase
D)increase;reduce

Question 18

An increase in the riskiness of corporate bonds will ________ the price of corporate bonds and ________ the price of Treasury bonds,everything else held constant.

A)increase;increase
B)reduce;reduce
C)reduce;increase
D)increase;reduce

Question 19

U.S.government bonds have no default risk because

A)they are issued in strictly limited quantities.
B)the federal government can increase taxes or print money to pay its obligations.
C)they are backed with gold reserves.
D)they can be exchanged for silver at any time.

Question 20

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.

A)decrease;increase
B)decrease;decrease
C)increase;increase
D)increase;decrease

Question 21

Corporate bonds are not as liquid as government bonds because

A)fewer corporate bonds for any one corporation are traded,making them more costly to sell.
B)the corporate bond rating must be calculated each time they are traded.
C)corporate bonds are not callable.
D)corporate bonds cannot be resold.

Question 22

Bonds with relatively low risk of default are called ________ securities and have a rating of Baa (or BBB)and above;bonds with ratings below Baa (or BBB)have a higher default risk and are called ________.

A)investment grade;lower grade
B)investment grade;junk bonds
C)high quality;lower grade
D)high quality;junk bonds

Question 23

If you have a very low tolerance for risk,which of the following bonds would you be least likely to hold in your portfolio?

A)a U.S.Treasury bond
B)a municipal bond
C)a corporate bond with a rating of Aaa
D)a corporate bond with a rating of Baa

Question 24

Which of the following statements are TRUE?

A)A decrease in default risk on corporate bonds lowers the demand for these bonds,but increases the demand for default-free bonds.
B)The expected return on corporate bonds decreases as default risk increases.
C)A corporate bond's return becomes less uncertain as default risk increases.
D)As their relative riskiness increases,the expected return on corporate bonds increases relative to the expected return on default-free bonds.

Question 25

Bonds with relatively high risk of default are called

A)Brady bonds.
B)junk bonds.
C)zero coupon bonds.
D)investment grade bonds.

Question 26

Which of the following bonds would have the highest default risk?

A)municipal bonds
B)investment-grade bonds
C)U.S.Treasury bonds
D)junk bonds

Question 27

The spread between interest rates on low quality corporate bonds and U.S.government bonds

A)widened significantly during the Great Depression.
B)narrowed significantly during the Great Depression.
C)narrowed moderately during the Great Depression.
D)did not change during the Great Depression.

Question 28

As default risk decreases,the expected return on corporate bonds ________,and the return becomes ________ uncertain,everything else held constant.

A)increases;less
B)increases;more
C)decreases;less
D)decreases;more

Question 29

The collapse of the subprime mortgage market

A)did not affect the corporate bond market.
B)increased the perceived riskiness of Treasury securities.
C)reduced the Baa-Aaa spread.
D)increased the Baa-Aaa spread.

Question 30

When the Treasury bond market becomes more liquid,other things equal,the demand curve for corporate bonds shifts to the ________ and the demand curve for Treasury bonds shifts to the ________.

A)right;right
B)right;left
C)left;right
D)left;left

Question 31

As their relative riskiness ________,the expected return on corporate bonds ________ relative to the expected return on default-free bonds,everything else held constant.

A)increases;increases
B)increases;decreases
C)decreases;decreases
D)decreases;does not change

Question 32

During the Great Depression years 1930-1933 there was a very high rate of business failures and defaults,we would expect the risk premium for ________ bonds to be very high.

A)U.S.Treasury
B)corporate Aaa
C)municipal
D)corporate Baa

Question 33

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

A)a reduction in risk.
B)a reduction in maturity.
C)a flight to quality.
D)a flight to liquidity.

Question 34

Which of the following statements is TRUE?

A)A liquid asset is one that can be quickly and cheaply converted into cash.
B)The demand for a bond declines when it becomes less liquid,decreasing the interest rate spread between it and relatively more liquid bonds.
C)The differences in bond interest rates reflect differences in default risk only.
D)The corporate bond market is the most liquid bond market.

Question 35

Which of the following long-term bonds has the highest interest rate?

A)corporate Baa bonds
B)U.S.Treasury bonds
C)corporate Aaa bonds
D)municipal bonds

Question 36

Risk premiums on corporate bonds tend to ________ during business cycle expansions and ________ during recessions,everything else held constant.

A)increase;increase
B)increase;decrease
C)decrease;increase
D)decrease;decrease

Question 37

Which of the following securities has the lowest interest rate?

A)junk bonds
B)U.S.Treasury bonds
C)investment-grade bonds
D)corporate Baa bonds

Question 38

Junk bonds,bonds with a low bond rating,are also known as

A)high-yield bonds.
B)investment grade bonds.
C)high quality bonds.
D)zero-coupon bonds.

Question 39

Everything else held constant,if the federal government were to guarantee today that it will pay creditors if a corporation goes bankrupt in the future,the interest rate on corporate bonds will ________ and the interest rate on Treasury securities will ________.

A)increase;increase
B)increase;decrease
C)decrease;increase
D)decrease;decrease

Question 40

During a "flight to quality"

A)the spread between Treasury bonds and Baa bonds increases.
B)the spread between Treasury bonds and Baa bonds decreases.
C)the spread between Treasury bonds and Baa bonds is not affected.
D)the change in the spread between Treasury bonds and Baa bonds cannot be predicted.

Question 41

Everything else held constant,the interest rate on municipal bonds rises relative to the interest rate on Treasury securities when

A)income tax rates are lowered.
B)income tax rates are raised.
C)municipal bonds become more widely traded.
D)corporate bonds become riskier.

Question 42

An increase in the liquidity of corporate bonds,other things being equal,shifts the demand curve for corporate bonds to the ________ and the demand curve for Treasury bonds shifts to the ________.

A)right;right
B)right;left
C)left;left
D)left;right

Question 43

Which of the following statements is TRUE?

A)State and local governments cannot default on their bonds.
B)Bonds issued by state and local governments are called municipal bonds.
C)All government issued bonds-local,state,and federal-are federal income tax exempt.
D)The coupon payment on municipal bonds is usually higher than the coupon payment on Treasury bonds.

Question 44

Everything else held constant,if the tax-exempt status of municipal bonds were eliminated,then

A)the interest rates on municipal bonds would still be less than the interest rate on Treasury bonds.
B)the interest rate on municipal bonds would equal the rate on Treasury bonds.
C)the interest rate on municipal bonds would exceed the rate on Treasury bonds.
D)the interest rates on municipal,Treasury,and corporate bonds would all increase.

Question 45

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

Question 46

Which of the following statements are TRUE?

A)An increase in tax rates will increase the demand for Treasury bonds,lowering their interest rates.
B)Because the tax-exempt status of municipal bonds was of little benefit to bond holders when tax rates were low,they had higher interest rates than U.S.government bonds before World War II.
C)Interest rates on municipal bonds will be higher than comparable bonds without the tax exemption.
D)Because coupon payments on municipal bonds are exempt from federal income tax,the expected after-tax return on them will be higher for individuals in lower income tax brackets.

Question 47

Everything else held constant,abolishing the individual income tax will

A)increase the interest rate on corporate bonds.
B)reduce the interest rate on municipal bonds.
C)increase the interest rate on municipal bonds.
D)increase the interest rate on Treasury bonds.

Question 48

A(n)________ in the liquidity of corporate bonds will ________ the price of corporate bonds and ________ the yield on corporate bonds,all else equal.

A)increase;increase;decrease
B)increase;decrease;decrease
C)decrease;increase;increase
D)decrease;decrease;decrease

Question 49

An increase in the liquidity of corporate bonds will ________ the price of corporate bonds and ________ the yield of Treasury bonds,everything else held constant.

A)increase;increase
B)reduce;reduce
C)increase;reduce
D)reduce;increase

Question 50

A decrease in the liquidity of corporate bonds will ________ the yield of corporate bonds and ________ the yield of Treasury bonds,everything else held constant.

A)increase;increase
B)decrease;decrease
C)increase;decrease
D)decrease;increase

Question 51

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

Question 52

Municipal bonds have default risk,yet their interest rates are lower than the rates on default-free Treasury bonds.This suggests that

A)the benefit from the tax-exempt status of municipal bonds is less than their default risk.
B)the benefit from the tax-exempt status of municipal bonds equals their default risk.
C)the benefit from the tax-exempt status of municipal bonds exceeds their default risk.
D)Treasury bonds are not default-free.

Question 53

Everything else held constant,a decrease in marginal tax rates would likely have the effect of ________ the demand for municipal bonds,and ________ the demand for U.S.government bonds.

A)increasing;increasing
B)increasing;decreasing
C)decreasing;increasing
D)decreasing;decreasing

Question 54

Everything else held constant,an increase in marginal tax rates would likely have the effect of ________ the demand for municipal bonds,and ________ the demand for U.S.government bonds.

A)increasing;increasing
B)increasing;decreasing
C)decreasing;increasing
D)decreasing;decreasing

Question 55

Everything else held constant,if income tax rates were lowered,then

A)the interest rate on municipal bonds would fall.
B)the interest rate on Treasury bonds would rise.
C)the interest rate on municipal bonds would rise.
D)the price of Treasury bonds would fall.

Question 56

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

A)less liquid than
B)less speculative than
C)tax-exempt unlike
D)lower-yielding than

Question 57

When the Treasury bond market becomes less liquid,other things equal,the demand curve for corporate bonds shifts to the ________ and the demand curve for Treasury bonds shifts to the ________.

A)right;right
B)right;left
C)left;right
D)left;left

Question 58

A decrease in the liquidity of corporate bonds,other things being equal,shifts the demand curve for corporate bonds to the ________ and the demand curve for Treasury bonds shifts to the ________.

A)right;right
B)right;left
C)left;left
D)left;right

Question 59

Three factors explain the risk structure of interest rates

A)liquidity,default risk,and the income tax treatment of a security.
B)maturity,default risk,and the income tax treatment of a security.
C)maturity,liquidity,and the income tax treatment of a security.
D)maturity,default risk,and the liquidity of a security.

Question 60

The Obama administration increased the tax on the top income tax bracket from 35% to 39%.Supply and demand analysis predicts the impact of this change was a ________ interest rate on municipal bonds and a ________ interest rate on Treasury bonds,all else the same.

A)higher;lower
B)lower;lower
C)higher;higher
D)lower;higher

Question 61

Economists' attempts to explain the term structure of interest rates

A)illustrate how economists modify theories to improve them when they are inconsistent with the empirical evidence.
B)illustrate how economists continue to accept theories that fail to explain observed behavior of interest rate movements.
C)prove that the real world is a special case that tends to get short shrift in theoretical models.
D)have proved entirely unsatisfactory to date.

Question 62

When yield curves are flat

A)long-term interest rates are above short-term interest rates.
B)short-term interest rates are above long-term interest rates.
C)short-term interest rates are about the same as long-term interest rates.
D)medium-term interest rates are above both short-term and long-term interest rates.

Question 63

If bonds with different maturities are perfect substitutes,then the ________ on these bonds must be equal.

A)expected return
B)surprise return
C)surplus return
D)excess return

Question 64

When yield curves are steeply upward sloping

A)long-term interest rates are above short-term interest rates.
B)short-term interest rates are above long-term interest rates.
C)short-term interest rates are about the same as long-term interest rates.
D)medium-term interest rates are above both short-term and long-term interest rates.

Question 65

If the expected path of one-year interest rates over the next five years is 4 percent,5 percent,7 percent,8 percent,and 6 percent,then the expectations theory predicts that today's interest rate on the five-year bond is

A)4 percent.
B)5 percent.
C)6 percent.
D)7 percent.

Question 66

If the expected path of 1-year interest rates over the next five years is 2 percent,4 percent,1 percent,4 percent,and 3 percent,the expectations theory predicts that the bond with the lowest interest rate today is the one with a maturity of

A)one year.
B)two years.
C)three years.
D)four years.

Question 67

Differences in ________ explain why interest rates on Treasury securities are not all the same.

A)risk
B)liquidity
C)time to maturity
D)tax characteristics

Question 68

When yield curves are downward sloping

A)long-term interest rates are above short-term interest rates.
B)short-term interest rates are above long-term interest rates.
C)short-term interest rates are about the same as long-term interest rates.
D)medium-term interest rates are above both short-term and long-term interest rates.

Question 69

According to the expectations theory of the term structure

A)the interest rate on long-term bonds will exceed the average of short-term interest rates that people expect to occur over the life of the long-term bonds,because of their preference for short-term securities.
B)interest rates on bonds of different maturities move together over time.
C)buyers of bonds prefer short-term to long-term bonds.
D)buyers require an additional incentive to hold long-term bonds.

Question 70

If the expected path of 1-year interest rates over the next five years is 1 percent,2 percent,3 percent,4 percent,and 5 percent,the expectations theory predicts that the bond with the highest interest rate today is the one with a maturity of

A)two years.
B)three years.
C)four years.
D)five years.

Question 71

According to the expectations theory of the term structure

A)when the yield curve is steeply upward sloping,short-term interest rates are expected to remain relatively stable in the future.
B)when the yield curve is downward sloping,short-term interest rates are expected to remain relatively stable in the future.
C)investors have strong preferences for short-term relative to long-term bonds,explaining why yield curves typically slope upward.
D)yield curves should be equally likely to slope downward as slope upward.

Question 72

The typical shape for a yield curve is

A)gently upward sloping.
B)mound shaped.
C)flat.
D)bowl shaped.

Question 73

A plot of the interest rates on default-free government bonds with different terms to maturity is called

A)a risk-structure curve.
B)a default-free curve.
C)a yield curve.
D)an interest-rate curve.

Question 74

According to the expectations theory of the term structure,the interest rate on a long-term bond will equal the ________ of the short-term interest rates that people expect to occur over the life of the long-term bond.

A)average
B)sum
C)difference
D)multiple

Question 75

The term structure of interest rates is

A)the relationship among interest rates of different bonds with the same maturity.
B)the structure of how interest rates move over time.
C)the relationship among the term to maturity of different bonds.
D)the relationship among interest rates on bonds with different maturities.

Question 76

If the expected path of 1-year interest rates over the next four years is 5 percent,4 percent,2 percent,and 1 percent,then the expectations theory predicts that today's interest rate on the four-year bond is

A)1 percent.
B)2 percent.
C)3 percent.
D)4 percent.

Question 77

An inverted yield curve

A)slopes up.
B)is flat.
C)slopes down.
D)has a U shape.

Question 78

According to the segmented markets theory of the term structure

A)the interest rate on long-term bonds will equal an average of short-term interest rates that people expect to occur over the life of the long-term bonds.
B)buyers of bonds do not prefer bonds of one maturity over another.
C)interest rates on bonds of different maturities do not move together over time.
D)buyers require an additional incentive to hold long-term bonds.

Question 79

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

A)1 percent.
B)2 percent.
C)3 percent.
D)4 percent.

Question 80

According to the segmented markets theory of the term structure

A)bonds of one maturity are close substitutes for bonds of other maturities,therefore,interest rates on bonds of different maturities move together over time.
B)the interest rate for each maturity bond is determined by supply and demand for that maturity bond.
C)investors' strong preferences for short-term relative to long-term bonds explains why yield curves typically slope downward.
D)because of the positive term premium,the yield curve will not be observed to be downward-sloping.