Question 1

The default risk premium

Accepted Answer

A) brings the expected yield on a security into equality with the expected yield on a default-free security. 
B) compensates risk-neutral investors for increased variability in yields. 
C) required by risk-neutral investors is always greater than that required by risk-averse investors. 
D) is always zero for risk-neutral investors.

Question 2

Under the expectations theory if market participants expect that future short-term rates will be higher than current short-term rates, the yield curve will

Accepted Answer

A) slope upward. 
B) slope downward. 
C) be flat. 
D) slope upward, slope downward, or be flat, depending on risk, liquidity, cost of information, and tax considerations.

Question 3

Currently, a three-year Treasury note pays 4.75%. Assuming that your tax rate is 20%, what is the minimum interest rate that you would you need to earn on a tax-free municipal bond in order to buy it instead?

Accepted Answer

A) 0.95% 
B) 3.8% 
C) 5.7% 
D) 15.25%

Question 4

Which of the following is NOT true of the expectations theory?

Accepted Answer

A) It assumes that instruments with different maturities are perfect substitutes. 
B) It implies that a long-term bond rate equals the average of short-term rates covering the same investment period. 
C) It implies that the yield curve will usually slope upward. 
D) It implies that the shape of the yield curve depends on the expected pattern of future short-term rates.

Question 5

Which of the following statements is true of the yield curve?

Accepted Answer

A) Typically, it changes its shape without shifting up or down. 
B) Typically, it shifts up or down without changing its shape. 
C) Typically, if it shifts up or down it will also change its shape. 
D) It only rarely shifts up or down or changes its shape.

Question 6

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 thirty-year U.S. Treasury bonds is 10%. You would be indifferent between buying a thirty-year Treasury 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%.

Question 7

According to the preferred habitat theory, the yield curve normally has a positive slope because

Accepted Answer

A) short-term interest rates are expected to rise. 
B) term premiums rise as the time to maturity increases. 
C) risk premiums rise over time. 
D) long-term bonds are more liquid than short-term bonds.

Question 8

The term structure is usually defined with yields on which securities?

Accepted Answer

A) Corporate bonds 
B) Commercial paper 
C) U.S. Treasury securities 
D) Municipal bonds

Question 9

If the expectations theory of the term structure is correct, would a reduction in the supply of thirty-year Treasury bonds affect their yields?

Accepted Answer

The answer of If the expectations theory of the term...

Question 10

The yield on a thirty-year Treasury bond is 8% at the same time as the yield on two-year Treasury note is 5%. This occurrence

Accepted Answer

A) indicates that the yield curve is downward sloping. 
B) is well explained by the segmented markets theory. 
C) is largely explained by the favorable tax treatment of Treasury notes. 
D) indicates that the bond market is anticipating that inflation will fall.

Question 11

If the average risk premium of corporate bonds increases,

Accepted Answer

A) the average price of corporate bonds will also increase. 
B) it's a indicator of a possible upcoming recession. 
C) interest rates on those bonds decrease. 
D) the risk premium on treasury bonds will also increase.

Question 12

Many savers are willing to accept a lower interest rate on municipal bonds than on comparable instruments because

Accepted Answer

A) the after-tax yield on municipal bonds is greater. 
B) municipal bonds invariably have lower default risk. 
C) municipal bonds are more liquid than most other instruments. 
D) the yield on municipal bonds is considered inflation proof.

Question 13

The yield on commercial paper minus the yield on U.S. Treasury bills

Accepted Answer

A) rises when financial markets believe that a recession is imminent. 
B) falls when financial markets believe that a recession is imminent. 
C) is an unreliable indicator of future economic activity. 
D) is strongly affected by marginal federal income tax rates.

Question 14

Government obligations, such as Treasury bills and bonds, have

Accepted Answer

A) high liquidity and high information costs. 
B) low liquidity and low information costs. 
C) low liquidity and high information costs. 
D) high liquidity and low information costs.

Question 15

Risk-neutral savers care

Accepted Answer

A) only about expected returns and not about the variability of those returns. 
B) only about the variability of returns and not about their expected value. 
C) about both expected returns and the variability of those returns. 
D) about neither expected returns nor about the variability of those returns.

Question 16

During the recession of the early 1980s the prices of U.S. Treasury securities

Accepted Answer

A) rose relative to the prices of corporate bonds. 
B) fell relative to the prices of corporate bonds. 
C) remained in the same relative position to the prices of corporate bonds. 
D) were frozen by order of the federal government.

Question 17

A one-year bond currently pays 5% interest. It's expected that it will pay 4.5% next year and 4% the following year. The two-year term premium is 0.2% while the three-year term premium is 0.35%. What is the interest rate on a three-year bond according to the preferred habitat theory?

Accepted Answer

A) 4.5% 
B) 4.68% 
C) 4.85% 
D) 5.05%

Question 18

Holding all other factors that affect yields constant, following passage of the Tax Reform Act of 1986which lowered marginal income tax ratesyields on

Accepted Answer

A) municipal bonds should have fallen relative to yields on U.S. Treasury securities. 
B) U.S. Treasury securities should have fallen relative to yields on corporate bonds. 
C) municipal bonds should have risen relative to yields on corporate bonds. 
D) corporate bonds should have risen relative to the yields on U.S. Treasury securities.

Question 19

Suppose that savers become much more willing to purchase a certain type of municipal bond. The result will be that the bond's price will

Accepted Answer

A) fall relative to the price of U.S. Treasury securities but rise relative to the price of corporate bonds. 
B) rise relative to the price of U.S. Treasury securities but fall relative to the price of corporate bonds. 
C) rise relative to the prices of U.S. Treasury securities and corporate bonds. 
D) fall relative to the prices of U.S. Treasury securities and corporate bonds.

Question 20

If the federal government replaced the current income tax with a consumption tax

Accepted Answer

A) the prices of corporate and municipal bonds would rise. 
B) the prices of corporate and municipal bonds would fall. 
C) the prices of corporate bonds would rise, while the prices of municipal bonds would fall. 
D) the prices of corporate bonds would fall, while the prices of municipal bonds would rise.

Exam 7: Risk Structure and Term Structure of Interest Rates