Question 1

If a one-year bond currently yields 4% and is expected to yield 6% next year, the liquidity premium theory suggests the yield today on a two-year bond will be:

Accepted Answer

A)   More than 4% but less than 5%.
B)   5%.
C)   4%.
D)   More than 5%. D

Question 2

Which of the following assigns widely followed bond ratings?

Accepted Answer

A)   The Federal Reserve
B)   The U.S. Treasury
C)   The New York Stock Exchange
D)   Standard & Poor's D

Question 3

The risk spread is:

Accepted Answer

A)   the difference between a bond's purchase price and selling price.
B)   the difference between the bond's yield and the yield on a U.S. Treasury bond of the same maturity.
C)   less than 0 (zero)  for a U.S. Treasury bond.
D)   assigned by a bond-rating agency. B

Question 4

Which of the following assigns widely followed bond ratings?

Accepted Answer

A)   The Federal Reserve
B)   The Wall Street Journal
C)   Moody's Investor Service
D)   The Nasdaq

Question 5

A proposed increase in the federal income tax rates may actually be viewed favorably by many mayors of cities because:

Accepted Answer

A)   it will allow them to also raise their tax rates.
B)   it will cause the demand for municipal bonds to increase and their yields to increase.
C)   people will pay less attention to local taxes.
D)   it will cause the price of municipal bonds to increase and their yields to decrease.

Question 6

Which of the following statements pertaining to the yield curve is not true?

Accepted Answer

A)   Yield curves usually slope upwards.
B)   The yield curve shows the difference in default risk between securities.
C)   The yield curve shows the relationship among bonds with the same risk characteristics but different maturities.
D)   The yield curve can be flat or downward sloping depending on market conditions.

Question 7

Suppose that interest rates are expected to remain unchanged over the next few years. However, there is a risk premium for longer-term bonds. According to the liquidity premium theory, the yield curve should be:

Accepted Answer

A)   upward sloping and very steep.
B)   upward sloping and relatively flat.
C)   inverted.
D)   vertical.

Question 8

Which of the following is true?

Accepted Answer

A)   Long-term bond yields move together but short-term yields do not.
B)   Short-term bond yields move together but long-term yields do not.
C)   U.S. Treasury Bill yields are lower than the yields on commercial paper.
D)   Long-term bond yields are usually the same as short-term yields.

Question 9

According to the Expectations Theory of the term structure, if interest rates are expected to be 2%, 2%, 4%, and 5% over the next four years, which yield is the closest to the yield on a three-year bond today?

Accepted Answer

A)   2.7%
B)   4%
C)   4.3%
D)   8%

Question 10

The yield on a tax-exempt bond:

Accepted Answer

A)   equals the taxable bond yield times one minus the tax rate.
B)   is equal to the yield on a U.S. 30-year bond.
C)   is called the risk-free yield.
D)   only applies to foreign bonds because they are exempt from U.S. income taxes.

Question 11

The usually upward sloping yield curve indicates that long-term bonds have higher yields than short-term bonds. Why is this?

Accepted Answer

The answer of The usually upward sloping yield curve indicates...

Question 12

An increased risk of a financial crisis in the euro area should cause the:

Accepted Answer

A)   demand for all government securities including U.S. Treasury securities to decrease.
B)   risk spread between U.S. Treasury bonds and other bonds to decrease.
C)   price of U.S. Treasury bonds to increase and the yield on other bonds to increase.
D)   price of U.S. Treasury bonds to increase and the yield on other bonds to decrease.

Question 13

If the yield curve is flat, using liquidity premium theory, what do you know about the expected future short-term interest rate?

Accepted Answer

The answer of If the yield curve is flat, using...

Question 14

If a bond's rating improves, we would expect:

Accepted Answer

A)   the demand for this bond to increase, all other factors constant.
B)   the demand for and the yield of this bond to increase, all other factors constant.
C)   the demand for this bond to decrease, and its yield to increase, all other factors constant.
D)   both the demand for and the price of the bond to decrease, all other factors constant.

Question 15

When we compare the graphs of GDP growth over time to the corresponding risk spread on
Baa bonds compared to 10-year U.S. Treasury bonds, what relationship can be inferred?

Accepted Answer

The answer of When we compare the graphs of GDP...

Question 16

In the fall of 1998 we saw an increase in the risk spread because:

Accepted Answer

A)   the risk spread always increases as we approach the end of the year.
B)   the Russian government defaulted on some of its bonds.
C)   there was an extraordinarily large amount of corporate fraud being reported in 1998.
D)   there was a significant increase in U.S. income tax rates.

Question 17

The yield on a 30-year U.S. Treasury security is 6.5%; the yield on a 2-year U.S. Treasury bond is 4.0%. This data indicate:

Accepted Answer

A)   the yield curve is downward sloping.
B)   the yield curve is flat since the risk premium needs to be added for longer maturities.
C)   the yield curve is upward sloping.
D)   that people expect inflation to decrease in the future.

Question 18

The terrorist attack on the World Trade Center on September 11, 2001:

Accepted Answer

A)   triggered a flight to quality in the bond market.
B)   caused the demand for U.S. Treasury securities to fall and the demand for corporate bonds to rise.
C)   caused the price of U.S. Treasury securities to fall and the yields on corporate bonds to fall.
D)   did not have any significant impact since the risk on all bonds increased.

Question 19

Describe the concept of flight to quality in terms of the Russian government default of
August 1998.

Accepted Answer

The answer of Describe the concept of flight to quality...

Question 20

We would expect the risk spread between Baa bonds and U.S. Treasury securities of the same maturities to:

Accepted Answer

A)   widen during periods of economic recession.
B)   remain relatively constant over the business cycle.
C)   decrease during economic slowdowns.
D)   increase during economic growth periods.

Exam 7: The Risk and Term Structure of Interest Rates

If a one-year bond currently yields 4% and is expected to yield 6% next year, the liquidity premium theory suggests the yield today on a two-year bond will be:

Which of the following assigns widely followed bond ratings?

The risk spread is:

Which of the following assigns widely followed bond ratings?

A proposed increase in the federal income tax rates may actually be viewed favorably by many mayors of cities because:

Which of the following statements pertaining to the yield curve is not true?

Suppose that interest rates are expected to remain unchanged over the next few years. However, there is a risk premium for longer-term bonds. According to the liquidity premium theory, the yield curve should be:

Which of the following is true?

According to the Expectations Theory of the term structure, if interest rates are expected to be 2%, 2%, 4%, and 5% over the next four years, which yield is the closest to the yield on a three-year bond today?

The yield on a tax-exempt bond:

The usually upward sloping yield curve indicates that long-term bonds have higher yields than short-term bonds. Why is this?

An increased risk of a financial crisis in the euro area should cause the:

If the yield curve is flat, using liquidity premium theory, what do you know about the expected future short-term interest rate?

If a bond's rating improves, we would expect:

When we compare the graphs of GDP growth over time to the corresponding risk spread on Baa bonds compared to 10-year U.S. Treasury bonds, what relationship can be inferred?

In the fall of 1998 we saw an increase in the risk spread because:

The yield on a 30-year U.S. Treasury security is 6.5%; the yield on a 2-year U.S. Treasury bond is 4.0%. This data indicate:

The terrorist attack on the World Trade Center on September 11, 2001:

Describe the concept of flight to quality in terms of the Russian government default of August 1998.

We would expect the risk spread between Baa bonds and U.S. Treasury securities of the same maturities to: