Question 1

Why did some economists and policymakers think ratings agencies had a conflict of interest leading up to the Financial Crisis of 2007-2009?

Accepted Answer

Since ratings agencies earn income by charging firms for their services,they may have an incentive to maintain higher ratings than justified in order to keep a firm's business.

Question 2

The default risk premium is measured

Accepted Answer

A)   by an index published monthly by the Securities and Exchange Commission.
B)   by an index published monthly by The Wall Street Journal.
C)   as the difference between the yield on a non-Treasury security and the yield on a U.S. Treasury security of the same maturity.
D)   as the difference between the nominal yield on the security and the real after-tax yield on the security. C

Question 3

All of the following are names for bonds receiving low ratings EXCEPT

Accepted Answer

A)   junk.
B)   garbage.
C)   high yield.
D)   speculative. B

Question 4

Investors often pay professional analysts to gather and monitor information on the creditworthiness of borrowers because

Accepted Answer

A)   federal law requires it.
B)   most investors are risk neutral.
C)   the cost of acquiring information about a borrower's creditworthiness can be high.
D)   doing so increases the net-of-tax yield on most investments.

Question 5

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 6

Default risk arises from the fact that

Accepted Answer

A)   borrowers differ in their ability to repay in full the principal and interest required by a bond agreement.
B)   the bond price drops when interest rates rise.
C)   it is inherently riskier to wait for a capital gain than to receive an immediate interest payment.
D)   interest rates are far more likely to go up than to go down.

Question 7

The expectations theory

Accepted Answer

A)   has difficulty explaining why U.S. Treasury securities have lower yields than corporate bonds.
B)   has difficulty explaining why yields on bonds of different maturities move together.
C)   has difficulty explaining why yield curves usually slope upward.
D)   accounts well for the fact that yield curves usually slope upward.

Question 8

A one-year bond has an interest rate of 0.2% and is expected to rise to 0.5% next year and 1.1% in two years.The term premium for a two-year bond is 0.1% and for a three-year bond is 0.25%.What are the interest rates on a two-year bond and three-year bond according to the liquidity premium theory?

Accepted Answer

The answer of A one-year bond has an interest rate...

Question 9

Table 5.1
 $$\begin{array} { | c | c | r | } 
\hline 1 \text { year } & 2 \text { years } & 3 \text { years } \
\hline 1.50 \% & 2.25 \% & 3.25 \% \
\hline
\end{array}$$ 
Table 5.1 shows the interest rates for Treasury securities of different maturities. Assume that the liquidity premium theory is correct.
-Refer to Table 5.1 On this day,what did investors expect the interest rate to be on the one-year Treasury bill in two years if the term premium on a two-year Treasury note is 0.25% and the term premium on a three-year Treasury note is 0.75%?

Accepted Answer

A)   2.375%
B)   3.25%
C)   3.50%
D)   4.75%

Question 10

Which of the following is NOT true of the yield curve for U.S.Treasury securities?

Accepted Answer

A)   Typically, it slopes upward.
B)   It depicts the relationship among yields on securities of different maturities.
C)   Typically, it shifts up or down rather than twists.
D)   Typically, it slopes downward.

Question 11

If lenders anticipate no changes in liquidity,information costs,and tax differences,the yield on a risky security should be

Accepted Answer

A)   greater than that on a safe security and the price of a risky security should also be greater than that of a safe security.
B)   less than that on a safe security and the price of a risky security should also be less than that of a safe security.
C)   greater than that on a safe security and the price of a risky security should be lower than that of a safe security.
D)   less than that on a safe security and the price of a risky security should be greater than that on a safe security.

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

In late 2008,the average risk premium rose because

Accepted Answer

A)   investors feared a revival of inflation.
B)   large tax increases in the United States reduced corporate profits and led to fears of increased defaults.
C)   of the financial crisis.
D)   of fraud in the market for municipal bonds.

Question 14

In 2016,as investors became more concerned with the default risk of bonds issued by the governments of Greece and Portugal relative to the default risk on bonds issued by the governments of Germany,France,and the Netherlands,the price of bonds issued by Germany,France,and the Netherlands would have most likely ________ and the yield on those bonds would have most likely ________.

Accepted Answer

A)   increased; increased
B)   increased; decreased
C)   decreased; increased
D)   decreased; decreased

Question 15

The liquidity premium theory holds that investors

Accepted Answer

A)   always choose the bond with the highest expected return, regardless of maturity.
B)   require a term premium to compensate them for investing in a less preferred maturity.
C)   view bonds of different maturities as perfect substitutes.
D)   view bonds of different maturities as completely unsubstitutable.

Question 16

Under the expectations theory,an upward-sloping yield curve indicates that investors expect future short-term rates to

Accepted Answer

A)   fall.
B)   rise.
C)   remain constant.
D)   either rise or remain constant.

Question 17

The investment strategy of borrowing at a low short-term interest rate and using the borrowed funds to invest at a higher long-term interest rate is called

Accepted Answer

A)   arbitrage.
B)   interest carry trade.
C)   risk structure.
D)   liquidity premium.

Question 18

What is a primary reason for the yield on 3-month Treasury bills being low during recessions?

Accepted Answer

A)   low risk premium
B)   the Fed pushing short-term interest rates down
C)   rising inflation
D)   the inversion of the yield curve

Question 19

U)S.Treasury securities

Accepted Answer

A)   are considered risk free because their prices never change.
B)   have been defaulted on several time in U.S. history.
C)   are considered default-risk-free instruments.
D)   have a large default risk premium.

Question 20

The default risk premium fluctuates mainly

Accepted Answer

A)   because bond rating agencies tend to be inconsistent in their ratings of bonds.
B)   because risk-neutral investors will often become risk-averse as time passes.
C)   because taxes tend to rise over the long run.
D)   as new information about a borrower's creditworthiness becomes available.

Exam 5: The Risk Structure and Term Structure of Interest Rates