Question 1

Which of the following statements are TRUE?

Accepted Answer

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 2

The ________ of the term structure of interest rates states that the interest rate on a long-term bond will equal the average of short-term interest rates that individuals expect to occur over the life of the long-term bond,and investors have no preference for short-term bonds relative to long-term bonds.

Accepted Answer

A) segmented markets theory 
B) expectations theory 
C) liquidity premium theory 
D) separable markets theory

Question 3

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

Accepted Answer

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 4

Which of the following securities has the lowest interest rate?

Accepted Answer

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

Question 5

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

Accepted Answer

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 6

According to the segmented markets theory of the term structure

Accepted Answer

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 7

-The U-shaped yield curve in the figure above indicates that the inflation rate is expected to

Accepted Answer

A) remain constant in the near-term and fall later on. 
B) fall sharply in the near-term and rise later on. 
C) rise moderately in the near-term and fall later on. 
D) remain constant in the near-term and rise later on.

Question 8

A particularly attractive feature of the ________ is that it tells you what the market is predicting about future short-term interest rates by just looking at the slope of the yield curve.

Accepted Answer

A) segmented markets theory 
B) expectations theory 
C) liquidity premium theory 
D) separable markets theory

Question 9

The collapse of the subprime mortgage market

Accepted Answer

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 10

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

Accepted Answer

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

Question 11

Everything else held constant,abolishing the individual income tax will

Accepted Answer

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 12

Bonds with relatively high risk of default are called

Accepted Answer

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

Question 13

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

Accepted Answer

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 14

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.

Accepted Answer

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

Question 15

The preferred habitat theory of the term structure is closely related to the

Accepted Answer

A) expectations theory of the term structure. 
B) segmented markets theory of the term structure. 
C) liquidity premium theory of the term structure. 
D) the inverted yield curve theory of the term structure.

Question 16

The expectations theory and the segmented markets theory do not explain the facts very well,but they provide the groundwork for the most widely accepted theory of the term structure of interest rates

Accepted Answer

A) the Keynesian theory. 
B) the separable markets theory. 
C) the liquidity premium theory. 
D) the asset market approach.

Question 17

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

Accepted Answer

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

Question 18

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

Accepted Answer

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

Question 19

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

Accepted Answer

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

Question 20

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

Accepted Answer

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

Exam 6: The Risk and Term Structure of Interest Rates