Question 1

-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 2

-The steeply upward sloping yield curve in the figure above indicates that ________.

Accepted Answer

A) short-term interest rates are expected to rise in the future 
B) short-term interest rates are expected to fall moderately in the future 
C) short-term interest rates are expected to fall sharply in the future 
D) short-term interest rates are expected to remain unchanged in the future

Question 3

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 4

The spread between interest rates on low quality corporate bonds and Canada bonds ________.

Accepted Answer

A) widens significantly during recessions 
B) narrows significantly during recessions 
C) narrows moderately during recessions 
D) does not change during recessions

Question 5

During a "flight to quality" ________.

Accepted Answer

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

Question 6

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

Accepted Answer

A) A federal government bond 
B) A provincial bond 
C) A corporate bond with a rating of Aaa 
D) A corporate bond with a rating of Baa

Question 7

Three factors explain the risk structure of interest rates: ________.

Accepted Answer

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 8

According to the liquidity premium theory of the term structure, a downward sloping yield curve indicates that short-term interest rates are expected to ________.

Accepted Answer

A) rise in the future 
B) remain unchanged in the future 
C) decline moderately in the future 
D) decline sharply in the future

Question 9

Canadian government bonds have no default risk because ________.

Accepted Answer

A) they are backed by the full faith and credit of the federal government 
B) the federal government can increase taxes to pay its obligations 
C) they are backed with gold reserves 
D) they can be exchanged for silver at any time

Question 10

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 ________.

Accepted Answer

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

Question 11

If the yield curve is flat for short maturities and then slopes downward for longer maturities, the liquidity premium theory (assuming a mild preference for shorter-term bonds)indicates that the market is predicting ________.

Accepted Answer

A) a rise in short-term interest rates in the near future and a decline further out in the future 
B) constant short-term interest rates in the near future and a decline further out in the future 
C) a decline in short-term interest rates in the near future and a rise further out in the future 
D) a decline in short-term interest rates in the near future and an even steeper decline further out in the future

Question 12

When yield curves are downward sloping, ________.

Accepted Answer

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 13

Which of the following securities has the lowest interest rate?

Accepted Answer

A) Junk bonds 
B) Canada bonds 
C) Investment-grade bonds 
D) Corporate Baa bonds

Question 14

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 15

When yield curves are flat, ________.

Accepted Answer

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 16

An inverted yield curve predicts that short-term interest rates ________.

Accepted Answer

A) are expected to rise in the future 
B) will rise and then fall in the future 
C) will remain unchanged in the future 
D) will fall in the future

Question 17

An inverted yield curve ________.

Accepted Answer

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

Question 18

When short-term interest rates are expected to fall sharply in the future, the yield curve will ________.

Accepted Answer

A) slope up 
B) be flat 
C) be inverted 
D) be an inverted U shape

Question 19

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

Accepted Answer

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

Question 20

Bonds with relatively low risk of default are called ________.

Accepted Answer

A) zero coupon bonds 
B) junk bonds 
C) investment grade bonds 
D) fallen angels

Exam 6: The Risk and Term Structure of Interest Rates