Question 1

According to the expectations theory, what will be the interest rate on a three-year bond if a one-year bond has an interest rate of 2% and is expected to have an interest rate of 3% next year and 5% in two year? Report your answer using a percentage with two decimal places.

Accepted Answer

The answer of According to the expectations theory, what will...

Question 2

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 3

Differences in the taxation of returns

Accepted Answer

A) only affect the yields of illiquid credit market instruments. 
B) have a negligible effect on the yields of credit market instruments. 
C) only affect the yields of high-information cost credit market instruments. 
D) create differences in yields among credit market instruments.

Question 4

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 5

The greatest appeal of U.S. Treasury securities is that

Accepted Answer

A) they have high yields. 
B) they have no default risk. 
C) the U.S. Treasury will repurchase them at any time. 
D) their market prices fluctuate very little.

Question 6

Almost every time that there has been an inverted yield curve, what took place within one year?

Accepted Answer

A) recession 
B) rising inflation 
C) financial crisis 
D) higher bond yields

Question 7

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 issued within your state (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 8

The existence of rating agencies has

Accepted Answer

A) lowered returns on corporate bonds. 
B) raised returns on corporate bonds. 
C) left returns on corporate bonds largely unaffected. 
D) raised returns on both corporate bonds and Treasury securities.

Question 9

According to the liquidity premium theory, if market participants expect that inflation in the future will be lower than it currently is, the yield curve will

Accepted Answer

A) slope upward. 
B) be flat. 
C) be inverted. 
D) be vertical.

Question 10

According to the liquidity premium theory

Accepted Answer

A) investors prefer longer to shorter maturities. 
B) investors prefer shorter to longer maturities. 
C) investors are indifferent between short and long maturities. 
D) investors are more interested in the tax treatment of bonds than they are in the liquidity of bonds.

Question 11

Default risk

Accepted Answer

A) is the probability that a borrower will not pay in full the promised coupon or principal. 
B) exists only for the bonds of small corporations. 
C) is also known as market risk. 
D) is zero for bonds issued by cities and states.

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 segmented markets theory

Accepted Answer

A) explains upward-sloping yield curves as resulting from the demand for long-term bonds being high relative to the demand for short-term bonds. 
B) explains upward-sloping yield curves as resulting from the demand for long-term bonds being low relative to the demand for short-term bonds. 
C) explains upward-sloping yield curves as resulting from the favorable tax treatment of long-term bonds. 
D) is unable to account for upward-sloping yield curves.

Question 14

When a company whose ability to repay its obligations in full is uncertain,

Accepted Answer

A) it will have to issue debt with longer maturities than would a company with a lower probability of default. 
B) its bonds will sell for higher prices than would the bonds of a company with a lower probability of default. 
C) it must offer investors higher yields to compensate them for the risk they take in buying their bonds or making loans. 
D) it must do so through financial markets rather than through financial intermediaries.

Question 15

The expectations theory suggests that

Accepted Answer

A) the yield curve should usually be upward-sloping. 
B) the yield curve should usually be downward-sloping. 
C) the slope of the yield curve depends on the expected future path of short-term rates. 
D) the slope of the yield curve reflects the risk premium incorporated into the yields on long-term bonds.

Question 16

Steve Forbes has run for president twice on a program of a "flat tax." Under a flat tax, there would be only one tax bracket for the federal income tax and most tax deductions and tax exemptions would be eliminated. Suppose that Forbes wins the 2016 presidential election. What would be the likely impact on the market for municipal bonds?

Accepted Answer

The answer of Steve Forbes has run for president twice...

Question 17

Which bond would someone in a 35% tax bracket choose to buy: a municipal bond with an interest rate of 7% or a corporate bond with an interest rate of 10%?

Accepted Answer

The answer of Which bond would someone in a 35%...

Question 18

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 liquidity premium theory?

Accepted Answer

A) 4)5% 
B) 4)68% 
C) 4)85% 
D) 5)05%

Question 19

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.

Question 20

Which of the following is true of the segmented markets theory?

Accepted Answer

A) It assumes that borrowers have particular periods for which they want to borrow. 
B) It assumes that lenders always lend for short periods. 
C) It provides a good explanation for why yield curves usually slope upward. 
D) It assumes that instruments with different maturities are perfect substitutes.

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