Question 1

An investor sees the current twelve-month rate at 4% and expects the following future twelve-month rate for each of the subsequent years; 4.5%, 5.5% and 6.0%. If this investor views a four-year maturity at 5.65% as equal to four consecutive one-year securities, what is his/her risk premium?

Accepted Answer

The answer of An investor sees the current twelve-month rate...

Question 2

All of the following are true about the risk spread except:

Accepted Answer

A)  It should be higher for highly speculative bonds than investment grade bonds 
B)  It should have a direct relationship with the bond's yield 
C)  It should have an inverse relationship with the bond's price 
D)  It should have a direct relationship with the bond's price

Question 3

If a local government eliminates the tax exemption on municipal bonds, we'd expect to see:

Accepted Answer

A)  An increase in the yield on taxable bonds 
B)  A decrease in the gap in yields on taxable and tax-exempt bonds 
C)  A decrease in the yield on municipal bonds 
D)  Municipal bonds will become more attractive to investors

Question 4

Interest on most bonds issued by states is usually exempt from:

Accepted Answer

A)  State income tax but not federal 
B)  Federal income tax but not state 
C)  Both state and federal income taxes 
D)  City income taxes

Question 5

If a bond's rating improves it should cause:

Accepted Answer

A)  The bond's price and yield to increase, all other factors constant 
B)  The bond's price and yield to decrease, all other factors constant 
C)  The bond's price to increase and its yield to decrease, all other factors constant 
D)  The bond's price to decrease and its yield to increase, all other factors constant

Question 6

What is the highest bond rating assigned by Standard and Poor's?

Accepted Answer

A)  AA 
B)  EEE 
C)  AAA 
D)  A

Question 7

Suppose the tax rate is 25% and the taxable bond yield is 8%. What is the tax-exempt bond yield?

Accepted Answer

A)  2% 
B)  2.3% 
C)  6% 
D)  6.9%

Question 8

The risk structure of interest rates says:

Accepted Answer

A)  The interest rates on a variety of bonds will move independently of each other 
B)  Lower rated bonds will have higher yields 
C)  U.S. Treasury bond yields always change by more than other bonds 
D)  Interest rates only compensate for risk in structured amounts

Question 9

What is the effective after-tax yield to an investor from a bond paying $70 per $1,000 annually, if the investor is in a 25% marginal tax bracket? Explain.

Accepted Answer

The answer of What is the effective after-tax yield to...

Question 10

Under the Expectations Hypothesis of the term structure of interest rates, explain the impact of a U.S. Treasury decision to phase out the 30-year bond and to only focus on 3-month, 1-year, 5-year and 10-year bonds?

Accepted Answer

The answer of Under the Expectations Hypothesis of the term...

Question 11

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 12

A borrower who has to pay an interest rate of 8% rather than 6% due to risk spread will:

Accepted Answer

A)  Pay $20 more in interest annually for every $100 borrowed 
B)  Pay 33.3% higher interest in dollar terms 
C)  Pay 2% in net interest 
D)  Pay less interest in total over the life of the loan

Question 13

Increasing tensions in many parts of the world should:

Accepted Answer

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

Question 14

An investor in a 30% marginal tax bracket, earning $10 in interest annually for a $100 U.S. Treasury bond:

Accepted Answer

A)  Earns a 10% after-tax return because interest on U.S. Treasury bonds is tax exempt at the federal level 
B)  Earns a 3% return after-tax 
C)  Would be indifferent between this bond and a municipal bond offering $7 annually per $100 of face value, assuming the same default risk 
D)  Earns a 1% return after-tax

Question 15

According to the Expectations Hypothesis:

Accepted Answer

A)  When short-term interest rates are expected to rise in the future, the long-term interest rates are equal to current short-term interest rates 
B)  When short-term rates are expected to remain constant in the future, the long-term interest rates are higher than current short-term interest rates 
C)  Short-term bonds are perfect substitutes for long-term bonds 
D)  Expectations of future short-term rates equal estimates of current short-term rates

Question 16

As technology allows information regarding the financial health of corporations to become easier to obtain, we should expect:

Accepted Answer

A)  The risk spread to decrease 
B)  The role of bond rating agencies to become more important 
C)  A decrease in the number of participants in the bond market 
D)  The risk spread to increase

Question 17

Under the Expectations Hypothesis, a downward-sloping yield curve suggests:

Accepted Answer

A)  Investors expect future short-term interest rates to fall 
B)  Investors expect future short-term interest rates to rise 
C)  This is a trick question, the yield curve always slopes upward 
D)  Investors expect future short-term interest rates to remain constant

Question 18

A yield curve that slopes upward says each of the following, except:

Accepted Answer

A)  Short-term rates are expected to decrease 
B)  People may be expecting short-term rates will be higher in the future 
C)  Short-term rates could be expected to remain constant 
D)  Long-term interest rates are higher than current short-term rates

Question 19

Consider the yield curve below. Using the Expectations Hypothesis, what conclusion can we draw from the data? Now, using the Liquidity Premium Theory, cite two possible conclusions we can draw from the data.

Accepted Answer

The answer of Consider the yield curve below. Using the...

Question 20

Most commercial paper is:

Accepted Answer

A)  Issued with maturities exceeding one year 
B)  Issued with maturities between 50 and 75 days 
C)  Used exclusively for short-term financing needs 
D)  Issued by foreign companies doing business in the United States

Exam 7: The Risk and Term Structure of Interest Rates