Question 1

Assume that today, the annualized two-year interest rate is 12 percent, and the one-year interest rate is 9 percent. A three-year security has an annualized interest rate of 14 percent. What is the one-year forward rate two years from now?

Accepted Answer

A) 12.67 percent 
B) 113 percent 
C) 195 percent 
D) 15.67 percent 
E) none of the above

Question 2

Other things equal, the yield required on A-rated bonds should be ____ the yield required on B-rated bonds whose other characteristics are exactly the same.

Accepted Answer

A) greater than 
B) equal to 
C) less than 
D) All of the above are possible, depending on the size of the bond offering.

Question 3

Interest income from municipal bonds is exempt from state taxes but is subject to federal taxes.

Accepted Answer

A) True 
 B)False

Question 4

The ____ theory suggests that although investors and borrowers may normally concentrate on a particular natural maturity market, certain events may cause them to wander from it.

Accepted Answer

A) pure expectations 
B) liquidity premium 
C) segmented markets 
D) preferred habitat

Question 5

Assume that a yield curve is influenced by interest rate expectations and a liquidity premium. Assume the yield curve is initially flat. If liquidity suddenly was no longer important, the yield curve would now have a ____ (assuming no other changes).

Accepted Answer

A) slight downward slope 
B) slight upward slope 
C) steep upward slope 
D) steep downward slope

Question 6

The yield offered on a debt security is ____ related to the prevailing risk-free rate and ____ related to the security's risk premium.

Accepted Answer

A) negatively; negatively 
B) positively; positively 
C) negatively; positively 
D) positively; negatively

Question 7

Vaughn Corporation is considering the issue of commercial paper and would like to know the yield it should offer on its commercial paper. The corporation believes that a 0.2 percent default risk premium, a 0.1 percent liquidity premium, and a 0.3 percent tax adjustment are necessary to sell its commercial paper to investors. Furthermore, annualized T-bill rates are 7 percent. Based on this information, Vaughn should offer ____ percent on its commercial paper.

Accepted Answer

A) 8.0 
B) 7.6 
C) 7.5 
D) 7.9 
E) none of the above

Question 8

Assume that the Treasury experiences a large decrease in the budget deficit and purchases a large number of T-bills. This action will ____ the supply of T-bills in the market and places ____ pressure on the yield of T-bills.

Accepted Answer

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

Question 9

The term structure of interest rates defines the relationship

Accepted Answer

A) between risk and return. 
B) between risk and maturity. 
C) between maturity and yield. 
D) between default risk ratings and maturity.

Question 10

According to the pure expectations theory of the term structure of interest rates, the ____ the difference between the implied one-year forward rate and today's one-year interest rate, the ____ is the expected change in the one-year interest rate.

Accepted Answer

A) greater; less 
B) less; greater 
C) greater; greater 
D) less; less 
E) C and D

Question 11

Securities that offer ____ liquidity will need to offer a ____ yield.

Accepted Answer

A) lower; higher 
B) lower; lower 
C) higher; higher 
D) B and C

Question 12

According to the segmented markets theory, if most investors suddenly preferred to invest in short-term securities and most borrowers suddenly preferred to issue long-term securities there would be

Accepted Answer

A) upward pressure on the price of long-term securities. 
B) upward pressure on the price of short-term securities. 
C) downward pressure on the yield of long-term securities. 
D) A and C

Question 13

The theory of the term structure of interest rates, which states that investors and borrowers choose securities with maturities that satisfy their forecasted cash needs, is the

Accepted Answer

A) pure expectations theory. 
B) liquidity premium theory. 
C) segmented markets theory. 
D) liquidity habitat theory.

Question 14

The preference for more liquid short-term securities places downward pressure on the slope of the yield curve.

Accepted Answer

A) True 
 B)False

Question 15

According to expectations theory, the sudden expectation of lower interest rates in the future will cause a ____ supply of short-term funds provided by investors, and a ____ supply of long-term funds.

Accepted Answer

A) large; large 
B) large; small 
C) small; small 
D) small; large

Question 16

According to pure expectations theory, if interest rates are expected to decrease, there will be ____ pressure on the demand for short-term funds by borrowers and ____ pressure on the demand for long-term funds issued by borrowers.

Accepted Answer

A) upward; upward 
B) downward; downward 
C) upward; downward 
D) downward; upward

Question 17

According to segmented markets theory, if investors have mostly short-term funds available and borrowers want long-term funds, there would be ____ pressure on the supply of short-term funds provided by investors and ____ pressure on the yield of long-term securities.

Accepted Answer

A) upward; upward 
B) downward; downward 
C) upward; downward 
D) downward; upward

Question 18

The graphic comparison of maturities and annualized yields is known as the interest rate curve.

Accepted Answer

A) True 
 B)False

Question 19

The yield curve for corporate bonds.

Accepted Answer

A) would typically lie below the Treasury yield curve. 
B) is identical to the Treasury yield curve. 
C) typically has the same slope as the Treasury yield curve. 
D) is irrelevant to investors.

Question 20

In some time periods there is evidence that corporations initially financed long-term projects with short-term funds. They planned to borrow long-term funds once interest rates were lower. This specifically supports the ____ for explaining the term structure of interest rates.

Accepted Answer

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

Exam 3: Structure of Interest Rates

Assume that today, the annualized two-year interest rate is 12 percent, and the one-year interest rate is 9 percent. A three-year security has an annualized interest rate of 14 percent. What is the one-year forward rate two years from now?

Other things equal, the yield required on A-rated bonds should be ____ the yield required on B-rated bonds whose other characteristics are exactly the same.

Interest income from municipal bonds is exempt from state taxes but is subject to federal taxes.

The ____ theory suggests that although investors and borrowers may normally concentrate on a particular natural maturity market, certain events may cause them to wander from it.

Assume that a yield curve is influenced by interest rate expectations and a liquidity premium. Assume the yield curve is initially flat. If liquidity suddenly was no longer important, the yield curve would now have a ____ (assuming no other changes) .

The yield offered on a debt security is related to the prevailing risk-free rate and related to the security's risk premium.

Assume that the Treasury experiences a large decrease in the budget deficit and purchases a large number of T-bills. This action will the supply of T-bills in the market and places pressure on the yield of T-bills.

The term structure of interest rates defines the relationship

According to the pure expectations theory of the term structure of interest rates, the the difference between the implied one-year forward rate and today's one-year interest rate, the is the expected change in the one-year interest rate.

Securities that offer liquidity will need to offer a yield.

According to the segmented markets theory, if most investors suddenly preferred to invest in short-term securities and most borrowers suddenly preferred to issue long-term securities there would be

The theory of the term structure of interest rates, which states that investors and borrowers choose securities with maturities that satisfy their forecasted cash needs, is the

The preference for more liquid short-term securities places downward pressure on the slope of the yield curve.

According to expectations theory, the sudden expectation of lower interest rates in the future will cause a supply of short-term funds provided by investors, and a supply of long-term funds.

According to pure expectations theory, if interest rates are expected to decrease, there will be pressure on the demand for short-term funds by borrowers and pressure on the demand for long-term funds issued by borrowers.

According to segmented markets theory, if investors have mostly short-term funds available and borrowers want long-term funds, there would be pressure on the supply of short-term funds provided by investors and pressure on the yield of long-term securities.

The graphic comparison of maturities and annualized yields is known as the interest rate curve.

The yield curve for corporate bonds.

In some time periods there is evidence that corporations initially financed long-term projects with short-term funds. They planned to borrow long-term funds once interest rates were lower. This specifically supports the ____ for explaining the term structure of interest rates.