Question 1

Suppose the private bond rating agencies ceased to exist.What would be the impact on the bond market?

Accepted Answer

The answer of Suppose the private bond rating agencies ceased...

Question 2

In late 2008,the average risk premium rose because

Accepted Answer

A)  investors feared a revival of inflation. 
B)  large tax increases in the United States reduced corporate profits and led to fears of increased defaults. 
C)  of the financial crisis. 
D)  of fraud in the market for municipal bonds.

Question 3

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 4

If a one-year bond currently yields 5% and is expected to yield 7% next year,the liquidity premium theory predicts that the yield today on a two-year bond should be

Accepted Answer

A)  5%. 
B)  less than 6%, but more than 5%. 
C)  6%. 
D)  more than 6%.

Question 5

Unlike the segmented markets theory,the expectations theory attributes the slope of the yield curve to

Accepted Answer

A)  tax considerations. 
B)  the fact that short-term bonds are not perfect substitutes for long-term bonds. 
C)  the market's view of future short-term interest rates. 
D)  the variance in the inflation rates over the business cycle.

Question 6

Under the liquidity premium theory,a flat yield curve indicates that investors expect future short-term rates to

Accepted Answer

A)  fall. 
B)  rise. 
C)  remain constant. 
D)  either fall or remain constant.

Question 7

Which of the following is NOT true of the term premium?

Accepted Answer

A)  It is zero under the expectations theory. 
B)  It is infinite under the segmented markets theory. 
C)  It increases as a bond's maturity increases. 
D)  It is zero for thirty-year bonds.

Question 8

Investors often pay professional analysts to gather and monitor information on the creditworthiness of borrowers because

Accepted Answer

A)  federal law requires it. 
B)  most investors are risk neutral. 
C)  the cost of acquiring information about a borrower's creditworthiness can be high. 
D)  doing so increases the net-of-tax yield on most investments.

Question 9

According to the expectations theory,which of the following is false?

Accepted Answer

A)  It assumes that instruments with different maturities are perfect substitutes. 
B)  It implies that a long-term bond rate equals the average of short-term rates covering the same investment period. 
C)  It implies that the yield curve will usually slope upward. 
D)  It implies that the shape of the yield curve depends on the expected pattern of future short-term rates.

Question 10

If the federal government replaced the current income tax with a value-added tax

Accepted Answer

A)  the prices of Treasury and municipal bonds would rise. 
B)  the prices of Treasury and municipal bonds would fall. 
C)  the prices of Treasury bonds would rise, while the prices of municipal bonds would fall. 
D)  the prices of Treasury bonds would fall, while the prices of municipal bonds would rise.

Question 11

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 12

During the financial crisis of 2008,the prices of U.S.Treasury securities

Accepted Answer

A)  rose and the price of corporate bonds declined. 
B)  fell relative to the prices of corporate bonds. 
C)  remained in the same relative position to the prices of corporate bonds. 
D)  were frozen by order of the federal government.

Question 13

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 two-year bond according to the liquidity premium theory?

Accepted Answer

A)  4.5% 
B)  4.75% 
C)  4.95% 
D)  4.975%

Question 14

According to the liquidity premium theory,the yield curve normally has a positive slope because

Accepted Answer

A)  short-term interest rates are expected to rise. 
B)  term premiums rise as the time to maturity increases. 
C)  risk premiums rise over time. 
D)  long-term bonds are more liquid than short-term bonds.

Question 15

Under the expectations theory if market participants expect that future short-term rates will be higher than current short-term rates,the yield curve will

Accepted Answer

A)  slope upward. 
B)  slope downward. 
C)  be flat. 
D)  slope upward, slope downward, or be flat, depending on risk, liquidity, cost of information, and tax considerations.

Question 16

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 17

The default risk premium fluctuates mainly

Accepted Answer

A)  because bond rating agencies tend to be inconsistent in their ratings of bonds. 
B)  because risk-neutral investors will often become risk-averse as time passes. 
C)  because taxes tend to rise over the long run. 
D)  as new information about a borrower's creditworthiness becomes available.

Question 18

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 19

How do ratings agencies earn income?

Accepted Answer

The answer of How do ratings agencies earn income?...

Question 20

Bond ratings

Accepted Answer

A)  are published annually by the federal government and are based largely on information contained in corporate tax returns. 
B)  are published annually by the federal government and are based on publicly available information. 
C)  are published monthly by the federal government and are based on publicly available information. 
D)  are published by private bond-rating agencies.

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