Exam 8: Understanding Risk and Market Factors in Financial Securities

In the American financial system the most readily marketable securities are issued by the U.S. Treasury Department.

Both capital gains and interest income on municipal bonds are exempt from federal taxation.

An Aaa-rated taxable corporate bond carries a current yield to maturity of 16 percent while Aaa-rated municipal bonds have a 12 percent yield to maturity. The break-even marginal tax rate is:

"On the run" Treasury bonds are so-called because of large purchases from the Cayman Islands and other bank "havens".

There is a pronounced association between risk premiums and state of the business cycle. We would expect that the yield spread between an Aaa and Baa rated security to:

A U.S. government bond carries a before-tax yield to maturity of 15 percent. It is purchased by a commercial bank, which plans to hold the bond until it matures. The bank's marginal tax rate (i.e., tax bracket) is 30 percent. What is the bond's after-tax yield to the bank (to the nearest tenth of a percent)?

Credit swaps:

The tax-exempt feature attached to municipal bonds actually limits, rather than expands, the market for these securities.

Liquid assets are reversible; this means they:

Rising concern over defaults and business bankruptcies in the 1980s and 1990s led to new techniques called credit derivatives that provide at least some positive rate of return to the beneficiaries of each contract.

If the risk-free rate is 6.25%, the inflation premium is 2% and the liquidity premium is 0.5%, the long-term Treasury bond rate should be:

Junk bonds, which refers to the probability that full repayment of these long-term debt securities are significantly below that for bonds rated investment quality, are rated:

Because it pays no coupon, a zero-coupon bond cannot have prepayment risk.

Securities that repay both interest and loan principal during their life are known as:

The foundation of the structure of interest rates in the financial markets is the risk-free interest rate.

The current market yield on U.S. Treasury bills (3-month maturities) is 5.38 percent. Investors are expecting zero inflation over the next three months, but the expected rate of long-term inflation is determined to be 2.25 percent and the long-term U.S. Treasury bond rate stands at 8.16 percent. The premium for accepting less marketability in a security is 30 basis points; the default risk premium for lower grade (Baa) corporate bonds is 105 basis points; and the call risk premium is 29 basis points. Using this information and the concept of the structure of interest rates developed in this chapter, what is the liquidity premium? What is the yield on Baa corporate bonds?

The term junk bonds refers to the likelihood of full repayment of these long-term debt securities is being significantly below that for bonds rated investment quality.

What types of securities and other financial instruments are most favored by tax laws?

The announcement of a stock split tends to decrease the value of a security issuer's securities, at least temporarily.

The greater the prepayment risk, the