Question 1

When the yield curve is downward-sloping,

Accepted Answer

A) short-term yields are higher than long-term yields. 
B) long-term yields are higher than short-term yields. 
C) the bond market is anticipating the U.S. Treasury may default on its obligations. 
D) the inflation rate is expected to rise.

Question 2

The expectations theory

Accepted Answer

A) has difficulty explaining why U.S. Treasury securities have lower yields than corporate bonds. 
B) has difficulty explaining why yields on bonds of different maturities move together. 
C) has difficulty explaining why yield curves usually slope upward. 
D) accounts well for the fact that yield curves usually slope upward.

Question 3

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 4

According to the preferred habitat 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 5

A steep yield curve may be an indicator of

Accepted Answer

A) expectations of a significant increase in inflation. 
B) an upcoming recession. 
C) an economic slowdown. 
D) lower future short-term interest rates.

Question 6

Which of the following is NOT true of the habitat 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 7

The default risk premium is

Accepted Answer

A) relevant only for securities issued by very small companies. 
B) the additional yield a saver requires for holding a risky instrument. 
C) zero for corporate bonds, but quite substantial for corporate stock. 
D) constant across the business cycle.

Question 8

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 the 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 9

According to the expectations theory, if investors believed that, for a holding period the average of the expected future short-term yields was greater than the long-term yield, they would act so as to

Accepted Answer

A) drive up the price of the short-term security and drive down the price of the long-term security. 
B) drive down the price of the short-term security and drive up the price of the long-term security. 
C) drive down the prices of the short-term and long-term securities. 
D) drive up the prices of the short-term and long-term securities.

Question 10

Which of the following assigns widely-followed bond ratings?

Accepted Answer

A) Standard & Poor's Corporation 
B) Securities and Exchange Commission 
C) Federal Reserve 
D) IBM

Question 11

Financial instruments with high information costs

Accepted Answer

A) will usually be more liquid than similar instruments with low information costs. 
B) will have lower yields than U.S. Treasury securities. 
C) may not be offered for sale in some states. 
D) will have lower prices than similar instruments with low information costs.

Question 12

Currently, a three-month Treasury bill pays 5% interest and a ten-year Treasury bond pays 4.7% interest. What is the risk premium of the typical A-rated corporate bond that pays 5.5% interest?

Accepted Answer

A) 0.5% 
B) 0.8% 
C) 5.5% 
D) 1.17

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 preferred habitat theory?

Accepted Answer

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

Question 14

Which of the following statements is true?

Accepted Answer

A) The more liquid the bond, the lower the interest rate. 
B) Tax-free bonds normally have a higher interest rate than other types of bonds. 
C) The price of a bond increases as it becomes more risky. 
D) The yield curve illustrates the relative risks of alternative types of bonds.

Question 15

Suppose that savers become less willing to purchase medium-quality corporate bonds. The result will be that the prices of medium-quality corporate bonds will

Accepted Answer

A) fall relative to the price of U.S. Treasury securities, but rise relative to the price of high-quality corporate bonds. 
B) rise relative to the price of U.S. Treasury securities, but fall relative to the price of high-quality corporate bonds. 
C) rise relative to the prices of U.S. Treasury securities and high-quality corporate bonds. 
D) fall relative to the prices of U.S. Treasury securities and high-quality corporate bonds.

Question 16

Which of the following is the lowest rating given to an investment-grade bond by Standard and Poor's?

Accepted Answer

A) AA 
B) A 
C) BBB 
D) B

Question 17

The liquidity premium

Accepted Answer

A) compensates savers for the illiquidity of an asset. 
B) is announced quarterly for each asset by the Securities and Exchange Commission. 
C) is published by private bond-rating agencies. 
D) compensates savers for the lower yield they would otherwise receive on highly taxed assets.

Exam 7: Risk Structure and Term Structure of Interest Rates