Question 1

Over the next three years, the expected path of 1-year interest rates is 4, 1, and 1 percent. The expectations theory of the term structure predicts that the current interest rate on 3-year bond is ________.

Accepted Answer

A)  1 percent 
B)  2 percent 
C)  3 percent 
D)  4 percent

Question 2

Explain using a diagram how the "flight to quality" after the Subprime collapse lead to a rising spread between lower-quality (BBB-rated) and highest-quality (AAA-rated) bonds.

Accepted Answer

The answer of Explain using a diagram how the "flight...

Question 3

Explain the factors that determine the risk structure of interest rates. Explain how a change of each factor changes interest rates.

Accepted Answer

The answer of Explain the factors that determine the risk...

Question 4

Which of the following bonds are considered to be default-risk free?

Accepted Answer

A)  Municipal bonds 
B)  Investment-grade bonds 
C)  Canadian government bonds 
D)  Junk bonds

Question 5

A bond with default risk will always have a ________ risk premium and an increase in its default risk will ________ the risk premium.

Accepted Answer

A)  positive; raise 
B)  positive; lower 
C)  negative; raise 
D)  negative; lower

Question 6

The risk that interest payments will not be made, or that the face value of a bond is not repaid when a bond matures is ________.

Accepted Answer

A)  interest rate risk 
B)  inflation risk 
C)  moral hazard 
D)  default risk

Question 7

An increase in the riskiness of corporate bonds will ________ the yield on corporate bonds and ________ the yield on government securities, everything else held constant.

Accepted Answer

A)  increase; increase 
B)  reduce; reduce 
C)  increase; reduce 
D)  reduce; increase

Question 8

According to the segmented markets theory of the term structure ________.

Accepted Answer

A)  bonds of one maturity are close substitutes for bonds of other maturities, therefore, interest rates on bonds of different maturities move together over time 
B)  the interest rate for each maturity bond is determined by supply and demand for that maturity bond 
C)  investors' strong preferences for short-term relative to long-term bonds explains why yield curves typically slope downward 
D)  because of the positive term premium, the yield curve will not be observed to be downward-sloping

Question 9

The risk premium on corporate bonds reflects the fact that corporate bonds have a higher default risk and are ________ Canada bonds.

Accepted Answer

A)  less liquid than 
B)  less speculative than 
C)  tax-exempt unlike 
D)  lower-yielding than

Question 10

-The U-shaped yield curve in the figure above indicates that short-term interest rates are expected to ________.

Accepted Answer

A)  rise in the near-term and fall later on 
B)  fall sharply in the near-term and rise later on 
C)  fall moderately in the near-term and rise later on 
D)  remain unchanged in the near-term and rise later on

Question 11

If the probability of a bond default increases because corporations begin to suffer large losses, then the default risk on corporate bonds will ________ and the expected return on these bonds will ________, everything else held constant.

Accepted Answer

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

Question 12

Which of the following statements is true?

Accepted Answer

A)  Because coupon payments on tax-exempt bonds are exempt from federal income tax, the expected after-tax return on them will be higher for individuals in higher income tax brackets. 
B)  An increase in tax rates will decrease the demand for tax-exempt bonds, lowering their interest rates. 
C)  Interest rates on tax-exempt bonds will be higher than comparable bonds without the tax exemption. 
D)  Because coupon payments on tax-exempt are exempt from federal income tax, the expected after-tax return on them will be lower for individuals in higher income tax brackets.

Question 13

According to the liquidity premium theory, a yield curve that is flat means that ________.

Accepted Answer

A)  bond purchasers expect interest rates to rise in the future 
B)  bond purchasers expect interest rates to stay the same 
C)  bond purchasers expect interest rates to fall in the future 
D)  the yield curve has nothing to do with expectations of bond purchasers

Question 14

If the U.S. government where to raise the income tax rates, would this have any impact on a state's cost of borrowing funds? Explain.

Accepted Answer

The answer of If the U.S. government where to raise...

Question 15

According to the segmented markets theory of the term structure ________.

Accepted Answer

A)  the interest rate on long-term bonds will equal an average of short-term interest rates that people expect to occur over the life of the long-term bonds 
B)  buyers of bonds do not prefer bonds of one maturity over another 
C)  interest rates on bonds of different maturities do not move together over time 
D)  buyers require an additional incentive to hold long-term bonds

Question 16

If a higher inflation is expected, what would you expect to happen to the shape of the yield curve? Why?

Accepted Answer

The answer of If a higher inflation is expected, what...

Question 17

According to the liquidity premium theory of the term structure ________.

Accepted Answer

A)  because buyers of bonds may prefer bonds of one maturity over another, interest rates on bonds of different maturities do not move together over time 
B)  the interest rate on long-term bonds will equal an average of short-term interest rates that people expect to occur over the life of the long-term bonds plus a term premium 
C)  because of the positive term premium, the yield curve will not be observed to be downward sloping 
D)  the interest rate for each maturity bond is determined by supply and demand for that maturity bond

Question 18

The spread between the interest rates on Baa corporate bonds and Canada bonds was very large during the Great Depression years 1930-1933. Explain this difference using the bond supply and demand analysis.

Accepted Answer

The answer of The spread between the interest rates on...

Question 19

The collapse of the subprime mortgage market increased the spread between Baa and default-free Canada bonds. This is due to ________.

Accepted Answer

A)  a reduction in risk 
B)  a reduction in maturity 
C)  a flight to quality 
D)  a flight to liquidity

Question 20

If 1-year interest rates for the next three years are expected to be 4, 2, and 3 percent, and the 3-year term premium is 1 percent, than the 3-year bond rate will be ________.

Accepted Answer

A)  1 percent 
B)  2 percent 
C)  3 percent 
D)  4 percent

Exam 6: The Risk and Term Structure of Interest Rates

Over the next three years, the expected path of 1-year interest rates is 4, 1, and 1 percent. The expectations theory of the term structure predicts that the current interest rate on 3-year bond is ________.

Explain using a diagram how the "flight to quality" after the Subprime collapse lead to a rising spread between lower-quality (BBB-rated) and highest-quality (AAA-rated) bonds.

Explain the factors that determine the risk structure of interest rates. Explain how a change of each factor changes interest rates.

Which of the following bonds are considered to be default-risk free?

A bond with default risk will always have a risk premium and an increase in its default risk will the risk premium.

The risk that interest payments will not be made, or that the face value of a bond is not repaid when a bond matures is ________.

An increase in the riskiness of corporate bonds will the yield on corporate bonds and the yield on government securities, everything else held constant.

According to the segmented markets theory of the term structure ________.

The risk premium on corporate bonds reflects the fact that corporate bonds have a higher default risk and are ________ Canada bonds.

-The U-shaped yield curve in the figure above indicates that short-term interest rates are expected to ________.

If the probability of a bond default increases because corporations begin to suffer large losses, then the default risk on corporate bonds will and the expected return on these bonds will , everything else held constant.

Which of the following statements is true?

According to the liquidity premium theory, a yield curve that is flat means that ________.

If the U.S. government where to raise the income tax rates, would this have any impact on a state's cost of borrowing funds? Explain.

According to the segmented markets theory of the term structure ________.

If a higher inflation is expected, what would you expect to happen to the shape of the yield curve? Why?

According to the liquidity premium theory of the term structure ________.

The spread between the interest rates on Baa corporate bonds and Canada bonds was very large during the Great Depression years 1930-1933. Explain this difference using the bond supply and demand analysis.

The collapse of the subprime mortgage market increased the spread between Baa and default-free Canada bonds. This is due to ________.

If 1-year interest rates for the next three years are expected to be 4, 2, and 3 percent, and the 3-year term premium is 1 percent, than the 3-year bond rate will be ________.