Chapter 5

HowDoRiskandTermStructureAffectInterest
Rates?

.1

Multiple Choice Questions

1.

Thetermstructureofinterestratesis
(a) therelationshipamonginterestratesofdifferentbondswiththesamematurity.
(b) thestructureofhowinterestratesmoveovertime.
(c) therelationshipamongthetermstomaturityofdifferentbonds.
(d) therelationshipamonginterestratesonbondswithdifferentmaturities.
Answer: D

2.

Theriskstructureofinterestratesis
(a) thestructureofhowinterestratesmoveovertime.
(b) therelationshipamonginterestratesofdifferentbondswiththesamematurity.
(c) therelationshipamongthetermstomaturityofdifferentbonds.
(d) therelationshipamonginterestratesonbondswithdifferentmaturities.
Answer: B

3.

Whichofthefollowinglongtermbondsshouldhavethelowestinterestrate?
(a) CorporateBaabonds
(b) U.S.Treasurybonds
(c) CorporateAaabonds
(d) Municipalbonds
Answer: D

4.

Whichofthefollowinglongtermbondsshouldhavethehighestinterestrate?
(a) CorporateBaabonds
(b) U.S.Treasurybonds
(c) CorporateAaabonds
(d) Municipalbonds
Answer: A

5.

Theriskpremiumoncorporatebondsbecomessmallerif
(a) theriskinessofcorporatebondsincreases.
(b) theliquidityofcorporatebondsincreases.
(c) theliquidityofcorporatebondsdecreases.
(d) theriskinessofcorporatebondsdecreases.
(e) either(b)or(d)occur.
Answer: E

6.

Bondswithrelativelylowriskofdefaultarecalled
(a) zerocouponbonds.
(b) junkbonds.
(c) investmentgradebonds.
(d) noneoftheabove.
Answer: C

7.

Bondswithrelativelyhighriskofdefaultarecalled

(a) Bradybonds.
(b) junkbonds.
(c) zerocouponbonds.
(d) investmentgradebonds.
Answer: B
8.

Acorporationsufferingbiglossesmightbemorelikelytosuspendinterestpaymentson
itsbonds,thereby
(a) raisingthedefaultriskandcausingthedemandforitsbondstorise.
(b) raisingthedefaultriskandcausingthedemandforitsbondstofall.
(c) loweringthedefaultriskandcausingthedemandforitsbondstorise.
(d) loweringthedefaultriskandcausingthedemandforitsbondstofall.
Answer: B

9.

(I)Ifacorporationsuffersbiglosses,thedemandforitsbondswillrisebecauseofthe
higherinterestratesthefirmmustpay.(II)Thespreadbetweentheinterestrateson
bondswithdefaultriskanddefaultfreebondsiscalledtheriskpremium.
(a) (I)istrue,(II)false.
(b) (I)isfalse,(II)true.
(c) Botharetrue.
(d) Botharefalse.
Answer: B

10.

Holdingeverythingelseconstant,ifacorporationbeginstosufferlargelosses,thenthe
defaultriskonitsbondswill_________andtheexpectedreturnonthosebondswill
_________.
(a) increase:increase
(b) decrease;increase
(c) increase;decrease

(d) decrease;decrease
Answer: C
11.

Holdingeverythingelsethesame,ifacorporationsearningsrise,thenthedefaultrisk
onitsbondswill_________andtheexpectedreturnonthosebondswill_________.
(a) increase;decrease
(b) decrease;decrease
(c) increase;increase
(d) decrease;increase
Answer: D

12. Ifacorporationbeginstosufferlargelosses,thenthedefaultriskonitsbondswill
_________andtheequilibriuminterestrateonthesebondswill_________.
(a) increase;decrease
(b) decrease;increase
(c) increase;increase
(d) decrease;decrease
Answer: C
13.

Ifacorporationsearningsrise,thenthedefaultriskonitsbondswill_________and
theequilibriuminterestrateonthesebondswill_________.
(a) increase;decrease
(b) decrease;decrease
(c) increase;increase
(d) decrease;increase
Answer: B

14.

Whenthedefaultriskoncorporatebondsdecreases,otherthingsequal,thedemand
curveforcorporatebondsshiftstothe_________andthedemandcurveforTreasury
bondsshiftstothe_________.
(a) right;right
(b) right;left
(c) left;left
(d) left;right
Answer: B

15.

(I)Anincreaseindefaultriskoncorporatebondsshiftsthedemandcurveforcorporate
bondstotheright.(II)Anincreaseindefaultriskoncorporatebondsshiftsthedemand
curveforTreasurybondstotheleft.
(a) (I)istrue,(II)false.
(b) (I)isfalse,(II)true.
(c) Botharetrue.
(d) Botharefalse.
Answer: D

16.

(I)Anincreaseindefaultriskoncorporatebondsshiftsthedemandcurveforcorporate
bondstotheleft.(II)Anincreaseindefaultriskoncorporatebondsshiftsthedemand
curveforTreasurybondstotheright.
(a) (I)istrue,(II)false.
(b) (I)isfalse,(II)true.
(c) Botharetrue.
(d) Botharefalse.
Answer: C

17. WhenbudgettalksbetweencongressionalRepublicansandPresidentClintonoccurredin
late1995,fearofagovernmentdefault_________,Treasurybondvalues_________,and
interestratesonTreasurybonds_________.
(a) rose;fell;rose

(b) rose;rose;rose
(c) fell;rose;fell
(d) fell;fell;fell
Answer: A
18.

ThespreadbetweeninterestratesonlowqualitycorporatebondsandU.S.government
bonds_________duringtheGreatDepression.
(a) wasreversed
(b) narrowedsignificantly
(c) widenedsignificantly
(d) didnotchange
Answer: C

19.

AsaresultoftheEnroncollapseandbankruptcy,thedemandforlowqualitycorporate
bonds_________,thedemandforhighqualitycorporatebonds_________,andthe
riskspread_________.
(a) increased;decreased;wasunchanged
(b) decreased;increased;increased
(c) increased;decreased;decreased
(d) decreased;increased;wasunchanged
Answer: B

20.

MoodysandStandardandPoorsareagenciesthat
(a) helpinvestorscollectwhencorporationsdefaultontheirbonds.
(b) advisemunicipalbondissuersonthetaxexemptstatusoftheirbonds.
(c) produceinformationabouttheprobabilityofdefaultoncorporatebonds.
(d) maintainliquidmarketsforcorporatebonds.

Answer: C
21.

IfMoodysorStandardandPoorsdowngradesitsratingonacorporatebond,the
demandforthebond_________anditsyield_________.
(a) increases;decreases
(b) decreases;increases
(c) increases;increases
(d) decreases;decreases
Answer: B

22.

Corporatebondsarenotasliquidasgovernmentbondsbecause
(a) fewerbondsforanyonecorporationaretraded,makingthemmorecostlytosell.
(b) thecorporatebondratingmustbecalculatedeachtimetheyaretraded.
(c) corporatebondsarenotcallable.
(d) alloftheabove.
(e) only(a)and(b)oftheabove.
Answer: A

23. (I)Theriskpremiumwidensasthedefaultriskoncorporatebondsincreases.(II)The
riskpremiumwidensascorporatebondsbecomelessliquid.
(a) (I)istrue,(II)false.
(b) (I)isfalse,(II)true.
(c) Botharetrue.
(d) Botharefalse.
Answer: C

24.

Whenthecorporatebondmarketbecomeslessliquid,otherthingsequal,thedemand
curveforcorporatebondsshiftstothe_________andthedemandcurveforTreasury
bondsshiftstothe_________.
(a) right;right
(b) right;left
(c) left;left
(d) left;right.
Answer: D

25.

Whenthecorporatebondmarketbecomesmoreliquid,otherthingsequal,thedemand
curveforcorporatebondsshiftstothe_________andthedemandcurveforTreasury
bondsshiftstothe_________.
(a) right;right
(b) right;left
(c) left;left
(d) left;right
AnswerB

26.

(I)Ifacorporatebondbecomeslessliquid,thedemandforthebondwillfall,causing
theinterestratetorise.(II)Ifacorporatebondbecomeslessliquid,thedemandfor
Treasurybondsdoesnotchange.
(a) (I)istrue,(II)false.
(b) (I)isfalse,(II)true.
(c) Botharetrue.
(d) Botharefalse.
Answer: A

27.

(I)Ifacorporatebondbecomeslessliquid,theinterestrateonthebondwillfall.(II)If
acorporatebondbecomeslessliquid,theinterestrateonTreasurybondswillfall.
(a) (I)istrue,(II)false.
(b) (I)isfalse,(II)true.

(c) Botharetrue.
(d) Botharefalse.
Answer: B
28. Whichofthefollowingbondsgenerallyhasthelowestinterestrate?
(a) Treasurybonds
(b) CorporateBaabonds
(c) Municipalbonds
(d) CorporateAaabonds
Answer: C
29.

Ifincometaxrateswerelowered,then
(a) theinterestrateonmunicipalbondswouldfall.
(b) theinterestrateonTreasurybondswouldrise.
(c) theinterestrateonmunicipalbondswouldrise.
(d) thepriceofTreasurybondswouldfall.
Answer: C

30.

Ifincometaxratesrise,then
(a) thepricesofmunicipalbondswillfall.
(b) thepricesofTreasurybondswillrise.
(c) theinterestrateonTreasurybondswillrise.
(d) theinterestrateonmunicipalbondswillrise.

Answer: C
31.

Anincreaseinmarginaltaxrateswouldlikelyhavetheeffectof_________the
demandformunicipalbondsand_________thedemandforU.S.governmentbonds.
(a) increasing;increasing
(b) increasing;decreasing
(c) decreasing;increasing
(d) decreasing;decreasing
Answer: B

32.

Adecreaseinmarginaltaxrateswouldlikelyhavetheeffectof_________thedemand
formunicipalbondsand_________thedemandforU.S.governmentbonds.
(a) increasing;increasing
(b) increasing;decreasing
(c) decreasing;increasing
(d) decreasing;decreasing
Answer: C

33.

Whichofthefollowingstatementsaretrue?
(a) Becausecouponpaymentsonmunicipalbondsareexemptfromfederalincometax,
theexpectedaftertaxreturnonthemwillbehigherforindividualsinhigher
incometaxbrackets.
(b) Anincreaseintaxrateswillincreasethedemandformunicipalbonds,lowering
theirinterestrates.
(c) Interestratesonmunicipalbondswillbelowerthanoncomparablebondswithout
thetaxexemption.
(d) Alloftheabovearetruestatements.
(e) Only(a)and(b)aretruestatements.
Answer: D

34.

Whichofthefollowingstatementsaretrue?
(a) Becausecouponpaymentsonmunicipalbondsareexemptfromfederalincometax,
theexpectedaftertaxreturnonthemwillbehigherforindividualsinhigher
incometaxbrackets.
(b) AnincreaseintaxrateswillincreasethedemandforTreasurybonds,lowering
theirinterestrates.
(c) Interestratesonmunicipalbondswillbehigherthanoncomparablebondswithout
thetaxexemption.
(d) Only(a)and(b)aretruestatements.
Answer: A

35.

Whenamunicipalbondisgiventaxfreestatus,thedemandformunicipalbondsshifts
_________,causingtheinterestrateonthebondto_________
(a) leftward;rise.
(b) leftward;fall.
(c) rightward;rise.
(d) rightward;fall.
Answer: D

36.

Whenamunicipalbondisgiventaxfreestatus,thedemandforTreasurybondsshifts
_________,andtheinterestrateonTreasurybonds_________
(a) leftward;rises.
(b) leftward;falls.
(c) rightward;rises.
(d) rightward;falls.
Answer: A

37.

Ifmunicipalbondsweretolosetheirtaxfreestatus,thenthedemandforTreasury
bondswouldshift_________,andtheinterestrateonTreasurybondswould
_________
(a) rightward;fall.
(b) rightward;rise.

(c) leftward;fall.
(d) leftward;rise.
Answer: A
38.

TheBushtaxcutpassedin2001reducesthetopincometaxbracketfrom39percentto
35percentoverthenexttenyears.Asaresultofthistaxcut,thedemandformunicipal
bondsshouldshifttothe_________andtheinterestrateonmunicipalbondsshould
_________.
(a) right;decline
(b) right;increase
(c) left;decline
(d) left;increase
Answer: D

39. Therelationshipamonginterestratesonbondswithidenticaldefaultrisk,butdifferent
maturities,iscalledthe
(a) timeriskstructureofinterestrates.
(b) liquiditystructureofinterestrates.
(c) yieldcurve.
(d) bonddemandcurve.
Answer: C
40.

Yieldcurvescanbeclassifiedas
(a) upwardsloping.
(b) downwardsloping.
(c) flat.
(d) alloftheabove.

(e) only(a)and(b)oftheabove.
Answer: D
41.

Typically,yieldcurvesare
(a) gentlyupwardsloping.
(b) gentlydownwardsloping.
(c) flat.
(d) bowlshaped.
(e) moundshaped.
Answer: A

42.

Whenyieldcurvesaresteeplyupwardsloping,
(a) longterminterestratesareaboveshortterminterestrates.
(b) shortterminterestratesareabovelongterminterestrates.
(c) shortterminterestratesareaboutthesameaslongterminterestrates.
(d) mediumterminterestratesareabovebothshorttermandlongterminterestrates.
(e) mediumterminterestratesarebelowbothshorttermandlongterminterestrates.
Answer: A

43.

Economistsattemptstoexplainthetermstructureofinterestrates
(a) illustratehoweconomistsmodifytheoriestoimprovethemwhentheyare
inconsistentwiththeempiricalevidence.
(b) illustratehoweconomistscontinuetoaccepttheoriesthatfailtoexplainobserved
behaviorofinterestratemovements.
(c) provethattherealworldisaspecialcasethattendstogetshortshriftintheoretical
models.
(d) haveprovedentirelyunsatisfactorytodate.

Answer: A
44. Accordingtothepureexpectationstheoryofthetermstructure,
(a) theinterestrateonlongtermbondswillexceedtheaverageofexpectedfuture
shortterminterestrates.
(b) interestratesonbondsofdifferentmaturitiesmovetogetherovertime.
(c) buyersofbondsprefershorttermtolongtermbonds.
(d) alloftheabove.
(e) only(a)and(b)oftheabove.
Answer: B
45.

Accordingtothepureexpectationstheoryofthetermstructure,
(a) whentheyieldcurveissteeplyupwardsloping,shortterminterestratesare
expectedtoriseinthefuture.
(b) whentheyieldcurveisdownwardsloping,shortterminterestratesareexpectedto
declineinthefuture.
(c) buyersofbondsprefershorttermtolongtermbonds.
(d) alloftheabove.
(e) only(a)and(b)oftheabove.
Answer: E

46.

Accordingtothepureexpectationstheoryofthetermstructure,
(a) whentheyieldcurveissteeplyupwardsloping,shortterminterestratesare
expectedtoriseinthefuture.
(b) whentheyieldcurveisdownwardsloping,shortterminterestratesareexpectedto
remainrelativelystableinthefuture.
(c) investorshavestrongpreferencesforshorttermrelativetolongtermbonds,
explainingwhyyieldcurvestypicallyslopeupward.
(d) alloftheabove.

(e) only(a)and(b)oftheabove.
Answer: A
47.

Accordingtothepureexpectationstheoryofthetermstructure,
(a) yieldcurvesshouldbeequallylikelytoslopedownwardastoslopeupward.
(b) whentheyieldcurveissteeplyupwardsloping,shortterminterestratesare
expectedtoriseinthefuture.
(c) whentheyieldcurveisdownwardsloping,shortterminterestratesareexpectedto
remainrelativelystableinthefuture.
(d) alloftheabove.
(e) only(a)and(b)oftheabove.
Answer: E

48.

Iftheexpectedpathofoneyearinterestratesoverthenextfouryearsis5percent,4
percent,
2percent,and1percent,thenthepureexpectationstheorypredictsthattodaysinterest
rateonthefouryearbondis
(a) 1percent.
(b) 2percent.
(c) 4percent.
(d) noneoftheabove.
Answer: D

49. Iftheexpectedpathofoneyearinterestratesoverthenextfiveyearsis1percent,2
percent,
3percent,4percent,and5percent,thepureexpectationstheorypredictsthatthebondwith
thehighestinterestratetodayistheonewithamaturityof
(a) oneyear.
(b) twoyears.
(c) threeyears.
(d) fouryears.

(e) fiveyears.
Answer: E
50.

Iftheexpectedpathofoneyearinterestratesoverthenextfiveyearsis2percent,4
percent,
1percent,4percent,and3percent,thepureexpectationstheorypredictsthatthebond
withthelowestinterestratetodayistheonewithamaturityof
(a) oneyear.
(b) twoyears.
(c) threeyears.
(d) fouryears.
Answer: A

51.

Accordingtothemarketsegmentationtheoryofthetermstructure,
(a) theinterestrateforbondsofonematurityisdeterminedbysupplyanddemandfor
bondsofthatmaturity.
(b) bondsofonematurityarenotsubstitutesforbondsofothermaturities;therefore,
interestratesonbondsofdifferentmaturitiesdonotmovetogetherovertime.
(c) investorsstrongpreferenceforshorttermrelativetolongtermbondsexplains
whyyieldcurvestypicallyslopeupward.
(d) alloftheabove.
(e) noneoftheabove.
Answer: D

52.

Accordingtothemarketsegmentationtheoryofthetermstructure,
(a) theinterestrateforbondsofonematurityisdeterminedbysupplyanddemandfor
bondsofthatmaturity.
(b) bondsofonematurityarenotsubstitutesforbondsofothermaturities;therefore,
interestratesonbondsofdifferentmaturitiesdonotmovetogetherovertime.
(c) investorsstrongpreferenceforshorttermrelativetolongtermbondsexplains
whyyieldcurvestypicallyslopedownward.
(d) only(a)and(b)oftheabove.
Answer: D

53.

Theliquiditypremiumtheoryofthetermstructure
(a) indicatesthattodayslongterminterestrateequalstheaverageofshortterm
interestratesthatpeopleexpecttooccuroverthelifeofthelongtermbond.
(b) assumesthatbondsofdifferentmaturitiesareperfectsubstitutes.
(c) suggeststhatmarketsforbondsofdifferentmaturitiesarecompletelyseparate
becausepeoplehavepreferredhabitats.
(d) doesnoneoftheabove.
Answer: D

54. Theliquiditypremiumtheoryofthetermstructure
(a) assumesinvestorstendtoprefershorttermbondsbecausetheyhavelessinterest
raterisk.
(b) assumesthatinterestratesonthelongtermbondrespondtodemandandsupply
conditionsforthatbond.
(c) assumesthatanaverageofexpectedshorttermratesisanimportantcomponentof
interestratesonlongtermbonds.
(d) assumesalloftheabove.
(e) assumesnoneoftheabove.
Answer: D
55.

Accordingtotheliquiditypremiumtheoryofthetermstructure,
(a) theinterestrateonlongtermbondswillequalanaverageofshortterminterest
ratesthatpeopleexpecttooccuroverthelifeofthelongtermbondsplusa
liquiditypremium.
(b) buyersofbondsmaypreferbondsofonematurityoveranother,yetinterestrates
onbondsofdifferentmaturitiesmovetogetherovertime.
(c) evenwithapositiveliquiditypremium,iffutureshortterminterestratesare
expectedtofallsignificantly,thentheyieldcurvewillbedownwardsloping.
(d) alloftheabove.
(e) only(a)and(b)oftheabove.
Answer: D

56.

Accordingtotheliquiditypremiumtheoryofthetermstructure,
(a) becausebuyersofbondsmaypreferbondsofonematurityoveranother,interest
ratesonbondsofdifferentmaturitiesdonotmovetogetherovertime.
(b) theinterestrateonlongtermbondswillequalanaverageofshortterminterest
ratesthatpeopleexpecttooccuroverthelifeofthelongtermbondsplusaterm
premium.
(c) becauseofthepositivetermpremium,theyieldcurvecannotbedownward
sloping.
(d) alloftheabove.
(e) only(a)and(b)oftheabove.
Answer: B

57.

Iftheyieldcurveslopeisflat,theliquiditypremiumtheoryindicatesthatthemarketis
predicting
(a) amildriseinshortterminterestratesinthenearfutureandamilddeclinefurther
outinthefuture.
(b) constantshortterminterestratesinthenearfutureandfurtheroutinthefuture.
(c) amilddeclineinshortterminterestratesinthenearfutureandacontinuingmild
declinefurtheroutinthefuture.
(d) constantshortterminterestratesinthenearfutureandamilddeclinefurtheroutin
thefuture.
Answer: C

58. Iftheyieldcurvehasamildupwardslope,theliquiditypremiumtheoryindicatesthat
themarketispredicting
(a) ariseinshortterminterestratesinthenearfutureandadeclinefurtheroutinthe
future.
(b) constantshortterminterestratesinthenearfutureandfurtheroutinthefuture.
(c) adeclineinshortterminterestratesinthenearfutureandarisefurtheroutinthe
future.
(d) adeclineinshortterminterestratesinthenearfutureandanevensteeperdecline
furtheroutinthefuture.
Answer: B
59.

Accordingtotheliquiditypremiumtheoryofthetermstructure,adownwardsloping
yieldcurveindicatesthatshortterminterestratesareexpectedto

(a) riseinthefuture.
(b) remainunchangedinthefuture.
(c) declinemoderatelyinthefuture.
(d) declinesharplyinthefuture.
Answer: D
60.

Accordingtotheliquiditypremiumtheoryofthetermstructure,whentheyieldcurve
hasitsusualslope,themarketexpects
(a) shortterminterestratestorisesharply.
(b) shortterminterestratestodropsharply.
(c) shortterminterestratestostayneartheircurrentlevels.
(d) noneoftheabove.
Answer: C

61.

Inactualpractice,shortterminterestratesarejustaslikelytofallastorise;thisisthe
majorshortcomingofthe
(a) marketsegmentationtheory.
(b) pureexpectationstheory.
(c) liquiditypremiumtheory.
(d) separablemarketstheory.
Answer: B

62.

Whichtheoryofthetermstructureproposesthatbondsofdifferentmaturitiesarenot
substitutesforoneanother?
(a) marketsegmentationtheory
(b) pureexpectationstheory
(c) liquiditypremiumtheory

(d) separablemarketstheory
Answer: A
63. Sinceyieldcurvesareusuallyupwardsloping,the_________indicatesthat,onaverage,
peopletendtopreferholdingshorttermbondstolongtermbonds.
(a) marketsegmentationtheory
(b) pureexpectationstheory
(c) liquiditypremiumtheory
(d) both(a)and(b)oftheabove
(e) both(a)and(c)oftheabove
Answer: E
64.

_________cannotexplaintheempiricalfactthatinterestratesonbondsofdifferent
maturitiestendtomovetogether.
(a) Themarketsegmentationtheory
(b) Thepureexpectationstheory
(c) Theliquiditypremiumtheory
(d) Both(a)and(b)oftheabove
(e) Both(a)and(c)oftheabove
Answer: A

65.

Whichofthefollowingtheoriesofthetermstructureis(are)abletoexplainthefact
thatinterestratesonbondsofdifferentmaturitiestendtomovetogetherovertime?
(a) Theexpectationshypothesis
(b) Thesegmentedmarketstheory
(c) Thepreferredhabitattheory

(d) Both(a)and(b)oftheabove
(e) Both(a)and(c)oftheabove
Answer: E
66.

Ofthefourtheoriesthatexplainhowinterestratesonbondswithdifferenttermsto
maturityarerelated,theonethatviewslongterminterestratesasequalingtheaverage
offutureshorttermratesexpectedtooccuroverthelifeofthebondisthe
(a) pureexpectationstheory.
(b) preferredhabitattheory.
(c) liquiditypremiumtheory.
(d) segmentedmarketstheory.
Answer: A

67.

Ofthefourtheoriesthatexplainhowinterestratesonbondswithdifferenttermsto
maturityarerelated,theonethatassumesthatbondsofdifferentmaturitiesarenot
substitutesforoneanother
isthe
(a) pureexpectationstheory.
(b) segmentedmarketstheory.
(c) liquiditypremiumtheory.
(d) preferredhabitattheory.
Answer: B

68. Amoderatelyupwardslopingyieldcurveindicatesthatshortterminterestratesare
expectedto
(a) neitherrisenorfallinthenearfuture.
(b) remainrelativelyunchanged,butthatlongtermratesareexpectedtofall.
(c) neitherrisenorfall,butthatlongtermratesareexpectedtorisemoderately.
(d) risemoderatelyinthenearfuture.

Answer: A
69.

Asteepupwardslopingyieldcurveindicatesthatshortterminterestratesareexpected
to
(a) neitherrisenorfallinthenearfuture.
(b) remainrelativelyunchanged,butthatlongtermratesareexpectedtofall.
(c) neitherrisenorfall,butthatlongtermratesareexpectedtorisemoderately.
(d) risemoderatelyinthenearfuture.
Answer: D

True/False
1.

Thetermstructureofinterestratesdescribeshowinterestratesmoveovertime.
Answer:

2.

Theriskstructureofinterestratesdescribestherelationshipbetweentheinterestrates
ofdifferentbondswiththesamematurity.
Answer:

3.

FALSE

Anincreaseinincometaxrateswillcausetheinterestratesontaxexemptmunicipal
bondstofallrelativetotheinterestrateontaxablecorporatesecurities.
Answer:

6.

TRUE

Theriskpremiumoncorporatebondsbecomessmallerastheliquidityofthebonds
falls.
Answer:

5.

TRUE

FollowingtheEnronbankruptcy,thespreadbetweentheinterestratesonBaabonds
andAaabondswidened.
Answer:

4.

FALSE

TRUE

Theinterestratesonbondsofdifferentmaturitiestendtomovetogetherovertime.
Answer:

TRUE

7.

Thepureexpectationstheoryisabletoexplainwhyyieldcurvesareusuallyupward
sloping.
Answer:

8.

Accordingtothepureexpectationstheory,theinterestrateonalongtermbondisthe
averageoftheshortterminterestratesexpectedoverthelifeofthelongtermbond.
Answer:

9.

TRUE

Anincreaseinthemarginaltaxratewouldlikelyincreasethedemandformunicipal
bonds,anddecreasethedemandforU.S.governmentbonds.
Answer:

14.

FALSE

Amildlyupwardslopingyieldcurvesuggeststhatthemarketispredictingconstant
shortterminterestrates.
Answer:

13.

FALSE

Apositiveliquiditypremiumindicatesthatinvestorspreferlongtermbondsovershort
termbonds.
Answer:

12.

FALSE

Bondswiththelowestriskofdefaultareoftenreferredtoasjunkbonds.
Answer:

11.

TRUE

Themarketsegmentationtheoryisabletoexplainwhyinterestratesonbondsof
differentmaturitiesmovetogetherovertime.
Answer:

10.

FALSE

TRUE

Whenyieldcurvesaredownwardsloping,longterminterestratesareaboveshortterm
interestrates.
Answer:

FALSE

Essay
1.

Contrasttheliquiditypremiumtheorytothemarketsegmentationtheoryoftheterm
structureofinterestrates.

2.

Whywouldanincreaseintheincometaxratereduceborrowingcoststo
municipalities?

3.

Discusswhatisshownbyayieldcurve.

4.

Whyisitunlikelythatthepureexpectationstheoryaloneisthecorrecttheoryfor
explainingtheyieldcurve?

5.

Whatismeantbytheriskstructureofinterestrates?

6.

Howwouldasevererecessionaffecttheriskpremiumoncorporatebonds?

7.

ExplainwhyaflighttoqualityoccurredfollowingtheEnronbankruptcyandhowthis
affectedtheinterestratesonlowerqualityandhigherqualitycorporatebonds.

8.

Whatdocreditratingagenciesdoandwhyisthisworkimportant?