Deck 6: The Structure of Interest Rates

Question 1

Default risk premiums are usually smaller during periods of high economic growth.

Answer 1

True

Question 2

Putable bonds offer higher yields than similar non-putable bonds

Answer 2

False

Question 3

A convertible bond will generally have a higher market yield relative to similar nonconvertible bonds.

Answer 3

False

Question 4

Investment-grade bonds are more likely to default than speculative-grade bonds.

Question 5

The market segmentation theory allows for the possibility of a discontinuous yield curve.

Question 6

A descending yield curve forecasts higher short-term rates in the future.

Question 7

Everything else the same, the higher the marginal tax rate of an investor, the more likely the investor is to invest in municipal bonds as opposed to similarly rated corporate bonds.

Question 8

The major reason that municipal bonds have lower yields than corporate bonds is that, as a class, municipal debt has less marketability than corporate debt.

Question 9

The less marketable a security, the higher its yield.

Question 10

A downward sloping yield curve is typically seen just before an economic expansion.

Question 11

Callable bonds have higher market yields than otherwise similar noncallable bonds.

Question 12

Treasury and corporate security yields may be combined when plotting a yield curve.

Question 13

If interest rates are expected to increase in the future, one would expect to see an upward sloping yield curve.

Question 14

Expected lower rates of inflation will lead to an upward sloping yield curve.

Question 15

An investor in the 33 percent tax bracket will buy a 6 percent municipal bond rather than a similarly rated 8.5 percent corporate bond.

Question 16

A downward sloping yield curve forecasts higher future interest rates.

Question 17

Bonds rated BBB would have lower yields than AAA-rated bonds, and higher prices, everything else the same.

Question 18

A put option sets a "floor" or minimum price of a bond at the exercise price, which is generally at or above par value.

Question 19

The call price of a bond is usually below the bond's par value.

Question 20

Liquidity premiums cause an observed yield curve to be less upward sloping than that predicted by the expectations theory.

Question 21

The yield curves show the relationship between interest rates on bonds similar in terms except for maturity.

Question 22

The source of data for a yield curve might be

A) bond yield by issuers over time.
B) historical Treasury security yields.
C) realized Treasury security yields by time.
D) outstanding Treasury security yields by maturity.

Question 23

A two-year interest rate is 7% and a one-year forward rate one year from now is 8%. According to the expectations theory, what is the current one-year rate?

A) 6.0%
B) 6.5%
C) 7.0%
D) 8.0%
E) 9.0%

Question 24

According to the expectations theory, what is the one-year forward rate three years from now if three and four-year spot rates are 5.50% and 5.80%, respectively?

A) The rate cannot be calculated from the information above.
B) 6.2%
C) 6.7%
D) 5.6%
E) 5.8%

Question 25

The preferred habitat theory explains the existence of discontinuities in the yields curve.

Question 26

The yield curve is a plot of

A) maturity changes as risk changes.
B) yields of securities with different levels of default risk.
C) yields by maturity of securities with similar default risk.
D) interest rates over time.

Question 27

Ceteris paribus, the required interest rate of a callable bond will be higher than the interest rate on a convertible bond.

Question 28

According to the expectations theory of the term structure of interest rates, if the yield curve slopes _______, the markets expect short-term interest rates to _______ in the future

A) upward; increase
B) downward; decrease
C) upward; decrease
D) both a and b
E) both a and c

Question 29

Which of the following statements about bonds is NOT true?

A) The greater the default risk, the greater the yield.
B) Bonds selling at premium are especially high quality.
C) The less marketable a bond, the higher the yield.
D) Municipal bonds have lower yields than similar corporate bonds.

Question 30

Which of the following statements is true?

A) Interest rates always rise before recessions.
B) Default risk premiums vary inversely with economic activity.
C) Municipal bond yields are usually higher than similar risk corporate yields.
D) Treasury bond yields are always higher than Treasury bill yields.

Question 31

According to the expectations theory of the term structure of interest rates,

A) investors prefer holding short-term securities.
B) the shape of the yield curve is determined by investors' expectations of future short-term interest rates.
C) institutional investors' maturity preferences determine the shape of the yield curve.
D) investors always expect short-term interest rates to increase.
E) both a and b

Question 32

An investor is more likely to exercise a put option on a bond after

A) an increase in interest rates.
B) a decrease in interest rates.
C) an increase in the bond's price.
D) an upgrade of the bond's rating by Moody's.
E) tax-free municipals become available.

Question 33

According to the preferred habitat theory, investors may change their preferred maturity in response to expected yield premiums.

Question 34

The term structure of interest rates

A) describes the relationship between maturity and yield for similar securities.
B) ranks security yield according to the default risk structure.
C) describes how interest rates vary over time.
D) describes the pattern of interest rates over the business cycle.

Question 35

An upward sloping yield curve indicates that security investors expect future interest rates to _____ and security prices to ______.

A) fall; fall.
B) fall; rise.
C) rise; fall.
D) rise; rise.

Question 36

The expectations theory can explain why the yield curve slopes upward most of the time.

Question 37

The shape of the yield curve is determined by expectations of changes in future interest rates.

Question 38

A one-year interest rate is 5.50% and a one-year forward rate two years from now is 6.0%. According to the expectations theory, what is the current two-year rate?

A) The rate cannot be calculated from the information above.
B) 5.0%
C) 5.5%
D) 6.0%
E) 6.25%

Question 39

The market segmentation theory assumes that investors are risk-neutral.

Question 40

A downward sloping yield curve indicates that future short-term rates are expected to ______ and outstanding security prices will _______.

A) fall; rise.
B) fall; fall.
C) rise; rise.
D) rise; fall.

Question 41

0

A) Which of the following statements is true?
B) The more marketable a security, the higher its yield.
C) The longer the security's term to maturity, the greater its yield.
D) Putable bonds offer higher yields than similar non-putable bonds
E) Taxable bonds have to offer higher before-tax yields than comparable tax-exempt bonds.
Use the following interest rate data to answer the next seven questions.
90-day Treasury bills 8.36 percent
180-day Treasury bills 8.48 percent
2-year Treasury notes 9.10 percent
3-year Treasury notes 9.25 percent
90-day Commercial paper 9.15 percent
3-year Corporate bonds (AA) 10.10 percent
3-year Municipal (AA) 7.07 percent
Expected 2-year inflation rate 3.50 percent

Question 42

If three-year securities are yielding 6% and two-year securities are yielding 5.5%, future short-term rates are expected to ______, and outstanding security prices are expected to ______.

A) fall; fall.
B) rise; fall.
C) fall; rise.
D) rise; rise

Question 43

Federal Agency securities have higher yields than similar Treasury securities because they

A) have greater default risk.
B) have shorter maturities.
C) are less marketable.
D) both a and c

Question 44

With reference to the data above, what is the one-year forward rate on Treasury securities two years from now according to the expectations theory?

A) 8.80%
B) 9.10%
C) 9.18%
D) 9.40%
E) 9.55%

Question 45

With reference to the data above, the default risk premium on the 90-day commercial paper above is

A) 3.39%
B) 0.17%
C) 0.64%
D) 1.84%

Question 46

With reference to the data above, what is the default risk premium on 3-year AA-rated corporate bonds?

A) 0.85%
B) 0.95%
C) 3.03%
D) 6.60%
E) There is no default risk on these bonds.

Question 47

Which of the following statements about interest rates is true?

A) Interest rates generally tend to move together.
B) The expected rate of inflation influences the level of interest rates.
C) At the bottom of the business cycle, the yield curve is typically upward sloping.
D) All the above are true.

Question 48

Default risk premiums vary _______ with the ________ of the security.

A) directly; default risk
B) inversely; default risk
C) inversely; maturity
D) directly; marketability

Question 49

With reference to the data above, what is the expected real rate of return on the 2-year Treasury security?

A) 12.6%
B) 9.1%
C) 5.4%
D) 4.2%
E) 3.5%

Question 50

With reference to the data above, what is the default risk premium on commercial paper?

A) 5.65%
B) 0.95%
C) 0.79%
D) 0.55%
E) 0%

Question 51

Bond A is not putable; bond B is putable. Investors will require a lower yield on bond __ and will pay ____ for the bond.

A) A; less
B) A; more
C) B; less
D) B; more

Question 52

Yield difference in Treasury securities of varied maturities may be explained by

A) marketability.
B) default risk.
C) expectations of future inflation.
D) all of the above
E) none of the above
Use the following interest rate data to answer the next five questions:
Treasury Bills, 90 days 4.20%
Commercial Paper, 90 days 4.84%
Treasury Bill, 1 year 4.67%
Treasury Note, 2 year 5.25%
Corporate Bond AA, 20 year 8.23%
Municipal Bond AA, 20 year 6.42%
Expected Annual Inflation Rate 3.00%

Question 53

31 Yield differences between two securities may be explained by differences in

A) maturity.
B) default risk.
C) marketability.
D) call provision.
E) all of the above

Question 54

If three-year securities are yielding 6% and two-year securities are yielding 5.5%, what is the expected one-year rate two years from now as implied by the two actual rates above?

A) 4.7%
B) 5.8%
C) 6.5%
D) 7.0%
E) 7.5%

Question 55

With reference to the data above, the yield curve slopes _______, indicating the market expectation of ______ future short-term rates.

A) downward; falling
B) downward; rising
C) upward; falling
D) upward; rising
E) flat; stable

Question 56

The major determinant of the bond ratings assigned by Moody's, Standard and Poor, or Fitch is

A) marketability.
B) tax treatment.
C) term to maturity.
D) default risk.
E) frequency of interest payments.

Question 57

With reference to the data above, at what tax rate would an investor be indifferent between holding the 3-year municipal or 3-year corporate bond?

A) 15%
B) 20%
C) 25%
D) 30%
E) 33%

Question 58

Which of the following statements about callable bonds is not true?

A) Callable bonds have higher yields than comparable noncallable bonds.
B) The call price is usually above the bond's par value.
C) The shorter the term to maturity, the greater the call interest premium.
D) Investors are notified when bonds are called.

Question 59

Bond A is not callable; bond B is callable. Investors will require a higher yield on bond __ and will pay ____ for the bond.

A) A; less
B) A; more
C) B; less
D) B; more

Question 60

With reference to the data above, which security below did the market view as having the greatest default risk?

A) 90-day Treasury securities
B) 180-day Treasury securities
C) 2-year Treasury securities
D) 90-day Commercial paper

Question 61

With reference to the data above, the implied one-year forward rate (expected one-year rate one year from now) on Treasuries is

A) 4.67%
B) 5.83%
C) 5.58%
D) 4.09%

Question 62

With reference to the above data, at what marginal tax rate would an investor be indifferent between owning the corporate bond and the municipal bond?

A) 18%
B) 20%
C) 22%
D) 28%

Question 63

Commercial banks, savings and loan associations, and finance companies traditionally have better profits when

A) the level of interest rates were expected to fall sharply.
B) the yield curve had a downward slope.
C) the yield curve had an upward slope.
D) loan losses were increasing.

Question 64

A conversion option gives a valuable right to a bond's _______; a put option gives a valuable right to a bond's _______.

A) issuer; issuer
B) issuer; holder
C) holder; issuer
D) holder; holder

Question 65

Consider a yield curve that has taken into consideration both the expectations theory and the liquidity premium theory. Assume the yield curve is initially downward sloping. If liquidity premium theory is no longer important, the yield curve you would expect to see would be:

A) more steeply downward sloping
B) more upward sloping
C) less steeply downward sloping
D) flat
E) Either c or d can happen.

Question 66

With reference to the data above, what is the expected after-tax real rate of return on the one-year Treasury Bill for an investor in the 33 percent marginal tax bracket?

A) 1.11%
B) 3.13%
C) 0.13%
D) -1.11%

Question 67

A bondholder in the 30 percent tax bracket owns a $1000 Treasury bond with an 8 percent coupon rate. What is the after-tax return on the bond?

A) 8 percent
B) 2.4 percent
C) 5.6 percent
D) 5 percent

Question 68

With reference to the above data, what is the approximate expected pre-tax real rate of return on the one-year Treasury bill?

A) 3.00%
B) 1.62%
C) 4.67%
D) 0.13%

Question 69

What actions by bond investors, given their expectations of increasing interest rates, result in an upward sloping yield curve?

A) selling long-term securities and buying short-term securities.
B) buying long-term securities and selling short-term securities.
C) selling short-term securities and holding cash.
D) selling long-term securities and holding cash.

Question 70

Which of the following is not considered when assigning a bond rating?

A) the variability of earnings
B) the expected cash flow
C) the rating on the prior issue of securities sold
D) the amount of the fixed contractual cash payments

Question 71

Which of the following statements is true?

A) Convertible bonds offer higher yields than similar nonconvertible bonds.
B) Putable bonds offer higher yields than similar nonputable bonds.
C) Bonds with call options must offer higher interest rates than similar noncallable bonds.
D) All Treasury securities offer lower rates than any securities issued by business firms.
E) All of the above statements are true.

Question 72

The liquidity premium theory of the term structure of interest rates is best supported by what type of yield curve?

A) a decreasing curve over time.
B) a flat yield curve.
C) an increasing yield curve over time.
D) a twisted yield curve
E) none of the above.

Question 73

Which of the following statements explains the liquidity premium theory of the term structure of interest rates?

A) Investors will pay higher prices for longer-term securities.
B) Investors demand a lower yield for securities that cannot be sold quickly at high prices.
C) Investors demand a higher return on longer-term securities with greater price risk and less marketability.
D) Investors will pay higher prices for securities with greater price risk and less marketability.

Question 74

Historically, high default premiums have been associated with

A) economic recessions.
B) economic boom periods.
C) generally rising interest rates.
D) the number of bonds rated by Moody's and Standard & Poor's.

Question 75

Applying the expectations theory, a bank depositor chooses between purchasing a one- year CD paying 5 percent and a two-year CD paying 5.5 percent. If indifferent between the two, the depositor must expect one-year CDs one year from now to have a rate of

A) 6.5%
B) 4.5%
C) 6.0%
D) 5.0%

Question 76

Which of the following theories of the term structure of interest rates best explains discontinuities in the yield curve?

A) the market segmentation theory
B) the liquidity premium theory
C) the expectations theory
D) the loanable funds theory

Question 77

Contingent Convertible bonds (CoCos) are NOT similar to ordinary convertible bonds because:

A) CoCos are convertible to the firm's preferred stock while the ordinary convertible bonds are convertible to the firm's common stock.
B) CoCos offer a higher coupon than ordinary convertible bonds.
C) Cocos are convertible into stock only if the firm's stock price hits a certain level.
D) Ordinary convertible bonds are converted to the firm's stock if the firm's stock falls below a certain level.

Question 78

Bonds are called speculative grade or junk bonds if their Standard & Poor's rating is

A) above BBB.
B) below BBB.
C) B and below.
D) A and below

Question 79

An issuer of a bond is more likely to exercise a call option on the bond after an increase in interest rates.

A) a decrease in interest rates.
B) a decrease in the bond's price.
C) a downgrade of the bond's rating by Moody's.

Question 80

The yield differentials between an AAA-rated corporate bond and an otherwise similar BBB-rated corporate bond may be explained by

A) marketability.
B) tax treatment.
C) default risk.
D) term to maturity.