Deck 5: The Term and Risk Structure of Interest Rates

Question 1

A graphic depiction of the relationship between yield and maturity is

A) the term structure of interest rates.
B) the yield curve.
C) the Phillips curve.
D) the risk-reward curve.

Answer 1

B

Question 2

If the yield on long-term securities is greater than the yield on comparable short-term securities, the yield curve will be

A) negatively sloped.
B) positively sloped.
C) in the negative quadrant.
D) undefined.

Answer 2

B

Question 3

Relative to a bond with a shorter maturity, a bond with a longer maturity has greater

A) interest rate volatility.
B) marketability.
C) price volatility.
D) default risk.

Answer 3

C

Question 4

If the yield on short-term securities is greater than the yield on comparable long-term securities, the yield curve will have a

A) positive slope.
B) negative slope.
C) constant slope.
D) zero slope.

Question 5

The supply and demand approach to term structure assumes that securities with different maturities are

A) close substitutes.
B) independent.
C) inversely related.
D) complements.

Question 6

The term structure of interest rates provides a framework for analyzing securities of the same

A) class.
B) yield.
C) maturity.
D) corporation.

Question 7

The supply-demand approach to explaining the term structure of interest rates assumes that

A) bond prices and yields are positively related.
B) the yield curve is horizontal.
C) the yield curve is upward sloping.
D) each maturity class is independent.

Question 8

If all future expected short-term interest rates are equal to the current short-term interest rate, the expectations theory predicts that the yield curve would be

A) horizontal.
B) upward sloping.
C) downward sloping.
D) vertical.

Question 9

Currently, 20-year Treasury bonds have a yield of 7 percent, while one-year Treasury bills have a yield of 5 percent. Based on this information, the yield curve is

A) upward sloping.
B) downward sloping.
C) a horizontal line.
D) None of the above.

Question 10

The assumption that prices for short-term and long-term securities are determined independently is the basis for the __________ approach to explaining the term structure.

A) liquidity preference
B) supply and demand
C) expectations
D) yield curve

Question 11

When the supply of a security __________, the yield on the security __________.

A) increases; rises
B) decreases; rises
C) increases; falls
D) None of the above.

Question 12

One-year securities are currently yielding 8 percent. You expect one-year securities to yield 10 percent next year. Currently, two-year securities are yielding 9.5 percent. Given this situation, portfolio managers would __________ two-year securities, pushing their yield __________.

A) buy; up
B) buy; down
C) sell; up
D) sell; down

Question 13

If the yield on short-term securities is the same as the yield on comparable long-term securities, the yield curve will have a

A) positive slope.
B) negative slope.
C) constant slope.
D) zero slope.

Question 14

Which theory of the term structure is usually criticized for underestimating the substitutability of different maturities of securities?

A) The expectations theory
B) The supply and demand approach
C) The liquidity premium theory
D) The preferred habitat approach

Question 15

The interrelationship between similar securities is not a focus of the

A) expectations approach to term structure.
B) supply and demand approach to term structure.
C) equilibrium approach to term structure.
D) liquidity premium approach to term structure.

Question 16

If one-year securities are yielding 5 percent, but the market anticipates that rates for one-year securities will rise to 7 percent, then according to the expectations theory, current two-year securities should be yielding

A) 12 percent.
B) 7 percent.
C) 6 percent.
D) 5 percent.

Question 17

The yield curve depicts the relationship between

A) interest rates and risk.
B) yield and risk.
C) yield and interest rates.
D) yield and maturity.

Question 18

According to the pure expectations approach to term structure, investors view securities with different maturities as

A) close substitutes.
B) complements.
C) inversely related.
D) independent.

Question 19

The relationship between yield and maturity of the same type of security is known as the

A) term structure of interest rates.
B) risk-reward structure of interest rates.
C) asset duration structure of interest rates.
D) market structure of interest rates.

Question 20

Two-year securities are yielding 6 percent, and comparable one-year securities are yielding 8 percent. According to the pure expectations theory, the market expects next year's comparable one-year securities to yield

A) 14 percent.
B) 8 percent.
C) 6 percent.
D) 4 percent.

Question 21

Commercial banks are likely to

A) require a liquidity premium to hold long-term securities.
B) purchase equally in each maturity segment of the market.
C) view similar securities of different maturities as close substitutes.
D) have a preference for long-term securities.

Question 22

Which of the following financial institutions is likely to have a preferred habitat in long-term securities?

A) Commercial banks
B) Money market mutual funds
C) Life insurance companies
D) Credit unions

Question 23

Which of the following is not a theory used to explain the term structure of interest rates?

A) Liquidity premium theory
B) Pure expectations theory
C) Preferred habitat theory
D) Pure liquidity theory

Question 24

According to pure expectations theory, the yield curve should on average be

A) upward sloping.
B) downward sloping.
C) flat.
D) vertical.

Question 25

When interest rates are relatively high, investors generally expect interest rates to __________. Thus, investors prefer to hold __________ securities.

A) fall; long-term
B) fall; short-term
C) rise; long-term
D) rise; short-term

Question 26

When yields are expected to __________ in the future, investors prefer __________ long-term securities.

A) rise; hold
B) rise; not to hold
C) fall; not to hold
D) None of the above

Question 27

Proponents of the preferred habitat theory of term structure assume that a sharp reduction in the supply of one-year securities will

A) decrease the yield on one-year securities.
B) shift the yield curve upward.
C) increase the yield on one year securities.
D) have no effect on the yield on one-year securities.

Question 28

The fact that yields on short-term securities fluctuate more over the course of the business cycle supports which theory of the term structure?

A) Pure expectations
B) Preferred habitat
C) Supply and demand
D) Liquidity premium

Question 29

In the long run, the yield curve tends to be

A) positively sloped.
B) negatively sloped.
C) nearly vertical.
D) nearly horizontal.

Question 30

Using the pure expectations theory of term structure, a positively sloped yield curve indicates that investors expect

A) short term interest rates to fall.
B) short term interest rates to rise.
C) falling long term interest rates.
D) rising long term interest rates.

Question 31

Which of the following accounts for differences in the yield to maturity on U.S. government bonds with the same maturity?

A) Capital gains tax treatment
B) Chance of repayment
C) Marketability
D) Default risk

Question 32

According to the expectations theory of term structure, if next year's short-term interest rate is expected to be above the current short-term rate, the

A) current long-term rate will be equal to the current short-term rate.
B) current long-term rate will be below the current short-term rate.
C) current long-term rate will be above the current short-term rate.
D) yield curve will have a negative slope.

Question 33

Observations of the yield curve suggest that when interest rates are high and investors expect interest rates to fall, the yield curve will have a(n)

A) upward slope.
B) downward slope.
C) horizontal slope.
D) vertical slope.

Question 34

Everything else being equal, most investors prefer __________ securities, while most bond issuers prefer to issue __________ securities.

A) short-term; long-term
B) long-term; long-term
C) short-term; short-term
D) long-term; short-term

Question 35

Using the pure expectations theory of term structure, a negatively sloped yield curve indicates that investors expect

A) falling short term interest rates.
B) rising short term interest rates.
C) falling long term interest rates.
D) rising long term interest rates.

Question 36

The supply of a particular security appears to influence the term structure only

A) during recessions.
B) during inflationary periods.
C) in the short run.
D) in the long run.

Question 37

Investors usually __________, because long-term securities have a greater risk of capital loss than do short-term securities.

A) require a higher yield on long-term securities
B) require a lower yield on long-term securities
C) pay a higher price for long-term securities
D) avoid long-term securities

Question 38

Compared with long-term securities, the prices of short-term securities are always

A) more volatile.
B) less volatile.
C) higher.
D) lower.

Question 39

When interest rates are relatively low, investors generally expect interest rates to __________. Thus, investors prefer to hold __________ securities

A) fall; long-term
B) fall; short-term
C) rise; long-term
D) rise; short-term

Question 40

The most actively traded government securities in the secondary market are

A) the oldest securities outstanding.
B) securities issued more than one year but less than five years ago.
C) the securities associated with the current coupon issue.
D) the securities with the longest maturity.

Question 41

A negatively sloped yield curve indicates that the economy

A) is likely to show strong growth in the coming months.
B) will not change noticeably in the coming months.
C) is likely to show significant weakness in the coming months.
D) None of the above.

Question 42

An investor pays 20 percent of his income in taxes and purchases a $1,000 corporate bond yielding 10 percent. The after-tax yield on this bond is

A) 9 percent.
B) 8 percent.
C) 7 percent.
D) 6 percent.

Question 43

In general the lower the yield to maturity of a bond, the

A) lower the duration of a bond.
B) higher the duration of a bond.
C) lower the default risk.
D) lower the price of the bond.

Question 44

A bond has a duration of 4 years and a price of $1,000. The yield to maturity of the bond just changed from 5 percent to 7 percent. The new price of the bond should be

A) $1,076.
B) $924..
C) $1,093.
D) $907.

Question 45

If the following securities are of equal maturity, which will have the lowest yield at a given point in time?

A) A consumer loan
B) A municipal bond rated Aaa
C) An Aaa-rated corporate bond
D) A Baa-rated corporate bond

Question 46

The formula for relating the percentage change in price to the bond duration is A) △P/P = [-△i/(1 + i) × D]. B) △P/P = [△i/(1 + i) × D]. C) △P/P = [-△i * (1 + i) ÷ D]. D) △P/P = [-△i/(1 + i) ÷ D].

Question 47

A municipal bond selling for $1,000 pays the holder $80 per year. If the bondholder pays a 25 percent income tax rate, the after-tax yield is

A) 8 percent.
B) 7 percent.
C) 6 percent.
D) 5 percent.

Question 48

Which of the following types of government bonds tend to be the most marketable?

A) "Off the run" bonds
B) "On the run" bonds
C) "Convertible" bonds
D) "Coupon" bonds

Question 49

Assume that the yield on long-term U.S. government bonds rises. The yield on corporate bonds with the same maturity will __________, because investors will substitute __________ for __________.

A) rise; government bonds; corporate bonds
B) rise; corporate bonds; government bonds
C) fall; government bonds; corporate bonds
D) fall; corporate bonds; government bonds

Question 50

A bond has a face value of $1,000 and an annual coupon rate of 6 percent. The yield to maturity of this bond is 5 percent, and the bond has 2 years remaining until maturity. Based on this information, this bond's duration is __________ years.

A) 1.9
B) 2.0
C) 1.0
D) 2.2

Question 51

A comprehensive measure of a bond's maturity that takes into account the timing of both coupon and principal payments is

A) term structure.
B) risk premium.
C) current coupon.
D) duration.

Question 52

Which of the following will have the highest yield at any point in time?

A) A five-year Aaa-rated corporate bond
B) A five-year Baa-rated corporate bond
C) A five-year C-rated corporate bond
D) A five-year U.S. Treasury bond

Question 53

As a factor explaining yield differences among U.S. government bonds, default risk is

A) always an important consideration.
B) important, but other factors such as market risk are more critical.
C) more important than soverign risk.
D) practically never a consideration.