Question 1

If the yield curve is positively sloped when averaged for long periods of time, this implies that&#10;A) The expectations hypothesis is the best explanation of this phenomenon&#10;B) Inflation dominates the yield curve&#10;C) The liquidity (term) premium hypothesis is the best explanation of this phenomenon&#10;D) Yield curves cannot be positively sloped over long periods of time

Accepted Answer

The liquidity (term) premium hypothesis suggests that longer-term bonds typically offer higher yields to compensate for their greater risk, including interest rate risk and inflation risk, which can explain why the yield curve is positively sloped over long periods.

Question 2

In an economic expansion&#10;A) Treasury yields rise&#10;B) Below-investment-grade corporate bond yields fall&#10;C) Corporate Aaa (AAA) yields rise&#10;D) All of the above

Accepted Answer

During an economic expansion, treasury yields typically rise due to expectations of higher inflation and potentially higher interest rates. Below-investment-grade corporate bond yields tend to fall as the risk of default decreases in a stronger economy, making these bonds more attractive. Similarly, Corporate Aaa (AAA) yields may rise as investors demand less premium for safety and move towards riskier assets for higher returns.

Question 3

More risk of holding bonds will&#10;A) Lower their yields&#10;B) Raise their yields&#10;C) Not affect their yields&#10;D) Increase supply

Accepted Answer

Higher risk associated with holding bonds typically requires a higher yield to compensate investors for that risk. This is because investors demand higher returns as compensation for taking on increased risk.

Question 4

A 10-year Treasury note has a yield of 2.71 percent, and a Baa (BBB) corporate bond with comparable maturity has a yield of 4.93 percent. The difference in yields owes to&#10;A) Differences in credit risk&#10;B) Differences in liquidity&#10;C) Expected inflation&#10;D) Both a and b

Accepted Answer

The difference in yields between a 10-year Treasury note and a Baa (BBB) corporate bond with comparable maturity is primarily due to differences in credit risk and liquidity. Treasury notes are considered virtually risk-free since they are backed by the full faith and credit of the U.S. government, whereas corporate bonds carry a higher risk of default. Additionally, Treasury securities are generally more liquid than corporate bonds, making them easier to buy and sell without significantly affecting the price.

Question 5

Credit rating agencies&#10;A) Advise investors on portfolio choice&#10;B) Regulate the corporate bond market&#10;C) Address asymmetric information by providing an assessment of the likelihood of default&#10;D) Place securities with investors

Accepted Answer

Credit rating agencies primarily address asymmetric information in the financial markets by providing an assessment of the likelihood of default on debt securities. This helps investors make informed decisions by evaluating the credit risk associated with different investment options.

Question 6

Federal tax reform that lowers marginal tax rates on income will&#10;A) Lower yields on munis&#10;B) Raise yields on munis&#10;C) Leave yields on munis unchanged&#10;D) Cannot tell without more information

Accepted Answer

The answer of Federal tax reform that lowers marginal tax...

Question 7

The current yield on a 2-year Treasury note is 1.21 percent and that on a 3-year note is 1.70 percent. This means that the implicit 1-year forward rate in year 3 is&#10;A) Equal to 1.21 percent&#10;B) Above 1.70 percent&#10;C) Equal to 1.70 percent&#10;D) Below 1.21 percent

Accepted Answer

The implicit 1-year forward rate in year 3 can be calculated using the formula that equates the return of investing in the 3-year note directly to the return of investing in the 2-year note and then reinvesting the proceeds for one more year at the forward rate. Given that the forward rate is calculated to provide an equivalent return, and considering the upward slope of the yield curve from 1.21% to 1.70%, the forward rate for the third year must be above 1.70% to compensate for the lower yield in the first two years.

Question 8

The difference between the yield on an on-the-run Treasury security and a comparable maturity off-the-run security is&#10;A) The on-the-run yield is higher&#10;B) The on-the-run yield is lower&#10;C) Their yields are the same&#10;D) The on-the-run yield is exempt from the Fisher effect

Accepted Answer

The on-the-run yield is typically lower than the off-the-run yield because on-the-run Treasuries are the most current issue and tend to have higher demand and liquidity, which drives their prices up and yields down compared to older, off-the-run securities.

Question 9

If the Treasury yield curve is flat&#10;A) Short-term interest rates are expected to be falling under the term premium hypothesis&#10;B) Short-term interest rates are expected to be flat under the expectations hypothesis&#10;C) One cannot make inferences about the expected path of short-term interest rates&#10;D) Both a and b

Accepted Answer

A flat Treasury yield curve suggests that short-term interest rates are expected to remain stable if one follows the expectations hypothesis, and under the term premium hypothesis, it might indicate expectations of falling short-term rates, as investors demand less of a term premium for longer maturities in anticipation of lower future rates.

Question 10

According to the term (liquidity) premium of the term structure, the term premium increases with the maturity of the security because of&#10;A) Market segmentation&#10;B) Increasing credit risk&#10;C) Diminishing liquidity&#10;D) Increasing price (interest rate) risk

Accepted Answer

The term premium increases with the maturity of the security due to increasing price (interest rate) risk, as longer-term securities are more sensitive to interest rate changes, requiring a higher premium to compensate for this risk.

Question 11

Should long-term interest rates equal an average of current and expected future short-term interest rates, this would be consistent with&#10;A) The term (liquidity) premium hypothesis&#10;B) The efficient markets hypothesis&#10;C) The expectations hypothesis&#10;D) The market-segmentation hypothesis

Accepted Answer

The answer of Should long-term interest rates equal an average...

Deck 5: Factors Affecting Yields