Question 1

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

Accepted Answer

During periods of high economic growth, the overall market risk is lower, leading to lower default risk premiums. As the economy grows, companies are more likely to generate revenue and meet their financial obligations, reducing the likelihood of default.

Question 2

Putable bonds offer higher yields than similar non-putable bonds

Accepted Answer

False

Question 3

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

Accepted Answer

Convertible bonds typically offer lower interest rates or yields compared to similar nonconvertible bonds because they also grant the holder the option to convert the bond into a predetermined number of shares of the issuing company, adding value through the potential for capital appreciation.

Question 4

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

Accepted Answer

This statement is false. Investment-grade bonds are considered to have lower default risk compared to speculative-grade bonds.

Question 5

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

Accepted Answer

The market segmentation theory suggests that different investors have different preferences and demand for various maturities of bonds. This can lead to a discontinuous yield curve, where certain maturities have higher or lower yields than neighboring maturities, rather than a smooth upward or downward sloping curve.

Question 6

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

Accepted Answer

A descending yield curve, also known as an inverted yield curve, typically forecasts lower short-term rates in the future as it suggests that investors expect economic slowdown or recession.

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.

Accepted Answer

This is true because municipal bonds are typically exempt from federal income taxes and sometimes state and local income taxes as well, making them more attractive to investors in higher tax brackets who are looking to minimize their tax liability. Similarly rated corporate bonds do not have these tax benefits.

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.

Accepted Answer

The major reason that municipal bonds have lower yields than corporate bonds is because municipal bonds are typically considered less risky than corporate bonds due to the fact that municipalities have the power to raise taxes to repay their debt. Therefore, investors are willing to accept lower yields on municipal bonds in exchange for greater safety. Marketability may play a role in pricing, but it is not the major reason for the yield difference between municipal and corporate bonds.

Question 9

The less marketable a security, the higher its yield.

Accepted Answer

Securities that are less marketable often come with a higher yield to compensate investors for the added risk of liquidity, making them less easily sold at a favorable price.

Question 10

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

Accepted Answer

A downward sloping yield curve, also known as an inverted yield curve, is typically seen just before an economic recession, as it indicates that short-term interest rates are higher than long-term interest rates, which can signal a lack of confidence in future economic growth.

Question 11

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

Accepted Answer

Callable bonds have a higher market yield because the issuer has the option to redeem or call the bond before maturity, which introduces a higher level of risk for the investor. In exchange for taking on this risk, callable bonds typically offer a higher yield.

Question 12

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

Accepted Answer

Treasury and corporate security yields are not typically combined when plotting a yield curve because they represent different types of debt with different risk profiles. A yield curve usually represents yields for a specific category, such as government securities or corporate bonds, to provide a clear picture of interest rate expectations for that category.

Question 13

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

Accepted Answer

An upward sloping yield curve suggests that longer-term interest rates are higher than shorter-term interest rates, indicating that market participants expect interest rates to rise in the future.

Question 14

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

Accepted Answer

An upward sloping yield curve typically indicates expectations of higher future interest rates, not lower inflation rates. Lower expected inflation would generally lead to a flatter or inverted 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.

Accepted Answer

Municipal bonds are often tax-exempt, so the after-tax yield for the investor in the 33 percent tax bracket would be higher for the 6 percent municipal bond compared to the 8.5 percent corporate bond, which is subject to taxes.

Question 16

A downward sloping yield curve forecasts higher future interest rates.

Accepted Answer

A downward sloping yield curve, also known as an inverted yield curve, forecasts lower future interest rates. This is because the long-term bonds are yielding lower returns compared to short-term bonds, indicating an expectation of economic contraction and lower inflation in the future. Central banks may respond by lowering interest rates to stimulate growth, hence causing a decrease in long-term bond yields.

Question 17

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

Accepted Answer

The answer of Bonds rated BBB would have lower yields...

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.

Accepted Answer

A put option on a bond allows the holder to force the issuer to buy back the bond at a specified price before maturity, but it does not set a floor or minimum price of the bond in the market; it only provides an option to sell back to the issuer. The market price of the bond can still fluctuate below the exercise price based on market conditions.

Question 19

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

Accepted Answer

The call price of a bond is typically at or above the bond's par value to compensate the bondholder for the early redemption.

Question 20

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

Accepted Answer

The answer of Liquidity premiums cause an observed yield curve...

Quiz 6: The Structure of Interest Rates