Question 1

When yield curves are steeply upward-sloping,
A) long-term interest rates are above short-term interest rates.
B) short-term interest rates are above long-term interest rates.
C) short-term interest rates are about the same as long-term interest rates.
D) medium-term interest rates are above both short-term and long-term interest rates.
E) medium-term interest rates are below both short-term and long-term interest rates.

Accepted Answer

When yield curves are steeply upward-sloping, it means that long-term interest rates are higher than short-term interest rates. This is known as a normal yield curve or a positive yield curve. It is a sign of expansion in the economy and investors expect higher inflation in the future. Therefore, they demand a higher yield on long-term bonds to compensate for the inflation risk.

Question 2

When a municipal bond is given tax-free status,the demand for municipal bonds shifts ________,causing the interest rate on the bond to ________.
A) leftward; rise
B) leftward; fall
C) rightward; rise
D) rightward; fall

Accepted Answer

When a municipal bond is given tax-free status, it becomes more attractive to investors because the interest income is exempt from federal (and in some cases, state and local) taxes. This increased attractiveness leads to a higher demand for municipal bonds, shifting the demand curve rightward. As demand increases, the price of the bonds goes up, and the interest rate, which moves inversely to bond prices, falls.

Question 3

The relationship among interest rates on bonds with identical default risk but different maturities is called the
A) time-risk structure of interest rates.
B) liquidity structure of interest rates.
C) yield curve.
D) bond demand curve.

Accepted Answer

The yield curve depicts the relationship between the interest rates on bonds of the same default risk but with different maturities. The curve shows how the yield or interest rate varies with the time to maturity.

Question 4

Typically,yield curves are
A) gently upward-sloping.
B) gently downward-sloping.
C) flat.
D) bowl shaped.
E) mound shaped.

Accepted Answer

Yield curves are typically gently upward-sloping, indicating that long-term interest rates are higher than short-term interest rates. This shape reflects the market's expectation of future economic growth and inflation, as well as the risk premium associated with holding onto a long-term investment. Downward-sloping yield curves, on the other hand, typically indicate an impending recession or economic slowdown. Flat yield curves can suggest economic uncertainty, while bowl or mound-shaped yield curves are rare but have been observed during periods of extreme market volatility.

Question 5

Which of the following statements are true?
A) Because coupon payments on municipal bonds are exempt from federal income tax, the expected after-tax return on them will be higher for individuals in higher income tax brackets.
B) An increase in tax rates will increase the demand for Treasury bonds, lowering their interest rates.
C) Interest rates on municipal bonds will be higher than on comparable bonds without the tax exemption.
D) Only A and B are true statements.

Accepted Answer

Municipal bonds are attractive to individuals in higher tax brackets because their interest income is exempt from federal income tax, effectively increasing the after-tax return for these investors. This makes statement A true. Statement B is incorrect because an increase in tax rates generally increases the demand for tax-exempt or tax-advantaged securities, such as municipal bonds, not Treasury bonds. Treasury bonds are taxable, so higher tax rates would not make them more attractive. Statement C is incorrect because the tax exemption on municipal bonds typically allows them to have lower interest rates than comparable taxable bonds, as investors are willing to accept a lower rate due to the tax benefits.

Question 6

When the corporate bond market becomes less liquid,other things equal,the demand curve for corporate bonds shifts to the ________ and the demand curve for Treasury bonds shifts to the ________.
A) right; right
B) right; left
C) left; left
D) left; right

Accepted Answer

When the corporate bond market becomes less liquid, investors become less willing to hold corporate bonds, resulting in a decrease in demand. As a result, the demand curve for corporate bonds shifts to the left. On the other hand, since Treasury bonds are perceived as safer and more liquid than corporate bonds, investors may switch their investment demand to Treasury bonds, causing the demand curve for Treasury bonds to shift to the right. Therefore, the correct choice is D.

Question 7

(I)If a corporate bond becomes less liquid,the demand for the bond will fall,causing the interest rate to rise.
(II)If a corporate bond becomes less liquid,the demand for Treasury bonds does not change.
A) (I) is true, (II) false.
B) (I) is false, (II) true.
C) Both are true.
D) Both are false.

Accepted Answer

If a corporate bond becomes less liquid, investors may demand a higher return to compensate for the increased risk they are taking on. This higher return is reflected in a higher interest rate for the bond. However, the decrease in demand for a corporate bond does not necessarily translate to a change in demand for Treasury bonds, which are considered very safe and liquid investments. Therefore, statement (I) is true while statement (II) is false.

Question 8

A decrease in marginal tax rates would likely have the effect of ________ the demand for municipal bonds and ________ the demand for U.S.government bonds.
A) increasing; increasing
B) increasing; decreasing
C) decreasing; increasing
D) decreasing; decreasing

Accepted Answer

A decrease in marginal tax rates reduces the tax benefits of municipal bonds, which are tax-free, thus decreasing the demand for them. On the other hand, a decrease in marginal tax rates reduces the after-tax return on U.S. government bonds, making them less attractive and reducing demand for them. Therefore, the demand for municipal bonds would decrease and the demand for U.S. government bonds would increase.

Question 9

When the corporate bond market becomes more liquid,other things equal,the demand curve for corporate bonds shifts to the ________ and the demand curve for Treasury bonds shifts to the ________.
A) right; right
B) right; left
C) left; left
D) left; right

Accepted Answer

When the corporate bond market becomes more liquid, investors tend to allocate more funds towards corporate bonds resulting in an increase in demand for corporate bonds shifting the demand curve for corporate bonds to the right. At the same time, the demand for Treasury bonds decreases, resulting in a shift of the demand curve for Treasury bonds to the left. Therefore, the correct answer is B.

Question 10

When a municipal bond is given tax-free status,the demand for Treasury bonds shifts ________,and the interest rate on Treasury bonds ________.
A) leftward; rises
B) leftward; falls
C) rightward; rises
D) rightward; falls

Accepted Answer

When a municipal bond is given tax-free status, it becomes more attractive to investors, leading to a decrease in demand for Treasury bonds (shift leftward). As demand for Treasury bonds decreases, the price of these bonds falls, causing the interest rate (which moves inversely to bond prices) to rise.

Question 11

Which of the following statements are true?
A) Because coupon payments on municipal bonds are exempt from federal income tax, the expected after-tax return on them will be higher for individuals in higher income tax brackets.
B) An increase in tax rates will increase the demand for municipal bonds, lowering their interest rates.
C) Interest rates on municipal bonds will be lower than on comparable bonds without the tax exemption.
D) All of the above are true statements.
E) Only A and B are true statements.

Accepted Answer

All the statements are true. A) Municipal bonds are attractive to individuals in higher tax brackets due to their tax-exempt status, increasing their after-tax return. B) Higher tax rates make tax-exempt municipal bonds more attractive, increasing demand and potentially lowering their interest rates. C) The tax exemption on municipal bonds typically results in lower interest rates compared to taxable bonds, as investors are willing to accept a lower rate due to the tax benefits.

Question 12

If income tax rates rise,then
A) the prices of municipal bonds will fall.
B) the prices of Treasury bonds will rise.
C) the interest rate on Treasury bonds will rise.
D) the interest rate on municipal bonds will rise.

Accepted Answer

If income tax rates rise, there will be an increase in the demand for tax-exempt investments like Treasury bonds. This would lead to an increase in the prices of Treasury bonds and a corresponding decrease in their interest rates. So, choice B is incorrect. Conversely, the prices of municipal bonds may fall as investors may shift to tax-exempt investments like Treasury bonds, leading to a decrease in demand for municipal bonds and an increase in their interest rate. Therefore, choice A and D are incorrect. Choice C correctly states that the interest rate on Treasury bonds will rise.

Question 13

Yield curves can be classified as
A) upward-sloping.
B) downward-sloping.
C) flat.
D) all of the above.
E) only A and B of the above.

Accepted Answer

Yield curves can be classified as upward-sloping, downward-sloping, or flat, depending on the relationship between the yield and the maturity of the debt securities.

Question 14

If income tax rates were lowered,then
A) the interest rate on municipal bonds would fall.
B) the interest rate on Treasury bonds would rise.
C) the interest rate on municipal bonds would rise.
D) the price of Treasury bonds would fall.

Accepted Answer

When income tax rates are lowered, the after-tax income of individuals increases which can make municipal bonds more valuable. This increased demand for municipal bonds can lead to an increase in their prices and a corresponding decrease in their interest rates. Therefore, the interest rate on municipal bonds would rise. The interest rate on Treasury bonds is not directly impacted by changes in income tax rates, so option B is incorrect. Option A is also incorrect because lower income tax rates could actually increase the demand for municipal bonds, leading to lower interest rates. Option D is incorrect because the price of Treasury bonds is negatively correlated with interest rates, meaning that if interest rates rise, the price of Treasury bonds will fall, but it is not directly influenced by changes in income tax rates.

Question 15

If municipal bonds were to lose their tax-free status,then the demand for Treasury bonds would shift ________,and the interest rate on Treasury bonds would ________.
A) rightward; fall
B) rightward; rise
C) leftward; fall
D) leftward; rise

Accepted Answer

If municipal bonds were to lose their tax-free status, then investors would demand more Treasury bonds, which would shift the demand curve for Treasury bonds to the right. This would cause the interest rate on Treasury bonds to rise.

Question 16

(I)The risk premium widens as the default risk on corporate bonds increases.
(II)The risk premium widens as corporate bonds become less liquid.
A) (I) is true, (II) false.
B) (I) is false, (II) true.
C) Both are true.
D) Both are false.

Accepted Answer

The risk premium is the excess return demanded by investors for investing in a risky asset compared to a risk-free asset. One of the factors that affect the risk premium on corporate bonds is the default risk. The higher the default risk, the higher the risk premium demanded by investors. Therefore, statement (I) is true.
Another factor that affects the risk premium is the liquidity risk. The less liquid the corporate bonds are, the higher the risk premium demanded by investors. Therefore, statement (II) is also true. So, both statements are true.

Question 17

An increase in marginal tax rates would likely have the effect of ________ the demand for municipal bonds and ________ the demand for U.S.government bonds.
A) increasing; increasing
B) increasing; decreasing
C) decreasing; increasing
D) decreasing; decreasing

Accepted Answer

An increase in marginal tax rates makes tax-exempt municipal bonds more attractive relative to taxable bonds, increasing their demand. Conversely, the demand for U.S. government bonds, which are taxable, would likely decrease as investors seek the tax advantages of municipal bonds.

Question 18

Corporate bonds are not as liquid as government bonds because
A) fewer bonds for any one corporation are traded, making them more costly to sell.
B) the corporate bond rating must be calculated each time they are traded.
C) corporate bonds are not callable.
D) all of the above.
E) only A and B of the above.

Accepted Answer

Corporate bonds are generally less liquid than government bonds because there are fewer of them traded, which can make them more costly to sell. Corporate bond ratings do not need to be recalculated each time they are traded, and the callability of a bond does not directly affect its liquidity.

Question 19

The Bush tax cut passed in 2001 reduces the top income tax bracket from 39 percent to 35 percent over the next ten years.As a result of this tax cut,the demand for municipal bonds should shift to the ________ and the interest rate on municipal bonds should ________.
A) right; decline
B) right; increase
C) left; decline
D) left; increase

Accepted Answer

The tax cut reduces the tax advantage of municipal bonds, which are tax-exempt, leading to decreased demand and higher interest rates.

Question 20

(I)If a corporate bond becomes less liquid,the interest rate on the bond will fall.
(II)If a corporate bond becomes less liquid,the interest rate on Treasury bonds will fall.
A) (I) is true, (II) false.
B) (I) is false, (II) true.
C) Both are true.
D) Both are false.

Accepted Answer

If a corporate bond becomes less liquid, the interest rate on that bond will likely increase (not decrease), as investors demand a higher return for the added risk of holding a less liquid security. Therefore, statement (I) is false. On the other hand, the liquidity of corporate bonds and Treasury bonds is not directly related, so a change in liquidity of one would not necessarily affect the interest rate of the other. Thus, statement (II) is also false.

Quiz 5: How Do Risk and Term Structure Affect Interest Rates?

When yield curves are steeply upward-sloping,

When a municipal bond is given tax-free status,the demand for municipal bonds shifts ,causing the interest rate on the bond to .

The relationship among interest rates on bonds with identical default risk but different maturities is called the

Typically,yield curves are

Which of the following statements are true?

When the corporate bond market becomes less liquid,other things equal,the demand curve for corporate bonds shifts to the and the demand curve for Treasury bonds shifts to the .

(I) If a corporate bond becomes less liquid,the demand for the bond will fall,causing the interest rate to rise. (II) If a corporate bond becomes less liquid,the demand for Treasury bonds does not change.

A decrease in marginal tax rates would likely have the effect of the demand for municipal bonds and the demand for U.S.government bonds.

When the corporate bond market becomes more liquid,other things equal,the demand curve for corporate bonds shifts to the and the demand curve for Treasury bonds shifts to the .

When a municipal bond is given tax-free status,the demand for Treasury bonds shifts ,and the interest rate on Treasury bonds .

Which of the following statements are true?

If income tax rates rise,then

Yield curves can be classified as

If income tax rates were lowered,then

If municipal bonds were to lose their tax-free status,then the demand for Treasury bonds would shift ,and the interest rate on Treasury bonds would .

(I) The risk premium widens as the default risk on corporate bonds increases. (II) The risk premium widens as corporate bonds become less liquid.

An increase in marginal tax rates would likely have the effect of the demand for municipal bonds and the demand for U.S.government bonds.

Corporate bonds are not as liquid as government bonds because

The Bush tax cut passed in 2001 reduces the top income tax bracket from 39 percent to 35 percent over the next ten years.As a result of this tax cut,the demand for municipal bonds should shift to the and the interest rate on municipal bonds should .

(I) If a corporate bond becomes less liquid,the interest rate on the bond will fall. (II) If a corporate bond becomes less liquid,the interest rate on Treasury bonds will fall.