Question 1

Vaughn Corporation is considering the issue of commercial paper and would like to know the yield it should offer on its commercial paper. The corporation believes that a 0.2 percent default risk premium, a 0.1 percent liquidity premium, and a 0.3 percent tax adjustment are necessary to sell its commercial paper to investors. Furthermore, annualized T-bill rates are 7 percent. Based on this information, Vaughn should offer ____ percent on its commercial paper.
A)8.0
B)7.6
C)7.5
D)7.9
E)none of the above

Accepted Answer

The answer of Vaughn Corporation is considering the issue of...

Question 2

An upward-sloping yield curve indicates that Treasury securities with ____ maturities offer ____ annualized yields.
A)longer; lower
B)longer; higher
C)shorter; lower
D)shorter; higher
E)B and C

Accepted Answer

The answer of An upward-sloping yield curve indicates that Treasury...

Question 3

According to segmented markets theory, if investors have mostly long-term funds available and borrowers want short-term funds, this will place ____ pressure on the demand for long-term funds issued by borrowers and the yield curve will be ____ sloping.
A)upward; downward
B)downward; upward
C)upward; upward
D)downward; downward

Accepted Answer

The answer of According to segmented markets theory, if investors...

Question 4

Assume that the Treasury experiences a large decrease in the budget deficit and purchases a large number of T-bills. This action will ____ the supply of T-bills in the market and places ____ pressure on the yield of T-bills.
A)decrease; downward
B)decrease; upward
C)increase; upward
D)increase; downward

Accepted Answer

The answer of Assume that the Treasury experiences a large...

Question 5

If liquidity influences the yield curve, the forward rate underestimates the market's expectation of the future interest rate.

Accepted Answer

The forward rate may either underestimate or overestimate the market's expectation of the future interest rate, as it reflects not only expectations about future interest rates but also premiums for bearing risk, such as liquidity risk.

Question 6

The forward rate is commonly used to represent the market's forecast of the future interest rate.

Accepted Answer

The forward rate is calculated based on the current spot rate, expected future spot rate, and time to maturity, and it represents the market's expectation of future interest rates. Therefore, the statement is true.

Question 7

If research showed that all investors attempt to purchase securities that perfectly match their time in which they will have available funds, this would specifically support the argument made by the
A)liquidity premium theory.
B)real interest rate theory.
C)expectations theory.
D)segmented markets theory.

Accepted Answer

The segmented markets theory suggests that the market for bonds is segmented based on the maturity of the bonds, and investors have specific preferences for different maturities. If investors are purchasing securities that match their available funds' timing, it supports the idea that they have specific maturity preferences, aligning with the segmented markets theory.

Question 8

If research showed that anticipation about future interest rates was the only important factor for all investors in choosing short-term or long-term securities, this would support the argument made by the
A)liquidity premium theory.
B)expectations theory.
C)segmented markets theory.
D)A and B

Accepted Answer

The expectations theory holds that the long-term interest rates are the expected average of short-term interest rates in the future. Therefore, if anticipation about future interest rates was the only important factor for all investors in choosing short-term or long-term securities, it would support the expectations theory. The liquidity premium theory suggests that investors demand a premium for the increased risk associated with longer-term securities, and the segmented markets theory suggests that investors only operate in a specific market and are not affected by interest rates in other markets.

Question 9

According to the segmented markets theory, the term structure of interest rates is determined solely by expectations of future interest rates.

Accepted Answer

The segmented markets theory suggests that different maturities of bonds are isolated from each other and are influenced by different supply and demand factors, rather than solely by expectations of future interest rates.

Question 10

You are considering the purchase of a tax-exempt security that is paying a yield of 10.08 percent. You are in the 28 percent tax bracket. To match this after-tax yield, you would consider taxable securities that pay
A)31.1 percent.
B)19 percent.
C)12.5 percent.
D)14 percent.

Accepted Answer

The answer of You are considering the purchase of a...

Question 11

The annualized yield on a three-year security is 13 percent; the annualized two-year interest rate is 12 percent, while the one-year interest rate is 9 percent. The forward rate two years ahead is ____ percent.
A)1.8
B)9.0
C)15.0
D)none of the above

Accepted Answer

To calculate the forward rate, we can use the formula:

(1 + r3)^3 = (1 + r1)^1 x (1 + f2)^2

Where r3 is the three-year interest rate, r1 is the one-year interest rate, and f2 is the forward rate two years ahead.

Plugging in the given values, we get:

(1 + 0.13)^3 = (1 + 0.09)^1 x (1 + f2)^2
1.4641 = 1.09 x (1 + f2)^2
(1 + f2)^2 = 1.4641/1.09
1 + f2 = (1.4641/1.09)^(1/2)
f2 = (1.4641/1.09)^(1/2) - 1
f2 = 0.1507 or 15.07%

Therefore, the forward rate two years ahead is 15.07%. The correct answer is (C).

Question 12

The higher a bond rating, the lower the perceived default risk.

Accepted Answer

This statement is true. Bond ratings assess the creditworthiness of a bond issuer, with a higher rating indicating a lower perceived risk of default.

Question 13

Treasury securities are exempt from federal and state income taxes.

Accepted Answer

Treasury securities are exempt from state and local income taxes, but they are subject to federal income taxes.

Question 14

The term structure of interest rates defines the relationship between maturity and annualized yield, holding other factors such as risk constant.

Accepted Answer

The term structure of interest rates shows how the yield or interest rate on a bond or other fixed-income security varies based on its time to maturity. It is an important concept in finance and investments.

Question 15

The annualized yield on a three-year security is 13 percent; the annualized two-year interest rate is 12 percent, while the one-year interest rate is 9 percent. The forward rate one-year ahead is ____ percent.
A)2.8
B)115
C)103
D)15.1

Accepted Answer

Using the formula for calculating forward rates:
(1 + r3)^3 = (1 + r1)(1 + f1, 2)(1 + f2, 3)
where r1 = 9%, r2 = 12%, and r3 = 13%
Solving for f1,2 we get:
f1,2 = [(1 + r3)^3 / (1 + r1)(1 + f2,3)] - 1
Plugging in the values:
f1,2 = [(1 + 0.13)^3 / (1 + 0.09)(1 + 0.12)] - 1
f1,2 = 0.151 or 15.1% (rounded to one decimal place)

Therefore, the answer is D, 15.1.

Question 16

The yield curve for corporate bonds.
A)would typically lie below the Treasury yield curve.
B)is identical to the Treasury yield curve.
C)typically has the same slope as the Treasury yield curve.
D)is irrelevant to investors.

Accepted Answer

The corporate bond yield curve typically has the same slope as the Treasury yield curve because both are influenced by similar economic factors, though corporate bonds generally have higher yields due to higher risk.

Question 17

If the Treasury uses a relatively large proportion of ____ debt to finance the deficit, this may place upward pressure on ____ interest rates, and corporations may reduce their investment in fixed assets.
A)long-term; long-term
B)long-term; short-term
C)short-term; long-term
D)B and C

Accepted Answer

Issuing a large proportion of long-term debt can increase long-term interest rates, as it may signal higher future borrowing costs or inflation expectations, leading corporations to reduce investment in fixed assets.

Question 18

Investors will always prefer the purchase of risk-free Treasury securities, since other securities have a higher level of risk.

Accepted Answer

This statement is not entirely true. While some investors may prefer the safety of Treasury securities, others may be willing to take on higher levels of risk in order to achieve higher potential returns. Additionally, there are different types of risk associated with different securities, and some investors may be more comfortable with certain types of risk than others.

Question 19

Some types of debt securities always offer a higher yield than others.

Accepted Answer

This is true because different types of debt securities carry different levels of risk and therefore different levels of return. For example, high yield bonds (also known as junk bonds) typically offer a higher yield than investment grade bonds because they are considered riskier investments. Similarly, emerging market debt may offer a higher yield than US Treasuries because the risks associated with investing in emerging markets are higher.

Question 20

The graphic comparison of maturities and annualized yields is known as the interest rate curve.

Accepted Answer

The answer of The graphic comparison of maturities and annualized...

Quiz 3: Structure of Interest Rates

An upward-sloping yield curve indicates that Treasury securities with maturities offer annualized yields.

According to segmented markets theory, if investors have mostly long-term funds available and borrowers want short-term funds, this will place pressure on the demand for long-term funds issued by borrowers and the yield curve will be sloping.

Assume that the Treasury experiences a large decrease in the budget deficit and purchases a large number of T-bills. This action will the supply of T-bills in the market and places pressure on the yield of T-bills.

If liquidity influences the yield curve, the forward rate underestimates the market's expectation of the future interest rate.

The forward rate is commonly used to represent the market's forecast of the future interest rate.

If research showed that all investors attempt to purchase securities that perfectly match their time in which they will have available funds, this would specifically support the argument made by the

If research showed that anticipation about future interest rates was the only important factor for all investors in choosing short-term or long-term securities, this would support the argument made by the

According to the segmented markets theory, the term structure of interest rates is determined solely by expectations of future interest rates.

You are considering the purchase of a tax-exempt security that is paying a yield of 10.08 percent. You are in the 28 percent tax bracket. To match this after-tax yield, you would consider taxable securities that pay

The annualized yield on a three-year security is 13 percent; the annualized two-year interest rate is 12 percent, while the one-year interest rate is 9 percent. The forward rate two years ahead is ____ percent.

The higher a bond rating, the lower the perceived default risk.

Treasury securities are exempt from federal and state income taxes.

The term structure of interest rates defines the relationship between maturity and annualized yield, holding other factors such as risk constant.

The annualized yield on a three-year security is 13 percent; the annualized two-year interest rate is 12 percent, while the one-year interest rate is 9 percent. The forward rate one-year ahead is ____ percent.

The yield curve for corporate bonds.

If the Treasury uses a relatively large proportion of debt to finance the deficit, this may place upward pressure on interest rates, and corporations may reduce their investment in fixed assets.

Investors will always prefer the purchase of risk-free Treasury securities, since other securities have a higher level of risk.

Some types of debt securities always offer a higher yield than others.

The graphic comparison of maturities and annualized yields is known as the interest rate curve.