Deck 6: The Economics of Interest-Rate Spreads and Yield Curves

Question 1

A two-year bond is a perfect substitute for two consecutive one-year bonds.

Answer 1

False

Question 2

A downward sloping yield curve indicates a possible future recession.

Answer 2

True

Question 3

An increase in household wealth increases the risk premium of corporate bonds.

Answer 3

False

Question 4

A change in the risk of a bond affects the bond's risk premium.

Question 5

No government agency has ever defaulted on its bonds in the United States.

Question 6

Ceteris paribus, a junk bond has a lower risk premium than other bonds.

Question 7

A CCC bond has higher interest rate risk than a BBB bond.

Question 8

A change in the profit opportunities of a company affects the risk premium of that company's bonds.

Question 9

A change in the relative return of a bond affects the bond's risk premium.

Question 10

The U.S. Federal government has never defaulted on its bonds.

Question 11

Positive spreads (long term rates - short term rates) indicate a possible future recession.

Question 12

An increase in expected inflation increases the risk premium of corporate bonds.

Question 13

If a positive liquidity premium is included in the formula for the term structure, a downward sloping yield curve is impossible.

Question 14

Government bonds are more liquid than corporate bonds.

Question 15

The liquidity premium is included in calculations of the yield curve to account for interest rate risk.

Question 16

Ceteris paribus, a blue chip bond has a lower risk premium than other bonds.

Question 17

The liquidity premium is included in calculations of the yield curve to account for default risk.

Question 18

A blue chip bond has greater default risk than a high yield corporate bond.

Question 19

An increase in expected inflation has an ambiguous effect on the risk premium of corporate bonds.

Question 20

An AAA bond has lower default risk than a BBB bond.

Question 21

Which of the following factors could explain difference in yields on bonds with the same time to maturity?

A) the risk that the issuer will not make future payments
B) differences in the taxation of the bonds
C) ease of finding buyers and sellers of a bond
D) all of the above

Question 22

Ceteris paribus, an AAA bond has a lower term premium than other bonds.

Question 23

The yield on a one-year bond is currently 3% and the expected yield for the next three years is also 3%. If the term premium is 0.5, then the yield curve

A) is upward sloping.
B) is flat.
C) is downward sloping.
D) cannot be determined.

Question 24

The recent increase in U.S. government debt could lead to a(n) _____ in yields due to an increase in

A) increase; default risk.
B) decrease; default risk.
C) increase; liquidity.
D) decrease; liquidity.

Question 25

Which of the following factors could explain difference in yields on bonds with the same time to maturity?

A) interest rate risk
B) credit risk
C) liquidity
D) none of the above

Question 26

Municipal bonds tend to have lower yields than other bonds, ceteris paribus, due to

A) higher default risk.
B) lower taxes.
C) higher liquidity.
D) none of the above.

Question 27

If a company gets concessions from labor in union negotiations, one would expect a(n) _____ in yields on its bonds due to an increase in

A) increase; default risk.
B) decrease; default risk.
C) increase; liquidity.
D) decrease; liquidity.

Question 28

Municipal bonds tend to have lower yields than other bonds, ceteris paribus, due to

A) higher default risk.
B) higher taxes.
C) higher liquidity.
D) none of the above.

Question 29

If a company gets concessions from labor in union negotiations, one would expect a(n) _____ in the risk premia on its bonds due to a shift in the ____ its bonds.

A) increase; demand for
B) decrease; demand for
C) increase; supply of
D) decrease; supply of

Question 30

Which of the following factors could explain difference in yields on bonds with the same time to maturity?

A) default risk
B) tax considerations
C) liquidity
D) all of the above

Question 31

During crises, flight to quality, investors are driven to sell riskier assets and move to safe ones.

Question 32

The yield curve plots yield against maturity.

Question 33

You cannot post-dict the changes in rank order between different types of bonds.

Question 34

If a company gets concessions from labor in union negotiations, one would expect a(n) _____ in the risk premia on its bonds due to an increase in

A) increase; default risk.
B) decrease; default risk.
C) increase; liquidity.
D) decrease; liquidity.

Question 35

If yields on one-year bonds are expected to fall and the liquidity premium increases with the time to maturity, the yield curve

A) will be upward sloping.
B) will be flat.
C) will be downward sloping.
D) cannot be determined.

Question 36

If S&P upgrades a corporate bond its yield will _____ and its risk premium will

A) rise; rise.
B) rise; fall.
C) fall; rise.
D) fall; fall.

Question 37

If S&P upgrades a corporate bond the _____ for the bond will shift and its risk premium will

A) demand; rise.
B) demand; fall.
C) supply; rise.
D) supply; fall.

Question 38

If yields on one-year bonds are expected to rise and the liquidity premium is zero, the yield curve will be

A) upward sloping.
B) flat.
C) downward sloping.
D) cannot be determined.

Question 39

Which of the following factors could explain difference in yields on bonds with the same time to maturity?

A) default risk
B) interest rate risk
C) credit risk
D) all of the above

Question 40

Ceteris paribus, a junk bond has a higher yield and higher risk premium than other bonds.

Question 41

If the government budget deficit rises, explain the impact on the risk premia of corporate bonds.

Question 42

If a corporate bond loses its listing on a centralized exchange, explain the effect on the risk premium in terms of the supply and demand for bonds.

Question 43

If a corporate bond becomes traded on an exchange (as opposed to OTC), the demand for the bond shifts to the _____ and its risk premia

A) right; rises.
B) right; falls.
C) left; rises.
D) left; falls.

Question 44

If interest rates on one-year bonds are expected to stay at 3% and the term premium is 1%, what would the yield curve look like?

Question 45

The yield curve indicates a possible future recession if it is

A) upward sloping.
B) flat.
C) downward sloping.
D) none of the above.

Question 46

What is the difference between risk and term structure?

Question 47

If the government makes it easier to buy its bonds online, the risk premia for corporate bonds will

A) increase.
B) decrease.
C) stay the same.
D) cannot be determined.

Question 48

Risk structure models the yields of bonds

A) with the same times to maturity.
B) with different times to maturity.
C) both of the above.
D) neither of the above.

Question 49

Interest rate risk is measured by the

A) term premium.
B) risk premium.
C) rate of inflation.
D) none of the above.

Question 50

Which theory that suggests that investors typically prefer more liquid, shorter-term bonds?

A) preferred habitat.
B) the yield curve.
C) liquidity preference.
D) none of the above.

Question 51

Term structure models the yields of bonds with

A) with the same times to maturity.
B) with different times to maturity.
C) both of the above.
D) neither of the above.

Question 52

If Moody's upgrades a corporate bond to AAA, explain the impact on the risk premium.

Question 53

The yield on a one-year bond is currently 4% and the expected yield on one-year bonds for the next two years is 5% and 6%. If the liquidity premium is 0.5%, what is the yield on a bond with two years to maturity?

A) 4.5%
B) 5%
C) 5.5%
D) 6%

Question 54

Default risk is measured by the

A) term premium.
B) risk premium.
C) credit premium.
D) none of the above.

Question 55

Which theory that suggests short and long term bonds are partial substitutes?

A) preferred habitat.
B) the yield curve.
C) substitute preference.
D) none of the above.

Question 56

Blue chip bonds tend to have

A) higher yields.
B) higher risk premia.
C) both of the above.
D) neither of the above.

Question 57

Junk bonds tend to have

A) higher risk premia.
B) higher yields.
C) higher default risk.
D) all of the above.

Question 58

Ceteris paribus, an increase in the government budget deficit will cause the risk premia on corporate bonds to

A) increase.
B) decrease.
C) stay the same.
D) cannot be determined.

Question 59

Structure of interest rates explains why bonds issued by _____ but of _____ sometimes have different yields.

A) the same economic entity, different maturities
B) different economic entities, the same maturities
C) different economic entities, different maturities
D) none of the above.

Question 60

Ratings from Moody's and S&P measure

A) liquidity risk.
B) interest rate risk.
C) default risk.
D) all of the above.

Question 61

Explain the concept of flight to quality.

Question 62

A strike against United Airlines puts the company's long term solvency in question. Using a graph, show (and explain) the effect on its risk premium.

Question 63

The current and expected future yields on the one year Treasury bond is 7%. The liquidity premium is 0.5(n-1), where n is the number years to maturity on the bond. Sketch the yield curve covering the next four years. Briefly explain your work.

Question 64

Does the information in the table about the yield curve indicate a possible recession?

Question 65

If Congress removed the tax exemption for municipal bonds, how would the risk premium on those bonds be affected? Use a graph to help explain.

Question 66

Explain the liquidity preference and its impact on the yield curve.

Question 67

The yield on a one-year bond is currently 6% and the expected yield on one-year bonds for the next three years is 4%, 2% and 1%. If the liquidity premium is 1%, what are the yields on a bond with two, three and four years to maturity?

Question 68

The yield on a one-year bond is currently 5% and the liquidity premium is 0.5(n-1)% where n is the years to maturity. You are told that the spread between two- and one-year bonds is positive. What does that tell you about the yield on the two-year bond?

Question 69

Does the information in the table about the yield curve indicate a possible recession?

Question 70

The use of auctions should make the cost of issuing bonds cheaper for corporations. Show the expected impact on risk premia for corporate bonds with a graph.