Question 1

Which of the following yield curves would be present during a period of high economic growth?
A) Upward sloping
B) Downward sloping
C) Horizontal
D) Humped

Accepted Answer

During a period of high economic growth, it is common for short-term interest rates to be lower than long-term interest rates, as the demand for credit increases. This leads to an upward sloping yield curve.

Question 2

A firm will usually increase the ratio of short-term debt to long-term debt when
A) short-term debt has a lower cost than long-term equity.
B) the term structure is inverted and expected to shift down.
C) the term structure is upward sloping and expected to shift up.
D) the firm is undertaking a large capital budgeting project.

Accepted Answer

When the term structure is inverted (short-term interest rates are higher than long-term rates) and is expected to shift down (meaning that short-term rates are expected to decrease), it makes sense for a firm to increase its ratio of short-term debt to long-term debt. This strategy allows the firm to take advantage of lower borrowing costs in the near future as short-term rates decline.

Question 3

The term structure of interest rates
A) changes daily to reflect current competitive conditions in the money and capital markets.
B) plots returns for securities of different risk.
C) shows the relative interest rate spread between bonds with different risk ratings such as AAA, AA, A, BBB, and so on.
D) depicts interest rates for T-bills over the last year.

Accepted Answer

The term structure of interest rates refers to the relationship between the interest rates and the time until maturity for a set of similar securities. This relationship is dynamic and changes daily to reflect current competitive conditions in the money and capital markets. Therefore, option A is the best choice.

Question 4

Yield curves change daily to reflect
A) changing conditions in the money and capital markets.
B) new inflation expectations.
C) changing conditions in the overall economy.
D) All of the options are correct.

Accepted Answer

Yield curves are affected by a variety of factors that can change daily, including changes in the money and capital markets, new inflation expectations, and changing conditions in the overall economy. Therefore, all of the options provided are correct.

Question 5

The term structure of interest rates
A) is often referred to as the yield curve.
B) depicts the relative level of short- and long-term interest rates.
C) is usually constructed with U.S. government securities of varying maturities.
D) All of the options are true.

Accepted Answer

All options are true. The term structure of interest rates is often referred to as the yield curve, which depicts the relative level of short- and long-term interest rates. It is usually constructed using U.S. government securities of varying maturities.

Question 6

As the economy moves through a business cycle, which of the following "term structure of interest rates" theories dominates the shape of the yield curve.
A) The expectations hypothesis.
B) The market segmentation theory.
C) The liquidity premium theory.
D) None of these theories dominate the shape of the yield curve.

Accepted Answer

The shape of the yield curve is influenced by a combination of factors, and no single theory consistently dominates throughout all phases of the business cycle. The expectations hypothesis, market segmentation theory, and liquidity premium theory each provide insights under different conditions, but none can be said to universally dominate.

Question 7

Ideally, which of the following type of assets should be financed with long-term financing?
A) Fixed assets only
B) Fixed assets and temporary current assets
C) Fixed assets and permanent current assets
D) Temporary and permanent current assets

Accepted Answer

Long-term financing is best suited for financing fixed assets and permanent current assets. Fixed assets have a longer useful life and are not typically sold or used up in the short term, so long-term funding is a more appropriate match for these assets. Permanent current assets are also needed on a long-term basis and are not likely to fluctuate significantly in the near term. It is not ideal to finance temporary current assets with long-term financing, as short-term liabilities are more appropriate for these items.

Question 8

Some analysts believe that the term structure of interest rates is determined by the behavior of various types of financial institutions. This theory is called the
A) expectations hypothesis.
B) market segmentation theory.
C) liquidity premium theory.
D) theory of industry supply and demand for bonds.

Accepted Answer

The theory that the term structure of interest rates is determined by the behavior of various types of financial institutions is called the market segmentation theory. This theory suggests that different maturity segments of the bond market are separated and catered to by different groups of investors, resulting in different interest rates for bonds with different maturities.

Question 9

Generally, more use is made of short-term financing because
A) short-term interest rates are generally lower than long-term interest rates.
B) most firms do not have basic access to the capital markets.
C) short-term financing is usually more predictable than long-term financing.
D) short-term interest rates are generally lower than long-term interest rates and most firms do not have basic access to the capital markets.

Accepted Answer

Short-term financing is preferred by most firms because short-term interest rates are generally lower than long-term interest rates and most firms do not have basic access to the capital markets. Additionally, short-term financing is usually more predictable than long-term financing.

Question 10

The belief that investors require a higher return to entice them into holding long-term securities is the viewpoint of the
A) expectations hypothesis.
B) market segmentation theory.
C) liquidity premium theory.
D) market credit crunch theory.

Accepted Answer

The belief that investors require a higher return for holding long-term securities is the central proposition of the liquidity premium theory. This theory explains the shape of the yield curve by emphasizing that investors are willing to pay a premium for holding short-term securities, which are more liquid and less risky than long-term securities. Therefore, long-term securities carry an additional risk premium to compensate investors for the greater uncertainty associated with holding them.

Question 11

The term structure of interest rates is influenced by
A) inflation.
B) money supply.
C) Federal Reserve activities.
D) All of the options are correct.

Accepted Answer

The term structure of interest rates is influenced by various factors, including inflation, money supply, and Federal Reserve activities. Therefore, all of the options are correct.

Question 12

Financial managers can accurately predict future interest rates beyond a few months by
A) calculating the anticipated inflation rate.
B) gauging the Fed's decision regarding the target federal funds rate.
C) measuring investor sentiment and consumer confidence indices.
D) None of the options are correct.

Accepted Answer

Financial managers cannot accurately predict future interest rates beyond a few months due to the complexity and variability of economic factors, including but not limited to inflation, central bank policies, and market sentiment.

Question 13

A firm will usually increase the ratio of short-term debt to long-term debt when
A) short-term debt has a lower cost than long-term equity.
B) future interest rates are expected to increase.
C) long-term debt has a lower cost than long-term equity.
D) future interest rates are expected to decrease.

Accepted Answer

Future interest rates are expected to increase, so the firm will want to lock in lower short-term rates before they go up.

Question 14

When the term structure of interest rates is downward sloping and interest rates are expected to decline, the
A) financial manager generally borrows short-term.
B) financial manager borrows at the lower long-term rates.
C) corporation's ratio of short-term to long-term debt is low.
D) None of the options are true.

Accepted Answer

The answer of When the term structure of interest rates...

Question 15

U.S. government securities are used to construct yield curves because
A) they are free of default risk.
B) the large number of maturities form a continuous curve.
C) they are free of default risk and the large number of maturities form a continuous curve.
D) None of the options are correct.

Accepted Answer

U.S. government securities are considered to be free of default risk, making them a safe investment. Additionally, there are a large number of maturities available, which allows for the construction of a continuous yield curve. Therefore, the combination of no default risk and a continuous curve makes U.S. government securities the ideal choice for constructing yield curves.

Question 16

A "normal" term structure of interest rates would depict
A) short-term rates are higher than long-term rates.
B) long-term rates are higher than short-term rates.
C) no general relationship between short- and long-term rates.
D) intermediate rates (one to five years) are lower than both the short-term and long-term rates.

Accepted Answer

A normal term structure of interest rates is one where long-term rates are higher than short-term rates. This is because investors generally require a higher rate of return for committing their funds for a longer period of time, as there is greater uncertainty and risk over longer time horizons. This pattern is known as a positive yield curve.

Question 17

The theory of the term structure of interest rates, which suggests that long-term rates are determined by the average of short-term rates expected over the time that a long-term bond is outstanding, is the
A) expectations hypothesis.
B) segmentation theory.
C) liquidity premium theory.
D) market average rate theory.

Accepted Answer

The theory described is known as the expectations hypothesis, which suggests that long-term rates are determined by market expectations of future short-term rates. It is sometimes also referred to as the pure expectations theory. The other answer choices describe different theories related to the term structure of interest rates, but do not match the description given in the question.

Question 18

An inverted yield curve would suggest that
A) interest rates are expected to rise.
B) interest rates are expected to fall.
C) inflation is expected to rise in the future.
D) long-term rates are being pushed up by Federal Reserve policy.

Accepted Answer

An inverted yield curve occurs when short-term interest rates are higher than long-term interest rates. This suggests that investors expect interest rates to fall in the future, which can be a sign of an economic slowdown or recession.

Question 19

A conservatively financed firm would
A) use long-term financing for all fixed assets and short-term financing for all other assets.
B) finance a portion of permanent assets and short-term assets with short-term debt.
C) use equity to finance fixed assets, use long-term debt to finance permanent assets, and use short-term debt to finance fluctuating current assets.
D) use long-term financing for three items: permanent current assets, fixed assets, and a portion of the short-term fluctuating assets. Then use short-term financing for all other short-term assets.

Accepted Answer

A conservatively financed firm would use long-term financing for permanent current assets, fixed assets, and a portion of the short-term fluctuating assets. Then use short-term financing for all other short-term assets, which would help the firm to manage its short-term liabilities and minimize the risk of default. This strategy balances the risk and cost of financing while ensuring the company's ability to meet its obligations. Thus, Choice D is the best option.

Question 20

The term structure of interest rates
A) is an indication of investors' expectations about inflation and future interest rates.
B) will be downward sloping if short-term interest rates are higher than long-term rates.
C) will be upward sloping under normal conditions.
D) All of the options are true.

Accepted Answer

All of the options are true. The term structure of interest rates reflects investors' expectations about inflation and future interest rates. The shape of the yield curve can vary depending on market conditions, but under normal conditions, it will be upward sloping, meaning that longer-term interest rates are higher than short-term rates. However, there may be times when short-term rates are higher than long-term rates, resulting in a downward sloping yield curve.

Quiz 6: Working Capital and the Financing Decision

Which of the following yield curves would be present during a period of high economic growth?

A firm will usually increase the ratio of short-term debt to long-term debt when

The term structure of interest rates

Yield curves change daily to reflect

The term structure of interest rates

As the economy moves through a business cycle, which of the following "term structure of interest rates" theories dominates the shape of the yield curve.

Ideally, which of the following type of assets should be financed with long-term financing?

Some analysts believe that the term structure of interest rates is determined by the behavior of various types of financial institutions. This theory is called the

Generally, more use is made of short-term financing because

The belief that investors require a higher return to entice them into holding long-term securities is the viewpoint of the

The term structure of interest rates is influenced by

Financial managers can accurately predict future interest rates beyond a few months by

A firm will usually increase the ratio of short-term debt to long-term debt when

When the term structure of interest rates is downward sloping and interest rates are expected to decline, the

U.S. government securities are used to construct yield curves because

A "normal" term structure of interest rates would depict

The theory of the term structure of interest rates, which suggests that long-term rates are determined by the average of short-term rates expected over the time that a long-term bond is outstanding, is the

An inverted yield curve would suggest that

A conservatively financed firm would

The term structure of interest rates