Question 1

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.

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 2

Yield curves can be classified as

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 3

(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.

Accepted Answer

When a corporate bond becomes less liquid, investors may become hesitant to invest in it, causing a decrease in demand for the bond. This decrease in demand causes the price of the bond to fall and the interest rate to rise in order to entice investors to buy it. However, the liquidity of Treasury bonds is not affected by the liquidity of corporate bonds, so the demand for Treasury bonds does not change.

Question 4

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 ________.

Accepted Answer

When the corporate bond market becomes more liquid, the demand for corporate bonds increases, shifting the demand curve to the right. This increases the price of corporate bonds and lowers their yields. As a result, investors may shift their demand to Treasury bonds, which are seen as safer and more stable investments. Therefore, the demand curve for Treasury bonds shifts to the left.

Question 5

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 ________.

Accepted Answer

The answer of The Bush tax cut passed in 2001...

Question 6

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

Accepted Answer

The relationship among interest rates on bonds with identical default risk but different maturities is known as the yield curve. This curve shows the term structure of interest rates, which reflects the various yields on bonds of different maturities.

Question 7

If income tax rates were lowered, then

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 8

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 ________.

Accepted Answer

The answer of If municipal bonds were to lose their...

Question 9

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.

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 10

Typically, yield curves are

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 11

When yield curves are steeply upward-sloping,

Accepted Answer

Steeply upward-sloping yield curves indicate that long-term interest rates are higher than short-term interest rates. This is because investors require higher compensation for lending their money for a longer period of time, which results in higher interest rates on long-term bonds.

Question 12

Corporate bonds are not as liquid as government bonds because

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 13

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

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 14

Which of the following statements are true?

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 15

(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.

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.

Question 16

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

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 17

If income tax rates rise, then

Accepted Answer

If income tax rates rise, it is expected to lead to an increase in government revenue, which could reduce the need for Treasury bonds to finance government operations. As a result, the prices for Treasury bonds may rise, and the interest rate may also increase. Municipal bonds, on the other hand, may become less attractive to investors due to the higher tax rate, which could lead to a decrease in demand and a rise in interest rates.

Question 18

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

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 19

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 ________.

Accepted Answer

When the corporate bond market becomes less liquid, investors tend to shift their demand towards more liquid and safe assets such as Treasury bonds. This increases the demand for Treasury bonds, shifting its demand curve to the right. On the other hand, the decrease in demand for corporate bonds shifts its demand curve to the left.

Question 20

Which of the following statements are true?

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.

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

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.

Yield curves can be classified as

(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.

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 .

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 .

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

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 .

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.

Typically, yield curves are

When yield curves are steeply upward-sloping,

Corporate bonds are not as liquid as government bonds because

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

Which of the following statements are true?

(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.

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

If income tax rates rise, then

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

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 .

Which of the following statements are true?