Question 1

Some financial institutions such as commercial banks are required by law to invest only in
A)junk bonds.
B)corporate stock.
C)Treasury securities.
D)investment-grade bonds.

Accepted Answer

Treasury securities are considered to be the safest type of investment, and as such, are often required by law to be held by financial institutions such as commercial banks.

Question 2

In general, securities with ____ characteristics will offer ____ yields.
A)favorable; higher
B)favorable; lower
C)unfavorable; lower
D)none of the above

Accepted Answer

B

Question 3

If a security can easily be converted to cash without a loss in value, it
A)is liquid.
B)has a high after-tax yield.
C)has high default risk.
D)is illiquid.

Accepted Answer

A security that can easily and quickly be sold or converted to cash without significant loss in value is considered liquid. This is an important characteristic for investors who may need to access their funds quickly in case of emergencies or to take advantage of investment opportunities.

Question 4

Credit ratings are most commonly used to indicate which financial institutions have available funds that they can lend to borrowers.

Accepted Answer

Credit ratings are used to indicate the creditworthiness of borrowers, not the availability of funds at financial institutions.

Question 5

Interest income from municipal bonds is exempt from state taxes but is subject to federal taxes.

Accepted Answer

Interest income from municipal bonds is generally exempt from federal taxes, but it may be subject to state taxes depending on the state and the specific bond.

Question 6

Holding other factors such as risk constant, the relationship between the maturity and annualized yield of securities is called the
A)term structure of interest rates.
B)default structure of interest rates.
C)liquidity structure of interest rates.
D)tax structure of interest rates.
E)none of the above

Accepted Answer

The relationship between the maturity and annualized yield of securities is known as the term structure of interest rates. This relationship reflects the market's expectation of future interest rates and is used to price various financial instruments. Other factors such as credit risk and liquidity can also impact interest rates, but the term structure provides insight into the general trend of interest rates over time.

Question 7

The yield offered on a debt security is ____ related to the prevailing risk-free rate and ____ related to the security's risk premium.
A)negatively; negatively
B)positively; positively
C)negatively; positively
D)positively; negatively

Accepted Answer

The yield on a debt security is positively related to both the prevailing risk-free rate and the security's risk premium. This is because as the risk-free rate increases, the overall yield required by investors also increases. Similarly, as the risk associated with a security (its risk premium) increases, investors demand a higher yield to compensate for the higher risk.

Question 8

Assume investors are indifferent among security maturities. Today, the annualized 2-year interest rate is 12 percent, and the 1-year interest rate is 9 percent. What is the forward rate according to the pure expectations theory?
A)15.08 percent
B)3.00 percent
C)12.00 percent
D)12.62 percent
E)11.41 percent

Accepted Answer

The answer of Assume investors are indifferent among security maturities....

Question 9

A firm in the 35 percent tax bracket is aware of a tax-exempt security that is paying a yield of 7 percent. To match this yield, taxable securities must offer a before-tax yield of
A)7.0 percent.
B)10.8 percent.
C)20.0 percent.
D)none of the above

Accepted Answer

To match the yield of 7 percent on the tax-exempt security, the before-tax yield on taxable securities must be calculated as follows:
Before-tax yield = tax-exempt yield / (1 - tax rate)
Before-tax yield = 0.07 / (1 - 0.35)
Before-tax yield = 0.1077 or 10.77%
Rounding up to the nearest tenth of a percent, the answer is 10.8%. Therefore, choice B is correct.

Question 10

Securities that offer ____ liquidity will need to offer a ____ yield.
A)lower; higher
B)lower; lower
C)higher; higher
D)B and C

Accepted Answer

Securities that offer lower liquidity means that they are harder to buy or sell quickly without significantly affecting the price. Therefore, buyers will demand a higher yield as compensation for taking on the risk of potentially not being able to sell the security quickly if needed.

Question 11

Default risk is likely to be highest for
A)short-term Treasury securities.
B)AAA corporate securities.
C)long-term Treasury securities.
D)BBB corporate securities.

Accepted Answer

BBB corporate securities have a higher default risk compared to AAA corporate securities and short-term Treasury securities. Long-term Treasury securities also have a low default risk.

Question 12

Within the category of capital market securities, municipal bonds have the ____ before-tax yield, and their after-tax yield is typically ____ of Treasury bonds from the perspective of investors in high tax brackets.
A)highest; below that
B)lowest; above that
C)highest; above that
D)lowest; below that

Accepted Answer

Municipal bonds generally offer the lowest before-tax yield because the interest income is exempt from federal income taxes and, in some cases, state and local taxes as well. For investors in high tax brackets, this tax exemption can make the after-tax yield of municipal bonds higher than that of Treasury bonds, which are subject to federal income tax.

Question 13

The theory for the term structure of interest rates that says the shape of the yield curve is determined solely by expectations of future interest rates is called the
A)segmented markets theory.
B)liquidity premium theory.
C)pure expectations theory.
D)theory of rational expectations.

Accepted Answer

The theory that says the shape of the yield curve is determined solely by expectations of future interest rates is called the pure expectations theory. This theory assumes that different maturities of bonds are perfect substitutes for investors and therefore their yields only reflect market expectations of future short-term rates.

Question 14

If issuers of securities (borrowers) and investors suddenly expect interest rates to decrease, their actions to benefit from their expectations should cause
A)long-term yields to rise.
B)short-term yields to decrease.
C)prices of long-term securities to decrease.
D)A and B
E)none of the above

Accepted Answer

The answer of If issuers of securities (borrowers) and investors...

Question 15

An investor's tax rate is 30 percent. What must the before-tax yield on a security be to have an after-tax yield of 11 percent?
A)7.7 percent
B)15.71 percent
C)130 percent
D)11.00 percent
E)none of the above

Accepted Answer

Let x be the before-tax yield on the security.
After-tax yield = before-tax yield x (1 - tax rate)
11% = x(1 - 0.3)
11% = 0.7x
x = 15.71%
Therefore, the before-tax yield on the security must be 15.71% to have an after-tax yield of 11%.

Question 16

If shorter term securities have higher annualized yields than longer term securities, the yield curve
A)is horizontal.
B)is upward sloping.
C)is downward sloping.
D)cannot be determined unless we know additional information (such as the level of market interest rates).

Accepted Answer

This is because a downward sloping yield curve indicates that longer-term securities have lower annualized yields than shorter-term securities.

Question 17

If all other characteristics are similar, ____ would have to offer ____.
A)taxable securities; a higher after-tax yield than tax-exempt securities
B)taxable securities; a higher before-tax yield than tax-exempt securities
C)tax-exempt securities; a higher after-tax yield than taxable securities
D)tax-exempt securities; a higher before-tax yield than taxable securities

Accepted Answer

Taxable securities must offer a higher before-tax yield than tax-exempt securities to compensate for the taxes investors must pay on the earnings from taxable securities, making them attractive compared to tax-exempt securities.

Question 18

Assume that annualized yields of short-term and long-term securities are equal. If investors suddenly believe interest rates will increase, their actions may cause the yield curve to
A)become inverted.
B)become flat.
C)become upward sloping.
D)be unaffected.

Accepted Answer

If investors suddenly believe interest rates will increase, they will sell off their long-term securities, causing their yields to increase. This will make the yield curve upward sloping, as long-term yields will be higher than short-term yields.

Question 19

Assume an investor's tax rate is 25 percent. The before-tax yield on a security is 12 percent. What is the after-tax yield?
A)16.00 percent
B)9.25 percent
C)9.00 percent
D)3.00 percent
E)none of the above

Accepted Answer

The answer of Assume an investor's tax rate is 25...

Question 20

The term structure of interest rates defines the relationship
A)between risk and return.
B)between risk and maturity.
C)between maturity and yield.
D)between default risk ratings and maturity.

Accepted Answer

The term structure of interest rates refers to the relationship between maturity and yield. It describes the differences in interest rates for securities with different maturities but similar credit quality. It is also known as the yield curve. It helps investors to understand the expectations of the market about the future direction of interest rates, inflation, and economic growth.

Quiz 3: Structure of Interest Rates

Some financial institutions such as commercial banks are required by law to invest only in

In general, securities with characteristics will offer yields.

If a security can easily be converted to cash without a loss in value, it

Credit ratings are most commonly used to indicate which financial institutions have available funds that they can lend to borrowers.

Interest income from municipal bonds is exempt from state taxes but is subject to federal taxes.

Holding other factors such as risk constant, the relationship between the maturity and annualized yield of securities is called the

The yield offered on a debt security is related to the prevailing risk-free rate and related to the security's risk premium.

Assume investors are indifferent among security maturities. Today, the annualized 2-year interest rate is 12 percent, and the 1-year interest rate is 9 percent. What is the forward rate according to the pure expectations theory?

A firm in the 35 percent tax bracket is aware of a tax-exempt security that is paying a yield of 7 percent. To match this yield, taxable securities must offer a before-tax yield of

Securities that offer liquidity will need to offer a yield.

Default risk is likely to be highest for

Within the category of capital market securities, municipal bonds have the before-tax yield, and their after-tax yield is typically of Treasury bonds from the perspective of investors in high tax brackets.

The theory for the term structure of interest rates that says the shape of the yield curve is determined solely by expectations of future interest rates is called the

If issuers of securities (borrowers) and investors suddenly expect interest rates to decrease, their actions to benefit from their expectations should cause

An investor's tax rate is 30 percent. What must the before-tax yield on a security be to have an after-tax yield of 11 percent?

If shorter term securities have higher annualized yields than longer term securities, the yield curve

If all other characteristics are similar, would have to offer .

Assume that annualized yields of short-term and long-term securities are equal. If investors suddenly believe interest rates will increase, their actions may cause the yield curve to

Assume an investor's tax rate is 25 percent. The before-tax yield on a security is 12 percent. What is the after-tax yield?

The term structure of interest rates defines the relationship