Question 1

If the liquidity premium exists, a flat yield curve would be interpreted as the market expecting ____ in interest rates.
A)no changes
B)a slight decrease
C)a slight increase
D)a large increase

Accepted Answer

The liquidity premium theory suggests that longer-term interest rates typically include a premium for holding longer-term bonds, due to their greater risk. If the yield curve is flat despite this, it implies that the market expects short-term interest rates to decrease slightly, offsetting the liquidity premium and resulting in a flat curve.

Question 2

Other things equal, the yield required on A-rated bonds should be ____ the yield required on B-rated bonds whose other characteristics are exactly the same.
A)greater than
B)equal to
C)less than
D)All of the above are possible, depending on the size of the bond offering.

Accepted Answer

A-rated bonds are considered to be more secure and less risky than B-rated bonds, so investors would require a lower yield on A-rated bonds compared to B-rated bonds with the same characteristics. Therefore, the yield on A-rated bonds should be less than the yield on B-rated bonds.

Question 3

Assume the yield curve is flat. If investors flood the short-term market and avoid the long-term market, they may cause the yield curve to
A)remain flat.
B)become upward sloping.
C)become downward sloping.
D)none of the above

Accepted Answer

If investors flood the short-term market and avoid the long-term market, it will increase the demand for short-term bonds, which would push their prices up and their yields down. At the same time, the lack of demand for long-term bonds would push their prices down and their yields up. This would result in a steepening of the yield curve, causing it to become upward sloping.

Question 4

If a yield curve is upward sloping, the investment strategy of buying long-term securities, then selling them after a short period (say, one year) is called
A)riding the yield curve.
B)liquidating the yield curve.
C)segmenting the yield curve.
D)a forward roll.
E)none of the above

Accepted Answer

Riding the yield curve refers to buying long-term securities and holding them for a short period to take advantage of the upward sloping yield curve. As interest rates rise, the prices of existing long-term securities increase, resulting in capital gains for the investor. This strategy is popular among bond traders and investors who believe that interest rates will remain low or continue to decline in the near future.

Question 5

Assume that a yield curve is influenced by interest rate expectations and a liquidity premium. Assume the yield curve is initially flat. If liquidity suddenly was no longer important, the yield curve would now have a ____ (assuming no other changes).
A)slight downward slope
B)slight upward slope
C)steep upward slope
D)steep downward slope

Accepted Answer

The answer of Assume that a yield curve is influenced...

Question 6

If liquidity influences the yield curve, but is not considered when deriving the forward interest rate, the forward interest rate ____ the market's expectation of the future interest rate.
A)overestimates
B)accurately estimates
C)underestimates
D)is an unbiased forecast of (it has an equal chance of overestimating or underestimating)

Accepted Answer

Liquidity preferences can cause the yield curve to reflect higher interest rates for longer maturities, not solely due to expectations of higher future rates but also due to the demand for premium for longer-term investments. If liquidity is not considered when deriving the forward interest rate from the current yield curve, the forward rate may overestimate the market's expectation of future interest rates, as it includes a liquidity premium that is not directly related to expectations of future rate movements.

Question 7

The theory of the term structure of interest rates, which states that investors and borrowers choose securities with maturities that satisfy their forecasted cash needs, is the
A)pure expectations theory.
B)liquidity premium theory.
C)segmented markets theory.
D)liquidity habitat theory.

Accepted Answer

The segmented markets theory of the term structure of interest rates posits that the market for bonds is segmented based on their maturity, with investors and borrowers choosing securities that match their specific investment or borrowing needs. This theory suggests that the demand and supply for bonds of different maturities are determined independently of each other, leading to interest rates for various maturities being determined separately.

Question 8

Assume that today, the annualized two-year interest rate is 12 percent, and the one-year interest rate is 9 percent. A three-year security has an annualized interest rate of 14 percent. What is the one-year forward rate two years from now?
A)12.67 percent
B)113 percent
C)195 percent
D)15.67 percent
E)none of the above

Accepted Answer

The answer of Assume that today, the annualized two-year interest...

Question 9

The degree to which the Treasury's debt management policy could affect the term structure of interest rates is greatest if
A)most debt is financed by foreign investors.
B)the Treasury's debt level is small.
C)maturity markets are segmented.
D)A and B

Accepted Answer

If maturity markets are segmented, then changes in the Treasury's debt management policy, such as the issuance of more short-term or long-term debt, could have a larger impact on the term structure of interest rates. If the markets are not segmented, then investors may simply adjust their portfolio allocation to offset any changes in the Treasury's debt mix. The other choices (A and B) do not necessarily have a significant impact on the degree to which the Treasury's debt management policy affects interest rates.

Question 10

A theory states that while investors and borrowers may normally concentrate on a particular natural maturity market, conditions may cause them to change maturity markets. This theory is called the
A)liquidity premium theory.
B)efficient markets theory.
C)pure expectations theory.
D)preferred habitat theory.

Accepted Answer

The preferred habitat theory states that investors and borrowers may have a preferred maturity market, but conditions such as liquidity needs or market conditions may cause them to venture into other maturity markets. This theory combines elements of the liquidity premium and pure expectations theories.

Question 11

According to segmented markets theory, if investors have mostly short-term funds available and borrowers want long-term funds, there would be ____ pressure on the supply of short-term funds provided by investors and ____ pressure on the yield of long-term securities.
A)upward; upward
B)downward; downward
C)upward; downward
D)downward; upward

Accepted Answer

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

Question 12

According to the liquidity premium theory, the expected yield on a two-year security will ____ the expected yield from consecutive investments in one-year securities.
A)equal
B)be less than
C)be greater than
D)B and C are possible, depending on the size of the liquidity premium

Accepted Answer

The answer of According to the liquidity premium theory, the...

Question 13

Assume that the current yield on one-year securities is 6 percent, and that the yield on a two-year security is 7 percent. If the liquidity premium on a two-year security is 0.4 percent, then the one-year forward rate is
A)8.0 percent.
B)7.6 percent.
C)3.0 percent.
D)7.0 percent.

Accepted Answer

The formula to calculate the one-year forward rate is:

one-year forward rate = [(1 + two-year yield) / (1 + one-year yield)] - 1 - liquidity premium on a two-year security

Plugging in the values, we get:

one-year forward rate = [(1 + 0.07) / (1 + 0.06)] - 1 - 0.004
one-year forward rate = 0.076 - 1 - 0.004
one-year forward rate = 0.072 or 7.2%

Therefore, the correct answer is B) 7.6 percent.

Question 14

The yield curve in a foreign country is
A)always downward sloping.
B)non-existent.
C)the same as the United States at any point in time.
D)none of the above

Accepted Answer

The shape of the yield curve in a foreign country may vary and is not always downward sloping or non-existent. It may also differ from the United States at any given point in time, as it is influenced by a country's economic conditions and monetary policy.

Question 15

Assume that the Treasury bond yield today is 2% higher than it was one year ago. Also assume that the credit (default) risk premium of an A-rated bond declined by 0.4% since one year ago. A newly issued A-rated bond will likely offer a yield today that is ____ the yield that was offered on an A-rated bond issued one year ago.
A)greater than
B)equal to
C)less than
D)A or B are both common

Accepted Answer

The yield on the A-rated bond today is likely greater than a year ago because the increase in the Treasury bond yield (2%) is larger than the decrease in the credit risk premium (0.4%), resulting in a net increase in yield.

Question 16

In some time periods there is evidence that corporations initially financed long-term projects with short-term funds. They planned to borrow long-term funds once interest rates were lower. This specifically supports the ____ for explaining the term structure of interest rates.
A)liquidity premium theory
B)expectations theory
C)segmented markets theory
D)A and C

Accepted Answer

The scenario described supports the expectations theory, which posits that long-term interest rates are determined by the market's expectations for future short-term interest rates. If corporations plan to borrow long-term funds when interest rates are expected to be lower in the future, this would contribute to a downward sloping yield curve, which is consistent with the expectations theory.

Question 17

According to the pure expectations theory of the term structure of interest rates, the ____ the difference between the implied one-year forward rate and today's one-year interest rate, the ____ is the expected change in the one-year interest rate.
A)greater; less
B)less; greater
C)greater; greater
D)less; less
E)C and D

Accepted Answer

The answer of According to the pure expectations theory of...

Question 18

According to the segmented markets theory, if most investors suddenly preferred to invest in short-term securities and most borrowers suddenly preferred to issue long-term securities there would be
A)upward pressure on the price of long-term securities.
B)upward pressure on the price of short-term securities.
C)downward pressure on the yield of long-term securities.
D)A and C

Accepted Answer

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

Question 19

According to expectations theory, the sudden expectation of lower interest rates in the future will cause a ____ supply of short-term funds provided by investors, and a ____ supply of long-term funds.
A)large; large
B)large; small
C)small; small
D)small; large

Accepted Answer

According to the expectations theory, if investors expect lower interest rates in the future, they will demand fewer long-term bonds in the present, leading to a decrease in supply. On the other hand, the demand for short-term funds may increase as investors may prefer to hold short-term bonds until the interest rates fall further. This would lead to a decrease in the supply of short-term funds as investors are holding onto their investments for a shorter duration. Therefore, the sudden expectation of lower interest rates will cause a small supply of short-term funds provided by investors, and a large supply of long-term funds.

Question 20

According to pure expectations theory, if interest rates are expected to decrease, there will be ____ pressure on the demand for short-term funds by borrowers and ____ pressure on the demand for long-term funds issued by borrowers.
A)upward; upward
B)downward; downward
C)upward; downward
D)downward; upward

Accepted Answer

The answer of According to pure expectations theory, if interest...

Quiz 3: Structure of Interest Rates

If the liquidity premium exists, a flat yield curve would be interpreted as the market expecting ____ in interest rates.

Other things equal, the yield required on A-rated bonds should be ____ the yield required on B-rated bonds whose other characteristics are exactly the same.

Assume the yield curve is flat. If investors flood the short-term market and avoid the long-term market, they may cause the yield curve to

If a yield curve is upward sloping, the investment strategy of buying long-term securities, then selling them after a short period (say, one year) is called

Assume that a yield curve is influenced by interest rate expectations and a liquidity premium. Assume the yield curve is initially flat. If liquidity suddenly was no longer important, the yield curve would now have a ____ (assuming no other changes) .

If liquidity influences the yield curve, but is not considered when deriving the forward interest rate, the forward interest rate ____ the market's expectation of the future interest rate.

The theory of the term structure of interest rates, which states that investors and borrowers choose securities with maturities that satisfy their forecasted cash needs, is the

Assume that today, the annualized two-year interest rate is 12 percent, and the one-year interest rate is 9 percent. A three-year security has an annualized interest rate of 14 percent. What is the one-year forward rate two years from now?

The degree to which the Treasury's debt management policy could affect the term structure of interest rates is greatest if

A theory states that while investors and borrowers may normally concentrate on a particular natural maturity market, conditions may cause them to change maturity markets. This theory is called the

According to segmented markets theory, if investors have mostly short-term funds available and borrowers want long-term funds, there would be pressure on the supply of short-term funds provided by investors and pressure on the yield of long-term securities.

According to the liquidity premium theory, the expected yield on a two-year security will ____ the expected yield from consecutive investments in one-year securities.

Assume that the current yield on one-year securities is 6 percent, and that the yield on a two-year security is 7 percent. If the liquidity premium on a two-year security is 0.4 percent, then the one-year forward rate is

The yield curve in a foreign country is

In some time periods there is evidence that corporations initially financed long-term projects with short-term funds. They planned to borrow long-term funds once interest rates were lower. This specifically supports the ____ for explaining the term structure of interest rates.

According to the pure expectations theory of the term structure of interest rates, the the difference between the implied one-year forward rate and today's one-year interest rate, the is the expected change in the one-year interest rate.

According to the segmented markets theory, if most investors suddenly preferred to invest in short-term securities and most borrowers suddenly preferred to issue long-term securities there would be

According to expectations theory, the sudden expectation of lower interest rates in the future will cause a supply of short-term funds provided by investors, and a supply of long-term funds.

According to pure expectations theory, if interest rates are expected to decrease, there will be pressure on the demand for short-term funds by borrowers and pressure on the demand for long-term funds issued by borrowers.