41) Economists’ attempts to explain the term structure of interest rates
A) illustrate how economists modify theories to improve them when they are inconsistent with
the empirical evidence.
B) illustrate how economists continue to accept theories that fail to explain observed behavior of
interest rate movements.
C) prove that the real world is a special case that tends to get short shrift in theoretical models.
D) have proved entirely unsatisfactory to date.
42) According to the expectations theory of the term structure,
A) the interest rate on long-term bonds will exceed the average of expected future short-term
interest rates.
B) interest rates on bonds of different maturities move together over time.
C) buyers of bonds prefer short-term to long-term bonds.
D) all of the above.
E) only A and B of the above.
43) According to the expectations theory of the term structure,
A) when the yield curve is steeply upward-sloping, short-term interest rates are expected to rise
in the future.
B) when the yield curve is downward-sloping, short-term interest rates are expected to decline in
the future.
C) buyers of bonds prefer short-term to long-term bonds.
D) all of the above.
E) only A and B of the above.
44) According to the expectations theory of the term structure,
A) when the yield curve is steeply upward-sloping, short-term interest rates are expected to rise
in the future.
B) when the yield curve is downward-sloping, short-term interest rates are expected to remain
relatively stable in the future.
C) investors have strong preferences for short-term relative to long-term bonds, explaining why
yield curves typically slope upward.
D) all of the above.
E) only A and B of the above.
45) According to the expectations theory of the term structure,
A) yield curves should be equally likely to slope downward as to slope upward.
B) when the yield curve is steeply upward-sloping, short-term interest rates are expected to rise
in the future.
C) when the yield curve is downward-sloping, short-term interest rates are expected to remain
relatively stable in the future.
D) all of the above.
E) only A and B of the above.
46) If the expected path of one-year interest rates over the next four years is 5 percent, 4 percent,
2 percent, and 1 percent, then the pure expectations theory predicts that today’s interest rate on
the four-year bond is
A) 1 percent.
B) 2 percent.
C) 4 percent.
D) none of the above.
47) If the expected path of one-year interest rates over the next five years is 1 percent, 2 percent,
3 percent, 4 percent, and 5 percent, then the pure expectations theory predicts that the bond with
the highest interest rate today is the one with a maturity of
A) one year.
B) two years.
C) three years.
D) four years.
E) five years.
48) If the expected path of one-year interest rates over the next five years is 2 percent, 4 percent,
1 percent, 4 percent, and 3 percent, then the pure expectations theory predicts that the bond with
the lowest interest rate today is the one with a maturity of
A) one year.
B) two years.
C) three years.
D) four years.
49) According to the market segmentation theory of the term structure,
A) the interest rate for bonds of one maturity is determined by the supply and demand for bonds
of that maturity.
B) bonds of one maturity are not substitutes for bonds of other maturities; therefore, interest rates
on bonds of different maturities do not move together over time.
C) investors’ strong preference for short-term relative to long-term bonds explains why yield
curves typically slope upward.
D) all of the above.
E) none of the above.
50) According to the market segmentation theory of the term structure,
A) the interest rate for bonds of one maturity is determined by the supply and demand for bonds
of that maturity.
B) bonds of one maturity are not substitutes for bonds of other maturities; therefore, interest rates
on bonds of different maturities do not move together over time.
C) investors’ strong preference for short-term relative to long-term bonds explains why yield
curves typically slope downward.
D) only A and B of the above.
51) The liquidity premium theory of the term structure
A) indicates that today’s long-term interest rate equals the average of short-term interest rates that
people expect to occur over the life of the long-term bond.
B) assumes that bonds of different maturities are perfect substitutes.
C) suggests that markets for bonds of different maturities are completely separate because people
have different preferences.
D) does none of the above.
52) The liquidity premium theory of the term structure
A) assumes investors tend to prefer short-term bonds because they have less interest-rate risk.
B) assumes that interest rates on the long-term bond respond to demand and supply conditions
for that bond.
C) assumes that an average of expected short-term rates is an important component of interest
rates on long-term bonds.
D) assumes all of the above.
E) assumes none of the above.
53) According to the liquidity premium theory of the term structure,
A) the interest rate on long-term bonds will equal an average of short-term interest rates that
people expect to occur over the life of the long-term bonds plus a liquidity premium.
B) buyers of bonds may prefer bonds of one maturity over another, yet interest rates on bonds of
different maturities move together over time.
C) even with a positive liquidity premium, if future short-term interest rates are expected to fall
significantly, then the yield curve will be downward-sloping.
D) all of the above.
E) only A and B of the above.
54) According to the liquidity premium theory of the term structure,
A) because buyers of bonds may prefer bonds of one maturity over another, interest rates on
bonds of different maturities do not move together over time.
B) the interest rate on long-term bonds will equal an average of short-term interest rates that
people expect to occur over the life of the long-term bonds plus a term premium.
C) because of the positive term premium, the yield curve cannot be downward-sloping.
D) all of the above.
E) only A and B of the above.
55) If the yield curve slope is flat, the liquidity premium theory indicates that the market is
predicting
A) a mild rise in short-term interest rates in the near future and a mild decline further out in the
future.
B) constant short-term interest rates in the near future and further out in the future.
C) a mild decline in short-term interest rates in the near future and a continuing mild decline
further out in the future.
D) constant short-term interest rates in the near future and a mild decline further out in the future.
56) If the yield curve has a mild upward slope, the liquidity premium theory indicates that the
market is predicting
A) a rise in short-term interest rates in the near future and a decline further out in the future.
B) constant short-term interest rates in the near future and further out in the future.
C) a decline in short-term interest rates in the near future and a rise further out in the future.
D) a decline in short-term interest rates in the near future and an even steeper decline further out
in the future.
57) According to the liquidity premium theory of the term structure, a downward-sloping yield
curve indicates that short-term interest rates are expected to
A) rise in the future.
B) remain unchanged in the future.
C) decline moderately in the future.
D) decline sharply in the future.
58) According to the liquidity premium theory of the term structure, when the yield curve has its
usual slope, the market expects
A) short-term interest rates to rise sharply.
B) short-term interest rates to drop sharply.
C) short-term interest rates to stay near their current levels.
D) none of the above.
59) In actual practice, short-term interest rates are just as likely to fall as to rise; this is the major
shortcoming of the
A) market segmentation theory.
B) expectations theory.
C) liquidity premium theory.
D) separable markets theory.
60) Which theory of the term structure proposes that bonds of different maturities are not
substitutes for one another?
A) Market segmentation theory
B) Expectations theory
C) Liquidity premium theory
D) Separable markets theory
61) Since yield curves are usually upward sloping, the ________ indicates that, on average,
people tend to prefer holding short-term bonds to long-term bonds.
A) market segmentation theory
B) expectations theory
C) liquidity premium theory
D) both A and B of the above
E) both A and C of the above
62) ________ cannot explain the empirical fact that interest rates on bonds of different maturities
tend to move together.
A) The market segmentation theory
B) The expectations theory
C) The liquidity premium theory
D) Both A and B of the above
E) Both A and C of the above
63) Of the four theories that explain how interest rates on bonds with different terms to maturity
are related, the one that views long-term interest rates as equaling the average of future short-
term rates expected to occur over the life of the bond is the
A) pure expectations theory.
B) preferred habitat theory.
C) liquidity premium theory.
D) segmented markets theory.
64) Of the four theories that explain how interest rates on bonds with different terms to maturity
are related, the one that assumes that bonds of different maturities are not substitutes for one
another is the
A) expectations theory.
B) segmented markets theory.
C) liquidity premium theory.
D) preferred habitat theory.
65) A moderately upward-sloping yield curve indicates that short-term interest rates are expected
to
A) neither rise nor fall in the near future.
B) remain relatively unchanged, but that long-term rates are expected to fall.
C) neither rise nor fall, but that long-term rates are expected to rise moderately.
D) rise moderately in the near future.
66) A steep upward-sloping yield curve indicates that short-term interest rates are expected to
A) neither rise nor fall in the near future.
B) remain relatively unchanged, but that long-term rates are expected to fall.
C) neither rise nor fall, but that long-term rates are expected to rise moderately.
D) rise moderately in the near future.
67) A bond rating of Aa or AA would mean that the quality of the bond is
A) the highest.
B) high.
C) medium grade.
D) speculative.
68) ________ bonds are the most liquid of all long-term bonds.
A) Callable
B) Municipal
C) Corporate Aaa
D) U.S. Treasury