978-0133427073 Test Bank Chapter 5 Part 3

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69) ________ bonds are exempt from federal income taxes.

A) Corporate Aaa

B) U.S. Treasury

C) Corporate Baa

D) Municipal

70) The risk structure of interest rates is explained by

A) default risk.

B) liquidity.

C) tax considerations.

D) all of the above.

71) The ________ theory is the most widely accepted theory of the term structure of interest

rates because it explains the major empirical facts about the term structure so well.

A) liquidity premium

B) market segmentation

C) expectations

D) none of the above

72) ________ are investment advisory firms that rate the quality of corporate and municipal

bonds in terms of probability of default.

A) Financial institutions

B) Credit-rating agencies

C) Securities companies

D) none of the above

73) If a bond has a favorable tax treatment, its required interest rate (all else equal)

A) will be higher.

B) will not be affected.

C) will be lower.

D) all of the above could happen.

74) Based on the expectations hypothesis, the steep upward sloping yield curve in June of 2013

indicted that short-term rates would ________ in the future.

A) climb

B) fall

C) remain the same

D) change in a random fashion

75) A bond with default risk will always have a ________ risk premium, and an increase in its

default risk will raise the risk premium.

A) positive

B) negative

C) unpredictable

D) minimal

76) Closely related to the ________ is the preferred habitat theory, which takes a somewhat less

direct approach to modifying the expectations hypothesis but comes to a similar conclusion.

A) liquidity premium theory

B) expectations theory

C) market segmentation theory

D) supply theory

1) The term structure of interest rates describes how interest rates move over time.

2) The risk structure of interest rates describes the relationship between the interest rates of

different bonds with the same maturities.

3) Following the subprime collapse, the spread (difference) between the interest rates on Baa

bonds and Treasury bonds widened.

4) The risk premium on corporate bonds becomes smaller as the liquidity of the bonds falls.

5) An increase in income tax rates will cause the interest rates on tax-exempt municipal bonds to

fall relative to the interest rate on taxable corporate securities.

6) The interest rates on bonds of different maturities tend to move together over time.

7) The expectations theory is able to explain why yield curves are usually upward-sloping.

8) According to the expectations theory, the interest rate on a long-term bond is the average of

the short-term interest rates expected over the life of the long-term bond.

9) The market segmentation theory is able to explain why interest rates on bonds of different

maturities move together over time.

10) Bonds with the lowest risk of default are often referred to as junk bonds.

11) A positive liquidity premium indicates that investors prefer long-term bonds over short-term

bonds.

12) A mildly upward-sloping yield curve suggests that the market is predicting constant short–

term interest rates.

13) An increase in the marginal tax rate would likely increase the demand for municipal bonds,

and decrease the demand for U.S. government bonds.

14) When yield curves are downward-sloping, long-term interest rates are above short-term

interest rates.

15) Risk occurs when the issuer of the bond is unable or unwilling to make interest payments

when promised or pay off the face value when the bond matures.

16) The spread between the interest rates on bonds with default risk and default-free bonds is

called the risk premium.

17) With the Obama tax increase that repealed the Bush tax cuts for high-income tax payers in

2013, the after-tax expected return on tax-free municipal bonds relative to Treasury bonds

decreases.

18) Risk, liquidity, and income tax rules all play a role in determining the risk structure of

interest rates.

19) During the budget negotiations in Congress in 1995-1996, and then again in 2011-2013, the

Republicans threatened to let Treasury bonds default, and this had an impact on the bond market.

5.3 Essay

1) Contrast the liquidity premium theory to the market segmentation theory of the term structure

of interest rates.

Topic: Chapter 5.2 Term Structure of Interest Rates