Chapter 03: Structure of Interest Rates
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1. In general, securities with ____ characteristics will offer ____ yields.
a.
favorable; higher
b.
favorable; lower
c.
unfavorable; lower
d.
none of the above
ANSWER:
b
POINTS:
1
DIFFICULTY:
Easy
LEARNING OBJECTIVES:
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Bloom’s: Knowledge
2. Credit (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.
ANSWER:
d
POINTS:
1
DIFFICULTY:
Easy
LEARNING OBJECTIVES:
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NATIONAL STANDARDS:
United States – BUSPROG.FMAI.MADU.15.03
STATE STANDARDS:
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KEYWORDS:
Bloom’s: Knowledge
3. Some financial institutions such as commercial banks typically invest only in
a.
b.
c.
d.
ANSWER:
d
POINTS:
1
DIFFICULTY:
Easy
LEARNING OBJECTIVES:
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NATIONAL STANDARDS:
United States – BUSPROG.FMAI.MADU.15.03
STATE STANDARDS:
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KEYWORDS:
Bloom’s: Knowledge
4. Credit ratings are most commonly used to indicate which financial institutions have available funds that they can lend
to borrowers.
a.
True
b.
False
ANSWER:
b
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5. 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 credit risk.
d.
is illiquid.
ANSWER:
a
POINTS:
1
DIFFICULTY:
Easy
LEARNING OBJECTIVES:
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NATIONAL STANDARDS:
United States – BUSPROG.FMAI.MADU.15.03
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KEYWORDS:
Bloom’s: Knowledge
6. Interest rate movements across countries tend to be _________ correlated as a result of ____________ financial
markets.
a.
positively; internationally integrated
b.
positively; fully segmented
c.
negatively; partially segmented
d.
negatively; internationally integrated
ANSWER:
a
POINTS:
1
DIFFICULTY:
Easy
LEARNING OBJECTIVES:
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NATIONAL STANDARDS:
United States – BUSPROG.FMAI.MADU.15.03
STATE STANDARDS:
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KEYWORDS:
Bloom’s: Knowledge
7. 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
ANSWER:
b
POINTS:
1
DIFFICULTY:
Moderate
LEARNING OBJECTIVES:
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NATIONAL STANDARDS:
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POINTS:
1
DIFFICULTY:
Easy
LEARNING OBJECTIVES:
FMAI.MADU.15.03.01
NATIONAL STANDARDS:
United States – BUSPROG.FMAI.MADU.15.03
STATE STANDARDS:
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Bloom’s: Knowledge
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8. 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
ANSWER:
c
POINTS:
1
DIFFICULTY:
Easy
LEARNING OBJECTIVES:
FMAI.MADU.15.03.01
NATIONAL STANDARDS:
United States – BUSPROG.FMAI.MADU.15.03
STATE STANDARDS:
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KEYWORDS:
Bloom’s: Application
9. 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
ANSWER:
b
POINTS:
1
DIFFICULTY:
Moderate
LEARNING OBJECTIVES:
FMAI.MADU.15.03.01
NATIONAL STANDARDS:
United States – BUSPROG.FMAI.MADU.15.03
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KEYWORDS:
Bloom’s: Application
10. 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
ANSWER:
a
POINTS:
1
DIFFICULTY:
Moderate
LEARNING OBJECTIVES:
FMAI.MADU.15.03.01
NATIONAL STANDARDS:
United States – BUSPROG.FMAI.MADU.15.03
STATE STANDARDS:
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Bloom’s: Comprehension
Chapter 03: Structure of Interest Rates
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a.
become inverted.
b.
become flat.
c.
become upward sloping.
d.
be unaffected.
ANSWER:
c
POINTS:
1
DIFFICULTY:
Easy
LEARNING OBJECTIVES:
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United States – BUSPROG.FMAI.MADU.15.03
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KEYWORDS:
Bloom’s: Application
15. 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
ANSWER:
e
POINTS:
1
DIFFICULTY:
Easy
LEARNING OBJECTIVES:
FMAI.MADU.15.03.04
NATIONAL STANDARDS:
United States – BUSPROG.FMAI.MADU.15.03
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KEYWORDS:
Bloom’s: Application
16. 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
ANSWER:
b
POINTS:
1
DIFFICULTY:
Moderate
LEARNING OBJECTIVES:
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Bloom’s: Knowledge
17. 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
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c.
negatively; positively
d.
positively; negatively
ANSWER:
b
POINTS:
1
DIFFICULTY:
Moderate
LEARNING OBJECTIVES:
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NATIONAL STANDARDS:
United States – BUSPROG.FMAI.MADU.15.03
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Bloom’s: Knowledge
18. 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.
ANSWER:
c
POINTS:
1
DIFFICULTY:
Easy
LEARNING OBJECTIVES:
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Bloom’s: Knowledge
19. 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
ANSWER:
a
POINTS:
1
DIFFICULTY:
Moderate
LEARNING OBJECTIVES:
FMAI.MADU.15.03.04
NATIONAL STANDARDS:
United States – BUSPROG.FMAI.MADU.15.03
STATE STANDARDS:
United States – OH – DISC.FMAI.MADU.15.02
KEYWORDS:
Bloom’s: Application
20. 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
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ANSWER:
b
POINTS:
1
DIFFICULTY:
Easy
LEARNING OBJECTIVES:
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United States – BUSPROG.FMAI.MADU.15.03
STATE STANDARDS:
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KEYWORDS:
Bloom’s: Knowledge
21. 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
ANSWER:
c
POINTS:
1
DIFFICULTY:
Moderate
LEARNING OBJECTIVES:
FMAI.MADU.15.03.04
NATIONAL STANDARDS:
United States – BUSPROG.FMAI.MADU.15.03
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Bloom’s: Knowledge
22. 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
ANSWER:
c
POINTS:
1
DIFFICULTY:
Moderate
LEARNING OBJECTIVES:
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United States – BUSPROG.FMAI.MADU.15.03
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KEYWORDS:
Bloom’s: Knowledge
23. 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
ANSWER:
e
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24. 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
ANSWER:
e
POINTS:
1
DIFFICULTY:
Moderate
LEARNING OBJECTIVES:
FMAI.MADU.15.03.04
NATIONAL STANDARDS:
United States – BUSPROG.FMAI.MADU.15.03
STATE STANDARDS:
United States – OH – DISC.FMAI.MADU.15.02
KEYWORDS:
Bloom’s: Application
25. 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
ANSWER:
a
POINTS:
1
DIFFICULTY:
Easy
LEARNING OBJECTIVES:
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Bloom’s: Knowledge
26. 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
ANSWER:
c
POINTS:
1
POINTS:
1
DIFFICULTY:
Moderate
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FMAI.MADU.15.03.04
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United States – BUSPROG.FMAI.MADU.15.03
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Bloom’s: Knowledge
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27. 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.
ANSWER:
b
POINTS:
1
DIFFICULTY:
Easy
LEARNING OBJECTIVES:
FMAI.MADU.15.03.04
NATIONAL STANDARDS:
United States – BUSPROG.FMAI.MADU.15.03
STATE STANDARDS:
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KEYWORDS:
Bloom’s: Application
28. 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)
ANSWER:
a
POINTS:
1
DIFFICULTY:
Easy
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Bloom’s: Knowledge
29. 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
ANSWER:
b
POINTS:
1
DIFFICULTY:
Easy
LEARNING OBJECTIVES:
FMAI.MADU.15.03.04
NATIONAL STANDARDS:
United States – BUSPROG.FMAI.MADU.15.03
DIFFICULTY:
Easy
LEARNING OBJECTIVES:
FMAI.MADU.15.03.04
NATIONAL STANDARDS:
United States – BUSPROG.FMAI.MADU.15.03
STATE STANDARDS:
United States – OH – DISC.FMAI.MADU.15.02
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Bloom’s: Knowledge
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30. 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.
ANSWER:
c
POINTS:
1
DIFFICULTY:
Easy
LEARNING OBJECTIVES:
FMAI.MADU.15.03.04
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United States – BUSPROG.FMAI.MADU.15.03
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Bloom’s: Knowledge
31. 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
ANSWER:
b
POINTS:
1
DIFFICULTY:
Easy
LEARNING OBJECTIVES:
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Bloom’s: Knowledge
32. 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.
ANSWER:
d
POINTS:
1
DIFFICULTY:
Easy
LEARNING OBJECTIVES:
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STATE STANDARDS:
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Bloom’s: Knowledge
STATE STANDARDS:
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Bloom’s: Knowledge
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33. 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
ANSWER:
a
POINTS:
1
DIFFICULTY:
Easy
LEARNING OBJECTIVES:
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Bloom’s: Knowledge
34. 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
ANSWER:
a
POINTS:
1
DIFFICULTY:
Easy
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Bloom’s: Knowledge
35. Other things being 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.
ANSWER:
c
POINTS:
1
DIFFICULTY:
Easy
LEARNING OBJECTIVES:
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Bloom’s: Knowledge
36. Assume that the Treasury bond yield today is 2 percentage points higher than it was one year ago. Also assume that
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the credit (default) risk premium of an A-rated bond declined by 0.4 percentage point 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
ANSWER:
a
POINTS:
1
DIFFICULTY:
Moderate
LEARNING OBJECTIVES:
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STATE STANDARDS:
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KEYWORDS:
Bloom’s: Application
37. 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
ANSWER:
b
POINTS:
1
DIFFICULTY:
Easy
LEARNING OBJECTIVES:
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STATE STANDARDS:
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KEYWORDS:
Bloom’s: Knowledge
38. According to expectations theory, the sudden expectation of lower interest rates in the future will cause investors to
provide a ____ supply of short-term funds and a ____ supply of long-term funds.
a.
large; large
b.
large; small
c.
small; small
d.
small; large
ANSWER:
d
POINTS:
1
DIFFICULTY:
Easy
LEARNING OBJECTIVES:
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Bloom’s: Knowledge
39. The yield curve in a foreign country is
a.
always downward sloping.