Chapter 07 – The Risk and Term Structure of Interest Rates
Multiple Choice Questions
1. The bond rating of a security reflects:
D. The size of the coupon rate relative to other interest rates
2. The two best known bond rating services are:
A. The Federal Reserve and Moody’s Investment Services
Chapter 07 – The Risk and Term Structure of Interest Rates
3. Investors usually obtain bond ratings from:
D. Public Information made available by the bond issuers
4. Which of the following assigns widely followed bond ratings?
A. The Federal Reserve
5. Which of the following assigns widely followed bond ratings?
A. The Federal Reserve
Chapter 07 – The Risk and Term Structure of Interest Rates
6. What is the highest bond rating assigned by Standard and Poor’s?
A. AA
7. The lowest rating for an investment grade bond assigned by Moody’s is:
D. Aa
8. Bonds rated as “highly speculative”:
D. Are rated so because they do not have any default risk
Chapter 07 – The Risk and Term Structure of Interest Rates
9. Which of the following would be most likely to earn an AAA rating from Standard &
Poor’s?
D. Shares of stock in Coca-Cola
10. Once a bond rating is assigned, it:
D. Can change on the next bond from the issuer but is fixed for the current bond
11. Commercial paper refers to:
A. The financial publications read by the CEOs of public corporations
Chapter 07 – The Risk and Term Structure of Interest Rates
12. Most commercial paper is:
A. Issued with maturities exceeding one year
13. If a bond’s rating improves it should cause:
A. The bond’s price and yield to increase, all other factors constant
14. If a bond’s rating improves, we would expect:
D. Both the demand for and the price of the bond to decrease, all other factors constant
Chapter 07 – The Risk and Term Structure of Interest Rates
15. Bonds issued by the U.S. Treasury are referred to as benchmark bonds because:
D. All bonds from the U.S. government have the same rate of interest
16. The risk spread is:
D. Assigned by a bond-rating agency
17. The risk spread:
D. Is always constant
Chapter 07 – The Risk and Term Structure of Interest Rates
18. All of the following are true about the risk spread except:
A. It should be higher for highly speculative bonds than investment grade bonds
19. The default-risk premium:
D. Is assigned by a bond-rating agency
20. The default-risk premium:
D. Should vary directly with the bond’s yield and the bond’s price
Chapter 07 – The Risk and Term Structure of Interest Rates
21. The risk structure of interest rates says:
D. Interest rates only compensate for risk in structured amounts
22. U.S. Treasury securities are considered to carry no risk spread because:
D. The yields on U.S. Treasury bonds are zero
23. The risk structure of interest rates refers to:
D. The additional interest required to compensate the buyer for the longer maturity of the
bond
Chapter 07 – The Risk and Term Structure of Interest Rates
24. A borrower who has to pay an interest rate of 8% rather than 6% due to risk spread will:
D. Pay less interest in total over the life of the loan
25. Which of the following is true?
A. Long-term bond yields move together but short-term yields do not
26. Taxes play an important role in bond returns because:
A. All interest from owning bonds is taxed
Chapter 07 – The Risk and Term Structure of Interest Rates
27. Municipal bonds are issued by:
A. Cities only
28. An investor in a 30% marginal tax bracket, earning $10 in interest annually for a $100
U.S. Treasury bond:
A. Earns a 10% after-tax return because interest on U.S. Treasury bonds is tax exempt at the
federal level
29. The yield on a tax-exempt bond:
D. Only applies to foreign bonds because they are exempt from U.S. income taxes
Chapter 07 – The Risk and Term Structure of Interest Rates
30. Holding risk constant, an investor earning 6% from a tax-exempt bond who is in a 25%
tax bracket would be indifferent between that bond and:
D. A taxable bond with a 7.5% yield
31. Holding risk constant, an investor earning 4% from a tax-exempt bond who is in a 20%
tax bracket would be indifferent between that bond and:
A. A taxable bond with a 7.5% yield
32. Municipal bonds are usually purchased by:
A. Retired investors who have no other taxable income
Chapter 07 – The Risk and Term Structure of Interest Rates
33. Suppose the tax rate is 25% and the taxable bond yield is 8%. What is the tax-exempt
bond yield?
34. In 2003, ratings agencies downgraded bonds issued by the State of California several
times. How will this affect the market for these bonds?
A. Yields on these bonds will decrease and the yield on Treasury bonds will increase
35. Tax-exempt bonds:
A. Generate higher returns for the bondholder when purchased through a tax-exempt
retirement account
Chapter 07 – The Risk and Term Structure of Interest Rates
36. If a local government eliminates the tax exemption on municipal bonds, we’d expect to
see:
D. Municipal bonds will become more attractive to investors
37. Which of the following is not typically used for qualifying mortgages as prime or
subprime?
A. The borrower’s income
38. According to the Expectations Theory of the term structure, if interest rates are expected
to be 2%, 2%, 4%, and 5% over the next four years, what is the yield on a three-year bond
today?
D. 8%
Chapter 07 – The Risk and Term Structure of Interest Rates
39. Suppose the economy has an inverted yield curve. According to the Expectations
Hypothesis, which of the following interpretations could be used to explain this?
D. The term spread is positive
40. Which fact about the term structure is the Expectations Theory unable to explain?
A. Why interest rates on bonds with different terms to maturity tend to move together over
time
41. Which fact about the term structure is the Expectations Theory able to explain?
A. Why interest rates on bonds with different terms to maturity tend to move together over
Chapter 07 – The Risk and Term Structure of Interest Rates
42. The risk spread on bonds fluctuates mainly because:
43. In the fall of 1998 we saw an increase in the risk spread because:
D. There was a significant increase in U.S. income tax rates
44. A company that continues to have strong profit performance during an economic
D. See the demand and price for their bonds decrease
Chapter 07 – The Risk and Term Structure of Interest Rates
D. Will still have different yields depending on their face values
46. The U.S. Treasury yield curve:
D. Always has a negative slope
47. During a recession you would expect the difference between the commercial paper rate
D. Fluctuate on a daily basis
Chapter 07 – The Risk and Term Structure of Interest Rates
48. Which of the following statements pertaining to the yield curve is not true?
D. The yield curve can be flat or downward sloping depending on market conditions
49. If the federal government replaced the current income tax with a national sales tax, the
price of:
A. Corporate bonds would rise
50. Interest on most bonds issued by states is usually exempt from:
A. State income tax but not federal
Chapter 07 – The Risk and Term Structure of Interest Rates
51. The term structure of interest rates:
D. Usually results in a downward sloping yield curve
52. Which of the following statements in not true of the yield curve for U.S. Treasury
securities?
D. The yield curve can shift over time
53. The yield curve for U.S. Treasury securities allows us to draw the following conclusions,
except that:
A. Long-term yields tend to higher than short term yields
Chapter 07 – The Risk and Term Structure of Interest Rates
54. When the yield curve is upward sloping, people are expecting:
55. When the yield curve is downward sloping:
D. People could be expecting a tightening in monetary policy
56. Any theory of the term structure of interest rates needs to explain each of the following,
except:
A. The upward slope of the yield curve
Chapter 07 – The Risk and Term Structure of Interest Rates
57. The Expectations Hypothesis assumes:
D. The risk premium increases with longer maturities
58. The Expectations Hypothesis suggests:
A. The yield curve should usually be downward sloping
59. The yield on a 30-year U.S. Treasury security is 6.5%; the yield on a 2-year U.S. Treasury
bond is 4.0%. This data:
A. Indicate the yield curve is downward sloping