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CHAPTER 6
TRUE/FALSE QUESTIONS
sloping yield curve.
a class, municipal debt has less marketability than corporate debt.
everything else the same.
the investor is to invest in municipal bonds as opposed to similarly rated corporate bonds.
predicted by the expectations theory.
a similarly rated 8.5 percent corporate bond.
generally at or above par value.
nonconvertible bonds.
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in response to expected yield premiums.
the interest rate on a convertible bond.
terms except for maturity.
interest rates.
MULTIPLE CHOICE QUESTIONS
a. The greater the default risk, the greater the yield.
b. Bonds selling at premium are especially high quality.
c. The less marketable a bond, the higher the yield.
d. Municipal bonds have lower yields than similar corporate bonds.
a. Interest rates always rise before recessions.
b. Default risk premiums vary inversely with economic activity.
c. Municipal bond yields are usually higher than similar risk corporate yields.
d. Treasury bond yields are always higher than Treasury bill yields.
a. describes the relationship between maturity and yield for similar securities.
b. ranks security yield according to the default risk structure.
c. describes how interest rates vary over time.
d. describes the pattern of interest rates over the business cycle.
a. maturity changes as risk changes.
b. yields of securities with different levels of default risk.
c. yields by maturity of securities with similar default risk.
d. interest rates over time.
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a. bond yield by issuers over time.
b. historical Treasury security yields.
c. realized Treasury security yields by time.
d. outstanding Treasury security yields by maturity.
a. an increase in interest rates.
b. a decrease in interest rates.
c. an increase in the bond’s price.
d. an upgrade of the bond’s rating by Moody’s.
e. tax-free municipals become available.
rates to _____ and security prices to ______.
a. fall; fall.
b. fall; rise.
c. rise; fall.
d. rise; rise.
______ and outstanding security prices will _______.
a. fall; rise.
b. fall; fall.
c. rise; rise.
d. rise; fall.
a. investors prefer holding short-term securities.
b. the shape of the yield curve is determined by investors’ expectations of future
short-term interest rates.
c. institutional investors’ maturity preferences determine the shape of the yield
curve.
d. investors always expect short-term interest rates to increase.
e. both a and b
curve slopes _______, the markets expect short-term interest rates to _______ in the
future
a. upward; increase
b. downward; decrease
c. upward; decrease
d. both a and b
e. both a and c
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6.0%. According to the expectations theory, what is the current two-year rate?
a. The rate cannot be calculated from the information above.
b. 5.0%
c. 5.5%
d. 6.0%
e. 6.25%
now if three and four-year spot rates are 5.50% and 5.80%, respectively?
a. The rate cannot be calculated from the information above.
b. 6.2%
c. 6.7%
d. 5.6%
e. 5.8%
According to the expectations theory, what is the current one-year rate?
a. 6.0%
b. 6.5%
c. 7.0%
d. 8.0%
e. 9.0%
short-term rates are expected to ______, and outstanding security prices are expected to
______.
a. fall; fall.
b. rise; fall.
c. fall; rise.
d. rise; rise
the expected one-year rate two years from now as implied by the two actual rates above?
a. 4.7%
b. 5.8%
c. 6.5%
d. 7.0%
e. 7.5%
Fitch is
a. marketability.
b. tax treatment.
c. term to maturity.
d. default risk.
e. frequency of interest payments.
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a. directly; default risk
b. inversely; default risk
c. inversely; maturity
d. directly; marketability
a. Interest rates generally tend to move together.
b. The expected rate of inflation influences the level of interest rates.
c. At the bottom of the business cycle, the yield curve is typically upward sloping.
d. All the above are true.
b. The more marketable a security, the higher its yield.
c. The longer the security’s term to maturity, the greater its yield.
d. Putable bonds offer higher yields than similar non-putable bonds
e. Taxable bonds have to offer higher before-tax yields than comparable tax-exempt
bonds.
Use the following interest rate data to answer the next seven questions.
90-day Treasury bills 8.36 percent
180-day Treasury bills 8.48 percent
2-year Treasury notes 9.10 percent
3-year Treasury notes 9.25 percent
90-day Commercial paper 9.15 percent
3-year Corporate bonds (AA) 10.10 percent
3-year Municipal (AA) 7.07 percent
Expected 2-year inflation rate 3.50 percent
greatest default risk?
a. 90-day Treasury securities
b. 180-day Treasury securities
c. 2-year Treasury securities
d. 90-day Commercial paper
Treasury security?
a. 12.6%
b. 9.1%
c. 5.4%
d. 4.2%
e. 3.5%
a. 5.65%
b. 0.95%
c. 0.79%
d. 0.55%
e. 0%
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two years from now according to the expectations theory?
a. 8.80%
b. 9.10%
c. 9.18%
d. 9.40%
e. 9.55%
between holding the 3-year municipal or 3-year corporate bond?
a. 15%
b. 20%
c. 25%
d. 30%
e. 33%
corporate bonds?
a. 0.85%
b. 0.95%
c. 3.03%
d. 6.60%
e. There is no default risk on these bonds.
expectation of ______ future short-term rates.
a. downward; falling
b. downward; rising
c. upward; falling
d. upward; rising
e. flat; stable
a. Callable bonds have higher yields than comparable noncallable bonds.
b. The call price is usually above the bond’s par value.
c. The shorter the term to maturity, the greater the call interest premium.
d. Investors are notified when bonds are called.
__ and will pay ____ for the bond.
a. A; less
b. A; more
c. B; less
d. B; more
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and will pay ____ for the bond.
a. A; less
b. A; more
c. B; less
d. B; more
they
a. have greater default risk.
b. have shorter maturities.
c. are less marketable.
d. both a and c
a. maturity.
b. default risk.
c. marketability.
d. call provision.
e. all of the above
a. marketability.
b. default risk.
c. expectations of future inflation.
d. all of the above
e. none of the above
Use the following interest rate data to answer the next five questions:
Treasury Bills, 90 days 4.20%
Commercial Paper, 90 days 4.84%
Treasury Bill, 1 year 4.67%
Treasury Note, 2 year 5.25%
Corporate Bond AA, 20 year 8.23%
Municipal Bond AA, 20 year 6.42%
Expected Annual Inflation Rate 3.00%
paper above is
a. 3.39%
b. 0.17%
c. 0.64%
d. 1.84%
rate one year from now) on Treasuries is
a. 4.67%
b. 5.83%
c. 5.58%
d. 4.09%
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indifferent between owning the corporate bond and the municipal bond?
a. 18%
b. 20%
c. 22%
d. 28%
return on the one-year Treasury bill?
a. 3.00%
b. 1.62%
c. 4.67%
d. 0.13%
one-year Treasury Bill for an investor in the 33 percent marginal tax bracket?
a. 1.11%
b. 3.13%
c. 0.13%
d. -1.11%
year CD paying 5 percent and a two-year CD paying 5.5 percent. If indifferent between
the two, the depositor must expect one-year CDs one year from now to have a rate of
a. 6.5%
b. 4.5%
c. 6.0%
d. 5.0%
what type of yield curve?
a. a decreasing curve over time.
b. a flat yield curve.
c. an increasing yield curve over time.
d. a twisted yield curve
e. none of the above.
result in an upward sloping yield curve?
a. selling long-term securities and buying short-term securities.
b. buying long-term securities and selling short-term securities.
c. selling short-term securities and holding cash.
d. selling long-term securities and holding cash.
percent coupon rate. What is the after-tax return on the bond?
a. 8 percent
b. 2.4 percent
c. 5.6 percent
d. 5 percent
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BBB-rated corporate bond may be explained by
a. marketability.
b. tax treatment.
c. default risk.
d. term to maturity.
structure of interest rates?
a. Investors will pay higher prices for longer-term securities.
b. Investors demand a lower yield for securities that cannot be sold quickly at high
prices.
c. Investors demand a higher return on longer-term securities with greater price risk
and less marketability.
d. Investors will pay higher prices for securities with greater price risk and less
marketability.
discontinuities in the yield curve?
a. the market segmentation theory
b. the liquidity premium theory
c. the expectations theory
d. the loanable funds theory
have better profits when
a. the level of interest rates were expected to fall sharply.
b. the yield curve had a downward slope.
c. the yield curve had an upward slope.
d. loan losses were increasing.
a. economic recessions.
b. economic boom periods.
c. generally rising interest rates.
d. the number of bonds rated by Moody’s and Standard & Poor’s.
a. above BBB.
b. below BBB.
c. B and below.
d. A and below
a. the variability of earnings
b. the expected cash flow
c. the rating on the prior issue of securities sold
d. the amount of the fixed contractual cash payments
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an increase in interest rates.
a. a decrease in interest rates.
b. a decrease in the bond’s price.
c. a downgrade of the bond’s rating by Moody’s.
valuable right to a bond’s _______.
a. issuer; issuer
b. issuer; holder
c. holder; issuer
d. holder; holder
a. Convertible bonds offer higher yields than similar nonconvertible bonds.
b. Putable bonds offer higher yields than similar nonputable bonds.
c. Bonds with call options must offer higher interest rates than similar noncallable
bonds.
d. All Treasury securities offer lower rates than any securities issued by business
firms.
e. All of the above statements are true.
because:
a. CoCos are convertible to the firm’s preferred stock while the ordinary
convertible bonds are convertible to the firm’s common stock.
b. CoCos offer a higher coupon than ordinary convertible bonds.
c. Cocos are convertible into stock only if the firm’s stock price hits a certain level.
d. Ordinary convertible bonds are converted to the firm’s stock if the firm’s stock
falls below a certain level.
the liquidity premium theory. Assume the yield curve is initially downward sloping. If
liquidity premium theory is no longer important, the yield curve you would expect to see
would be:
a. more steeply downward sloping
b. more upward sloping
c. less steeply downward sloping
d. flat
e. Either c or d can happen.
decrease in the near future would
a. invest in short-term securities immediately.
b. invest in long-term securities immediately.
c. sell long-term securities from her portfolio.
d. sell corporate securities and invest in Treasury securities.
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increase in the near future, it would lead to
a. an increase in the demand for short-term securities.
b. an increase in the demand for long-term securities.
c. a decrease in the supply of short-term securities.
d. an increase in the supply of long-term securities.
decrease in the near future,
a. borrowers would immediately increase their supply of short-term securities.
b. investors would immediately increase their demand for long-term securities.
c. borrowers would immediately increase their supply of long-term securities.
d. neither borrowers nor investors would do anything until the interest rates actually
increase.
e. both a and b
a. term structure
b. loan covenant
c. bond indenture
d. Fisher effect
a. markets are segmented and buyers stay in their own segment
b. the long term spot rate is an average of the current and expected future short term
interest rates
c the term structure will most often be upward sloping
d liquidity premiums are negative and time varying
a. inflationary expectations.
b. liquidity preferences.
c. the comparative equilibrium of supply and demand in the short-term and long-term
market segments.
d. all of the above.
year U.S. T-note = 8%, IBM common stock = 15%, IBM Corporate Bond (Moody’s rating
Aaa) = 14%, and 10-year U.S. T-bond = 6.5%. Based on the above information, the shape
of the yield curve is
a. upward sloping.
b. downward sloping.
c. flat.
d. normal.
a. prohibition on selling accounts receivable.
b. constraint on subsequent borrowing.
c. supplying the creditor with audited financial statements.
d. prohibition on entering certain types of lease arrangements.
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ESSAY QUESTIONS
1. List the five basic factors which explain the differences in interest rates on different securities at any
point in time.
2. Explain how the term structure of interest rates can be used to help forecast future interest rates.
Explain why municipal bonds have lower yields than comparable corporate taxable bonds.
Answer: Since investors are concerned with the after-tax yield earned, they will bid up the prices
3. Define the term default risk premium. Why does the “premium” represent the “expected default loss
rate”? Explain how and why default risk premiums vary over the business cycle.
4. How do bond options such as a call, put, and convertibility influence the yields on securities relative
to bonds without such options?
5. What shapes of the yield curve can be explained by each of the theories of the term structure of
interest rates?
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6. Explain (a.) liquidity problem in bond market, (b.) default risk, and (c.) maturity risk premiums.