Answer Choices:
a. True
b. False
Answer: b. False
Question: Which of the following statements is CORRECT?
Answer Choices:
a. The yield on a 3-year Treasury bond cannot exceed the yield on a 2-year Treasury bond.
b. The yield on a 2-year corporate bond should always exceed the yield on a 2-year Treasury bond.
c. The yield on a 3-year corporate bond should always exceed the yield on a 2-year corporate bond.
d. The yield on a 10-year AAA-rated corporate bond should always exceed the yield on a 5-year AAA-rated corporate bond.
e. The following represents a “possibly reasonable” formula for the maturity risk premium on bonds: MRP = -0.1%(t), where t is the years to maturity.
Answer: b. The yield on a 2-year corporate bond should always exceed the yield on a 2-year Treasury bond.
Question: If the Treasury yield curve were downward sloping, the yield to maturity on a 10-year Treasury coupon bond would be higher than that on a 1-year T-bill.
Answer Choices:
a. True
b. False
Answer: b. False
Question: Which of the following statements is CORRECT?
Answer Choices:
a. The yield on a 2-year corporate bond should always exceed the yield on a 2-year Treasury bond.
b. The yield on a 3-year corporate bond should always exceed the yield on a 2-year corporate bond.
c. The yield on a 3-year Treasury bond should always exceed the yield on a 2-year Treasury bond.
d. If inflation is expected to increase, then the yield on a 2-year bond should exceed that on a 3-year bond.
Answer: a. The yield on a 2-year corporate bond should always exceed the yield on a 2-year Treasury bond.
Question: If the pure expectations theory of the term structure is correct, which of the following statements would be CORRECT?
Answer Choices:
a. An upward-sloping yield curve would imply that interest rates are expected to be lower in the future.
b. If a 1-year Treasury bill has a yield to maturity of 7% and a 2-year Treasury bill has a yield to maturity of 8%, this would imply the market believes that 1-year rates will be 7.5% one year from now.
c. The yield on a 5-year corporate bond should always exceed the yield on a 3-year Treasury bond.
d. Interest rate (price) risk is higher on long-term bonds, but reinvestment rate risk is higher on short-term bonds.
e. Interest rate (price) risk is higher on short-term bonds, but reinvestment rate risk is higher on long-term bonds.
Answer: d. Interest rate (price) risk is higher on long-term bonds, but reinvestment rate risk is higher on short-term bonds.
Question: Assuming the pure expectations theory is correct, which of the following statements is CORRECT?
Answer Choices:
a. If 2-year Treasury bond rates exceed 1-year rates, then the market must expect interest rates to rise.
b. If both 2-year and 3-year Treasury rates are 7%, then 5-year rates must also be 7%.
c. If 1-year rates are 6% and 2-year rates are 7%, then the market expects 1-year rates to be 6.5% in one year.
d. Reinvestment rate risk is higher on long-term bonds, and interest rate (price) risk is higher on short-term bonds.
e. Interest rate (price) risk and reinvestment rate risk are relevant to investors in corporate bonds, but these concepts do not apply to Treasury bonds.
Answer: a. If 2-year Treasury bond rates exceed 1-year rates, then the market must expect interest rates to rise.
Question: Which of the following factors would be most likely to lead to an increase in nominal interest rates?
Answer Choices:
a. Households reduce their consumption and increase their savings.
b. A new technology like the Internet has just been introduced, and it increases investment opportunities.
c. There is a decrease in expected inflation.
d. The economy falls into a recession.
e. The Federal Reserve decides to try to stimulate the economy.
Answer: b. A new technology like the Internet has just been introduced, and it increases investment opportunities.
Question: Which of the following statements is CORRECT?
Answer Choices:
a. If the maturity risk premium (MRP) is greater than zero, the Treasury bond yield curve must be upward sloping.
b. If the maturity risk premium (MRP) equals zero, the Treasury bond yield curve must be flat.
c. If inflation is expected to increase in the future and the maturity risk premium (MRP) is greater than zero, the Treasury bond yield curve must be upward sloping.
d. If the expectations theory holds, the Treasury bond yield curve will never be downward sloping.
e. Because long-term bonds are riskier than short-term bonds, yields on long-term Treasury bonds will always be higher than yields on short-term T-bonds.
Answer: c. If inflation is expected to increase in the future and the maturity risk premium (MRP) is greater than zero, the Treasury bond yield curve must be upward sloping.
Question: Which of the following statements is CORRECT?
Answer Choices:
a. Even if the pure expectations theory is correct, there might at times be an inverted Treasury yield curve.
b. If the yield curve is inverted, short-term bonds have lower yields than long-term bonds.
c. The higher the maturity risk premium, the higher the probability that the yield curve will be inverted.
d. Inverted yield curves can exist for Treasury bonds, but because of default premiums, the corporate yield curve cannot become inverted.
e. The most likely explanation for an inverted yield curve is that investors expect inflation to increase in the future.
Answer: a. Even if the pure expectations theory is correct, there might at times be an inverted Treasury yield curve.
Question: If the Treasury yield curve is downward sloping, how should the yield to maturity on a 10-year Treasury coupon bond compare to that on a 1-year T-bill?
Answer Choices:
a. The yield on a 10-year bond would be less than that on a 1-year bill.
b. The yield on a 10-year bond would have to be higher than that on a 1-year bill because of the maturity risk premium.
c. It is impossible to tell without knowing the coupon rates of the bonds.
d. The yields on the two securities would be equal.
e. It is impossible to tell without knowing the relative risks of the two securities.
Answer: a. The yield on a 10-year bond would be less than that on a 1-year bill.
Question: If the pure expectations theory is correct (that is, the maturity risk premium is zero), which of the following is CORRECT?
Answer Choices:
a. An upward-sloping Treasury yield curve means that the market expects interest rates to decline in the future.
b. A 5-year T-bond would always yield less than a 10-year T-bond.
c. The yield curve for corporate bonds may be upward sloping even if the Treasury yield curve is flat.
d. The yield curve for stocks must be above that for bonds, but both yield curves must have the same slope.
e. If the maturity risk premium is zero for Treasury bonds, then it must be negative for corporate bonds.
Answer: c. The yield curve for corporate bonds may be upward sloping even if the Treasury yield curve is flat.
Question: The risk that interest rates will increase, and that increase will lead to a decline in the prices of outstanding bonds, is called “interest rate risk,” or “price risk.”
Answer Choices:
a. True
b. False
Answer: a. True
Question: An upward-sloping yield curve is often call a “normal” yield curve, while a downward-sloping yield curve is called “abnormal.”
Answer Choices:
a. True
b. False
Answer: a. True
Question: Short Corp just issued bonds that will mature in 10 years, and Long Corp issued bonds that will mature in 20 years. Both bonds promise to pay a semiannual coupon, they are not callable or convertible, and they are equally liquid. Further assume that the Treasury yield curve is based only on the pure expectations theory. Under these conditions, which of the following statements is CORRECT?
Answer Choices:
a. If the yield curve for Treasury securities is flat, Short’s bond must under all conditions have the same yield as Long’s bonds.
b. If the yield curve for Treasury securities is upward sloping, Long’s bonds must under all conditions have a higher yield than Short’s bonds.
c. If Long’s and Short’s bonds have the same default risk, their yields must under all conditions be equal.
d. If the Treasury yield curve is upward sloping and Short has less default risk than Long, then Short’s bonds must under all conditions have a lower yield than Long’s bonds.
e. If the Treasury yield curve is downward sloping, Long’s bonds must under all conditions have the lower yield.
Answer: d. If the Treasury yield curve is upward sloping and Short has less default risk than Long, then Short’s bonds must under all conditions have a lower yield than Long’s bonds.