Answer Choices:
a. True
b. False
Answer: a. True
Question: Because the maturity risk premium is normally positive, the yield curve must have an upward slope. If you measure the yield curve and find a downward slope, you must have done something wrong.
Answer Choices:
a. True
b. False
Answer: b. False
Question: The “yield curve” shows the relationship between bonds’ maturities and their yields.
Answer Choices:
a. True
b. False
Answer: a. True
Question: Because the maturity risk premium is normally positive, the yield curve is normally upward sloping.
Answer Choices:
a. True
b. False
Answer: a. True
Question: A bond trader observes the following information:
The Treasury yield curve is downward sloping.
Empirical data indicate that a positive maturity risk premium applies to both Treasury and corporate bonds.
Empirical data also indicate that there is no liquidity premium for Treasury securities but that a positive liquidity premium is built into corporate bond yields.
On the basis of this information, which of the following statements is most CORRECT?
Answer Choices:
a. A 10-year corporate bond must have a higher yield than a 5-year Treasury bond.
b. A 10-year Treasury bond must have a higher yield than a 10-year corporate bond.
c. A 5-year corporate bond must have a higher yield than a 10-year Treasury bond.
d. The corporate yield curve must be flat.
e. Since the Treasury yield curve is downward sloping, the corporate yield curve must also be downward sloping.
Answer: c. A 5-year corporate bond must have a higher yield than a 10-year Treasury bond.
Question: Which of the following statements is CORRECT?
Answer Choices:
a. The maturity premiums embedded in the interest rates on U.S. Treasury securities are due primarily to the fact that the probability of default is higher on long-term bonds than on short-term bonds.
b. Reinvestment rate risk is lower, other things held constant, on long-term than on short-term bonds.
c. The pure expectations theory of the term structure states that borrowers generally prefer to borrow on a long-term basis while savers generally prefer to lend on a short-term basis, and as a result, the yield curve is normally upward sloping.
d. If the maturity risk premium were zero and interest rates were expected to decrease in the future, then the yield curve for U.S. Treasury securities would, other things held constant, have an upward slope.
e. Liquidity premiums are generally higher on Treasury than on corporate bonds.
Answer: d. If the maturity risk premium were zero and interest rates were expected to decrease in the future, then the yield curve for U.S. Treasury securities would, other things held constant, have an upward slope.
Question: One of the four most fundamental factors that affect the cost of money as discussed in the text is the expected rate of inflation. If inflation is expected to be relatively high, then interest rates will tend to be relatively low, other things held constant.
Answer Choices:
a. True
b. False
Answer: b. False
Question: During periods when inflation is increasing, interest rates tend to increase, while interest rates tend to fall when inflation is declining.
Answer Choices:
a. True
b. False
Answer: a. True
Question: Which of the following statements is CORRECT?
Answer Choices:
a. The yield curve should be downward sloping, with the rate on a 1-year bond at 6%.
b. The interest rate today on a 2-year bond should be approximately 6%.
c. The interest rate today on a 2-year bond should be approximately 7%.
d. The interest rate today on a 3-year bond should be approximately 7%.
e. The interest rate today on a 3-year bond should be approximately 8%.
Answer: a. The yield curve should be downward sloping, with the rate on a 1-year bond at 6%.
Question: Which of the following statements is CORRECT?
Answer Choices:
a. The higher the maturity risk premium, the higher the probability that the yield curve will be inverted.
b. The most likely explanation for an inverted yield curve is that investors expect inflation to increase.
c. The most likely explanation for an inverted yield curve is that investors expect inflation to decrease.
d. If the yield curve is inverted, short-term bonds have lower yields than long-term bonds.
e. Inverted yield curves can exist for Treasury bonds, but because of default premiums, the corporate yield curve can never be inverted.
Answer: c. The most likely explanation for an inverted yield curve is that investors expect inflation to decrease.
Question: Which of the following statements is CORRECT, other things held constant?
Answer Choices:
a. If companies have fewer good investment opportunities, interest rates are likely to increase.
b. If individuals increase their savings rate, interest rates are likely to increase.
c. If expected inflation increases, interest rates are likely to increase.
d. Interest rates on all debt securities tend to rise during recessions because recessions increase the possibility of bankruptcy, hence the riskiness of all debt securities.
e. Interest rates on long-term bonds are more volatile than rates on short-term debt securities like T-bills.
Answer: c. If expected inflation increases, interest rates are likely to increase.
Question: Assume that inflation is expected to decline steadily in the future, but that the real risk-free rate, r*, will remain constant. Which of the following statements is CORRECT, other things held constant?
a. If the pure expectations theory holds, the Treasury yield curve must be downward sloping.
b. If the pure expectations theory holds, the corporate yield curve must be downward sloping.
c. If there is a positive maturity risk premium, the Treasury yield curve must be upward sloping.
d. If inflation is expected to decline, there can be no maturity risk premium.
e. The expectations theory cannot hold if inflation is decreasing.
Answer Choices:
a. True
Answer:
Question: Assume the following: The real risk-free rate, r*, is expected to remain constant at 3%. Inflation is expected to be 3% next year and then to be constant at 2% a year thereafter. The maturity risk premium is zero. Given this information, which of the following statements is CORRECT?
Answer Choices:
a. The yield curve for U.S. Treasury securities will be upward sloping.
b. A 5-year corporate bond must have a lower yield than a 5-year Treasury security.
c. A 5-year corporate bond must have a lower yield than a 7-year Treasury security.
d. The real risk-free rate cannot be constant if inflation is not expected to remain constant.
e. This problem assumed a zero maturity risk premium, but that is probably not valid in the real world.
Answer: e. This problem assumed a zero maturity risk premium, but that is probably not valid in the real world.
Question: The risk that interest rates will decline, and that decline will lead to a decline in the income provided by a bond portfolio as interest and maturity payments are reinvested, is called “reinvestment rate risk.”
Answer Choices:
a. True
b. False
Answer: a. True
Question: If the pure expectations theory holds, which of the following statements is CORRECT?
Answer Choices:
a. The yield on a 3-year Treasury bond should always exceed the yield on a 2-year Treasury bond.
b. The yield on a 2-year corporate bond must 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. If inflation is expected to increase, then the yield on a 2-year bond should exceed that on a 3-year bond.
Answer: b. The yield on a 2-year corporate bond must always exceed the yield on a 2-year Treasury bond.
Question: Which of the following statements is CORRECT?
Answer Choices:
a. Downward-sloping yield curves are inconsistent with the expectations theory.
b. The actual shape of the yield curve depends only on expectations about future inflation.
c. If the pure expectations theory is correct, a downward-sloping yield curve indicates that interest rates are expected to decline in the future.
d. If the yield curve is upward sloping, the maturity risk premium must be positive and the inflation rate must be zero.
e. Yield curves must be either upward or downward sloping—they cannot first rise and then decline.
Answer: c. If the pure expectations theory is correct, a downward-sloping yield curve indicates that interest rates are expected to decline in the future.
Question: One of the four most fundamental factors that affect the cost of money as discussed in the text is the time preference for consumption. The higher the time preference, the lower the cost of money, other things held constant.
Answer Choices:
a. True
b. False
Answer: b. False