chapter 3 | mcq

Question 1

In general, securities with ____ characteristics will offer ____ yields.
a. favorable; higher
b. favorable; lower
c. unfavorable; lower
d. None of these are correct.

Answer 1

b. favorable; lower

Question 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 2

d. BBB corporate securities

Question 3

Some financial institutions such as commercial banks typically invest only in:
a. junk bonds
b. corporate bonds rated B or higher
c. Treasury securities
d. investment-grade bonds

Answer 3

d. investment-grade bonds

Question 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 4

b. False

Question 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 5

a. is liquid.

Question 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 6

a. positively; internationally integrated

Question 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 7

b. taxable securities; a higher before-tax yield than tax-exempt securities

Question 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 these are correct.

Answer 8

c. 9.00 percent

Question 9

According to the segmented markets theory, if most investors suddenly preferred to invest in long-term securities and most borrowers suddenly preferred to issue short-term securities, there would be
a. downward pressure on the price of long-term securities.
b. downward pressure on the short-term yields.
c. downward pressure on the yield of long-term securities.
d. downward pressure on the price of long-term securities AND downward pressure on the yield of long-term securities.

Answer 9

b. downward pressure on the short-term yields.

Question 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 these are correct.

Answer 10

a. 7.0 percent

Question 11

Holding other factors such as risk constant, the relationship between the maturity and the annualized yield of debt securities is called the:
a. term structure of interest rates
b. default structure of interest rates
c. liquidity structure of interest rates
d. tax structure of interest rates
e. None of these are correct.

Answer 11

a. term structure of interest rates

Question 12

The term structure of interest rates defines the relationship
a. between risk and return.
b. between risk and maturity.
c. between maturity and yield.
d. between default risk ratings and maturity.

Answer 12

c. between maturity and yield.

Question 13

If shorter-term securities have higher annualized yields than longer-term securities, the yield curve
a. is horizontal.
b. is upward sloping.
c. is downward sloping.
d. cannot be determined unless we know additional information (such as the level of market interest rates).

Answer 13

c. is downward sloping.

Question 14

Assume that annualized yields of short-term and long-term securities are equal. If investors suddenly believe interest rates will increase, their actions may cause the yield curve to
a. become inverted.
b. become flat.
c. become upward sloping.
d. be unaffected.

Answer 14

c. become upward sloping.

Question 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. long-term yields to rise AND short-term yields to decrease.
e. None of these are correct.

Answer 15

e. None of these are correct.

Question 16

Within the category of capital market securities, municipal bonds have the before-tax yield, and
their after-tax yield is typically brackets.
a. highest; below that
b. lowest; above that
c. highest; above that
d. lowest; below that

Answer 16

b. lowest; above that

Question 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
c. negatively; positively
d. positively; negatively

Answer 17

b. positively; positively

Question 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 18

c. pure expectations theory.

Question 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 19

a. 15.08 percent

Question 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 these are correct.

Answer 20

b. become upward sloping.

Question 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 21

c. upward; downward

Question 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. most debt is financed by foreign investors AND the Treasury’s debt level is small.

Answer 22

c. maturity markets are segmented.

Question 23

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. greater; greater AND less; less

Answer 23

e. greater; greater AND less; less

Question 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 these are correct.

Answer 24

e. None of these are correct.

Question 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 25

a. slight downward slope

Question 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. be less than AND be greater than are possible, depending on the size of the liquidity premium

Answer 26

c. be greater than

Question 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 27

b. 7.6 percent.

Question 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 28

a. overestimates

Question 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 29

b. a slight decrease

Question 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 30

c. segmented markets theory.

Question 31

According to the segmented markets theory, if most investors suddenly preferred to invest in short-
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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. upward pressure on the price of long-term securities AND downward pressure on the yield of long-term securities.

Answer 31

b. upward pressure on the price of short-term securities.

Question 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 32

d. preferred habitat theory.

Question 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 33

a. upward: upward

Question 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 these are correct.

Answer 34

a. riding the yield curve

Question 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 these are possible, depending on the size of the bond offering.

Answer 35

c. less than

Question 36

Assume that the Treasury bond yield today is 2 percentage points higher than it was one year ago. Also assume that 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 36

a. greater than

Question 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. liquidity premium theory AND segmented markets theory

Answer 37

b. expectations theory

Question 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 38

d. small; large

Question 39

The yield curve in a foreign country is:
a. always downward sloping
b. nonexistent
c. the same as the United States at any point in time d. None of these are correct.

Answer 39

d. None of these are correct.

Question 40

If research showed that anticipation about future interest rates was the only important factor for all investors in choosing short-term or long-term securities, this would support the argument made by the:
a. liquidity premium theory
b. expectations theory
c. segmented markets theory
d. liquidity premium theory AND expectations theory

Answer 40

b. expectations theory

Question 41

If research showed that all investors attempt to purchase securities that perfectly match the time for which they will have available funds, this would specifically support the argument made by the
a. liquidity premium theory.
b. real interest rate theory.
c. expectations theory.
d. segmented markets theory.

Answer 41

d. segmented markets theory.

Question 42

Assume that debt maturity markets are segmented, such that short-term debt markets are funded by surplus units that are different from the surplus units that fund the long-term debt markets. If the Treasury uses a relatively large proportion of ____ debt to finance the deficit, this may place upward pressure on ____ interest rates.
a. long-term; long-term
b. long-term; short-term
c. short-term; long-term
d. long-term; short-term AND short-term; long-term

Answer 42

a. long-term; long-term

Question 43

You are considering the purchase of a tax-exempt security that is paying a yield of 10.08 percent. You are in the 28 percent tax bracket. To match this after-tax yield, you would consider taxable securities that pay
a. 31.1 percent.
b. 19 percent.
c. 12.5 percent.
d. 14 percent.

Answer 43

d. 14 percent.

Question 44

The annualized yield on a three-year security is 13 percent; the annualized two-year interest rate is 12 percent, while the one-year interest rate is 9 percent. The forward rate one-year ahead is ____ percent.
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a. 2.8 b. 115 c. 103 d. 15.1

Answer 44

d. 15.1

Question 45

The annualized yield on a three-year security is 13 percent; the annualized two-year interest rate is 12 percent, while the one-year interest rate is 9 percent. The forward rate two years ahead is ____ percent.
a. 1.8
b. 9.0
c. 15.0
d. None of these are correct.

Answer 45

c. 15.0

Question 46

According to segmented
borrowers want short-term funds, this will place ____ pressure on the demand for long-term funds issued by borrowers and the yield curve will be ____ sloping.
a. upward; downward
b. downward; upward
c. upward; upward
d. downward; downward

Answer 46

d. downward; downward

Question 47

An upward-sloping yield curve indicates that Treasury securities with ____ maturities offer ____ annualized yields.
a. longer; lower
b. longer; higher
c. shorter; lower
d. shorter; higher
e. longer; higher AND shorter; low

Answer 47

a. longer; lower

Question 48

Assume that the Treasury experiences a large decrease in the budget deficit and purchases a large number of T-bills. This action will ____ the supply of T-bills in the market and place ____ pressure on the yield of T-bills.
a. decrease; downward
b. decrease; upward
c. increase; upward
d. increase; downward

Answer 48

b. decrease; upward

Question 49

Vaughn Corporation is considering the issue of commercial paper and would like to know the yield it should offer on its commercial paper. The corporation believes that a 0.2 percent credit risk premium, a 0.1 percent liquidity premium, and a 0.3 percent tax adjustment are necessary to sell its commercial paper to investors. Furthermore, annualized T-bill rates are 7 percent. Based on this information, Vaughn should offer ____ percent on its commercial paper.
a. 8.0
b. 7.6
c. 7.5
d. 7.9
e. None of these are correct.

Answer 49

b. 7.6

Question 50

If liquidity influences the yield curve, the forward rate underestimates the market’s expectation of the future interest rate.
a. True
b. False

Answer 50

b. False

Question 51

The yield curve for corporate bonds
a. would typically lie below the Treasury yield curve.
b. identical to the Treasury yield curve.
c. typically has the same slope as the Treasury yield curve.
d. is irrelevant to investors.

Answer 51

c. typically has the same slope as the Treasury yield curve.

Question 52

Some types of debt securities always offer a higher yield than others.
a. True
b. False

Answer 52

a. True

Question 53

Investors will always prefer the purchase of risk-free Treasury securities, since other securities have a higher level of risk.
a. True
b. False

Answer 53

b. False

Question 54

The higher a bond rating, the lower the perceived credit risk.
a. True
b. False

Answer 54

a. True

Question 55

Treasury securities are exempt from federal and state income taxes.
a. True
b. False

Answer 55

b. False

Question 56

The term structure of interest rates defines the relationship between maturity and annualized yield, holding other factors such as risk constant.
a. True
b. False

Answer 56

a. True

Question 57

The graphic comparison of maturities and annualized yields is known as the interest rate curve.
a. True
b. False

Answer 57

b. False

Question 58

According to the segmented markets theory, the term structure of interest rates is determined solely by expectations of future interest rates.
a. True
b. False

Answer 58

b. False

Question 59

The forward rate is commonly used to represent the market’s forecast of the future interest rate.
a. True
b. False

Answer 59

a. True

Question 60

Other things being equal, an expected decrease in interest rates will increase the demand for long-term funds by borrowers.
a. True
b. False

Answer 60

b. False

Question 61

The preference for more the yield curve.
a. True
b. False

Answer 61

b. False

Question 62

When expectations theory is combined with the liquidity theory, the yield on a security will always be equal to the yield from consecutive investments in shorter-term securities over the same investment horizon.
a. True
b. False

Answer 62

b. False

Question 63

The segmented markets theory suggests that although investors and borrowers may normally concentrate on a particular natural maturity market, certain events may cause them to wander from it.
a. True
b. False

Answer 63

b. False

Question 64

If the yield curve is upward sloping, some investors may attempt to benefit from the higher yields on longer-term securities, even when they have funds for only a short period of time. This strategy is known as riding the yield curve.
a. True
b. False

Answer 64

a. True

Question 65

Yield curves are always upward sloping.
a. True
b. False

Answer 65

b. False

Question 66

Which of the following statements is NOT true with respect to debt securities?
a. Some types of debt securities always offer a higher yield than others.
b. Debt securities offer different yields because they exhibit different characteristics that influence the offered yield.
c. In general, securities with favorable characteristics will offer higher yields to entice investors.
d. All of these are correct with respect to debt securities.

Answer 66

c. In general, securities with favorable characteristics will offer higher yields to entice investors.

Question 67

Which of the following is NOT a characteristic affecting the yields on debt securities?
a. credit (default) risk
b. liquidity
c. tax status
d. term to maturity
e. All of these are correct and affect yields on debt securities.

Answer 67

a. credit (default) risk

Question 68

All other characteristics being equal, securities with ____ liquidity would have to offer a ____ yield to be preferred.
a. lower; higher
b. higher; higher
c. lower; lower
d. None of these are correct.

Answer 68

a. lower; higher

Question 69

A downward-sloping yield curve indicates that Treasury securities with ____ maturities offer ____ annualized yields.
a. longer; lower
b. longer; higher
c. shorter; lower
d. shorter; higher
e. longer; lower AND shorter; higher

Answer 69

e. longer; lower AND shorter; higher

Question 70

Assume that the Treasury experiences a large increase in the budget deficit and issues a large number of T-bills. This action will ____ the supply of T-bills in the market and place ____ pressure on the yield of T-bills.
a. decrease; downward
b. decrease; upward
c. increase; upward
d. increase; downward

Answer 70

c. increase; upward

Question 71

If the liquidity premium theory completely describes the term structure of interest rates, then, on the average, the yield curve should be:
a. flat
b. downward sloping.
c. upward sloping.
d. None of these are correct.

Answer 71

c. upward sloping.

Question 72

If interest rates are expected to decrease, the yield on new short-term securities may be expected to ____, and the yield curve should be ____ sloping.
a. increase; upward
b. increase; downward
c. decrease; upward
d. decrease; downward

Answer 72

b. increase; downward

Question 73

According to segmented
borrowers want short-term funds, this will place ____ pressure on the demand for short-term funds by borrowers and the yield curve will be ____ sloping.
a. upward; downward
b. downward; upward
c. upward; upward
d. downward; downward

Answer 73

a. upward; downward

Question 74

The ____ theory suggests that although investors and borrowers may normally concentrate on a particular natural maturity market, certain events may cause them to wander from it.
a. pure expectations
b. liquidity premium
c. segmented markets
d. preferred habitat

Answer 74

d. preferred habitat

Question 75

If the Treasury uses a relatively large proportion of ____ debt to finance a budget deficit, this would place ____ pressure on long-term yields.
a. short-term; downward
b. long-term; downward
c. short-term; upward
d. long-term; upward

Answer 75

d. long-term; upward

Question 76

Bonds issued at different times by the same corporation may not receive the same rating from a rating agency.
a. True
b. False

Answer 76

a. True

Question 77

Investment-grade bonds are bonds that are rated as Caa or better by Moody’s and as CCC or better by Standard & Poor’s.
a. True
b. False

Answer 77

b. False

Question 78

A flat or inverted yield curve is most commonly interpreted to signal that that the economy will
strengthen in the near future
a. True
b. False

Answer 78

a. True

Question 79

The yields of securities commonly move in the same direction over time.
a. True
b. False

Answer 79

a. True

Question 80

Because interest rates may vary significantly across countries at a given point in time, investors do not monitor the term structures of interest rates in foreign countries unless they are interested in investing in a particular foreign country.
a. True
b. False

Answer 80

b. False