chapter 3 | mcq Flashcards
In general, securities with ____ characteristics will offer ____ yields.
a. favorable; higher
b. favorable; lower
c. unfavorable; lower
d. None of these are correct.
b. favorable; lower
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
d. BBB corporate securities
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
d. investment-grade bonds
Credit ratings are most commonly used to indicate which financial institutions have available funds that they can lend to borrowers.
a. True
b. False
b. False
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.
a. is liquid.
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
a. positively; internationally integrated
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
b. taxable securities; a higher before-tax yield than tax-exempt securities
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.
c. 9.00 percent
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.
b. downward pressure on the short-term yields.
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.
a. 7.0 percent
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.
a. term structure of interest rates
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.
c. between maturity and yield.
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).
c. is downward sloping.
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.
c. become upward sloping.
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.
e. None of these are correct.
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
b. lowest; above that
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
b. positively; positively
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.
c. pure expectations theory.
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
a. 15.08 percent
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.
b. become upward sloping.
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
c. upward; downward
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.
c. maturity markets are segmented.
- 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
e. greater; greater AND less; less
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.
e. None of these are correct.
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
a. slight downward slope
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
c. be greater than
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.
b. 7.6 percent.
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)
a. overestimates
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
b. a slight decrease
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.
c. segmented markets theory.
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.
b. upward pressure on the price of short-term securities.
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.
d. preferred habitat theory.
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
a. upward: upward
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.
a. riding the yield curve
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.
c. less than
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
a. greater than
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
b. expectations theory
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
d. small; large
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.
d. None of these are correct.
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
b. expectations theory
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.
d. segmented markets theory.
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
a. long-term; long-term
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.
d. 14 percent.
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
d. 15.1
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.
c. 15.0
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
d. downward; downward
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
a. longer; lower
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
b. decrease; upward
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.
b. 7.6
If liquidity influences the yield curve, the forward rate underestimates the market’s expectation of the future interest rate.
a. True
b. False
b. False
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.
c. typically has the same slope as the Treasury yield curve.
Some types of debt securities always offer a higher yield than others.
a. True
b. False
a. True
Investors will always prefer the purchase of risk-free Treasury securities, since other securities have a higher level of risk.
a. True
b. False
b. False
The higher a bond rating, the lower the perceived credit risk.
a. True
b. False
a. True
Treasury securities are exempt from federal and state income taxes.
a. True
b. False
b. False
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
a. True
The graphic comparison of maturities and annualized yields is known as the interest rate curve.
a. True
b. False
b. False
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
b. False
The forward rate is commonly used to represent the market’s forecast of the future interest rate.
a. True
b. False
a. True
Other things being equal, an expected decrease in interest rates will increase the demand for long-term funds by borrowers.
a. True
b. False
b. False
The preference for more the yield curve.
a. True
b. False
b. False
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
b. False
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
b. False
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
a. True
Yield curves are always upward sloping.
a. True
b. False
b. False
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.
c. In general, securities with favorable characteristics will offer higher yields to entice investors.
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.
a. credit (default) risk
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.
a. lower; higher
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
e. longer; lower AND shorter; higher
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
c. increase; upward
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.
c. upward sloping.
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
b. increase; downward
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
a. upward; downward
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
d. preferred habitat
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
d. long-term; upward
Bonds issued at different times by the same corporation may not receive the same rating from a rating agency.
a. True
b. False
a. True
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
b. False
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
a. True
The yields of securities commonly move in the same direction over time.
a. True
b. False
a. True
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
b. False
