Chapter 6

Question 1

relative ease and speed with which an asset can be converted into cash

Corporate bonds are less liquid than U.S. Treasury bonds because fewer bonds are traded for any one corporation; thus, it can be costly to sell them because it might be hard to find buyers quickly.

The difference between the interest rate on a corporate bond and a Treasury bond (risk premium) reflects the corporate bonds’ lesser liquidity.

Answer 1

Liquidity

Question 2

A federal tax exemption means that federal income tax is not paid on payments received from the bond which raises the after-tax expected return compared to bonds that are not tax exempt.

Specifically, municipal bond payments are exempt from federal income tax so interest rates on municipal bonds can be less than those on Treasury bonds.

Answer 2

Income Tax Considerations

Question 3

a plot of the yields on bonds with differing terms to maturity but the same risk, liquidity, and tax considerations

Typically slope upward, but when short-term interest rates are high, yield curves are more likely to be inverted (slope downward).

Answer 3

Yield curve