Slides 10-11

Question 1

The four elements of the quantity demanded of an asset are ___, ___, ___ and ___.

Answer 1

Wealth, Expected Return, Risk and Liquidity

Question 2

At lower prices, bonds must have (lower/higher) interest rates, and the quantity supplied of bonds is (lower/higher), a ___ relationship.

Answer 2

Higher interest rates, Qty supplied is lower, A positive relationship

Question 3

The supply of bonds is a function of ___, ___, ___ and ___.

Answer 3

1. Government Deficits: Increased budget deficits shift the supply curve to the right, 2. Alternative Cost of Financing: Internally Generated Cash Flow, Money Market Rates, Generating Funds via the Equity Market, 3. Expected Profitability: Investment opportunities, 4. Expected Inflation: An increase in expected inflation shifts the supply curve for bonds to the right

Question 4

An increase in inflation shifts the bond Dx curve ___ and Sx ___, driving bond prices (up/down) and yields (up/down).

Answer 4

Increase in Expected Inflation, Shifts Demand Inward and Supply Out, Driving Bond Prices Down and Yields Up

Question 5

The Cumulative Effect of Deficits Is a Swelling of ___.

Answer 5

Federal (Treasury Debt Outstanding)

Question 6

Other Things Equal An Increase In Treasury Debt Outstanding Would Make Bond Prices ___, Interest Rates ___.

Answer 6

Bond Prices Fall, Interest Rates Rise

Question 7

Even if the deficit were to fall to zero, the Treasury would have to issue new debt to ___.

Answer 7

Redeem maturing debt

Question 8

The four types of bids are ___, ___, ___ and ___.

Answer 8

Competitive, Noncompetitive, Foreign International Monetary Authority (FIMA)—Noncompetitive, and System Open Market Account (SOMA) –roll over bid

Question 9

If bond prices fall, stock prices (rise/fall).

Answer 9

Rise

Question 10

The risk premium for bonds is ___.

Answer 10

The spread between the interest rates on bonds w/ default risk and the interest rates on T-bonds.

Question 11

T-bills are (short/long) term securities maturing in ___. T-notes have a fixed maturity of ___.

Answer 11

Short, <1 year, Fixed maturity of not less than 1 year

Question 12

If the yield curve is upward sloping, then long term rates are ___ short-term rates. If the curve is flat, then short and long term rates are ___. If the curve is inverted, then long term rates are ___ short-term.

Answer 12

Upward Sloping=Long-Term above Short-Term, Flat=Short&Long Term Rates are the Same, Inverted=Long-Term Rates are Below Short Term Rates

Question 13

When short-term rates are low, yield curves are more likely to have a ___ slope; when short-term rates are high, yield curves are more likely to slope ___ and be ___

Answer 13

Upward, Slope downward and be inverted

Question 14

The 3 yield curve theories are the ___, ___ and ___.

Answer 14

1) Expectations theory, 2) Segmented markets theory and 3) Liquidity premium theory

Question 15

The Expectations theory states that the interest rate on long-term bonds will equal ___.

Answer 15

The average of expected short-term rates over the life of the bond. Example: Let the current rate on one-year bond be 6%. You expect the interest rate on a one-year bond to be 8% next year. Then the expected return for buying two one-year bonds averages (6% + 8%)/2 = 7%.
The interest rate on a two-year bond must be 7% for you to be willing to purchase it.

Question 16

The expectations theory explains why ___ and (fact 1) why ___.

Answer 16

Why the term structure of interest rates changes at different times and (fact 1) why interest rates on bonds with different maturities move together over time.

Question 17

The expectations theory explains why (fact 2) ___ but cannot explain why (fact 3) ___.

Answer 17

Why yield curves tend to slope up when short-term rates are high, but cannot explain why yield curves usually slope upward

Question 18

The segmented markets theory claims that bond of different maturities are not ___, and that the interest rate for each bond is determined by ___.

Answer 18

Are not substitutes at all, determined by the demand for and supply of that bond.

Question 19

An assumption of the segmented markets theory is that investors have preferences for ___, and that yield curves usually slope upward because investors have ___ holding periods and generally prefer bonds with ___ maturities that have ___ interest rate risk.

Answer 19

Investors have preferences for bonds of one maturity over another, Investors have short desired holding periods, prefer bonds with shorter maturities that have less interest-rate risk

Question 20

The liquidity premium theory states that the interest rate on a long-term bond will equal ___ of short-term rates expected to occur over the life of the bond plus a ___ that responds to supply and demand conditions for that bond.

Answer 20

Will equal an average of, Plus a liquidity premium

Question 21

An assumption of the liquidity premium theory is that bonds of different maturities are ___.

Answer 21

Are substitutes but not perfect substitutes.

Question 22

The preferred habitat theory is that investors have a ___ for bonds of one maturity over another, and that they are likely to prefer ___ bonds over ___ bonds.

Answer 22

Have a preference, prefer short term bonds over longer term bonds

Question 23

The preferred habitat theory states that investors would be willing to buy bonds of different maturities only if they ___.

Answer 23

Can earn a somewhat higher expected return

Question 24

Operation Twist in 1961 was an ___ type of policy aimed at ___ aggregate demand, and a ___ type of policy aimed at ___ aggregate demand (thereby reducing demand for ___).

Answer 24

An expansionary policy to increase aggregate demand, and a contradictory policy aimed at reducing aggregate demand (reducing demand for imports/for BoP deficit).

Question 25

Operation Twist was engaged by buying ___ and selling ___. The Treasury thus issued more ___ and less ___, inducing (higher/lower) short term rates in support of the BoP.

Answer 25

Buying longer-term securities, and selling short-term securities, The Treasury issued more bills and less longer-term securities thereby inducing higher short-term rates.

Question 26

When the coupon bond is priced at its face value, the YTM equals ___.

Answer 26

The coupon rate

Question 27

The price of a coupon bond and the YTM are ___ related.

Answer 27

Negatively

Question 28

If the YTM is greater than the coupon rate, then the bond is priced ___ face value or par.

Answer 28

Priced below

Question 29

The more distant a bond’s maturity, the (lower/higher) the rate of return that occurs as a result of the interest rate.

Answer 29

The lower

Question 30

The security with the larger Duration provides the (larger/smaller) percentage change in price for a given change in yield.

Answer 30

The larger