unit 6 review

Question 1

1) The risk structure of interest rates is
A) the structure of how interest rates move over time.
B) the relationship among interest rates of different bonds with the same maturity.
C) the relationship among the term to maturity of different bonds.
D) the relationship among interest rates on bonds with different maturities.

Answer 1

B) the relationship among interest rates of different bonds with the same maturity.

Question 2

2) The risk that interest payments will not be made, or that the face value of a bond is not repaid when a bond matures is
A) interest rate risk.
B) inflation risk.
C) liquidity risk.
D) default risk.

Answer 2

D) default risk.

Question 3

3) Bonds with no default risk are called
A) flower bonds.
B) no-risk bonds.
C) default-free bonds.
D) zero-risk bonds.

Answer 3

C) default-free bonds.

Question 4

4) Which of the following bonds are considered to be default-risk free?
A) municipal bonds
B) investment-grade bonds
C) U.S. Treasury bonds
D) junk bonds

Answer 4

C) U.S. Treasury bonds

Question 5

5) U.S. government bonds have no default risk because
A) they are issued in strictly limited quantities.
B) the federal government can increase taxes or print money to pay its obligations.
C) they are backed with gold reserves.
D) they can be exchanged for silver at any time.

Answer 5

B) the federal government can increase taxes or print money to pay its obligations.

Question 6

6) The spread between the interest rates on bonds with default risk and default-free bonds is called the
A) risk premium.
B) junk margin.
C) bond margin.
D) default premium.

Answer 6

A) risk premium.

Question 7

7) If the probability of a bond default increases because corporations begin to suffer large losses, then the
default risk on corporate bonds will ________ and the expected return on these bonds will ________,
everything else held constant.
A) decrease; increase
B) decrease; decrease
C) increase; increase
D) increase; decrease

Answer 7

D) increase; decrease

Question 8

8) A bond with default risk will always have a ________ risk premium and an increase in its default risk
will ________ the risk premium.
A) positive; raise
B) positive; lower
C) negative; raise
D) negative; lower

Answer 8

A) positive; raise

Question 9

9) If a corporation begins to suffer large losses, then the default risk on the corporate bond will
A) increase and the bond’s return will become more uncertain, meaning the expected return on the
corporate bond will fall.
B) increase and the bond’s return will become less uncertain, meaning the expected return on the
corporate bond will fall.
C) decrease and the bond’s return will become less uncertain, meaning the expected return on the
corporate bond will fall.
D) decrease and the bond’s return will become less uncertain, meaning the expected return on the
corporate bond will rise.

Answer 9

A) increase and the bond’s return will become more uncertain, meaning the expected return on the
corporate bond will fall.

Question 10

10) If the possibility of a default increases because corporations begin to suffer losses, then the default risk on corporate bonds will ________, and the bonds’ returns will become ________ uncertain, meaning
that the expected return on these bonds will decrease, everything else held constant.
A) increase; less
B) increase; more
C) decrease; less
D) decrease; more

Answer 10

B) increase; more

Question 11

11) Other things being equal, an increase in the default risk of corporate bonds shifts the demand curve for
corporate bonds to the ________ and the demand curve for Treasury bonds to the ________.
A) right; right
B) right; left
C) left; right
D) left; left

Answer 11

C) left; right

Question 12

12) Other things being equal, a decrease in the default risk of corporate bonds shifts the demand curve for
corporate bonds to the ________ and the demand curve for Treasury bonds to the ________.
A) right; right
B) right; left
C) left; right
D) left; left

Answer 12

B) right; left

Question 13

13) A(n) ________ in the riskiness of corporate bonds will ________ the price of corporate bonds and
________ the yield on corporate bonds, all else equal.
A) increase; increase; increase
B) increase; decrease; increase
C) decrease; increase; increase
D) decrease; decrease; decrease

Answer 13

B) increase; decrease; increase

Question 14

14) An increase in the riskiness of corporate bonds will ________ the price of corporate bonds and
________ the price of Treasury bonds, everything else held constant.
A) increase; increase
B) reduce; reduce
C) reduce; increase
D) increase; reduce

Answer 14

C) reduce; increase

Question 15

15) A decrease in the riskiness of corporate bonds will ________ the price of corporate bonds and
________ the price of Treasury bonds, everything else held constant.
A) increase; increase
B) reduce; reduce
C) reduce; increase
D) increase; reduce

Answer 15

D) increase; reduce

Question 16

16) An increase in the riskiness of corporate bonds will ________ the yield on corporate bonds and
________ the yield on Treasury securities, everything else held constant.
A) increase; increase
B) reduce; reduce
C) increase; reduce
D) reduce; increase

Answer 16

C) increase; reduce

Question 17

17) A decrease in the riskiness of corporate bonds will ________ the yield on corporate bonds and
________ the yield on Treasury securities, everything else held constant.
A) increase; increase
B) decrease; decrease
C) increase; decrease
D) decrease; increase

Answer 17

D) decrease; increase

Question 18

18) An increase in default risk on corporate bonds ________ the demand for these bonds, but ________
the demand for default-free bonds, everything else held constant.
A) increases; lowers
B) lowers; increases
C) does not change; greatly increases
D) moderately lowers; does not change

Answer 18

B) lowers; increases

Question 19

19) A decrease in default risk on corporate bonds ________ the demand for these bonds, and ________
the demand for default-free bonds, everything else held constant.
A) increases; lowers
B) lowers; increases
C) does not change; greatly increases
D) moderately lowers; does not change

Answer 19

A) increases; lowers

Question 20

20) As default risk increases, the expected return on corporate bonds ________, and the return becomes
________ uncertain, everything else held constant.
A) increases; less
B) increases; more
C) decreases; less
D) decreases; more

Answer 20

D) decreases; more

Question 21

21) As default risk decreases, the expected return on corporate bonds ________, and the return becomes
________ uncertain, everything else held constant.
A) increases; less
B) increases; more
C) decreases; less
D) decreases; more

Answer 21

A) increases; less

Question 22

22) As their relative riskiness ________, the expected return on corporate bonds ________ relative to the
expected return on default-free bonds, everything else held constant.
A) increases; increases
B) increases; decreases
C) decreases; decreases
D) decreases; does not change

Answer 22

B) increases; decreases

Question 23

23) Which of the following statements are TRUE?
A) A decrease in default risk on corporate bonds lowers the demand for these bonds, but increases the
demand for default-free bonds.
B) The expected return on corporate bonds decreases as default risk increases.
C) A corporate bond’s return becomes less uncertain as default risk increases.
D) As their relative riskiness increases, the expected return on corporate bonds increases relative to the
expected return on default-free bonds.

Answer 23

B) The expected return on corporate bonds decreases as default risk increases.

Question 24

24) Everything else held constant, if the federal government were to guarantee today that it will pay
creditors if a corporation goes bankrupt in the future, the interest rate on corporate bonds will ________
and the interest rate on Treasury securities will ________.
A) increase; increase
B) increase; decrease
C) decrease; increase
D) decrease; decrease

Answer 24

C) decrease; increase

When the federal government guarantees that it will pay creditors if a corporation goes bankrupt, the risk associated with corporate bonds decreases. This reduction in risk makes corporate bonds more attractive to investors, which in turn decreases the interest rate on corporate bonds. Conversely, with corporate bonds becoming more attractive, investors may demand a higher interest rate to continue investing in relatively less attractive Treasury securities, causing the interest rate on Treasury securities to increase

Question 25

25) Bonds with relatively high risk of default are called A) Brady bonds. B) junk bonds. C) zero coupon bonds. D) investment grade bonds.

Answer 25

B) junk bonds.

Question 26

26) Junk bonds, bonds with a low bond rating, are also known as A) high-yield bonds. B) investment grade bonds. C) high quality bonds. D) zero-coupon bonds.

Answer 26

A) high-yield bonds.

Question 27

27) Bonds with relatively low risk of default are called ________ securities and have a rating of Baa (or BBB) and above; bonds with ratings below Baa (or BBB) have a higher default risk and are called ________. A) investment grade; lower grade B) investment grade; junk bonds C) high quality; lower grade D) high quality; junk bonds

Answer 27

B) investment grade; junk bonds

Question 28

28) Which of the following bonds would have the highest default risk? A) municipal bonds B) investment-grade bonds C) U.S. Treasury bonds D) junk bonds

Answer 28

D) junk bonds

Question 29

29) Which of the following long-term bonds has the highest interest rate? A) corporate Baa bonds B) U.S. Treasury bonds C) corporate Aaa bonds D) municipal bonds

Answer 29

A) corporate Baa bonds

Question 30

31) The spread between interest rates on low quality corporate bonds and U.S. government bonds A) widened significantly during the Great Depression. B) narrowed significantly during the Great Depression. C) narrowed moderately during the Great Depression. D) did not change during the Great Depression.

Answer 30

A) widened significantly during the Great Depression.

Question 31

32) During the Great Depression years 1930-1933 there was a very high rate of business failures and defaults, we would expect the risk premium for ________ bonds to be very high. A) U.S. Treasury B) corporate Aaa C) municipal D) corporate Baa

Answer 31

D) corporate Baa

Question 32

33) Risk premiums on corporate bonds tend to ________ during business cycle expansions and ________ during recessions, everything else held constant. A) increase; increase B) increase; decrease C) decrease; increase D) decrease; decrease

Answer 32

C) decrease; increase

Question 33

38) Which of the following statements is TRUE? A) A liquid asset is one that can be quickly and cheaply converted into cash. B) The demand for a bond declines when it becomes less liquid, decreasing the interest rate spread between it and relatively more liquid bonds. C) The differences in bond interest rates reflect differences in default risk only. D) The corporate bond market is the most liquid bond market.

Answer 33

A) A liquid asset is one that can be quickly and cheaply converted into cash.

Question 34

42) A decrease in the liquidity of corporate bonds, other things being equal, shifts the demand curve for corporate bonds to the ________ and the demand curve for Treasury bonds shifts to the ________. A) right; right B) right; left C) left; left D) left; right

Answer 34

D) left; right

Question 35

43) An increase in the liquidity of corporate bonds, other things being equal, shifts the demand curve for corporate bonds to the ________ and the demand curve for Treasury bonds shifts to the ________. A) right; right B) right; left C) left; left D) left; right

Answer 35

B) right; left

Question 36

48) Which of the following statements is TRUE? A) State and local governments cannot default on their bonds. B) Bonds issued by state and local governments are called municipal bonds. C) All government issued bonds—local, state, and federal—are federal income tax exempt. D) The coupon payment on municipal bonds is usually higher than the coupon payment on Treasury bonds.

Answer 36

B) Bonds issued by state and local governments are called municipal bonds.

Question 37

50) Municipal bonds have default risk, yet their interest rates are usually lower than the rates on default-free Treasury bonds. This suggests that A) the benefit from the tax-exempt status of municipal bonds is less than their default risk. B) the benefit from the tax-exempt status of municipal bonds equals their default risk. C) the benefit from the tax-exempt status of municipal bonds exceeds their default risk. D) Treasury bonds are not default-free.

Answer 37

C) the benefit from the tax-exempt status of municipal bonds exceeds their default risk.

Question 38

51) Everything else held constant, an increase in marginal tax rates would likely have the effect of ________ the demand for municipal bonds, and ________ the demand for U.S. government bonds. A) increasing; increasing B) increasing; decreasing C) decreasing; increasing D) decreasing; decreasing

Answer 38

B) increasing; decreasing Municipal bonds are normally exempt from taxes so higher tax rates would increase demand for these bonds and would decrease demand for govt bonds

Question 39

60) If the federal government were to guarantee payment on municipal bonds, the price of municipal bonds would ________ and the yield on U.S. Treasury bonds would ________, all else equal. A) increase; increase B) increase; decrease C) decrease; decrease D) decrease; increase Answer: A Question Status: Previous Edition AACSB: Application of Knowledge

Answer 39

A) increase; increase If the federal government guarantees payment on municipal bonds, the perceived risk associated with municipal bonds decreases. As a result, these bonds become more attractive to investors, leading to an increase in their price and a corresponding decrease in their yield. For U.S. Treasury bonds, if municipal bonds become more attractive due to the guarantee, some investors might shift their investments from Treasury bonds to municipal bonds. This shift could lead to a decrease in demand for Treasury bonds, which would cause Treasury bond prices to fall and their yields to increase.

Question 40

1) The term structure of interest rates is A) the relationship among interest rates of different bonds with the same maturity. B) the structure of how interest rates move over time. C) the relationship among the term to maturity of different bonds. D) the relationship among interest rates on bonds with different maturities.

Answer 40

D) the relationship among interest rates on bonds with different maturities.

Question 41

2) A plot of the interest rates on default-free government bonds with different terms to maturity is called A) a risk-structure curve. B) a default-free curve. C) a yield curve. D) an interest-rate curve.

Answer 41

C) a yield curve.

Question 42

3) Differences in ________ explain why interest rates on Treasury securities are not all the same. A) risk B) liquidity C) time to maturity D) tax characteristics

Answer 42

C) time to maturity

Question 43

4) The typical shape for a yield curve is A) gently upward sloping. B) mound shaped. C) flat. D) bowl shaped.

Answer 43

A) gently upward sloping.

Question 44

5) When yield curves are steeply upward sloping A) long-term interest rates are above short-term interest rates. B) short-term interest rates are above long-term interest rates. C) short-term interest rates are about the same as long-term interest rates. D) medium-term interest rates are above both short-term and long-term interest rates.

Answer 44

A) long-term interest rates are above short-term interest rates.

Question 45

6) When yield curves are flat A) long-term interest rates are above short-term interest rates. B) short-term interest rates are above long-term interest rates. C) short-term interest rates are about the same as long-term interest rates. D) medium-term interest rates are above both short-term and long-term interest rates.

Answer 45

C) short-term interest rates are about the same as long-term interest rates.

Question 46

7) When yield curves are downward sloping A) long-term interest rates are above short-term interest rates. B) short-term interest rates are above long-term interest rates. C) short-term interest rates are about the same as long-term interest rates. D) medium-term interest rates are above both short-term and long-term interest rates.

Answer 46

B) short-term interest rates are above long-term interest rates.

Question 47

21) According to the expectations theory of the term structure A) the interest rate on long-term bonds will exceed the average of short-term interest rates that people expect to occur over the life of the long-term bonds, because of their preference for short-term securities. B) interest rates on bonds of different maturities move together over time. C) buyers of bonds prefer short-term to long-term bonds. D) buyers require an additional incentive to hold long-term bonds.

Answer 47

B) interest rates on bonds of different maturities move together over time.