Question 1

The collapse of the subprime mortgage market ________.
A) did not affect the corporate bond market
B) increased the perceived riskiness of Treasury securities
C) reduced the Baa-Aaa spread
D) increased the Baa-Aaa spread

Accepted Answer

The collapse of the subprime mortgage market increased the perceived riskiness of all debt securities, including corporate bonds and Treasury securities. As a result, investors demanded a higher spread between the yield on riskier bonds (Baa-rated) and safer bonds (Aaa-rated), leading to an increase in the Baa-Aaa spread. Therefore, the correct choice is D, which states that the collapse of the subprime mortgage market increased the Baa-Aaa spread.

Question 2

Corporate bonds are not as liquid as Canada bonds because ________.
A) fewer corporate bonds for any one corporation are traded, making them more costly to sell
B) the corporate bond rating must be calculated each time they are traded
C) corporate bonds are not callable
D) corporate bonds cannot be resold

Accepted Answer

The liquidity of a bond depends on the frequency of trades and the availability of buyers and sellers. Since there are typically fewer corporate bonds for any one corporation traded, they can be more expensive to sell compared to Canada bonds, which have a more active and robust market.

Question 3

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) federal government
B) corporate Aaa
C) provincial
D) corporate Baa

Accepted Answer

During the Great Depression years, many businesses failed, leading to a higher risk of default for corporate bonds. Corporate Baa bonds have a higher risk of default than Aaa bonds, so we would expect the risk premium for corporate Baa bonds to be very high during that time period.

Question 4

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.

Accepted Answer

A liquid asset is one that can be quickly and easily converted into cash without significant loss of value, making it more attractive to investors. The demand for a bond may decrease if it becomes less liquid, but it does not necessarily lead to a decrease in interest rate spread between it and more liquid bonds. Bond interest rates reflect not only default risk, but also inflation expectations and other factors. The corporate bond market is not necessarily the most liquid bond market, as it depends on factors such as the size and quality of the issuers and the demand from buyers.

Question 5

The collapse of the subprime mortgage market increased the spread between Baa and default-free Canada bonds. This is due to ________.
A) a reduction in risk
B) a reduction in maturity
C) a flight to quality
D) a flight to liquidity

Accepted Answer

A flight to quality occurs when investors move their investments from higher-risk to lower-risk assets. In this case, the collapse of the subprime mortgage market increased the riskiness of certain types of bonds, causing investors to shift their investments towards safer assets such as default-free Canada bonds. This increased demand for safer assets caused the spread between Baa and default-free Canada bonds to widen.

Question 6

Which of the following long-term bonds has the highest interest rate?
A) Corporate Baa bonds
B) Canada bonds
C) Corporate Aaa bonds
D) Provincial bonds

Accepted Answer

Generally, corporate bonds offer higher interest rates than government bonds, and Baa-rated bonds have a higher risk premium than Aaa-rated bonds. Therefore, Corporate Baa bonds have the highest interest rate among the options given.

Question 7

If you have a very low tolerance for risk, which of the following bonds would you be least likely to hold in your portfolio?
A) A federal government bond
B) A provincial government bond
C) A corporate bond with a rating of Aaa
D) A corporate bond with a rating of Baa

Accepted Answer

A corporate bond with a rating of Baa is the least creditworthy of the given options and therefore carries a higher risk of default. If you have a low tolerance for risk, you would be less likely to hold this bond in your portfolio. The other options - a federal government bond, a provincial government bond, and a corporate bond with a rating of Aaa - are all considered to be more secure and have a lower risk of default.

Question 8

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

Accepted Answer

Risk premiums on corporate bonds typically decrease during business cycle expansions as the economic outlook improves and investors perceive lower risk in lending to corporations. Conversely, during recessions, risk premiums increase due to heightened concerns over corporate defaults and the overall economic downturn.

Question 9

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 Canada bonds shifts to the ________.
A) right; right
B) right; left
C) left; left
D) left; right

Accepted Answer

A decrease in liquidity of corporate bonds makes them less attractive to investors, which causes a decrease in their demand. This shift of demand curve for corporate bonds is to the left. As investors now prefer Canada bonds as an alternative investment, the demand curve for Canada bonds will shift to the right.

Question 10

During a "flight to quality" ________.
A) the spread between Canada bonds and Baa bonds increases
B) the spread between Canada bonds and Baa bonds decreases
C) the spread between Canada bonds and Baa bonds is not affected
D) the change in the spread between Canada bonds and Baa bonds cannot be predicted

Accepted Answer

During a "flight to quality," investors move their money to safer assets, which typically causes the spread between safer government bonds (like Canada bonds) and riskier corporate bonds (like Baa rated bonds) to increase. This is because the demand for safer assets drives up their prices (and thus lowers their yields), while the demand for riskier assets decreases (lowering their prices and increasing their yields).

Question 11

When Canada bonds become more liquid, other things equal, the demand curve for corporate bonds shifts to the ________ and the demand curve for Canada bonds shifts to the ________.
A) right; right
B) right; left
C) left; right
D) left; left

Accepted Answer

When Canada bonds become more liquid, they become more attractive to investors, increasing the demand for Canada bonds and shifting their demand curve to the right. Conversely, as investors prefer the more liquid Canada bonds, the demand for corporate bonds decreases, shifting their demand curve to the left.

Question 12

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

Accepted Answer

Bonds with ratings of Baa (or BBB) and above are considered investment grade, while bonds with ratings below Baa (or BBB) are referred to as junk bonds.

Question 13

Which of the following bonds would have the highest default risk?
A) Provincial bonds
B) Investment-grade bonds
C) Canada bonds
D) Junk bonds

Accepted Answer

Junk bonds, also known as high-yield bonds, are issued by companies and governments with lower credit ratings and therefore have a higher default risk compared to investment-grade bonds, Canada bonds, and Provincial bonds.

Question 14

The risk premium on corporate bonds reflects the fact that corporate bonds have a higher default risk and are ________ Canada bonds.
A) less liquid than
B) less speculative than
C) tax-exempt unlike
D) lower-yielding than

Accepted Answer

The risk premium on corporate bonds reflects that they have a higher default risk compared to Canada bonds. Due to the higher default risk, investors require a higher return for holding corporate bonds, which increases their yield. This is why corporate bonds are less liquid than Canada bonds.

Question 15

Bonds with relatively low risk of default are called ________.
A) zero coupon bonds
B) junk bonds
C) investment grade bonds
D) fallen angels

Accepted Answer

Investment grade bonds are considered to have low risk of default and are rated by credit rating agencies as BBB- or higher. Zero coupon bonds are bonds that are sold at a discount and do not pay periodic interest payments. Junk bonds are bonds that have high risk of default and are rated BB or lower. Fallen angels are bonds that were initially investment grade but have been downgraded to junk status.

Question 16

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

Accepted Answer

Bonds with relatively high risk of default are called junk bonds.

Question 17

Which of the following statements is true?
A) Because coupon payments on tax-exempt bonds are exempt from federal income tax, the expected after-tax return on them will be higher for individuals in higher income tax brackets.
B) An decrease in tax rates will increase the demand for U.S Treasury bonds, lowering their interest rates.
C) Interest rates on tax-exempt bonds will be higher than comparable bonds without the tax exemption.
D) An decrease in tax rates will increase the supply of U.S Treasury bonds, lowering their interest rates.

Accepted Answer

Tax-exempt bonds provide a higher after-tax return to individuals in higher income tax brackets because they don't have to pay federal income tax on the coupon payments. Therefore, they are more attractive to investors in higher tax brackets.

Question 18

An increase in the liquidity of corporate bonds will ________ the price of corporate bonds and ________ the interest rate on those corporate bonds, everything else held constant.
A) increase; increase
B) reduce; reduce
C) increase; reduce
D) reduce; increase

Accepted Answer

An increase in the liquidity of corporate bonds makes them more attractive to investors, leading to higher demand and higher prices for these bonds. As bond prices increase, the interest rates, which move inversely to bond prices, decrease.

Question 19

Which of the following statements is true?
A) Because coupon payments on tax-exempt bonds are exempt from federal income tax, the expected after-tax return on them will be higher for individuals in higher income tax brackets.
B) An increase in tax rates will decrease the demand for tax-exempt bonds, lowering their interest rates.
C) Interest rates on tax-exempt bonds will be higher than comparable bonds without the tax exemption.
D) Because coupon payments on tax-exempt are exempt from federal income tax, the expected after-tax return on them will be lower for individuals in higher income tax brackets.

Accepted Answer

Because the coupon payments on tax-exempt bonds are exempt from federal income tax, individuals in higher income tax brackets will have a higher after-tax return due to their larger tax liabilities. This is because they would otherwise have to pay a higher tax rate on the interest income from taxable bonds. Therefore, option A is true. Option B is incorrect because a decrease in demand would actually raise the interest rates on tax-exempt bonds. Option C is incorrect because tax-exempt bonds usually have lower interest rates than comparable taxable bonds. Option D is incorrect because higher income tax brackets generally lead to a higher after-tax return due to the tax-exempt status of the bond coupon payments.

Question 20

Which of the following securities has the lowest interest rate?
A) Junk bonds
B) Canada bonds
C) Investment-grade bonds
D) Corporate Baa bonds

Accepted Answer

Canada bonds are issued by the government of Canada and are considered one of the safest securities available. They typically offer lower interest rates compared to other bonds to reflect this lower risk. Junk bonds, on the other hand, are high-risk and high-yield securities that offer higher interest rates to compensate for the risk. Investment-grade and Corporate Baa bonds are generally considered moderate-risk securities and offer moderate interest rates.

Quiz 6: The Risk and Term Structure of Interest Rates

The collapse of the subprime mortgage market ________.

Corporate bonds are not as liquid as Canada bonds because ________.

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.

Which of the following statements is true?

The collapse of the subprime mortgage market increased the spread between Baa and default-free Canada bonds. This is due to ________.

Which of the following long-term bonds has the highest interest rate?

If you have a very low tolerance for risk, which of the following bonds would you be least likely to hold in your portfolio?

Risk premiums on corporate bonds tend to during business cycle expansions and during recessions, everything else held constant.

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 Canada bonds shifts to the .

During a "flight to quality" ________.

When Canada bonds become more liquid, other things equal, the demand curve for corporate bonds shifts to the and the demand curve for Canada bonds shifts to the .

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 .

Which of the following bonds would have the highest default risk?

The risk premium on corporate bonds reflects the fact that corporate bonds have a higher default risk and are ________ Canada bonds.

Bonds with relatively low risk of default are called ________.

Bonds with relatively high risk of default are called ________.

Which of the following statements is true?

An increase in the liquidity of corporate bonds will the price of corporate bonds and the interest rate on those corporate bonds, everything else held constant.

Which of the following statements is true?

Which of the following securities has the lowest interest rate?