Question 1

If Moody's or Standard and Poor's downgrades its rating on a corporate bond, the demand for the bond ________ and its yield ________.
A)increases; decreases
B)decreases; increases
C)increases; increases
D)decreases; decreases

Accepted Answer

If Moody's or Standard and Poor's downgrades its rating on a corporate bond, it means that the creditworthiness of the issuer has decreased. As a result, investors will demand a higher yield to compensate for the increased risk. This leads to a decrease in demand for the bond and an increase in its yield.

Question 2

A corporation suffering big losses might be more likely to suspend interest payments on its bonds, thereby
A)raising the default risk and causing the demand for its bonds to rise.
B)raising the default risk and causing the demand for its bonds to fall.
C)lowering the default risk and causing the demand for its bonds to rise.
D)lowering the default risk and causing the demand for its bonds to fall.

Accepted Answer

Suspending interest payments raises the default risk because it indicates the company is struggling financially and unable to fulfill its obligations. As a result, demand for its bonds is likely to fall as investors seek safer investments with lower default risk.

Question 3

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

Accepted Answer

The term structure of interest rates refers to the relationship among interest rates on bonds with different maturities but similar risk. It is also known as the yield curve. The shape of the yield curve provides important information about market expectations of future interest rates and economic conditions.

Question 4

(I)An increase in default risk on corporate bonds shifts the demand curve for corporate bonds to the left. (II)An increase in default risk on corporate bonds shifts the demand curve for Treasury bonds to the right.
A)(I)is true, (II)false.
B)(I)is false, (II)true.
C)Both are true.
D)Both are false.

Accepted Answer

Both statements are true. An increase in default risk on corporate bonds makes them less attractive to investors, leading to a decrease in demand and shifting the demand curve to the left. Conversely, as investors seek safer investments, the demand for Treasury bonds, which are considered risk-free, increases, shifting their demand curve to the right.

Question 5

The risk premium on corporate bonds becomes smaller if
A)the riskiness of corporate bonds increases.
B)the liquidity of corporate bonds increases.
C)the liquidity of corporate bonds decreases.
D)the riskiness of corporate bonds decreases.
E)either B or D of the above occur.

Accepted Answer

The risk premium on corporate bonds decreases if the liquidity of the bonds increases or if the riskiness of the bonds decreases. Increased liquidity makes the bonds more attractive to investors, reducing the premium required to compensate for risk. Similarly, a decrease in riskiness directly reduces the risk premium required by investors.

Question 6

Which of the following long-term bonds should have the lowest interest rate?
A)Corporate Baa bonds
B)U)S. Treasury bonds
C)Corporate Aaa bonds
D)Municipal bonds

Accepted Answer

The answer of Which of the following long-term bonds should...

Question 7

Which of the following long-term bonds should have the highest interest rate?
A)Corporate Baa bonds
B)U)S. Treasury bonds
C)Corporate Aaa bonds
D)Municipal bonds

Accepted Answer

Corporate Baa bonds typically have a higher interest rate compared to U.S. Treasury bonds, Corporate Aaa bonds, and Municipal bonds due to their lower credit quality. Higher risk associated with Baa bonds demands a higher yield as compensation.

Question 8

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 9

If a corporation begins to suffer large losses, then the default risk on its bonds will ________ and the equilibrium interest rate on these bonds will ________.
A)increase; decrease
B)decrease; increase
C)increase; increase
D)decrease; decrease

Accepted Answer

When a corporation begins to suffer large losses, its default risk increases because it becomes less likely to meet its debt obligations. As a result, investors will demand a higher interest rate to compensate for this increased risk, leading to an increase in the equilibrium interest rate on these bonds.

Question 10

(I)If a corporation suffers big losses, the demand for its bonds will rise because of the higher interest rates the firm must pay. (II)The spread between the interest rates on bonds with default risk and default-free bonds is called the risk premium.
A)(I)is true, (II)false.
B)(I)is false, (II)true.
C)Both are true.
D)Both are false.

Accepted Answer

(I) is false because if a corporation suffers big losses, the demand for its bonds is likely to fall due to increased risk of default, not rise. (II) is true as the spread between interest rates on bonds with default risk and those without (default-free bonds) is indeed referred to as the risk premium, reflecting the additional risk investors take on.

Question 11

Holding everything else the same, if a corporation's earnings rise, then the default risk on its bonds will ________ and the expected return on those bonds will ________.
A)increase; decrease
B)decrease; decrease
C)increase; increase
D)decrease; increase

Accepted Answer

When a corporation's earnings rise, its ability to pay back its bonds increases, which decreases the default risk on its bonds. This leads to an increase in the expected return on those bonds, as investors are more willing to invest in them with lower default risk. Therefore, the correct answer is D: decrease in default risk and increase in expected return.

Question 12

Moody's and Standard and Poor's are agencies that
A)help investors collect when corporations default on their bonds.
B)advise municipal bond issuers on the tax exempt status of their bonds.
C)produce information about the probability of default on corporate bonds.
D)maintain liquid markets for corporate bonds.

Accepted Answer

Moody's and Standard and Poor's are credit rating agencies that produce information about the probability of default on corporate bonds. They rate bonds based on their creditworthiness and assign them a letter grade indicating their level of risk. This information is valuable for investors to make informed decisions about investing in corporate bonds.

Question 13

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 terms to maturity of different bonds.
D)the relationship among interest rates on bonds with different maturities.

Accepted Answer

The risk structure of interest rates refers to the relationship among interest rates of different bonds with the same maturity, taking into account factors like credit risk.

Question 14

As a result of the subprime collapse, the demand for low -quality corporate bonds ________, the demand for high-quality Treasury bonds ________, and the risk spread ________.
A)increased; decreased; was unchanged
B)decreased; increased; increased
C)increased; decreased; decreased
D)decreased; increased; was unchanged

Accepted Answer

The subprime collapse led to a decrease in demand for low-quality corporate bonds as investors sought safer investments, increasing the demand for high-quality Treasury bonds. This shift also widened the risk spread between low-quality and high-quality bonds.

Question 15

When the default risk on corporate bonds decreases, other things equal, the demand curve for corporate bonds shifts to the ________ and the demand curve for Treasury bonds shifts to the ________.
A)right; right
B)right; left
C)left; left
D)left; right

Accepted Answer

When the default risk on corporate bonds decreases, investors tend to shift their demand towards corporate bonds. This increases the demand for corporate bonds, causing the demand curve to shift to the right. As a result, the demand curve for Treasury bonds shifts to the left as investors are now less willing to invest in Treasury bonds due to the reduced default risk on corporate bonds. Therefore, the correct choice is B (right; left).

Question 16

Bonds with relatively low risk of default are called
A)zero coupon bonds.
B)junk bonds.
C)investment-grade bonds.
D)none of the above.

Accepted Answer

Investment-grade bonds are considered to have relatively low risk of default compared to junk bonds (which have high risk of default) and zero coupon bonds (which don't pay interest).

Question 17

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

Accepted Answer

During the Great Depression, the spread between interest rates on low-quality corporate bonds and U.S. government bonds widened significantly. This was because investors were more likely to buy safer government bonds during such an uncertain economic time, causing the demand for corporate bonds to decrease and their interest rates to increase.

Question 18

(I)An increase in default risk on corporate bonds shifts the demand curve for corporate bonds to the right. (II)An increase in default risk on corporate bonds shifts the demand curve for Treasury bonds to the left.
A)(I)is true, (II)false.
B)(I)is false, (II)true.
C)Both are true.
D)Both are false.

Accepted Answer

An increase in default risk on corporate bonds makes them less attractive to investors, shifting the demand curve for corporate bonds to the left, not the right. Conversely, an increase in default risk on corporate bonds may make Treasury bonds more attractive due to their perceived safety, potentially shifting the demand curve for Treasury bonds to the right, not the left.

Question 19

If a corporation's earnings rise, then the default risk on its bonds will ________ and the equilibrium interest rate on these bonds will ________.
A)increase; decrease
B)decrease; decrease
C)increase; increase
D)decrease; increase

Accepted Answer

When a corporation's earnings rise, its ability to meet its debt obligations (including interest payments on its bonds) improves. Therefore, the default risk on its bonds decreases. As a result, investors will demand a lower yield on these bonds (i.e. the equilibrium interest rate will decrease) to reflect the reduced default risk.

Question 20

Holding everything else constant, if a corporation begins to suffer large losses, then the default risk on its bonds will ________ and the expected return on those bonds will ________.
A)increase: increase
B)decrease; increase
C)increase; decrease
D)decrease; decrease

Accepted Answer

When a corporation begins to suffer large losses, its likelihood of defaulting on its bonds increases, leading to higher default risk on its bonds. Investors will demand a higher expected return to compensate for the increased risk, resulting in a decrease in the expected return on those bonds. Therefore, the correct answer is C, increase in default risk and decrease in expected return on those bonds.

Quiz 5: How Do Risk and Term Structure Affect Interest Rates

If Moody's or Standard and Poor's downgrades its rating on a corporate bond, the demand for the bond and its yield .

A corporation suffering big losses might be more likely to suspend interest payments on its bonds, thereby

The term structure of interest rates is

(I) An increase in default risk on corporate bonds shifts the demand curve for corporate bonds to the left. (II) An increase in default risk on corporate bonds shifts the demand curve for Treasury bonds to the right.

The risk premium on corporate bonds becomes smaller if

Which of the following long-term bonds should have the lowest interest rate?

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

Bonds with relatively high risk of default are called

If a corporation begins to suffer large losses, then the default risk on its bonds will and the equilibrium interest rate on these bonds will .

(I) If a corporation suffers big losses, the demand for its bonds will rise because of the higher interest rates the firm must pay. (II) The spread between the interest rates on bonds with default risk and default-free bonds is called the risk premium.

Holding everything else the same, if a corporation's earnings rise, then the default risk on its bonds will and the expected return on those bonds will .

Moody's and Standard and Poor's are agencies that

The risk structure of interest rates is

As a result of the subprime collapse, the demand for low -quality corporate bonds , the demand for high-quality Treasury bonds , and the risk spread .

When the default risk on corporate bonds decreases, other things equal, the demand curve for corporate bonds shifts to the and the demand curve for Treasury bonds shifts to the .

Bonds with relatively low risk of default are called

The spread between interest rates on low-quality corporate bonds and U.S. government bonds ________ during the Great Depression.

(I) An increase in default risk on corporate bonds shifts the demand curve for corporate bonds to the right. (II) An increase in default risk on corporate bonds shifts the demand curve for Treasury bonds to the left.

If a corporation's earnings rise, then the default risk on its bonds will and the equilibrium interest rate on these bonds will .

Holding everything else constant, if a corporation begins to suffer large losses, then the default risk on its bonds will and the expected return on those bonds will .