Question 1

When a municipal bond is given tax-free status, the demand for Treasury bonds shifts ________, and the interest rate on Treasury bonds ________.
A)leftward; rises
B)leftward; falls
C)rightward; rises
D)rightward; falls

Accepted Answer

When a municipal bond is given tax-free status, it becomes more attractive to investors, leading to a decrease in demand for Treasury bonds (shift leftward). As demand for Treasury bonds decreases, the price of these bonds falls, causing the interest rate (which moves inversely to bond prices) to rise.

Question 2

Which of the following statements are true?
A)Because coupon payments on municipal 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 increase the demand for municipal bonds, lowering their interest rates.
C)Interest rates on municipal bonds will be lower than on comparable bonds without the tax exemption.
D)All of the above are true statements.
E)Only A and B are true statements.

Accepted Answer

All the statements are true. A) Municipal bonds are attractive to individuals in higher tax brackets due to their tax-exempt status, increasing their after-tax return. B) Higher tax rates make tax-exempt municipal bonds more attractive, increasing demand and potentially lowering their interest rates. C) The tax exemption on municipal bonds typically results in lower interest rates compared to taxable bonds, as investors are willing to accept a lower rate due to the tax benefits.

Question 3

When a municipal bond is given tax-free status, the demand for municipal bonds shifts ________, causing the interest rate on the bond to ________.
A)leftward; rise
B)leftward; fall
C)rightward; rise
D)rightward; fall

Accepted Answer

When a municipal bond is given tax-free status, it becomes more attractive to investors because the interest income is exempt from federal (and in some cases, state and local) taxes. This increased attractiveness leads to a higher demand for municipal bonds, shifting the demand curve rightward. As demand increases, the price of the bonds goes up, and the interest rate, which moves inversely to bond prices, falls.

Question 4

Yield curves can be classified as
A)upward-sloping.
B)downward-sloping.
C)flat.
D)all of the above.
E)only A and B of the above.

Accepted Answer

Yield curves can be classified as upward-sloping, downward-sloping, or flat, depending on the relationship between the yield and the maturity of the debt securities.

Question 5

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

Accepted Answer

An increase in marginal tax rates makes tax-exempt municipal bonds more attractive relative to taxable bonds, increasing their demand. Conversely, the demand for U.S. government bonds, which are taxable, would likely decrease as investors seek the tax advantages of municipal bonds.

Question 6

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.
E)medium-term interest rates are below both short-term and long-term interest rates.

Accepted Answer

A steep upward-sloping yield curve indicates that long-term interest rates are higher than short-term interest rates. This is because investors demand higher yields for the risk of holding longer-term bonds, and this drives up long-term interest rates relative to short-term rates.

Question 7

When the corporate bond market becomes more liquid, 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 corporate bond market becomes more liquid, investors may be more willing to invest in these bonds as they are easier to buy and sell. Therefore, the demand for corporate bonds will likely increase, causing the demand curve to shift to the right. On the other hand, the demand for Treasury bonds may decrease because investors have more options for where to invest their money. This would cause the demand curve for Treasury bonds to shift to the left.

Question 8

(I)If a corporate bond becomes less liquid, the demand for the bond will fall, causing the interest rate to rise. (II)If a corporate bond becomes less liquid, the demand for Treasury bonds does not change.
A)(I)is true, (II)false.
B)(I)is false, (II)true.
C)Both are true.
D)Both are false.

Accepted Answer

(I) is true because a decrease in liquidity would make the bond less attractive to investors, which would result in a decrease in demand for the bond. As demand decreases, the issuer must offer a higher interest rate to attract buyers, resulting in an increase in interest rates.

(II) is false because a decrease in demand for a corporate bond may cause investors to look for alternative investment opportunities, such as Treasury bonds, leading to an increase in demand for Treasury bonds and potentially lower interest rates.

Question 9

Corporate bonds are not as liquid as government bonds because
A)fewer 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)all of the above.
E)only A and B of the above.

Accepted Answer

Corporate bonds are generally less liquid than government bonds because there are fewer of them traded, which can make them more costly to sell. Corporate bond ratings do not need to be recalculated each time they are traded, and the callability of a bond does not directly affect its liquidity.

Question 10

If income tax rates were lowered, then
A)the interest rate on municipal bonds would fall.
B)the interest rate on Treasury bonds would rise.
C)the interest rate on municipal bonds would rise.
D)the price of Treasury bonds would fall.

Accepted Answer

When income tax rates are lowered, the after-tax income of individuals increases which can make municipal bonds more valuable. This increased demand for municipal bonds can lead to an increase in their prices and a corresponding decrease in their interest rates. Therefore, the interest rate on municipal bonds would rise. The interest rate on Treasury bonds is not directly impacted by changes in income tax rates, so option B is incorrect. Option A is also incorrect because lower income tax rates could actually increase the demand for municipal bonds, leading to lower interest rates. Option D is incorrect because the price of Treasury bonds is negatively correlated with interest rates, meaning that if interest rates rise, the price of Treasury bonds will fall, but it is not directly influenced by changes in income tax rates.

Question 11

A decrease 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

Accepted Answer

A decrease in marginal tax rates reduces the tax benefits of municipal bonds, which are tax-free, thus decreasing the demand for them. On the other hand, a decrease in marginal tax rates reduces the after-tax return on U.S. government bonds, making them less attractive and reducing demand for them. Therefore, the demand for municipal bonds would decrease and the demand for U.S. government bonds would increase.

Question 12

If municipal bonds were to lose their tax-free status, then the demand for Treasury bonds would shift ________, and the interest rate on Treasury bonds would ________.
A)rightward; fall
B)rightward; rise
C)leftward; fall
D)leftward; rise

Accepted Answer

The answer of If municipal bonds were to lose their...

Question 13

Typically, yield curves are
A)gently upward-sloping.
B)gently downward-sloping.
C)flat.
D)bowl shaped.
E)mound shaped.

Accepted Answer

Yield curves are typically gently upward-sloping, indicating that long-term interest rates are higher than short-term interest rates. This shape reflects the market's expectation of future economic growth and inflation, as well as the risk premium associated with holding onto a long-term investment. Downward-sloping yield curves, on the other hand, typically indicate an impending recession or economic slowdown. Flat yield curves can suggest economic uncertainty, while bowl or mound-shaped yield curves are rare but have been observed during periods of extreme market volatility.

Question 14

The relationship among interest rates on bonds with identical default risk but different maturities is called the
A)time-risk structure of interest rates.
B)liquidity structure of interest rates.
C)yield curve.
D)bond demand curve.

Accepted Answer

The relationship among interest rates on bonds with identical default risk but different maturities is represented by the yield curve. The yield curve shows the relationship between bond yields and time to maturity. It is an important tool for investors and analysts to understand the market's expectations for future economic conditions and interest rate movements. The other options, time-risk structure and liquidity structure of interest rates, are not commonly used terms in finance. The bond demand curve is a graph that shows the relationship between bond prices and the quantity of bonds demanded at different interest rates.

Question 15

The Bush tax cut passed in 2001 reduces the top income tax bracket from 39 percent to 35 percent over the next ten years. As a result of this tax cut, the demand for municipal bonds should shift to the ________ and the interest rate on municipal bonds should ________.
A)right; decline
B)right; increase
C)left; decline
D)left; increase

Accepted Answer

The answer of The Bush tax cut passed in 2001...

Question 16

(I)The risk premium widens as the default risk on corporate bonds increases. (II)The risk premium widens as corporate bonds become less liquid.
A)(I)is true, (II)false.
B)(I)is false, (II)true.
C)Both are true.
D)Both are false.

Accepted Answer

The risk premium is the excess return demanded by investors for investing in a risky asset compared to a risk-free asset. One of the factors that affect the risk premium on corporate bonds is the default risk. The higher the default risk, the higher the risk premium demanded by investors. Therefore, statement (I) is true.
Another factor that affects the risk premium is the liquidity risk. The less liquid the corporate bonds are, the higher the risk premium demanded by investors. Therefore, statement (II) is also true. So, both statements are true.

Question 17

If income tax rates rise, then
A)the prices of municipal bonds will fall.
B)the prices of Treasury bonds will rise.
C)the interest rate on Treasury bonds will rise.
D)the interest rate on municipal bonds will rise.

Accepted Answer

When income tax rates rise, individuals seek tax shelters to reduce their taxable income. Treasury bonds are considered tax sheltered investments and demand for them increases, causing their prices to rise and interest rates to decrease. Therefore, option B is incorrect. On the other hand, municipal bonds are tax-exempt, so their demand decreases when income tax rates rise, causing their prices to fall and interest rates to rise. Therefore, option A is also incorrect. Overall, option C is the best choice.

Question 18

Which of the following statements are true?
A)Because coupon payments on municipal 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 increase the demand for Treasury bonds, lowering their interest rates.
C)Interest rates on municipal bonds will be higher than on comparable bonds without the tax exemption.
D)Only A and B are true statements.

Accepted Answer

Option A is true because the tax exemption on coupon payments increases the after-tax return on municipal bonds, making them more attractive to higher-income tax brackets than other comparable bonds.

Option B is false because an increase in tax rates would prompt investors to seek out tax-free investments like municipal bonds. As a result, Treasury bond demand would decrease, resulting in increased interest rates to attract buyers.

Option C is false because the tax exemption on coupon payments makes municipal bonds more appealing to investors, which reduces the interest rates issuers must provide to gain financing.

Question 19

When the corporate bond market becomes less liquid, 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 corporate bond market becomes less liquid, investors become more risk-averse and demand for corporate bonds decreases. This results in a leftward shift of the demand curve for corporate bonds. As a result, investors may shift their demand towards more liquid Treasury bonds, leading to an increase in demand and a rightward shift of the demand curve for Treasury bonds.

Question 20

(I)If a corporate bond becomes less liquid, the interest rate on the bond will fall. (II)If a corporate bond becomes less liquid, the interest rate on Treasury bonds will fall.
A)(I)is true, (II)false.
B)(I)is false, (II)true.
C)Both are true.
D)Both are false.

Accepted Answer

If a corporate bond becomes less liquid, the interest rate on that bond will likely increase (not decrease), as investors demand a higher return for the added risk of holding a less liquid security. Therefore, statement (I) is false. On the other hand, the liquidity of corporate bonds and Treasury bonds is not directly related, so a change in liquidity of one would not necessarily affect the interest rate of the other. Thus, statement (II) is also false.

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

When a municipal bond is given tax-free status, the demand for Treasury bonds shifts , and the interest rate on Treasury bonds .

Which of the following statements are true?

When a municipal bond is given tax-free status, the demand for municipal bonds shifts , causing the interest rate on the bond to .

Yield curves can be classified as

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.

When yield curves are steeply upward-sloping,

When the corporate bond market becomes more liquid, other things equal, the demand curve for corporate bonds shifts to the and the demand curve for Treasury bonds shifts to the .

(I) If a corporate bond becomes less liquid, the demand for the bond will fall, causing the interest rate to rise. (II) If a corporate bond becomes less liquid, the demand for Treasury bonds does not change.

Corporate bonds are not as liquid as government bonds because

If income tax rates were lowered, then

A decrease in marginal tax rates would likely have the effect of the demand for municipal bonds and the demand for U.S. government bonds.

If municipal bonds were to lose their tax-free status, then the demand for Treasury bonds would shift , and the interest rate on Treasury bonds would .

Typically, yield curves are

The relationship among interest rates on bonds with identical default risk but different maturities is called the

The Bush tax cut passed in 2001 reduces the top income tax bracket from 39 percent to 35 percent over the next ten years. As a result of this tax cut, the demand for municipal bonds should shift to the and the interest rate on municipal bonds should .

(I) The risk premium widens as the default risk on corporate bonds increases. (II) The risk premium widens as corporate bonds become less liquid.

If income tax rates rise, then

Which of the following statements are true?

When the corporate bond market becomes less liquid, other things equal, the demand curve for corporate bonds shifts to the and the demand curve for Treasury bonds shifts to the .

(I) If a corporate bond becomes less liquid, the interest rate on the bond will fall. (II) If a corporate bond becomes less liquid, the interest rate on Treasury bonds will fall.