Question 1

If the liquidity premium theory completely describes the term structure of interest rates, then, on the average, the yield curve should be
A)flat.
B)downward sloping.
C)upward sloping.
D)none of the above.

Accepted Answer

According to the liquidity premium theory, investors demand a higher yield for longer-term bonds due to the increased uncertainty and risk associated with holding them. This leads to an upward sloping yield curve, where longer-term bonds have higher yields than shorter-term bonds. Therefore, choice C (upward sloping) is the expected average yield curve if the liquidity premium theory completely describes the term structure of interest rates.

Question 2

In response to criticism of the ratings they assigned before the credit crisis, credit rating agencies now:
A) a. are paid through fees assessed on the purchasers of bonds.
B) a. are depending more on sensitivity analysis in which they assess how creditworthiness may change in response to abrupt changes in the economy.
C) a. are not allowing the employees who promote an agency to influence the ratings that the agency assigns.
D) a. B and C

Accepted Answer

Choice A is not entirely accurate as credit rating agencies have always charged fees for their services; however, after the credit crisis, they have become more transparent about their fee structure. Choice B and C are both correct. Credit rating agencies are now relying more on sensitivity analysis to take into account abrupt changes in the economy, and they have implemented policies to prevent any potential conflicts of interest. Therefore, the best choice is D, which includes both B and C.

Question 3

Other things being equal, an expected decrease in interest rates will increase the demand for long-term funds by borrowers.

Accepted Answer

The answer of Other things being equal, an expected decrease...

Question 4

If the yield curve is upward sloping, some investors may attempt to benefit from the higher yields on longer-term securities, even when they have funds for only a short period of time. This strategy is known as riding the yield curve.

Accepted Answer

Riding the yield curve is a strategy used by investors in an upward sloping yield curve environment to benefit from the higher yields on longer-term securities even if they have funds for a shorter period of time.

Question 5

Which of the following statements is not true with respect to debt securities?
A)Some types of debt securities always offer a higher yield than others.
B)Debt securities offer different yields because they exhibit different characteristics that influence the offered yield.
C)In general, securities with favorable characteristics will offer higher yields to entice investors.
D)All of the above are true with respect to debt securities.

Accepted Answer

The answer of Which of the following statements is not...

Question 6

Which of the following is not a characteristic affecting the yields on debt securities?
A)default risk
B)liquidity
C)tax status
D)term to maturity
E)All of the above affect yields on debt securities.

Accepted Answer

All the listed factors, including default risk, liquidity, tax status, and term to maturity, affect the yields on debt securities.

Question 7

The Financial Reform Act of 2010 established the __________ within the _________ to regulate credit rating agencies.
A) a. Bureau of Thrift Agency Supervision; Treasury Department
B) a. Office of Credit Ratings; Securities and Exchange Commission
C) a. Federal Ratings Assurance Corporation; Treasury Department
D) a. Ratings Oversight Commission; Federal Reserve

Accepted Answer

The Financial Reform Act of 2010 established the Office of Credit Ratings within the Securities and Exchange Commission to regulate credit rating agencies. None of the other options listed are accurate.

Question 8

If interest rates are expected to decrease, the yield on new short-term securities may be expected to ____, and the yield curve should be ____ sloping.
A)increase; upward
B)increase; downward
C)decrease; upward
D)decrease; downward

Accepted Answer

The answer of If interest rates are expected to decrease,...

Question 9

Investment-grade bonds are bonds that are rated as Caa or better by Moody's and as CCC or better by Standard & Poor's.

Accepted Answer

Investment-grade bonds are bonds that are rated as Baa or better by Moody's and as BBB or better by Standard & Poor's.

Question 10

If the Treasury uses a relatively large proportion of ____ debt to finance a budget deficit, this would place ____ pressure on long-term yields.
A)short-term; downward
B)long-term; downward
C)short-term; upward
D)long-term; upward

Accepted Answer

If the Treasury uses a relatively large proportion of long-term debt to finance a budget deficit, this would place upward pressure on long-term yields. This is because the increased supply of long-term bonds and notes would drive up their yields to attract investors.

Question 11

The ____ theory suggests that although investors and borrowers may normally concentrate on a particular natural maturity market, certain events may cause them to wander from it.
A)pure expectations
B)liquidity premium
C)segmented markets
D)preferred habitat

Accepted Answer

The preferred habitat theory suggests that investors and borrowers may normally prefer a particular natural maturity market, but certain events - such as changes in interest rates or market conditions - could cause them to "wander" from it and seek out a different maturity range. The other answer choices do not fit this description. The pure expectations theory is focused on forward rates and expectations of future interest rates. The liquidity premium theory suggests that investors will demand higher yields for securities that are less liquid. The segmented markets theory suggests that different maturity ranges are completely distinct markets with little connection between them.

Question 12

The preference for more liquid short-term securities places downward pressure on the slope of the yield curve.

Accepted Answer

The answer of The preference for more liquid short-term securities...

Question 13

All other characteristics being equal, securities with ____ liquidity would have to offer a ____ yield to be preferred.
A)lower; higher
B)higher; higher
C)lower; lower
D)none of the above

Accepted Answer

Securities with lower liquidity would have to offer a higher yield to be preferred by investors as they are more risky and difficult to sell quickly, whereas securities with higher liquidity are easier to sell and therefore do not need to offer as high of a yield to attract investors.

Question 14

Assume that the Treasury experiences a large increase in the budget deficit and issues a large number of T-bills. This action will ____ the supply of T-bills in the market and place ____ pressure on the yield of T-bills.
A)decrease; downward
B)decrease; upward
C)increase; upward
D)increase; downward

Accepted Answer

When the Treasury issues a large number of T-bills to finance a large increase in the budget deficit, the supply of T-bills in the market increases. This increase in supply puts upward pressure on the yield of T-bills as investors demand higher yields to compensate for the increased supply of T-bills. Therefore, option C is the correct answer.

Question 15

The segmented markets theory suggests that although investors and borrowers may normally concentrate on a particular natural maturity market, certain events may cause them to wander from it.

Accepted Answer

The segmented markets theory suggests that the bond market is divided into segments based on the maturity of the bonds, and investors typically stay within a particular segment and do not wander from it, even in response to certain events.

Question 16

According to segmented markets theory, if investors have mostly long-term funds available and borrowers want short-term funds, this will place ____ pressure on the demand for short-term funds by borrowers and the yield curve will be ____ sloping.
A)upward; downward
B)downward; upward
C)upward; upward
D)downward; downward

Accepted Answer

The answer of According to segmented markets theory, if investors...

Question 17

Yield curves are always upward sloping.

Accepted Answer

Yield curves can have different shapes, including upward sloping (normal), downward sloping (inverted), and flat (horizontal). The shape of the yield curve depends on various factors, such as the current economic conditions and expectations for future interest rates and inflation.

Question 18

Bonds issued at different times by the same corporation may not receive the same rating from a rating agency.

Accepted Answer

The ratings of bonds issued by a corporation can vary based on several factors, such as changes in the financial condition of the corporation, changes in the economy, and changes in the rating criteria used by the rating agency. Therefore, it is possible for bonds issued at different times by the same corporation to receive different ratings from a rating agency.

Question 19

A downward-sloping yield curve indicates that Treasury securities with ____ maturities offer ____ annualized yields.
A)longer; lower
B)longer; higher
C)shorter; lower
D)shorter; higher
E)Answers A and D are correct.

Accepted Answer

The answer of A downward-sloping yield curve indicates that Treasury...

Question 20

When expectations theory is combined with the liquidity theory, the yield on a security will always be equal to the yield from consecutive investments in shorter-term securities over the same investment horizon.

Accepted Answer

Expectations theory suggests that long-term interest rates reflect expected future short-term rates, while liquidity theory adds that investors demand a premium for longer-term securities due to their higher risk and lower liquidity. Therefore, the yield on a long-term security may not always equal the yield from consecutive investments in shorter-term securities, as it could be higher due to the liquidity premium.

Quiz 3: Structure of Interest Rates

If the liquidity premium theory completely describes the term structure of interest rates, then, on the average, the yield curve should be

In response to criticism of the ratings they assigned before the credit crisis, credit rating agencies now:

Other things being equal, an expected decrease in interest rates will increase the demand for long-term funds by borrowers.

If the yield curve is upward sloping, some investors may attempt to benefit from the higher yields on longer-term securities, even when they have funds for only a short period of time. This strategy is known as riding the yield curve.

Which of the following statements is not true with respect to debt securities?

Which of the following is not a characteristic affecting the yields on debt securities?

The Financial Reform Act of 2010 established the __ within the _ to regulate credit rating agencies.

If interest rates are expected to decrease, the yield on new short-term securities may be expected to , and the yield curve should be sloping.

Investment-grade bonds are bonds that are rated as Caa or better by Moody's and as CCC or better by Standard & Poor's.

If the Treasury uses a relatively large proportion of debt to finance a budget deficit, this would place pressure on long-term yields.

The ____ theory suggests that although investors and borrowers may normally concentrate on a particular natural maturity market, certain events may cause them to wander from it.

The preference for more liquid short-term securities places downward pressure on the slope of the yield curve.

All other characteristics being equal, securities with liquidity would have to offer a yield to be preferred.

Assume that the Treasury experiences a large increase in the budget deficit and issues a large number of T-bills. This action will the supply of T-bills in the market and place pressure on the yield of T-bills.

The segmented markets theory suggests that although investors and borrowers may normally concentrate on a particular natural maturity market, certain events may cause them to wander from it.

According to segmented markets theory, if investors have mostly long-term funds available and borrowers want short-term funds, this will place pressure on the demand for short-term funds by borrowers and the yield curve will be sloping.

Yield curves are always upward sloping.

Bonds issued at different times by the same corporation may not receive the same rating from a rating agency.

A downward-sloping yield curve indicates that Treasury securities with maturities offer annualized yields.

When expectations theory is combined with the liquidity theory, the yield on a security will always be equal to the yield from consecutive investments in shorter-term securities over the same investment horizon.