ECO 303

Ch. 6 Quiz

Name: Shannah Henk

Multiple choice @ 1 point each. Select the best answer available.

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.
2) 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.
3) 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
4) 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
5) The collapse of the subprime mortgage market
A) did not affect the corporate bond market.
C) reduced the Baa-Aaa spread.

B) increased the perceived riskiness of Treasury securities.

D) increased the Baa-Aaa spread.

6) 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

7) According to the liquidity premium theory of the term structure, a slightly (modest) upward sloping yield curve indicates that short-term
interest rates are expected to
A) rise in the future. B) decline moderately in the future. C) remain unchanged in the future.
D) decline sharply in the future.
8) According to the preferred habitat theory of the term structure, an flat yield curve indicates that short-term interest rates are
expected to
A) rise in the future.
B) remain unchanged in the future.
C) decline moderately in the future.
D) decline sharply in the future.
9) If the expected path of one-year interest rates over the next five years is 4 percent, 5 percent, 6 percent, 7 percent, and 8 percent, then
the segmented markets theory predicts that today's interest rate on the five-year bond is
A) 7% .
B) 6%.
C) 5%.
D) 4%.
E) unable to be determined with the information given.

10) Which theory of term structure predicts that long-term yields will exceed short-term yields on average?
A) Pure expectations

B) Segmented markets

C) Liquidity premium

D) None of the previous.

11) Which theory of term structure asserts that lenders and borrowers have very strong preferences for particular maturities?
A) Pure expectations

B) Segmented markets

C) Liquidity premium

D) None of the previous.

12) A ________ market yield curve could be considered an indicator for stable future inflation rates.
A) slightly upward sloping
B) steeply upward sloping
C) flat
D) downward sloping
13) An inverted yield curve would be mostly commonly observed:
A) at the trough of expansion.
B) at the peak of a recession
recession.

C) in the middle of an expansion.

D) in the middle of a

14) If the expected path of 1-year interest rates over the next four years is 2.5%, 3.5%, 4.5%, and 5.5%, the preferred
habitat theory predicts that the bond with the lowest interest rate today is the one with a maturity of
A) four year.
B) three years.
C) two years.
D) one year. E) unable to be determined with the information given.
15) If the expected path of 1-year interest rates over the next five years is 4 percent, 6 percent, 6 percent, 5 percent, and 4 percent,
the expectations theory predicts that the bond with the highest interest rate today is the one with a maturity of
A) two years.
B) three years.
C) four years.
D) five years.
E) unable to be determined with the information given.

Do the following problem @ 15 points. Show all work for full credit. If you need additional paper, use the paper at the front of the room.
Do not use any of your own paper. Staple your additional paper to the quiz when finished. Write your name on the extra paper.
Given the following market data on U.S. Treasury instruments:

1-year note yield = 1.83%

5-year note yield = 2.79%

2-year note yield = 1.99%

6-year note yield = 3.04%

3-year note yield = 2.21%

7-year note yield = 3.58%

4-year note yield = 2.42%

8-year note yield = 4.18%
And non-changing premiums of 0, .07%, .22%, .39%, .52%, .64%, .75%, 88%, & .98%
a.
b.
c.
d.
e.
f.

Calculate the expected expectations yield for a (3,2,1,2) path.

Calculate the pure expectations yield for a (1,4,3,) path.
Calculate the expected empirical yields for a (2,5,1) path.
Calculate the expected expectations yield for a 5-year note purchased at the beginning of year 3.
Calculate the expected market yield on a 4-year note purchased at the beginning of year 2.
Determine the expectations yield on a 5-year note purchased today.