FI 301- Ch. 3

In general, securities with _______ characteristics will offer _______ yields.
A) favorable; higher
B) favorable; lower
C) unfavorable; lower
D) none of these

favorable; lower

Default risk is likely to be highest for:
A) short term Treasury securities.
B) AAA corporate securities.
C) long term Treasury securities.
D) BBB corporate securities.

BBB corporate securities

Some financial institutions, such as commercial banks, are required by law to invest only in:
A) junk bonds.
B) corporate stock.
C) Treasury securities.
D) investment-grade bonds.

investment-grade bonds

If a security can easily be converted to cash without a loss in value, it:
A) is liquid.
B) has a high after tax yield.
C) has high default risk.
D) is illiquid.

is liquid

Securities that offer _______ liquidity will offer a _______ yield to be preferred.
A) lower; higher
B) lower; lower
C) higher; higher
D) higher; lower

lower; higher

If all other characteristics are similar, _______ would have to offer _______.
A) taxable securities; a higher after tax yield than tax exempt securities
B) taxable securities; a higher before tax yield than tax exempt securities
C) tax exempt securities;

taxable securities; a higher before tax yield than tax-exempt securities

Assume an investor's tax rate is 25 percent. The before tax yield on a security is 12 percent. What is the after tax yield?
A) 16.00 percent
B) 9.25 percent
C) 9.00 percent
D) 3.00 percent
E) none of these

9.00 percent

An investor's tax rate is 30 percent. What must the before tax yield on a security be to have an after tax yield of 11 percent?
A) 7.7 percent
B) 15.71 percent
C) 130 percent
D) 11.00 percent
E) none of these

15.71 percent

A firm in the 35 percent tax bracket is aware of a tax-exempt security that is paying a yield of 7 percent. To match this yield, taxable securities must offer a before-tax yield of _______ percent.
A) 7.0
B) 10.8
C) 20.0
D) none of these

10.8

Holding other factors, such as risk constant, the relation�ship between the maturity and annualized yield of secur�ities is called the _______ structure of interest rates.
A) term
B) default
C) liquidity
D) tax
E) none of these

term

The term structure of interest rates defines the relationship between _______ and _______.
A) risk; return
B) risk; maturity
C) maturity; yield
D) default risk ratings; maturity

maturity; yield

If shorter term securities have higher annualized yields than longer term securities, the yield curve:
A) is horizontal.
B) is upward sloping.
C) is downward sloping.
D) cannot be determined without additional infor�ma�tion (such as the level of market in

is downward sloping

Assume that annualized yields of short term and long term securities are equal. If investors suddenly believe inter�est rates will increase, their actions may cause the yield curve to:
A) become inverted.
B) become flat.
C) become upward sloping.
D) be un

become upward sloping

If issuers of securities (borrowers) and investors suddenly expect interest rates to decrease, their actions to benefit from their expectations should cause:
A) long term yields to rise.
B) short term yields to decrease.
C) prices of long term securities

none of these

Within the category of capital market securities, municipal bonds have the _______ before-tax yield, and their after-tax yield is typically _______ of Treasury bonds from the perspective of investors in high tax brackets.
A) highest; below that
B) lowest;

lowest; above that

The yield offered on a debt security is _______ related to the prevailing risk-free rate and _______ related to the security's risk premium.
A) negatively; negatively
B) positively; positively
C) negatively; positively
D) positively; negatively

positively; positively

The theory for the term structure of interest rates that says the shape of the yield curve is determined solely by expectations of future interest rates is called the:
A) segmented markets theory.
B) liquidity premium theory.
C) pure expectations theory.

pure expectations theory

Assume investors are indifferent among security maturities. Today, the annualized two year interest rate is 12 percent, and the one year interest rate is 9 percent. What is the forward rate according to the pure expectations theory?
A) 15.08 percent
B) 3.

15.08

Assume the yield curve is flat. If investors flood the short-term market and avoid the long-term market, they may cause the yield curve to:
A) remain flat.
B) become upward sloping.
C) become downward sloping.
D) do none of these.

become upward sloping

According to pure expectations theory, if interest rates are expected to decrease, there will be _______ pressure on the demand for short-term funds by borrowers and _______ pressure on the demand for long-term funds issued by borrowers.
A) upward; upward

upward; downward

The degree to which the Treasury's debt management policy could affect the term structure of interest rates is greatest if:
A) most debt is financed by foreign investors.
B) the Treasury's debt level is small.
C) maturity markets are segmented.
D) most de

maturity markets are segmented

According to the pure expectations theory of the term structure of interest rates, the _______ the difference between the implied one year forward rate and today's one year interest rate, the _______ is the expected change in the one year interest rate.
A

greater; greater

Assume that today, the annualized two year interest rate is 12 percent, and the one year interest rate is 9 percent. A three-year security has an annualized interest rate of 14 percent. What is the one year forward rate two years from now?
A) 12.67 percen

none of these

Assume that a yield curve is influenced by interest rate expectations and a liquidity premium. Assume the yield curve is initially flat. If liquidity suddenly was no longer important, the yield curve would now have a _______ slope (assuming no other chang

slight downward

According to the liquidity premium theory, the expected yield on a two year security will _______ the expected yield from consecutive investments in one year securities.
A) equal
B) be less than
C) be greater than
D) be less than or greater than, dependin

be greater than

Assume that the current yield on one-year securities is 6 percent, and that the yield on a two-year security is 7 percent. If the liquidity premium on a two-year security is 0.4 percent, then the one-year forward rate is _______ percent.
A) 8.0
B) 7.6
C)

7.6

If liquidity influences the yield curve, but is not considered when deriving the forward interest rate, the forward interest rate _______ the market's expectation of the future interest rate.
A) overestimates
B) accurately estimates
C) underestimates
D) i

overestimates

If the liquidity premium exists, a flat yield curve would be interpreted as the market expecting _______ in interest rates.
A) no changes
B) a slight decrease
C) a slight increase
D) a large increase

a slight decrease

The theory of the term structure of interest rates, which states that investors and borrowers choose securities with maturities that satisfy their forecasted cash needs, is the _______ theory.
A) pure expectations
B) liquidity premium
C) segmented markets

segmented markets

According to the segmented markets theory, if most investors suddenly preferred to invest in short term securities and most borrowers suddenly preferred to issue long term securities, there would be:
A) upward pressure on the price of long� term securitie

upward pressure on the prices of short-term seurities

A theory states that while investors and borrowers may normally concentrate on a particular natural maturity market, conditions may cause them to change maturity markets. This theory is called the _______ theory.
A) liquidity premium
B) efficient markets

preferred habitat

According to segmented markets theory, if investors have mostly short-term funds available and borrowers want long-term funds, there would be _______ pressure on the supply of short-term funds provided by investors and _______ pressure on the yield of lon

upward; upward

If a yield curve is upward sloping, the investment strategy of buying long term securities, then selling them after a short period (say, one year) is called:
A) riding the yield curve.
B) liquidating the yield curve.
C) segmenting the yield curve.
D) a fo

riding the yield curve

Other things equal, the yield required on A-rated bonds should be _______ the yield required on B-rated bonds whose other characteristics are exactly the same.
A) greater than
B) equal to
C) less than
D) All of these are possible, depending on the size of

less than

The price at which non convertible bonds can be issued should be _______ the price at which convertible bonds can be issued (assuming that all other characteristics of the two types of bonds are exactly the same).
A) greater than
B) equal to
C) less than

less than

In some time periods, there is evidence that corporations initially financed long term projects with short term funds. They planned to borrow long term funds once inter�est rates were lower. This specifically supports the _______ theory for explaining the

expectations

According to the expectations theory, the sudden expectation of lower interest rates in the future will cause a _______ supply of short term funds provided by investors, and a _______ supply of long term funds.
A) large; large
B) large; small
C) small; sm

small; large

The yield curve of Canada is:
A) always downward sloping.
B) always upward sloping.
C) exactly the same as the United States at any point in time.
D) none of these.

none of these

If research showed that anticipation about future interest rates was the only important factor for all investors in choosing short term or long term securities, this would support the argument made by the _______ theory.
A) liquidity premium
B) expectatio

expectations

If research showed that all investors attempt to purchase securities that perfectly match their time in which they will have available funds, this would specifically support the argument made by the _______ theory.
A) liquidity premium
B) real interest ra

segmented markets

You are considering the purchase of a tax-exempt security that is paying a yield of 10.08 percent. You are in the 28 percent tax bracket. To match this after-tax yield, you would consider taxable securities that pay _______ percent.
A) 31.1
B) 19
C) 12.5

14

The annualized yield on a three-year security is 13 percent; the annualized two-year interest rate is 12 percent, while the one-year interest rate is 9 percent. The forward rate one-year ahead is _______ percent.
A) 2.8
B) 115
C) 103
D) 15.1

15.1

The annualized yield on a three-year security is 13 percent; the annualized two-year interest rate is 12 percent, while the one-year interest rate is 9 percent. The forward rate two years ahead is _______ percent.
A) 1.8
B) 9.0
C) 15.0
D) none of these

15

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 long-term funds issued by borrowers and the yield curve will be _______ slopi

downward; downward

Assume that the Treasury experiences a large decrease in the budget deficit and purchases a large number of T-bills. This action will _______ the supply of T-bills in the market and places _______ pressure on the yield of T-bills.
A) decrease; downward
B)

decrease; upward

Vaughn Corporation is considering the issue of commercial paper and would like to know the yield it should offer on its commercial paper. The corporation believes that a 0.2 percent default risk premium, a 0.1 percent liquidity premium, and a 0.3 percent

7.6

The yield curve for corporate bonds:
A) would typically lie below the Treasury yield curve.
B) is identical to the Treasury yield curve.
C) typically has the same slope as the Treasury yield curve.
D) is irrelevant to investors.

typically has the same slope as the treasury yield curve

In general, credit ratings have served as reasonable indicators of the likelihood of default.
A) true
B) false

true

Interest income from municipal bonds is exempt from state taxes but is subject to federal taxes.
A) true
B) false

false

If liquidity influences the yield curve, the forward rate underestimates the market's expectation of the future interest rate.
A) true
B) false

false