Chapter 3 Structure of Interest Rates 279 Chapter 3 Structure of Interest Rates 1 In general securities with characteristics will offer yields A favorable higher B favorable lower C unfavorable lower D none of these ANSWER B 2 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 ANSWER D 3 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 ANSWER D 4 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 ANSWER A 5 Securities that offer liquidity will offer a yield to be preferred A lower higher B lower lower C higher higher D higher lower ANSWER A 280 Chapter 3 Structure of Interest Rates 6 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 a higher after tax yield than taxable securities D tax exempt securities a higher before tax yield than taxable securities ANSWER B 7 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 ANSWER C 8 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 ANSWER B 9 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 ANSWER B 10 Holding other factors such as risk constant the relationship between the maturity and annualized yield of securities is called the structure of interest rates A term B default C liquidity D tax E none of these ANSWER A Chapter 3 Structure of Interest Rates 281 11 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 ANSWER C 12 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 information such as the level of market interest rates ANSWER C 13 Assume that annualized yields of short term and long term securities are equal If investors suddenly believe interest rates will increase their actions may cause the yield curve to A become inverted B become flat C become upward sloping D be unaffected ANSWER C 14 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 to decrease D long term yields to rise and short term yields to decrease E none of these ANSWER E 15 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 above that C highest above that D lowest below that ANSWER B 282 Chapter 3 Structure of Interest Rates 16 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 ANSWER B 17 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 D theory of rational expectations ANSWER C 18 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 00 percent C 12 00 percent D 12 62 percent E 11 41 percent ANSWER A 19 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 ANSWER B 20 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 B downward downward C upward downward D downward upward ANSWER C Chapter 3 Structure of Interest Rates 283 21 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 debt is financed by foreign investors and the Treasury s debt level is small ANSWER C 22 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 less B less greater C greater greater D none of these ANSWER C 23 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 percent B 113 percent C 195 percent D 15 67 percent E none of these ANSWER E 24 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 changes A slight downward B slight upward C steep upward D steep downward ANSWER A 25 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