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  1. The relationship between the rates of return on financial instruments and the terms under which they are callable is known as the term structure of interest rates. 

    a) True
    b) False
    b) False

    The term structure of interest rates refers to the rates of return on financial instruments and their maturity dates.
  2. An upward-sloping yield curve indicates that borrowers must pay higher interest rates for long-term loans than for short-term loans. 

    a) True
    b) False
    a) True

    The upward-sloping yield curve indicates that the rates offered for long-term loans are higher than for short-term loans, assuming risk and other factors are constant.
  3. The unbiased expectations hypothesis states that the shape of the yield curve is determined principally by investor expectations of changes in long-term interest rates. 

    a) True
    b) False
    b) False

    According to the unbiased expectations hypothesis, it is investor expectations about short-term interest rates that determine the shape of the yield curve.
  4. According to the unbiased expectations hypothesis, it is immaterial to investors with a planned 10-year investment horizon whether they buy a 10-year security, two successive 5-year securities, or 10 successive one-year securities. 

    a) True
    b) False
    a) True

    The unbiased expectations hypothesis assumes that investors act as profit maximizers over their planned holding periods and have no maturity preferences.
  5. The unbiased expectations hypothesis implies that changes in the relative amounts of available long-term versus short-term securities have a major influence on the shape of the yield curve. 

    a) True
    b) False
    b) False

    Since the unbiased expectations hypothesis assumes investors have no maturity preferences, changes in the relative amounts of available short-term and long-term securities will not influence the shape of the yield curve unless investors change their expectations about future short-term rates.
  6. According to the liquidity premium view of the yield curve, the normal shape of the yield curve is upward sloping. 

    a) True
    b) False
    a) True

    The liquidity premiums theory assumes investors are risk averse and must be paid a premium in the form of a higher interest return to induce them to purchase long-term, less-liquid investments.
  7. A yield curve that is flat at the longest maturities may be influenced by the fact that there are no major differences in liquidity between long-term securities of various maturities. 

    a) True
    b) False
    a) True

    At the long end of the yield curve, investors do not seem to require a much higher return to get them to purchase 20-year bonds as opposed to 10-year bonds. The size of the liquidity premium seems to decrease at the longest maturities.
  8. The hedging principle of portfolio management suggests balancing the structure of interest rates earned by a financial institution with the structure of its interest costs. 

    a) True
    b) False
    b) False

    The hedging principle of portfolio management suggests balancing the maturity structure of a financial institution's assets with that of its liabilities.
  9. The market segmentations theory of the term structure of interest rates assumes that demand and supply curves within each maturity range are the dominant factors shaping the level of interest rates for that maturity range. 

    a) True
    b) False
    a) True  

    The hedging-pressure theory assures that securities are not perfect substitutes for one another and that investors do not stray from their preferred maturity range unless induced by higher yields.
  10. If the segmented-markets theory of interest rates is true, government can alter the shape of the yield curve by selling large quantities of long-term bonds and simultaneously purchasing large quantities of short-term securities. 

    a) True
    b) False
    a) True

    The segmented-markets theory assumes that the shape of the yield curve could be altered by changes in government policy in any one sector of the yield curve.
  11. A rising yield curve is generally unfavorable for a savings and loan association. 

    a) True
    b) False
    b) False

    A rising yield curve is generally favorable to a savings and loan association. It borrows most of its funds by selling short-term deposits (at rates on the lower part of the curve) and investing on a long-term basis (at rates on the upper part of the curve).
  12. The yield curve is a useful tool for forecasting the future course of price levels of bonds and other long-term securities.

    a) True
    b) False
    a) True

    Forecasting interest rates, and thus bond prices, is often undertaken by individuals who hold that one of the theories of interest rates is correct.
  13. If a downward-sloping yield curve starts to flatten, managers of a savings and loan association should try to lock in short-term sources of funds by getting long-term commitments from depositors. 

    a) True
    b) False
    b) False

    If the yield curve is downward sloping, short-term rates are higher than long-term rates. A flattening of such a curve opens up improved profit opportunities for a savings and loan association by enabling it to lower its short-term cost of money. Hence, it would not be wise to try to lock in the declining short-term rates.
  14. If the rate of return on a security lies above the yield curve, it signals that the security is temporarily overpriced. 

    a) True
    b) False
    b) False

    A rate of return that is above the yield curve suggests that the security is temporarily underpriced.
  15. The yield curve can help measure the trade-off confronting an investor who is considering extending the maturity of his or her portfolio. 

    a) True
    b) False
    a) True

    Yield curves provide a clue to the trade-off, the gain or loss in return, that can be expected for a given change in a portfolio's maturity on both a current and historical basis.
  16. The default-risk premium on a security is the difference between the promised yield on a risky security and the promised yield on the security in question.

    a) True
    b) False
    b) False

    The default-risk premium is the difference between the promised yield on the security in question and the risk-free interest rate.
  17. If the market generally has assigned a 4 percent default-risk premium to a security and an investor has assigned it a 6 percent default-risk premium, in the investor's opinion the security is overpriced. 

    a) True
    b) False
    a) True  

    The risk of the security as estimated by the investor is higher than that assigned by the market, and the investor will not purchase a security he or she considers overpriced.
  18. The spread between the yields on risk-free securities and risky securities tends to widen during periods of economic expansion. 

    a) True
    b) False
    b) False

    The spread between the yields on risk-free and risky securities tends to widen during periods of recession and to narrow during periods of expansion.
  19. The yields on junk bonds tend to be insufficient to cover the default risk inherent in such issues.

    a) True
    b) False
    b) False  

    • The yield on a junk bond includes a premium to adjust for the default rate.
    •  
  20. The call privilege on a bond gives the investor the right to exchange the bond for a specified number of shares of the issuing company's common stock.

    a) True
    b) False
    b) False

    The call privilege permits the borrower to retire all or a portion of a bond issue at a fixed price.
  21. The call privilege is a greater advantage to the issuer of a bond than to the purchaser. 

    a) True
    b) False
    a) True

    A call privilege gives the bond issuer the right to take advantage of favorable interest-rate movements to the detriment of the investor.
  22. If interest rates are expected to rise substantially over the lifetime of a callable security, the risk that the security will be called is low.

    a) True
    b) False
    a) True

    If interest rates rise, there is no reason to call the security before maturity.
  23. All other things being equal, the interest rate on a convertible security is typically higher than that on a nonconvertible security. 

    a) True
    b) False
    b) False

    Because the conversion feature gives an extra advantage to the investor, a convertible security typically sells at a higher price and carries a lower yield than a nonconvertible security, all other things being equal.
  24. The interest income from municipal bonds is exempt from federal income taxes. 

    a) True
    b) False
    a) True

    The interest earned on municipal bonds is exempt from federal income taxes.
  25. The tax-exempt feature attached to municipal bonds actually limits, rather than expands, the market for these securities.

    a) True
    b) False
    a) True

    The market for municipal bonds is limited to taxable investors and those mostly in the higher tax brackets.
  26. A downward-sloping yield curve indicates that

    A) securities are generally declining in price 
    B) the average time to maturity on new security issues is becoming longer 
    C) the yield on a security falls as its price rises
    D) interest rates for short-term securities are higher than those for long-term securities 
    D) interest rates for short-term securities are higher than those for long-term securities

    A yield curve depicts the relationship between the yield on securities and their maturity dates.
    A yield curve shows nothing about general price levels or length of time to maturity for new issues of securities.
    A yield curve does not show a relationship between the price and the yield on a security.
    (this multiple choice question has been scrambled)
  27. Other things being equal, which of the following characteristics of a security tend to cause it to have a relatively high yield?

    A) a low degree of marketability   
    B) an absence of a call privilege   
    C) a low degree of default risk   
    D) a liberal conversion privilege
    A) a low degree of marketability   

    The other features, all of which are advantageous to the investor, tend to cause the security to pay a relatively low yield, all other things being equal.
    (this multiple choice question has been scrambled)
  28. If investors expect that interest rates will rise in the near future, what will be the likely impact on the prices of long-term bonds?

    A) The effect cannot be predicted.
    B) Their prices will remain unchanged.   
    C) Their prices will rise.   
    D) Their prices will fall.   
    D) Their prices will fall.   

    If interest rates are expected to rise, this is bad news for investors in long-term bonds. They will want to get out of (sell) their long-term, low-yielding bonds, but new investors will not buy these bonds except at a reduced price. Both actions will cause bond prices to decline.
     
    (this multiple choice question has been scrambled)
  29. Which of the following statements is consistent with the unbiased-expectations hypothesis concerning the term structure of interest rates?

    A) Long-term interest rates are less volatile than short-term interest rates.   
    B) Investor expectations do not affect the yield curve.   
    C) Short-term interest rates are usually higher than long-term interest rates.   
    D) Investors have strong maturity preferences.
    A) Long-term interest rates are less volatile than short-term interest rates.   

    Investor expectations regarding changes in future short-term interest rates are believed to determine the shape of the yield curve.
    Short-term interest rates are normally lower than long-term rates.
    The theory assumes investors do not have strong maturity preferences.
     
    (this multiple choice question has been scrambled)
  30. Which of the following theories of the term structure of interest rates assume(s) that maturity preferences exist among major investor groups?

    I. unbiased-expectations-hypothesis theory

    II. segmented-markets theory

    A) Both I and II   
    B) I only   
    C) II only   
    D) Neither I nor II
    C) II only   

    I is incorrect because the unbiased expectations hypothesis assumes investors have no maturity preferences.
     
    (this multiple choice question has been scrambled)
  31. Which of the following conditions will increase the likelihood that a corporate bond will be called?

    I. The bond's call deferment period is near its end.

    II. The general level of interest rates in the economy rises.

    A) II only   
    B) Neither I nor II
    C) I only   
    D) Both I and II   
    C) I only 

    II is incorrect because rising interest rates decrease the probability of a call. The bond issuer who wishes to retire a bond early probably will buy it in the open market at a depressed price rather than pay a higher call price for it.
     
    (this multiple choice question has been scrambled)

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