Financial Markets and Institutions, 7e (Mishkin)

Chapter 5 How Do Risk and Term Structure Affect Interest Rates?

5.1 Multiple Choice

1) The term structure of interest rates is

A) the relationship among interest rates of different bonds with the same risk and maturity. B) the structure of how interest rates move over time.

C) the relationship among the terms to maturity of different bonds from different issuers. D) the relationship among interest rates on bonds with different maturities but similar risk. Answer: D

2) 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 terms to maturity of different bonds.

D) the relationship among interest rates on bonds with different maturities. Answer: B

3) Which of the following long-term bonds should have the lowest interest rate? A) Corporate Baa bonds B) U.S. Treasury bonds C) Corporate Aaa bonds D) Municipal bonds Answer: D

4) Which of the following long-term bonds should have the highest interest rate? A) Corporate Baa bonds B) U.S. Treasury bonds C) Corporate Aaa bonds D) Municipal bonds Answer: A

5) The risk premium on corporate bonds becomes smaller if A) the riskiness of corporate bonds increases. B) the liquidity of corporate bonds increases. C) the liquidity of corporate bonds decreases. D) the riskiness of corporate bonds decreases. E) either B or D of the above occur. Answer: E

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6) Bonds with relatively low risk of default are called A) zero coupon bonds. B) junk bonds.

C) investment-grade bonds. D) none of the above. Answer: C

7) Bonds with relatively high risk of default are called A) Brady bonds. B) junk bonds.

C) zero coupon bonds.

D) investment-grade bonds. Answer: B

8) A corporation suffering big losses might be more likely to suspend interest payments on its bonds, thereby

A) raising the default risk and causing the demand for its bonds to rise. B) raising the default risk and causing the demand for its bonds to fall. C) lowering the default risk and causing the demand for its bonds to rise. D) lowering the default risk and causing the demand for its bonds to fall. Answer: B

9) (I) If a corporation suffers big losses, the demand for its bonds will rise because of the higher interest rates the firm must pay.

(II) The spread between the interest rates on bonds with default risk and default-free bonds is called the risk premium.

A) (I) is true, (II) false. B) (I) is false, (II) true. C) Both are true. D) Both are false. Answer: B

10) Holding everything else constant, if a corporation begins to suffer large losses, then the default risk on its bonds will ________ and the expected return on those bonds will ________. A) increase: increase B) decrease; increase C) increase; decrease D) decrease; decrease Answer: C

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11) Holding everything else the same, if a corporation's earnings rise, then the default risk on its bonds will ________ and the expected return on those bonds will ________. A) increase; decrease B) decrease; decrease C) increase; increase D) decrease; increase Answer: D

12) If a corporation begins to suffer large losses, then the default risk on its bonds will ________ and the equilibrium interest rate on these bonds will ________. A) increase; decrease B) decrease; increase C) increase; increase D) decrease; decrease Answer: C

13) If a corporation's earnings rise, then the default risk on its bonds will ________ and the equilibrium interest rate on these bonds will ________. A) increase; decrease B) decrease; decrease C) increase; increase D) decrease; increase Answer: B

14) When the default risk on corporate bonds decreases, other things equal, the demand curve for

corporate bonds shifts to the ________ and the demand curve for Treasury bonds shifts to the ________. A) right; right B) right; left C) left; left D) left; right Answer: B

15) (I) An increase in default risk on corporate bonds shifts the demand curve for corporate bonds to the right.

(II) An increase in default risk on corporate bonds shifts the demand curve for Treasury bonds to the left.

A) (I) is true, (II) false. B) (I) is false, (II) true. C) Both are true. D) Both are false. Answer: D

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16) (I) An increase in default risk on corporate bonds shifts the demand curve for corporate bonds to the left.

(II) An increase in default risk on corporate bonds shifts the demand curve for Treasury bonds to the right.

A) (I) is true, (II) false. B) (I) is false, (II) true. C) Both are true. D) Both are false. Answer: C

17) The spread between interest rates on low-quality corporate bonds and U.S. government bonds ________ during the Great Depression. A) was reversed

B) narrowed significantly C) widened significantly D) did not change Answer: C

18) As a result of the subprime collapse, the demand for low -quality corporate bonds ________, the demand for high-quality Treasury bonds ________, and the risk spread ________. A) increased; decreased; was unchanged B) decreased; increased; increased C) increased; decreased; decreased

D) decreased; increased; was unchanged Answer: B

19) Moody's and Standard and Poor's are agencies that

A) help investors collect when corporations default on their bonds.

B) advise municipal bond issuers on the tax exempt status of their bonds. C) produce information about the probability of default on corporate bonds. D) maintain liquid markets for corporate bonds. Answer: C

20) If Moody's or Standard and Poor's downgrades its rating on a corporate bond, the demand for the bond ________ and its yield ________. A) increases; decreases B) decreases; increases C) increases; increases D) decreases; decreases Answer: B

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