41) Economists' attempts to explain the term structure of interest rates

A) illustrate how economists modify theories to improve them when they are inconsistent with the empirical evidence.

B) illustrate how economists continue to accept theories that fail to explain observed behavior of interest rate movements.

C) prove that the real world is a special case that tends to get short shrift in theoretical models. D) have proved entirely unsatisfactory to date. Answer: A

42) According to the expectations theory of the term structure,

A) the interest rate on long-term bonds will exceed the average of expected future short-term interest rates.

B) interest rates on bonds of different maturities move together over time. C) buyers of bonds prefer short-term to long-term bonds. D) all of the above.

E) only A and B of the above. Answer: B

43) According to the expectations theory of the term structure,

A) when the yield curve is steeply upward-sloping, short-term interest rates are expected to rise in the future.

B) when the yield curve is downward-sloping, short-term interest rates are expected to decline in the future.

C) buyers of bonds prefer short-term to long-term bonds. D) all of the above.

E) only A and B of the above. Answer: E

44) According to the expectations theory of the term structure,

A) when the yield curve is steeply upward-sloping, short-term interest rates are expected to rise in the future.

B) when the yield curve is downward-sloping, short-term interest rates are expected to remain relatively stable in the future.

C) investors have strong preferences for short-term relative to long-term bonds, explaining why yield curves typically slope upward. D) all of the above.

E) only A and B of the above. Answer: A

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45) According to the expectations theory of the term structure,

A) yield curves should be equally likely to slope downward as to slope upward.

B) when the yield curve is steeply upward-sloping, short-term interest rates are expected to rise in the future.

C) when the yield curve is downward-sloping, short-term interest rates are expected to remain relatively stable in the future. D) all of the above.

E) only A and B of the above. Answer: E

46) If the expected path of one-year interest rates over the next four years is 5 percent, 4 percent, 2 percent, and 1 percent, then the pure expectations theory predicts that today's interest rate on the four-year bond is A) 1 percent. B) 2 percent. C) 4 percent.

D) none of the above. Answer: D

47) If the expected path of one-year interest rates over the next five years is 1 percent, 2 percent, 3 percent, 4 percent, and 5 percent, then the pure expectations theory predicts that the bond with the highest interest rate today is the one with a maturity of A) one year. B) two years. C) three years. D) four years. E) five years. Answer: E

48) If the expected path of one-year interest rates over the next five years is 2 percent, 4 percent, 1 percent, 4 percent, and 3 percent, then the pure expectations theory predicts that the bond with the lowest interest rate today is the one with a maturity of A) one year. B) two years. C) three years. D) four years. Answer: A

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49) According to the market segmentation theory of the term structure,

A) the interest rate for bonds of one maturity is determined by the supply and demand for bonds of that maturity.

B) bonds of one maturity are not substitutes for bonds of other maturities; therefore, interest rates on bonds of different maturities do not move together over time.

C) investors' strong preference for short-term relative to long-term bonds explains why yield curves typically slope upward. D) all of the above. E) none of the above. Answer: D

50) According to the market segmentation theory of the term structure,

A) the interest rate for bonds of one maturity is determined by the supply and demand for bonds of that maturity.

B) bonds of one maturity are not substitutes for bonds of other maturities; therefore, interest rates on bonds of different maturities do not move together over time.

C) investors' strong preference for short-term relative to long-term bonds explains why yield curves typically slope downward. D) only A and B of the above. Answer: D

51) The liquidity premium theory of the term structure

A) indicates that today's long-term interest rate equals the average of short-term interest rates that people expect to occur over the life of the long-term bond.

B) assumes that bonds of different maturities are perfect substitutes.

C) suggests that markets for bonds of different maturities are completely separate because people have different preferences.

D) does none of the above. Answer: D

52) The liquidity premium theory of the term structure

A) assumes investors tend to prefer short-term bonds because they have less interest-rate risk.

B) assumes that interest rates on the long-term bond respond to demand and supply conditions for that bond.

C) assumes that an average of expected short-term rates is an important component of interest rates on long-term bonds.

D) assumes all of the above. E) assumes none of the above. Answer: D

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53) According to the liquidity premium theory of the term structure,

A) the interest rate on long-term bonds will equal an average of short-term interest rates that people expect to occur over the life of the long-term bonds plus a liquidity premium.

B) buyers of bonds may prefer bonds of one maturity over another, yet interest rates on bonds of different maturities move together over time.

C) even with a positive liquidity premium, if future short-term interest rates are expected to fall significantly, then the yield curve will be downward-sloping. D) all of the above.

E) only A and B of the above. Answer: D

54) According to the liquidity premium theory of the term structure,

A) because buyers of bonds may prefer bonds of one maturity over another, interest rates on bonds of different maturities do not move together over time.

B) the interest rate on long-term bonds will equal an average of short-term interest rates that people expect to occur over the life of the long-term bonds plus a term premium.

C) because of the positive term premium, the yield curve cannot be downward-sloping. D) all of the above.

E) only A and B of the above. Answer: B

55) If the yield curve slope is flat, the liquidity premium theory indicates that the market is predicting A) a mild rise in short-term interest rates in the near future and a mild decline further out in the future. B) constant short-term interest rates in the near future and further out in the future.

C) a mild decline in short-term interest rates in the near future and a continuing mild decline further out in the future.

D) constant short-term interest rates in the near future and a mild decline further out in the future. Answer: C

56) If the yield curve has a mild upward slope, the liquidity premium theory indicates that the market is predicting

A) a rise in short-term interest rates in the near future and a decline further out in the future. B) constant short-term interest rates in the near future and further out in the future.

C) a decline in short-term interest rates in the near future and a rise further out in the future.

D) a decline in short-term interest rates in the near future and an even steeper decline further out in the future.

Answer: B

57) According to the liquidity premium theory of the term structure, a downward-sloping 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. Answer: D

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