58) According to the liquidity premium theory of the term structure, when the yield curve has its usual slope, the market expects

A) short-term interest rates to rise sharply. B) short-term interest rates to drop sharply.

C) short-term interest rates to stay near their current levels. D) none of the above. Answer: C

59) In actual practice, short-term interest rates are just as likely to fall as to rise; this is the major shortcoming of the

A) market segmentation theory. B) expectations theory.

C) liquidity premium theory. D) separable markets theory. Answer: B

60) Which theory of the term structure proposes that bonds of different maturities are not substitutes for one another?

A) market segmentation theory B) expectations theory

C) liquidity premium theory D) separable markets theory Answer: A

61) Since yield curves are usually upward sloping, the ________ indicates that, on average, people tend to prefer holding short-term bonds to long-term bonds. A) market segmentation theory B) expectations theory

C) liquidity premium theory D) both A and B of the above E) both A and C of the above Answer: E

62) ________ cannot explain the empirical fact that interest rates on bonds of different maturities tend to move together.

A) The market segmentation theory B) The expectations theory

C) The liquidity premium theory D) Both A and B of the above E) Both A and C of the above Answer: A

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63) Of the four theories that explain how interest rates on bonds with different terms to maturity are related, the one that views long-term interest rates as equaling the average of future short-term rates expected to occur over the life of the bond is the A) pure expectations theory. B) preferred habitat theory. C) liquidity premium theory. D) segmented markets theory. Answer: A

64) Of the four theories that explain how interest rates on bonds with different terms to maturity are related, the one that assumes that bonds of different maturities are not substitutes for one another is the A) expectations theory.

B) segmented markets theory. C) liquidity premium theory. D) preferred habitat theory. Answer: B

65) A moderately upward-sloping yield curve indicates that short-term interest rates are expected to A) neither rise nor fall in the near future.

B) remain relatively unchanged, but that long-term rates are expected to fall. C) neither rise nor fall, but that long-term rates are expected to rise moderately. D) rise moderately in the near future. Answer: A

66) A steep upward-sloping yield curve indicates that short-term interest rates are expected to A) neither rise nor fall in the near future.

B) remain relatively unchanged, but that long-term rates are expected to fall. C) neither rise nor fall, but that long-term rates are expected to rise moderately. D) rise moderately in the near future. Answer: D

67) A bond rating of Aa or AA would mean that the quality of the bond is A) the highest. B) high.

C) medium grade. D) speculative. Answer: B

68) ________ bonds are the most liquid of all long-term bonds. A) Callable B) Municipal C) Corporate Aaa D) U.S. Treasury Answer: D

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69) ________ bonds are exempt from federal income taxes. A) Corporate Aaa B) U.S. Treasury C) Corporate Baa D) Municipal Answer: D

70) The risk structure of interest rates is explained by A) default risk. B) liquidity.

C) tax considerations. D) all of the above. Answer: D

71) The ________ theory is the most widely accepted theory of the term structure of interest rates because it explains the major empirical facts about the term structure so well. A) liquidity premium B) market segmentation C) expectations D) none of the above Answer: A

72) ________ are investment advisory firms that rate the quality of corporate and municipal bonds in terms of probability of default. A) Financial institutions B) Credit-rating agencies C) Securities companies D) none of the above Answer: B

73) If a bond has a favorable tax treatment, its required interest rate (all else equal) A) will be higher.

B) will not be affected. C) will be lower.

D) all of the above could happen. Answer: C

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