All the following statements concerning a yield curve are correct, EXCEPT:(RM 186)
A. Securities represented on a yield curve have varying degrees of risk.
A yield curve shows interest rates for securities of varying durations to maturity. All other characteristics of the securities on the curve, including their degree of risk and tax treatment, are the same.
Which of the following statements concerning the shape of a yield curve is correct?(RM 186)
B. A downward-sloping yield curve indicates lower rates for long-term than for short-term loans.
A downward-sloping yield curve depicts a situation in which interest rates on long-term securities are lower than those on short-term securities.
A horizontal curve depicts no variation in interest rates, regardless of duration, and an upward-sloping curve shows long-term rates that are above short-term rates.
The shape of the yield curve changes over time, particularly in response to changes in interest rate expectations.
Which of the following statements concerning the unbiased expectations hypothesis is (are) correct?(RM 186-188)
I Investor expectations of changes in short-term interest rates determine the shape of the yield curve.
II Arbitrage balances long-term and short-term yields.
C. Both I and II
Both statements correctly describe the unbiased expectations hypothesis as an explanation of the shape of the yield curve.
According to the unbiased expectations hypothesis, which of the following statements concerning relative changes in long- and short-term interest rates are correct? (RM 186-188)
I Long-term interest rates are volatile and may have wide swings, but short-term interest rates tend to change less and move slowly.
II The geometric average of short-term interest rates over a period of time will tend to equal the long-term rates for that period, so a series of short-term securities in a period will have the same yield as a long-term security for the period.
B. II only
I is incorrect because long-term interest rates are less volatile and usually move in narrower ranges than short-term rates.
Which of the following statements concerning policy implications of the unbiased expectations hypothesis is (are) correct?(RM 186-188)I Changing the proportions of long- and short-term securities will change the shape of the yield curve if investors keep the same expectations for short-term interest rates.II The Federal Reserve can influence the shape of the yield curve by purchasing short-term securities and selling long-term securities.
D. Neither I nor II
I is incorrect because only if investor expectations about short-term rates change will the shape of the yield curve change.
II is incorrect for the same reason.
All the following statements concerning the liquidity premium view of the yield curve are correct, EXCEPT:(RM 189-190)
A. The liquidity premium requires a higher yield for shorter-term securities.
Because long-term securities are less liquid than short-term securities, investors in long-term securities require a higher yield in the form of a higher liquidity premium.
Which of the following statements concerning the segmented markets or hedging pressure argument to describe the shape of the yield curve is (are) correct?(RM 191-192)
I Securities of different maturities are not seen as perfect substitutes, and they are sold in separate segments of the financial markets.
II Portfolio managers will hedge against risk by trying to balance maturity structures of liabilities and assets.
C. Both I and II
Both statements correctly describe the segmented markets or hedging pressure theory of the yield curve.
A change in the Federal Reserve’s monetary policy is most often associated with what kind of change in the yield curve?(RM 192-193)
D. A change in the slope of the yield curve
A change in Federal Reserve monetary policy has been found to influence the slope of the yield curve. Macroeconomic forces such as inflation, a weaker economy, or technological change are associated with a change in level of the yield curve. A change in curvature is associated with changes in interest rates in the mid section of the maturity range.
The yield curve may change along all of the following dimensions, EXCEPT:(RM 193)
Yield curves change in their level, slope, and curvature but not in their length.
According to the expectations theory, all the following are valid investor uses of the yield curve, EXCEPT:(RM 193-194)
B. Finding securities to buy with yields below the yield curve because such securities are underpriced
If the expectations theory of the yield curve is correct, securities whose yields lie below the yield curve are overpriced.
All the following statements concerning marketability are correct, EXCEPT:(RM 213-214)
D. Marketable securities generally have a higher rate of return than securities having poor marketability.
Marketability is an advantage to the investor in securities. Therefore, the greater a security’s marketability, the lower will be its rate of return, all other things being equal.
Which of the following statements concerning default risk and the default risk premium is (are) correct?(RM 214-215)
I The default risk is the risk that a borrower will not make promised payments on time.
II The default risk premium is the difference between the promised yield on a risky security and the interest rate on a risk-free security.
C. Both I and II
I and II correctly define default risk and default risk premium, respectively.
Which of the following statements concerning the relationship between anticipated loss and default risk premiums is (are) correct?(RM 215-216)I When the default risk premium exceeds the investor’s anticipated loss on a risky security, the investor will buy the security.II An investor will find a security’s price too high if the investor’s estimate of anticipated loss is less than the default risk premium.
A. I only
II is incorrect because if the investor considers the security as less risky than the risk premium suggests, the investor would view the security as a bargain, as indicated in I.
All the following statements concerning default risk are correct, EXCEPT:(RM 215-216)
B. The spread between yields of securities with different ratings has been constant over time.
The spread between yields on securities in different risk categories has varied significantly over time.
Which of the following statements concerning junk bonds is correct?(RM 220-222)
C. They are sometimes issued to facilitate mergers.
Junk bonds, which are often used to facilitate mergers, carry high default risk premiums, though they have not "almost always" been defaulted upon by their issuers. Junk bonds are often purchased by financial institutions seeking high yields.
Which of the following statements concerning the junk-bond spread is correct?(RM 222)
D. A rise in this spread signals a weakening economy.
The junk-bond spread is the difference in yield between the top quality corporate bonds and the highest quality junk bonds. A rise in this spread signals a weakening economy. In general, there is a positive correlation between default risk and expected return, and the junk-bond spread does not suggest a different view.
Which of the following statements concerning credit derivatives is correct?(RM 223-224)
C. A credit swap allows a lender to diversify its sources of revenue.
Credit derivatives seek to reduce default risk by transferring the risk to another party. In a credit swap, two lending institutions will exchange some expected payments from borrowers. A credit swap allows a lender to diversify its sources of revenue because the lender will exchange with an institution that makes loans in a different industry or different geographic area. A total return swap guarantees a lender a minimum rate of return on its loans. A credit option guarantees a lender that borrowing costs will not exceed a stated amount.
All the following statements concerning bond call privileges are correct, EXCEPT: (RM 225-228)
D. Because callable bonds are callable at a premium, the investor is usually pleased when the bond is called.
The call feature will be exercised only when it is advantageous to the issuer and, therefore, disadvantageous to the investor, to do so. Bonds are most likely to be called when the call price, which includes a call premium over the face amount, is below the market price of the bond.
Which of the following statements concerning the call privilege, call premiums, and interest rates is correct?(RM 227-228)
B. When interest rates fall substantially, a firm is more likely to redeem callable securities.
The yield on callable securities rises with short call deferment periods.
If interest rates are expected to rise, it is less likely that the bond will be called, so the call premium is likely to be lower.
The call feature places an upper limit on the investor’s potential gain from a rise in the security’s market price.
An increase in the value of a capital asset such as a corporate bond that the taxpayer converts into cash is: (RM 231)
B. taxed as ordinary income.
Capital gains are taxed at the same rates as ordinary income, but not to exceed 28%.
Assume that an investor is in a 28% marginal income tax bracket. Which of the following otherwise comparable securities would be financially most advantageous to this investor?(RM 232-234)
D. A security offering a tax-free rate of return of 7.5%
Which of the following statements concerning convertible securities is (are) correct?(RM 235-236)
I Convertible securities are special types of corporate preferred stock or bonds.
II Convertible securities permit an owner to turn in common stock and get bonds instead.
A. I only
II is incorrect because the conversion feature is normally attached to bonds or preferred stock. The privilege gives the holder of such securities the right to exchange them for common stock of the company.
Which of the following statements concerning convertible securities is (are) correct? (RM 235-236)
I The timing of the conversion of a convertible security is solely at the option of the corporation issuing the convertible security.
II Convertible securities are called hybrid securities because they promise stable income and the opportunity to gain from increases in common stock prices.
B. II only
I is incorrect because the conversion privilege is exercised at the option of the investor, not the corporation.
All the following statements concerning convertible securities are correct, EXCEPT: (RM 235-236)
D. Convertible securities cannot be traded on the New York Stock Exchange.
Many convertible bonds and preferred stocks are traded on the New York Exchange.
Which of the following statements concerning the risk-free rate of interest is (are) correct?(RM 236-237)
I It is the opportunity cost of holding money and the reward for saving money.
II It is a component of the interest rates on all securities of different levels of risk and with varying maturity, marketability, taxation, call, and convertibility provisions.
C. Both I and II
Both I and II correctly describe the risk-free rate of interest.
Which of the following statements concerning interest rates or the structure of interest rates is (are) correct? (RM 236-237)
I There is a structure of different rates of interest in which rates vary with the premiums paid for accepting different degrees and types of risks.
II When interest rates change, the changes may reflect changes in any risk premium elements or changes in the real risk-free interest rate.
C. Both I and II
Both statements correctly describe interest rates or the structure of interest rates.