Assignment 4
Instructions:
1. Due date: 8:00 pm, 03/04/2020 (Wednesday). Late assignments will not be graded.
2. Please put all your answer in the table below and upload your file (Office Word,
PDF, etc.) to Blackboard.
3. DO NOT email me your assignment.
4. There are 26 multiple choice questions. Each question has 4 points. The highest
grade you can get for this assignment is 100 points.
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Questions based on “05 Financial Markets – The Behavior of Interest Rates – Part 2”
1. In Keynes’s liquidity preference framework, as the expected return on bonds increases (holding
everything else unchanged), the expected return on money ________ relative to the expected return
on bonds, causing the demand for ________ to fall.
A) falls; bonds
B) falls; money
C) rises; bonds
D) rises; money
2. Holding everything else constant in the market for money, as the interest rate rises, the opportunity
cost of holding money ________ thus making money less desirable. So the quantity of money
demanded ________.
A) increases; falls
B) increases; rises
C) remains the same; rises
D) decreases; falls
3. In the market for money, a lower level of income causes the demand for money to ________ and
the interest rate to ________, everything else held constant.
A) decrease; decrease
B) decrease; increase
C) increase; decrease
D) increase; increase
4. In the market for money, when the Fed decreases the money stock, the money supply curve shifts
to the ________ and the interest rate ________, everything else held constant.
A) right; rises
B) right; falls
C) left; falls
D) left; rises
5. Milton Friedman called the response of lower interest rates resulting from an increase in the money
supply the ________ effect.
A) liquidity
B) price level
C) expected-inflation
D) income
Questions based on “06 Financial Markets – The Risk and Term Structure of Interest
Rates – Part 1”
6. The risk structure of interest rates is
A) the structure of how interest rates move over time.
B) the relationship among interest rates on bonds with different maturities.
C) the relationship among the term to maturity of different bonds.
D) the relationship among interest rates of different bonds with the same maturity.
7. Three factors explain the risk structure of interest rates
A) liquidity, default risk, and the income tax treatment of a security.
B) maturity, default risk, and the income tax treatment of a security.
C) maturity, liquidity, and the income tax treatment of a security.
D) maturity, default risk, and the liquidity of a security.
8. The risk that interest payments will not be made, or that the face value of a bond is not repaid when
a bond matures is
A) interest rate risk.
B) inflation risk.
C) liquidity risk.
D) default risk.
9. The spread between the interest rates on bonds with default risk and default-free bonds is called the
A) bond margin.
B) junk margin.
C) risk premium.
D) default premium.
10. If the probability of a bond default increases because corporations begin to suffer large losses, then
the default risk on corporate bonds will ________ and the expected return on these bonds will
________, everything else held constant.
A) decrease; increase
B) decrease; decrease
C) increase; increase
D) increase; decrease
11. A(n) ________ in the riskiness of corporate bonds will ________ the price of corporate bonds and
________ the yield on corporate bonds, all else equal.
A) increase; increase; increase
B) increase; decrease; increase
C) decrease; increase; increase
D) decrease; decrease; decrease
12. Everything else held constant, if the federal government were to guarantee today that it will pay
creditors if a corporation goes bankrupt in the future, the interest rate on corporate bonds will
________ and the interest rate on Treasury securities will ________.
A) increase; increase
B) increase; decrease
C) decrease; increase
D) decrease; decrease
13. Bonds with relatively low risk of default are called ________ securities and have a rating of Baa
(or BBB) and above; bonds with ratings below Baa (or BBB) have a higher default risk and are
called ________.
A) investment grade; lower grade
B) investment grade; junk bonds
C) high quality; lower grade
D) high quality; junk bonds
14. Junk bonds, bonds with a low bond rating, are also known as
A) high-yield bonds.
B) investment grade bonds.
C) high quality bonds.
D) zero-coupon bonds.
15. Risk premiums on corporate bonds tend to ________ during business cycle expansions and
________ during recessions, everything else held constant.
A) increase; increase
B) increase; decrease
C) decrease; increase
D) decrease; decrease
16. During a “flight to quality”
A) the spread between Baa bonds and Treasury bonds is not affected.
B) the spread between Baa bonds and Treasury bonds decreases.
C) the spread between Baa bonds and Treasury bonds increases.
D) the change in the spread between Treasury bonds and Baa bonds cannot be predicted.
17. Which of the following statements is TRUE?
A) A liquid asset is one that can be quickly and cheaply converted into cash.
B) The demand for a bond declines when it becomes less liquid, decreasing the interest rate
spread between it and relatively more liquid bonds.
C) The differences in bond interest rates reflect differences in default risk only.
D) The corporate bond market is the most liquid bond market.
18. A(n) ________ in the liquidity of corporate bonds will ________ the price of corporate bonds and
________ the yield on corporate bonds, all else equal.
A) increase; increase; decrease
B) increase; decrease; decrease
C) decrease; increase; increase
D) decrease; decrease; decrease
19. The risk premium on corporate bonds reflects the fact that corporate bonds have a higher default
risk and are ________ U.S. Treasury bonds.
A) less liquid than
B) less speculative than
C) tax-exempt unlike
D) lower-yielding than
20. Municipal bonds have default risk, yet their interest rates are usually lower than the rates on defaultfree Treasury bonds. This suggests that
A) the benefit from the tax-exempt status of municipal bonds is less than their default risk.
B) the benefit from the tax-exempt status of municipal bonds equals their default risk.
C) the benefit from the tax-exempt status of municipal bonds exceeds their default risk.
D) Treasury bonds are not default-free.
21. Everything else held constant, if the tax-exempt status of municipal bonds were eliminated, then
A) the interest rates on municipal bonds would still be less than the interest rate on Treasury
bonds.
B) the interest rate on municipal bonds would equal the rate on Treasury bonds.
C) the interest rate on municipal bonds would exceed the rate on Treasury bonds.
D) the interest rates on municipal, Treasury, and corporate bonds would all increase.
22. Everything else held constant, an increase in marginal tax rates would likely have the effect of
________ the demand for municipal bonds, and ________ the demand for U.S. government bonds.
A) increasing; increasing
B) increasing; decreasing
C) decreasing; increasing
D) decreasing; decreasing
Questions based on “06 Financial Markets – The Risk and Term Structure of Interest
Rates – Part 2”
23. The term structure of interest rates is
A) the relationship among interest rates of different bonds with the same maturity.
B) the structure of how interest rates move over time.
C) the relationship among the term to maturity of different bonds.
D) the relationship among interest rates on bonds with different maturities.
24. A plot of the interest rates on default-free government bonds with different terms to maturity is
called
A) a risk-structure curve.
B) a default-free curve.
C) a yield curve.
D) an interest-rate curve.
25. When yield curves are downward sloping
A) long-term interest rates are above short-term interest rates.
B) short-term interest rates are above long-term interest rates.
C) short-term interest rates are about the same as long-term interest rates.
D) medium-term interest rates are above both short-term and long-term interest rates.
26. An inverted yield curve
A) slopes up.
B) is flat.
C) slopes down.
D) has a U shape.
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