Question

We studied several different theories of the yield curve. Which of the following statements is most likely correct?

a. The liquidity premium version of the expectations theory cannot explain a flat term structure of interest rates

b. The pure expectations theory suggests that an upward-sloping term structure of interest rates is a consequence of investors expecting short-term rates to remain unchanged for a period of time, followed by investors expecting short-term rates to rise for a period of time

c. The liquidity premium version of the expectations theory suggests that a downward-sloping term structure of interest rates is due to declining expected short-term rates, and although there is a maturity premium to consider, it is not large enough to offset the expected decline in short-term rates.

Answer #1

a. is correct. Liquidity preference theory is based on the premise that investors prefer short-term horizon because the interest rate risk is higher in long-term horizon. The investors should be compensated for this risk if they chose a long-term horizon. Hence the yield curve will be upward sloping. It cannot explain a flat yield curve.

b. is not correct. upward sloping yield curve is a result of expected increase in inflation rate and interest rate in the future.

c. is not correct. Liquidity preference theory cannot explain a downward-slopping curve.

Can an inverted (i.e., downward sloping) yield curve occur with
the three
theories of the term structure of interest rates? (Pure
expectations theory,
liquidity preference theory, and market segmentation theory.)
a. Yes.
b. All except pure expectations.
c. All except liquidity preference.
d. None of the above

Which of the term structure theories would support the argument
that the yield curve is determined by investors' expectations of
future interest rates?
Answer Options:
The yield curve theory.
The liquidity preference theory.
The market segmentation theory.
The unbiased expectations theory.
The term structure of interest rates theory.

Suppose that we observe the following spot rates, i.e. the yield
curve is downward sloping. The spot rates are annual rates that are
semi-annually compounded.
Time to Maturity
Spot Rate
0.5
3.00%
1.0
3.00%
1.5
3.00%
2.0
3.00%
1. Compute the six-month forward curve, i.e. compute
f(0,0.5,1.0), f(0,1.0,1.5), f(0,1.5,2.0).
2. What can we say about the forward curve?
When the term structure of interest rates is flat sloping, the
forward curve is _____________ (upward/downward/flat) sloping.

1-According to the expectations theory of the term structure of
interest rates,
A
a long-term interest rate is equal to the average of current and
expected future short-term interest rates.
B-
the yield curve is always flat.
C-
a short-term interest rate has no relation to long-term interest
rates.
D- a short-term interest rate is equal to the average of current
and expected future long-term interest rates.
2-The expectations theory of yield curves is not very realistic
because
A-
a...

_________ is a plot of the yields on bonds with different terms
to maturity with the same risks.
Expectation
Forward rate
Yield curve
Market segmentation
__________ bonds have higher default risk than bonds with
ratings above Baa (BBB).
Expectation
Junk
Liquidity
Spot
QUESTION 3
________ occurs when the bond issuer is unable to make interest
payments when promised.
Liquidity
Intermediation
Default
Yield
1 points
QUESTION 4
_____ indicates how much additional interest investors must
receive to hold a riskier...

A. What is the basic difference between the Expectations
Hypothesis and Liquidity Premium Theory? Which has a higher
interest rate in a normal market?
B. If we have an “inverted yield curve”, what does the
Expectations Hypothesis claim about long and short-term rates?
C. If you see a steep upward slope of the yield curve, are short
term rates expected to rise or fall?

Which of the following statements about a bond is true?
Group of answer choices
A. If the yield curve is downward sloping, long-term yields are
lower than short-term yields because market interest rates are
expected to decrease.
B. If the yield curve is downward sloping, long-term yields are
lower than short-term yields because market interest rates are
expected to increase
C.The value of a bond cannot be traded in the market at its face
value
D. All else being equal,...

Which of the following statements about term structure is(are)
most correct?
A. Term structure is the relationship between interest rates and
discount rates.
B. Term structure can be expressed either in tabular form or in
graphical form.
C. A term structure graph is called a valuation graph.
D. The yield curve can have a variety of shapes, but the most
common is downward sloping.
E. All of the above statements are correct.

If the pure expectations theory of the term structure is
correct, which of the following statements is CORRECT?
A. An upward sloping yield curve would imply that interest rates
are expected to be lower in the future.
B. If a 1-year Treasury bill has a yield to maturity of 7% and a
2-year Treasury bill has a yield to maturity of 8%, this would
imply the market believes that 1-year rates will be 7.5% one year
from now.
C. The...

Which one of the following statement is most FALSE?
a. a treasury yield curve plots the interest rates relative to
time to maturity
b. the pure time value of money is the term structure of
interest rates.
c. U.S. Treasury bonds are quoted as a percentage of par.
d. U.S. treasury bonds are considered to be free of interest
rate risk
e. interest rates that include an inflation premium are referred
to as nominal interest rate.

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