BNAD 301 Exam #2 | Complete Study Guide, Practice
Questions & Exam Review
In the fall of 2008, AIG, the largest insurance company in the world at the time, was at risk of
defaulting due to the severity of the global financial crisis. As a result, the U.S. government
stepped in to support AIG with large capital injections and an ownership stake. How would this
affect, if at all, the yield and risk premium on AIG corporate debt? - correct answer ✔✔The Yield
and risk premium will fall since demand for AIG corporate will increase
What would happen to the risk premium on corporate bonds if brokerage commissions were
lowered in the corporate bond market? - correct answer ✔✔Lower brokerage commissions for
corporate bonds would make them more liquid and thus increase demand, which would lower
the risk premium
During 2008, the difference in yield (the yield spread) between 3-month AA-rated financial
commercial paper and 3-month AA-rated nonfinancial commercial paper steadily increased
from its usual level of close to zero, spiking to over a full percentage point at its peak in October
2008. Which of the following explains this sudden increase? - correct answer ✔✔The increase
in the yield spread was a result of the decrease in demand for financial commercial paper due
to the uncertainty and soundness of financial companies and banks.
If the income tax exemption on municipal bonds were abolished, the interest rates on these
bonds would - correct answer ✔✔Increase
"According to the expectations theory of the term structure, it is better to invest in one-year
bonds, reinvested over two years, than to invest in a two-year bond, if interest rates on one-
year bonds are expected to be the same in both years." Is this statement true, false, or
uncertain? - correct answer ✔✔False: These investments are almost of the same profitability.
, if bond investors decide that 30-year bonds are no longer as desirable an investment, the yield
curve would - correct answer ✔✔steepen at the end of the year curve and flatten along the rest
of the curve
Suppose the interest rates on one-, five-, and ten-year U.S. Treasury bonds are currently 3%, 6%,
and 6%, respectively. Investor A chooses to hold only one-year bonds, and Investor B is
indifferent with regard to holding five- and ten-year bonds. Which theories best explain the
behavior of Investors A and B? - correct answer ✔✔InvestorIn A's preferences are best
explained by the segmented markets theory, while Investor B's preferences are more consistent
with the expectations theory.
Suppose you observe a change in the relationship between short-term and long-term bonds.
Specifically, you note that although interest rates on both short-term and long-term bond are
rising together, as expected, the rate on long-term bonds is not rising by as much as has been
observed in the past. - correct answer ✔✔Assuming the liquidity premium theory of term
structure, you conclude that the liquidity premium is
decreasing
.
As a result, the yield curve becomes
flatter
.
If expectations of future short-term interest rates suddenly fall, what would happen to the slope
of the yield curve? - correct answer ✔✔flatter
Following a policy meeting on March 19, 2009, the Federal Reserve made an announcement
that it would purchase up to $300 billion of longer-term Treasury securities over the following
six months. What effect might this policy have on the yield curve? - correct answer ✔✔The yield
curve would shift down, but mostly on medium- and long-term maturities.
Questions & Exam Review
In the fall of 2008, AIG, the largest insurance company in the world at the time, was at risk of
defaulting due to the severity of the global financial crisis. As a result, the U.S. government
stepped in to support AIG with large capital injections and an ownership stake. How would this
affect, if at all, the yield and risk premium on AIG corporate debt? - correct answer ✔✔The Yield
and risk premium will fall since demand for AIG corporate will increase
What would happen to the risk premium on corporate bonds if brokerage commissions were
lowered in the corporate bond market? - correct answer ✔✔Lower brokerage commissions for
corporate bonds would make them more liquid and thus increase demand, which would lower
the risk premium
During 2008, the difference in yield (the yield spread) between 3-month AA-rated financial
commercial paper and 3-month AA-rated nonfinancial commercial paper steadily increased
from its usual level of close to zero, spiking to over a full percentage point at its peak in October
2008. Which of the following explains this sudden increase? - correct answer ✔✔The increase
in the yield spread was a result of the decrease in demand for financial commercial paper due
to the uncertainty and soundness of financial companies and banks.
If the income tax exemption on municipal bonds were abolished, the interest rates on these
bonds would - correct answer ✔✔Increase
"According to the expectations theory of the term structure, it is better to invest in one-year
bonds, reinvested over two years, than to invest in a two-year bond, if interest rates on one-
year bonds are expected to be the same in both years." Is this statement true, false, or
uncertain? - correct answer ✔✔False: These investments are almost of the same profitability.
, if bond investors decide that 30-year bonds are no longer as desirable an investment, the yield
curve would - correct answer ✔✔steepen at the end of the year curve and flatten along the rest
of the curve
Suppose the interest rates on one-, five-, and ten-year U.S. Treasury bonds are currently 3%, 6%,
and 6%, respectively. Investor A chooses to hold only one-year bonds, and Investor B is
indifferent with regard to holding five- and ten-year bonds. Which theories best explain the
behavior of Investors A and B? - correct answer ✔✔InvestorIn A's preferences are best
explained by the segmented markets theory, while Investor B's preferences are more consistent
with the expectations theory.
Suppose you observe a change in the relationship between short-term and long-term bonds.
Specifically, you note that although interest rates on both short-term and long-term bond are
rising together, as expected, the rate on long-term bonds is not rising by as much as has been
observed in the past. - correct answer ✔✔Assuming the liquidity premium theory of term
structure, you conclude that the liquidity premium is
decreasing
.
As a result, the yield curve becomes
flatter
.
If expectations of future short-term interest rates suddenly fall, what would happen to the slope
of the yield curve? - correct answer ✔✔flatter
Following a policy meeting on March 19, 2009, the Federal Reserve made an announcement
that it would purchase up to $300 billion of longer-term Treasury securities over the following
six months. What effect might this policy have on the yield curve? - correct answer ✔✔The yield
curve would shift down, but mostly on medium- and long-term maturities.
