Term Structure of Interest Rate

Economists' attempts to explain the term structure of interest rates

• illustrate how economists modify theories to improve them when they are inconsistent with the empirical evidence.

• illustrate how economists continue to accept theories that fail to explain observed behavior of interest rate movements.

• prove that the real world is a special case that tends to get short shrift in theoretical models.

• have proved entirely unsatisfactory to date.

If the expected path of 1-year interest rates over the next five years is 2 percent, 4 percent, 1 percent, 4 percent, and 3 percent, the expectations theory predicts that the bond with the lowest interest rate today is the one with a maturity of

• one year.

• two years.

• three years.

• four years.

According to the expectations theory of the term structure

• when the yield curve is steeply upward sloping, short-term interest rates are expected to remain relatively stable in the future.

• when the yield curve is downward sloping, short-term interest rates are expected to remain relatively stable in the future.

• investors have strong preferences for short-term relative to long-term bonds, explaining why yield curves typically slope upward.

• yield curves should be equally likely to slope downward as slope upward.

According to the segmented markets theory of the term structure

• bonds of one maturity are close substitutes for bonds of other maturities, therefore, interest rates on bonds of different maturities move together over time.

• the interest rate for each maturity bond is determined by supply and demand for that maturity bond.

• investors' strong preferences for short-term relative to long-term bonds explains why yield curves typically slope downward.

• because of the positive term premium, the yield curve will not be observed to be downward-sloping.

The additional incentive that the purchaser of a Treasury security requires to buy a long-term security rather than a short-term security is called the

• risk premium.

• term premium.

• tax premium.

• market premium.

According to the liquidity premium theory of the term structure, a slightly upward sloping yield curve indicates that short-term interest rates are expected to

• rise in the future.

• remain unchanged in the future.

• decline moderately in the future.

• decline sharply in the future.

If the yield curve is flat for short maturities and then slopes downward for longer maturities, the liquidity premium theory (assuming a mild preference for shorter-term bonds) indicates that the market is predicting

• a rise in short-term interest rates in the near future and a decline further out in the future.

• constant short-term interest rates in the near future and a decline further out in the future.

• a decline in short-term interest rates in the near future and a rise further out in the future.

• a decline in short-term interest rates in the near future and an even steeper decline further out in the future.

The ________ of the term structure of interest rates states that the interest rate on a long-term bond will equal the average of short-term interest rates that individuals expect to occur over the life of the long-term bond, and investors have no preference for short-term bonds relative to long-term bonds.

• segmented markets theory

• expectations theory

• liquidity premium theory

• separable markets theory

Which of these countries does NOT have a coast?

• Mongolia

• Peru

• Poland

• Turkey

Which letter of the alphabet has the most water?

• A

• B

• C

• D