Risk Structure of Interest Rates

Default risk is:

• the chance the issuing firm will be sold to another firm

• the chance the issuer will retire the debt early.

• the chance the issuer will be unable to make interest payments or repay principal

• the chance the issuer will sell more debt.

Suppose that there are two bonds, A and B. Suppose also the default risk on bond A increases. As a result of this we would expect to see:

• the demand for A to increase and the demand for B to decrease.

• the demand for A to decrease and the demand for B to increase.

• the demand for A to decrease and the demand for B to decrease.

• the demand for A to increase and the demand for B to increase.

The risk premium on a bond is:

• the difference in interest rate between that bond and a municipal bond.

•   the difference in interest rate between that bond and a bank CD.

• the difference in interest rate between that bond and US Treasury bond.

• the difference in interest rates between that bond and a S&P 500 firm bond.

Municipal bonds generally have lower interest rates than U.S. Government bonds because:

• they have less risk.

• they are exempt from Federal taxes.

• they never mature.

• they are more liquid.

Yield curves show:

• the relationship between bond interest rates (yields) and bond prices.

• the relationship between time to maturity and bond interest rates (yields).

• the relationship between risk and bond interest rates (yields).

•   the relationship between liquidity and bond interest rates (yields).

The liquidity premium theory explains an inverted yield curve by

 

• Assuming that interest rated move together over time

• Assuming that the liquidity premium is always positive

• Assuming that short-term rates are expected to fall to a great degree in the future

• Assuming that investors prefer shorter-term bonds over longer maturity bonds

The liquidity premium theory suggests that yield curves should usually be:

• inverted.

• up-sloping through year 1, then flat thereafter.

• flat.

• up-sloping.

The liquidity premium theory is based upon the idea that, other things remaining equal,

• investors are indifferent between short-term and long-term bonds.

• investors prefer long-term bonds.

• investors prefer short-term bonds.

• investors prefer intermediate-term bonds.

The shape of the yield curve is usually:

 

• downward sloping.

• flat.

• upward sloping.

• upward sloping for shorter maturities and downward sloping for longer maturities.

What are the different methods of raising capital for a business?

• Selling personal belongings

• Asking friends and family for donations

• Winning the lottery

• Taking out loans, seeking investment, crowdfunding, issuing bonds, going public