What is the term structure of interest rates?

• Relationship between rates of different maturities

• Fixed rates

• Average market rate

Answer explanation

The term structure of interest rates refers to the relationship between interest rates of different maturities. It illustrates how rates vary over time, which is crucial for understanding investment and borrowing costs.

What does an upward-sloping yield curve typically indicate?

• Economic growth

• Recession

• Stability

Answer explanation

An upward-sloping yield curve indicates that long-term interest rates are higher than short-term rates, typically signaling investor confidence and expectations of economic growth.

What is the risk premium associated with longer-term bonds?

• Higher uncertainty

• Lower return

• No risk

Answer explanation

The risk premium for longer-term bonds is associated with higher uncertainty due to factors like interest rate changes and inflation over time. This increased risk leads to a higher expected return compared to shorter-term bonds.

How does inflation affect the term structure of interest rates?

• Increases nominal rates

• Decreases rates

• No effect

Answer explanation

Inflation typically leads to higher nominal interest rates as lenders demand compensation for the decrease in purchasing power over time. Thus, it increases nominal rates, affecting the term structure of interest rates.

What is a zero-coupon bond?

• A bond that pays no interest

• A high-risk bond

• A bond with high interest

Answer explanation

A zero-coupon bond is defined as a bond that pays no interest during its life. Instead, it is sold at a discount and matures at its face value, making the correct choice "A bond that pays no interest."

What does a flat yield curve suggest about future economic expectations?

• Uncertain growth

• Guaranteed recession

• Stable economy

Answer explanation

A flat yield curve indicates that interest rates for short-term and long-term bonds are similar, suggesting uncertainty about future economic growth. This reflects mixed expectations rather than a clear path to recession or stability.

What is the primary reason for the risk premium on corporate bonds?

• Default risk

• Interest rate risk

• Liquidity risk

Answer explanation

The primary reason for the risk premium on corporate bonds is default risk. Investors demand higher yields to compensate for the possibility that the issuer may fail to make interest or principal payments.

How do interest rates on municipal bonds typically compare to corporate bonds?

• Higher

• Lower

• The same

Answer explanation

Interest rates on municipal bonds are typically lower than those on corporate bonds. This is because municipal bonds often offer tax advantages, making them less risky and thus yielding lower interest rates compared to corporate bonds.

What is the liquidity preference theory?

• Preference for liquid assets

• Only applies to large investors

• Interest rate expectations

Answer explanation

Liquidity preference theory suggests that investors prefer liquid assets, which can be easily converted to cash, over illiquid ones. This preference influences interest rates and investment decisions.

What is an inverted yield curve?

• Short-term rates higher than long-term rates

• Constant rates

• Always increasing rates

Answer explanation

An inverted yield curve occurs when short-term interest rates are higher than long-term rates, indicating investor pessimism about future economic growth. This is the correct choice, as it defines the phenomenon accurately.