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econ423hw3answer

econ423hw3answer - Econ 423 Summer 2009 Lauren Heller...

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Unformatted text preview: Econ 423, Summer 2009 Lauren Heller Homework #3, Due 6—30—09 Name “ -. 3 ' _ ' - ' . h M '15- 7?. - __..-/-« ' MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question. 1) The risk premium on corporate bonds becomes smaller if A) the riskiness of corporate bonds increases. B) the riskiness of corporate bonds decreases. C) the liquidity of corporate bonds decreases. D) the liquidity of corporate bonds increases. 'l E) either (b) or (d) occur. 2) (I) If a corporation suffers big losses, the demand for its bonds will rise because of the higher interest rates the firm must pay. (II) The spread between the interest rates on bonds with default risk and default—free bonds is called the risk premium, A) (l) is true, (11) false. "‘B)_'.5_(l) is false, (11} true. C) Both are true. D) Both are false. 3) (l) An increase in default risk on corporate bonds shifts the demand curve for corporate bonds to the right. (II) An increase in default risk on corporate bonds shifts the demand curve for Treasury bonds to the left. A) (I) is true, {11) false. #3). (l) is false, (ll) true. C) Both are true. D) Both are false. 4) When the corporate bond market becomes more liquid, other things equal, the demand curve for corporate bonds shifts to the and the demand curve for Treasury bonds shifts to the A) left; left B) left; right _-'-‘1C)N_§T:right; left D) right; right 5) A decrease in marginal tax rates would likely have the effect of the demand for municipal bonds and the demand for U.S. government bonds. A) mcreasm g, increasing B) decreasing; decreasing EC), decreasing; increasing D) increasing; decreasing 6) Which of the following statements are true? A) An increase in tax rates will increase the demand for municipal bonds, lowering their interest rates. B) Because coupon payments on municipal bonds are exempt from federal income tax, the expected after—tax return on them will be higher for individuals in higher income tax brackets. C) Interest rates on municipal bonds will be lower than on comparable bonds without the tax exemption -'D)_ All of the above are true statements. E) Only A and B are true statements. 7) The relationship among interest rates on bonds with identical default risk, but different maturities, is called the A). yield curve. B) time—risk structure of interest rates. C) bond demand curve. D) liquidity structure of interest rates. 1) " 3) 4) 5) Note: All questions are to be completed on your own, without any assistance from others. 8) When yield curves are steeply upward— sloping, 8) J short- term interest rates are about the same as long—term interest rates" B): long— —term interest rates are above short— term interest rates. C) medium—term interest rates are below both short— term and long-term interest rates D) short— term interest rates are above long—term interest rates. E) mediu m—term interest rates are above both short—term and long— term interest rates. 9) According to the expectations theory of the term structure, 9) I I t A) when the yield curve is dUanard-sloping, short—term interest rates are expected to decline in the future. B) when the yield curve is steeply upward—sloping, short— term interest rates are expected to rise in the future. C) buyers of bonds prefer short— term to long—term bonds. DJ all of the above 4’15); only A and B of the above 10) If the expected path of one—year interest rates over the next five years is 2 percent, 4 percent, 1 10) a percent 4 percent and 3 percent the pure expectations theory predicts that the bond with the loysest interest rate today 15 the one with a maturity of 3A) one year. B) two years. C) three years. D) four years. 3" "ta-5.- 11) According to the market segmentation theory of the term structure, 11) A) investors' strong preference for short-term relative to long—term bonds explains why yield curves typically slope upward. B) bonds of one maturity are not substitutes for bonds of other maturities; therefore, interest rates on bonds of different maturities do not move together over time. C) the interest rate for bonds of one maturity is determined by supply and demand for bonds of "fat: that maturity. TD} all of the above I. E) none of the above 12) According to the liquidity premium theory of the term structure, 12) t; . A) because of the positive term premium the yield curve cannot be downward- -sloping. I B) the interest rate on long— —term bonds will equal an average of short— term interest rates that ' people expect to occur over the life of the long—term bonds plus a term premium. C) because buyers of bonds may prefer bonds of one maturity over another, interest rates on bonds of different maturities do not move together over time. D) all of the above. B) only A and B of the above. A .. 13) In actual practice, short—term interest rates are just as likely to fall as to rise; this is the major 13) it I shortcoming of the fat.) A) liquidity premium theory. _-__B). fexpectations theory. C) market segmentation theory. 5) separable markets theory. Note: All questions are to be completed on your own, without any assistance from others. 14) If the optimal forecast of the return on a security exceeds the equilibrium return, then A) an unexploi ted profit opportunity exists. B) the market is inefficient. _§).:_the market is in equilibrium. D) only A and B of the above are true. E) only B and C of the above are true. 15) To §ay that stock prices follow a "random w alk" is to argue that A). stock prices cannot be predicted based on pa st trends. 13) stock prices tend to follow trends. C) stock prices rise, then fall, then rise again. D} stock prices rise, then fail in a predictable fashion. 16) Sometimes one observes that the price of a company's stock falls after the announcement of favorable earnings. This phenomenon is 9A) consistent with the efficient market hypothesis if the earnings were not as high as anticipated. B) consistent with the efficient market hypothesis if the earnings were not as low as anticipated. C) clearly inconsistent with the efficient market hypothesis. D) the result of none of the above. 17) Although the verdict is not yet in, the available evidence indicates that, for many purposes, the efficient market hypothesis is A) too general to be a useful tool for analyzing expectations. ) not a good starting point for analyzing expectations. tC) 'a good starting point for analyzing expectations. 13) none of the above. 18) ThesmaII— firm effect refers to the observation that small firms stocks _A_)5 have earned abnormally high returns even taking into account their greater risk 13) have earned abnormally low returns given their greater risk. C) follow a random walk but large firms' stocks do not. D) sell for lower prices than do large firms' st0cks. 19) M reversion refers to the observation that A), stocks with low returns are likely to have high returns in the future. 8) stocks prices are more volatile than fluctuations 1n their fundamental value would predict. C) stocks with low returns are likely to have even lower returns in the future. D) stock prices overact to news announcements. 20) An investor gains from short selling by and then later ). buying a stock,- selling it at a lower price ii.__l_i)3'fselljng a stock; buying at back at a lower price C) buying a stock,- selling it at a higher price D) selling a stock; buying it back at a higher price ESSAY. Write your answar in the space provided or on a separate sheet of paper. 21) Mishkin and Eakins, p. 125, Question 1'37 22) Mishkin and Eakins, p. 125, Quantitative Problem #4 14) 16) 17} 18) 20) i- iv ...
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