Discus The Risk and Term Structure of Interest Rates

Discus The Risk and Term Structure of Interest Rates
1. Which should have the higher risk premium on its
interest rates, a corporate bond with a Moody’s Baa
rating or a corporate bond with a C rating? Why?
*2. Why do U.S. Treasury bills have lower interest rates
than large-denomination negotiable bank CDs?
3. Risk premiums on corporate bonds are usually anticyclical; that is, they decrease during business cycle expansions and increase during recessions. Why is this so?
*4. “If bonds of different maturities are close substitutes, their
interest rates are more likely to move together.” Is this
statement true, false, or uncertain? Explain your answer.
5. If yield curves, on average, were flat, what would this
say about the liquidity (term) premiums in the term
structure? Would you be more or less willing to accept
the expectations theory?
*6. Assuming that the expectations theory is the correct
theory of the term structure, calculate the interest
rates in the term structure for maturities of one to five
years, and plot the resulting yield curves for the following series of one-year interest rates over the next
five years:
(a) 5%, 7%, 7%, 7%, 7%
(b) 5%, 4%, 4%, 4%, 4%
How would your yield curves change if people preferred shorter-term bonds over longer-term bonds?
Discus The Risk and Term Structure of Interest Rates
7. Assuming that the expectations theory is the correct
theory of the term structure, calculate the interest rates
in the term structure for maturities of one to five years,
and plot the resulting yield curves for the following
path of one-year interest rates over the next five years:
(a) 5%, 6%, 7%, 6%, 5%
(b) 5%, 4%, 3%, 4%, 5%
How would your yield curves change if people preferred shorter-term bonds over longer-term bonds?
QUIZ
*8. If a yield curve looks like the one shown in figure (a)
in this section, what is the market predicting about
the movement of future short-term interest rates?
What might the yield curve indicate about the market’s predictions about the inflation rate in the future?
9. If a yield curve looks like the one shown in (b), what
is the market predicting about the movement of future
short-term interest rates? What might the yield curve
indicate about the market’s predictions about the inflation rate in the future?
*10. What effect would reducing income tax rates have on
the interest rates of municipal bonds? Would interest
rates of Treasury securities be affected, and if so, how?