Reading 63: Understanding Yield Spreads LOS c习题精选 demand, interest, structure, 2010

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LOS c, (Part 1): Explain the basic theories of the term structure of interest rates.

The term structure theory that rests on the interaction of supply and demand forces in the debt market is the:

A) expectation hypothesis.

B) GIC inverse term structure theory.

C) market segmentation theory.

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The market segmentation theory holds that the market is segmented into different parts based on the maturity preferences of investors. The theory also holds that the supply and demand forces at work within each segment determine the prevailing level of interest rates for that part of the market.

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Generally speaking, an upward-sloping yield curve can be expected when:

A) the supply of long-term funds falls short of demand.

B) the supply of long-term funds falls short of demand and investors begin to show a preference for more liquid/less risky short-term securities.

C) inflationary expectations are beginning to subside and investors begin to show a preference for more liquid/less risky short-term securities.

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When demand for loanable funds outstrips supply, interest rates can be expected to rise in that (long-term) segment of the market; also, more preference for short-term securities can be expected to drive up long-term rates as the liquidity premium rises. Thus, both circumstances in the answer can be expected to put upward pressure on the long end of the yield curve.

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Generally speaking, an upward-sloping yield curve can be expected when:

A) the supply of long-term funds falls short of demand.

B) the supply of long-term funds falls short of demand and investors begin to show a preference for more liquid/less risky short-term securities.

C) inflationary expectations are beginning to subside and investors begin to show a preference for more liquid/less risky short-term securities.

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When demand for loanable funds outstrips supply, interest rates can be expected to rise in that (long-term) segment of the market; also, more preference for short-term securities can be expected to drive up long-term rates as the liquidity premium rises. Thus, both circumstances in the answer can be expected to put upward pressure on the long end of the yield curve.

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If the slope of the yield curve begins to rise sharply, it is usually an indication that:

A) stocks are offering abnormally high rates of return.

B) the Fed has been aggressively driving up short-term interest rates.

C) the rate of inflation is starting to increase or is expected to do so in the near future.

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According to the expectations hypothesis, higher long-term interest rates and, therefore, upward-sloping yield curves will occur if the rate of inflation starts to heat up or is expected to do so in the near future.

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According to the pure expectations theory an upward-sloping yield curve implies:

A) longer-term bonds are riskier than short-term bonds.

B) interest rates are expected to increase in the future.

C) interest rates are expected to decline in the future.

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According to the expectations hypothesis, the shape of the yield curve results from the interest rate expectations of market participants.  More specifically, it holds that any long-term interest rate simply represents the geometric mean of current and future 1-year interest rates expected to prevail over the maturity of the issue.  The expectations theory can explain any shape of yield curve. 

Expectations for rising short-term rates in the future cause a rising (upward-sloping) yield curve; expectations for falling short-term rates in the future will cause long-term rates to lie below current short-term rates, and the yield curve will decline (or slope downward).

Thus, an upward-sloping yield curve implies that interest rates are expected to increase in the future.

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Which theory of the term structure of interest rates concludes that the shape of the yield curve is determined by the supply and demand for securities in particular maturity ranges, and what shape of the yield curve is implied by this theory?

       Theory                            Yield curve

A) market segmentation upward sloping

B) liquidity preference  upward sloping

C) market segmentation   no specific shape

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The shape of the yield curve under market segmentation is determined by the supply and demand for securities within a given maturity range. No specific shape of the yield curve is implied by this theory.

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An analyst forecasts that spot interest rates will increase more than the increase implied by the current forward interest rates. Under these circumstances:

A) the analyst should establish a bullish bond portfolio.

B) all bond positions earn the same return.

C) the analyst should establish a bearish bond portfolio.

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Bond prices fall with a rise in interest rates. If realized rates rise more than the associated forward rate implied, then a bearish bond position will be the most beneficial.

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The liquidity preference theory holds that:

A) because they are so marketable, there is a liquidity premium that normally has to be paid to invest in short-term debt securities.

B) the yield curve should be upward-sloping.

C) cash should be preferred to Treasury securities because it is more liquid.

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The liquidity preference theory definitely has an upward-sloping bias with regard to the shape of the yield curve. That is because it holds that investors generally prefer the greater liquidity and reduced risk that accompanies short-term securities and, as a result, require a premium (higher yields) to get them to invest in longer-term securities.

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According to the expectations hypothesis, investors’ expectations of decreasing inflation will result in:

A) a flat yield curve.

B) a downward-sloping yield curve.

C) an upward-sloping yield curve.

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The expectations hypothesis holds that the shape of the yield curve reflects investor expectations about the future behavior of inflation and market interest rates. Thus, if investors believe inflation will be slowing down in the future, they will require lower long-term rates today and, therefore, the yield curve will be downward-sloping.

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Suppose that the one-year forward rate starting one year from now is 6%. Which of the following statements is most accurate under the pure expectations hypothesis? The expected:

A) future risk premium for short-term bills is 6%.

B) future one-year spot rate in one year's time is equal to 6%.

C) one-year forward rate in one year's time is equal to 6%.

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Under the pure expectations hypothesis forward rates are equal to expected future spot rates.