Question & Answer

In countries experiencing high inflation, the annual interest rate may exceed 50 percent; in other countries such as the United States and many European countries, the annual interest rates are typically less than 10 percent. Do you think such a large difference in interest rates is due primarily to country-specific differences in the risk-free rates or in the credit risk premiums? Explain. (LO3)

Consider how economic conditions affect the credit risk premium. Do you think the credit risk premium will likely increase or decrease during this semester? How do you think the yield curve will change during this semester? Offer some logic to support your answers. (LO1, LO3)

During some crises, investors shift their funds out of the stock market and into money market securities for safety, even if they do not fear that interest rates will rise. Explain how and why these actions by investors affect the yield curve. Is the shift best explained by expectations theory, liquidity premium theory, or segmented markets theory? (LO3)

Assume that (1) investors and borrowers expect that the economy will weaken and that inflation will decline, (2) investors require a small liquidity premium, and (3) markets are partially segmented and the Treasury currently has a preference for borrowing in shortterm markets. Explain how each of these forces would affect the term structure, holding other factors constant. Then explain the effect on the term structure overall. (LO3)

Assume that the yield curves in the United States, France, and Japan are flat. If the U.S. yield curve suddenly becomes positively sloped, do you think the yield curves in France and Japan would be affected? If so, how? (LO3)

Assuming that liquidity and interest rate expectations are both important for explaining the shape of a yield curve, what does a flat yield curve indicate about the market’s perception of future interest rates? (LO3) 

Theory Suppose that the U.S. Treasury decided to finance its deficit with mostly long-term funds. How could this decision affect the term structure of interest rates? If short-term and long-term markets were segmented, would the Treasury’s decision have a more or less pronounced impact on the term structure? Explain. (LO3)

Which factors influence the shape of the yield curve? Describe how financial market participants use the yield curve. (LO3)

Theory Explain the preferred habitat theory. (LO3)

Theory If the segmented markets theory causes an upward-sloping yield curve, what does this imply? If markets are not completely segmented, should we dismiss the segmented markets theory as even a partial explanation for the term structure of interest rates? Explain. (LO3)

Theory If a downward-sloping yield curve is mainly attributed to segmented markets theory, what does that suggest about the demand for and supply of funds in the short-term and long-term maturity markets? (LO3)

Explain how consideration of a liquidity premium affects the estimate of a forward interest rate. (LO3)

Explain the liquidity premium theory. (LO3)

Theory Assume an expectation of lower interest rates in the future arises quite suddenly. What would be the effect on the shape of the yield curve? Explain. (LO3) 

What is the meaning of the forward rate in the context of the term structure of interest rates? Why might forward rates consistently overestimate future interest rates? How could such a bias be avoided? (LO3)

Explain how a yield curve would shift in response to a sudden expectation of rising interest rates, according to the pure expectations theory. (LO3)

Do investors in high tax brackets or those in low tax brackets benefit more from tax-exempt securities? Why? At a given point in time, which offers a higher before-tax yield: municipal bonds or corporate bonds? Why? Which has the higher after-tax yield? If taxes did not exist, would Treasury bonds offer a higher or lower yield than municipal bonds with the same maturity? Why? (LO1)

Discuss the relationship between the yield and the liquidity of securities. (LO1)

How does high credit risk affect the yield offered on securities? (LO1)

Identify the relevant characteristics of any security that can affect its yield. (LO1)

: Describe the concept of total quality management (TQM) and major TQM techniques, including quality circles, benchmarking, Six Sigma principles, quality partnering, and continuous improvement.

: Contrast the hierarchical and decentralized methods of control.

: Explain how the balanced scorecard addresses the four steps in the control process.

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1. : Explain why organizational control is a key management function. 
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Given your knowledge of how interest rates are influenced by various factors reflecting the demand for funds and the supply of funds available in the credit markets, write a short essay to explain how and why interest rates will change over the next three months.