Deck 4: The Level of Interest Rates

Question 1

The market rate of interest can be viewed as the real rate of interest plus a premium for the expected rate of inflation.

Answer 1

True

Question 2

The flow of funds forecasting method utilizes the concept of supply and demand of loanable funds.

Answer 2

True

Question 3

Declining interest rates can be caused by an upward shift in the demand for loanable funds relative to the supply of loanable funds.

Answer 3

False

Question 4

Economic models forecast interest rates then estimate measures of economic output.

Question 5

If yields on thirty-year U. S. Treasury bonds are 8% and the real rate of interest is estimated at 3%, the historical rate of inflation is 5%.

Question 6

Deficit spending units supply loanable funds.

Question 7

The current rate of inflation affects the expected level of interest rates.

Question 8

Interest rates are directly related to inflation expectations and inversely related to the level of economic activity.

Question 9

The real rate of interest can be viewed as the time value of not consuming.

Question 10

An increase in the desired saving rate will increase real interest rates.

Question 11

Interest rate forecasting using economic models assumes that financial markets are very efficient.

Question 12

The expected real rate of interest is likely to be negative.

Question 13

The realized real rate of interest can be negative if expected inflation is less than actual inflation.

Question 14

The Fisher Effect holds that nominal interest rates include an expected inflation rate.

Question 15

Expected increased inflation usually drives up bond prices.

Question 16

An upward shift in the supply of loanable funds is likely to increase interest rates.

Question 17

An increase in rates of return on real capital investment will increase real interest rates.

Question 18

An increase in desired investment shifts the desired savings supply line upward to higher real rates of interest.

Question 19

Economic models and flow-of-funds are two ways of forecasting interest rates.

Question 20

Nominal interest rates reflect anticipated inflation.

Question 21

If current market rates on Treasury bonds are 6 percent and the real growth of the economy has and will be expected to grow at 3 percent. According to the Fisher effect, what is the expected rate of inflation?

A) 3%
B) 9%
C) higher than 6%
D) close to zero

Question 22

If a security's realized return is negative, the expected return was smaller than the required return.

Question 23

The Fisher effect is a theory which holds that

A) nominal rates include the real rate of interest plus past annual inflation rates.
B) nominal rates include the real rate of interest plus expected annual inflation rates.
C) real rates are always positive.
D) inflation has no impact upon interest rates.

Question 24

Which statement is true about interest rate movements?

A) Interest rates move counter-cyclically with the business cycle.
B) Long-term interest rates have greater swings than short-term rates.
C) The expected rate of inflation impacts the level of interest rates.
D) Bond prices and interest rates move directly with one another.

Question 25

If the real rate of interest is 4%, actual inflation for the last year was 5%, and expected inflation is 8%, the Fisher effect predicts what current level of nominal interest rates?

A) 9%
B) 8%
C) 13%
D) 12%

Question 26

All but one of the following affects the supply of loanable funds?

A) the level of income
B) the investment opportunities in the economy.
C) the savings rate
D) Federal Reserve monetary policy actions.

Question 27

Which of the following factors influence the real rate of interest?

A) investor's positive time preference
B) the gold supply
C) return on capital investments
D) the rate of inflation
E) both a and c

Question 28

An increase in the rate of expected inflation will

A) shift the demand for loanable funds to the left (down).
B) shift the supply of loanable funds to the left (down).
C) shift demand and supply for loanable funds to the right (up) decreasing interest rates.
D) shifts demand and supply for loanable funds to the right (up) increasing interest rates.

Question 29

Interest is

A) the price of money.
B) the rent on money.
C) time value of delayed consumption.
D) all of the above.

Question 30

If nominal interest rates are 10% and expected inflation is 5%, according to Fisher equation,

A) actual inflation exceeds 10%.
B) the real rate of interest is 5%.
C) market rates are expected to increase to 15%.
D) expected interest rates are 5%.

Question 31

The demand for loanable funds may shift upward (increase) from

A) a decline in the supply of loanable funds.
B) a decline in business prospects.
C) an improvement in technology.
D) an expectation of an upcoming recession.

Question 32

Which one of the following statements about interest rates is incorrect?

A) Bond prices and interest rates change inversely with one another.
B) The expected rate of inflation affects current market interest rates.
C) Short-term interest rates are not as volatile as long-term interest rates.
D) Interest rates are directly related to the level of output in the economy.

Question 33

________ real rates are almost always positive; _______real rates may be negative.

A) Realized; expected
B) Expected; realized
C) Government; private
D) Expected; expected

Question 34

Which one of the following is NOT an explanation for paying interest on borrowed money?

A) Interest is the rental cost of purchasing power.
B) Interest is the penalty paid for consuming income before it is earned.
C) Interest is always paid at the maturity of a loan.
D) Interest is the time value of delayed consumption.

Question 35

In 2010 and 2011, Federal Reserve announced quantitative easing's, or QEs, which is to create money. This would lead to interest rates increase.

Question 36

Interest rates will decline when the demand for loanable funds

A) shifts to the left.
B) shifts to the right.
C) anticipates reduced growth in the economy.
D) "a" and "c" above.

Question 37

All but one of the following factors influences the real rate of interest?

A) the rate of inflation
B) investor positive time preference for current versus future consumption.
C) the return on alternative real investments.
D) the real level of output in the economy.

Question 38

For a investment project to be accepted by management, its return must exceed the firm's cost of capital.

Question 39

Nominal rates generally exceed the real rate.

Question 40

Deficit spending units (DSU) are represented in loanable funds theory as

A) suppliers of loanable funds.
B) demanders of financial claims.
C) demanders of loanable funds.
D) DSUs are not represented in the loanable funds theory of interest rate determination.

Question 41

If the actual rate of inflation is less than the rate expected during a period,

A) borrowers benefited at the expense of lenders.
B) lenders benefited at the expense of borrowers.
C) both borrowers and lenders benefited.
D) neither borrowers nor lenders benefited.

Question 42

Which of the following is more likely to adversely affect long-term bond prices?

A) a forecast of lower inflation in the future.
B) a forecast of a slower economy next year.
C) a forecast of higher inflation in the future.
D) a forecast of lower government budget deficits.

Question 43

Increased government budget deficits

A) shifts the demand for loanable funds to the left, reducing interest rates.
B) shifts the supply of loanable funds to the right, reducing interest rates.
C) shifts the demand for loanable funs to the right, increasing interest rates.
D) shifts the supply of loanable funds to the left, reducing interest rates.

Question 44

Which of the following is more likely to affect long-term bond yields?

A) announcement of the last year's inflation rate
B) announcement of this month's inflation rate
C) a forecast of next month's inflation rate
D) a forecast of inflation for the next five years

Question 45

An investor received an 8 percent coupon rate last year on a $1000 bond purchased at par. The inflation rate during the year was 4 percent and is expected to be 5 percent next year. The realized real rate earned by the investor last year was:

A) 8%
B) 3%
C) 4%
D) -1 percent.

Question 46

An economic recession would be represented in loanable funds theory as

A) a shift in the demand for loanable funds to the right associated with reduced business investment demand and a decline in interest rates.
B) a shift in the demand for loanable funds to the left as real investment weakens, a shift to the right of the supply of loanable funds as the Fed expands the money supply, and a decrease in interest rates.
C) a movement along the demand for loanable funds as interest rates decline.
D) an increase in the supply of loanable funds as the level of savings increases accompanied with an increase in the demand for loanable funds as housing investment is increased, and a decrease in interest rates.

Question 47

Which of the following best explains why public interest rate forecasts have a low rate of accuracy?

A) Accurate forecasters do not make their forecasts public.
B) Reasonably efficient financial markets preclude a forecaster from consistently outguessing the direction of interest rates.
C) The level of training of forecasters is lagging an evermore sophisticated economy.
D) (a) and (b) above

Question 48

The flow of funds approach to interest rate forecasting is associated with all but one of the following:

A) the National Income Accounts.
B) the Flow of Funds Accounts.
C) the loanable funds theory of interest rate determination.
D) the Federal Reserve System.

Question 49

The realized rate of return may be negative if

A) investors' expected rate of inflation (P_e) was less than actual inflation (P_a).
B) investors' expected rate of inflation (P_e) was greater than actual inflation (P_a).
C) investors over-anticipated the level of inflation.
D) investors expected more inflation than was realized.

Question 50

An increase (shift to right) in the supply of loanable funds (SL) may be related to all but one of the following:

A) an increase in the money supply.
B) an increase in household thriftiness.
C) an increase in household income.
D) an increase in personal income taxes.

Question 51

If the real rate of interest is 4% and the expected inflation rate is 7%, a loan at 12%

A) would reward the lender at the borrower's expense
B) would reward the borrower at the lender's expense
C) would penalize the lender at the borrower's expense
D) none of the above

Question 52

If expected inflation in a period exceeds actual inflation

A) borrowers will benefit.
B) savers will lose purchasing power.
C) SSUs will benefit at the expense of DSUs.
D) interest rates are likely to increase in the future.

Question 53

A decrease in interest rates may best be related to

A) a recession and a decline in inflationary expectations.
B) an acceleration in the growth rate of M₁.
C) decreased real investment opportunities.
D) all of the above

Question 54

Which of the following is best associated with interest rate movements and inflation?

A) Interest rates move inversely with inflation.
B) Interest rates vary directly with expected inflation.
C) Interest rates vary directly with past inflation rates.
D) Inflation is impacted by expected interest rates.

Question 55

Interest rates should decease if

A) The economy is in a boom.
B) Inflationary expectations have decreased.
C) The Federal Reserve has decreased M₁ and the supply of loanable funds.
D) Business investment demand has decreased significantly.

Question 56

Economic models predict interest rates by estimating the statistical relationships between the and the resulting .

A) level of interest rates; measures of economic output
B) past level of interest rates; future level of interest rates
C) measures of economic output; level of interest rates
D) prior level of GNP; future level of interest rates

Question 57

An investor earned 12 percent last year, a year when actual inflation was 9 percent and was expected to have been 6 percent. The investor realized real rate of return was:

A) 3%
B) 6%
C) 18%
D) 12%

Question 58

Negative realized real rates of interest are associated with periods where

A) inflation forecasts significantly underestimate inflation.
B) nominal interest rates were too high relative to actual inflation.
C) prior inflation forecasts overestimated inflation.
D) bond prices were priced too low relative to actual inflation.

Question 59

The Federal Reserve Bank of St. Louis develops quarterly forecasts of a number of key economic statistics using only eight equations. The is an example of

A) a naive forecasting model.
B) the flow of funds approach.
C) a hedged forecast.
D) an economic forecasting model.

Question 60

Basic approaches to forecasting interest rates include

A) economic models
B) flow-of-funds
C) both of the above
D) none of the above

Question 61

Interest rates represent

A) allocational forces
B) penalties for early consumption
C) rewards for deferring consumption
D) all of the above

Question 62

You are the Chief Economist of Free Formosan Investment and are conducting research on inflation forecasting by using the information of the Treasury Inflation-Protected Securities (TIPS). The information that you have are as the following: Nominal yield on 10-year nonindexed Treasury bond is 4.5%; Real yield on 10-year TIPS is 2.25%; The market adjustment for inflation and liquidity risk is 45 basis-points. What is the expected annual inflation rate over the next decade?

Question 63

On any given day if the market interest rate is above the equilibrium interest rate level,

A) the Fed will declare a monetary policy.
B) there will be a shortage of loanable funds and interest rates will increase.
C) there will be a surplus of loanable funds at that rate and rates will decline to the equilibrium rate.
D) there will be a shortage of loanable funds at that rate and rates will increase to the equilibrium rate.

Question 64

With the real rate at 3 percent, most loans were made at 10 percent last year. This year interest rates have declined to 8 percent. What was the expected inflation rate last year?

A) 5%
B) 2%
C) 7%
D) 8%

Question 65

An increase in income tax rates

A) will decrease the savings rate.
B) will decrease the supply of loanable funds.
C) will increase interest rates.
D) all of the above.

Question 66

Which of the following actions will reduce the interest rate risk of the lender?

A) Make fixed interest rate loans.
B) Make fixed interest rate, long-term loans.
C) Make variable interest rate loans.
D) Invest in fixed rate Treasury bonds.

Question 67

Calculate the price of a $1000 face value bond, maturing in three years with a 9 percent coupon (paid semiannually) if current real rates of interest are 4 percent, historical inflation rates are 3 percent, and expected inflation rates are 4 percent. (Use if next chapter covered in exam)

Question 68

All but one of the following is associated with economies with very high inflation rates?

A) Very few people who wish to borrow at a fixed rate.
B) Little if any long-term debt market.
C) Variable interest rate loans.
D) Reliance on short-term debt contracts.

Question 69

The lower a consumer's positive time preference for consumption,

A) the more savings they will accumulate.
B) the lower the level of interest rates.
C) the greater the supply of loanable funds.
D) all of the above.

Question 70

Explain how price expectations influence the level of interest rates. What impact has inflation premiums had on interest rate levels in recent years?

Question 71

A decrease in the money stock by the Federal Reserve

A) shifts the supply of loanable funds to the left, decreasing interest rates.
B) shifts the demand for loanable funds to the left, increasing interest rates.
C) shifts the supply of loanable funds to the left, increasing interest rates.
D) shifts the supply of loanable funds to the right, increasing interest rates.

Question 72

In January 2011, a Japanese investor placing money in dollar denominated assets desires a 5% real rate of return. Then international expected inflation rate is about 2.5% and the dollar is expected to decline against Japanese Yen by 10% over the investment period. What is the minimum required rate of return for this Japanese investor?

Question 73

A change from an income tax to a value added tax on consumption

A) should decrease the supply of loanable funds.
B) would decrease the demand for loanable funds.
C) should increase the supply of loanable funds.
D) should shift consumers' preferences toward consumption.

Question 74

A person with a very high positive time preference for consumption

A) will have a high savings rate.
B) will have a low savings rate.
C) prefers savings to consumption.
D) is not as likely to borrow money as other people with lower positive time preference.

Question 75

Sam has just lent Mary $1000 for 1 year 6%. Sam and Mary expect inflation to be 3% over the next year. If inflation turns out to have been only 2%, what is the impact upon Sam and Mary?

Question 76

Economies with very high current and expected inflation rates

A) will have a significant long-term debt market.
B) will have debt instruments with interest rates indexed to the inflation rate.
C) will favor long-term financing over short-term.
D) will have very low interest rates.

Question 77

Explain why realized real rates of interest are sometimes negative, but expected real rates are always positive. Give an example.

Question 78

Interest rates move ______ with expected inflation; _____ with economic activity.

A) directly/inversely
B) inversely/inversely
C) directly/directly
D) inversely/directly

Question 79

An investor loaned money at 14 percent with an expected rate of inflation of 11 percent. During the year the actual rate of inflation was 8 percent. The investor's expected real rate of interest was _____ and the realized real rate for the investor was ______?

A) 14 percent; 8 percent.
B) 6 percent; 3 percent.
C) 3 percent; 3 percent.
D) 3 percent; 6 percent.

Question 80

Using loanable funds theory, discuss how changes in consumer savings, business investment, and in the money supply by the Federal Reserve System can influence the level of interest rates.