Deck 7: Effects of Inflation and Yield Curves on Stock Prices and Investments

Question 1

Default risk is held constant when drawing a yield curve.

Answer 1

True

Question 2

According to the expectations hypothesis, future changes in short-term interest rates determine the shape of the yield curve.

Answer 2

True

Question 3

A positively sloped yield curve, according to the expectations hypothesis, suggests that short-term interest rates are expected to fall from their current levels.

Answer 3

False

Question 4

A horizontal yield curve implies that investors in the market expect interest rates to remain essentially unchanged from their present level.

Question 5

The expectations hypothesis assumes that investors act as risk minimizers over their planned holding period.

Question 6

The expectations hypothesis asserts that investors derive their expectations about future interest rates on the basis of historical experience.

Question 7

The price elasticity of a security must be positive except when interest rates fall.

Question 8

An increase in the price of gasoline is an example of inflation.

Question 9

The Consumer Price Index (CPI), and the GDP inflator are common indexes used to measure inflation in a particular area over a particular length of time.

Question 10

The correlation between the rate of inflation and interest rates was relatively high for the 1970s but the correlation between inflation and interest rates was even higher in the U.S. during the 1960s, according to the textbook.

Question 11

The difference between the real rate of interest and the nominal rate (ignoring the cross-product term) is equal to the inflation premium.

Question 12

The Fisher effect assumes that inflation is only partly anticipated by investors.

Question 13

According to the inflation-caused wealth effect, people will borrow and lend the same amount of funds at any expected real interest rate, regardless of the expected inflation rate.

Question 14

The price elasticity of a security usually is measured from its par value and coupon rate.

Question 15

The price elasticity of a debt security is always negative.

Question 16

The price elasticity of a debt security measures to speed of change in price with a change in interest rates.

Question 17

For the same change in yield, capital gains from a fixed-income debt security (such as a bond) will be smaller than capital losses.

Question 18

The greater the price elasticity of a security the greater its price change for any given change in market interest rates.

Question 19

The elasticity of a debt security is not affected by its coupon rate, but the security's maturity does affect its elasticity; longer-maturity debt instruments usually have greater elasticity.

Question 20

A debt security with a low coupon rate compared to one with a high coupon rate, both having the same maturity date, will behave as though it has a longer maturity than the high-coupon security.

Question 21

Duration is unaffected by changes in a security's yield to maturity.

Question 22

Duration measures the price elasticity of a debt instrument with respect to changes in the instrument's yield to maturity.

Question 23

Duration can exceed the amount of calendar time before a fixed-income debt security reaches maturity.

Question 24

Duration measures the average amount of time needed for an investor to recover his or her original cash outlay used to buy the security.

Question 25

Securities with a higher duration value have lower price risk.

Question 26

Zero-coupon bonds or a loan paid off in one lump sum at maturity have a duration of one.

Question 27

The duration of a zero-coupon bond is equal the length of time between its purchase and its maturity.

Question 28

When the investor's desired holding period equals the duration of the security he or she holds, the investor's total dollar return is immunized against changes in interest rates.

Question 29

Portfolio immunization is not affected by changes in the slope of the yield curve.

Question 30

The Harrod-Keynes' effect argues that nominal rates will not necessarily be affected by inflation, but the real rate will be affected by inflation.

Question 31

Nominal rates of return decline by less than any given decrease in the expected inflation rate, according to recent research.

Question 32

According to recent research, real interest rates are constant over time with very few fluctuations.

Question 33

According to recent research, the Fisher effect is stable over time.

Question 34

Accelerating inflation appears to be associated with a yield curve increasingly positive in slope, according to the results of recent research.

Question 35

The real rate of interest is the dollar amount of interest the investor receives.

Question 36

Some researchers argue that because corporate contracts and balance sheets are in nominal terms, rising inflation reduces corporate profitability, causing stock prices to fall.

Question 37

Most loans are either very short-term or very long-term.

Question 38

If an upward-sloping yield curve starts to flatten, portfolio managers should try to shorten the maturity of their liabilities.

Question 39

Segmented markets hypothesis states that the market for investments is more appropriately thought of as a collection of disjoint or segmented markets based on the investment horizon of the assets in question.

Question 40

The yield curve measures the rate of return on bonds over a period of time.

Question 41

According to the textbook nations with faster rates of price inflation generally experience higher interest rates.

Question 42

A contract between a business firm issuing bonds and investors buying those bonds which fixes the promised interest rate on the bonds is an example of portfolio immunization.

Question 43

If a business firm enters into nominal contracts that fix its expenses at a constant level and inflation turns out to be greater than expected the firm's stock price is likely to rise, other factors held constant.

Question 44

If a business firm enters into nominal contracts that fix its revenue at a constant level and inflation turns out to be less than expected the firm's stock price is likely to fall, other factors held constant.

Question 45

Recent research observes that yield curves in major industrialized countries tend to change over time in roughly the same way.

Question 46

Recent research evidence has emerged that finds yield curves providing useful forecasts of inflation over periods of one year or longer.

Question 47

Actual deflation, with falling average prices, has not been seen in the U.S. since the Great Depression of the 1930's.

Question 48

In 1997, the U.S. was the first government to issue inflation-indexed bonds, known as TIPS.

Question 49

In "yield spread" studies, researchers found that inverted yield curves preceded all five of the last boom economies in the U.S.

Question 50

Portfolio immunization is a technique used to maximize real returns.

Question 51

Portfolio immunization using duration seems to work well because the largest single element seen in most interest-rate movements is a parallel change in all interest rates.

Question 52

In the wake of terrorist attacks and a weakening economy as the new century began, both U.S. interest rates and inflation sank to 40-year lows.

Question 53

The I series bonds of the U.S. savings bond program are inflation-adjusted bonds.

Question 54

When the public expects slower inflation, TIPS and other inflation-adjusted securities become more valuable.

Question 55

Inflation is defined as the percentage increase in the average level of prices for all goods and services.

Question 56

The unbiased expectations hypothesis states that any two investment strategies that are available in the market and that involve assets which differ only by their terms to maturity, should yield the same holding period return for the investor.

Question 57

According to be unbiased expectations hypothesis, whenever the current short-term interest rate is below the current long-term interest rate, then the short term rate is expected to rise in the future.

Question 58

When the yield curve is flat, short-term interest rates are expected to increase.

Question 59

The size with the liquidity premium will vary over time but will always remain negative.

Question 60

If we hold risk and liquidity fixed, then at the long-term interest rate appears to be largely composed of a weighted average of current and future expected to short-term interest rates.

Question 61

There is an increasing flow of the worldwide pool of savings across the political boundaries to finance the world's low cost productive capacity.

Question 62

Convexity measures the rate of change of the elasticity of prices with respect to yield.

Question 63

Some researchers argue that because corporate contracts and balance sheets are in nominal terms, rising inflation reduces corporate profitability, causing stock prices to rise.

Question 64

If an upward-sloping yield curve starts to steepen, portfolio managers should try to shorten the maturity of their liabilities.

Question 65

Convexity measures the rate of change of the elasticity of prices with respect to interest rates.

Question 66

The size with the liquidity premium will vary over time but will always remain positive.

Question 67

TIPS bonds provide investors with substantial real gain.

Question 68

One of the following statements is not a conclusion or assumption of the expectations hypothesis. Which one?

A) All maturities of securities are perfect substitutes in the minds of investors
B) In equilibrium the investor should earn the same yield from buying a long-term security as from purchasing a series of short-term securities whose combined maturity equals that of the long-term security
C) Changes in the relative amounts in the marketplace of long-term versus short-term securities will influence the shape of the yield curve
D) The long-term interest rate is the geometric average of a series of interest rates on short-term loans whose combined maturities equal that of the long-term loan
E) All of the above are assumptions or conclusions of the expectations hypothesis

Question 69

The published or quoted rate of interest attached to a loan or security is called the:

A) Nominal rate
B) Risk-free rate
C) Real rate
D) Promised rate
E) None of the above

Question 70

If a rise in the expected inflation rate leads to an increase in real income through reduced saving and increased consumption this describes the ____ effect.

A) Expectations
B) Income
C) Tax
D) Wealth
E) Segmented markets
F) Inflation

Question 71

The statement that in periods of rapid inflation the true cost of using up capital equipment is understated, thus inflating business income is known as the:

A) Inflation effect
B) Fisher effect
C) Liquidity effect
D) Depreciation effect
E) Risk effect
F) Segmented markets effect

Question 72

According to the liquidity premium view of the yield curve, most yield curves should have a ____ slope. Which choice below correctly fills in the blank in the preceding sentence?

A) Negative
B) Positive
C) Zero
D) Either positive or zero
E) The yield curve's slope is indeterminate according to the liquidity premium view

Question 73

One of the following statements is not part of the segmented markets (hedging-pressure) theory of the yield curve. Which one is not?

A) All maturities of securities are perfect substitutes in the minds of investors
B) Many large institutional investors are risk minimizers
C) Many investing institutions follow the hedging principle
D) The market for medium-term securities attracts different investor groups than the long-term security market
E) All of the above statements are consistent with the segmented-market theory

Question 74

According to your text, a practical use of the yield curve employed frequently by dealers in United States Government securities is:

A) Detecting overpriced and underpriced securities
B) Forecasting interest rates
C) Riding the yield curve
D) Calculating the trade-off between yield and maturity
E) None of the above

Question 75

The so-called coupon effect states that:

A) Prices of low-coupon securities tend to rise faster than the prices of high-coupon securities when market interest rates decline
B) The potential for capital gains and losses is greater for securities carrying high, rather than low, coupon rates
C) The present-value of a stream of expected payments from a security is more sensitive to interest rate changes with higher, rather than lower, coupon rates
D) The coupon rate attached to a security affects its market price but does not affect its price rise
E) None of the above

Question 76

A 20 year U.S. Government bond with a 10-percent annual coupon rate sells at $1,000 (par value) when prevailing interest rates on comparable securities are 10 percent. When interest rates on comparable securities drop to 8 percent this bond has a price of $1,197.90. On the other hand, when comparable rates rise to 12 percent the bond's price falls to $849.50. The price elasticity of this bond, when rates move downward from the coupon rate, must be (to the nearest thousandth place):

A) -0.990
B) -0.779
C) -0.550
D) -0.880
E) None of the above

Question 77

When the risk that interest-rate changes will affect the total dollar return from a security portfolio is reduced to zero, this is referred to as:

A) Hedging
B) Portfolio immunization
C) Duration
D) Zero price elasticity
E) None of the above

Question 78

A U.S. Government bond having a par value of $1,000, a coupon rate of 10 percent and a maturity of 10 years is being considered for purchase by an investor. The dealer selling the bond indicates that, based upon its price today, the bond has a yield to maturity of 12 percent. The bond's duration in years must be (to the nearest hundredths place):

A) 7.35 years
B) 7.10 years
C) 6.85 years
D) 6.80 years
E) None of the above

Question 79

The view that financial assets are not perfectly substitutable messes best with the ideas put forth by:

A) Fisher
B) Harrod-Keynes
C) Darby
D) Segmented Markets Hypothesis
E) None of the above

Question 80

The Unbiased Expectations Hypothesis argues that:

A) There is a direct positive relationship between the nominal rate of interest on bonds and the expected rate of inflation
B) Expected future short term rates of return should be such that a long term asset held over n periods yields the same return as a short term asset that is held, sold, and reinvested over n periods.
C) Expectations over the value of inflation lowers the return on common stocks and real assets in all possible situations
D) The real rate of return on bonds is determined by the total demand for and the expected supply of money
E) None of the above