Deck 17: The Theory and Structure of Interest Rates

Question 1

The rate that would prevail in the economy if price levels remain constant is referred to as the:

A) Real rate.
B) Short-term interest rate.
C) Nominal rate.
D) Effective rate.
E) None of the above.

Answer 1

Real rate.

Question 2

The marginal rate of substitution between current and future consumption is the slope of the:

A) Security market line.
B) Capital market line.
C) Indifference curve.
D) Efficient frontier.
E) None of the above.

Answer 2

Indifference curve.

Question 3

A large endowment of the current commodity relative to the future will make people:

A) More eager to lend.
B) Raise the supply curve for loans.
C) Reduce R.
D) All of the above.
E) a and b only.

Answer 3

All of the above.

Question 4

The transformation curve or production function:

A) Rises from the left to the right.
B) Assumes that the more is invested, the more will be the resulting future output.
C) Assumes decreasing returns to scale.
D) Has a slope, which measures the marginal productivity of capital.
E) All of the above.

Question 5

The consumer has several decisions to make regarding:

A) How much to invest.
B) How much to lend.
C) How much to consume now and later.
D) a and b only.
E) All of the above.

Question 6

The optimum rate of investment for a firm is found at the point where:

A) The marginal productivity of capital equals the market gross rate.
B) The supply of capital equals the demand for capital.
C) Total investment equals total savings.
D) The firm's indifference curve is just tangent to the market line.
E) None of the above.

Question 7

A most important property resulting from the existence of a perfect loan market is that:

A) It separates the current consumption decision from the current income position by opening the possibility to save and dissave.
B) It frees the investment from the saving decision.
C) a and b only.
D) Borrowing and lending rates are equal.
E) All of the above.

Question 8

The market-clearing interest rate is found:

A) At the intersection of the saving and investment function.
B) At the intersection of supply and demand.
C) At the point where borrowing and saving take place.
D) At the point where the transformation curve has a slope equal to R.
E) None of the above.

Question 9

If it is not possible to reallocate inputs and outputs in such a way that some will be better off while nobody will lose, this property is referred to by economists as:

A) Non-Pareto optimal.
B) Pareto optimal.
C) Efficient.
D) Inefficient.
E) None of the above.

Question 10

According to Fisher's Law, the nominal gross rate is equal to:

A) The product of the gross real rate and one plus the inflation rate.
B) The sum of the gross real rate and the inflation rate.
C) The difference between the real gross rate and the inflation rate.
D) a and b only.
E) None of the above.

Question 11

The minimum yield sought on an investment as measured by the yield on an on-the-run Treasury security with comparable maturity is referred to as the:

A) Base interest rate.
B) Benchmark interest rate.
C) Bond-equivalent interest rate.
D) a and b only.
E) B and c only.

Question 12

The yield spread between a non-Treasury security and a Treasury security of comparable maturity is called a:

A) Risk premium.
B) Treasury spread.
C) Income spread.
D) Government option spread.
E) None of the above.

Question 13

The factors that affect the yield spread between a non-Treasury security and a comparable Treasury security are:

A) The type of issuer.
B) The issuer's perceived creditworthiness.
C) The maturity of the instrument.
D) The expected liquidity of the issue.
E) All of the above.

Question 14

Within the corporate market sector, issuers are classified as:

A) Utilities.
B) Industrials.
C) Finance.
D) Banks.
E) All of the above.

Question 15

The risk that the issuer of a bond may not be able to make timely interest and principal payments is called:

A) Credit risk.
B) Default risk.
C) Market risk.
D) a and b only.
E) All of the above.

Question 16

Investment-grade bonds are bond issues that are assigned a rating:

A) In the top four rating categories.
B) Below the top four rating categories.
C) Of zero.
D) Junk.
E) None of the above.

Question 17

The spread between Treasury securities and non-Treasury securities that are identical in all respects except for quality is referred to as:

A) Risk premium.
B) Quality spread.
C) Income spread.
D) Credit spread.
E) b and d only.

Question 18

The term structure of interest rates is the relationship between the yields on comparable securities but different:

A) Spreads.
B) Maturities.
C) Credit ratings.
D) Provisions.
E) None of the above.

Question 19

A provision in a bond issue that grants the issuer the right to retire the debt, fully or partially, before the scheduled maturity date is called:

A) A tax provision.
B) A call provision.
C) A put provision.
D) A conversion provision.
E) None of the above.

Question 20

Which of the following statements is most correct?

A) Municipalities are not permitted to tax the interest income from securities issued by the U.S. Treasury.
B) Municipal bonds are securities issued by the U.S. Treasury.
C) The equivalent taxable yield is the before-tax yield on Treasury securities.
D) The yield on municipal bonds is more than that on Treasuries with the same maturity.
E) None of the above.

Question 21

A "basket" or "bundle" consists of a certain quantity of currency consumption and a certain quantity of future consumption.

Question 22

In the market for loans, net borrowing is zero.

Question 23

There is not just one interest rate in any economy, rather there is a structure of interest rates.

Question 24

A high-grade bond is a bond with a quality rating that indicates low credit risk.

Question 25

Bonds trade with the same degrees of liquidity.

Question 26

Explain Fisher's Law.

Question 27

Discuss the factors that affect the yield spread between a non-Treasury security and a Treasury security with the same maturity.