Deck 4: Determining Interest Rates

Question 1

Suppose there's a 50% chance of a stock rising by 20% and a 50% chance of it falling by 20%.What is the expected rate of return on the stock?

A) -20%
B) 0%
C) 10%
D) 20%

Answer 1

0%

Question 2

Which of the following financial assets has both the highest risk and highest return for the period of 1926-2015?

A) small company stocks
B) large company stocks
C) corporate bonds
D) Treasury bills

Answer 2

small company stocks

Question 3

The average investor must weigh the benefits of liquidity against

A) the high taxes generally levied on liquid assets.
B) the lower returns on liquid assets.
C) the high transactions costs involved in disposing of liquid assets.
D) the greater variability in the nominal returns on liquid assets.

Answer 3

the lower returns on liquid assets.

Question 4

A portfolio is a

A) brokerage house specializing in the trading of common stock.
B) brokerage house specializing in the trading of corporate bonds.
C) measure of the risk involved with a holding a particular asset.
D) collection of assets.

Question 5

As wealth decreases,which of the following is likely to account for a smaller fraction of a saver's portfolio?

A) stocks
B) corporate bonds
C) cash
D) U.S. government securities

Question 6

Suppose that you own $10,000 worth of stock in General Motors.Adding stock in which of the following companies would be least likely to reduce the risk in your portfolio?

A) Google
B) Walmart
C) Ford
D) General Electric

Question 7

Investors value liquidity in an asset because

A) liquid assets tend to have high rates of return.
B) liquid assets incur lower selling costs.
C) liquid assets incur lower tax liabilities.
D) whereas liquid assets have high information costs, their low risk offsets this.

Question 8

Suppose there's an 80% chance of a stock rising by 20% and a 20% chance of it falling by 40%.What is the expected rate of return on the stock?

A) -40%
B) -20%
C) 8%
D) 16%

Question 9

Which best describes the relationship between the cost of acquiring information and return?

A) A high return must compensate for a high cost of acquiring information.
B) A higher cost of information corresponds with a low return.
C) A low cost of acquiring information corresponds with a high return.
D) A higher return results in a lower cost of acquiring information.

Question 10

Which combination of assets represents the most diversification?

A) holding corporate and Treasury bonds
B) holding shares of Google and Yahoo
C) holding shares of Google and Microsoft
D) holding shares of Google along with Treasury bonds

Question 11

Economists believe that as a saver's wealth increases,the saver will generally

A) increase his or her holdings of all assets proportionately.
B) increase the fraction of wealth held as cash.
C) increase the fraction of wealth held as common stock.
D) decrease the fraction of wealth held as corporate bonds.

Question 12

Risk that is common to all assets of a certain type is referred to as

A) systematic risk.
B) unsystematic risk.
C) idiosyncratic risk.
D) structural risk.

Question 13

Suppose there's an 80% chance of a stock rising by 20% and a 20% chance of it falling by 40%.Which type of investor would prefer an investment with a guaranteed return of 5%?

A) risk loving investor
B) risk neutral investor
C) risk averse investor
D) Risk is not relevant in this example.

Question 14

Why do CDs have lower rates of return than stocks?

A) CDs are much riskier investments than stocks.
B) CDs are less risky than stocks.
C) CDs are not taxed while stocks' returns are taxable.
D) CDs are not as liquid as stocks.

Question 15

As wealth decreases,which of the following is likely to account for a larger fraction of a saver's portfolio?

A) corporate stock
B) corporate bonds
C) U.S. government securities
D) checking account balance

Question 16

Given that most investors tend to be risk averse

A) no one buys risky assets.
B) there's a trade-off between risk and return.
C) low risk assets provide the best return.
D) it must be a superior strategy compared to one that is risk loving.

Question 17

Since all assets typically do NOT move together,how can investors typically reduce risk?

A) purchase only the best performing assets
B) diversify one's portfolio across different asset classes
C) avoid poor performing assets
D) actively manage one's portfolio

Question 18

Which of the following can best be characterized as a "Black Swan" event?

A) decline in stock prices due to a recession
B) rising market interest rates as the Fed tightens monetary policy
C) a financial crisis causing credit to dry up
D) an individual firm unexpectedly filing for bankruptcy

Question 19

In an article,"Preparing for the Next Black Swan" (Wall Street Journal,Aug 21,2010),the point is made that diversification may be insufficient in protecting one's portfolio during a "Black Swan" event.Why may this be TRUE?

A) Virtually all asset classes may decline at the same time.
B) Investors may be unable to buy different assets during a "Black Swan" event.
C) Some assets may rise while others decline during a "Black Swan" event.
D) Black Swan events are surprises and thus one cannot prepare for such an event.

Question 20

As a person's wealth increases,which of the following portfolio holdings is likely to increase the least?

A) checking account
B) stocks
C) money market fund
D) bonds

Question 21

Which is the best example of idiosyncratic risk?

A) a financial crisis
B) a lawsuit because the corporation produced a faulty product
C) a recession
D) rising interest rates

Question 22

In November 2012,HP claimed that they had weak earnings due to questionable accounting by a company that they had taken over.This is an example of

A) market risk.
B) systemic risk.
C) idiosyncratic risk.
D) liquidity risk.

Question 23

An investor who desires the ability to have quick and easy access to cash would prefer to hold which type of asset?

A) risky
B) liquid
C) tax free
D) any form of bond

Question 24

If you think that there is a 75% chance of a stock increasing by 8% and a 25% change of it falling by 20%,what is the expected return on the stock? Report using percentages with two decimal places.

Question 25

Suppose you are risk loving and you are deciding between two investments.One has a guaranteed return of 5% while the second has a 50% chance of a 10% return and a 50% chance of a 0% return.Which investment would you choose? Why?

Question 26

The wealth of most people declined as a result of the financial crisis of 2007-2009.As a result,which asset most likely became a larger portion of their portfolio?

A) bonds
B) stocks
C) house
D) checking account

Question 27

How can diversification reduce idiosyncratic risk but not systematic risk?

Question 28

Suppose you are risk averse and you are deciding between two investments.One has a guaranteed return of 5% while the second has a 50% chance of a 10% return and a 50% chance of a 0% return.Which investment would you choose? Why?

Question 29

How should a financial plan of an older saver differ from that of a younger saver?

Question 30

A one-year discount bond with a face value of $10,000 that is currently selling for $9,400 has an interest rate of

A) 3.10%.
B) 6%.
C) 6.38%.
D) 60%.

Question 31

A one-year discount bond with a face value of $1,000 that is currently selling for $900 has an interest rate of

A) 5.26%.
B) 10%.
C) 11.1%.
D) 100%.

Question 32

Which type of investor is most likely to have a diversified portfolio?

A) risk averse
B) risk loving
C) risk neutral
D) risk tolerant

Question 33

The bond demand curve slopes down because

A) interest rates decline as bond prices decline.
B) when bond prices are low, inflation is low.
C) the lender is willing and able to purchase more bonds when the price of the bond is low.
D) the borrower is willing and able to purchase more bonds when the price of the bond is low.

Question 34

Which of the following assets had both the lowest average annual return and lowest risk between 1926 and 2015?

A) small company stocks
B) large company stocks
C) long-term corporate bonds
D) U.S. Treasury bills

Question 35

Suppose you are risk neutral and you are deciding between two investments.One has a guaranteed return of 2% while the second has a 60% chance of a 10% return and a 40% chance of a -5% return.Which investment would you choose? Why?

Question 36

What is a black swan event?

Question 37

A one-year discount bond with a face value of $1,000 has an interest rate of 4%.What is its price?

A) $960
B) $961.54
C) $996
D) $1,040

Question 38

The formula for the yield to maturity,i,on a discount bond is

A) i = (Face value - Price)/Price.
B) i = (Price - Face value)/Price.
C) i = (Face value - Price)/Face value.
D) i = (Price - Face value)/Face value.

Question 39

Diversification is most effective in reducing

A) market risk.
B) systemic risk.
C) idiosyncratic risk.
D) all forms of risk.

Question 40

An investor who bases the decision to buy an asset solely on the expected return of an asset is considered to be

A) risk loving.
B) risk averse.
C) risk neutral.
D) risk avoiding.

Question 41

Businesses typically issue bonds to finance

A) their inventories.
B) payments to their workers.
C) spending on new plant and equipment.
D) dividend payments to their stockholders.

Question 42

In the bond market,the seller is considered to be

A) the lender.
B) the borrower.
C) the lender or the borrower depending upon the use to which the funds are put.
D) the lender or the borrower depending upon whether interest rates are rising or falling.

Question 43

The supply curve for bonds would decline due to

A) an increase in wealth.
B) an increase in the expected return on bonds.
C) an increase in expected inflation.
D) a decrease in the riskiness of bonds relative to other assets.

Question 44

The bond supply curve

A) shows the quantity of bonds lenders are willing to supply as bond prices change.
B) shows the quantity of bonds lenders are willing to supply as interest rates change.
C) shows the quantity of bonds borrowers are willing to supply as bond prices change.
D) is represented by a downward-sloping line when the price of bonds is on the vertical axis and the quantity of bonds supplied is on the horizontal axis.

Question 45

As wealth decreases in the economy,savers are likely to

A) hold less cash relative to their holdings of bonds.
B) buy more bonds at any given price.
C) lend more at any given interest rate.
D) lend less at any given interest rate.

Question 46

In the bond market,the buyer is considered to be

A) the lender.
B) the borrower.
C) the lender or the borrower, depending upon the use to which the funds are put.
D) the lender or the borrower, depending upon whether interest rates are rising or falling.

Question 47

In an effort to increase government revenue,Congress and the president decide to increase the corporate profits tax.The likely result will be

A) the supply curve for bonds shifts to the left.
B) the demand curve for bonds shifts to the left.
C) the equilibrium interest rate rises.
D) the equilibrium price of bonds falls.

Question 48

As wealth increases in the economy,savers are willing to

A) hold more cash relative to their holdings of bonds.
B) buy fewer bonds at any given price.
C) buy more bonds at any given price.
D) lend less at any given interest rate.

Question 49

The bond supply curve slopes up because

A) interest rates rise as bond prices rise.
B) when bond prices are high, inflation is high.
C) the lender is willing and able to offer more bonds when the price of the bond is low.
D) the borrower is willing and able to offer more bonds when the price of the bond is high.

Question 50

The demand curve for bonds would be shifted to the left by

A) an increase in expected returns on other assets.
B) a decrease in the information costs of bonds relative to other assets.
C) a decrease in expected inflation.
D) an increase in the liquidity of bonds relative to other assets.

Question 51

If there is an excess demand for bonds at a given price of bonds,then

A) the interest rate will fall.
B) the interest rate will rise.
C) the price of bonds will fall.
D) the interest rate may rise or the interest rate may fall depending upon the reasons for the excess demand for bonds.

Question 52

Which of the following would NOT cause the demand curve for bonds to shift?

A) a change in wealth
B) a change in the price of bonds
C) a change in the liquidity of bonds
D) a change in expected inflation

Question 53

If the expected gains on stocks rise,while the expected returns on bonds do NOT change,then

A) the demand curve for bonds will shift to the left.
B) the supply curve for loanable funds will shift to the right.
C) the demand curve for loanable funds will shift to the left.
D) the equilibrium interest rate will fall.

Question 54

As wealth increases in the economy,we would expect to observe

A) bond prices and interest rates both rise.
B) bond prices and interest rates both fall.
C) bond prices rise and interest rates fall.
D) bond prices fall and interest rates rise.

Question 55

Suppose that a new bond rating service is established that specializes in rating municipal bonds that had not previously been rated.The likely result would be

A) a shift to the left in the demand curve for municipal bonds.
B) a shift to the left in the supply curve for municipal bonds.
C) an increase in the equilibrium interest rate.
D) a decrease in the equilibrium interest rate.

Question 56

If the expected gains on stocks rise,while the expected returns on bonds do NOT change,then

A) the demand curve for bonds will shift to the right.
B) the supply curve for loanable funds will shift to the right.
C) the equilibrium interest rate will fall.
D) the equilibrium interest rate will rise.

Question 57

How is the interest rate that prevails in the bond market determined?

A) by the interaction of stock prices and bond prices
B) by the decision of the president, in consultation with Congress
C) by the intersection of the demand for and supply of bonds
D) by the Board of Governors of the New York Stock Exchange

Question 58

The demand curve for bonds would be shifted to the left by an

A) increase in wealth.
B) increase in expected returns on bonds.
C) increase in expected inflation.
D) increase in the liquidity of bonds relative to other assets.

Question 59

The demand curve for bonds would be reduced by

A) a decrease in expected returns on other assets.
B) an increase in the information costs of bonds relative to other assets.
C) an increase in wealth.
D) an increase in the liquidity of bonds relative to other assets.

Question 60

If there is an excess supply of bonds at a given price of bonds,then

A) the interest rate will fall.
B) the interest rate will rise.
C) the price of bonds will rise.
D) the interest rate may rise or the interest rate may fall depending upon the reasons for the excess supply for bonds.

Question 61

During most of the time in recent decades,the domestic government sector was

A) a net borrower.
B) a net lender.
C) neither a borrower nor a lender.
D) a major factor in keeping real interest rates low.

Question 62

During most of the time in recent decades,the government sector

A) has not spent more than it collected in taxes.
B) has run large deficits.
C) has run large surpluses.
D) has balanced its budget every year.

Question 63

In July 2016,concern was raised about Puerto Rico's sovereign debt.Make use of a graph of the bond market to show how this would affect the price of Puerto Rican bonds.

Question 64

If the federal government decreases its spending and doesn't decrease taxes,the bond supply shifts to the

A) left and the equilibrium interest rate rises.
B) left and the equilibrium interest rate falls.
C) right and the equilibrium interest rate rises.
D) right and the equilibrium interest rate falls.

Question 65

If bond investors think they lack enough details to evaluate the likelihood of defaults on certain bonds,this will result in higher

A) expected return.
B) liquidity.
C) information costs.
D) expected inflation.

Question 66

The supply curve for bonds would be shifted to the right by

A) a decrease in expected profitability.
B) a decrease in the corporate tax on profits.
C) a decrease in tax subsidies for investment.
D) a decrease in government borrowing.

Question 67

Assess the impact on the bond market of the rise in Internet trading of stocks.

Question 68

An increase in the tax rate on dividends,other things equal,is likely to result in a(n)

A) increased demand for bonds due to an increase in the expected return on bonds relative to stocks.
B) increased supply of bonds due to an increase in the expected return on bonds relative to stocks.
C) reduced demand for bonds due to a decrease in the expected return on bonds relative to stocks.
D) reduced demand for bonds due to an increase in the expected return on bonds relative to stocks.

Question 69

Suppose that there is concern about the stability of the global financial system causing a flight to the safety of U.S.government bonds.Which of the following is NOT a likely consequence?

A) higher price of U.S. government bonds
B) lower interest rate on U.S. government bonds
C) increased demand for U.S. government bonds
D) reduced supply of U.S. government bonds

Question 70

Which of the following is the most likely explanation of Japan's very low market interest rates in the early 2000s?

A) expected deflation
B) an increasing budget deficit
C) an increasing trade surplus
D) an increase in corporate profits

Question 71

If the government were to simultaneously cut the personal income tax and the corporate profits tax,the equilibrium interest rate

A) would fall.
B) would rise.
C) would be unaffected.
D) might either rise or fall.

Question 72

Other things equal,an increase in the tax on dividends is likely to result in all of the following EXCEPT

A) higher expected return on bonds relative to stocks.
B) increased demand for bonds.
C) lower interest rates.
D) higher interest rates.

Question 73

Which of the following is NOT a likely impact on the bond market if corporations become convinced that a robust economic recovery is underway?

A) increased demand for bonds
B) increased supply of bonds
C) lower bond prices
D) higher interest rates

Question 74

Suppose that Congress passes an investment tax credit.The likely result will be

A) the supply curve for bonds will shift to the right.
B) the demand curve for bonds will shift to the left.
C) the demand curve for bonds will shift to the right.
D) the equilibrium interest rate will fall.

Question 75

A rise in expected inflation will result in all of the following EXCEPT

A) lower nominal interest rates.
B) lower real interest rates.
C) reduced demand for bonds.
D) increased supply of bonds.

Question 76

The supply curve for bonds would be shifted to the left by

A) a decrease in government borrowing.
B) a decrease in the corporate tax on profits.
C) an increase in tax subsidies for investment.
D) an increase in expected inflation.

Question 77

If the government increases taxes while holding expenditures constant

A) the bond supply curve will shift to the left and the equilibrium interest rate will fall.
B) the bond supply curve will shift to the right and the real interest rate will fall.
C) government borrowing will be increased.
D) the government's deficit will increase.

Question 78

An increase in the corporate profits tax is likely to cause

A) the equilibrium interest rate to rise and the equilibrium price of bonds to fall.
B) the equilibrium interest rate to fall and the equilibrium price of bonds to rise.
C) the equilibrium interest rate and the equilibrium price of bonds to both rise.
D) the equilibrium interest rate and the equilibrium price of bonds to both fall.

Question 79

In 2008,the liquidity of mortgage-backed securities declined significantly.Make use of a graph of the bond market to show how this affected the price of mortgage-backed securities.

Question 80

If a government's income tax receipts exceed its expenditures,the government is running a

A) surplus and is a net borrower of funds.
B) surplus and is a net saver of funds.
C) deficit and is a net borrower of funds.
D) deficit and is a net saver of funds.