Deck 4: Determining Interest Rates

Question 1

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

Answer 1

D

Question 2

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

Answer 2

B

Question 3

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

Answer 3

C

Question 4

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) Wal-Mart
C) Ford
D) General Electric

Question 5

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 6

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 7

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 8

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.

Question 9

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%

Question 10

Which of the following financial assets has both the highest risk and highest return for the period of 1926-2009?

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

Question 11

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 12

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 13

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 14

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 15

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 16

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 17

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 held as corporate bonds.

Question 18

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 19

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 stock s returns are taxable.
D) CDs are not as liquid as stocks.

Question 20

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

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

Question 21

A one-year discount bond with a face value of $1000 has an interest rate of 4%.What is its price?

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

Question 22

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 23

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% change of a 0% return.Which investment would you choose? Why?

Question 24

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% change of a 0% return.Which investment would you choose? Why?

Question 25

A one-year discount bond with a face value of $10,000 that is currently selling for $9400 has an interest rate of

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

Question 26

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 27

What is a black swan event?

Question 28

How can diversification reduce idiosyncratic risk but not systematic risk?

Question 29

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 30

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 31

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

Question 32

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 33

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

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

Question 34

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 35

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 36

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) lend more at any given interest rate.
D) lend less at any given interest rate.

Question 37

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 38

A one-year discount bond with a face value of $1000 that is currently selling for $900 has an interest rate of

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

Question 39

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 fall.
D) the interest rate may rise or the interest rate may fall depending upon the reasons for the excess demand for bonds.

Question 40

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 41

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 42

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 43

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.

Question 44

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 demand for and supply of bonds
D) by the Board of Governors of the New York Stock Exchange

Question 45

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 46

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 47

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 48

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 49

Studies by economists suggest that

A) households do not increase their saving as the government's dissaving increases.
B) households increase their saving, but not by the full amount of an increase in government dissaving.
C) households also increase their dissaving when the government increases its dissaving.
D) households also increase their saving when the government increases its saving.

Question 50

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 51

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 52

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 vertical axis.

Question 53

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 54

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 both rise.
D) the equilibrium interest rate and the equilibrium price of bonds both fall.

Question 55

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 56

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 57

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 58

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 59

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 60

The supply curve for loanable funds 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 61

During an economic recession,

A) the bond demand and supply curves both shift to the left and the equilibrium interest rate usually falls.
B) the bond demand and supply curves both shift to the right and the equilibrium interest rate usually rises.
C) the bond demand curve shifts to the right, the bond supply curve shifts to the left, and the equilibrium interest rate usually falls.
D) the bond demand curve shifts to the left, the bond supply curve shifts to the right, and the equilibrium interest rate usually rises.

Question 62

In November 2010,concern was raised about Ireland's sovereign debt.Make use of a graph of the bond market to show how this would affect the price of Irish bonds.

Question 63

During an economic recession,

A) the demand and supply curves for loanable funds both shift to the right and the equilibrium interest rate usually rises.
B) the demand and supply curves for loanable funds both shift to the left and the equilibrium interest rate usually falls.
C) the demand curve for loanable funds shifts to the right, the supply curve for loanable funds shifts to the left, and the equilibrium interest rate usually falls.
D) the demand curve for loanable funds shifts to the left, the supply curve for loanable funds shifts to the right, and the equilibrium interest rate usually rises.

Question 64

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 65

During a period of economic expansion,when expected profitability is high,

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

Question 66

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 67

If expected inflation declines by 2%,what should happen to nominal interest rates according to the Fisher effect?

A) rise by 2%
B) fall by 2%
C) be cut in half
D) double in size

Question 68

As a result of higher expected inflation,

A) the demand and supply curves for loanable funds both shift to the right and the equilibrium interest rate usually rises.
B) the demand and supply curves for loanable funds both shift to the left and the equilibrium interest rate usually falls.
C) the demand curve for loanable funds shifts to the right, the supply curve for loanable funds shifts to the left, and the equilibrium interest rate usually rises.
D) the demand curve for loanable funds shifts to the left, the supply curve for loanable funds shifts to the right, and the equilibrium interest rate usually rises.

Question 69

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 70

A decrease in expected inflation

A) usually leads to falling nominal interest rates.
B) results in increased nominal capital gains on physical assets.
C) will shift the bond demand curve to the left.
D) will shift the supply curve for loanable funds to the left.

Question 71

The Federal Reserve issues a report indicating that future inflation will be higher than had previously seemed likely.As a result

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

Question 72

An increase in expected inflation results in

A) lower nominal interest rates and higher bond prices.
B) lower real interest rates and higher bond prices.
C) higher real interest rates and lower bond prices.
D) higher nominal interest rates and lower bond prices.

Question 73

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

Question 74

The idea that nominal interest rates rise or fall one-for-one with expected inflation is known as

A) market risk.
B) systematic risk.
C) idiosyncratic risk.
D) the Fisher effect.

Question 75

During 2000,the government repurchased $30 billion in U.S.Treasury bonds outstanding.This was the first time this had been done since the administration of Herbert Hoover in the early 1930s.Analyze the impact of this repurchase on the bond market.

Question 76

In Spring 2010,many investors feared that Greece may default on its bonds.Make use of a graph of the bond market to show how this affected interest rates on Greek bonds.

Question 77

If households increase their saving at the same time that the government increases its deficit,

A) the demand and supply curves for bonds will be unaffected.
B) the demand curve for bonds will shift to the left.
C) the supply curve for bonds will shift to the right.
D) the equilibrium interest rate will definitely rise.

Question 78

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 79

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 80

In late 2008 and early 2009,many feared that the economy may experience deflation.Make use of a graph of the bond market to show how this affected interest rates.