Question 1

The "yield curve" shows the relationship between bonds' maturities and their yields.

Accepted Answer

The yield curve plots the yields on bonds with different maturities, allowing us to visualize the relationship between yield and maturity.

Question 2

If investors expect a zero rate of inflation, then the nominal rate of return on a very short-term U.S. Treasury bond should be equal to the real risk-free rate, r*.

Accepted Answer

If investors expect zero inflation, then the nominal rate of return on a very short-term Treasury bond should be equal to the real risk-free rate because there is no expected inflation to account for in the calculation. Therefore, the nominal rate of return and the real risk-free rate should be the same.

Question 3

Because the maturity risk premium is normally positive, the yield curve must have an upward slope. If you measure the yield curve and find a downward slope, you must have done something wrong.

Accepted Answer

This statement is false. While a positive maturity risk premium is typically associated with an upward sloping yield curve, the yield curve can have a downward slope due to other factors such as expectations of a future economic slowdown or changes in monetary policy.

Question 4

An upward-sloping yield curve is often call a "normal" yield curve, while a downward-sloping yield curve is called "abnormal."

Accepted Answer

This is correct. A yield curve that slopes upward from left to right is often referred to as a "normal" yield curve because it suggests that investors expect interest rates to rise in the future as the economy improves. In contrast, a downward-sloping yield curve (also known as an inverted yield curve) is considered "abnormal" because it suggests that investors have little confidence in the economy and expect interest rates to decline in the future.

Question 5

During periods when inflation is increasing, interest rates tend to increase, while interest rates tend to fall when inflation is declining.

Accepted Answer

This is because central banks usually raise interest rates to combat inflation by reducing the money supply and increasing the cost of borrowing money. On the other hand, when inflation is low, central banks may lower interest rates to encourage borrowing and spending, which can stimulate economic growth.

Question 6

One of the four most fundamental factors that affect the cost of money as discussed in the text is the time preference for consumption. The higher the time preference, the lower the cost of money, other things held constant.

Accepted Answer

The statement is incorrect. The higher the time preference for consumption, the higher the cost of money, as lenders will demand a higher return to compensate for the increased risk of the borrower preferring to consume in the present rather than repay the loan in the future.

Question 7

If investors expect the rate of inflation to increase sharply in the future, then we should not be surprised to see an upward-sloping yield curve.

Accepted Answer

If investors expect inflation to increase, it means that the purchasing power of future payments will be reduced. As a result, investors will demand higher yields for longer-term bonds to compensate for the expected loss of purchasing power. This leads to an upward-sloping yield curve.

Question 8

The four most fundamental factors that affect the cost of money are (1) production opportunities, (2) time preferences for consumption, (3) risk, and (4) weather conditions.

Accepted Answer

The fourth factor listed, weather conditions, is not a fundamental factor that affects the cost of money. The correct fourth factor is inflation. The four fundamental factors that affect the cost of money are (1) production opportunities, (2) time preferences for consumption, (3) risk, and (4) inflation.

Question 9

If the pure expectations theory is correct, a downward-sloping yield curve indicates that interest rates are expected to decline in the future.

Accepted Answer

The answer of If the pure expectations theory is correct,...

Question 10

The four most fundamental factors that affect the cost of money are (1) production opportunities, (2) time preferences for consumption, (3) risk, and (4) the skill level of the economy's labor force.

Accepted Answer

The four most fundamental factors that affect the cost of money are (1) production opportunities, (2) time preferences for consumption, (3) risk, and (4) inflation expectations. The skill level of the economy's labor force may indirectly affect these factors, but it is not one of the four fundamental factors.

Question 11

Since yield curves are based on a real risk-free rate plus the expected rate of inflation, at any given time there can be only one yield curve, and it applies to both corporate and Treasury securities.

Accepted Answer

While Treasury securities help to form the yield curve, corporate securities have additional risks and therefore do not always follow the same exact curve. Thus, there can be multiple yield curves at any given time.

Question 12

The four most fundamental factors that affect the cost of money are (1) production opportunities, (2) time preferences for consumption, (3) risk, and (4) inflation.

Accepted Answer

These four factors are considered the most fundamental determinants of the cost of money by economists and financial analysts.

Question 13

The risk that interest rates will decline, and that decline will lead to a decline in the income provided by a bond portfolio as interest and maturity payments are reinvested, is called "reinvestment rate risk."

Accepted Answer

Reinvestment rate risk is the risk that a decline in interest rates will lead to a decline in the income provided by a bond portfolio as interest and maturity payments are reinvested at lower rates.

Question 14

If the Treasury yield curve were downward sloping, the yield to maturity on a 10-year Treasury coupon bond would be higher than that on a 1-year T-bill.

Accepted Answer

The answer of If the Treasury yield curve were downward...

Question 15

One of the four most fundamental factors that affect the cost of money as discussed in the text is the expected rate of inflation. If inflation is expected to be relatively high, then interest rates will tend to be relatively low, other things held constant.

Accepted Answer

If inflation is expected to be relatively high, then interest rates will tend to be relatively high, not low. This is because lenders will demand higher interest rates to compensate for the decrease in purchasing power of the money they will be repaid in the future.

Question 16

One of the four most fundamental factors that affect the cost of money as discussed in the text is the risk inherent in a given security. The higher the risk, the higher the security's required return, other things held constant.

Accepted Answer

This statement is true as investors require a higher return to compensate for taking on higher levels of risk.

Question 17

The risk that interest rates will increase, and that increase will lead to a decline in the prices of outstanding bonds, is called "interest rate risk," or "price risk."

Accepted Answer

Interest rate risk refers to the risk of a decline in bond prices due to an increase in interest rates. This is also referred to as price risk. Therefore, the statement is true.

Question 18

Because the maturity risk premium is normally positive, the yield curve is normally upward sloping.

Accepted Answer

The upward slope of the yield curve reflects the higher return investors require for investing in longer-term bonds due to the increased risk of changes in interest rates and inflation over time, which includes a maturity risk premium.

Question 19

One of the four most fundamental factors that affect the cost of money as discussed in the text is the current state of the weather. If the weather is dark and stormy, the cost of money will be higher than if it is bright and sunny, other things held constant.

Accepted Answer

The current state of the weather is not one of the four most fundamental factors that affect the cost of money. The factors are inflation, economic growth, government monetary policy, and the global economy.

Question 20

If the demand curve for funds increased but the supply curve remained constant, we would expect to see the total amount of funds supplied and demanded increase and interest rates in general also increase.

Accepted Answer

When there is an increase in demand for funds but the supply remains constant, there is a disequilibrium in the market. This situation results in an increase in interest rates to encourage more suppliers to offer funds. As a result, the total amount of funds both supplied and demanded would increase, leading to a higher price for funds.

Quiz 7: Interest Rates