Question 1

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 yield curves are based on a real risk-free rate plus the expected rate of inflation, there can be multiple yield curves at any given time. The yield curve for Treasury securities may differ from the yield curve for corporate securities due to factors such as credit risk and liquidity.

Question 2

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

Question 3

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 commonly recognized as the most significant determinants of the cost of money. Production opportunities refer to the rate of return that investors can earn by putting their money to work in productive activities. Time preferences for consumption measure the degree to which individuals or organizations are willing to defer consumption in order to receive goods or services in the future. Risk reflects the possibility of loss or reduced return on investment, which must be compensated for in the cost of money. Finally, inflation refers to the decline in purchasing power of money over time due to rising prices, which must be factored into the cost of borrowing or investment.

Question 4

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 the prices of outstanding bonds due to an increase in interest rates. This is also known as price risk.

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 often raise interest rates in order to combat rising inflation, and lower interest rates to stimulate economic growth and combat lower inflation.

Question 6

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 7

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

Accepted Answer

The maturity risk premium compensates investors for the increased risk associated with longer-term bonds, and is typically positive. As a result, yields on longer-term bonds are usually higher than yields on shorter-term bonds, leading to an upward sloping yield curve.

Question 8

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

Accepted Answer

The yield curve is a graphical representation of the yields of bonds with different maturities. It typically shows a curve or line that slopes upward, indicating that longer-term bonds have higher yields than shorter-term bonds.

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

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

Accepted Answer

This statement is true. An upward-sloping yield curve is considered "normal" because it reflects the expectation that interest rates will increase over time as the economy grows. On the other hand, a downward-sloping yield curve (also known as an inverted yield curve) is considered "abnormal" because it suggests that investors expect interest rates to decrease in the future, possibly indicating a weak economy or the possibility of a recession.

Question 11

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

An increase in demand for funds, with a constant supply, would result in an increase in both the quantity of funds supplied and demanded. This would lead to an upward pressure on interest rates, since borrowers would be willing to pay more to secure the funds they need.

Question 12

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

This statement is false. The four most fundamental factors that affect the cost of money are supply and demand, inflation expectations, the risk of default, and the time value of money. The weather does not have a direct impact on the cost of money.

Question 13

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. The level of risk associated with a security will impact the required return on that security. Investors demand higher returns for taking on higher levels of risk.

Question 14

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

The statement is the opposite of what is true. If inflation is expected to be relatively high, then interest rates will tend to be relatively high as well, to compensate investors for the loss in purchasing power of their money.

Question 15

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, the higher the cost of money, other things held constant. A higher time preference means individuals value current consumption over future consumption, therefore they will demand a higher return on their investment to compensate for the opportunity cost of not being able to consume now. This results in a higher cost of money.

Question 16

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 are actually production opportunities, time preferences for consumption, risk, and inflation. The skill level of the economy's labor force is not considered one of the four fundamental factors.

Question 17

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

The statement is false. While the maturity risk premium is normally positive, other factors such as expectations of future interest rates can cause the yield curve to slope downward. Therefore, it is possible to have a downward-sloping yield curve in certain market conditions.

Question 18

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 there is no expected inflation, the nominal rate of return on a bond should reflect only the real risk-free rate. Therefore, the nominal rate of return on a very short-term U.S. Treasury bond should be equal to the real risk-free rate, r*.

Question 19

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

This statement is true. Reinvestment rate risk refers to the risk that future cash flows from a bond portfolio will have to be reinvested at a lower interest rate than the rate originally earned, leading to a decline in income.

Question 20

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

An upward-sloping yield curve indicates that long-term interest rates are higher than short-term interest rates. This can occur when investors expect inflation to increase, as they demand higher yields on long-term bonds to compensate for the higher inflation rate.

Quiz 6: Interest Rates