Question 1

According to the textbook nations with faster rates of price inflation generally experience higher interest rates.

Accepted Answer

Nations with faster rates of price inflation generally experience higher interest rates because lenders demand higher returns as compensation for the decrease in purchasing power of future interest and principal repayments.

Question 2

A contract between a business firm issuing bonds and investors buying those bonds which fixes the promised interest rate on the bonds is an example of portfolio immunization.

Accepted Answer

Portfolio immunization is a strategy used to minimize the risk of interest rate fluctuations affecting the value of a bond portfolio, not a contract fixing the interest rate of bonds.

Question 3

If a business firm enters into nominal contracts that fix its expenses at a constant level and inflation turns out to be greater than expected the firm's stock price is likely to rise, other factors held constant.

Accepted Answer

If inflation is higher than expected, the real cost of the firm's expenses decreases because the fixed nominal contracts do not adjust for the higher inflation. This can lead to higher profits and potentially a higher stock price, assuming other factors remain constant.

Question 4

If a business firm enters into nominal contracts that fix its revenue at a constant level and inflation turns out to be less than expected the firm's stock price is likely to fall, other factors held constant.

Accepted Answer

If inflation is lower than expected, the real value of the firm's fixed nominal revenues increases, potentially leading to higher profits and possibly a higher stock price, other factors held constant.

Question 5

Recent research observes that yield curves in major industrialized countries tend to change over time in roughly the same way.

Accepted Answer

Yield curves in major industrialized countries often exhibit similar patterns of change over time due to global economic trends, monetary policies, and interconnected financial markets.

Question 6

Recent research evidence has emerged that finds yield curves providing useful forecasts of inflation over periods of one year or longer.

Accepted Answer

Yield curves have been found to provide useful forecasts of future economic conditions, including inflation, over periods of one year or longer. This is because the shape of the yield curve reflects investors' expectations about future interest rates, which are influenced by their expectations about future inflation and economic growth.

Question 7

Actual deflation, with falling average prices, has not been seen in the U.S. since the Great Depression of the 1930's.

Accepted Answer

The U.S. experienced a period of deflation during the Great Recession, specifically in 2009, when the Consumer Price Index (CPI) indicated a year-over-year decline in prices.

Question 8

In 1997, the U.S. was the first government to issue inflation-indexed bonds, known as TIPS.

Accepted Answer

The United Kingdom was the first country to issue inflation-indexed bonds in 1981, well before the U.S. introduced Treasury Inflation-Protected Securities (TIPS) in 1997.

Question 9

In "yield spread" studies, researchers found that inverted yield curves preceded all five of the last boom economies in the U.S.

Accepted Answer

Inverted yield curves are typically seen as predictors of economic recessions, not boom economies. They occur when short-term interest rates exceed long-term rates, suggesting investor pessimism about the near-term economy.

Question 10

Portfolio immunization is a technique used to maximize real returns.

Accepted Answer

Portfolio immunization is a strategy used to minimize the impact of interest rate changes on the value of a portfolio, not to maximize real returns.

Question 11

Portfolio immunization using duration seems to work well because the largest single element seen in most interest-rate movements is a parallel change in all interest rates.

Accepted Answer

Portfolio immunization using duration works well because it assumes that changes in interest rates are parallel, affecting all maturities equally. This simplifies the management of interest rate risk.

Question 12

In the wake of terrorist attacks and a weakening economy as the new century began, both U.S. interest rates and inflation sank to 40-year lows.

Accepted Answer

Following the terrorist attacks on September 11, 2001, and the subsequent economic downturn, the Federal Reserve lowered interest rates to stimulate the economy, which, along with other factors, contributed to both interest rates and inflation reaching their lowest levels in decades.

Question 13

The I series bonds of the U.S. savings bond program are inflation-adjusted bonds.

Accepted Answer

I Series Bonds are a type of U.S. savings bond designed to protect the investor from inflation, as their interest rates adjust with changes in the inflation rate.

Question 14

When the public expects slower inflation, TIPS and other inflation-adjusted securities become more valuable.

Accepted Answer

TIPS and other inflation-adjusted securities become more valuable when the public expects higher inflation, as their payouts increase with inflation, protecting investors' purchasing power.

Question 15

Inflation is defined as the percentage increase in the average level of prices for all goods and services.

Accepted Answer

Inflation is indeed defined as the percentage increase in the average level of prices for all goods and services in an economy over a period of time, reflecting how much more expensive a set of goods and services has become.

Question 16

The unbiased expectations hypothesis states that any two investment strategies that are available in the market and that involve assets which differ only by their terms to maturity, should yield the same holding period return for the investor.

Accepted Answer

The unbiased expectations hypothesis suggests that the expected returns on different maturity investments should be equal when adjusted for risk, assuming investors have no preference for one maturity over another.

Question 17

According to be unbiased expectations hypothesis, whenever the current short-term interest rate is below the current long-term interest rate, then the short term rate is expected to rise in the future.

Accepted Answer

The unbiased expectations hypothesis suggests that the long-term interest rate is an average of current and future expected short-term interest rates. Therefore, if the current short-term rate is below the long-term rate, it implies that the short-term rate is expected to rise in the future to converge with the long-term rate.

Question 18

When the yield curve is flat, short-term interest rates are expected to increase.

Accepted Answer

A flat yield curve indicates that there is little difference between short-term and long-term interest rates, suggesting that investors expect stable interest rates in the future, not necessarily an increase in short-term rates.

Question 19

The size with the liquidity premium will vary over time but will always remain negative.

Accepted Answer

The liquidity premium can vary over time and may be positive or negative, reflecting the extra return investors demand for holding less liquid securities.

Question 20

If we hold risk and liquidity fixed, then at the long-term interest rate appears to be largely composed of a weighted average of current and future expected to short-term interest rates.

Accepted Answer

This statement aligns with the expectations hypothesis, which suggests that the long-term interest rate is indeed determined by the market's expectations of future short-term rates, adjusted for risk and liquidity preferences. Holding risk and liquidity constant, the long-term rate reflects an average of current and anticipated short-term rates.

Quiz 7: Effects of Inflation and Yield Curves on Stock Prices and Investments