Question 1

The contention that there is a direct (positive) relationship between liquidity premiums and the level of market interest rates is known as the:

Accepted Answer

The answer of The contention that there is a direct...

Question 2

The contention that liquidity premiums are inversely related to the level of market interest rates is known as the:

Accepted Answer

The price-risk hypothesis states that liquidity premiums are inversely related to the level of market interest rates. This is because when interest rates are high, investors are more likely to hold liquid assets in order to take advantage of the higher returns. As a result, the demand for liquid assets increases, which drives up their prices and lowers their liquidity premiums.

Question 3

The use of portfolio immunization means that:

Accepted Answer

Portfolio immunization is a strategy to ensure that a portfolio will earn a predetermined return regardless of interest rate changes, thus providing identical total earnings whether rates go up or down.

Question 4

An investor facing an upward-sloping yield curve buys a six-month Treasury bill with the intent of selling it three months later. This investor __________.

Accepted Answer

Riding the yield curve involves buying longer-term securities and selling them before maturity, benefiting from the generally higher yields on longer maturities in an upward-sloping yield curve environment. This strategy does not necessarily reflect expectations about specific security pricing or interest rate movements, but rather takes advantage of the shape of the yield curve itself.

Question 5

An investor plots the yield curve for AAA corporate bonds and discovers that the yield on BGA Inc.'s bonds is above that of other AAA corporate bonds with the same maturity. If BGA Inc.'s bonds are correctly classified as AAA, the investor will profit by:

Accepted Answer

The higher yield on BGA Inc.'s AAA bonds compared to other AAA bonds of the same maturity suggests they are undervalued. Buying these bonds and selling them when the yield falls (which implies the price rises) would result in a profit.

Question 6

The term structure of interest rates plots yield versus:

Accepted Answer

The term structure of interest rates, also known as the yield curve, plots the yields of bonds with different maturities but of the same risk class at a specific point in time.

Question 7

The ____ theory states that investors choose a particular maturity based on the type of business they are in.

Accepted Answer

The market segmentation theory suggests that investors have specific maturity preferences based on their business needs, leading them to choose particular maturities.

Question 8

According to the inflation-caused depreciation effect:

Accepted Answer

Inflation causes the historical cost basis used in depreciation methods to understate the true replacement cost of capital goods, as the actual cost to replace the equipment at current prices is higher than the historical cost.

Question 9

According to the textbook, studies looking for evidence of the Fisher effect across countries find that nations with faster rates of price inflation generally experience:

Accepted Answer

The Fisher effect posits that real interest rates are stable over time, and that nominal interest rates adjust to compensate for inflation. Therefore, countries with higher inflation rates tend to have higher nominal interest rates to maintain a stable real interest rate.

Question 10

Recent studies of the linkages between stock prices and inflation generally find a ____ relationship. The choice below that correctly fills in the blank in the preceding sentence is:

Accepted Answer

Recent studies generally find a negative relationship between stock prices and inflation, meaning that as inflation increases, stock prices tend to decrease, and vice versa. This is because high inflation can erode the real returns on investments, leading investors to adjust their portfolios away from stocks.

Question 11

Agreements that fix the time and terms in current dollars under which a business firm will compensate its employees, creditors and other suppliers are known as:

Accepted Answer

Nominal contracts fix the terms of compensation in current dollars without adjustments for inflation, specifying the exact amounts to be paid or received.

Question 12

Recently, the Japanese economy has experienced signs of deflation, which can be defined as:

Accepted Answer

Deflation is characterized by a decline in the average price level of goods and services, which is accurately described in option C.

Question 13

In 1997, the U.S. Treasury issued inflation-indexed bonds, known as Treasury Inflation Protection Securities (TIPS). Reasons for doing so include:

Accepted Answer

TIPS allow investors to protect themselves against inflation, as their principal value adjusts with inflation, separating inflation risk from interest rate risk.

Question 14

The U.S. Treasury issues inflation-indexed bonds, known as Treasury Inflation Protection Securities (TIPS), as a way for investors to offset inflation risk in their portfolios, some aspects include:

Accepted Answer

TIPS are designed to protect investors from inflation. The real rate of return is maintained because both the principal and interest payments are adjusted for inflation, ensuring the investor's purchasing power. However, the adjustments for inflation can potentially push an investor into a higher tax bracket, thereby not eliminating all inflation risk. This makes all the statements about TIPS correct.

Question 15

Yield curve studies of the yield spread between long-term and short-term government securities are being used to predict:

Accepted Answer

Yield curve studies, particularly the spread between long-term and short-term government securities, are a tool used by economists and investors to predict economic conditions. A normal yield curve (where long-term rates are higher than short-term rates) suggests economic expansion, while an inverted yield curve (where short-term rates are higher than long-term rates) is often seen as a predictor of economic recession. Therefore, these studies can help predict the probability of a recession (A) and near-term GDP growth (B). They are not directly used to predict the size of government budget deficits (C).

Question 16

Price deflation:

Accepted Answer

Price deflation increases the real value of money over time, which benefits lenders as they receive back money that is worth more in terms of purchasing power than when they lent it out. Borrowers, on the other hand, end up repaying their loans with money that is more valuable than when they borrowed it, effectively paying more in real terms.

Question 17

The relationship between an asset's change in market price and its change in yield or interest rate is called its

Accepted Answer

The answer of The relationship between an asset's change in...

Question 18

Inflation is the percentage increase in the average level of prices for

Accepted Answer

Inflation is defined as the percentage increase in the average level of prices for a broad range of goods and services, not limited to specific categories such as land, automobiles, or any other single category.

Question 19

A popular measure of the inflation rate is

Accepted Answer

The Consumer Price Index (CPI) and the GDP deflator are both popular measures of the inflation rate. CPI measures the average change over time in the prices paid by urban consumers for a market basket of consumer goods and services, while the GDP deflator measures the change in prices of all new, domestically produced, final goods and services in an economy.

Question 20

The liquidity premium will be positive on the following assets

Accepted Answer

The liquidity premium is typically positive for longer-term investments to compensate investors for the increased risk associated with the longer duration. Treasury bonds and notes, regardless of their term lengths, are considered less liquid compared to short-term instruments, hence they carry a liquidity premium.

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