Question 1

Investors can lock in a real interest rate and thus avoid most of the risk of unexpected inflation by buying
A)corporate bonds.
B)inflation-indexed securities.
C)stock.
D)mortgage-backed securities.

Accepted Answer

Inflation-indexed securities, also known as TIPS (Treasury Inflation-Protected Securities), are designed to provide investors with a real rate of return by adjusting the principal of the security for inflation. This means that as the Consumer Price Index (CPI) rises, the principal of the security increases, and the interest payments on the security also increase. Therefore, investors can lock in a real interest rate and avoid the risk of unexpected inflation.

Question 2

According to the Fisher hypothesis, if the real interest rate is 2 percent and the inflation rate falls from 3 percent to 1  percent, then the nominal interest rate will_____percentage points and the real interest rate will decline by______ percentage points. 
A)decline by 0; 2
B)increase by 2; 2
C)increase by 0; 0
D)decline by 2; 0 percentage points and the real interest rate will decline by

Accepted Answer

According to the Fisher hypothesis, the nominal interest rate is equal to the real interest rate plus the expected inflation rate.
Initially, the nominal interest rate would have been 5% (real interest rate of 2% + inflation rate of 3%). 
When the inflation rate falls to 1%, the nominal interest rate should fall by the same amount to 3% (real interest rate of 2% + inflation rate of 1%). So, the nominal interest rate will decline by 2 percentage points.
Since the real interest rate remains constant at 2%, the decline in the nominal interest rate means that the inflation rate has declined by 2 percentage points, from 3% to 1%.

Question 3

If actual inflation was 4 percent over the past year and you owned a one-year bond that paid 6 percent interest, what was your after-tax realized real interest rate if your tax rate was 15 percent?
A)−0.6 percent
B)0.0 percent
C)1.1 percent
D)2.0 percent

Accepted Answer

The after-tax realized real interest rate can be calculated as follows:
Real interest rate = Nominal interest rate - Inflation rate
Real interest rate = 6% - 4% = 2%
After-tax real interest rate = Real interest rate × (1 - Tax rate)
After-tax real interest rate = 2% × (1 - 0.15) = 1.7%
Therefore, the after-tax realized real interest rate is 1.7%. The best choice is C.

Question 4

Which of the following happens when the expected inflation rate rises?​
A)​Both the demand and supply curve for bonds shift upward.
B)The demand curve for bonds shift to the left.
C)​The supply curve for bonds shift to the right.
D)​The expected real interest rate rises.

Accepted Answer

The answer of Which of the following happens when the...

Question 5

Realized real interest rates in the United States were often negative in the early
A)1960s.
B)1970s.
C)1980s.
D)1990s.

Accepted Answer

Real interest rates in the United States were often negative in the 1970s due to high inflation rates. Inflation eroded the value of money, causing real interest rates (nominal interest rates adjusted for inflation) to be negative. This was not as prominent in the other decades listed.

Question 6

In recessions, the long-term expected real interest rate usually
A)rises.
B)declines.
C)stays unchanged.
D)rises early in the recession; declines later in the recession.

Accepted Answer

In recessions, there is typically a decrease in demand for goods and services, which leads to lower inflation rates. As a result, the long-term expected real interest rate (the nominal interest rate adjusted for inflation expectations) also decreases. This is because lenders can charge lower interest rates to borrowers and still earn a positive real return.

Question 7

If you expect inflation to be 2 percent next year and you buy a one-year bond paying 5 percent interest, what is your after-tax expected real interest income if the price of the bond is $200 and your tax rate is 40 percent?
A)$0.20
B)$20
C)$10
D)$2

Accepted Answer

The answer of If you expect inflation to be 2...

Question 8

If you expect inflation to be 3 percent next year and you buy a one-year bond paying 4 percent interest, what is your after-tax expected real interest rate if you face a tax rate of 30 percent?
A)−0.2 percent
B)0.0 percent
C)0.3 percent
D)1.0 percent

Accepted Answer

The after-tax real interest rate is the nominal interest rate minus the expected inflation rate, adjusted for taxes. In this case, the nominal interest rate is 4%, the expected inflation rate is 3%, and the tax rate is 30%. So, the after-tax real interest rate is:(4% - 3%) * (1 - 30%) = 0.2%

Question 9

If the actual inflation was 4 percent over the past year and you owned a one-year bond that paid 4 percent interest, what was your after-tax realized real interest rate if your tax rate was 15 percent?
A)−0.6 percent
B)0.0 percent
C)1.1 percent
D)2.0 percent

Accepted Answer

The after-tax return on the bond is 4% * (1 - 0.15) = 3.4%. Since inflation was 4%, the real interest rate, adjusting for inflation, is 3.4% - 4% = -0.6%.

Question 10

According to the Fisher hypothesis, if the real interest rate is 5 percent and the inflation rate rises from 2 percent to 4 percent, then the nominal interest rate will _____percentage points and the real interest rate will change by ______percentage points. 
A)rise by 0; ?2
B)fall by 2; ?2
C)rise by 2; 0
D)fall by 1; 1

Accepted Answer

According to the Fisher hypothesis, the nominal interest rate is equal to the sum of the real interest rate and the expected inflation rate. Thus, if the real interest rate is 5 percent and the inflation rate rises from 2 percent to 4 percent, the expected inflation rate increases by 2 percentage points. Therefore, the nominal interest rate will rise by 2 percentage points (5% + 2% = 7%). The real interest rate will remain unchanged at 5% because it is determined by the difference between the nominal interest rate and the inflation rate (5% = 7% - 2%). Therefore, the best choice is (C) rise by 2; 0.

Question 11

$\text { Suppose you buy an inflation-indexed bond that will adjust with inflation and thus pay you } \$ 1,500 \text { in real (inflation- }$ adjusted) terms each year for the next five years, plus your real principal of $75,000 at the end of the fifth year.The nominal interest rate is 5 percent and the expected inflation rate is 2 percent.What is the present value of the bond? (Round off your answer to the nearest thousand dollars and pick the answer closest to the one you calculate.)
A)$65,000
B)$68,000
C)$72,000
D)$75,000

Accepted Answer

We can use the formula for present value of an annuity: PV = PMT x ((1 - (1/(1+r)^n))/r) + FV/(1+r)^n, where PV is the present value, PMT is the annual payment, r is the nominal interest rate, n is the number of years, and FV is the future value. Plugging in the values, we get PV = $14,395 x ((1 - (1/1.05^5))/0.05) + $75,000/1.05^5 = $72,181. Rounded to the nearest thousand dollars, the answer is $72,000, which is closest to choice C.

Question 12

Which of the following will NOT play a role in eliminating the shortcoming of the taxation system, particularly the fact that the tax system taxes nominal return rather than real return?
A)Eliminating taxation of interest
B)Introducing inflation-indexed bonds
C)Taxing only real interest income, not nominal interest income
D)Reducing inflation to zero

Accepted Answer

The answer of Which of the following will NOT play...

Question 13

The hypothesis that an increase in the expected inflation rate will cause the nominal interest rate to rise and the real interest rate to remain unchanged is the
A)Fisher hypothesis.
B)rational-expectations theory.
C)Okun's hypothesis.
D)Keynesian hypothesis.

Accepted Answer

The hypothesis that an increase in expected inflation will cause an increase in nominal interest rates while the real interest rate remains unchanged is known as the Fisher hypothesis, named after economist Irving Fisher. This hypothesis is based on the idea that investors require compensation for inflationary risks, which results in higher nominal interest rates being demanded.

Question 14

Realized real interest rates in the United States were the highest in the
A)1960s.
B)1970s.
C)1980s.
D)1990s.

Accepted Answer

The real interest rates were the highest in the 1980s due to the increase in inflation during the late 1970s and early 1980s, which led the Federal Reserve to raise nominal interest rates to combat inflation. This resulted in high real interest rates. In the 1960s and 1970s, inflation was relatively low, and real interest rates were not as high as in the 1980s. In the 1990s, inflation was again low, and real interest rates were lower than in the 1980s.

Question 15

Suppose you buy an inflation-indexed bond that will adjust with inflation and thus pay you $1,500 in real (inflation- adjusted) terms in one year.The real interest rate is 3 percent.What is the present value of the bond? (Round off your answer to the nearest dollar and pick the answer closest to the one you calculate.)
A)$1,415
B)$1,456
C)$1,471
D)$1,530

Accepted Answer

The present value of the bond can be calculated using the formula for present value: PV = FV / (1 + r)^n, where FV is the future value ($1,500), r is the real interest rate (0.03), and n is the time period in years (1). Plugging in the values, we get PV = $1,500 / (1 + 0.03)^1 = $1,500 / 1.03 ≈ $1,456.

Question 16

According to the Fisher hypothesis, an increase in the expected inflation rate should lead to____ in the nominal Interest rate and ____ in the expected real interest rate.
A)an increase; a decrease
B)an increase; no change
C)an increase; an increase
D)a decrease; a decrease

Accepted Answer

The Fisher hypothesis posits that an increase in the expected inflation rate will lead to an increase in the nominal interest rate, but the expected real interest rate will remain unchanged. This is because lenders will demand higher nominal rates to compensate for the expected loss of purchasing power due to inflation, but the real return they expect to achieve, after accounting for inflation, does not change.

Question 17

One way that homeowners and banks can share the risk of inflation is through
A)fixed-rate mortgages.
B)refinancing.
C)default.
D)adjustable-rate mortgages.

Accepted Answer

Adjustable-rate mortgages (ARMs) allow the interest rate to fluctuate over time based on prevailing interest rates, thus sharing the risk of inflation between homeowners and banks. If inflation rises, the interest rate on the mortgage can increase, protecting the lender, but also potentially increasing costs for the borrower.

Question 18

Suppose you buy an inflation-indexed bond that will adjust with inflation and thus pay you $1,500 in real (inflation- adjusted) terms each year for the next five years, plus your real principal of $75,000 at the end of the fifth year.The nominal interest rate is 5 percent and the expected inflation rate is 3 percent.What is the present value of the bond? (Round off your answer to the nearest thousand dollars and pick the answer closest to the one you calculate.)
A)$65,000
B)$70,000
C)$74,000
D)$75,000

Accepted Answer

The answer of Suppose you buy an inflation-indexed bond that...

Question 19

One year ago, you bought a bond for $40,000.Today, you received the $40,000 principal back plus an interest of $2,000.If the inflation rate over the last year was 3 percent, calculate your real return (Round off your answer to the nearest percentage point).
A)2 percent
B)3 percent
C)4 percent
D)5 percent

Accepted Answer

The nominal return is calculated as the interest received divided by the initial investment, which is $2,000 / $40,000 = 5%. To find the real return, adjust the nominal return for inflation using the formula: real return = ((1 + nominal return) / (1 + inflation rate)) - 1. Substituting the given values: real return = ((1 + 0.05) / (1 + 0.03)) - 1 = 1.94%, which rounds off to 2%.

Question 20

In recessions, the short-term expected real interest rate usually
A)rises by about 4 percentage points.
B)rises by about 2 percentage points.
C)declines by about 2 percentage points.
D)declines by about 4 percentage points.

Accepted Answer

During recessions, the Federal Reserve often cuts interest rates as a tool to boost economic growth. This leads to a decline in the short-term expected real interest rate by about 4 percentage points.

Quiz 6: Real Interest Rates

Investors can lock in a real interest rate and thus avoid most of the risk of unexpected inflation by buying

According to the Fisher hypothesis, if the real interest rate is 2 percent and the inflation rate falls from 3 percent to 1 percent, then the nominal interest rate will_percentage points and the real interest rate will decline by__ percentage points.

If actual inflation was 4 percent over the past year and you owned a one-year bond that paid 6 percent interest, what was your after-tax realized real interest rate if your tax rate was 15 percent?

Which of the following happens when the expected inflation rate rises?

Realized real interest rates in the United States were often negative in the early

In recessions, the long-term expected real interest rate usually

If you expect inflation to be 2 percent next year and you buy a one-year bond paying 5 percent interest, what is your after-tax expected real interest income if the price of the bond is $200 and your tax rate is 40 percent?

If you expect inflation to be 3 percent next year and you buy a one-year bond paying 4 percent interest, what is your after-tax expected real interest rate if you face a tax rate of 30 percent?

If the actual inflation was 4 percent over the past year and you owned a one-year bond that paid 4 percent interest, what was your after-tax realized real interest rate if your tax rate was 15 percent?

According to the Fisher hypothesis, if the real interest rate is 5 percent and the inflation rate rises from 2 percent to 4 percent, then the nominal interest rate will _percentage points and the real interest rate will change by __percentage points.

Which of the following will NOT play a role in eliminating the shortcoming of the taxation system, particularly the fact that the tax system taxes nominal return rather than real return?

The hypothesis that an increase in the expected inflation rate will cause the nominal interest rate to rise and the real interest rate to remain unchanged is the

Realized real interest rates in the United States were the highest in the

According to the Fisher hypothesis, an increase in the expected inflation rate should lead to in the nominal Interest rate and in the expected real interest rate.

One way that homeowners and banks can share the risk of inflation is through

One year ago, you bought a bond for $40,000.Today, you received the $40,000 principal back plus an interest of $2,000.If the inflation rate over the last year was 3 percent, calculate your real return (Round off your answer to the nearest percentage point) .

In recessions, the short-term expected real interest rate usually