Question 1

If the yield curve is downward sloping, what is the yield to maturity on a 10-year Treasury coupon bond, relative to that on a 1-year T-bond?

Accepted Answer

When the yield curve is downward sloping, it indicates that short-term interest rates are higher than long-term interest rates. As a result, the yield to maturity on a 10-year Treasury coupon bond will be less than that on a 1-year T-bond.

Question 2

The existence of an upward sloping yield curve proves that the _____ is correct, because an upward sloping curve necessarily implies that lenders will lend short-term funds at lower rates than they lend long-term funds.

Accepted Answer

The liquidity preference theory suggests that investors demand a premium for longer-term investments due to increased risk and uncertainty, leading to an upward sloping yield curve.

Question 3

If the Federal Reserve loosens money supply then:

Accepted Answer

When the Federal Reserve loosens money supply, it means they are increasing the availability of money in the economy. This in turn leads to a decrease in interest rates, as the supply of credit increases. This is because banks have more money to lend, and as such they can offer lower interest rates.

Question 4

During _____, both the demand for money and the rate of inflation tend to fall, which prompts the Fed to increase the money supply, and as a result, interest rates decline.

Accepted Answer

During a recession, both the demand for money and the rate of inflation tend to fall. This prompts the Fed to increase the money supply in order to stimulate economic growth and raise inflation back up to its target level. As a result, interest rates decline.

Question 5

Open market operations are operations in which:

Accepted Answer

Open market operations refer to the buying and selling of Treasury securities by the Federal Reserve to either increase or decrease the supply of money in the economy. This is one of the monetary policy tools used by the central bank to influence economic activity. Options A, B, D, and E are not related to open market operations.

Question 6

A normal yield curve that is upward sloping implies that:

Accepted Answer

An upward sloping yield curve indicates that long-term interest rates are higher than short-term interest rates. Therefore, option C is correct.

Question 7

Assume that the expectations theory holds, and that liquidity and maturity risk premiums are zero. If the annual rate of interest on a 2-year Treasury bond is 10.5 percent and the rate on a 1-year Treasury bond is 12 percent, what rate of interest should you expect on a 1-year Treasury bond one year from now?

Accepted Answer

The answer of Assume that the expectations theory holds, and...

Question 8

The Federal Reserve purchases U.S. Treasury securities to:

Accepted Answer

The Federal Reserve purchases U.S. Treasury securities to increase the money supply, which is known as monetary easing. This is done to stimulate economic growth and increase inflation.

Question 9

When the economy is expanding too quickly and the Federal Reserve (Fed) wants to control future growth in the economy, the Fed will:

Accepted Answer

When the economy is expanding too quickly, the Fed will decrease the money supply to control future growth in the economy. By decreasing the money supply, interest rates will rise, which makes borrowing money more expensive, therefore reducing spending and slowing the economy down.

Question 10

Which of the following factors will lead to an increase in interest rates?

Accepted Answer

A federal deficit means that the government is borrowing more money to fund its expenses, which leads to an increase in demand for borrowing and thus an increase in interest rates.

Question 11

Interest rates on 1-year, 2-year, and 3-year Treasury bills are 5%, 6%, and 7% respectively. Assume that the pure expectations theory holds and that the market is in equilibrium. Which of the following statements is correct?

Accepted Answer

According to the pure expectations theory, the interest rate on a long-term bond is an average of the short-term interest rates that people expect to occur over the life of the long-term bond. Given the rates, the market expects the one-year rate to be 7% one year from today to make the average rate for the 2-year bond 6%.

Question 12

If the U.S. runs a large foreign trade deficit, then the:

Accepted Answer

When a country runs a large foreign trade deficit, it means that it is importing more goods and services than it is exporting. This leads to an increased demand for foreign currency, putting downward pressure on the value of the domestic currency. One way to stem this pressure is for the central bank to raise interest rates, which attracts foreign investment and strengthens the currency. Therefore, the correct answer is B, interest rates will increase. None of the other choices are directly related to a trade deficit.

Question 13

Assume that the current yield curve is upward sloping or normal. This implies that

Accepted Answer

An upward sloping yield curve implies that short-term interest rates are lower than long-term interest rates. This is because investors demand a higher return for holding longer-term bonds, which exposes them to more potential risks such as inflation and interest rate changes over time.

Question 14

If the Federal Reserve sells $50 billion of short-term U.S. Treasury securities to the public, other things held constant, what will this tend to do to short-term security prices and interest rates?

Accepted Answer

If the Federal Reserve sells $50 billion of short-term U.S. Treasury securities to the public, this will increase the supply of short-term securities available in the market. This increase in supply will lead to a decrease in short-term security prices (as there will be less demand relative to supply) and an increase in interest rates (as issuers will need to offer higher rates to entice investors to purchase the securities). Therefore, the correct answer is D: Prices will decline and interest rates will rise.

Question 15

Assume that the current interest rate on a 1-year bond is 8 percent, the current rate on a 2-year bond is 10 percent, and the current rate on a 3-year bond is 12 percent. If the expectations theory of the term structure is correct, what is the 1-year interest rate expected during Year 3? (Base your answer on an arithmetic rather than geometric average.)

Accepted Answer

The answer of Assume that the current interest rate on...

Question 16

During periods of _____, the general tendency is toward higher interest rates.

Accepted Answer

During periods of inflation, the general tendency is toward higher interest rates to control inflationary pressures on the economy. Higher interest rates make borrowing more expensive, which in turn reduces spending and can help to slow down an overheated economy.

Question 17

Which of the following actions of the Federal Reserve will reduce federal deficit?

Accepted Answer

The answer of Which of the following actions of the...

Question 18

A federal deficit occurs when:

Accepted Answer

A federal deficit occurs when a government spends more money than it collects in tax revenues. This results in the government having to borrow money to meet its financial obligations, which leads to an increase in the national debt. Issuing securities to the public may be one way to borrow money to cover the deficit, but it is not the cause of the deficit itself. Stock prices of private companies, social security benefits, and money supply in the market are all unrelated to the government's fiscal deficit.

Question 19

If the expectations theory of the term structure of interest rates is correct, and if the other term structure theories are invalid, and we observe a downward sloping yield curve, which of the following is a true statement?

Accepted Answer

The expectations theory states that long-term interest rates are determined by the market’s expectations of future short-term interest rates. If the yield curve is downward sloping, it suggests that investors expect interest rates to decrease in the future. This is consistent with the expectations theory, where short-term rates are expected to fall, leading to lower long-term rates. Thus, choice C is the correct answer. Choices A, B, D, and E are incorrect because they do not explain the observed downward sloping yield curve.

Question 20

Other things constant, the larger the federal deficit,:

Accepted Answer

When the federal deficit is larger, the government has to borrow more money to finance its spending. This increased demand for borrowing leads to higher interest rates as lenders demand higher returns for the increased risk.

Quiz 5: The Cost of Money Interest Rates