Financial Markets and Institutions, 6e (Mishkin/Eakins)
Chapter 4 Why Do Interest Rates Change?
4.1 Multiple Choice
1) As the price of a bond _________ and the expected return _________, bonds become more
attractive to investors and the quantity demanded rises.
A) falls; rises
B) falls; falls
C) rises; rises
D) rises; falls
2) The supply curve for bonds has the usual upward slope, indicating that as the price
_________, ceteris paribus, the _________ increases.
A) falls; supply
B) falls; quantity supplied
C) rises; supply
D) rises; quantity supplied
3) When the price of a bond is above the equilibrium price, there is excess _________ in the
bond market and the price will _________.
A) demand; rise
B) demand; fall
C) supply; fall
D) supply; rise
4) When the price of a bond is below the equilibrium price, there is excess _________ in the
bond market and the price will _________.
A) demand; rise
B) demand; fall
C) supply; fall
D) supply; rise
5) When the price of a bond is _________ the equilibrium price, there is an excess supply of
bonds and the price will _________.
A) above; rise
B) above; fall
C) below; fall
D) below; rise
6) When the price of a bond is _________ the equilibrium price, there is an excess demand for
bonds and the price will _________.
A) above; rise
B) above; fall
C) below; fall
D) below; rise
7) When the interest rate on a bond is above the equilibrium interest rate, there is excess
_________ in the bond market and the interest rate will _________.
A) demand; rise
B) demand; fall
C) supply; fall
D) supply; rise
8) When the interest rate on a bond is below the equilibrium interest rate, there is excess
_________ in the bond market and the interest rate will _________.
A) demand; rise
B) demand; fall
C) supply; fall
D) supply; rise
9) When the interest rate on a bond is _________ the equilibrium interest rate, there is excess
_________ in the bond market and the interest rate will _________.
A) above; demand; fall
B) above; demand; rise
C) below; supply; fall
D) above; supply; rise
10) When the interest rate on a bond is _________ the equilibrium interest rate, there is excess
_________ in the bond market and the interest rate will _________.
A) below; demand; rise
B) below; demand; fall
C) below; supply; rise
D) above; supply; fall
11) When the demand for bonds _________ or the supply of bonds _________, interest rate rise.
A) increases; increases
B) increases; decreases
C) decreases; decreases
D) decreases; increases
12) When the demand for bonds _________ or the supply of bonds _________, interest rates fall.
A) increases; increases
B) increases; decreases
C) decreases; decreases
D) decreases; increases
13) When the demand for bonds _________ or the supply of bonds _________, bond prices rise.
A) increases; decreases
B) decreases; increases
C) decreases; decreases
D) increases; increases
14) When the demand for bonds _________ or the supply of bonds _________, bond prices fall.
A) increases; increases
B) increases; decreases
C) decreases; decreases
D) decreases; increases
15) Factors that determine the demand for an asset include changes in the
A) wealth of investors.
B) liquidity of bonds relative to alternative assets.
C) expected returns on bonds relative to alternative assets.
D) risk of bonds relative to alternative assets.
E) all of the above.
16) The demand for an asset rises if _________ falls.
A) risk relative to other assets
B) expected return relative to other assets
C) liquidity relative to other assets
D) wealth
17) The higher the standard deviation of returns on an asset, the _________ is the asset’s
_________.
A) greater; risk
B) smaller; risk
C) greater; expected return
D) smaller; expected return
18) Diversification benefits an investor by
A) increasing wealth.
B) increasing expected return.
C) reducing risk.
D) increasing liquidity.
19) In a recession when income and wealth are falling, the demand for bonds _________ and the
demand curve shifts to the _________.
A) falls; right
B) falls; left
C) rises; right
D) rises; left
20) During business cycle expansions when income and wealth are rising, the demand for bonds
_________ and the demand curve shifts to the _________.
A) falls; right
B) falls; left
C) rises; right
D) rises; left
21) For a holding period of one year, the expected return on a consol is _________ the higher is
the price of the consol today, and _________ the higher is the price of the consol next year.
A) higher; higher
B) higher; lower
C) lower; higher
D) lower; lower
22) Higher expected interest rates in the future _________ the demand for long–term bonds and
shift the demand curve to the _________.
A) increase; left
B) increase; right
C) decrease; left
D) decrease; right
23) Lower expected interest rates in the future _________ the demand for long–term bonds and
shift the demand curve to the _________
A) increase; left.
B) increase; right.
C) decrease; left.
D) decrease; right.
24) When people begin to expect a large stock market decline, the demand curve for bonds shifts
to the _________ and the interest rate _________.
A) right; falls
B) right; rises
C) left; falls
D) left; rises
25) When people begin to expect a large run up in stock prices, the demand curve for bonds
shifts to the _________ and the interest rate _________.
A) right; rises
B) right; falls
C) left; falls
D) left; rises
26) An increase in the expected rate of inflation will _________ the expected return on bonds
relative to that on _________ assets, and shift the _________ curve to the left.
A) reduce; financial; demand
B) reduce; real; demand
C) raise; financial; supply
D) raise; real; supply
27) A decrease in the expected rate of inflation will _________ the expected return on bonds
relative to that on _________ assets.
A) reduce; financial
B) reduce; real
C) raise; financial
D) raise; real
28) When the expected inflation rate increases, the demand for bonds _________, the supply of
bonds _________, and the interest rate _________.
A) increases; increases; rises
B) decreases; decreases; falls
C) increases; decreases; falls
D) decreases; increases; rises
29) When the expected inflation rate decreases, the demand for bonds _________, the supply of
bonds _________, and the interest rate _________.
A) increases; increases; rises
B) decreases; decreases; falls
C) increases; decreases; falls
D) decreases; increases; rises
30) When bond interest rates become more volatile, the demand for bonds _________ and the
interest rate _________.
A) increases; rises
B) increases; falls
C) decreases; falls
D) decreases; rises
31) When bond interest rates become less volatile, the demand for bonds _________ and the
interest rate _________.
A) increases; rises
B) increases; falls
C) decreases; falls
D) decreases; rises
32) When prices in the stock market become more uncertain, the demand curve for bonds shifts
to the _________ and the interest rate _________.
A) right; rises
B) right; falls
C) left; falls
D) left; rises
33) When stock prices become less volatile, the demand curve for bonds shifts to the _________
and the interest rate _________.
A) right; rises
B) right; falls
C) left; falls
D) left; rises
34) When bonds become more widely traded, and as a consequence the market becomes more
liquid, the demand curve for bonds shifts to the _________ and the interest rate _________.
A) right; rises
B) right; falls
C) left; falls
D) left; rises
35) When bonds become less widely traded, and as a consequence the market becomes less
liquid, the demand curve for bonds shifts to the _________ and the interest rate _________.
A) right; rises
B) right; falls
C) left; falls
D) left; rises
36) Factors that cause the demand curve for bonds to shift to the left include
A) an increase in the inflation rate.
B) an increase in the liquidity of stocks.
C) a decrease in the volatility of stock prices.
D) all of the above.
E) none of the above.
37) Factors that cause the demand curve for bonds to shift to the left include
A) a decrease in the inflation rate.
B) an increase in the volatility of stock prices.
C) an increase in the liquidity of stocks.
D) all of the above.
E) only A and B of the above.
38) During an economic expansion, the supply of bonds _________ and the supply curve shifts
to the _________.
A) increases, left
B) increases, right
C) decreases, left
D) decreases, right
39) During a recession, the supply of bonds _________ and the supply curve shifts to the
_________.
A) increases, left
B) increases, right
C) decreases, left
D) decreases, right
40) An increase in expected inflation causes the supply of bonds to _________ and the supply
curve to shift to the _________.
A) increase, left
B) increase, right
C) decrease, left
D) decrease, right
41) When the federal government’s budget deficit increases, the _________ curve for bonds shifts
to the _________.
A) demand; right
B) demand; left
C) supply; left
D) supply; right
42) When the federal government’s budget deficit decreases, the _________ curve for bonds
shifts to the _________.
A) demand; right
B) demand; left
C) supply; left
D) supply; right
43) When the inflation rate is expected to increase, the expected return on bonds relative to real
assets falls for any given interest rate; as a result, the _________ bonds falls and the
_________ curve shifts to the left.
A) demand for; demand
B) demand for; supply
C) supply of; demand
D) supply of; supply
44) When the inflation rate is expected to increase, the real cost of borrowing declines at any
given interest rate; as a result, the _________ bonds increases and the _________ curve shifts
to the right.
A) demand for; demand
B) demand for; supply
C) supply of; demand
D) supply of; supply
Figure 4.1
45) In Figure 4.1, the most likely cause of the increase in the equilibrium interest rate from i1 to
i2 is
A) an increase in the price of bonds.
B) a business cycle boom.
C) an increase in the expected inflation rate.
D) a decrease in the expected inflation rate.
46) In Figure 4.1, the most likely cause of the increase in the equilibrium interest rate from i1 to
i2 is a(n) _________ in the _________.
A) increase; expected inflation rate
B) decrease; expected inflation rate
C) increase; government budget deficit
D) decrease; government budget deficit
47) In Figure 4.1, the most likely cause of a decrease in the equilibrium interest rate from i2 to i1
is
A) an increase in the expected inflation rate.
B) a decrease in the expected inflation rate.
C) a business cycle expansion.
D) a combination of both A and C of the above.
48) Factors that can cause the supply curve for bonds to shift to the right include
A) an expansion in overall economic activity.
B) a decrease in expected inflation.
C) a decrease in government deficits.
D) all of the above.
E) only A and B of the above.
49) Factors that can cause the supply curve for bonds to shift to the left include
A) an expansion in overall economic activity.
B) a decrease in expected inflation.
C) an increase in government deficits.
D) only A and C of the above.
50) The economist Irving Fisher, after whom the Fisher effect is named, explained why interest
rates _________ as the expected rate of inflation _________.
A) rise; increases
B) rise; stabilizes
C) rise; decreases
D) fall; increases
E) fall; stabilizes
51) An increase in the expected rate of inflation causes the demand for bonds to _________ and
the supply for bonds to _________.
A) fall; fall
B) fall; rise
C) rise; fall
D) rise; rise
52) A decrease in the expected rate of inflation causes the demand for bonds to _________ and
the supply of bonds to _________.
A) fall; fall
B) fall; rise
C) rise; fall
D) rise; rise