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CHAPTER 4
TRUE-FALSE QUESTIONS
the expected rate of inflation.
funds relative to the supply of loanable funds.
inflation.
real rates of interest.
level of economic activity.
estimated at 3%, the historical rate of inflation is 5%.
loanable funds.
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efficient.
required return.
create money. This would lead to interest rates increase.
cost of capital.
MULTIPLE-CHOICE QUESTIONS
a. the price of money.
b. the rent on money.
c. time value of delayed consumption.
d. all of the above.
money?
a. Interest is the rental cost of purchasing power.
b. Interest is the penalty paid for consuming income before it is earned.
c. Interest is always paid at the maturity of a loan.
d. Interest is the time value of delayed consumption.
a. investor’s positive time preference
b. the gold supply
c. return on capital investments
d. the rate of inflation
e. both a and c
a. the rate of inflation
b. investor positive time preference for current versus future consumption.
c. the return on alternative real investments.
d. the real level of output in the economy.
a. Realized; expected
b. Expected; realized
c. Government; private
d. Expected; expected
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a. Interest rates move counter-cyclically with the business cycle.
b. Long-term interest rates have greater swings than short-term rates.
c. The expected rate of inflation impacts the level of interest rates.
d. Bond prices and interest rates move directly with one another.
a. Bond prices and interest rates change inversely with one another.
b. The expected rate of inflation affects current market interest rates.
c. Short-term interest rates are not as volatile as long-term interest rates.
d. Interest rates are directly related to the level of output in the economy.
a. nominal rates include the real rate of interest plus past annual inflation rates.
b. nominal rates include the real rate of interest plus expected annual inflation rates.
c. real rates are always positive.
d. inflation has no impact upon interest rates.
equation,
a. actual inflation exceeds 10%.
b. the real rate of interest is 5%.
c. market rates are expected to increase to 15%.
d. expected interest rates are 5%.
inflation is 8%, the Fisher effect predicts what current level of nominal interest rates?
a. 9%
b. 8%
c. 13%
d. 12%
economy has and will be expected to grow at 3 percent. According to the Fisher effect,
what is the expected rate of inflation?
a. 3%
b. 9%
c. higher than 6%
d. close to zero
a. a decline in the supply of loanable funds.
b. a decline in business prospects.
c. an improvement in technology.
d. an expectation of an upcoming recession.
a. shifts to the left.
b. shifts to the right.
c. anticipates reduced growth in the economy.
d. “a” and “c” above.
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a. the level of income
b. the investment opportunities in the economy.
c. the savings rate
d. Federal Reserve monetary policy actions.
a. shift the demand for loanable funds to the left (down).
b. shift the supply of loanable funds to the left (down).
c. shift demand and supply for loanable funds to the right (up) decreasing interest
rates.
d. shifts demand and supply for loanable funds to the right (up) increasing interest
rates.
a. suppliers of loanable funds.
b. demanders of financial claims.
c. demanders of loanable funds.
d. DSUs are not represented in the loanable funds theory of interest rate
determination.
a. a shift in the demand for loanable funds to the right associated with reduced
business investment demand and a decline in interest rates.
b. a shift in the demand for loanable funds to the left as real investment weakens, a
shift to the right of the supply of loanable funds as the Fed expands the money
supply, and a decrease in interest rates.
c. a movement along the demand for loanable funds as interest rates decline.
d. an increase in the supply of loanable funds as the level of savings increases
accompanied with an increase in the demand for loanable funds as housing
investment is increased, and a decrease in interest rates.
a. shifts the demand for loanable funds to the left, reducing interest rates.
b. shifts the supply of loanable funds to the right, reducing interest rates.
c. shifts the demand for loanable funs to the right, increasing interest rates.
d. shifts the supply of loanable funds to the left, reducing interest rates.
a. investors’ expected rate of inflation (Pe) was less than actual inflation (Pa).
b. investors’ expected rate of inflation (Pe) was greater than actual inflation (Pa).
c. investors over-anticipated the level of inflation.
d. investors expected more inflation than was realized.
one of the following:
a. an increase in the money supply.
b. an increase in household thriftiness.
c. an increase in household income.
d. an increase in personal income taxes.
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a. would reward the lender at the borrower’s expense
b. would reward the borrower at the lender’s expense
c. would penalize the lender at the borrower’s expense
d. none of the above
a. borrowers benefited at the expense of lenders.
b. lenders benefited at the expense of borrowers.
c. both borrowers and lenders benefited.
d. neither borrowers nor lenders benefited.
a. borrowers will benefit.
b. savers will lose purchasing power.
c. SSUs will benefit at the expense of DSUs.
d. interest rates are likely to increase in the future.
a. The economy is in a boom.
b. Inflationary expectations have decreased.
c. The Federal Reserve has decreased M1 and the supply of loanable funds.
d. Business investment demand has decreased significantly.
a. a recession and a decline in inflationary expectations.
b. an acceleration in the growth rate of M1.
c. decreased real investment opportunities.
d. all of the above
par. The inflation rate during the year was 4 percent and is expected to be 5 percent next
year. The realized real rate earned by the investor last year was:
a. 8%
b. 3%
c. 4%
d. -1 percent.
was expected to have been 6 percent. The investor realized real rate of return was:
a. 3%
b. 6%
c. 18%
d. 12%
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a. announcement of the last year’s inflation rate
b. announcement of this month’s inflation rate
c. a forecast of next month‘s inflation rate
d. a forecast of inflation for the next five years
a. a forecast of lower inflation in the future.
b. a forecast of a slower economy next year.
c. a forecast of higher inflation in the future.
d. a forecast of lower government budget deficits.
a. inflation forecasts significantly underestimate inflation.
b. nominal interest rates were too high relative to actual inflation.
c. prior inflation forecasts overestimated inflation.
d. bond prices were priced too low relative to actual inflation.
a. economic models
b. flow-of-funds
c. both of the above
d. none of the above
the and the resulting .
a. level of interest rates; measures of economic output
b. past level of interest rates; future level of interest rates
c. measures of economic output; level of interest rates
d. prior level of GNP; future level of interest rates
economic statistics using only eight equations. The is an example of
a. a naive forecasting model.
b. the flow of funds approach.
c. a hedged forecast.
d. an economic forecasting model.
the following:
a. the National Income Accounts.
b. the Flow of Funds Accounts.
c. the loanable funds theory of interest
rate determination.
d. the Federal Reserve System.
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accuracy?
a. Accurate forecasters do not make their forecasts public.
b. Reasonably efficient financial markets preclude a forecaster from consistently
outguessing the direction of interest rates.
c. The level of training of forecasters is lagging an evermore sophisticated
economy.
d. (a) and (b) above
a. Interest rates move inversely with inflation.
b. Interest rates vary directly with expected inflation.
c. Interest rates vary directly with past inflation rates.
d. Inflation is impacted by expected interest rates.
a. shifts the supply of loanable funds to the left, decreasing interest rates.
b. shifts the demand for loanable funds to the left, increasing interest rates.
c. shifts the supply of loanable funds to the left, increasing interest rates.
d. shifts the supply of loanable funds to the right, increasing interest rates.
a. the Fed will declare a monetary policy.
b. there will be a shortage of loanable funds and interest rates will increase.
c. there will be a surplus of loanable funds at that rate and rates will decline to the
equilibrium rate.
d. there will be a shortage of loanable funds at that rate and rates will increase to the
equilibrium rate.
a. the more savings they will accumulate.
b. the lower the level of interest rates.
c. the greater the supply of loanable funds.
d. all of the above.
a. will have a high savings rate.
b. will have a low savings rate.
c. prefers savings to consumption.
d. is not as likely to borrow money as other people with lower positive time
preference.
a. should decrease the supply of loanable funds.
b. would decrease the demand for loanable funds.
c. should increase the supply of loanable funds.
d. should shift consumers‘ preferences toward consumption.
a. will decrease the savings rate.
b. will decrease the supply of loanable funds.
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c. will increase interest rates.
d. all of the above.
a. will have a significant long-term debt market.
b. will have debt instruments with interest rates indexed to the inflation rate.
c. will favor long-term financing over short-term.
d. will have very low interest rates.
a. Very few people who wish to borrow at a fixed rate.
b. Little if any long-term debt market.
c. Variable interest rate loans.
d. Reliance on short-term debt contracts.
interest rates have declined to 8 percent. What was the expected inflation rate last year?
a. 5%
b. 2%
c. 7%
d. 8%
a. directly/inversely
b. inversely/inversely
c. directly/directly
d. inversely/directly
a. allocational forces
b. penalties for early consumption
c. rewards for deferring consumption
d. all of the above
a. Make fixed interest rate loans.
b. Make fixed interest rate, long-term loans.
c. Make variable interest rate loans.
d. Invest in fixed rate Treasury bonds.
During the year the actual rate of inflation was 8 percent. The investor’s expected real
rate of interest was _____ and the realized real rate for the investor was ______?
a. 14 percent; 8 percent.
b. 6 percent; 3 percent.
c. 3 percent; 3 percent.
d. 3 percent; 6 percent.
coupon rate, paid annually, and matures in five years. The investor sold the bond one
year later for $965, while the price level was increasing at 5 percent. Calculate the pre-
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tax real realized rate of return on the investment?
a. –.7%
b. 8%
c. 3%
d. 5%
the equilibrium rate of interest?
a. Federal Reserve increases in the money supply
b. Business savings
c. Government budget surpluses
d. Consumer credit purchases
securities have increased. The yield increases may be explained by which one of the
following:
a. A decrease in current and expected future returns of real corporate investments
b. Newly expected increase in the value of the dollar
c. An increase in U.S. inflationary expectations
d. Decreases in the U.S. Government budget deficit
the U.S. long-term government debt from AAA to AA+. If other things are equal, what is
the impact on the yields on the Treasury securities?
a. Yields increase
b. Yields decrease
c. Yield unchanged
economy would be to
a. Decrease the supply of loanable funds
b. Increase the savings rate
c. Increase interest rates
d. Federal Reserve decreases in the money supply
ESSAY QUESTIONS
1. Using loanable funds theory, discuss how changes in consumer savings, business investment, and
in the money supply by the Federal Reserve System can influence the level of interest rates.
2. Explain how price expectations influence the level of interest rates. What impact has inflation
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premiums had on interest rate levels in recent years?
3. Explain why realized real rates of interest are sometimes negative, but expected real rates are
always positive. Give an example.
4. Calculate the price of a $1000 face value bond, maturing in three years with a 9 percent coupon
(paid semiannually) if current real rates of interest are 4 percent, historical inflation rates are 3
percent, and expected inflation rates are 4 percent. (Use if next chapter covered in exam)
5. Sam has just lent Mary $1000 for 1 year 6%. Sam and Mary expect inflation to be 3% over the
next year. If inflation turns out to have been only 2%, what is the impact upon Sam and Mary?
6. You are the Chief Economist of Free Formosan Investment and are conducting research on
inflation forecasting by using the information of the Treasury Inflation-Protected Securities
(TIPS). The information that you have are as the following: Nominal yield on 10-year
nonindexed Treasury bond is 4.5%; Real yield on 10-year TIPS is 2.25%; The market adjustment
for inflation and liquidity risk is 45 basis-points. What is the expected annual inflation rate over
the next decade?
7. In January 2011, a Japanese investor placing money in dollar denominated assets desires a 5%
real rate of return. Then international expected inflation rate is about 2.5% and the dollar is
expected to decline against Japanese Yen by 10% over the investment period. What is the
minimum required rate of return for this Japanese investor?