M&B Chapter 5

In the market for money, an interest rate below equilibrium results in an excess ________ money and the interest rate will ________. A) demand for; rise B) demand for; fall C) supply of; fall D) supply of; rise

A

Milton Friedman called the response of lower interest rates resulting from an increase in the money supply the ________ effect. A) liquidity B) price level C) expected-inflation D) income

A

Of the four effects on interest rates from an increase in the money supply, the one that works in the opposite direction of the other three is the ________. A) liquidity effect B) income effect C) price level effect D) expected inflation effect

A

Of the four factors that influence asset demand, which factor will cause the demand for all assets to increases, everything else held constant? A) Wealth B) Expected returns C) Risk D) Liquidity

A

Pieces of property that serve as a store of value are called ________. A) assets B) units of account C) liabilities D) borrowings

A

The ________ the returns on two securities move together, the ________ benefit there is from diversification. A) less; more B) less; less C) more; more D) more; greater

A

The demand for silver decreases, other things equal, when ________. A) the gold market is expected to boom B) the market for silver becomes more liquid C) wealth grows rapidly D) interest rates are expected to rise

A

The price of gold should be ________ to the expected inflation rate. A) positively related B) negatively related C) inversely related D) unrelated

A

The risk of a well-diversified portfolio depends only on the ________ risk of the assets in the portfolio. A) systematic B) nonsystematic C) portfolio D) investment

A

A business cycle expansion increases income, causing money demand to ________ and interest rates to ________, everything else held constant. A) increase; increase B) increase; decrease C) decrease; decrease D) decrease; increase

A

A lower level of income causes the demand for money to ________ and the interest rate to ________, everything else held constant. A) decrease; decrease B) decrease; increase C) increase; decrease D) increase; increase

A

A movement along the bond demand or supply curve occurs when ________ changes. A) bond price B) income C) wealth D) expected return

A

A return to the gold standard, that is, using gold for money will ________ the ________ for gold, ________ its price, everything else held constant. A) increase; demand; increasing B) decrease; demand; decreasing C) increase; supply; increasing D) decrease; supply; increasing

A

An increase in an asset's expected return relative to that of an alternative asset, holding everything else constant, ________ the quantity demanded of the asset. A) increases B) decreases C) has no effect on D) erases

A

An increase in the expected inflation rate will ________ the ________ for gold, ________ its price, everything else held constant. A) increase; demand; increasing B) decrease; demand; decreasing C) increase; supply; increasing D) decrease; supply; increasing

A

Both the CAPM and APT suggest that an asset should be priced so that it has a higher expected return ________. A) when it has a greater systematic risk B) when it has a greater risk in isolation C) when it has a lower systematic risk D) when it has a lower systematic risk and a lower risk in isolation

A

Both the CAPM and APT suggest that an asset should be priced so that it has a higher expected return ________. A) when it has a greater systematic risk B) when it has a greater risk in isolation C) when it has a lower systematic risk D) when it has a lower systematic risk and a lower risk in isolation

A

Everything else held constant, an increase in the liquidity of bonds results in a ________ in demand for bonds and the demand curve shifts to the ________. A) rise; right B) rise; left C) fall; right D) fall; left

A

Everything else held constant, if the expected return on bonds falls from 10 to 5 percent and the expected return on GE stock rises from 7 to 8 percent, then the expected return of holding GE stock ________ relative to bonds and the demand for GE stock ________. A) rises; rises B) rises; falls C) falls; rises D) falls; falls

A

Holding all other factors constant, the quantity demanded of an asset is ________. A) positively related to wealth B) negatively related to its expected return relative to alternative assets C) positively related to the risk of its returns relative to alternative assets D) negatively related to its liquidity relative to alternative assets

A

Holding many risky assets and thus reducing the overall risk an investor faces is called ________. A) diversification B) foolishness C) risk acceptance D) capitalization

A

In a business cycle expansion, the ________ of bonds increases and the ________ curve shifts to the ________ as business investments are expected to be more profitable. A) supply; supply; right B) supply; supply; left C) demand; demand; right D) demand; demand; left

A

When stock prices become more volatile, the ________ curve for gold shifts right and gold prices ________, everything else held constant. A) demand; increase B) demand; decrease C) supply; increase D) supply; decrease

A

________ in the money supply creates excess ________ money, causing interest rates to ________, everything else held constant. A) A decrease; demand for; rise B) An increase; demand for; fall C) An increase; supply of; rise D) A decrease; supply of; fall

A

What is the impact on interest rates when the Bank of Canada decreases the money supply by selling bonds to the public?

Answer: Bond supply increases and the bond supply curve shifts to the right. The new equilibrium bond price is lower and thus interest rates will increase.

Using the liquidity preference framework, show what happens to interest rates during a business cycle recession.

Answer: During a business cycle recession, income will fall. This causes the money demand curve to shift to the left. The resulting equilibrium will be at a lower interest rate

Using the liquidity preference framework, what will happen to interest rates if the Bank of Canada increases the money supply?

Answer: The Bank of Canada's actions shift the money supply curve to the right. The new equilibrium interest rate will be lower than it was previously.

Economists recognize that interest rates are typically procyclical, meaning that interest rates increase during economic expansions and decline during recessions. Real income and generally inflation rise and fall with the economy. Using the liquidity preference model of interest rates, give three reasons why interest rates are procyclical.

Answer: The answer should explain that the income, price-level, and expected inflation effects would all increase interest rates during an expansion and decrease them in a recession.

Use demand and supply analysis to explain why an expectation of interest rate hikes would cause Government bond prices to fall.

Answer: The expected return on bonds would decrease relative to other assets resulting in a decrease in the demand for bonds. The leftward shift of the bond demand curve results in a new lower equilibrium price for bonds.

Everything else held constant, would an increase in volatility of stock prices have any impact on the demand for rare coins? Why or why not?

Answer: Yes, it would cause the demand for rare coins to increase. The increased volatility of stock prices means that there is relatively more risk in owning stock than there was previously and so the demand for an alternative asset, rare coins, would increase.

A decline in the expected inflation rate causes the demand for money to ________ and the demand curve to shift to the ________, everything else held constant. A) decrease; right B) decrease; left C) increase; right D) increase; left

B

A decrease in the brokerage commissions in the housing market from 6 percent to 5 percent of the sales price will shift the ________ curve for bonds to the ________, everything else held constant. A) demand; right B) demand; left C) supply; right D) supply; left

B

A higher ________ means that an asset's return is more sensitive to changes in the value of the market portfolio. A) alpha B) beta C) CAPM D) APT

B

A limitation of the CAPM is the assumption that ________. A) there are multiple sources of systematic risk B) there is a single source of systematic risk C) investors have different assessments of expected returns and standard deviations D) they cannot borrow freely at the risk-free rate

B

An increase in the expected rate of inflation will ________ the expected return on bonds relative to the that on ________ assets, everything else held constant. A) reduce; financial B) reduce; real C) raise; financial D) raise; real

B

Everything else held constant, an increase in expected inflation, lowers the expected return on ________ compared to ________ assets. A) bonds; financial B) bonds; real C) physical; financial D) physical; real

B

Everything else held constant, during a business cycle expansion, the supply of bonds shifts to the ________ as businesses perceive more profitable investment opportunities, while the demand for bonds shifts to the ________ as a result of the increase in wealth generated by the economic expansion. A) right; left B) right; right C) left; left D) left; right

B

If brokerage commissions on bond sales decrease, then, other things equal, the demand for bonds will ________ and the demand for real estate will ________. A) increase; increase B) increase; decrease C) decrease; decrease D) decrease; increase

B

If housing prices are expected to increase, then, other things equal, the demand for houses will ________ and that of Treasury bills will ________. A) increase; increase B) increase; decrease C) decrease; decrease D) decrease; increase

B

In Keynes's liquidity preference framework, as the expected return on bonds increases (holding everything else unchanged), the expected return on money ________, causing the demand for ________ to fall. A) falls; bonds B) falls; money C) rises; bonds D) rises; money

B

In contrast to the CAPM, the APT assumes that there can be several sources of ________ that cannot be eliminated through diversification. A) nonsystematic risk B) systematic risk C) credit risk D) arbitrary risk

B

In the Keynesian liquidity preference framework, a rise in the price level causes the demand for money to ________ and the demand curve to shift to the ________, everything else held constant. A) increase; left B) increase; right C) decrease; left D) decrease; right

B

The bond supply and demand framework is easier to use when analyzing the effects of changes in ________, while the liquidity preference framework provides a simpler analysis of the effects from changes in income, the price level, and the supply of ________. A) expected inflation; bonds B) expected inflation; money C) government budget deficits; bonds D) government budget deficits; money

B

The demand for gold increases, other things equal, when ________. A) the market for silver becomes more liquid B) interest rates are expected to rise C) interest rates are expected to fall D) real estate prices are expected to increase

B

When real income ________, the demand curve for money shifts to the ________ and the interest rate ________, everything else held constant. A) falls; right; rises B) rises; right; rises C) falls; left; rises D) rises; left; rises

B

When the economy slips into a recession, normally the demand for bonds ________, the supply of bonds ________, and the interest rate ________, everything else held constant. A) increases; increases; rises B) decreases; decreases; falls C) increases; decreases; falls D) decreases; increases; rises

B

When the government has a surplus, as occurred in the late 1990s, the ________ curve of bonds shifts to the ________, everything else held constant. A) supply; right B) supply; left C) demand; right D) demand; left

B

When the inflation rate is expected to increase, the ________ for bonds falls, while the ________ curve shifts to the right, everything else held constant. A) demand; demand B) demand; supply C) supply; demand D) supply; supply

B

When the interest rate on a bond is ________ the equilibrium interest rate, in the bond market there is excess ________ and the interest rate will ________. A) above; demand; rise B) above; demand; fall C) below; supply; fall D) above; supply; rise

B

When the interest rate on a bond is above the equilibrium interest rate, in the bond market there is excess ________ and the interest rate will ________. A) demand; rise B) demand; fall C) supply; fall D) supply; rise

B

During a recession, the supply of bonds ________ and the supply curve shifts to the ________, everything else held constant. A) increases; left B) increases; right C) decreases; left D) decreases; right

C

During business cycle expansions when income and wealth are rising, the demand for bonds ________ and the demand curve shifts to the ________, everything else held constant. A) falls; right B) falls; left C) rises; right D) rises; left

C

Everything else held constant, a decrease in wealth ________. A) increases the demand for stocks B) increases the demand for bonds C) reduces the demand for silver D) increases the demand for gold

C

Everything else held constant, if the expected return on RST stock declines from 12 to 9 percent and the expected return on XYZ stock declines from 8 to 7 percent, then the expected return of holding RST stock ________ relative to XYZ stock and demand for XYZ stock ________. A) rises; rises B) rises; falls C) falls; rises D) falls; falls

C

If the price of bonds is set ________ the equilibrium price, the quantity of bonds demanded exceeds the quantity of bonds supplied, a condition called excess ________. A) above; demand B) above; supply C) below; demand D) below; supply

C

If there is an excess supply of money ________. A) individuals sell bonds, causing the interest rate to rise B) individuals sell bonds, causing the interest rate to fall C) individuals buy bonds, causing interest rates to fall D) individuals buy bonds, causing interest rates to rise

C

In Keynes's liquidity preference framework, if there is excess demand for money, there is ________. A) excess demand for bonds B) equilibrium in the bond market C) excess supply of bonds D) too much money

C

In Keynes's liquidity preference framework, individuals are assumed to hold their wealth in two forms: ________. A) real assets and financial assets B) stocks and bonds C) money and bonds D) money and gold

C

In the Keynesian liquidity preference framework, an increase in the interest rate causes the demand curve for money to ________, everything else held constant. A) shift right B) shift left C) stay where it is D) invert

C

In the bond market, the market equilibrium shows the market-clearing ________ and market-clearing ________. A) price; deposit B) interest rate; deposit C) price; interest rate D) interest rate; premium

C

Keynes assumed that money has ________ rate of return. A) a positive B) a negative C) a zero D) an increasing

C

The opportunity cost of holding money is ________. A) the level of income B) the price level C) the interest rate D) the discount rate

C

The riskiness of an asset is measured by ________. A) the magnitude of its return B) the absolute value of any change in the asset's price C) the standard deviation of its return D) risk is impossible to measure

C

When the interest rate is above the equilibrium interest rate, there is an excess ________ money and the interest rate will ________. A) demand for; rise B) demand for; fall C) supply of; fall D) supply of; rise

C

When the price of a bond decreases, all else equal, the bond demand curve ________. A) shifts right B) shifts left C) does not shift D) inverts

C

When the price of a bond is above the equilibrium price, there is an excess ________ bonds and price will ________. A) demand for; rise B) demand for; fall C) supply of; fall D) supply of; rise

C

You would be less willing to purchase bonds, other things equal, if ________. A) you inherit $1 million from your Uncle Harry B) you expect interest rates to fall C) gold becomes more liquid D) stock prices are expected to fall

C

Everything else held constant, when households save less, wealth and the demand for bonds ________ and the bond demand curve shifts ________. A) increase; right B) increase; left C) decrease; right D) decrease; left

D

A rise in the price level causes the demand for money to ________ and the interest rate to ________, everything else held constant. A) decrease; decrease B) decrease; increase C) increase; decrease D) increase; increase

D

An increase in the interest rate ________. A) increases the demand for money B) increases the quantity of money demanded C) decreases the demand for money D) decreases the quantity of money demanded

D

Discovery of new gold in Alaska will ________ the ________ of gold, ________ its price, everything else held constant. A) increase; demand; increasing B) decrease; demand; decreasing C) decrease; supply; increasing D) increase; supply; decreasing

D

Everything else held constant, an increase in the riskiness of bonds relative to alternative assets causes the demand for bonds to ________ and the demand curve to shift to the ________. A) rise; right B) rise; left C) fall; right D) fall; left

D

Everything else held constant, if the expected return on ABC stock rises from 5 to 10 percent and the expected return on CBS stock is unchanged, then the expected return of holding CBS stock ________ relative to ABC stock and the demand for CBS stock ________. A) rises; rises B) rises; falls C) falls; rises D) falls; falls

D

Everything else held constant, if the expected return on government bonds falls from 8 to 7 percent and the expected return on corporate bonds falls from 10 to 8 percent, then the expected return of corporate bonds ________ relative to government bonds and the demand for corporate bonds ________. A) rises; rises B) rises; falls C) falls; rises D) falls; falls

D

Everything else held constant, 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

D

Everything else held constant, 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

D

If fluctuations in interest rates become smaller, then, other things equal, the demand for stocks ________ and the demand for long-term bonds ________. A) increases; increases B) increases; decreases C) decreases; decreases D) decreases; increases

D

If gold becomes acceptable as a medium of exchange, the demand for gold will ________ and the demand for bonds will ________, everything else held constant. A) decrease; decrease B) decrease; increase C) increase; increase D) increase; decrease

D

If stock prices are expected to drop dramatically, then, other things equal, the demand for stocks will ________ and that of Treasury bills will ________. A) increase; increase B) increase; decrease C) decrease; decrease D) decrease; increase

D

If the liquidity effect is smaller than the other effects, and the adjustment to expected inflation is immediate, then the ________. A) interest rate will fall B) interest rate will rise C) interest rate will fall immediately below the initial level when the money supply grows D) interest rate will rise immediately above the initial level when the money supply grows

D

If the price of gold becomes less volatile, then, other things equal, the demand for stocks will ________ and the demand for gold will ________. A) increase; increase B) increase; decrease C) decrease; decrease D) decrease; increase

D

In Keynes's liquidity preference framework, ________. A) the demand for bonds must equal the supply of money B) the demand for money must equal the supply of bonds C) an excess demand of bonds implies an excess demand for money D) an excess supply of bonds implies an excess demand for money

D

In the 1990s Japan had the lowest interest rates in the world due to a combination of ________. A) inflation and recession B) deflation and expansion C) inflation and expansion D) deflation and recession

D

Interest rates increased continuously during the 1970s. The most likely explanation is ________. A) banking failures that reduced the money supply B) a rise in the level of income C) the repeated bouts of recession and expansion D) increasing expected rates of inflation

D

The demand curve for bonds has the usual downward slope, indicating that at ________ prices of the bond, everything else equal, the ________ is higher. A) higher; demand B) higher; quantity demanded C) lower; demand D) lower; quantity demanded

D

The riskiness of an asset that is unique to the particular asset is ________. A) systematic risk B) portfolio risk C) investment risk D) nonsystematic risk

D

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

D

When gold prices become more volatile, the ________ curve for gold shifts to the ________; ________ the price of gold. A) supply; right; increasing B) supply; left; increasing C) demand; right; decreasing D) demand; left; decreasing

D

When the price of a bond is ________ the equilibrium price, there is an excess demand for bonds and price will ________. A) above; rise B) above; fall C) below; fall D) below; rise

D