Eco 29 Quiz questions midterm 1

-If you lend money at a 12% nominal interest rate, but you expect inflation to be 5% over the life of the loan, then you expect your purchasing power to grow at a rate of (1)____ -The real interest rate is negative when the nominal interest rate is (2) Greater than, less than, equal to) the inflation rate -(3) If the nominal interest rate is 4% and the expected rate of inflation is 1%, then the real interest rate is: A. − 1%. B. 0%. C. 2%. D. 1%. E. 3%.

1) 7% 2) less than 3) E. 3%.

What is the opportunity cost of holding $1,000 in cash if the relevant interest rate is 3 percent? The opportunity cost is ______ (1) If interest rates rise, this opportunity cost will (increase, decrease, stay the same)(2) , and individuals will hold (larger, smaller, same amount of) (3) cash balances.

1)$30 2) increase 3) smaller

Suppose the interest rates on one, five, and tenyear U.S. Treasury bonds are currently 3%, 6%, and 6%, respectively. Investor A chooses to hold only oneyear bonds, and Investor B is indifferent with regard to holding five and tenyear bonds. Which theories best explain the behavior of Investors A and B? Investor A's preferences are best explained by the (1) (liquidity premium, expectations, segmented markets) theory, while Investor B's are best explained by the (2)( expectations, preferred habitat,segmented markets) theory.

1)Segmented Markets 2)expectations

Segmented markets is 1. The interest rate for each bond with a different maturity is determined by the supply of and demand for that bond, with no effects from expected returns on other bonds with other maturities. 2. The interest rate on a longterm bond will equal an average of the shortterm interest rates that people expect to occur over the life of the longterm bond. 3. When shortterm interest rates are low, yield curves are more likely to have an upward slope; when shortterm interest rates are high, yield curves are more likely to slope downward and be inverted. 4. The interest rate on a longterm bond will equal an average of shortterm interest rates expected to occur over the life of the longterm bond plus a liquidity premium (also referred to as a term premium) that responds to supply and demand conditions for that bond.

1. The interest rate for each bond with a different maturity is determined by the supply of and demand for that bond, with no effects from expected returns on other bonds with other maturities.

Expectations theory is 1. The interest rate for each bond with a different maturity is determined by the supply of and demand for that bond, with no effects from expected returns on other bonds with other maturities. 2. The interest rate on a longterm bond will equal an average of the shortterm interest rates that people expect to occur over the life of thelongterm bond. 3. When shortterm interest rates are low, yield curves are more likely to have an upward slope; when shortterm interest rates are high, yield curves are more likely to slope downward and be inverted. 4. The interest rate on a longterm bond will equal an average of shortterm interest rates expected to occur over the life of the longterm bond plus a liquidity premium (also referred to as a term premium) that responds to supply and demand conditions for that bond.

2. The interest rate on a longterm bond will equal an average of the shortterm interest rates that people expect to occur over the life of thelongterm bond.

Preferred Habitat 1. The interest rate for each bond with a different maturity is determined by the supply of and demand for that bond, with no effects from expected returns on other bonds with other maturities. 2. The interest rate on a longterm bond will equal an average of the shortterm interest rates that people expect to occur over the life of thelongterm bond. 3. When shortterm interest rates are low, yield curves are more likely to have an upward slope; when shortterm interest rates are high, yield curves are more likely to slope downward and be inverted. 4. The interest rate on a longterm bond will equal an average of shortterm interest rates expected to occur over the life of the longterm bond plus a liquidity premium (also referred to as a term premium) that responds to supply and demand conditions for that bond.

4. The interest rate on a longterm bond will equal an average of shortterm interest rates expected to occur over the life of the longterm bond plus a liquidity premium (also referred to as a term premium) that responds to supply and demand conditions for that bond.

If monetary policy becomes more transparent about the future course of interest rates, how would that affect stock prices, if at all? A. Stock prices will remain unchanged, as increased transparency will not affect investment decisions. B. Stock prices will increase, as the risk and required return on the investment will be reduced. C. Stock prices will decrease because investors are now aware of stock prices and won't overpay. D. Stock prices will be unaffected, as stock prices and transparent monetary policy are

B. Stock prices will increase, as the risk and required return on the investment will be reduced.

What would happen to the demand for Rembrandt paintings if the stock market undergoes a boom? A. The demand for Rembrandt paintings would increase because people would want to hold more stocks B. The demand for Rembrandt paintings would increase because of the increase in people's wealth C. The demand for Rembrandt paintings would increase because bond values would decline D. The demand for Rembrandt paintings would decrease because people would want to use their wealth for other things

B. The demand for Rembrandt paintings would increase because of the increase in people's wealth

In the fall of 2008, AIG, the largest insurance company in the world at the time, was at risk of defaulting due to the severity of the global financial crisis. As a result, the U.S. government stepped in to support AIG with large capital injections and an ownership stake. How would this affect, if at all, the yield and risk premium on AIG corporate debt? A. The yield and risk premium will not change as normal operations will resume at AIG after the government bailout. B. The yield and risk premium will fall since demand for AIG corporate debt will increase. C. The yield will rise and attract investors; however, as demand for AIG corporate debt rises, the risk premium will fall. D. The yield and risk premium will continue to rise due to expectations of potential default.

B. The yield and risk premium will fall since demand for AIG corporate debt will increase.

To pay for college, you have just taken out a $1,000 government loan that makes you pay $126 per year for 25 years. However, you don't have to start making these payments until you graduate from college two years from now. Why is the yield to maturity necessarily less than 12% (this is the yield to maturity on a normal $1,000 fixed payment loan in which you pay $126 per year for 25 years)? A. This is the case because the loan has a government guarantee. B. This is the case because the first payment due begins at a future date. C. This is the case because market interest rates are less than 12%. D. This is the case because of the known effects of inflation

B. This is the case because the first payment due begins at a future date.

"No one who is riskaverse will ever buy a security that has a lower expected return, more risk, and less liquidity than another security." Is this statement true, false, or uncertain? A. False because by diversifying or hedging your portfolio, it is possible to avoid risks and increase your expected return. B. True because for a riskaverse person, those characteristics make a security less desirable. C. Uncertain because there may be other crucial characteristics to consider when purchasing a security.

B. True because for a risk averse person, those characteristics make a security less desirable.

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

B. the interest rate.

If expectations are formed adaptively, then people A. often change their expectations quickly when faced with new information. B. use only the information from past data on a single variable to form their expectations of that variable. C. never change their expectations once they have been made. D. use more information than just past data on a single variable to form their expectations of that variable.

B. use only the information from past data on a single variable to form their expectations of that variable.

What basic principle of finance can be applied to the valuation of any investment asset? A. Priceearnings ratio B. Internal rate of return C. Present value D. Cash flow analysis

C. Present value

Everything else held constant, when real estate prices are expected to decrease A. the demand curve for bonds shifts to the left and the interest rate rises. B. the demand curve for bonds shifts to the left and the interest rate falls. C. the demand curve for bonds shifts to the right and the interest rate falls. D. the supply curve for bonds shifts to the right and the interest rate falls.

C. The demand curve for bonds shifts to the right and the interest rate falls.

Would fiscal policy makers ever have reason to worry about potentially inflationary conditions? A. No, fiscal policy makers have enough policy instruments available to them to stave off or contain inflation. B. Yes, if people expect higher potential inflation, it increases spending and causes M1 and M2 to increase too rapidly. C. Yes, higher inflation leads to a higher debt service burden and increases the costs of financing deficit spending. D. No, policy makers view potential inflation as a positive for the economy, as it increases demand on the most liquid assets such as Treasury bonds.

C. Yes, higher inflation leads to a higher debt service burden and increases the costs of financing deficit spending.

Economists have focused more attention on the formation of expectations in recent years. This increase in interest can probably best be explained by the recognition that A. expectations influence only a few individuals, have little impact on the overall economy, but can have important effects on a few markets. B. models that ignore expectations have little predictive power, even in the short run. C. expectations influence the behavior of participants in the economy and thus have a major impact on economic activity. D. expectations influence many individuals, have little impact on the overall economy, but can have distributional effects.

C. expectations influence the behavior of participants in the economy and thus have a major impact on economic activity

'Forecasters' predictions of inflation are notoriously inaccurate, so their expectations of inflation cannot be rational.' This statement is: A. true, as a forecast is optimal if it is the best possible forecast even if the forecast errors are large B. false, as inaccurate forecasts are never rational C. false, as expectations can be highly inaccurate and still be rational D. true, as optimal forecasts are not necessarily accurate

C. false, as expectations can be highly inaccurate and still be rationa

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

C. liquidity

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

C. money and bonds.

According to the Generalized Dividend Model, the final sales price of a stock depends on the following except the A. dividend payments. B. number of periods. C. price of the stock in the last period. D. required return on investments in equity. If a company called Advanced Technologies has yet to pay a dividend on its stock, the generalized dividend model predicts that the company's stock may still have value because A. people expect Advanced Technologies to pay dividends in the future. B. all companies that have any physical assets have value. C. the required return on investment for high technology companies is zero. D. all companies are legally required to pay Dividends within ten years of the initial public offering of stock.

C. price of the stock in the last period. A. people expect Advanced Technologies to pay dividends in the future.

The bond supply curve is ________ sloping, indicating a(n) ________ relationship between the price and quantity supplied of bonds everything else equal. A. upward; inverse B. downward; direct C. upward; direct D. downward; inverse

C. upward; direct

Retired persons often have much of their wealth placed in savings accounts and other interest bearing investments, and complain whenever interest rates are low. Which of the following, if true, would be a valid complaint? A. Nominal interest rates decrease, while there is a slight increase in real interest rates. B. There has not been significant growth of nominal interest rates for the last 5 years. C. Expected inflation is falling at the same rate as nominal interest rates. D. Expected inflation is falling at a slower rate than nominal interest rates.

D. Expected inflation is falling at a slower rate than nominal interest rates

In asset markets, an asset's price is A. set equal to the lowest price a seller is willing to accept. B. set equal to the highest price a seller will accept. C. set equal to the highest price a buyer is willing to pay. D. set by the buyer willing to pay the highest price.

D. set by the buyer willing to pay the highest price.

If the yield curve suddenly becomes steeper, how would you revise your predictions of interest rates in the future? You would (not change, raise, lower) your predictions of future interest rates.

raise

An expectation may fail to be rational if A. relevant information was not available at the time the forecast is made. B. relevant information is available but ignored at the time the forecast is made. C. information was available to insiders only. D. information changes after the forecast is

B. relevant information is available but ignored at the time the forecast is made.

A financial adviser has just given you the following advice: "Longterm bonds are a great investment because their interest rate is over 20%." Is the financial adviser necessarily right? A. No. When making an investment decision, you should take the yield to maturity into account, not the interest rate. B. Yes. The higher the annual interest rate, the higher the annual income on bonds. C. No. If interest rates rise sharply in the future, longterm bonds may suffer a sharp fall in price, causing their return to be quite low. D. Yes. If the interest rate remains unchanged until maturity, the price of the bond will be more than its face value.

C. No. If interest rates rise sharply in the future, longterm bonds may suffer a sharp fall in price, causing their return to be quite low.

If a forecast is made using all available information, then economists say that the expectation formation is A. reasonable. B. irrational. C. adaptive. D. rational.

D. rational

What will happen to interest rates on a corporation's bonds if the federal government guarantees today that it will pay creditors if the corporation goes bankrupt in the future? Interest rates on corporate bonds (decrease , not change, increase)

decrease