Chapter 21 Practice Questions

What is the present value of $5,000 to be received in one year if the current market interest rate is 6.0%?

$4,717

What is the present value of $1,000 to be received in two years if the current market interest rate is 8.0%?

$857

Housing prices peaked in

2006.

Explain how a consumption tax could lead to a decrease in real interest rates.

A tax on consumption would discourage individuals from making purchases. As a result, these individuals would be saving more. That would lead to an increase in the supply of loanable funds which would lead to a decrease in real interest rates.

Which of the following statements is true with regard to the Fed's response to the economic crisis of 2008?

Although the Fed lowered its interest rates to nearly zero, there are other actions it can take to improve the economy.

Which of the following is not true with regard to mutual funds? A. Some mutual funds allow investors to invest in all stocks in a given market. B. Mutual fund returns are greater than those for an individual who selects his/her own stocks. C. They allow individuals to spread risk across many different companies. D. Investors gain access to the services of a financial expert.

B. Mutual fund returns are greater than those for an individual who selects his/her own stocks.

Which of the following is not true regarding bonds?

Bondholders face no risk from changing market interest rates on bonds that have a fixed interest rate

Other things equal, which of the following is the result of increased saving? A. a decrease in interest rates B. a decrease in prices C. forgone consumption D. all of the above

D. all of the above

Other things held constant, investment in physical capital will increase: A. labor productivity. B. national income. C. wages. D. all of the above

D. all of the above

Which of the following is a method by which a firm can obtain financial resources to invest in capital? A. use of retained earnings B. borrowing from financial intermediaries C. selling stocks or bonds D. all of the above

D. all of the above

Which of the following is true? A. In 2007, the default rate on fixed rate mortgages was lower than that on ARMs. B. From 2006-2008, housing construction decreased in the U.S. C. Zero-down mortgages decreased the incentive for homeowners to prevent defaulting on their homes. D. all of the above

D. all of the above

A bond can be: A. partial ownership in a corporation. B. a debt obligation of a company. C. a debt obligation of a government or government agency. D. both B and C above

D. both B and C above

Which of the following is true regarding bonds? A. Other things equal, bondholders have greater financial security than stockholders. B. The possibility of a bond's value increasing greatly is limited compared to stocks. C. The legal obligation to bondholders is of higher priority than that of stockholders. D. Higher market interest rates represent a risk to bondholders. E. all of the above

E. all of the above

Because of fixed interest rates, there is no risk involved with holding government bonds

FALSE

Which of the following is a government sponsored enterprise that funds or guarantees a substantial number of mortgage loans in the U.S.?

Fannie Mae and Freddy Mac

If the real interest rate is below equilibrium, which of the following is likely to occur?

Lenders will raise their interest rates which will encourage saving.

List the various reasons that contributed to the financial crisis that occurred in 2008

Low interest rates from 2002 to 2004 caused excessive borrowing. Deregulation in the mortgage industry and lower standards by Fannie Mae and Freddy Mac led to the significant amount of sub-prime mortgages to borrowers who could not afford to make payments when interest rates increased in 2006. With limited down payments and decreasing home values, some owners walked away from their homes leading to more foreclosures and a further decline in the housing market. These mortgages were then bundled and sold to investors; this leveraging concentrated the risk which was not rated correctly by agencies like Moody's and S&P.

Why are real interest rates more important than nominal interest rates with regard to analyzing the supply and demand of loanable funds?

Nominal interest rates only indicate the amount of dollars that are paid or received as interest. Real interest rates indicate the amount of purchasing power paid or received as interest. Borrowers are more influenced by the purchasing power than they will sacrifice to borrow money; similarly savers are more influenced by the purchasing power they will receive for on their deposits.

Rank bonds, common stock, and preferred stock with regard to two factors the possibility of a substantial increase in value. Rank these same securities with regard to investors' legal claims for repayment on their investments.

Possibility of increase in value: (1) common stock - (2) preferred stock - (3) bonds Legal claims: - (1) bonds - (2) preferred stock - (3) common stock

In the loanable funds market which of the following is true?

Savers represent supply and borrowers represent demand

Which of the following must be true?

Savings must equal investment in a closed economy.

Public saving equals

T - G - TR

If the government runs a deficit, which of the following will be true?

T < G + TR

Private saving equals:

Y - C - T + TR

The crowding-out effect indicates that increased government borrowing will lead to:

a decrease in consumption by households and a decrease in investment spending by firms.

A government budget deficit will lead to:

a decrease in the supply of loanable funds and an increase in real interest rates

The concept that it is very difficult to consistently pick winners in the stock market without inside information is known as:

a random walk

The actions of a miser benefit ____ and the actions of a philanthropist benefit ____.

a wide range of individuals; a select few

Which of the following will increase the demand for loanable funds?

creation of an investment tax credit for businesses

Would a relatively high P/E ratio lead us to conclude that a stock is overvalued or undervalued? Why or why not?

f a stock's price to earnings ratio is higher than other firms in the industry, that stock could be considered overvalued. However, the higher ratio may be an indication that the market expects the company's performance to improve significantly in the future.

A decrease in real interest rates will lead to an increase in the demand for loanable funds.

false

A rational individual would rather receive $5,000 today than receive $6,000 in one year if the applicable nominal interest rate was 10%.

false

A stock is an obligation issued by a corporation that promises the holder to receive fixed annual interest payments and payment of the principal upon maturity.

false

Because of fixed interest rates, there is no risk involved with holding corporate bonds

false

Crowding out will lead to a decrease in supply of loanable funds, a decrease in real interest rates, and subsequently a decrease in spending by households and firms

false

In a closed economy, the formula for public saving is: Sprivate = T + G + TR

false

Incentives for borrowers and savers in the loanable funds market are determined by the nominal interest rate as opposed to the real interest rate.

false

The PE ratio is determined by dividing the earnings per share by the current market price of the stock

false

Most economists believe that the financial crisis of 2008 began because of problems in the ____ industry.

housing

"Saving" refers to ____ while "savings" refers to ____

how much is saved within a certain time period; accumulated assets

In 2005, the percentages of mortgages that were considered sub-prime

increased dramatically

In 2005 and 2006, because of fears of inflation, the Fed

increased interest rates which lead to higher monthly payments on adjustable rate mortgages.

The substantial risks taken by financial intermediaries like Sallie Mae because they are effectively insured are examples of what economists refer to as

moral hazard

A government budget deficit will have a:

negative effect on public saving causing a leftward shift in the supply of loanable funds.

Which of the following is a type of ownership that features a fixed payment?

preferred stock

An increase in the ____ interest rate will lead to an increase in the ____

real; quantity of loanable funds supplied

According to the crowding-out effect, a budget deficit will lead to:

reduced investment spending and a reduction in long-term economic growth

Which of the following was not a reason for the significant decline in housing prices in 2007?

strict regulation

Adjustable rate mortgages with extremely low initial interest rates which enable high risk buyers to purchase homes are known as:

sub-prime loans

Which of the following is likely to increase the equilibrium real interest rate?

technological improvement creating profitable investment opportunities

Which of the following was not a reason for the financial collapse in 2008?

the absence of financial leveraging in the banking industry

A bank is an example of a financial intermediary

true

A consumption tax would lead to an increase in the supply of loanable funds and a decrease in real interest rates

true

A rational individual would rather receive $1,000 today than receive $1,100 in one year if the applicable nominal interest rate was 12%

true

An increase in real interest rates will lead to an increase in the quantity of loanable funds supplied.

true

In a closed economy, the formula for private saving is: Sprivate = Y - C - T + TR

true

Owners of preferred stock received fixed dividend payments while owners of common stock receive dividend payments that vary with the level of profits.

true

Stocks and bonds are both considered securities.

true

The 2008 financial crisis was caused by the decline of real estate values as well as several other factors.

true

The PE ratio is a measure of how highly a stock is valued relative to its current earnings..

true

The term "saving" is a flow concept while the term "savings" is a stock concept.

true

The use of financial leveraging on mortgage backed securities played a central role in the 2008 financial crisis

true