FIM - Chapter 4

9) The Fisher Effect predicts that an increase in expected inflation will lower the interest rate on bonds.

Answer: FALSE

10) An increase in the federal government budget deficit will raise the interest rate on bonds.

Answer: TRUE

12) An increase in an asset's expected return relative to that of an alternative asset, holding everything else unchanged, raises the quantity demanded of the asset.

Answer: TRUE

13) The more liquid an asset is relative to alternative assets, holding everything else unchanged, the more desirable it is, and the greater the quantity demanded.

Answer: TRUE

2) When an economy grows out of a recession, normally the demand for bonds increases and the supply of bonds increases.

Answer: TRUE

4) Investors make their choices of which assets to hold by comparing the expected return, liquidity, and risk of alternative assets.

Answer: TRUE

6) Interest rates are procyclical in that they tend to rise during business cycle expansions and fall during recessions.

Answer: TRUE

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

A) demand; rise

8) An increase in the inflation rate will cause the demand curve for bonds to shift to the right.

Answer: FALSE

5) A person who is risk averse prefers to hold assets that are more, not less, risky.

Answer: FALSE

85) What is the model whose equations are estimated using statistical procedures used in forecasting interest rates called? A) Econometric model B) Liquidity preference framework C) Market equilibrium D) Fisher effect

A) Econometric model

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

A) decrease; left

81) _______ is the total resources owned by an individual, including all assets. A) Expected return B) Wealth C) Liquidity D) Risk

B) Wealth

48) 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.

B) a decrease in expected inflation.

46) In Figure 4.4, 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.

B) a decrease in the expected inflation rate.

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

B) above; fall

52) When the economy slips into a recession, normally 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

B) decreases; decreases; falls

56) In Figure 4.2, one possible explanation for a decrease in the interest rate from i2 to i1 is A) an increase in government budget deficits. B) an increase in expected inflation. C) a decrease in economic growth. D) a decrease in the riskiness of bonds relative to other investments.

C) a decrease in economic growth.

83) When the quantity of bonds demanded equals the quantity of bonds supplied, there is A) excess supply. B) excess demand. C) a market equilibrium. D) an asset market approach.

C) a market equilibrium.

44) In Figure 4.4, 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. an increase in the expected inflation rate. C) an increase in the expected inflation rate. D) a decrease in the expected inflation rate.

C) an increase in the expected inflation rate.

36) 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

C) an increase in the liquidity of stocks.

84) Determining asset prices using stocks of assets rather than flow is called A) asset transformation. B) expected return. C) asset market approach. D) market equilibrium.

C) asset market approach.

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

C) below; supply; rise

87) As expected inflation falls for the coming year, we expected the price of gold to ________ due to a leftward shift the in ________ curve. A) increase; demand B) increase; supply C) decrease; demand D) decrease; supply

C) decrease; demand

21) 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

C) decrease; left

38) 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

C) decreases; left

54) In Figure 4.2, one possible explanation for the increase in the interest rate from i1 to i2 is a(n) ________ in ________. A) increase; the expected inflation rate B) decrease; the expected inflation rate C) increase; economic growth D) decrease; economic growth

C) increase; economic growth

18) Diversification benefits an investor by A) increasing wealth. B) increasing expected return. C) reducing risk. D) increasing liquidity.

C) reducing risk.

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

C) rises; right

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

C) supply; fall

41) 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

C) supply; left

11) When the demand for bonds ________ or the supply of bonds ________, interest rates rise. A) increases; increases B) increases; decreases C) decreases; decreases D) decreases; increases

D) decreases; increases

35) 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.

D) all of the above.

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

D) below; rise

27) 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

D) decreases; increases; rises

29) When bond prices become more volatile, the demand for bonds ________ and the interest rate ________. A) increases; rises B) increases; falls C) decreases; falls D) decreases; rises

D) decreases; rises

24) 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

D) left; rises

32) 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) left; rises

34) 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) left; rises

26) 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

D) raise; real

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

A) above; demand; fall

47) 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.

A) an expansion in overall economic activity.

55) In Figure 4.2, one possible explanation for the increase in the interest rate from i1 to i2 is A) an increase in economic growth. B) an increase in government budget deficits. C) a decrease in government budget deficits. D) a decrease in economic growth. E) a decrease in the riskiness of bonds relative to other investments.

A) an increase in economic growth.

42) 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

A) demand for; demand

45) In Figure 4.4, 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

A) increase; expected inflation rate

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

A) increases; decreases

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

B) demand; fall

50) 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

B) fall; rise

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

B) falls; left

39) 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

B) increase; right

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) increase; right

22) 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.

B) increase; right.

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

B) increases; decreases

30) When bond prices become less volatile, the demand for bonds ________ and the interest rate ________. A) increases; rises B) increases; falls C) decreases; falls D) decreases; rises

B) increases; falls

25) 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

B) reduce; real; demand

31) 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

B) right; falls

33) 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

B) right; falls

82) A ________ prefers stock in a less risky asset than in a riskier asset. A) risk preferrer B) risk-averse person C) risk lover D) risk-favorable person

B) risk-averse person

28) 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

C) increases; decreases; falls

51) 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

C) rise; fall

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

D) decreases; increases

In his liquidity preference framework, Keynes assumed that money has a zero rate of return; thus, when interest rates ________ the expected return on money falls relative to the expected return on bonds, causing the demand for money to ________. A) rise; rise B) fall; fall C) fall; rise D) rise; fall

D) rise; fall

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

D) rises; quantity supplied

43) 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

D) supply of; supply

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

A) falls; rises

17) The higher the standard deviation of returns on an asset, the ________ the asset's ________. A) greater; risk B) smaller; risk C) greater; expected return D) smaller; expected return

A) greater; risk

86) As expected inflation increases for the coming year, we expected the price of gold to ________ due to a rightward shift the in ________ curve. A) increase; demand B) increase; supply C) decrease; demand D) decrease; supply

A) increase; demand

53) When the economy enters into a boom, normally the demand for bonds ________, the supply of bonds ________, and the interest rate ________. A) increases; increases; rises B) decreases; decreases; falls C) increases; decreases; rises D) decreases; increases; rises

A) increases; increases; rises

23) 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

A) right; falls

49) 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

A) rise; increases

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

A) risk relative to other assets

In his Liquidity Preference Framework, Keynes assumed that money has a zero rate of return; thus, A) when interest rates rise, the expected return on money falls relative to the expected return on bonds, causing the demand for money to fall. B) when interest rates rise, the expected return on money falls relative to the expected return on bonds, causing the demand for money to rise. C) when interest rates fall, the expected return on money falls relative to the expected return on bonds, causing the demand for money to fall. D) when interest rates fall, the expected return on money falls relative to the expected return on bonds, causing the demand for money to rise.

A) when interest rates rise, the expected return on money falls relative to the expected return on bonds, causing the demand for money to fall.

1) When interest rates decrease, the demand curve for bonds shifts to the left.

Answer: FALSE

11) Holding everything else constant, an increase in wealth lowers the quantity demanded of an asset.

Answer: FALSE

14) A movement along the demand (or supply) curve occurs when the quantity demanded (or supplied) changes at each given price (or interest rate) of the bond in response to a change in some other factor besides the bond's price or interest rate.

Answer: FALSE

3) When the federal government's budget deficit decreases, the demand curve for bonds shifts to the right.

Answer: FALSE

7) When income and wealth are rising, the demand for bonds rises and the demand curve shifts to the right.

Answer: TRUE

37) 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

B) increases; right

40) When the federal governments budget deficit increases, the ________ curve for bonds shifts to the ________. A) demand; right B) demand; left C) supply; left D) supply; right

D) supply; right

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

D) supply; rise

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.

E) all of the above.