SMART BOOK WEEK 2

True or false: Market forces react to disequilibrium with a change in the equilibrium interest rate.

True

When the government's budgeted expenditures exceed its tax revenues, it is said to have a

budget deficit.

A decrease in the non-price restrictions on borrowers means that borrowers will find it overall ________ to borrow funds.

easier

According to the unbiased expectations theory, in equilibrium the return to an investor from holding one "n" year maturity security must _______ the return from holding a series of "n" one-year maturity securities.

equal

In a growing economy, the demand for funds is _______ and interest rates will tend to ________.

high; increase

The financial sector of U.S. business is the _________ provider of loanable funds and the _________ user of loanable funds.

largest; largest

Short-term securities have a more active secondary market and hence are more ________ than long-term securities.

liquid

The theory that investors must be compensated for the higher price risk and lower liquidity inherent in longer-term securities is called the

liquidity premium theory.

A single payment received at the beginning or end of an investment period is called a

lump sum payment.

When the non-price restrictions on borrowing are reduced, borrowers will demand ______ funds and interest rates will _______.

more; increase

Long maturity securities have more _______ than short maturity securities.

price risk

The loanable funds theory views the level of interest rates as being determined by

supply and demand for funds.

The equilibrium interest rate for a security is the interest rate where the _______ and ________ intersect.

supply curve; demand curve

Market segmentation theory posits that the ______ and ______ of securities of differing maturities determines the interest rate at each maturity and hence the shape of the yield curve.

supply; demand

The relationship among the real risk-free rate, the expected inflation, and the nominal interest rate is called

the Fisher effect.

A rate is an expected or "implied" rate on a short-term security that is to be originated at some point in the future.

Blank 1: forward

A risk-free investment is one in which the return is

Certain

True or false: The equilibrium interest rate is permanent, since it does not change over time.

False

An increase in which of the following factors will cause households to increase their supply of loanable funds provided?

Interest rates Household wealth

A security whose returns are tax-free can pay _______ interest than a taxable security and still be attractive to investors.

LOWER

An increase in which of the following factors will cause households to decrease their supply of loanable funds provided?

Riskiness of investments Immediate consumption needs

Businesses demand funds for which of the following reasons?

To satisfy short-term working capital needs for inventory and receivables To invest in long-term (fixed) assets like plant and equipment

True or false: The unbiased expectations theory acknowledges that an investor with an "n" year investment horizon has a choice between purchasing one "n" year maturity security, or a series of "n" one-year maturity securities.

True

The most frequently reported and analyzed yield curve is the curve for

U.S. Treasury securities.

__________ are regarded as having no default risk.

U.S. government securities

If the rate of interest is set below the equilibrium rate, there will be _________ loanable funds.

a deficit of

If the rate of interest is set above the equilibrium rate, there will be _________ loanable funds.

a surplus of

A series of equal cash flows received at fixed intervals over an entire finite investment period are

annuity payments.

Investors demand more funds at lower interest rates because

cost of borrowing funds is lower.

Investors demand more funds at lower interest rates because the

cost of borrowing funds is lower.

The difference between the nominal rate quoted on a security and the rate quoted on a Treasury security with similar characteristics is called the

credit risk premium. default risk premium

The default risk premium tends to _______ when the economy is _________.

decrease; expanding increase; contracting

The Fisher effect predicts that the ________ expected inflation is, the _________ will be nominal interest rates.

higher; higher lower; lower

The ______ the interest rate "r", the _______ the value of future value.

higher; higher lower; lower

The _______ the default risk of a security, the _______ the interest rate demanded by the buyer.

higher; higher lower; lower

The _______ the level of actual or expected inflation, the _______ the level of interest rates.

higher; higher lower; lower

The ______ the interest rate "r", the _______ the value of present value.

higher; lower lower; higher

When economic conditions in a country ________, the supply of loanable funds will tend to ________ in that country.

improve-increase declines-decreases

As the risk of an investment increases, investors are willing to supply less funds to invest in it. The supply curve shifts to the left and the interest rate _________.

increases

The supply of loanable funds _________ with increasing interest rates.

increases

A real risk-free interest rate is what an investor could earn in a world without

inflation.

The Blank______ the interest rate "r", the Blank______ the present value of the annuity. Multiple select question.

lower; higher higher; lower

The ______ the annuity payment "PMT", the _______ the present value of the annuity.

lower; lower higher; higher

The theory that argues that investors have specific maturity preferences and must be paid a premium to hold securities of a different maturity is the

market segmentation theory.

Both the unbiased expectations theory and the liquidity premium theory ignore investor preferences regarding the ________ of the securities they hold.

maturity

The difference between the required yield on long and short-term securities of the same characteristics except maturity is called the

maturity premium.

The prices of securities with longer maturities are ________ sensitive to changes in interest rates when compared to shorter maturity securities.

more

The quoted rates actually observed by investors in financial markets are called ________ rates.

nominal

Investors may demand a liquidity risk premium for longer-maturity securities to compensate them for the greater _________ they are exposed to compared to shorter-maturity securities.

price risk

When interest rates are high, businesses prefer to finance investments with

retained earnings.

Which of the following is the correct equation for calculating the future value of a lump sum at "n" periods in the future given interest rate "r"?

FV = PV(1+r)^n

Which of the following is the correct equation for calculating the present value of a lump sum received "n" periods in the future given interest rate "r"?

PV = FV/(1+r)^n

A consequence of the unbiased expectations theory is that if investors believe that short-term interest rates will _______ in future periods, the yield curve will be ________ sloped.

decrease; negatively increase; positively

The non-financial sectors of U.S. business ________ far more loanable funds than they ________.

demand; supply

The tendency of foreign investors to invest their funds in risk-free U.S. government securities during times of crisis is referred to as a

flight to quality.

Foreign investors supply funds to U.S. financial markets when interest rates on U.S. securities are __________ than on comparable securities in their home markets.

higher

Investors in callable securities generally require _______ interest compared to non-callable securities.

higher

The ______ the annuity payment "PMT", the _______ the future value of the annuity.

higher; higher lower; lower

The ______ the interest rate "r", the _______ the future value of the annuity.

higher; higher lower; lower

For securities that are not highly liquid, investors demand a(n) ___________ to the interest rate as compensation.

liquidity risk premium

One model that is commonly used to explain interest rates and interest rate movements is called the

loanable funds theory.

When financial market participants have ______ near-term spending needs, the supply of loanable funds at every interest rate is ________.

lower; higher higher; lower

The term structure of interest rates represents the market's current expectations of future short-term interest rates, so the _____ can be used to forecast forward rates.

unbiased expectations theory

The theory that asserts that the yield curve at a given point in time reflects the market's current expectations of future short-term interest rates is the

unbiased expectations theory.

Nominal interest rates tend to _________ over time.

vary

A highly liquid asset has which of the following characteristics?

Low transaction cost Can be sold quickly Predictable price

The demand for loanable funds _________ as interest rates increase.

decreases

The largest net supplier of loanable funds in the U.S. is

households.

The decrease in funds demanded with increasing interest rates will lead to a demand curve that is _________ sloped.

negatively

Governments demand funds to finance temporary imbalances between __________ and ___________.

operating revenues; expenditures

When local governments temporarily invest tax revenues in financial markets until the funds are needed, they become a _________ of loanable funds.

supplier

The loanable funds theory categorizes all market participants (consumers, businesses, governments, and foreign participants) as net Blank______ or Blank______ of funds.

suppliers; demanders

As the _______ of financial market participants increases, the absolute dollar value available for investments purposes increases, and the supply curve shifts to the ________.

wealth; right

The relationship between interest rates and the maturity of securities that differ only in their maturity characteristic is called the term structure of interest rates, or the

yield curve.

The greater the number of _________, the greater the demand for funds by businesses.

profitable projects

The increase in funds supplied with increasing interest rates will lead to a supply curve that is _________ sloped.

positively

Over time, the most common shape of the yield curve is _______ indicating that on average, the maturity premium is ________.

positively sloped; positive

The higher the level of actual or expected inflation, the (higher/lower) will be the prices of good and services in the future.

Blank 1: higher