ECO 315 Exam 1 hmwk questions

Assume that you borrow $2000 at 10% annual interest to finance a new business project. For this loan to be profitable, the minimum amount this project must generate in annual earnings is

$201.

If your nominal income in 1998 is $50,000, and prices increase by 50% between 1998 and 2011, then to have the same real income, your nominal income in 2011 must be

$75,000.

With an interest rate of 6 percent, the present value of $100 to be received next year is approximately

$94.

What is the return on a 5 percent coupon bond that initially sells for $1,000 and sells for $900 next year?

-5 percent

If a security pays $110 next year and $121 the year after that, what is its yield to maturity if it sells for $200?

10 percent

If the price level increases from 200 in year 1 to 220 in year 2, the rate of inflation from year 1 to year 2 is

10%.

If the nominal rate of interest is 2 percent, and the expected inflation rate is -10 percent, the real rate of interest is

12 percent.

If 1-year interest rates for the next three years are expected to be 1, 1, and 1 percent, and the 3-year term premium is 1 percent, than the 3-year bond rate will be

2 percent.

If you expect the inflation rate to be 4 percent next year and a one year bond has a yield to maturity of 7 percent, then the real interest rate on this bond is

3 percent.

A discount bond selling for $15,000 with a face value of $20,000 in one year has a yield to maturity of

33.3 percent.

An $8,000 coupon bond with a $400 coupon payment every year has a coupon rate of

5 percent.

Assuming the same coupon rate and maturity length, when the interest rate on a Treasury Inflation-Indexed Security is 3 percent, and the yield on a nonindexed Treasury bond is 8 percent, the expected rate of inflation is

5 percent.

If real GDP grows from $10 trillion in 2002 to $10.5 trillion in 2003, the growth rate for real GDP is

5%.

You can borrow $5000 to finance a new business venture. This new venture will generate annual earnings of $251. The maximum interest rate that you would pay on the borrowed funds and still increase your income is

5%.

If the expected path of one-year interest rates over the next five years is 4 percent, 5 percent, 7 percent, 8 percent, and 6 percent, then the expectations theory predicts that today's interest rate on the five-year bond is

6 percent.

I purchase a 10 percent coupon bond. Based on my purchase price, I calculate a yield to maturity of 8 percent. If I hold this bond to maturity, then my return on this asset is

8 percent.

Which of the following bonds would you prefer to be buying?

a $10,000 face-value security with a 10 percent coupon selling for $9,000

If the interest rates on all bonds rise from 5 to 6 percent over the course of the year, which bond would you prefer to have been holding?

a bond with one year to maturity

When the yield curve is flat or downward-sloping, it suggests that the economy is more likely to enter

a recession.

A plot of the interest rates on default-free government bonds with different terms to maturity is called

a yield curve.

In the figure above, a factor that could cause the supply of bonds to increase (shift to the right) is

expectations of more profitable investment opportunities.

The U-shaped yield curve in the figure above indicates that short-term interest rates are expected to

fall sharply in the near-term and rise later on.

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 ________

fall; left

The present value of an expected future payment ________ as the interest rate increases.

falls

Holding everything else constant, if the price of a Bitcoin becomes less volatile, the demand for bonds ________, the price of bonds ________, and the interest rate ________.

falls; falls; rises

The typical shape for a yield curve is

gently upward sloping.

Financial markets have the basic function of

getting people with funds to lend together with people who want to borrow funds.

The yield to maturity is ________ than the ________ rate when the bond price is ________ its face value.

greater; coupon; below

The purpose of the disclosure requirements of the Securities and Exchange Commission is to

increase the information available to investors.

Athe individual income tax will

increase the interest rate on municipal bonds.

Higher government deficits ________ the supply of bonds and shift the supply curve to the ________, everything else held constant.

increase; right

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

increases

Everything else held constant, an increase in interest rates on student loans

increases the cost of a college education.

If wealth increases, the demand for stocks ________ and that of long-term bonds ________, everything else held constant.

increases; increases

If there is an excess supply of money

individuals buy bonds, causing interest rates to fall.

If the liquidity effect is smaller than the other effects, and the adjustment to expected inflation is slow, then the

interest rate will initially fall but eventually climb above the initial level in response to an increase in money growth.

According to the expectations theory of the term structure

interest rates on bonds of different maturities move together over time.

The riskiness of an asset's returns due to changes in interest rates is

interest-rate risk.

In the market for money, when the Fed decreases the money stock, the money supply curve shifts to the ________ and the interest rate ________, everything else held constant

left; rises

In the bond market, the bond demanders are the ________ and the bond suppliers are the ________.

lenders; borrowers

The figure above illustrates the effect of an increased rate of money supply growth at time period T0. From the figure, one can conclude that the

liquidity effect is larger than the expected inflation effect and interest rates adjust slowly to changes in expected inflation.

The figure above illustrates the effect of an increased rate of money supply growth at time period T0. From the figure, one can conclude that the

liquidity effect is smaller than the expected inflation effect and interest rates adjust slowly to changes in expected inflation.

Of the four effects on interest rates from an increase in the money supply, the initial effect is, generally, the

liquidity effect.

Three factors explain the risk structure of interest rates

liquidity, default risk, and the income tax treatment of a security.

In recent years in Europe, Japan, and the United States, interest rates have remained low because of a combination of

low inflation and a lack of profitable investment opportunities.

Financial intermediaries provide customers with liquidity services. Liquidity services

make it easier for customers to conduct transactions.

An example of the problem of ________ is when a corporation uses the funds raised from selling bonds to fund corporate expansion to pay for Caribbean cruises for all of its employees and their families

moral hazard

When the total value of final goods and services is calculated using current prices, the resulting measure is referred to as

nominal GDP.

When talking about a coupon bond, face value and ________ mean the same thing.

par value

The concept of ________ is based on the common-sense notion that a dollar paid to you in the future is less valuable to you than a dollar today.

present value

The ________ of a coupon bond and the yield to maturity are inversely related.

price

Well-functioning financial markets

produce an efficient allocation of capital.

The sum of the current yield and the rate of capital gain is called the

rate of return.

The ________ interest rate more accurately reflects the true cost of borrowing.

real

Economies of scale enable financial institutions to

reduce transaction costs.

An increase in the expected rate of inflation will ________ the expected return on bonds relative to the that on ________ assets, everything else held constant.

reduce; real

According to the liquidity premium theory of the term structure, a slightly upward sloping yield curve indicates that short-term interest rates are expected to

remain unchanged in the future.

According to the liquidity premium theory of the term structure, a steeply upward sloping yield curve indicates that short-term interest rates are expected to

rise in the future.

The economist Irving Fisher, after whom the Fisher effect is named, explained why interest rates ________ as the expected rate of inflation ________, everything else held constant.

rise; increases

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 ________.

rise; right

In the market for money, when the price level ________, the demand curve for money shifts to the ________ and the interest rate ________, everything else held constant.

rises; right; rises

Everything else held constant, if the expected return on U.S. Treasury 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 U.S. Treasury bonds and the demand for GE stock ________.

rises; rises

When I purchase ________, I own a portion of a firm and have the right to vote on issues important to the firm and to elect its directors

stock

The additional incentive that the purchaser of a Treasury security requires to buy a long-term security rather than a short-term security is called the

term premium.

The equilibrium price and corresponding equilibrium interest rate in the bond market are found where

the bond demand curve and the bond supply curve intersect.

According to the segmented markets theory of the term structure

the interest rate for each maturity bond is determined by supply and demand for that maturity bond.

Every financial market has the following characteristic

It channels funds from lenders-savers to borrowers-spenders.

If bad credit risks are the ones who most actively seek loans and, therefore, receive them from financial intermediaries, then financial intermediaries face the problem of

adverse selection.

A liquid asset is

an asset that can easily and quickly be sold to raise cash.

In the figure above, the factor responsible for the decline in the interest rate is

an increase in the money supply.

A key assumption in the segmented markets theory is that bonds of different maturities

are not substitutes at all.

A goal of the Securities and Exchange Commission is to reduce problems arising from

asymmetric information

According to the expectations theory of the term structure, the interest rate on a long-term bond will equal the ________ of the short-term interest rates that people expect to occur over the life of the long-term bond.

average

Financial markets promote economic efficiency by

channeling funds from savers to investors.

Negative yields to maturity imply that bond purchasers are better off to hold cash. Acceptance of slightly negative yields by purchasers in recent times suggest that the

convenience of storing large sums is also important to decisions.

A credit market instrument that pays the owner a fixed coupon payment every year until the maturity date and then repays the face value is called a

coupon bond.

In the market for money, a lower level of income causes the demand for money to ________ and the interest rate to ________, everything else held constant.

decrease; decrease

An increase in the interest rate

decreases the quantity of money demanded.

When the economy slips into a recession, normally the demand for bonds ________, the supply of bonds ________, and the interest rate ________, everything else held constant.

decreases; decreases; falls

Holding everything else constant, if interest rates are expected to increase, the demand for bonds ________ and the demand curve shifts ________.

decreases; left

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 ________

demand; fall

When the inflation rate is expected to increase, the ________ for bonds falls, while the ________ curve shifts to the right, everything else held constant.

demand; supply

Reducing risk through the purchase of assets whose returns do not always move together is

diversification.

When the price of a bond decreases, all else equal, the bond demand curve

does not shift.

The concept of diversification is captured by the statement

don't put all your eggs in one basket.

A share of common stock is a claim on a corporation's

earnings and assets.

The ________ interest rate is adjusted for expected changes in the price level.

ex ante real

The interest rate that describes how well a lender has done in real terms after the fact is called the

ex post real interest rate.

According to the liquidity premium theory of the term structure

the interest rate on long-term bonds will equal an average of short-term interest rates that people expect to occur over the life of the long-term bonds plus a term premium.

The price paid for the rental of borrowed funds (usually expressed as a percentage of the rental of $100 per year) is commonly referred to as the

the interest rate.

When the growth rate of the money supply increases, interest rates end up being permanently lower if

the liquidity effect is larger than the other effects.

The expectations theory and the segmented markets theory do not explain the facts very well, but they provide the groundwork for the most widely accepted theory of the term structure of interest rates

the liquidity premium theory.

The gross domestic product is

the market value of all final goods and services produced in an economy in a year.

The interest rate on Treasury Inflation-Indexed Securities can be roughly interpreted as

the real interest rate.

The term structure of interest rates is

the relationship among interest rates on bonds with different maturities.

The time and money spent in carrying out financial transactions are called

transaction costs.

In his Liquidity Preference Framework, Keynes assumed that money has a zero rate of return; thus

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

The interest rate that equates the present value of payments received from a debt instrument with its value today is the

yield to maturity.