FIN 3100 - Chapter 2 SmartBook

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

False: The equilibrium interest rate is only temporary and changes over time due to several factors.

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

True or false: The unbiased expectations theory posits that current long-term interest rates are geometric averages of current and expected future short-term interest rates.

True

The demand for loanable funds _________ as interest rates increase.

decreases

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

The higher the level of actual or expected inflation, the ______ will be the prices of good and services in the future.

higher

When government monetary policy is restrictive and the money supply is constricted, interest rates will _______.

increase

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

operating revenues; expenditures

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

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

supplier

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

demand; supply

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

retained earnings.

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

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

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

easier

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.

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

liquid

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

supply and demand for funds.

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

Investors demand more funds at lower interest rates because the

cost of borrowing funds is lower.

Nominal interest rates are important because they affect the _________ of most securities traded in the money and capital markets at home and abroad.

price

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

profitable projects

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

U.S. Treasury securities.

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

nominal

Investors are willing to supply more funds at higher interest rates because

their reward is higher.

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

higher; lower lower; higher

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

maturity

The cumulative sum of past U.S. government deficits is called the

national debt.

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

suppliers; demanders

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

Nominal interest rates tend to _________ over time.

vary

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

Household wealth and interest rates

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.

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

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.

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

forward

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

high; increase

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

higher

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

budget deficit.

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

decline; decrease. improve; increase.

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

largest; largest

Long maturity securities have more _______ than short maturity securities.

price risk

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

higher; higher lower; lower

The supply of loanable funds _________ with increasing interest rates.

increases

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

Riskiness of investments and immediate consumption needs

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

a surplus of

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

the Fisher effect.

Businesses demand funds for which of the following reasons?

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

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

households.

As an investor's utility (enjoyment) of assets obtained with borrowed funds increases, the demand for borrowed funds will _______ and interest rates will ________.

increase; increase

During the recent financial crisis, the federal government attempted to rescue the U.S. economy from a deep economic recession by _________ the supply of funds to business and consumers.

increasing

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.

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

maturity premium.

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

higher; higher lower; lower

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

a deficit of

Due to the value of the conversion option, convertible securities generally pay ________ rate of interest than similar non-convertible securities.

a lower

The risk that a security issuer will fail to make interest and principal payment on the security is called _______ risk.

default