TAMU FINC 409 Ch 8

yield curve

graphic presentation of the term structure of interest rates at a given point in time

market segmentation theory

hold that securities of different maturities are not perfect substitutes for one another

loanable fund theory

holds that interest rates are a function of the supply of and demand for loanable funds

dealer system

composed of a closely linked network of dealers and brokers in government securities with an effective marketing network throughout the US

T or F Holding supply constant, a decrease in the demand for loanable funds will result in a decrease in interest rates

true

T or F If the Fed changes discount policies it may affect the supply of loanable funds

true

T or F Interest rates will move from one equilibrium level to another if an unanticipated change occurs that causes the demand for loanable funds to change

true

T or F Tax deferral on investments may increase the volume of savings

true

T or F The interest rate that is the basic price that equates the demand for supply of loanable funds in the financial markets

true

T or F The liquidity premium is compensation for those financial debt instruments that cannot be easily converted to cash at prices copse to their estimated fair market values

true

T or F The liquidity premium is the compensation that investors demand for holding securities that cannot easily be converted to cash without major price discounts

true

T or F The loanable funds theory states that interest rates are a function of the supply of and demand for loanable funds

true

T or F The maturity risk premium is the compensation expected by investors due to interest rate risk on debt instruments with longer maturity

true

T or F The nominal interest rate may include a default risk premium

true

T or F The risk free rate of interest is the interest rate on a debt instrument with no default, maturity, or liquidity risks

true

T or F The risk-free rate of interest is equal to the real rate of interest plus a premium for inflation

true

T or F There are 2 basic sources of loanable funds: current savings and the expansion of deposits of depository institutions

true

T or F There is an inverse relation between debt instruments prices and nominal interest rates in the marketplace

true

T or F While the Federal Reserve strongly influences the supply of funds, the Treasury's major influence is on the demand for funds, as it borrows heavily to finance federal deficits

true

T or F The demand for loanable funds comes form all sectors of the economy

ture

high-yield bonds (junk bonds)

with rating lower than Baa, bonds that have a substantial probability of default

A maturity ris premium at a pertain point in time may be expressed by comparing the interest rates on a. a Treasury bill and a Treasury bond b. a Treasury bill and a long-term corporate bond c. a Treasury bill and a Federal Reserve note d. a risky stock and a comparable maturity US Treasury security e. none of the above

a. a Treasury bill and a Treasury bond

A basic source of loanable funds is: a. current savings that flow through financial institutions b. futures savings and investment by the Federal Reserve c. current and future savings d. investment by the Federal Reserve and expansion of deposits by insurance companies

a. current savings that flow through financial institutions

When investors expect higher inflation rates they will require _____ nominal interest rates so that a real rate of return will remain after the inflation a. higher b. lower c. the same d. there is no connection between inflation expectations and nominal interest rates

a. higher

A decrease in the supply for loanable funds accompanied by an increase in demand will cause interest rates to: a. increase b. decrease c. stay the same d. not enough information to tell

a. increase

A decrease in the supply for loanable funds, holding demand constant, will cause interest rates to: a. increase b. decrease c. stay the same d. not enough information to tell

a. increase

An increase in the demand for loanable funds, holding supply constant, will cause interest rates to: a. increase b. decrease c. stay the same d. not enough information to tell

a. increase

An increase in the supply for loanable funds, holding demand constant, will cause interest rates to a. increase b. decrease c. stay the same d. not enough information to tell

a. increase

Holding demand constant, a decrease in the supply of loanable funds will result in a(n) ____ in interest rates a. increase b. decrease c. increase or decrease d. none of the above

a. increase

The basic price that equates the demand for and supply of loanable funds in the financial markets is the_____ a. interest rate b. yield curve c. term structure d. cash price e. none of the above

a. interest rate

Compensation for those financial debt instruments that cannot be easily converted to cash at prices close to estimated fair market values is termed: a. liquidity premium b. market risk premium c. maturity premium d. none of the above

a. liquidity premium

If interest rates increase because of a previously unanticipated inflation rate risk, the value of: a. long-lived fixed-rate debt instruments will decline more than short-lived fixed rate debt instruments b. long-loved fixed-rate debt instruments will decline less than short-lived fixed-rate debt instruments c. neither set of debt instruments will decline d. all other things being equal, both should decline equally

a. long- lived fixed-rate debt instruments will decline MORE than short-lived fixed-rate debt instruments

As interest rates fall, the prices of existing bonds will: a. fall b. stay the same c. fall d. either a or b, depending on the state of the economy

a. rise

In an inflationary period, interest rates have a tendency to: a. rise b. fall c. stay the same d. act erratically

a. rise

demand-pull inflation

an excess demand for good and services during periods of economic expansion relative to supply

inflation

an increase in the price of good or services that is not offset by an increase in quality

inflation premium

average inflation rate expected over the life of the instrument

Holding supply constant, a decrease in the demand of loanable funds will result in a(n) ___ in interest rates a. increase b. decrease c increase or decrease d. none of the above

b decrease

What is the real rate of interest if the nominal rate of interest if 15%, the IP is 5%, the DRP is 3%, the MRP is 4%, and the LP is 1%? a. 4% b. 2% c. 5% d. 13%

b. 2% r = RR + IP + DRP + MRP +LP 15% = RR+5%+3%+4%+1% RR= 15%-13% = 2%

If you expect the inflation premium to be 2%, the default risk premium to be 1% and the real interest rate to be 4%, what interest would you expect to observe in the marketplace under the simplest form of market interest rates? a. 4% b. 7% c. 2% d. 1%

b. 7% r= RR + IP + DRP r = 4% + 2%+ 1% = 7%

The basic sources of loanable funds are: a. short-term funds and currency b. current savings and the creation of new funds through the expansion of credit by depository institutions c. contractual savings and commercial bank credit d. bank loans and the creation of new funds throughout the contraction of credit by depository institutions

b. current savings and the creation of new funds through the expansion of credit by depository institutions

A decrease in the demand for loanable funds, holding supply constant, will cause interest rates to a. increase b. decrease c. stay the same d. not enough information to tell

b. decrease

An increase in the supply for loanable funds accompanied by a decrease in demand will cause interest rates to: a. increase b. decrease c. stay the same d. not enough information to tell

b. decrease

The major factor that determines the volume of savings, corporate as well as individual, is the: a. volume of spending b. level of national income c. amount of private pension plans d. amount of life insurance policies

b. level of national income

interest rate

basic price that equates the demand for and supply of loanable fund in the financial markets

If the nominal rate of interest is 10%, the real rate of interest is 3%, the default premium is 2%, the liquidity premium is 0.5%, and the maturity premium is 1.5%, then the inflation premium must be____. a. 2% b. 2.5% c. 3% d. 4.5%

c. 3% r = RR + IP + DRP + MRP + LP 10% = 3% + IP + 2% + 1.5% +.5% IP = 10% - 7% = 3%

If you expect the inflation premium to be 2%, the default risk premium to be 1% and the real interest rate to be 4%, what interest would you expect to observe in the marketplace on short term Treasury securities? a. 8% b. 7% c. 6% d. 5%

c. 6% DRP and LP on Treasury securities are 0% MRP short term are 0% r= RR + IP + DRP +MRP + LP r = 4% +2% + 0% + 0% + 0% = 6%

Which of the following statements is most correct? a. The liquidity preference theory holds that interest rates are determined by the supply of and demand for loanable funds b. The loanable funds theory and the liquidity preference theory are incompatible with each other because one is right and the other is wrong c. Marketable US securities are mainly sold through dealers and have interest payments that are federally taxable d. The market segmentation theory holds that securities of different maturities are perfect substitutes for each other

c. Marketable US securities are mainly sold through dealers and have interest patents that are federally taxable

As interest rates rise, the prices of existing bonds will: a. rise b. stay the same c. fall d. either a or b, depending on the state of the economy

c. fall

Sources of loanable funds do not include a. current savings b. the expansion of deposits by depository institutions c. federal deficits d. all of the above are sources of loanable funds

c. federal deficits

An unanticipated increase in inflation should a. decrease the demand for loanable funds b. decrease the interest rate on loans c. increase the interest rate on loans d. none of the above

c. increase the interest rate on loans

Long-run inflation expectations in the capital markets can be estimated by: a. subtracting the rap return and maturity risk premium components from the rate on short-term Treasury bills b. adding the real return and maturity risk premium components to interest rates on long-term corporate bonds c. subtracting the real return and maturity risk premium components from the rate on long-term Treasury securities d. adding the real return and maturity risk premium components to interest rates on long-term securities

c. subtracting the real return and maturity risk premium components from the rate on long-term Treasury securities

Which of the following is NOT a determinant of market interest rates? a. the inflation premium b. the maturity risk premium c. the volatility risk premium d. the real rate of interest

c. the volatility risk premium

speculative inflation

caused by the expectation that prices will continue to rise, resulting in increased buying to avoid even higher future prices

liquidity premium

compensation for those financial debt instruments that cannot easily be converted to cash at prices close to their estimated fair market values

Which of the following statements is false? a. a major determinant in the long run of the volume of agings is the level of taxes b. the money market involves obtaining and trading of credit and debt instruments with maturity of one year or less c. bond risk premiums follow changes in investor optimism/pessimism about expected economic activity d. a high interest rate level but downward sloping yield curve is generally perceived as being conductive to future economic expansion

d. a high interest rate level but downward sloping yield curve is generally perceived as being conductive to future economic expansion

The default risk premium at a certain point in time may be expressed by comparing the interest rate on a. a Treasury bill and a Treasury bond b. a Treasury bill and a long-term corporate bond c. a Treasury bill and the commercial paper rate d. a risky security and a comparable maturity US Treasury security

d. a risky security and comparable maturity US Treasury security

Which of the following factors affects the supply of loanable funds? a. the volume of savings b. expansion of deposits by banks c. attitudes about liquidity d. all of the above

d. all of the above

Which of the following factors directly impact the level of interest rates? a. risk b. marketability c. maturity d. all of the above

d. all of the above

Which of the following may accumulate savings? a. individuals b. corporations c. sometimes governmental units d. all the above may have savings

d. all the above may have savings

If the nominal interest rate for Treasury bonds is 8% and the risk-free rate is 3%, the expected inflation rate must be: a. 3% b. 5% c. 11% d. cannot be determined without additional information

d. cannot be determined without additional information

Holding demand constant, an increase in the supply of loanable funds will result in a(n)_____ in interest rates a. increase b. decrease c. increase or decrease d. none of the above

d. decrease

Which of the following costs serves to compensate the lender for not being able to quickly convert the loan to cash at a price closer to he estimated market value of the loan? a. administrative costs of making the loan b. cost of paying for the risk involved c. cost to offset the likelihood of inflation d. liquidity premium

d. liquidity premium

If the nominal rate of interest is 8%, the real rate of interest is .75%, the risk-free rate of interest is 2%, the default premium is 4%, the liquidity premium is .5%, and the maturity premium is 1.5%, then the inflation premium must be ____. a. 2% b. 2.5% c. 3% d. none of the above

d. none of the above Risk-free rate = RR + IP 2% = .75% +IP IP = 1.25%

A decrease in the supply for loanable funds accompanied by a decrease in demand will cause interest rates to: a. increase b. decrease c. stay the same d. not enough information to tell

d. not enough information to tell

An increase in the supply for loanable funds accompanied by an increase in demand will cause inters rates to: a. increase b. decrease c. stay the same d, not enough information to tell

d. not enough information to tell

_____ states that interest rates are a function of the supply and demand for loanable funds a the expectations theory b. the market segmentation theory c. the liquidity theory d. the loanable funds theory

d. the loanable funds theory

T or F The shorter the maturity of a fixed-rate debt instrument, the greater the reduction in its value to a given interest rate increase

false

T or F An economy with a large share of young people will have more total savings than one with more late middle-aged people

false

T or F Business will increase current long-term borrowing if they forecast a decrease in interest rates in the near future

false

T or F Interest rates in the United States are only influenced by domestic factors

false

T or F The Treasury's major influence through its borrowing to finance federal deficits is on the supply rather than demand for loanable

false

T or F The interest rate that is observed in the marketplace is called real interest rate

false

T or F The maturity risk premium is the added return expected by lenders because of the expectation of inflation

false

T or F The maturity risk premium is the compensation that investors demand for holding securities that cannot easily be converted to cash without major price discount

false liquidity premium

T or F The risk-free rate of interest is found by combining the real rate of interest and the rate paid on US Treasury bills

false combine real rate and inflation premium, risk free rate in US is represented by US Treasury debt instruments

T or F Holding demand constant, an increase in the supply of loanable funds will result in an increase in interest rates

false decrease supply curve---> increased interest rate

T or F Interest rates generally fall during periods of expansion and rise during economic contraction

false discussion of historical changes in interest rate levels

T or F The default risk premium is the compensation that investors demand for holding securities that cannot be converted to cash without major price discounts

false liquidity premium

T or F Holding supply constant, an incase in the demand for loanable funds will result in a decrease in interest rates

false increased demand curve---> increased interest rate

Treasury bills

federal obligations issued with maturities up to one year

Treasury bonds

federal obligations issued with original maturities in excess of 10 years, often issued for 20 and sometimes even 30 years

Treasury notes

federal obligations usually issued for maturities of 1 to 10 years

liquidity preference theory

holds that investors or debt instrument holders prefer to invest short term of they have greater liquidity and less maturity or interest rate risk

term structure

indicated the relationship between interest rates or yields and maturity of comparable quality debt instruments

default risk premium

indicates compensation for the possibility that the borrower will not pay interest and/or will not repay principle according to the financial instrument's contractual arrangements

real rate of interest

interest rate on a risk-free debt instrument when no inflation is expected

nominal interest rate

interest rate that is observed in the marketplace and that included a premium for expected inflation

cost-push inflation

occurs when prices are raised to cover rising production costs, such as wages

Investment grade bonds

ratings of Baa or higher that meet financial institution investment standards

interest rate risk

reflects the possibility of changes or fluctuations in market value of fixed-rate debt instruments as market interest rates change over time

default risk

risk that a borrower will not pay interest and/or repay the principal on a loan or other debt instrument according to the agreed contractual terms

marketable government securities

securities that can be purchased and sold through customary market channels

non marketable government securities

securities that connote be transferred to other persons or institutions and can be redeemed only by being turned into the US government

expectations theory

states that the shape of the yield curve reflects investor expectations about future inflation rates

maturity risk premium

the added return expected by lenders or investors because of interest rate risk on instruments with longer maturities

risk- free rate of interest

the combination of the real rate of interest and the inflation premium, which in the US is represented by US Treasury debt instruments or securities

administrative inflation

the tendency of prices, aided by union-corportaion contracts, to rise during economic expansion and to resist decline during recessions

T or F A "shock" may be defined as an unanticipated change that will cause the demand for, or supply, of loanable funds to change

true

T or F Holding demand constant, a decrease in the supply of loanable funds will result in an increase in interest rates

true