Bnad301 Test 1
A ________ is bought at a price below its face value, and the ________ value is repaid at the maturity date.
discount bond; face
When economists say that money promotes ________, they mean that money encourages specialization and the division of labor.
efficiency
An important characteristic of the modern payments system has been the rapidly increasing use of
electronic fund transfers.
In the figure above, a factor that could cause the demand for bonds to shift to the right is: Graph looks like tick tack toe B1 left x B2 right x
expectations of lower interest rates in the future.
The present value of an expected future payment ________ as the interest rate increases.
falls
If the price level doubles, the value of money
falls by 50 percent.
Paper currency that has been declared legal tender but is not convertible into coins or precious metals is called ________ money.
fiat
Money is
anything that is generally accepted in payment for goods and services or in the repayment of debt.
Compared to checks, paper currency and coins have the major drawbacks that they
are easily stolen.
Which of the following is a disadvantage of using checks as a means of payment?
All the paper shuffling required to process checks is costly.
You have just won $20,000 in the state lottery, which promises to pay you $1,000 (tax free) every year for the next twenty years. The interest rate is 5%. In reality, you receive the first payment of $1,000 today, which is worth ______ today. The value of the second $1,000 payment is worth ________ today. Your total lottery winnings are actually worth ________ $20,000 to you today.
$1,000 $852.38 less than
How much would you pay for a perpetual bond that pays an annual coupon of $80 per year and yields on competing instruments are 5%? You would pay $______ If competing yields are expected to change to 10%, what is the current yield on this same bond assuming that you paid $1,600? The current yield is _______ If you sell this bond in exactly one year, having paid $1,600, and received exactly one coupon payment, what is your total return if competing yields are 10%? Your total return is ___
$1,600 5% -45.00%
If you expect the inflation rate to be 12 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
-5 %
The return on a 5 percent coupon bond that initially sells for $1,000 and sells for $950 next year is
0%
Calculate the present value of aa $1,300 discount bond with 4 years to maturity if the yield to maturity is 4%. The present value is $
1,111.25
If a $10,000 face−value discount bond maturing in one year is selling for $5,000, then its yield to maturity is
100%
If the nominal rate of interest is 2 percent, and the expected inflation rate is −10 percent, the real rate of interest is
12%
Refer to the diagram to the right. What is the risk and liquidity premium on the 30-year Treasury bond in 2002?
2.00%
The demand curve and supply curve for one-year discount bonds with a face value of $1,030 are represented by the following equations: Bd:Price= −0.8Quantity + 1,160 Bs: Price= Quantity + 720 The expected equilibrium quantity of bonds is The expected equilibrium price of bonds is The expected interest rate in this market is
244 $964 6.85%
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 %
Calculate the yield to maturity (YTM) for a one-year bond with a purchase price of $800, a face value of $1,000, and a current yield of 10%. The yield to maturity is ____ The yield to maturity on the bond given above is _____ the YTM of a similar $1,000 20-year bond with a current yield of 20% selling for
35.0% Greater than
Using the numbers 1, 2, 3, and 4, rank the following four assets from most liquid (1) to least liquid (4). A 10,000-square-foot office building $2,000 in cash A $10,000 Treasury bill 100 shares of Google stock
4 1 2 3
Refer to the diagram to the right. What is the risk premium on 10-year corporate Baa bonds in 2002?
4.75%.
If a perpetuity has a price of $500 and an annual interest payment of $25, the interest rate is
5%
If $22,050 is the amount payable in two years for a $20,000 simple loan made today, the interest rate 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.
A $1000 face value coupon bond with a $60 coupon payment every year has a coupon rate of
6%
Assume you just deposited $1,200 into a bank account. The current real interest rate is 2%, and inflation is expected to be 7% over the next year. What nominal rate would you require from the bank over the next year? The required nominal rate would be How much money will you have at the end of one year? You will have ____ at the end of the year. If you are saving to buy a fancy bicycle that currently sells for $1,250, will you have enough to buy it?
9% $1,308 Uncertain. It depends on whether the price of the bicycle increases with inflation.
Refer to the diagram to the right where a nominal interest rate (the 6-month annualized Treasury rate) and the rate of inflation are plotted. In which of the three decades (1970-79, 1980-89, 1990-99) is the inflation rate the most stable? The inflation rate is most stable during the In which of the three decades does the economy experience disinflation? Disinflation is experienced during the In which of the three decades is the real interest rate , on average, the highest? On average, the real interest rate is highest during the
90s 80s 80s
There is a perceived increase in the riskiness of bonds. Bond Market A: arrows to left under Bd Bond Market B: arrows to left above bd Bond Market C: arrow to right above bd Which market is likely to represent corporate Baa bonds? Which market is likely to represent the 10-year Treasury note?
A C
Risk premiums on corporate bonds are usually anticyclical; that is, they decrease during business cycle expansions and increase during recessions. Why is this so?
As the economy enters an expansion, there is greater likelihood that borrowers will be able to service their debt.
________ money could be used for some other purpose other than as a medium of exchange, for example, gold coins could be melted down and turned into gold jewelry.
Commodity
Which of the following is included in both M1 and M2?
Currency
Retired persons often have much of their wealth placed in savings accounts and other interest-bearing investments, and complain whenever interest rates are low. Which of the following, if true, would be a valid complaint?
Expected inflation is falling at a slower rate than nominal interest rates.
"According to the expectations theory of the term structure, it is better to invest in one-year bonds, reinvested over two years, than to invest in a two-year bond, if interest rates on one-year bonds are expected to be the same in both years." Is this statement true, false, or uncertain?
False: These investments are almost of the same profitability.
The demand curve and supply curve for one-year discount bonds with a face value of $1,000 are represented by the following equations: Bd:Price = −0.6Quantity + 1,160 Bs:Price = Quantity + 690 Suppose that, as a result of monetary policy actions, the Federal Reserve sells 90 bonds that it holds. Assume that bond demand and money demand are held constant. Which of the following statements is true?
If the Fed increases the supply of bonds in the market by 90, at any given price, the bond supply equation will become Price=Quantity + 600. The expected interest rate on a one-year discount bond will increase to 5.26%.
Yields for the following 10-year corporate bonds are listed in the table below along with their Moody's bond rating. 10-year Corporate Bond& Reference Number, Moody's Rating, Yield (% annually) 1 C 8.50% 2 Baa 7.45% 3 Ca 7.75% 4 A 4.60%
If the yield on a 10-year T-note is 4.00%, what is the risk premium on bond #4? The risk premium is .60% What is a likely range of yields for a 10-year corporate bond with a Ba rating? The minimum yield is 7.45% and the maximum yield is 7.75%.
Which of the following is a true statement?
Income is a flow variable.
Using the formula given below: Rbonds =(F − P)/P if the market price of a $1,200-face-value discount bond changes from $950 to $925, the yield to maturity
Increases by 3.41
Which of the following are true of fixed payment loans?
Installment loans and mortgages are frequently of the fixed payment type.
Suppose the interest rates on one-, five-, and ten-year U.S. Treasury bonds are currently 3%, 6%, and 6%, respectively. Investor A chooses to hold only one-year bonds, and Investor B is indifferent with regard to holding five- and ten-year bonds. Which theories best explain the behavior of Investors A and B?
Investor A's preferences are best explained by the segmented markets theory, while Investor B's preferences are more consistent with the expectations theory.
Which of the following bonds would have the highest default risk?
Junk bonds
What would happen to the risk premium on corporate bonds if brokerage commissions were lowered in the corporate bond market?
Lower brokerage commissions for corporate bonds would make them more liquid and thus increase demand, which would lower the risk premium
Would you be more or less willing to buy a house under the following circumstances: You just inherited $100,000. Real estate commissions fall from 6% of the sales price to 5% of the sales price. You expect Microsoft stock to double in value next year. Prices in the stock market become more volatile. You expect housing prices to fall.
More willing More willing Less willing More willing Less willing
Use the graph and the supply and demand for bonds to show what will happen to interest rates if there is a rise in the riskiness of bonds. Using the liquidity preference framework, an increase in the riskiness of bonds will cause:
Move Bd2 to the left an increase in the demand for money, no change in the quantity of money, and a higher interest rate. From the graph, we see that a rise in the riskiness of bonds will cause the interest rate in the liquidity preference framework to increase and cause the interest rate in the bond market to increase
Using the liquidity preference framework, show why interest rates are procyclical (rising when the economy is expanding and falling during recessions). Suppose GDP is rising.
Move MD2 up
For every $1,000 of annual income, households maintain average cash balances (their demand for money) of $200. How will growth in GDP affect interest rates, holding the money supply constant? Use the liquidity preference framework
Move MD2 up mS
The figure to the right depicts the market for money. Show the appropriate change in the money supply that would cause an increase in interest rates.
Move Ms2 to the left
Which of the following statements is true?
Only a coupon bond can have a negative nominal interest rate.
descriptions of risk, enter correstponding Standard and Poor's rating Description: High grade high quality Highly speculative Upper medium grade Prime maximum safety Speculative
Rating: AA B A AAA BB
The U.S. Treasury offers some of its debt as Treasury Inflation Protected Securities, or TIPS, in which the price of bonds is adjusted for inflation over the life of the debt instrument. TIPS bonds are traded on a much smaller scale than nominal U.S. Treasury bonds of equivalent maturity. What can you conclude about the liquidity premium between TIPS and nominal U.S. bonds?
The liquidity premium for a TIPS bond is usually smaller than inflation compensation in nominal U.S. bond yields of equal maturity.
Which of the following are true for discount bonds?
The purchaser receives the face value of the bond at the maturity date.
In 2010 and 2011, the government of Greece risked defaulting on its debt due to a severe budget crisis. Using bond market graphs, determine how default would affect the risk premium between U.S. Treasury debt and Greek debt with comparable maturity. In the case of default, what would happen to the risk premium between U.S. Treasury debt and comparable maturity Greek debt?
The risk premium would increase, which corresponds to segment B on the graphs above.
Why is simply counting currency an inadequate measure of money?
There are other liquid assets similar to currency that can be used as money to purchase goods and services.
M1 money growth in the U.S. was about 16% in 2008, 7% in 2009, and 9% in 2010. Over the same time period, the yield on 3-month Treasury bills fell from almost 3% to close to 0%. Given these high rates of money growth, why did interest rates fall, rather than increase?
The income, price-level, and expected-inflation effects were small relative to the liquidity effect.
Why do U.S. Treasury bills have lower interest rates than large-denomination negotiable bank CDs?
Treasuries are considered to be risk-free debt instruments.
In Brazil, a country that underwent a rapid inflation before 1994, many transactions were conducted in dollars rather than in reals, the domestic currency. During this period, the US dollar served what property or properties in Brazil?
Unit of account Medium of exchange Store of value
If the yield curve suddenly becomes steeper, how would you revise your predictions of interest rates in the future?
You would RAISE your predictions of future interest rates.
In a barter economy the number of prices in an economy with N goods is
[N(N − 1)]/2.
When paper currency is decreed by governments as legal tender, legally it must be ________.
accepted as payment for debts
In Keynes's liquidity preference framework, if there is excess demand for money, there is
an excess supply of bonds.
A smart card is the equivalent of
cash
The interest rate on a consol equals the
coupon payment divided by the price.
The components of the U.S. M1 money supply are demand and checkable deposits plus
currency plus travelers checks.
A discount bond will have a negative nominal interest rate when the:
current bond price is greater than its face value.
If the price of gold becomes less volatile, then, other things equal, the demand for stocks will ________ and the demand for antiques will ________.
decrease; decrease
Assume that you are interested in earning some return on idle balances you usually keep in your checking account and decide to buy some money market mutual fund shares by writing a check. Everything else the same, M1 will _______ and M2 will _______
decrease; stay the same
Everything else held constant, the interest rate on municipal bonds rises relative to the interest rate on Treasury securities when
income tax rates are lowered.
An individual's annual salary is her
income.
If the possibility of a default increases because corporations begin to suffer losses, then the default risk on corporate bonds will ________, and the bonds' returns will become ________ uncertain, meaning that the expected return on these bonds will decrease, everything else held constant.
increase; more
A decrease in the riskiness of corporate bonds will ________ the price of corporate bonds and ________ the price of Treasury bonds, everything else held constant.
increase; reduce
All of the following are necessary criteria for a commodity to function as money except
it must deteriorate quickly.
The M2 monetary aggregate contains everything that is in M1 plus other assets that are highly ________ (can be turned into cash quickly at very little cost).
liquid
Prices and returns for ________ bonds are more volatile than those for ________ bonds, everything else held constant.
long−term; short−term
An increase in default risk on corporate bonds ________ the demand for these bonds, but ________ the demand for default −free bonds, everything else held constant.
lowers; increases
During hyperinflations,
money no longer functions as a good store of value and people may resort to barter transactions on a much larger scale.
A situation in which the quantity of bonds supplied exceeds the quantity of bonds demanded is called a condition of excess supply; because people want to sell ________ bonds than others want to buy, the price of bonds will ________.
more; fall
The figure to the right depicts the bond market. Explain the effect that a large federal deficit will have on interest rates. The effect of this shock will likely cause interest rates to
move BS2 to the right increase
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.
When the Treasury bond market becomes less liquid, other things equal, the demand curve for corporate bonds shifts to the ________ and the demand curve for Treasury bonds shifts to the ________.
right; left
The spread between the interest rates on bonds with default risk and default −free bonds is called the
risk premium.
When the federal government sells a Treasury bond in the primary market —via Treasury auction, it is:
seeking to finance government spending as an alternative to raising taxes.
When yield curves are downward sloping,
short−term interest rates are above long−term interest rates.
A ________ yield curve predicts a future increase in inflation.
steeply upward sloping
In ancient Greece, what property made gold a more likely candidate for use as money than wine? Gold's property as a ________ made it a more likely candidate for use as money when compared to wine.
store of value
Assuming the same coupon rate and maturity length, the difference between the yield on a Treasury Inflation Indexed Security and the yield on a nonindexed Treasury security provides insight into
the expected inflation rate.
In September 2008, the growth rate of the M1 money supply was zero, while the growth rate of the M2 money supply was about 5%. In July 2009, the growth rate of M1 was about 17%, and the growth rate of M2 was about 8%. When interpreting changes in the growth rates of M1 and M2, Federal Reserve policymakers should recognize:
the growth rate of M2 should be higher than the 3% increase shown over this period. an inflationary problem may exist in the future as the growth of M1 to 17% is alarmingly high.
The payments system is
the method of conducting transactions in the economy.
Differences in ________ explain why interest rates on Treasury securities are not all the same.
time to maturity
Compared to an economy that uses a medium of exchange, in a barter economy
transaction costs are higher.
A person's house is part of her
wealth
The segmented markets theory can explain
why yield curves usually tend to slope upward.
If the price of bonds is set ________ the equilibrium price, the quantity of bonds demanded exceeds the quantity of bonds supplied, a condition called excess ________.
below; demand
When the price of a bond is ________ the equilibrium price, there is an excess demand for bonds and price will ________.
below; rise
If the interest rate on a bond is above the equilibrium interest rate, there is an excess ________ for bonds and the bond price will ________.
demand; rise
The yield to maturity is ________ than the ________ rate when the bond price is ________ its face value.
greater; coupon; below
When an economy grows out of a recession, normally the demand for bonds ________ and the supply of bonds ________, everything else held constant.
increases; increases
In the bond market, the bond demanders are the ________ and the bond suppliers are the ________.
lenders; borrowers
Everything else held constant, during a business cycle expansion, the supply of bonds shifts to the ________ as businesses perceive more profitable investment opportunities, while the demand for bonds shifts to the ________ as a result of the increase in wealth generated by the economic expansion.
right; right
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
