FIN 3414 - Test 1

a. The yield on a 10-year bond would be less than that on a 1-year bill.

If the Treasury yield curve is downward sloping, how should the yield to maturity on a 10-year Treasury coupon bond compare to that on a 1-year T-bill? a. The yield on a 10-year bond would be less than that on a 1-year bill. b. The yield on a 10-year bond would have to be higher than that on a 1-year bill because of the maturity risk premium. c. It is impossible to tell without knowing the coupon rates of the bonds. d. The yields on the two securities would be equal. e. It is impossible to tell without knowing the relative risks of the two securities.

False - The demand curve for T- securities will shift out right resulting in a higher demand curve for T-securities. The equilibrium price and quantity of T-securities will increase. Due to exchange of securities with "money", the supply of money increases. The money supply curve shifts right resulting in a higher quantity at the equilibrium and with a lower interest rate.

T/F: During a recession, if FED injects money into the financial system by buying more Treasury securities, then the interest rate will increase.

True - Starting with a supply and demand curve before the increase in demand, find the equilibrium price and quantity at the intersection of supply and demand curves. With higher demand, we need to use a demand curve that is to the right of the initial demand curve. Find the intersection where both price and quantity is higher.

T/F: If the demand curve for funds increased but the supply curve remained constant, we would expect to see the total amount of funds supplied and demanded increase and interest rates in general also increase.

False - If the expected inflation increases, then bond yield must increase as well, so that investors are compensated for the higher inflation risk. T-bond yield= real rate + IP + MRP. Higher IP increases right hand side, hence left hand side also increases.

T/F: If the expected inflation increases, then an investor who is investing on a Treasury bond will earn a lower bond yield, since the inflation is higher.

False - FV=PV(1+r)n A higher n will result in a higher value on the right hand side. Hence left hand side of the equation must be higher.

T/F: If the number of compounding intervals increases, then the future value of an amount will decrease.

True - Since the demand for money increases, the demand curve shifts right. Money has "more" value now. The new intersection is at a higher interest rate. Hence the interest rates increase.

T/F: In the wake of the start of an economic boom, if the firms expand their investment plans, then the interest rate will increase.

False - Higher expected rate of inflation implies a higher interest rate

T/F: One of the four most fundamental factors that affect the cost of money is the expected rate of inflation. If inflation is expected to be relatively high, then interest rates will tend to be relatively low, other things held constant.

True

T/F: The "yield curve" shows the relationship between bonds' maturities and their yields.

True

T/F: The Federal Reserve tends to take actions to increase interest rates when the economy is very strong and to decrease rates when the economy is weak

True

T/F: The risk that interest rates will increase, and that increase will lead to a decline in the prices of outstanding bonds, is called "interest rate risk," or "price risk."

a. The present value of a 3-year, $150 annuity due will exceed the present value of a 3-year, $150 ordinary annuity.

Which of the following statements is CORRECT? a. The present value of a 3-year, $150 annuity due will exceed the present value of a 3-year, $150 ordinary annuity. b. If a loan has a nominal annual rate of 8%, then the effective rate can never be greater than 8%. c. If a loan or investment has annual payments, then the effective, periodic, and nominal rates of interest will all be different. d. The proportion of the payment that goes toward interest on an amortized loan increases over time. e. An investment that has a nominal rate of 6% with semiannual payments will have an effective rate that is smaller than 6%.