Financial Markets – The Meaning of Interest Rates
Financial Markets – The Meaning of Interest Rates – Part 2”
1. The ________ is defined as the payments to the owner plus the change in a security’s value expressed as a fraction of the security’s purchase price.
A) yield to maturity B) current yield C) rate of return D) yield rate
2. Which of the following are TRUE concerning the distinction between interest rates and returns?
A) The rate of return on a bond will not necessarily equal the interest rate on that bond.
B) The rate of return on a bond can be expressed as the difference between the current yield and the rate of capital gains.
C) The rate of return on a bond will be greater than the interest rate when the price of the bond falls during the holding period.
D) The rate of return on a bond can be expressed as the sum of the discount yield and the rate of capital gains.
3. A $1,000-face-value bond has a 5% coupon rate, its current price is $1,000, and its price is expected to decrease to $900 next year. What’s the expected rate of return of this bond?
A) 5 percent B) 10 percent C) -5 percent D) -10 percent
4. Suppose you are holding a 5 percent coupon bond maturing in one year with a yield to maturity of 15 percent. If the interest rate on one-year bonds rises from 15 percent to 20 percent over the course of the year, what is the yearly rate of return on the bond you are holding?
A) 5 percent B) 10 percent C) 15 percent D) 20 percent
5. 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
A) 10 percent. B) 8 percent. C) 12 percent. D) there is not enough information to determine the return.
6. 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) a bond with one year to maturity
B) a bond with five years to maturity
C) a bond with ten years to maturity
D) a bond with twenty years to maturity
7. An equal decrease in all bond interest rates
A) increases the price of a five-year bond more than the price of a ten-year bond.
B) increases the price of a ten-year bond more than the price of a five-year bond.
C) decreases the price of a five-year bond more than the price of a ten-year bond.
D) decreases the price of a ten-year bond more than the price of a five-year bond.
8. The riskiness of an asset’s returns due to changes in interest rates is
A) exchange-rate risk. B) price risk. C) asset risk. D) interest-rate risk.
9. Prices and returns for ________ bonds are more volatile than those for ________ bonds, everything else held constant.
A) long-term; long-term B) long-term; short-term C) short-term; long-term D) short-term; short-term
10. The ________ interest rate is adjusted for expected changes in the price level.
A) ex ante real B) ex post real C) ex post nominal D) ex ante nominal
11. The ________ states that the nominal interest rate equals the real interest rate plus the expected rate of inflation.
A) Fisher equation B) Keynesian equation C) Monetarist equation D) Marshall equation
12. Suppose that you want to take out a loan and that your local bank wants to charge you an annual real interest rate equal to 3%. Assuming that the annualized expected rate of inflation over the life of the loan is 2.5%, the nominal interest rate that the bank will charge you would be ________. Given the calculated nominal interest rate, the real interest rate would be ________ if, over the life of the loan, actual inflation is 1.5%.
A) 5.5%, 4% B) 5.5%, 3% C) 3%, 4% D) 3%, 1.5%
13. In which of the following situations would you prefer to be the borrower?
A) The interest rate is 9 percent and the expected inflation rate is 7 percent.
B) The interest rate is 4 percent and the expected inflation rate is 1 percent.
C) The interest rate is 13 percent and the expected inflation rate is 15 percent.
D) The interest rate is 25 percent and the expected inflation rate is 50 percent.
14. If wealth increases, the demand for stocks ________ and that of long-term bonds ________, everything else held constant.
A) increases; increases B) increases; decreases C) decreases; decreases D) decreases; increases
15. 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 ________.
A) rises; rises B) rises; falls C) falls; rises D) falls; falls
16. If housing prices are expected to increase, then, other things equal, the demand for houses will ________ and that of Treasury bills will ________.
A) increase; increase B) increase; decrease C) decrease; decrease D) decrease; increase
17. An increase in the expected rate of inflation will ________ the expected return on bonds relative to the that on ________ assets, everything else held constant.
A) reduce; financial B) reduce; real C) raise; financial D) raise; real
18. If brokerage commissions on bond sales decrease, then, other things equal, the demand for bonds will ________ and the demand for real estate will ________.
A) increase; increase B) increase; decrease C) decrease; decrease D) decrease; increase
19. You would be more willing to buy AT&T bonds (holding everything else constant) if
A) the brokerage commissions on bond sales become cheaper.
B) interest rates are expected to rise.
C) your wealth has decreased.
D) you expect diamonds to appreciate in value.
20. In the bond market, the bond demanders are the ________ and the bond suppliers are the ________.
A) lenders; borrowers B) lenders; advancers C) borrowers; lenders D) borrowers; advancers
21. The demand curve for bonds has the usual downward slope, indicating that at ________ prices of the bond, everything else equal, the ________ is higher.
A) higher; demand B) higher; quantity demanded C) lower; demand D) lower; quantity demanded
22. Everything else held constant, if interest rates are expected to fall in the future, the demand for long-term bonds today ________ and the demand curve shifts to the ________.
A) rises; right B) rises; left C) falls; right D) falls; left
23. When the expected inflation rate increases, the real cost of borrowing ________ and bond supply ________, everything else held constant.
A) increases; increases B) increases; decreases C) decreases; increases D) decreases; decreases
24. Everything else held constant, when bonds become less widely traded, and as a consequence the market becomes less liquid, the demand curve for bonds shifts to the ________ and the interest rate ________.
A) right; rises B) right; falls C) left; falls D) left; rises
25. When the expected inflation rate increases, the demand for bonds ________, the supply of bonds ________, and the interest rate ________, everything else held constant.
A) increases; increases; rises B) decreases; decreases; falls C) increases; decreases; falls D) decreases; increases; rises
26. If stock prices are expected to climb next year, everything else held constant, the ________ curve for bonds shifts ________ and the interest rate ________.
A) demand; left; rises B) demand; right; rises C) demand; left; falls D) supply; left; rises
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