Chapter 8
Interest Rates

TRUE-FALSE QUESTIONS

1. The interest rate is the basic price that equates the demand for supply of loanable funds in the financial markets.

Difficulty Level: Easy

Subject Heading: Supply and Demand for Loanable Funds

L.O. 8.1

2. Interest rates will move from one equilibrium level to another if an anticipated change occurs that causes the demand for loanable funds to change.

Difficulty Level: Easy

Subject Heading: Supply and Demand for Loanable Funds

L.O. 8.1

3. A “shock” may be defined as an unanticipated change that will cause the demand for, or supply of loanable funds to change.

Difficulty Level: Easy

Subject Heading: Supply and Demand for Loanable Funds

L.O. 8.1

4. The loanable funds theory states that interest rates are a function of the supply of and demand for loanable funds.

Difficulty Level: Easy

Subject Heading: Supply and Demand for Loanable Funds

L.O. 8.1

5. There are two basic sources of loanable funds: current savings and the expansion of deposits of depository institutions.

Difficulty Level: Medium

Subject Heading: Loanable Funds Theory

L.O. 8.1

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

Difficulty Level: Medium

Subject Heading: Loanable Funds Theory

L.O. 8.1

7. Interest rates in the United States are only influenced by domestic factors.

Difficulty Level: Medium

Subject Heading: Determinants of Interest Rates

L.O. 8.1

8. Tax deferral on investments may increase the volume of savings.

Difficulty Level: Medium

Subject Heading: Determinants of Interest Rates

L.O. 8.1

9. Business will increase current long-term borrowing if they forecast a decrease in interest rates.

Difficulty Level: Medium

Subject Heading: Determinants of Interest Rates

L.O. 8.1

10. The Treasury’s major influence through its borrowing to finance federal deficits is on the supply rather than demand for loanable funds.

Difficulty Level: Medium

Subject Heading: Determinants of Interest Rates

L.O. 8.1

11. The supply of savings comes from all sectors of the economy.

Difficulty Level: Medium

Subject Heading: Loanable Funds Theory

L.O. 8.1

12. The demand for loanable funds comes from all sectors of the economy.

Difficulty Level: Medium

Subject Heading: Loanable Funds Theory

L.O. 8.1

13. Holding demand constant, an increase in the supply of loanable funds will result in an increase in interest rates.

Difficulty Level: Medium

Subject Heading: Loanable Funds Theory

L.O. 8.1

14. Holding demand constant, a decrease in the supply of loanable funds will result in an increase in interest rates.

Difficulty Level: Medium

Subject Heading: Loanable Funds Theory

L.O. 8.1

15. Holding supply constant, an increase in the demand for loanable funds will result in a decrease in interest rates.

Difficulty Level: Medium

Subject Heading: Loanable Funds Theory

L.O. 8.1

16. Holding supply constant, a decrease in the demand for loanable funds will result in a decrease in interest rates.

Difficulty Level: Medium

Subject Heading: Loanable Funds Theory

L.O. 8.1

17. 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.

Difficulty Level: Medium

Subject Heading: Loanable Funds Theory

L.O. 8.1

18. Loanable funds amount of money made available by the government to borrowers.

Difficulty Level: Easy

Subject Heading: Loanable Funds Theory

L.O. 8.1

19. Equilibrium interest rate is the tax rate that equates the demand for and supply of loanable funds.

Difficulty Level: Medium

Subject Heading: Loanable Funds Theory

L.O. 8.1

20. The rapid economic expansion after the Civil War caused the first period of falling interest rates, from 1864 to 1873.

Difficulty Level: Medium

Subject Heading: Historical Changes in U.S. Interest Rate Levels

L.O. 8.1

21. Beginning in 1966, interest rates entered a period of unusual increases, leading to the highest rates in U.S. history.

Difficulty Level: Medium

Subject Heading: Historical Changes in U.S. Interest Rate Levels

L.O. 8.1

22. The major factor that determines the volume of savings, corporate as well as individual, is the level of national taxation. Lower levels of taxation lead to higher levels of savings.

Difficulty Level: Medium

Subject Heading: Loanable Funds Theory

L.O. 8.1

23. Historically, one of the biggest borrowers has been the federal government.

Difficulty Level: Easy

Subject Heading: Loanable Funds Theory

L.O. 8.1

24. Interest rates in the United States are mainly influenced by domestic factors.

Difficulty Level: Medium

Subject Heading: Loanable Funds Theory

L.O. 8.1

25. The interest rate that is observed in the marketplace is called a real interest rate.

Difficulty Level: Easy

Subject Heading: Components of Market Interest Rates

L.O. 8.2

26. The observed market interest rate (r) can be expressed as r = RR x IP.

Difficulty Level: Hard

Subject Heading: Components of Market Interest Rates

L.O. 8.2

27. The maturity risk premium is the compensation expected by investors due to interest rate risk on debt instruments with longer maturity.

Difficulty Level: Easy

Subject Heading: Components of Market Interest Rates

L.O. 8.2

28. There is an inverse relation between debt instrument prices and nominal interest rates in the marketplace.

Difficulty Level: Medium

Subject Heading: Components of Market Interest Rates

L.O. 8.2

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

Difficulty Level: Medium

Subject Heading: Components of Market Interest Rates

L.O. 8.2

30. The maturity premium is the compensation that investors demand for holding securities that cannot easily be converted to cash without major price discounts.

Difficulty Level: Medium

Subject Heading: Components of Market Interest Rates

L.O. 8.2

31. The risk-free rate of interest is equal to the real rate of interest plus a premium for inflation.

Difficulty Level: Easy

Subject Heading: Components of Market Interest Rates

L.O. 8.2

32. The liquidity premium is compensation for those financial debt instruments that cannot be easily converted to cash at prices close to their estimated fair market values.

Difficulty Level: Easy

Subject Heading: Components of Market Interest Rates

L.O. 8.2

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

Difficulty Level: Medium

Subject Heading: Components of Market Interest Rates

L.O. 8.2

34. The maturity risk premium is the added return expected by lenders because of the expectation of inflation.

Difficulty Level: Medium

Subject Heading: Components of Market Interest Rates

L.O. 8.2

35. The risk-free rate of interest is found by combining the real rate of interest and the rate paid on U.S. Treasury debt.

Difficulty Level: Easy

Subject Heading: Components of Market Interest Rates

L.O. 8.2

36. The most important holders of Treasury bills are corporations and individuals.

Difficulty Level: Medium

Subject Heading: Marketable Securities

L.O. 8.3

37. Treasury bonds may be issued with any maturity but generally have an original maturity in excess of one year.

Difficulty Level: Medium

Subject Heading: Marketable Securities

L.O. 8.3

38. Treasury notes are intermediate-term Federal debt obligations.

Difficulty Level: Easy

Subject Heading: Marketable Securities

L.O. 8.3

39. The term structure of interest rates indicates the relation between interest rates and the maturity of comparable quality debt instruments.

Difficulty Level: Easy

Subject Heading: Term or Maturity Structure of Interest Rates

L.O. 8.4

40. In general, short-term interest rates are more stable than long-term interest rates.

Difficulty Level: Medium

Subject Heading: Personal Financial Planning

L.O. 8.3

41. Treasury securities that may be bought and sold through the customary market channels are called Treasury bills.

Difficulty Level: Medium

Subject Heading: Marketable Securities

L.O. 8.3

42. Treasury bonds are government securities issued with maturities ranging from 11 to 50 years.

Difficulty Level: Medium

Subject Heading: Marketable Securities

L.O. 8.3

43. A dealer cartel is a small group of dealers in government securities with an effective marketing network throughout the United States,

Difficulty Level: Medium

Subject Heading: Dealer System

L.O. 8.3

44. Special Treasury bills are government securities that cannot be transferred between persons or institutions and must be redeemed with the U.S. government,

Difficulty Level: Medium

Subject Heading: Ownership of Public Debt Securities

L.O. 8.3

45. The expectations theory contends that the shape of the yield curve reflects investor expectations about future GDP growth rates.

Difficulty Level: Medium

Subject Heading: Term Structure Theories

L.O. 8.4

46. The market segmentation theory holds that securities of different maturities are not perfect substitutes for each other.

Difficulty Level: Medium

Subject Heading: Term Structure Theories

L.O. 8.4

47. Three theories commonly used to explain the term structure of interest rates are the expectations theory, the liquidity preference theory, and the market segmentation theory.

Difficulty Level: Medium

Subject Heading: Term Structure Theories

L.O. 8.4

48. Interest rates generally fall during periods of economic expansion and rise during economic contraction.

Difficulty Level: Medium

Subject Heading: Relationship Between Yield Curves and the Economy

L.O. 8.5

49. Cost-push inflation occurs when prices are raised to cover rising production costs, such as wages.

Difficulty Level: Medium

Subject Heading: Types of Inflation

L.O. 8.5

50. Inflation is an increase in the price of goods or services that is not offset by an increase in quality.

Difficulty Level: Easy

Subject Heading: Inflation Premiums and Price Movements

L.O. 8.5

51. Demand-pull inflation may be defined as an excessive demand for goods and services during periods of economic expansion as a result of large increases in the money supply.

Difficulty Level: Medium

Subject Heading: Types of Inflation

L.O. 8.5

52. Cost-push inflation during economic expansions when demand for goods and services is greater than supply.

Difficulty Level: Medium

Subject Heading: Types of Inflation

L.O. 8.5

53. Speculative inflation is caused by the expectation that prices will continue to rise, resulting in increased buying to avoid even higher future prices.

Difficulty Level: Medium

Subject Heading: Types of Inflation

L.O. 8.5

54. Administrative inflation is the tendency of prices, aided by union-corporation contracts, to rise during economic expansion and to resist declines during recessions.

Difficulty Level: Medium

Subject Heading: Types of Inflation

L.O. 8.5

55. Speculative inflation is aided by union-corporation contracts.

Difficulty Level: Medium

Subject Heading: Types of Inflation

L.O. 8.5

56. The default risk premium is the compensation that investors demand for holding securities that cannot easily be converted to cash without major price discounts.

Difficulty Level: Medium

Subject Heading: Default Risk Premiums

L.O. 8.6

57. The nominal interest rate may include a default risk premium.

Difficulty Level: Easy

Subject Heading: Default Risk Premiums

L.O. 8.6

58. Default risk is the 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.

Difficulty Level: Easy

Subject Heading: Default Risk Premiums

L.O. 8.6

59. Investment grade bonds have ratings of Aaa or higher that meet financial institution investment standards.

Difficulty Level: Easy

Subject Heading: Default Risk Premiums

L.O. 8.6

60. Junk bonds are bonds that have a relatively high probability of default.

Difficulty Level: Easy

Subject Heading: Default Risk Premiums

L.O. 8.6

61. Junk bonds and high-yield bonds are the same thing.

Difficulty Level: Easy

Subject Heading: Default Risk Premiums

L.O. 8.6

62. The interest on all federal obligations is exempt from federal income taxes.

Difficulty Level: Medium

Subject Heading: Tax Status of Federal Obligations

L.O. 8.3

63. The Public Debt Act of 1941 prohibits the federal government from issuing tax-free obligations.

Difficulty Level: Medium

Subject Heading: Tax Status of Federal Obligations

L.O. 8.3

64. Income from the obligations of the federal government is exempt from all state and local taxes.

Difficulty Level: Medium

Subject Heading: Tax Status of Federal Obligations

L.O. 8.3

65. Federal obligations are not subject to state inheritance, estate, or gift taxes.

Difficulty Level: Medium

Subject Heading: Tax Status of Federal Obligations

L.O. 8.3

66. Treasure notes are issued in 1-year, 2-year, 5-year, 10-year, and 15-year notes.

Difficulty Level: Medium

Subject Heading: Marketable Securities

L.O. 8.3

67. Treasury notes are held largely by private investors.

Difficulty Level: Medium

Subject Heading: Marketable Securities

L.O. 8.3

68. It is illegal for individuals to own Treasury notes in this country.

Difficulty Level: Medium

Subject Heading: Marketable Securities

L.O. 8.3

69. The default risk premiums on Baa corporate bonds are generally better indicators of investor pessimism or optimism about economic expectations than are those on Aaa-rated bonds.

Difficulty Level: Medium

Subject Heading: Default Risk Premiums

L.O. 8.6

MULTIPLE-CHOICE QUESTIONS

70. In an inflationary period, interest rates have a tendency to:

a. rise

b. fall

c. stay the same

d. act erratically

Difficulty Level: Easy

Subject Heading: Historical Changes in U.S. Interest Rate Levels

L.O. 8.1

71. 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

Difficulty Level: Easy

Subject Heading: Supply and Demand for Loanable Funds

L.O. 8.1

72. 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 through the contraction of credit by depository institutions

Difficulty Level: Medium

Subject Heading: Loanable Funds Theory

L.O. 8.1

73. Sources of loanable funds do not include:

a. current savings

b. the expansion of deposits by depository institutions

c. federal deficits

d. unissued treasury bonds

Difficulty Level: Easy

Subject Heading: Loanable Funds Theory

L.O. 8.1

74. A basic source of loanable funds is:

a. current savings that flow through financial institutions

b. future 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

Difficulty Level: Medium

Subject Heading: Loanable Funds Theory

L.O. 8.1

75. Which of the following does not accumulate savings?

a. individuals

b. corporations

c. governmental units

d. federal government

Difficulty Level: Easy

Subject Heading: Loanable Funds Theory

L.O. 8.1

76. 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. increase rapidly then decrease rapidly

Difficulty Level: Medium

Subject Heading: Loanable Funds Theory

L.O. 8.1

77. 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. decrease rapidly then increase slowly

Difficulty Level: Medium

Subject Heading: Loanable Funds Theory

L.O. 8.1

78. 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. increase slowly then decrease rapidly

Difficulty Level: Medium

Subject Heading: Loanable Funds Theory

L.O. 8.1

79. 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. decrease slowly then increase slowly

Difficulty Level: Medium

Subject Heading: Loanable Funds Theory

L.O. 8.1

80. 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

Difficulty Level: Medium

Subject Heading: Loanable Funds Theory

L.O. 8.1

81. An increase 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

Difficulty Level: Medium

Subject Heading: Loanable Funds Theory

L.O. 8.1

82. 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

Difficulty Level: Medium

Subject Heading: Loanable Funds Theory

L.O. 8.1

83. 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

Difficulty Level: Medium

Subject Heading: Loanable Funds Theory

L.O. 8.1

84. 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

Difficulty Level: Medium

Subject Heading: Loanable Funds Theory

L.O. 8.1

85. Which of the following factors does not affect the supply of loanable funds?

a. the volume of savings

b. expansion of deposits by banks

c. attitudes about liquidity

d. quantity of unissued Treasury bonds

Difficulty Level: Medium

Subject Heading: Loanable Funds Theory

L.O. 8.1

86. The loanable funds theory used to explain the level of interest rates holds that interest rates are a function of the supply of:

a. loanable funds and the demand for money

b. loanable funds and the demand for loanable funds

c. money and the demand for loanable funds

d. money and the demand for money

Difficulty Level: Medium

Subject Heading: Loanable Funds Theory

L.O. 8.1

87. 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. undetermined change

Difficulty Level: Easy

Subject Heading: Loanable Funds

L.O. 8.1

88. 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. undetermined change

Difficulty Level: Easy

Subject Heading: Loanable Funds

L.O. 8.1

89. ___________________ 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 preference theory

d. The loanable funds theory

Difficulty Level: Easy

Subject Heading: Loanable Funds

L.O. 8.1

90. If the nominal interest rate is 8% and the risk-free rate is 3%, the expected inflation rate must be:

a. 3%

b. 5%

c. 11%

d. 13%

Difficulty Level: Medium

Subject Heading: Equation 8.1

L.O. 8.2

91. There are several problems that are unique to family businesses or ventures. Which of the following is not one of those problems?

a. Issues of succession

b. Problems of control, fairness, and equity

c. Issues of credibility

d. Family dynamics

Difficulty Level: Easy

Subject Heading: Small Business Practice

L.O. 8.1

92. 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

Difficulty Level: Easy

Subject Heading: Components of Market Interest Rates

L.O. 8.2

93. As interest rates fall, 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

Difficulty Level: Medium

Subject Heading: Components of Market Interest Rates

L.O. 8.2

94. Which of the following factors does not directly impact the level of interest rates?

a. risk

b. marketability

c. maturity

d. cost of producing and distributing new currency

Difficulty Level: Easy

Subject Heading: Marketable Securities

L.O. 8.3

95. 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 1%

b 2%

c 5%

d 7%

Difficulty Level: Medium

Subject Heading: Equation 8.2

L.O. 8.2

96. 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%

Difficulty Level: Medium

Subject Heading: Equation 8.2

L.O. 8.2

97. 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. environmental premium

Difficulty Level: Easy

Subject Heading: Components of Market Interest Rates

L.O. 8.2

98. The risk-free interest rate is composed of:

a. an inflation premium and a default risk premium

b. a default risk premium and a maturity risk premium

c. a real rate of interest and a liquidity premium

d. a real rate of interest and an inflation premium

Difficulty Level: Easy

Subject Heading: Components of Market Interest Rates

L.O. 8.2

99. If the nominal rate of interest is 10%, the real rate of interest is 3%, the default premium is 3%, the liquidity premium is 0.5%, and the maturity premium is 1.5%, then the inflation premium must be ______.

a. 2.0%

b. 2.5%

c. 3.0%

d. 1.5%

Difficulty Level: Medium

Subject Heading: Equation 8.3

L.O. 8.2

100. If the nominal rate of interest is 11%, the risk-free rate of interest is 2%, the default premium is 4%, the liquidity premium is 0.5%, and the maturity premium is 1.5%, then the inflation premium must be ______.

a. 2.0%

b. 2.5%

c. 3.0%

d. 3.5%

Difficulty Level: Medium

Subject Heading: Equation 8.3

L.O. 8.2

101. 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

Difficulty Level: Medium

Subject Heading: Components of Market Interest Rates

L.O. 8.2

102. What is the real rate of interest if the nominal rate of interest is 15%, the IP is 3%, the DRP is 3%, the MRP is 3%, and the LP is 2%?

a. 3%

b. 4%

c. 5%

d. 6%

Difficulty Level: Medium

Subject Heading: Equation 8.3

L.O. 8.2

103. 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 U.S. 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.

Difficulty Level: Hard

Subject Heading: Marketable Securities

L.O. 8.2

104. Long-run inflation expectations in the capital markets can be estimated by:

a. subtracting a real return component from the rate on short-term Treasury bills

b. adding a real return component to interest rates on long-term corporate bonds

c. subtracting a real return component from the rate on long-term Treasury securities

d. adding a real return component to interest rates on short-term corporate securities

Difficulty Level: Hard

Subject Heading: Equation 8.3

L.O. 8.2

105. An increase in inflation should:

a. increase the demand for loanable funds

b. decrease the interest rate on loans

c. increase the interest rate on loans

d. increase supply of loanable funds

Difficulty Level: Easy

Subject Heading: Equation 8.3

L.O. 8.2

106. The interest rate observed in the marketplace for a debt instrument.

a. Observed interest rate

b. Inflation-free interest rate

c. Risk-free rate of interest

d. Real rate of interest

Difficulty Level: Easy

Subject Heading: Components of Market Interest Rates

L.O. 8.2

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

a. Observed interest rate

b. Market interest rate

c. Risk-free rate of interest

d. Real rate of interest

Difficulty Level: Easy

Subject Heading: Components of Market Interest Rates

L.O. 8.2

108. An additional expected return to compensate for anticipated inflation over the life of a debt instrument.

a. Maturity risk premium

b. Default risk premium

c. Interest rate risk

d. Inflation premium

Difficulty Level: Easy

Subject Heading: Components of Market Interest Rates

L.O. 8.2

109. An additional expected return to compensate for the possibility a borrower will fail to pay interest and/or principal when due maturity.

a. Maturity risk premium

b. Default risk premium

c. Interest rate risk

d. Inflation premium

Difficulty Level: Easy

Subject Heading: Components of Market Interest Rates

L.O. 8.2

110. An additional expected return to compensate for interest rate risk on debt instruments with longer maturities.

a. Maturity risk premium

b. Default risk premium

c. Interest rate risk

d. Inflation premium

Difficulty Level: Easy

Subject Heading: Components of Market Interest Rates

L.O. 8.2

111. The risk of changes in the price or value of fixed-rate debt instruments resulting from changes in market interest rates.

a. Maturity risk premium

b. Default risk premium

c. Interest rate risk

d. Inflation premium

Difficulty Level: Easy

Subject Heading: Components of Market Interest Rates

L.O. 8.2

112. Economists have estimated that the real rate of interest in the United States and other countries has averaged in the ________________ range in recent years.

a. 1 to 2 percent

b. 3 to 5 percent

c. 4 to 6 percent

d. 5 to 7 percent

Difficulty Level: Easy

Subject Heading: Default Risk-Free Securities: U.S. Treasury Debt Instruments

L.O. 8.3

113. Which of the following is not true of Treasury bills?

a. long-lived

b. sold at a discount

c. mature at par

d. pay lower interest rates than Treasury bonds

Difficulty Level: Medium

Subject Heading: Marketable Securities

L.O. 8.3

114. Which of the following is not true of Treasury bonds?

a. long-lived

b. noncallable

c. stated interest rate

d. pay higher rates of interest than Treasury bills

Difficulty Level: Medium

Subject Heading: Treasury Securities

L.O. 8.3

115. The average maturity of the marketable debt in the United States:

a. is of little importance, unlike that of private corporations

b. has been constant for the last two decades

c. remains unchanged unless new obligations are issued

d. decreases day by day unless new obligations are issued to offset such decreases

Difficulty Level: Medium

Subject Heading: Maturity Distribution of Marketable Debt Securities

L.O. 8.3

116. Which one of the following is not a marketable government security?

a. Treasury stock

b. Treasury bill

c. Treasury note

d. Treasury bond

Difficulty Level: Easy

Subject Heading: Marketable Securities

L.O. 8.3

117. The federal debt is owned primarily by:

a. foreign and international investors

b. commercial banks

c. insurance companies

d. the sum of all private investors

Difficulty Level: Medium

Subject Heading: Ownership of Public Debt Securities

L.O. 8.3

118. Federal obligations usually issued for maturities of two to ten years are called:

a. Treasury bonds

b. Treasury notes

c. Treasury bills

d. Agency issues

Difficulty Level: Easy

Subject Heading: Marketable Securities

L.O. 8.3

119. Federal obligations usually issued for maturities in excess of ten years are called:

a. Treasury bonds

b. Treasury notes

c. Treasury bills

d. Agency issues

Difficulty Level: Easy

Subject Heading: Marketable Securities

L.O. 8.3

120. Federal obligations usually issued for maturities up to one year are called:

a. Treasury bonds

b. Treasury notes

c. Treasury bills

d. Agency issues

Difficulty Level: Easy

Subject Heading: Marketable Securities

L.O. 8.3

121. Treasury bills are:

a. issued on a premium basis and pay a fixed annual interest rate.

b. issued on a discount basis and mature at par.

c. issued on a premium basis and mature at par.

d. issued on a discount basis and pay a fixed annual interest rate.

Difficulty Level: Medium

Subject Heading: Marketable Securities

L.O. 8.3

122. Securities that may be bought and sold through the usual market channels are called:

a. Treasury bonds

b. Treasury notes

c. Treasury bills

d. Marketable government securities

Difficulty Level: Easy

Subject Heading: Marketable Securities

L.O. 8.3

123. Which of the following statements is most correct?

a. Income from the obligations of the federal government is exempt from all state and local taxes but is subject to federal and state inheritance, estate, or gift taxes.

b. Income from the obligations of the federal government is exempt from all federal taxes but is subject to state and local income taxes, state inheritance, estate, or gift taxes.

c. Income from the obligations of the federal government is exempt from all federal, state and local taxes but is subject to inheritance, estate, or gift taxes.

d. Treasury notes and bonds pay interest monthly by check

Difficulty Level: Hard

Subject Heading: Tax Status of Federal Obligations

L.O. 8.3

124. Which of the following statements is most correct?

a. Marketable government securities are those securities that cannot be transferred to other persons or institutions and can be redeemed only by being turned in to the U.S. government

b. Nonmarketable government securities are those securities that can be transferred to other persons or institutions and can be redeemed only by being turned in to the U.S. government

c. Nonmarketable government securities are those securities that cannot be transferred to other persons or institutions and can be redeemed only by being turned in to the U.S. government

d. Marketable government securities must only be sold or transferred through commercial banks

Difficulty Level: Hard

Subject Heading: Ownership of Public Debt Securities

L.O. 8.3

125. Which of the following statements is most correct?

a. Advance refunding is one of the new debt-management techniques used to extend the average maturity of the marketable debt without disturbing the financial markets and occurs when the Treasury offers the owners of a given issue the opportunity to exchange their holdings well in advance of the holdings’ regular maturity for new securities of longer maturity.

b. Reverse refunding is one of the new debt-management techniques used to extend the average maturity of the marketable debt without disturbing the financial markets and occurs when the Treasury offers the owners of a given issue the opportunity to exchange their holdings well in advance of the holdings’ regular maturity for new securities of longer maturity.

c. Extended refunding is one of the new debt-management techniques used to extend the average maturity of the marketable debt without disturbing the financial markets and occurs when the Treasury offers the owners of a given issue the opportunity to exchange their holdings well in advance of the holdings’ regular maturity for new securities of longer maturity.

d. Laddered refunding is one of the new debt-management techniques used to extend the average maturity of the marketable debt without disturbing the financial markets and occurs when the Treasury offers the owners of a given issue the opportunity to exchange their holdings well in advance of the holdings’ regular maturity for new securities of longer maturity.

Difficulty Level: Hard

Subject Heading: Maturity Distribution of Marketable Debt Securities

L.O. 8.3

126. A government securities issued with maturities up to one year.

a. Treasury notes

b. Treasury certificate

c. Treasury bills

d. Treasury bonds

Difficulty Level: Easy

Subject Heading: Marketable Securities

L.O. 8.3

127. A government securities issued with maturities ranging from two to 10 years.

a. Treasury notes

b. Treasury certificate

c. Treasury bills

d. Treasury bonds

Difficulty Level: Easy

Subject Heading: Marketable Securities

L.O. 8.3

128. A government securities issued with maturities ranging from 11 to 30 years.

a. Treasury notes

b. Treasury certificate

c. Treasury bills

d. Treasury bonds

Difficulty Level: Easy

Subject Heading: Marketable Securities

L.O. 8.3

129. The liquidity preference theory holds that interest rates are determined by the:

a. investor preference for short-term securities

b. investor preference for higher-yielding long-term securities.

c. “flow” of funds over time

d. “flow” of bank credit over time

Difficulty Level: Easy

Subject Heading: Term Structure Theories

L.O. 8.4

130. Which of the following is not considered to be a basic theory used to explain the term structure of interest rates?

a. expectations theory

b. loanable funds theory

c. liquidity premium theory

d. market segmentation theory

Difficulty Level: Medium

Subject Heading: Term Structure Theories

L.O. 8.4

131. As the economy begins moving out of a recessionary period, the yield curve is generally:

a. upward sloping

b. flattened out

c. downward sloping

d. discontinuous

Difficulty Level: Medium

Subject Heading: Term or Maturity Structure of Interest Rates

L.O. 8.4

132. When referring to an “upward sloping” yield curve, interest rates:

a. are flat across all maturities

b. decrease as maturity increases

c. increase as maturity decreases

d. increase as maturity increases

Difficulty Level: Easy

Subject Heading: Relationship Between Yield Curves and the Economy

L.O. 8.4

133. When referring to a “downward sloping” yield curve:

a. as maturities shorten, interest rates decline

b. as maturities shorten, interest rates rise

c. as maturities lengthen, interest rates remain the same

d. as maturities lengthen, interest rates rise

Difficulty Level: Easy

Subject Heading: Relationship Between Yield Curves and the Economy

L.O. 8.4

134. The yield curve or the term structure of interest rates is typically downward sloping when:

a. short-term Treasury interest rates are lower than long-term Treasury interest rates

b. short-term and long-term Treasury interest rates are the same

c. long-term Treasury interest rates are lower than short-term Treasury interest rates

d. long-term Treasure interest rates are higher than short-term Treasury interest rates

Difficulty Level: Medium

Subject Heading: Relationship Between Yield Curves and the Economy

L.O. 8.4

135. Assume that these current yields exist: long-term government securities yield 9 percent, five-year Treasury securities yield 8.5 percent, and one-year Treasury bills yield 8 percent. What type of yield curve is depicted?

a. downward sloping

b. flat or level

c. upward sloping

d. U shaped

Difficulty Level: Medium

Subject Heading: Relationship Between Yield Curves and the Economy

L.O. 8.4

136. What yield curve shape is depicted if intermediate-term Treasury securities yield 10 percent, short-term Treasuries yield 10.5 percent, and long-term Treasuries yield 9.5 percent?

a. downward sloping

b. flat or level

c. upward sloping

d. U shaped

Difficulty Level: Medium

Subject Heading: Relationship Between Yield Curves and the Economy

L.O. 8.4

137. Which of the following statements is most correct?

a. a downward sloping yield curve implies that government securities with long-term maturities have lower interest rates relative to similar quality securities with short-term maturities.

b. commercial paper is a primary source of short-term borrowing used by the U.S. government.

c. a decline in interest rates for long-term Treasury securities indicates an increase in investor long-run inflation expectations.

d. the establishment of the Federal Reserve System has caused the yield curve to always be upward sloping.

Difficulty Level: Hard

Subject Heading: Multiple Topics

L.O. 8.4

138. Which of the following statements is false?

a. A major determinant in the long run of the volume of savings 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.

Difficulty Level: Hard

Subject Heading: Multiple Topics

L.O. 8.4

139. The relationship between interest rates or yields and the time to maturity for debt instruments of comparable quality is called:

a. the yield to maturity

b. the term structure of interest rates

c. the maturity risk premium

d. the expectations hypothesis

Difficulty Level: Easy

Subject Heading: Term or Maturity Structure of Interest Rates

L.O. 8.4

140. In reaction to the then developing 2007-2009 financial crisis, short-term interest rates _______ sharply and were ______ than ______ percent by October, 2008.

a. declined, less, 0.5

b. rose, more, 10

c. declined, more, 6.

d. declined, less, 20

Difficulty Level: Hard

Subject Heading: Table 8.3

L.O. 8.4

141. If the money supply and total demand increase faster than output, prices will:

a. fall

b. stay the same

c. rise

d. reflect lower inflation

Difficulty Level: Medium

Subject Heading: Interest Rates and Asset Values

L.O. 8.5

142. If interest rates increase because of a previously unanticipated inflation rate risk:

a. long-lived debt instruments will decline more than short-lived debt instruments

b. long-lived debt instruments will decline less than short-lived debt instruments

c. neither set of debt instruments will decline

d. all other things being equal, both should decline equally

Difficulty Level: Medium

Subject Heading: Types of Inflation

L.O. 8.5

143. When investors expect __________ inflation rates they will require __________ nominal interest rates so that a real rate of return will remain after the inflation.

a. higher, higher

b. higher, lower

c. lower, higher

d. level, higher

Difficulty Level: Medium

Subject Heading: Inflation Premiums and Price Movements

L.O. 8.5

144. Price inflation has been characteristic of:

a. modern industrial society

b. our post gold-standard period

c. the history of prices since earliest recorded history

d. only modern industrialized societies

Difficulty Level: Easy

Subject Heading: Historical International Price Movements

L.O. 8.5

145. Inflation caused by an increase in the money supply is called:

a. demand-pull inflation

b. cost-push inflation

c. administrative inflation

d. a combination of administrative and speculative inflation

Difficulty Level: Easy

Subject Heading: Types of Inflation

L.O. 8.5

146. ______________ occurs during economic expansions when demand for goods and services is greater than supply.

a. Administrative inflation

b. Speculative inflation

c. Cost-push inflation

d. Demand-pull inflation

Difficulty Level: Easy

Subject Heading: Types of Inflation

L.O. 8.5

147. ______________ is the tendency of prices, aided by union-corporation contracts, to rise during economic expansions and resist declines during recessions.

a. Administrative inflation

b. Speculative inflation

c. Cost-push inflation

d. Demand-pull inflation

Difficulty Level: Medium

Subject Heading: Types of Inflation

L.O. 8.5

148. Economists who believe that long-run inflationary bias will continue base their belief on which of the following factors:

a. Prices and wages tend to decrease during periods of boom in a competitive economy; this tendency is reinforced by wage contracts that provide escalator clauses to keep wages in line with prices and by wage increases that are sometimes greater than increases in productivity.

b. During recessions, prices tend to rise rather than decrease because major unions have long-run contracts calling for annual wage increases no matter what economic conditions are at the time.

c. The tendency of large corporations to rely on non-price competition (advertising, and style and color changes) and to reduce output makes prices drop.

d. If prices decline drastically in a field, the government is likely to step in with programs to help take excess supplies off the market.

Difficulty Level: Hard

Subject Heading: Types of Inflation

L.O. 8.5

149. Which of the following factors is most correct?

a. Demand-pull inflation traditionally exists during periods of economic expansion when the demand for goods and services exceeds the available supply of such goods and services.

b. Cost-push inflation occurs when prices are raised to cover rising production costs, such as wages

c. Speculative inflation is caused by the expectation that prices will continue to rise, resulting in increased buying to avoid even higher future prices

d. All of the above are correct

Difficulty Level: Hard

Subject Heading: Types of Inflation

L.O. 8.5

150. The default risk premium at a certain 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 the commercial paper rate.

d. a risky security and a comparable maturity U.S. Treasury security.

Difficulty Level: Medium

Subject Heading: Default Risk Premium

L.O. 8.6

151. A maturity risk premium at a certain 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 the commercial paper rate.

d. a risky security and a comparable maturity U.S. Treasury security.

Difficulty Level: Hard

Subject Heading: Default Risk Premium

L.O. 8.6

152. In response to the financial crisis of 2007-2009, the yield spread between AAA corporate bonds and treasury bonds:

a. widened

b. narrowed

c. remained the same

d. has no relationship

Difficulty Level: Medium

Subject Heading: Default Risk Premium

L.O. 8.6

153. The default risk premiums on _______ corporate bonds are generally better indicators of investor pessimism or optimism about economic expectations than are those on ______ bonds.

a. Aaa, Baa

b. Baa, Aaa

c. Baa, Caa

d. Caa, Baa

Difficulty Level: Medium

Subject Heading: Default Risk Premiums

L.O. 8.6

154. Which of the following statements is most correct?

a. More firms fail or suffer financial distress during periods of economic expansion than during periods of economic recession. Thus, investors tend to require higher premiums to compensate for default risk when the economy is in a recession or is expected to enter one.

b. More firms fail or suffer financial distress during periods of recession than during periods of economic expansion. Thus, investors tend to require lower premiums to compensate for default risk when the economy is in a recession or is expected to enter one.

c. Fewer firms fail or suffer financial distress during periods of recession than during periods of economic expansion. Thus, investors tend to require higher premiums to compensate for default risk when the economy is in a recession or is expected to enter one.

d. More firms fail or suffer financial distress during periods of recession than during periods of economic expansion. Thus, investors tend to require higher premiums to compensate for default risk when the economy is in a recession or is expected to enter one.

Difficulty Level: Hard

Subject Heading: Default Risk Premiums

L.O. 8.6