Eco 353 final and answer KEY

1) When stock prices become less volatile, the ______ curve for bonds shifts to the _____. A) demand; right B) demand; left C) supply; left D) supply; right 2) When the federal government’s budget deficit decreases, the _____ curve for bonds shifts to the _____. A) demand; right B) demand; left C) supply; left D) supply; right 3) 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 4) When prices in the art market become less uncertain, A) the demand curve for bonds shifts to the left and the interest rate falls. B) the demand curve for bonds shifts to the right and the interest rate rises. C) the supply curve for bonds shifts to the right and the interest rate falls. D) none of the above occurs. 5) When prices in the stock market become more uncertain, the demand curve for bonds shifts to the _____ and the interest rate _____. A) right; rises B) right; falls C) left; falls D) left; rises 6) When the interest rate is above the equilibrium interest rate, there is an excess _____ for (of) money and the interest rate will _____. A) demand; rise B) demand; fall C) supply; fall D) supply; rise 7) When the price level rises, the demand curve for money shifts to the _____ and the interest rate _____. A) right; rises B) right; falls C) left; falls D) left; rises 8) When the price level falls, the demand curve for money shifts to the _____ and the interest rate _____. A) right; rises B) right; falls C) left; falls D) left; rises 9) When real income _____, the demand curve for money shifts to the _____ and the interest rate _____. A) falls; left; falls B) falls; right; falls C) falls; left; rises D) rises; left; rises E) rises; right; falls 10) When the price level _____, the demand curve for money shifts to the _____ and the interest rate _____. A) falls; left; rises B) falls; right; falls C) rises; right; rises D) rises; right; falls 11) When the Fed _____ the money stock, the money supply curve shifts to the _____ and the interest rate _____. A) decreases; right; rises B) increases; right; falls C) decreases; left; falls D) increases; left; rises E) decreases; right; falls 12) When stock prices become _____ volatile, the demand curve for bonds shifts to the _____ and the interest rate _____. A) more; right; rises B) more; left; falls C) less; left; falls D) less; left; rises E) less; right; falls 13) When the growth rate of the money supply increases, interest rates end up being permanently higher if A) the liquidity effect is larger than the other effects. B) there is fast adjustment of expected inflation. C) there is slow adjustment of expected inflation. D) the expected inflation effect is larger than the liquidity effect. 14) When the growth rate of the money supply decreases, interest rates end up being permanently higher if A) the liquidity effect is larger than the other effects. B) there is fast adjustment of expected inflation. C) there is slow adjustment of expected inflation. D) the expected inflation effect is larger than the liquidity effect. 15) When the growth rate of the money supply is decreased, interest rates will rise immediately if the liquidity effect is _____ than the other money supply effects and there is _____ adjustment of expected inflation. A) larger; fast B) larger; slow C) smaller; slow D) smaller; fast 16) Holding the expected return on bonds constant, a decrease in the expected return on stocks would _____ the demand for bonds, shifting the demand curve to the _____. A) decrease; left B) decrease; right C) increase; left D) increase; right 17) Factors that cause the demand curve for bonds to shift to the right include A) a decrease in the inflation rate. B) an increase in the volatility of stock prices. C) an increase in the liquidity of stocks. D) all of the above. E) only (a) and (b) of the above. 18) Factors that can cause the supply curve for bonds to shift to the right include A) an expansion in overall economic activity. B) an increase in expected inflation. C) an increase in government deficits. D) all of the above. E) only (a) and (b) of the above. 19) In Keynes’s liquidity preference framework, individuals are assumed to hold their wealth in two forms: A) real assets and financial assets. B) stocks and bonds. C) money and bonds. D) money and gold. 20) A higher level of income causes the demand for money to _____ and the demand curve for money to shift to the _____. A) decrease; right B) decrease; left C) increase; right D) increase; left 21) A decline in the price level causes the demand for money to _____ and the demand curve to shift to the _____. A) decrease; right B) decrease; left C) increase; right D) increase; left 22) A decline in the expected inflation rate causes the demand for money to _____ and the demand curve to shift to the _____. A) decrease; right B) decrease; left C) increase; right D) increase; left 23) Holding everything else equal, an increase in the money supply causes A) interest rates to decline initially. B) interest rates to increase initially. C) bond prices to decline initially. D) both (a) and (c) of the above. E) both (b) and (c) of the above. 24) It is entirely possible that when the money supply rises, interest rates may _____ if the _____ effect is more than offset by changes in income, the price level, and expected inflation. A) fall; liquidity B) fall; risk C) rise; liquidity D) rise; risk 25) Of the four effects on interest rates from an increase in the money supply, the one that works in the opposite direction of the other three is the A) liquidity effect. B) income effect. C) price level effect. D) expected inflation effect. 26) An increase in the riskiness of bonds relative to alternative assets causes the demand for bonds to _____ and the demand curve to shift to the _____. A) rise, right B) rise, left C) fall, right D) fall, left 27) Higher government deficits _____ the supply of bonds and shift the supply curve to the _____. A) increase, left B) increase, right C) decrease, left D) decrease, right 28) When the inflation rate is expected to increase, the real cost of borrowing declines at any given interest rate; the _____ of bonds increases and the _____ curve shifts to the right. A) demand, demand B) demand, supply C) supply, demand D) supply, supply 29) When the inflation rate is expected to rise, interest rates will _____; this result has been termed the _____. A) fall, Keynes effect B) fall, Fisher effect C) rise, Pigou effect D) rise, Fisher effect E) rise, Keynes effect 30) In his Liquidity Preference Framework, Keynes assumed that money has a zero rate of return; thus, A) when interest rates rise, the expected return on money falls relative to the expected return on bonds, causing the demand for money to fall. B) when interest rates rise, the expected return on money falls relative to the expected return on bonds, causing the demand for money to rise. C) when interest rates fall, the expected return on money falls relative to the expected return on bonds, causing the demand for money to fall. D) when interest rates fall, the expected return on money falls relative to the expected return on bonds, causing the demand for money to rise. 31) Shifting the demand for money curve, a decline in the interest rate can be explained by A) a decrease in income. B) a decrease in the expected price level. C) an increase in money growth. D) both (a) and (b) of the above. E) both (a) and (c) of the above. Figure 5-4 32) In Figure 5-4, the increase in the interest rate from i2 to i1 can be explained by A) a decrease in money growth. B) an increase in the expected price level. C) an increase in income. D) both (a) and (c) of the above. E) both (b) and (c) of the above. Figure 5-5 33) Figure 5-5 illustrates the effect of an increased rate of money supply growth. From the figure, one can conclude that the A) the liquidity effect is smaller than the expected inflation effect and interest rates adjust quickly to changes in expected inflation. B) the liquidity effect is larger than the expected inflation effect and interest rates adjust quickly to changes in expected inflation. C) the liquidity effect is larger than the expected inflation effect and interest rates adjust slowly to changes in expected inflation. D) the liquidity effect is smaller than the expected inflation effect and interest rates adjust slowly to changes in expected inflation. Figure 5-6 34) Figure 5-6 illustrates the effect of an increased rate of money supply growth. From the figure, one can conclude that the A) the liquidity effect is smaller than the expected inflation effect and interest rates adjust quickly to changes in expected inflation. B) the liquidity effect is larger than the expected inflation effect and interest rates adjust quickly to changes in expected inflation. C) the liquidity effect is larger than the expected inflation effect and interest rates adjust slowly to changes in expected inflation. D) the liquidity effect is smaller than the expected inflation effect and interest rates adjust slowly to changes in expected inflation. Figure 5-7 35) Figure 5-7 illustrates the effect of an increased rate of money supply growth. From the figure, one can conclude that the A) the liquidity effect is smaller than the expected inflation effect and interest rates adjust quickly to changes in expected inflation. B) the liquidity effect is larger than the expected inflation effect and interest rates adjust quickly to changes in expected inflation. C) the liquidity effect is larger than the expected inflation effect and interest rates adjust slowly to changes in expected inflation. D) the liquidity effect is smaller than the expected inflation effect and interest rates adjust slowly to changes in expected inflation.

1)   The term structure of interest rates is

A) the relationship among interest rates of different bonds with the same maturity.

B) the structure of how interest rates move over time.

C) the relationship among the term to maturity of different bonds.

D) the relationship among interest rates on bonds with different maturities.

 

 

2)         When the default risk in corporate bonds decreases, other things equal, the demand curve for corporate bonds shifts to the _____ and the demand curve for Treasury bonds shifts to the _____.

A) right; right B)  right; left C)  left; left D)  left; right

 

 

3)   When the Treasury bond market becomes more liquid, other things equal, the demand curve for corporate bonds shifts to the _____ and the demand curve for Treasury bonds shifts to the _____.

A) right; right B)  right; left C)  left; right D)  left; left

 

 

4)   The risk premium on corporate bonds becomes smaller if

A) the riskiness of corporate bonds increases.

B) the liquidity of corporate bonds increases.

C) the liquidity of corporate bonds decreases.

D) the riskiness of corporate bonds decreases.

E) both (b) and (d) occur.

 

 

5)   The risk premium on corporate bonds rises when

A) brokerage commissions fall in the corporate bond market.

B) a flurry of major corporate bankruptcies occurs.

C) the Treasury bond market becomes less liquid.

D) any of the above occurs.

 

 

6)         The interest rate on municipal bonds falls relative to the interest rate on Treasury securities when

A) there is a major default in the municipal bond market.

B) income tax rates are raised.

C) municipal bonds become less widely traded.

D) corporate bonds become riskier.

E) none of the above occur.

 

7)   If income tax rates were lowered, then

A) the prices of municipal bonds would fall.

B) the interest rate on municipal bonds would fall.

C) the interest rate on Treasury bonds would rise.

D) both (a) and (b) would occur.

 

 

8)   If income tax rates were lowered, then

A) the interest rate on municipal bonds would rise.

B) the interest rate on Treasury bonds would fall.

C) the interest rate on municipal bonds would fall.

D) both (a) and (b) would occur.

E) both (b) and (c) would occur.

 

 

9)   A plot of the interest rates on default-free government bonds with different terms to maturity is called

A) a risk-structure curve.                           B)  a term-structure curve.

C) a yield curve.                                        D)  an interest-rate curve.

 

 

10) The liquidity premium theory of the term structure

A) indicates that today’s long-term interest rate equals the average of short-term interest rates that people expect to occur over the life of the long-term bond.

B) assumes that bonds of different maturities are perfect substitutes.

C) suggests that markets for bonds of different maturities are completely separate because people have preferred habitats.

D) does none of the above.

 

 

11)       Which of the following theories of the term structure is (are) able to explain the fact that interest rates on bonds of different maturities tend to move together over time?

A) The expectations theory

B) The segmented markets theory

C) The liquidity premium theory

D) Both (a) and (b) of the above

E) Both (a) and (c) of the above

 

 

12) 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

A) 4 percent. B)  5 percent. C)  6 percent. D)  7 percent. E)  8 percent.

 

 

13) If the yield curve is flat for short maturities and then slopes downward for longer maturities, the liquidity premium theory (assuming a mild preference for shorter-term bonds) indicates that the market is predicting.

A) a rise in short-term interest rates in the near future and a decline further out in the future.

B) constant short-term interest rates in the near future and a decline further out in the future.

C) a decline in short-term interest rates in the near future and a rise further out in the future.

D) a decline in short-term interest rates in the near future and an even steeper decline further out in the future.

 

 

14)       Interest rates on bonds of the same maturity will differ because of differences in

A) liquidity.

B) risk.

C) income tax treatment.

D) all of the above.

E) only (a) and (b) of the above.

 

 

15) If a corporation begins to suffer large losses, then

A) the default risk on the corporate bond will increase and the bond’s return will become more uncertain, meaning the expected return on the corporate bond will fall.

B) the default risk on the corporate bond will increase and the bond’s return will become less uncertain, meaning the expected return on the corporate bond will fall.

C) the default risk on the corporate bond will decrease and the bond’s return will become less uncertain, meaning the expected return on the corporate bond will fall.

D) the default risk on the corporate bond will decrease and the bond’s return will become less uncertain, meaning the expected return on the corporate bond will rise.

 

 

16)       The theory of asset demand predicts that as the possibility of a default on a corporate bond decreases, the expected return on the bond _____ while its relative riskiness _____.

A) rises; rises B)  rises; falls C)  falls; rises D)  falls; falls

 

 

17) The theory of asset demand predicts that a decline in the expected return on corporate bonds due to a rise in relative riskiness causes

A) a decline in the demand for default-free bonds.

B) an increase in the demand of corporate bonds.

C) a decline in the demand for corporate bonds.

D) a decline in the supply of corporate bonds.

 

 

18) Corporate bonds are not as liquid as government bonds because

A) fewer corporate bonds for any one corporation are traded, making them more costly to sell.

B) the corporate bond rating must be calculated each time they are traded.

C) corporate bonds are not callable.

D) of all of the above.

E) of only (a) and (b) of the above.

 

 

19) The risk structure of interest rates is explained by differences in

A) the bonds’ relative default risks.

B) the bonds’ relative liquidity.

C) the bond’s relative tax treatment.

D) all of the above.

E) only (a) and (b) of the above.

 

 

20) Factors that influence interest rates on bonds include

A) risk.

B) liquidity.

C) tax considerations.

D) term to maturity.

E) all of the above.

 

 

21) Typically, yield curves are

A) gently upward sloping.

B) gently downward sloping.

C) flat.

D) bowl shaped.

E) mound shaped.

 

 

22) When yield curves are steeply upward sloping,

A) long-term interest rates are above short-term interest rates.

B) short-term interest rates are above long-term interest rates.

C) short-term interest rates are about the same as long- term interest rates.

D) medium-term interest rates are above both short-term and long-term interest rates.

E) medium-term interest rates are below both short-term and long-term interest rates.

 

 

23) When yield curves are downward sloping,

A) long-term interest rates are above short-term interest rates.

B) short-term interest rates are above long-term interest rates.

C) short-term interest rates are about the same as long- term interest rates.

D) medium-term interest rates are above both short-term and long-term interest rates.

E) medium-term interest rates are below both short-term and long-term interest rates.

 

 

24) When yield curves are flat,

A) long-term interest rates are above short-term interest rates.

B) short-term interest rates are above long-term interest rates.

C) short-term interest rates are about the same as long- term interest rates.

D) medium-term interest rates are above both short-term and long-term interest rates.

E) medium-term interest rates are below both short-term and long-term interest rates.

 

25) According to the expectations theory of the term structure

A) the interest rate on long-term bonds will equal an average of short-term interest rates that people expect to occur over the life of the long-term bonds.

B) buyers of bonds do prefer short-term to long-term bonds.

C) interest rates on bonds of different maturities do not move together over time.

D) all of the above.

 

 

26) According to the expectations theory of the term structure

A) the interest rate on long-term bonds will equal an average of short-term interest rates that people expect to occur over the life of the long-term bonds.

B) interest rates on bonds of different maturities are not expected to move together over time since buyers of bonds prefer short-term to long-term bonds.

C) investors’ strong preferences for short-term relative to long-term bonds explains why yield curves typically slope upward.

D) all of the above.

E) only (a) and (b) of the above.

 

 

27)       According to the segmented markets theory of the term structure

A) the interest rate for each maturity bond is determined by supply and demand for that maturity bond.

B) bonds of one maturity are not substitutes for bonds of other maturities, therefore, interest rates on bonds of different maturities do not move together over time.

C) investors’ strong preferences for short-term relative to long-term bonds explains why yield curves typically slope upward.

D) all of the above.

E) none of the above.

 

 

28) Bonds with no default risk are called

A) flower bonds.                                       B)  no-risk bonds.

C) default-free bonds.                               D)  zero-risk bonds.

 

 

29) The spread between the interest rates on bonds with default risk and default-free bonds is called the

A) risk premium.                                       B)  junk margin.

C) bond margin.                                         D)  default premium.

 

 

30) As default risk increases, the expected return on corporate bonds _____, and the return becomes _____ uncertain.

A) increases, less B)  increases, more C)  decreases, less D)  decreases, more

 

 

31) As their relative riskiness _____, the expected return on corporate bonds _____ relative to the expected return on default-free bonds.

A) increases, increases

B) increases, decreases

C) decreases, decreases

D) decreases, does not change

E) increases, does not change

 

32)    Which of the following statements are true?

A) A bond with default risk will always have a positive risk premium, and an increase in its default risk will raise the risk premium.

B) The expected return on corporate bonds decreases as default risk decreases.

C) A corporate bond’s return becomes more uncertain as default risk increases.

D) Only (a) and (b) of the above are true statements.

 

 

33)    The spread between interest rates on low quality corporate bonds and U.S. government bonds

A) widened significantly during the Great Depression.

B) narrowed significantly during the Great Depression.

C) narrowed moderately during the Great Depression.

D) did not change during the Great Depression.

 

 

34)       The _____ of the term structure of interest rates states that the interest rate on a long-term bond will equal the average of short-term interest rates that individuals expect to occur over the life of the long-term bond.

A) segmented markets theory                 B)  expectations theory

C) liquidity premium theory                   D)  separable markets theory

 

 

35)    When the yield curve is upward sloping,

A) the expectations theory suggests that short-term interest rates are expected to rise.

B) the expectations theory suggests that short-term interest rates are expected to fall.

C) the segmented markets theory suggests that short-term interest rates are expected to fall.

D) the liquidity premium theory suggests that short-term interest rates are expected to fall.

 

 

36)    According to this theory of the term structure, bonds of different maturities are not substitutes for one another.

A) segmented markets theory                 B)  expectations theory

C) liquidity premium theory                   D)  separable markets theory

 

 

37)    Since yield curves are usually upward sloping, the _____ indicates that, on average, people tend to prefer holding short-term bonds to long-term bonds.

A) segmented markets theory

B) expectations theory

C) liquidity premium theory

D) both (a) and (b) of the above

E) both (a) and (c) of the above

 

 

38)    According to the liquidity premium theory

A) a steeply rising yield curve indicates that short-term interest rates are expected to remain unchanged in the future.

B) a moderately rising yield curve indicates that short-term interest rates are not expected to change much in the future.

C) a flat yield curve indicates that short-term interest rates are expected to rise moderately in the future.

D) only (a) and (b) of the true.

 

 

Figure 6-1

 

 

39)    The steeply upward sloping yield curve in Figure 6-1 indicates that

A) short-term interest rates are expected to rise in the future.

B) short-term interest rates are expected to fall moderately in the future.

C) short-term interest rates are expected to fall sharply in the future.

D) short-term interest rates are expected to remain unchanged in the future.

 

 

 

 

Figure 6-2

 

 

40)    The U-shaped yield curve in Figure 6-2 indicates that _____ interest rates are expected to _____

A) short-term; rise in the near-term and fall later on.

B) short-term; fall sharply in the near-term and rise later on.

C) short-term; fall moderately in the near-term and rise later on.

D) short-term; remain unchanged in the near-term and rise later on.

 

 1)    When the value of the British pound changes from $1.50 to $1.25, then

A) the pound has appreciated and the dollar has appreciated.

B) the pound has depreciated and the dollar has appreciated.

C) the pound has appreciated and the dollar has depreciated.

D) the pound has depreciated and the dollar has depreciated.

 

 

2)   According to the law of one price, if the price of Colombian coffee is 100 Colombian pesos per pound and the price of Brazilian coffee is 4 Brazilian reals per pound, then the exchange rate between the Colombian peso and the Brazilian reals is:

A) 40 pesos per real.

B) 100 pesos per real.

C) 25 pesos per real.

D) 0.4 pesos per real.

E) none of the above.

 

 

3)   If the 2001 inflation rate in Canada is 4 percent, and the inflation rate in Mexico is 2 percent, then the theory of purchasing power parity predicts that, during 2001, the value of the Canadian dollar in terms of Mexican pesos will

A) rise by 5 percent.

B) rise by 2 percent.

C) fall by 5 percent.

D) fall by 2 percent.

E) do none of the above.

 

 

4)   The theory of purchasing power parity cannot fully explain exchange rate movements because

A) not all goods are identical in different countries.

B) monetary policy differs across countries.

C) some goods are not traded between countries.

D) of both (a) and (c) of the above.

E) of both (b) and (c) of the above.

 

 

5)   If, in retaliation for “unfair” trade practices, Congress imposes a 30 percent tariff on Japanese videocassette recorders, but at the same time, U.S. demand for Japanese goods increases, then, in the long run,

A) the Japanese yen should appreciate relative to the dollar.

B) the Japanese yen should depreciate relative to the dollar.

C) the dollar should depreciate relative to the yen.

D) it is not clear whether the dollar should appreciate or depreciate relative to the yen.

 

 

6)   If the inflation rate in the United States is higher than that in Mexico and productivity is growing at a slower rate in the United States than in Mexico, then, in the long run,

A) the Peso should appreciate relative to the dollar.

B) the Peso should depreciate relative to the dollar.

C) the dollar should neither appreciate nor appreciate relative to the Peso.

D) we cannot know whether the dollar will appreciate or depreciate since these factors offset each other.

 

 

7) If the Brazilian demand for American exports rises at the same time that U.S. productivity rises relative to Brazilian productivity, then, in the long run,

A) the Brazilian real should depreciate relative to the dollar.

B) the Brazilian real should appreciate relative to the dollar.

C) the dollar should depreciate relative to the Brazilian real..

D) both (a) and (c) will occur.

E) it is not clear whether the Brazilian real should appreciate or depreciate relative to the dollar.

 

 

8)   If the interest rate is 7 percent on euro-denominated assets and 5 percent on dollar-denominated assets, and if the dollar is expected to appreciate at a 4 percent rate,

A) euro-denominated assets have a lower expected return than dollar-denominated assets.

B) the expected return on euro-denominated assets in dollars is 1 percent.

C) the expected return on dollar-denominated assets in euros is 1 percent.

D) the expected return on euro-denominated assets in dollars is 3 percent.

E) the expected return on dollar-denominated assets in euros is 3 percent.

 

 

9)   The theory of asset demand suggests that the most important factor affecting the demand for domestic and foreign deposits is

A) the level of trade and capital flows.

B) the expected return on these assets relative to one another.

C) the liquidity of these assets relative to one another.

D) the riskiness of these assets relative to one another.

 

 

10) When Americans or foreigners expect the return on _____ deposits to be high relative to the return on _____ deposits, there is a higher demand for dollar deposits and a correspondingly lower demand for foreign deposits.

A) dollar; dollar B)  dollar; foreign C)  foreign; dollar D)  foreign; foreign

 

 

11) If the interest rate on dollar deposits is 10 percent, and the dollar is expected to appreciate by 7 percent over the coming year, the expected return on dollar deposits in terms of the foreign currency is

A) 3 percent.

B) 10 percent.

C) 13.5 percent.

D) 17 percent.

E) 24 percent.

 

 

12) As the relative expected return on dollar deposits increases,

A) foreigners will want to hold fewer dollar deposits and more foreign deposits.

B) Americans will want to hold more dollar deposits and less foreign deposits.

C) Americans will want to hold fewer dollar deposits and more foreign deposits.

D) Americans and foreigners will be indifferent towards holding dollar deposits or foreign deposits.

 

 

 

13) In a world with few impediments to capital mobility, the domestic interest rate equals the sum of the foreign interest rate and the expected depreciation of the domestic currency, a situation known as the

A) interest parity condition.                                   B)  purchasing power parity condition.

C) exchange rate parity condition.                         D)  foreign asset parity condition.

 

 

 

14) According to the interest parity condition, if the domestic interest rate is 10 percent and the foreign interest rate is 12 percent, then

A) the expected appreciation of the foreign currency must be 4 percent.

B) the expected appreciation of the foreign currency must be 2 percent.

C) the expected depreciation of the foreign currency must be 2 percent.

D) the expected depreciation of the foreign currency must be 4 percent.

 

 

 

15) A decrease in the foreign interest rate shifts the expected return schedule for _____ deposits to the _____ and causes the domestic currency to appreciate.

A) domestic; right B)  domestic; left C)  foreign; right D)  foreign; left

 

 

16) A rise in the expected future exchange rate shifts the expected return schedule for _____ deposits to the _____ and causes the domestic currency to appreciate.

A) domestic; right B)  domestic;

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