Quiz 2 practice questions

Question 1

1) The concept of ________ is based on the common-sense notion that a dollar paid to
you in the future is less valuable to you than a dollar today.
A) present value
B) future value
C) interest
D) deflation

Answer 1

a) present value

Question 2

2) The present value of an expected future payment ________ as the interest rate increases.
A) falls
B) rises
C) is constant
D) is unaffected

Answer 2

A) falls

present value decreases as the interest rate increases

PV=FV/(1+r)^n

Question 3

3) An increase in the time to the promised future payment ________ the present value
of the payment.
A) decreases
B) increases
C) has no effect on
D) is irrelevant to

Answer 3

B) decreases

the longer you wait to receive a payment the less valuable it is today given that the money could have been invested to earn a return in the meantime

Question 4

4) With an interest rate of 6 percent, the present value of $100 to be received next year
is approximately
A) $106.
B) $100.
C) $94.
D) $92.

Answer 4

C)$94
PV=FV/(1+r)^n
100=FV/(1.06)
=94

Question 5

5) What is the present value of $500.00 to be paid in two years if the interest rate is 5
percent?
A) $453.51
B) $500.00
C) $476.25
D) $550.00

Answer 5

A)453.51
PV=FV/(1+r)^n
PV=500/(1.05)^2
=453.51

Question 6

If a security pays $55 in one year and $133 in three years, its present value is $150 if
the interest rate is
A) 5 percent.
B) 10 percent.
C) 12.5 percent.
D) 15 percent.

Answer 6

PV= C1/(1+r)^1+ C2/(1+r)^3
PV1+PV2=150
C1=55
C3=133
150=55/(1+r) + 133/(1+r)^3
Test options

B)10%

Question 7

To claim that a lottery winner who is to receive $1 million per year for twenty years has won $20 million ignores the process of
A) face value.
B) par value.
C) deflation.
D) discounting the future

Answer 7

D) discounting the future

the concept of discounting the future acknowledges that money available today is worth more than the same money in the future

Question 8

credit market instrument that provides the borrower with an amount of funds that must be repaid at the maturity date along with an interest payment is known as a
A) simple loan.
B) fixed-payment loan.
C) coupon bond.
D) discount bond

Answer 8

A) simple loan.

Question 9

credit market instrument that requires the borrower to make the same payment
every period until the maturity date is known as a
A) simple loan.
B) fixed-payment loan.
C) coupon bond.
D) discount bond

Answer 9

B) fixed-payment loan.

Question 10

Which of the following are TRUE of fixed payment loans?
A) The borrower repays both the principal and interest at the maturity date.
B) Installment loans and mortgages are frequently of the fixed payment type.
C) The borrower pays interest periodically and the principal at the maturity date.
D) Commercial loans to businesses are often of this type

Answer 10

B) Installment loans and mortgages are frequently of the fixed payment type.

Question 11

1) Pieces of property that serve as a store of value are called
A) assets.
B) units of account.
C) liabilities.
D) borrowings.

Answer 11

A) assets.

Question 12

2) Of the four factors that influence asset demand, which factor will cause the demand for all assets to increase when it increases, everything else held constant?
A) wealth
B) expected returns
C) risk
D) liquidity

Answer 12

A) wealth

When wealth increases, individuals have more resources available to allocate toward purchasing assets, leading to an increase in the demand for all types of assets. This is assuming all other factors remain constant.

Question 13

12) 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

Answer 13

B) reduce; real

Question 14

13) If fluctuations in interest rates become smaller, then, other things equal, the demand for stocks ________ and the demand for long-term bonds ________.
A) increases; increases
B) increases; decreases
C) decreases; decreases
D) decreases; increases

Answer 14

C) increases; decreases

Smaller Fluctuations in Interest Rates: When interest rate fluctuations become smaller, there is less uncertainty in the market regarding the cost of borrowing and the returns on interest-bearing assets.

Demand for Stocks: A more stable interest rate environment can make stocks more attractive because they might now offer relatively better risk-adjusted returns compared to bonds, especially if interest rate risk was a significant factor previously. Thus, the demand for stocks increases.

Demand for Long-Term Bonds: As investors become more interested in stocks due to their attractive risk-return profile, the demand for long-term bonds decreases. In addition, long-term bonds are more sensitive to interest rate changes, so in a stable interest rate environment, the appeal of their inflation protection also lessens.

Question 15

17) The demand for Picasso paintings rises (holding everything else equal) when A) stocks become easier to sell.
B) people expect a boom in real estate prices.
C) Treasury securities become riskier.
D) people expect gold prices to rise.

Answer 15

C) Treasury securities become riskier.

Question 16

You would be less willing to purchase U.S. Treasury bonds, other things equal, if A) you inherit $1 million from your Uncle Harry.
B) you expect interest rates to fall.
C) gold becomes more liquid.
D) stock prices are expected to fall.

Answer 16

C) gold becomes more liquid.

Question 17

20) 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.

Answer 17

A) the brokerage commissions on bond sales become cheaper.

cost of transaction is reduced

Question 18

23) Holding everything else constant

A) if asset A’s risk rises relative to that of alternative assets, the demand will increase for asset A.

B) the more liquid is asset A, relative to alternative assets, the greater will be the demand for asset A.

C) the lower the expected return to asset A relative to alternative assets, the greater will be the demand for asset A.

D) if wealth increases, demand for asset A increases and demand for alternative assets decreases.

Answer 18

B) the more liquid is asset A, relative to alternative assets, the greater will be the demand for asset A.

Question 19

24) Holding all other factors constant, the quantity demanded of an asset is
A) positively related to wealth.
B) negatively related to its expected return relative to alternative assets.
C) positively related to the risk of its returns relative to alternative assets.
D) negatively related to its liquidity relative to alternative assets.

Answer 19

A) positively related to wealth.

Question 20

27) Holding everything else equal, if the expected return on My Company stock increases from 10% to 15% and the expected return on That Company stock increases from 10% to 12%, the demand for My Company stock

A) increases because the expected return has increased relative to the alternative asset.

B) decreases because it is riskier.

C) decreases because owners are now wealthier.

D) increases because the expected return of That Company stock increased.

Answer 20

A) increases because the expected return has increased relative to the alternative asset.

Question 21

3) The bond demand curve is ________ sloping, indicating a(n) ________ relationship between the price and quantity demanded of bonds, everything else equal.
A) downward; inverse
B) downward; direct
C) upward; inverse
D) upward; direct

Answer 21

A) downward; inverse
neg relationship between price and quantity, price of bond and interest rate are inversely related

Question 22

4) The supply curve for bonds has the usual upward slope, indicating that as the price ________, ceteris paribus, the ________ increases.
A) falls; supply
B) falls; quantity supplied
C) rises; supply
D) rises; quantity supplied

Answer 22

D) rises; quantity supplied

Question 23

7) When the price of a bond is above the equilibrium price, there is an excess ________ bonds and price will ________.
A) demand for; rise
B) demand for; fall
C) supply of; fall
D) supply of; rise

Answer 23

C) supply of; fall

Question 24

10) When the interest rate on a bond is ________ the equilibrium interest rate, in the bond market there is excess ________ and the interest rate will ________.
A) above; demand; rise
B) above; demand; fall
C) below; supply; fall
D) above; supply; rise

Answer 24

B) above; demand; fall

The equilibrium interest rate is the rate where bond supply equals bond demand.
When the interest rate on a bond is above the equilibrium rate, it means bonds are offering a higher return than usual.
At higher interest rates, bond prices are lower, making them more attractive to investors. This leads to higher demand for bonds and less supply.
The excess demand for bonds pushes bond prices up, which in turn causes the interest rate to fall back toward equilibrium (since bond prices and interest rates move inversely).

Question 25

1) A movement along the bond demand or supply curve occurs when ________ changes. A) bond price B) income C) wealth D) expected return

Answer 25

A) bond price When the price of the bond changes, it results in a movement along the demand or supply curve, reflecting a change in the quantity demanded or supplied. Changes in other factors, such as income, wealth, or expected returns, would cause a shift in the demand or supply curve rather than a movement along it

Question 26

2) When the price of a bond decreases, all else equal, the bond demand curve A) shifts right. B) shifts left. C) does not shift. D) invert

Answer 26

C) does not shift.

Question 27

3) During business cycle expansions when income and wealth are rising, the demand for bonds ________ and the demand curve shifts to the ________, everything else held constant. A) falls; right B) falls; left C) rises; right D) rises; left

Answer 27

C) rises; right

Question 28

4) Everything else held constant, when households save less, wealth and the demand for bonds ________ and the bond demand curve shifts ________. A) increase; right B) increase; left C) decrease; right D) decrease; left

Answer 28

D) decrease; left

Question 29

5) 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

Answer 29

A) rises; right Interest Rates and Bonds: When you buy a bond, you're essentially lending money to whoever issued the bond (like a company or government), and in return, you receive interest payments. The bonds pay a fixed rate of interest, called the coupon rate. Expectations of Future Interest Rates: If people expect interest rates to fall in the future, then the current bonds with higher fixed rates become more attractive. This is because future bonds will likely have lower rates compared to these current bonds. Demand for Long-Term Bonds: Rises: Because the current bonds' fixed rates are more attractive than future lower rates, more investors will want to buy these long-term bonds now. Shifts in Demand Curve: Right Shift: An increase in demand for bonds means that at every price (or interest rate), more bonds are demanded. Graphically, this is shown as a shift of the demand curve to the right. Therefore, when people expect interest rates to decline, they increase their demand for currently issued long-term bonds, shifting the demand curve to the right.

Question 30

7) Holding the expected return on bonds constant, an increase in the expected return on common stocks would ________ the demand for bonds, shifting the demand curve to the ________. A) decrease; left B) decrease; right C) increase; left D) increase; right

Answer 30

A) decrease; left

Question 31

15) Factors that decrease the demand for bonds include A) an increase in the volatility of stock prices. B) a decrease in the expected returns on stocks. C) a decrease in the inflation rate. D) a decrease in the riskiness of stocks.

Answer 31

D) a decrease in the riskiness of stocks. A) An increase in the volatility of stock prices: This would likely increase the demand for bonds, as bonds are generally seen as a safer investment compared to volatile stocks. B) A decrease in the expected returns on stocks: This would also likely increase the demand for bonds, as bonds might become relatively more attractive if stock returns are expected to be lower. C) A decrease in the inflation rate: This would likely increase the demand for bonds, because lower inflation means that the real return on bonds (the return after adjusting for inflation) is higher. D) A decrease in the riskiness of stocks: This would decrease the demand for bonds. If stocks become less risky, they become more attractive to investors compared to bonds, which could lead to a shift away from bonds and into stocks.

Question 32

16) During a recession, the supply of bonds ________ and the supply curve shifts to the ________, everything else held constant. A) increases; left B) increases; right C) decreases; left D) decreases; right

Answer 32

C) decreases; left

Question 33

17) In a business cycle expansion, the ________ of bonds increases and the ________ curve shifts to the ________ as business investments are expected to be more profitable, everything else held constant. A) supply; supply; right B) supply; supply; left C) demand; demand; right D) demand; demand; left

Answer 33

A) supply; supply; right

Question 34

18) 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

Answer 34

The correct answer is C) decreases; increases. nominal= real + inflation when expected inflation increases real interest rate decreases Real Cost of Borrowing: The real interest rate is approximately the nominal interest rate minus the expected inflation rate. When the expected inflation rate increases, the real interest rate decreases (assuming the nominal interest rate doesn't change immediately). This means the real cost of borrowing decreases. Bond Supply: When the real cost of borrowing decreases, it becomes cheaper for firms to issue bonds to finance their activities. As a result, the supply of bonds increases. Therefore, when the expected inflation rate increases, the real cost of borrowing decreases, leading to an increase in the supply of bonds.

Question 35

19) An increase in the expected inflation rate causes the supply of bonds to ________ and the supply curve to shift to the ________, everything else held constant. A) increase; left B) increase; right C) decrease; left D) decrease; right

Answer 35

B) increase; right Expected Inflation and Cost of Borrowing: When the expected inflation rate increases, the real cost of borrowing decreases (since the real interest rate is the nominal rate minus expected inflation). Supply of Bonds: As the cost of borrowing decreases, it becomes more attractive for issuers to supply more bonds to finance their activities and investments, as borrowing is effectively cheaper. Supply Curve Shift: An increase in the supply of bonds is represented by a rightward shift in the supply curve.

Question 36

20) Higher government deficits ________ the supply of bonds and shift the supply curve to the ________, everything else held constant. A) increase; left B) increase; right C) decrease; left D) decrease; right

Answer 36

B) increase; right

Question 37

21) Factors that can cause the supply curve for bonds to shift to the right, everything else held constant, include A) an expansion in overall economic activity. B) a decrease in expected inflation. C) a decrease in government deficits. D) a business cycle recession

Answer 37

A) an expansion in overall economic activity.

Question 38

30) When the economy slips into a recession, normally 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

Answer 38

B) decreases; decreases; falls

Question 39

49) In the figure above, a factor that could cause the supply of bonds to shift to the right is A) a decrease in government budget deficits. B) a decrease in expected inflation. C) a recession. D) a business cycle expansion.

Answer 39

D) a business cycle expansion.

Question 40

53) In the figure above, a factor that could cause the demand for bonds to shift to the right is A) an increase in the riskiness of bonds relative to other assets. B) an increase in the expected rate of inflation. C) expectations of lower interest rates in the future. D) a decrease in wealth.

Answer 40

C) expectations of lower interest rates in the future.

Question 41

In the figure above, the price of bonds would fall from P2 to P1 if A) there is a business cycle recession. B) there is a business cycle expansion. C) inflation is expected to increase in the future. D) inflation is expected to decrease in the future.

Answer 41

C) inflation is expected to increase in the future. the price of bonds falls , which indicates a decrease in bond prices. Higher expected inflation reduces the real return on bonds because the fixed interest payments from bonds lose value in terms of purchasing power. As a result, investors demand higher yields to compensate for inflation, which leads to a drop in bond prices (since bond prices and yields move inversely). This shift is reflected in the bond demand curve shifting left or the bond supply curve shifting right, leading to lower bond prices.

Question 42

55) Holding everything else constant, if the price of a Bitcoin becomes less volatile, the demand for bonds ________, the price of bonds ________, and the interest rate ________. A) falls; falls; rises B) falls; falls; falls C) rises; rises; rises D) rises; falls; rises

Answer 42

A) falls; falls; rises

Question 43

3) In Keynes's liquidity preference framework, if there is excess demand for money, there is A) an excess demand for bonds. B) equilibrium in the bond market. C) an excess supply of bonds. D) too much money.

Answer 43

C) an excess supply of bonds. In Keynes's liquidity preference framework, people choose between holding money (liquid asset) and bonds (interest-bearing asset). If there is excess demand for money, people want to hold more cash and are willing to sell bonds to obtain it. This leads to an excess supply of bonds in the market. As a result, bond prices decrease, causing interest rates to rise, which eventually restores equilibrium by making bonds more attractive relative to money.

Question 44

Using both the supply and demand for bonds and liquidity preferences frameworks, show how interest rates are affected when the riskiness of bonds rises. Are the results the same in the two frameworks?

Answer 44

1. Bond Supply and Demand Framework In the bond market, the equilibrium interest rate is determined by the interaction of bond supply and bond demand. Effect on Bond Demand: If bonds become riskier, investors will be less willing to hold bonds, causing the demand for bonds to decrease (shift left). Effect on Bond Supply: The supply of bonds may remain unchanged in the short run because bond issuers (governments or corporations) are still looking to sell bonds. Impact on Bond Prices and Interest Rates: Since bond demand decreases while supply remains stable, bond prices fall. Because bond prices and interest rates move inversely, this leads to higher interest rates. Conclusion (Bond Market Framework): Bond demand ↓ → Bond prices ↓ → Interest rates rise Effect on Money Demand: If bonds become riskier, people prefer to hold money (liquidity) rather than invest in bonds. This leads to an increase in the demand for money (shift right in the money demand curve). Effect on Money Supply: The money supply is assumed to be fixed by the central bank. Impact on Interest Rates: Since money demand increases while money supply remains the same, the interest rate must rise to restore equilibrium in the money market. Conclusion (Liquidity Preference Framework): Money demand ↑ → Interest rates rise