Financial Markets and Institutions (FIN310) Problem Set I (Chapter 2)
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11. The required return to implement a given business project will be ____ if interest rates are lower. This implies that businesses will demand a ____ quantity of loanable funds when interest rates are lower.
a. greater; lower
b. lower; greater
c. lower; lower
d. greater; greater
12. The federal government demand for loanable funds is ____. If the budget deficit was expected to increase, the federal government demand for loanable funds would ____.
a. interest elastic; decrease
b. interest elastic; increase
c. interest inelastic; increase
d. interest inelastic; decrease
13. Which of the following is likely to cause a decrease in the equilibrium U.S. interest rate, other things being equal?
a. a decrease in savings by foreign savers
b. an increase in inflation
c. pessimistic economic projections that cause businesses to reduce expansion plans
d. a decrease in savings by U.S. households
14. The Fisher effect states that the
a. nominal interest rate equals the expected inflation rate plus the real rate of interest.
b. nominal interest rate equals the real rate of interest minus the expected inflation rate.
c. real rate of interest equals the nominal interest rate plus the expected inflation rate.
d. expected inflation rate equals the nominal interest rate plus the real rate of interest.
Summer 2016
15. Other things being equal, a ____ quantity of U.S. funds would be demanded by foreign governments and corporations if their domestic interest rates were ____ relative to U.S. rates.
a. smaller; high
b. larger; high
c. larger; low
d. none of the above
16. The aggregate demand for loanable funds is positively related to interest rates at any point in time.
a. True
b. False
17. If the aggregate demand for loanable funds increases without a corresponding ____ in aggregate supply, there will be a ____ of loanable funds.
a. increase; surplus
b. increase; shortage
c. decrease; surplus
d. decrease; shortage
18. The ____ suggests that the market interest rate is determined by factors that control the supply of and demand for loanable funds.
a. Fisher effect
b. loanable funds theory
c. real interest rate
d. none of the above
19. If inflation turns out to be lower than expected
a. savers benefit.
b. borrowers benefit while savers are not affected.
c. savers and borrowers are equally affected.
d. savers are adversely affected but borrowers benefit.
20. If a strong economy allows for a large ____ in households income, the supply curve will shift ____.
a. decrease; outward
b. increase; inward
c. increase; outward
d. none of the above
21. The ____ sector is the largest supplier of loanable funds. Summer 2016
a. household
b. government
c. business
d. none of the above
22. Securities that offer ____ liquidity will need to offer a ____ yield.
a. lower; higher
b. lower; lower
c. higher; higher
d. B and C
23. If all other characteristics are similar, ____ would have to offer ____.
a. taxable securities; a higher after-tax yield than tax-exempt securities
b. taxable securities; a higher before-tax yield than tax-exempt securities
c. tax-exempt securities; a higher after-tax yield than taxable securities
d. tax-exempt securities; a higher before-tax yield than taxable securities
24. Assume an investor's tax rate is 25 percent. The before-tax yield on a security is 12 percent. What is the after-tax yield?
a. 16.00 percent
b. 9.25 percent
c. 9.00 percent
d. 3.00 percent
e. none of the above
25. A firm in the 35 percent tax bracket is aware of a tax-exempt security that is paying a yield of 7 percent. To match this yield, taxable securities must offer a before-tax yield of
a. 7.0 percent.
b. 10.8 percent.
c. 20.0 percent.
d. none of the above
26. Holding other factors such as risk constant, the relationship between the maturity and annualized yield of securities is called the
a. term structure of interest rates.
b. default structure of interest rates.
c. liquidity structure of interest rates.
d. tax structure of interest rates.
e. none of the above
27. Assume that annualized yields of short-term and long-term securities are equal. If investors suddenly believe interest rates will increase, their actions may cause the yield curve to
a. become inverted.
b. become flat.
c. become upward sloping.
d. be unaffected.
28. According to pure expectations theory, if interest rates are expected to decrease, there will be ____ pressure on the demand for short-term funds by borrowers and ____ pressure on the
demand for long-term funds issued by borrowers.
a. upward; upward
b. downward; downward
c. upward; downward
d. downward; upward
29. According to the liquidity premium theory, the expected yield on a two-year security will ____ the expected yield from consecutive investments in one-year securities.
a. equal
b. be less than
c. be greater than
d. B and C are possible, depending on the size of the liquidity premium
30. The theory of the term structure of interest rates, which states that investors and borrowers choose securities with maturities that satisfy their forecasted cash needs, is the
a. pure expectations theory.
b. liquidity premium theory.
c. segmented markets theory.
d. liquidity habitat theory.
31. Vaughn Corporation is considering the issue of commercial paper and would like to know the yield it should offer on its commercial paper. The corporation believes that a 0.2 percent default risk premium, a 0.1 percent liquidity premium, and a 0.3 percent tax adjustment are necessary to sell its commercial paper to investors. Furthermore, annualized T-bill rates are 7 percent. Based on this information, Vaughn should offer ____ percent on its commercial paper.
a. 8.0
b. 7.6
c. 7.5
d. 7.9
e. none of the above
32. The graphic comparison of maturities and annualized yields is known as the interest rate curve.
a. True
b. False
33. If a security can easily be converted to cash without a loss in value, it
a. is liquid.
b. has a high after-tax yield.
c. has high default risk.
d. is illiquid.
34. The term structure of interest rates defines the relationship
a. between risk and return.
b. between risk and maturity.
c. between maturity and yield.
d. between default risk ratings and maturity.
35. Assume the yield curve is flat. If investors flood the short-term market and avoid the longterm market, they may cause the yield curve to
a. remain flat.
b. become upward sloping.
c. become downward sloping.
d. none of the above
36. Which of the following is not a major component of the Federal Reserve System?
a. member banks
b. Federal Open Market Committee
c. Securities and Exchange Commission
d. Board of Governors
37. The ____ rate is the interest rate charged on Fed district bank loans to depository institutions.
a. federal funds
b. prime
c. discount
d. real
38. The purchase of government securities by someone other than the Fed results in
a. an overall increase in funds among commercial banks.
b. an overall decrease in funds among commercial banks.
c. offsetting changes in funds at commercial banks.
d. an increase in securities maintained by the Fed.
39. When open market operations are used to ____ bank funds, the yield on debt instruments ____.
a. reduce; decreases
b. reduce; increases
c. increase; increases
d. none of the above
40. Assume that the reserve requirement ratio is 12 percent and that the Fed uses open market operations by buying $200 million worth of Treasury securities. Assuming that banks use all funds except required reserves to make loans and that the public does not store any cash, the money supply should ____ by about ____.
a. increase; $200 million
b. increase; $1.67 billion
c. decrease; $200 million
d. decrease; $1.67 billion
41. According to the theory of rational expectations, if the Fed uses open market operations in order to increase
the supply of loanable funds, the ultimate effect on interest rates is definitely
a. a reduction in interest rates.
b. an increase in interest rates.
c. no effect on the interest rates.
d. the impact on interest rates cannot be determined.
42. The Fed can ____ the level of spending as a means of stimulating the economy by ____ the money supply.
a. increase; decreasing
b. decrease; increasing
c. decrease; decreasing
d. increase; increasing
43. If the Fed attempts to reduce inflation, it would likely increase money supply growth.
a. True
b. False
44. When the Fed uses open market operations by selling some of its Treasury securities to investors in the U.S., there will be
a. an outward shift in the supply schedule of loanable funds.
b. an inward shift in the supply schedule of loanable funds.
c. no shift in the supply schedule of loanable funds.
d. an outward shift in the demand schedule for loanable funds.
45. ____ serves as the most direct indicator of economic growth in the United States.
a. Gross domestic product (GDP)
b. National income
c. The unemployment rate
d. The industrial production index
46. The ____ indicators tend to occur before a business cycle.
a. leading
b. lagging
c. coincident
d. none of the above
47. In general, there is:
a. a positive relationship between unemployment and inflation.
b. an inverse relationship between unemployment and inflation.
c. an inverse relationship between GNP and inflation.
d. a positive relationship between GNP and unemployment.
48. The Fed can affect the interaction between the demand for money and the supply of money to influence interest rates, the aggregate level of spending, and therefore economic growth.
a. True
b. False
49. A high budget deficit tends to place ____ pressure on interest rates; the Fed's tightening of the money supply tends to place ____ pressure on interest rates.
a. upward; upward
b. upward; downward
c. downward; downward
d. downward; upward
50. It is possible to have a substantial reduction in unemployment during a period of weak economic growth.
a. True
b. False