CHAPTER 7
Interest Rates and Bond Prices
1. The
is the return on a bond which includes both the interest return and any
capital gain or loss.
a. coupon payment
b. yield to maturity
c. nominal interest rate
d. term to maturity
ANSWER b
2. A bond sells at
originally issued.
a. an inflation premium
b. par value
c. a premium above par
d. a discount from par
ANSWER d
because interest rates have increased since the bond was
3. A bond sells at
issued.
a. an inflation premium
b. par value
c. a premium above par
d. a discount from par
ANSWER c
because interest rates have fallen since the bond was originally
4. The amount of nominal interest added to the real interest rate to compensate the lender for the
expected loss in purchasing power that will accompany any inflation is called
a. an inflation premium.
b. par value.
c. a premium above par.
d. a discount from par.
ANSWER a
5.
represents the value today of funds to be received or lent on a future date.
a. Compounding
b. The money illusion
c. The present value
d. The principal
ANSWER c
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Interest Rates and Bond Prices
91
6. Reacting to nominal changes caused by changes in prices when real variables, such as interest
rates, have not changed is called
a. compounding.
b. money illusion.
c. discounting.
d. principal.
ANSWER b
7. The
is the market interest rate.
a. nominal interest rate
b. inflation-adjusted interest rate
c. real interest rate
d. Both b and c
ANSWER a
8. The
is the interest rate corrected for changes in the purchasing power of
money.
a. nominal interest rate
b. nominal interest rate minus the expected rate of inflation
c. real interest rate
d. Both b and c
ANSWER d
9.
is the method used to determine the future value of a sum lent today.
a. Discounting
b. Compounding
c. Present value
d. A consol
ANSWER b
10.
is the method used to determine the present value of a sum to be received in the
future.
a. Discounting
b. Compounding
c. Present value
d. The time value of money
ANSWER a
11. The original amount of funds lent is called the
a. dividend.
b. coupon payment.
c. consol.
d. principal.
ANSWER d
12. The periodic payments made to bondholders is called the
a. dividend.
b. coupon payment.
c. consol.
d. principal.
ANSWER b
13. The profits which are distributed to stockholders are called
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Chapter 7
a. dividends.
b. coupon payments.
c. consols.
d. principals.
ANSWER a
14. The demand for loanable funds comes from
a. DSUs.
b. SSUs.
c. the Fed in its provision of reserves in the conduct of monetary policy.
d. None of the above
ANSWER a
15. The supply of loanable funds comes from
a. DSUs.
b. SSUs.
c. the Fed in its provision of reserves in the conduct of monetary policy.
d. Both b and c
ANSWER d
16. The relationship between the willingness to postpone purchases into the future and the reward is
which of the following?
a. Direct
b. Inverse
c. Negative
d. Inverse with falling diminishing returns
ANSWER: a
17. Lending in the present enables which of the following?
a. Spending the sum of what is lent minus the interest earned in the future
b. Spending the sum of what is lent plus the interest earned in the present
c. Spending the sum of what is lent plus the interest earned in the future
d. Spending the sum of what is lent minus the interest earned in the future
ANSWER: c
18. Borrowing involves which of he following?
a. Spending today and paying back with interest tomorrow
b. Spending today and paying back without interest tomorrow
c. Spending today and paying back with interest today
d. None of the above
ANSWER: a
19. The interest rate is a major influence of
a. consumption in the future.
b. consumption in the present.
c. saving in the present.
d. all of the above.
ANSWER: d
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20. The time value of money is represented by the
a. demand for loanable funds.
b. inflation rate.
c. interest rate.
d. terms of trade.
ANSWER: c
21. Ceteris paribus, the phenomenon of a dollar today being worth more than a dollar tomorrow is
called which of these terms?
a. Time value of money
b. Future value
c. Present value
d. Compounding
ANSWER: a
22. When trying to determine the future value of money lent today, which method is used?
a. The present-value borrowing formula
b. The present-value lending formula
c. Compounding
d. Discounting
ANSWER: c
23. An increase in the interest rate
a. encourages SSUs to save.
b. encourages DSUs to borrow.
c. discourages DSUs from saving.
d. Both a and b
ANSWER: a
24. If you have $10,000 today, which of the following methods should you use to determine what it
will be worth in the future, assuming a 10% interest rate?
a. Time value of money
b. Compounding
c. Discounting
d. Guessing
ANSWER: b
25. If Erik lends Dan $5,000 and Dan agrees to repay Erik $6,000 in 1 year's time, the $5,000 is the
a. interest rate.
b. compounding amount.
c. principal.
d. real return.
ANSWER: c
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Chapter 7
26. Which of the following equations represents the method used to determine present value of a
sum of money to be received n years from now in the future?
a. V1 = V0 x (1 + i) n
b. I = $C/$PB
c. V0 = Vn / (1 + i)n
d. $PB = $C1 /(1+i)1 + $C2/(1+i)2 + . . . $Cn / (1+i)n + $F / (1+i)n
ANSWER: c
27. Which of the following equations represents the method used to determine the future value in n
years of a sum that you have today?
a. V1 = V0 x (1 + i) n
b. I = $C/$PB
c. V0 = Vn / (1 + i)n
d. $PB = $C1 /(1+i)1 + $C2/(1+i)2 + . . . $Cn / (1+i)n + $F / (1+i)n
ANSWER: a
28. Which of the following equations represents the method used to determine the present value of a
bond?
a. V1 = V0 x (1 + i) n
b. I = $C/$PB
c. V0 = Vn / (1 + i)n
d. $PB = $C1 /(1+i)1 + $C2/(1+i)2 + . . . $Cn / (1+i)n + $F / (1+i)n
ANSWER: d
29. Which of the following equations represents the method used to determine the present value of a
consol?
a. V1 = V0 x (1 + i) n
b. $PB = $C/i
c. V0 = Vn / (1 + i)n
d. $PB = $C1 /(1+i)1 + $C2/(1+i)2 + . . . $Cn / (1+i)n + $F / (1+i)n
ANSWER: b
30. If a bank will pay 15% interest compounded annually on a $1,000 deposit today, the depositor
will receive how much at the end of 2 years?
a. $1,150.00
b. $1,300.00
c. $1,322.50
d. $1,645.00
ANSWER: c
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31. If a bank will pay 7% interest compounded annually on $2,500 deposited today, the depositor
will receive how much at the end of 8 years?
a. $3,900.00
b. $3,950.45
c. $4,267.63
d. $4,295.47
ANSWER: d
32. Discounting answers which of these questions?
a. What is the present value of money to be paid in the future?
b. What is the future value of money to be paid in the future?
c. What is the future value of money to be paid in the present?
d. None of the above
ANSWER: a
33. Assuming an interest rate of 5%, what would the present value be of $4 million to be received in
4 years?
a. $2,468,107.42
b. $2,887,753.24
c. $3,290,809.89
d. $3,469,145.89
ANSWER: c
34. Corporate bonds and government bonds share all of the following characteristics except
a. they both have a face value.
b. they are both issued for a certain number of years.
c. the issuer agrees to make coupon payments.
d. they both pay dividends.
ANSWER: d
35. Periodic interest payments over the term to maturity of bonds are called
a. par values.
b. present values.
c. coupon payments.
d. discountings.
ANSWER: c
36. Coupon payments are equal to the
a. coupon rate on a bond multiplied by the face value of the bond.
b. par value on a bond divided by the face value of the bond.
c. par value on a bond minus the face value of the bond.
d. coupon rate on a bond minus the face value of the bond.
ANSWER: a
37. If a bond is sold at a discount from par, this
a. lowers the yield on the bond.
b. does not change the yield on the bond.
c. raises the yield on the bond.
d. None of the above
ANSWER: c
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Chapter 7
38. As market interest rates rise, what happens to the price of existing bonds?
a. Prices of existing bonds fall.
b. Prices of existing bonds increase.
c. Prices of existing bonds remain the same.
d. Prices of existing bonds increase and then decrease.
ANSWER: a
39. As market interest rates fall, what happens to the prices of existing bonds?
a. Prices of existing bonds fall.
b. Prices of existing bonds increase.
c. Prices of existing bonds remain the same.
d. Prices of existing bonds increase and then decrease.
ANSWER: b
40. Bond prices fall until the yield to maturity of the bond becomes
a. less than the current interest rate.
b. more than the current interest rate.
c. equal to the current interest rate.
d. less than comparable stock options.
ANSWER: c
41. Which of the following best describes the relationship between bond prices and the interest rate?
a. When the interest rate decreases, the price of the bond decreases.
b. When the interest rate increases, the price of the bond increases.
c. When the interest rate increases, the price of the bond decreases.
d. Both a and b
ANSWER: c
42. A/An
relationship exists between the price of outstanding bonds and the
prevailing level of market interest rates.
a. inverse
b. direct
c. uncertain
d. positive
ANSWER: a
43. In general, if bond prices are rising, then interest rates are
a. rising.
b. falling.
c. unchanging.
d. rising slightly, then stabilizing.
ANSWER: b
44. In general, if interest rates are rising, then bond prices are
a. rising.
b. falling.
c. unchanging.
d. rising slightly, then stabilizing.
ANSWER: b
Interest Rates and Bond Prices
45. The demand of loanable funds originates from
a. household DSUs.
b. government DSUs.
c. business DSUs.
d. All of the above.
ANSWER: d
46. The demand curve for loanable funds is
a. upward sloping.
b. downward sloping.
c. perfectly horizontal.
d. perfectly vertical.
ANSWER: b
47. The supply of loanable funds originates from
a. household and business SSUs.
b. the Fed.
c. government SSUs.
d. All of the above.
ANSWER: d
48. The supply curve for loanable funds is
a. upward sloping.
b. downward sloping.
c. perfectly horizontal.
d. perfectly vertical.
ANSWER: a
49. When GDP rises, ceteris paribus, firms and households become
a. less willing to borrow.
b. more willing and able to borrow.
c. indifferent with regard to borrowing.
d. less able to borrow.
ANSWER: b
50. The relationship between GDP and the demand for funds is
a. negative.
b. direct.
c. indifferent.
d. inverse.
ANSWER: b
51. In general, when income falls, the willingness and ability to borrow and spend will
a. increase.
b. decrease.
c. remain the same.
d. be impossible to determine.
ANSWER: b
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Chapter 7
52. Typically the supply of loanable funds and the interest rate are
a. directly
b. inversely
c. positively
d. unrelated
ANSWER: b
related.
53. The interest rate corrected for changes in the purchasing power of money is called the
a. nominal interest rate.
b. real interest rate.
c. discount rate.
d. prime lending rate.
ANSWER: b
54. The real interest rate is defined by
a. The nominal interest rate plus the expected rate of inflation over the life of the asset.
b. The discount rate plus the expected rate of inflation over the life of the asset.
c. The nominal interest rate minus the expected rate of inflation over the life of the asset.
d. The discount rate minus the expected rate of inflation over the life of the asset.
ANSWER: c
55. In general, the direction of the change in interest rates will
a. follow the direction of the change in inflationary expectations.
b. not be affected by the direction of the change in inflationary expectations.
c. go the opposite direction of the change in inflationary expectation.
d. either go in the opposite direction of the change in inflationary expectations or remain the
same.
ANSWER: a
56. Given an interest rate of 5%, which has a higher present value: A payment of $80 at the present
time, or $100 in 2 years?
a. The present amount ($80 now) has a higher present value because of a positive time
preference.
b. The future amount ($100 in 2 years ) has a higher present value, give an interest rate of 5%.
c. The present amount ($80 now) has a higher present value, given an interest rate of 5 %.
d. The present amount ($80 now) has a higher compounded value.
ANSWER: b
57. If a bond has 10 years to go to maturity, a par value of $5,000, is paying a dividend of $300
annually, and costs $6,000 today, the current yield is which of the following?
a. 6%
b. 5%
c. 10%
d. Impossible to deduce from the information given
ANSWER: b
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58. The real interest rate is which of these?
a. The nominal interest rate minus the expected inflation rate
b. The nominal interest rate plus the inflation rate
c. The nominal rate
d. Always positive
ANSWER: a
59. The interest rate is __________ related to changes in income, __________ related to changes in
money supply, and __________ related to changes in expected inflation.
a. positively, positively, positively
b. negatively, negatively, negatively
c. positively, negatively, negatively
d. positively, negatively, positively
ANSWER: d
60. Under what conditions will a bond sell at a premium above its initial selling price?
a. When interest rates have increased since the bond was issued
b. When interest rates have fallen since the bond was issued
c. When a broker in secondary market is charging a commission
d. Never
ANSWER: b
61. The present value of a $100 payment to be received in 2 years is $82.64. What is the interest
rate?
a. 5%
b. 7%
c. 10%
d. 12.5%
ANSWER: c
62. Given an interest rate of 10%, what is the present value of a $100 payment to be received in 2
years?
a. $121.00
b. $86.45
c. $90.00
d. $82.64
ANSWER: d
63. Reacting to nominal values rather than to real values is which of the following?
a. Myopia
b. Suffering from money illusion
c. Rational expectations
d. The proper thing to do
ANSWER: b
64. The relationship between stock prices and the interest rate is generally which of these?
a. Direct
b. Inverse
c. Positive
d. None of the above
ANSWER: b
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Chapter 7
65. Which of the following statements is false?
a. A consol is a perpetual bond with no maturity date.
b. Compounding gives the future value of a present sum.
c. Discounting gives the present value of a future sum.
d. The interest rate and the price of a bond are directly related.
ANSWER: d
66. Interest rates tend to do which of the following?
a. Go up in expansions and down in recessions
b. Increase when the demand for funds increases, and increase when the supply of funds
decreases, ceteris paribus
c. Change when price expectations change
d. All of the above
ANSWER: d
67. The interest rate is
a. The rental cost of money
b. The return or yield to lenders
c. The "price" of money
d. All of the above
ANSWER: d
Use Figure 7–1 to answer Questions 68–70
Interest
rate
(%)
SS
DD
Loanable funds
(billions)
D'D'
Figure 7–1
68. Which of the following best describes the diagram?
a. The demand for loanable funds increased. This, in turn, increased the interest rate and the
supply of loanable funds.
b. The demand for loanable funds increased. This, in turn, increased the interest rate and the
quantity supplied of loanable funds.
c. The supply of loanable fund increased. In turn, interest rates increased.
d. Interest rates increased, causing the demand of loanable funds to increase.
ANSWER: b
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69. Which of the following occurrences could have generated the phenomena diagrammed above?
a. A decrease in income
b. An increase in income
c. An increase in money supply
d. A decrease in money supply
ANSWER: b
70. In which phase of the business cycle would the diagrammed phenomena most likely have
occurred?
a. Recession
b. Expansion
c. Trough
d. Depression
ANSWER: b
71. Assume that you can borrow $1,000 and pay back the principal and interest three years later.
The lender charges 12% interest per year on the outstanding balance at the end of each year, all
due and payable at the end of 3 years. How much would have to be repaid at the end of three
years?
a. $1,360.00
b. $1,254.40
c. $4,214.79
d. $1,404.93
ANSWER: d
Use Figure 7–2 below to answer Questions 72–74.
Interest
rate
(%)
SS
S'S'
DD
Loanable funds
(billions)
Figure 7–2
72. Which of the following best describes the diagram?
a. The demand for loanable funds decreased. This in turn decreased the interest rate and
increased the quantity supplied of loanable funds.
b. The supply of loanable funds increased. This in turn increased the interest rate.
c. The supply of loanable funds increased. In turn, interest rates decreased and the quantity
demanded of loanable funds increased.
d. The interest rate fell, causing an increase in the supply of loanable funds.
ANSWER: c
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Chapter 7
73. Which of the following occurrences could have generated the phenomena diagrammed above?
a. A decrease in income
b. A tighter monetary policy by the Federal Reserve
c. An easier monetary policy by the Federal Reserve
d. An increase in income
ANSWER: c
74. In which phase of the business cycle would the diagrammed phenomena most likely have
occurred?
a. Recession
b. Expansion
c. Trough
d. Depression
ANSWER: a
74. If the nominal interest rate is 7% and the real interest rate is 3%, then the expected rate of
inflation must be
a. 6%.
b. 4%.
c. — 4%.
d. 5%.
ANSWER: b
75. If the nominal interest rate is 9% and expected inflation is 11%, then the real interest rate is
a. -2%.
b. 2%.
c. 20%.
d. unknown.
ANSWER: a
76. If the real interest rate is 3% and expected inflation is 5%, then the nominal interest rate is
a. 2%.
b. –2%.
c. 8%.
d. unknown.
ANSWER: c
77. The par value of a bond is
a. the face value printed on a bond.
b. the amount the bond originally sold for.
c. the amount that will be repaid at maturity.
d. All of the above.
ANSWER: d
78. The market for loanable funds is in equilibrium
a. when the demand for loanable funds is equal to the supply of loanable funds.
b. at the interest rate determined by the intersection of the demand curve and the supply curve
of loanable funds.
c. when the quantity demanded is equal to the quantity supplied of loanable funds.
d. Both b and c.
ANSWER: d
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79. What is the price of a consol with a constant coupon payment of $100 per year if the interest rate
is 7 %?
a. $1,428.57
b. $1,000
c. $700
d. None of the above.
ANSWER: a
80. A consol with a coupon payment of $100 is purchased for $1,000. When the consol is sold, the
interest rate is 20%. What has happened to the price of the consol?
a. The consol’s price remains at $1,000.
b. The consol’s price will have increased to $2,000.
c. The consol’s price will have decreased to $500.
d. It is impossible to determined from the information given what the price of the consol will
be.
ANSWER: c
81. If both income and the money supply are increasing, what will happen to the interest rate?
a. the interest rate will increase.
b. the interest rate will decrease.
c. the interest rate will remain unchanged.
d. the interest rate can increase, decrease, or remain the same.
ANSWER: d
82. A consol is
a. a special type of bond that matures in 100 years.
b. A perpetual bond with no maturity date.
c. a bond whose price is directly related to changes in the interest rate.
d. a sum resulting from compounding. As opposed to discounting.
ANSWER: b
83. If a bond is selling above par,
a. its current yield will be lower than its coupon yield.
b. its current yield will be higher than its coupon yield.
c. its current yield will equal its coupon yield.
d. its price has fallen since it was originally issued.
ANSWER: a