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2013-07-05 14:54:50
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  1. High interest rates tend to produce a larger volume of savings together with a higher volume of borrowing.

    a) True
    b) False
    b) False

    Although high interest rates do tend to produce a larger volume of savings, they tend to reduce the volume of borrowing.
  2. One of the economic functions performed by the rate of interest is to ration the available supply of credit, generally in favor of those investment projects with the lowest expected returns.

    a) True
    b) False
    b) False

    The interest rate does ration the available supply of credit but generally in favor of those investment projects with the highest expected returns.
  3. The risk-free interest rate represents the true "opportunity cost" of holding idle money.

    a) True
    b) False
    a) True

    The rate on U.S. Treasury bonds is often used to approximate the opportunity cost of holding money.
  4. According to the classical theory of interest rates, the level of interest rates is the only determinant of the volume of household savings.

    a) True
    b) False
    • b) False
    •  
    • Although interest rates do play an important role in determining the volume of saving by households, the classical theory recognizes that other factors, particularly the size of household income, also exert a major influence.
  5. The substitution effect says there is an inverse relationship between interest rates and the volume of saving.

    a) True
    b) False
    b) False

    While the substitution effect says higher interest rates bring out greater volume of savings, the relationship is positive, not inverse.
  6. High interest rates in the money and capital markets typically encourage business firms to make greater use of internally generated funds to finance projects.

    a) True
    b) False
    a) True

    External financing is more favorable when interest rates are considered low. High external rates force firms to seek more funds internally.
  7. The internal rate-of-return method of investment decision making entails discounting future cash flows back to their present value.

    a) True
    b) False
    a) True

    The IRR method equates the total cost of an investment project with future net cash flows expected from that project discounted back to their present values.
  8. One of the major limitations of the classical theory of interest rates is that it overemphasizes the potential impact on interest rates caused by the ability of commercial banks to create money.

    a) True
    b) False
    b) False

    The classical theory ignores the power of commercial banks to create money as a factor that affects interest rates.
  9. According to the liquidity-preference theory, neither the precautionary demand nor the transactions demand for money is heavily influenced by changes in interest rates.

    a) True
    b) False
    a) True

    Only the speculative demand is heavily influenced by changes in interest rates.
  10. Government demand for loanable funds, like business demand, is generally highly responsive to changes in the rate of interest.

    a) True
    b) False
    b) False

    Government demand for loanable funds is generally less responsive to interest rate changes than is business demand.
  11. According to the loanable-funds theory of interest rates, a principal source of loanable funds is household savings.

    a) True
    b) False
    a) True

    Saving by households is the difference between current income and current consumption. It is the principal source of loanable funds.
  12. If money and capital markets are highly efficient in digesting and reacting to new information that affects interest rates, those rates will always be at or very near their equilibrium levels.

    a) True
    b) False
    a) True

    Under these assumptions, any deviation from the equilibrium will be quickly eliminated.
  13. In recent years, interest rates and inflation have tended not to be closely correlated.

    a) True
    b) False
    b) False

    Recently, interest rates and inflation have been quite closely correlated. In the late 1970s, for example, both the CPI and the interest rate on prime commercial paper rose rapidly. During the 1980s, both declined steadily.
  14. During a period of inflation, the nominal interest rate on loans is higher than the real interest rate.

    a) True
    b) False
    a) True  

    During periods of inflation the nominal rate of interest rises much faster than the real rate of interest. The real interest rate is the return to the lender measured in actual purchasing power.
  15. The inflation premium is a measure of the inflation rate expected by investors during the life of a financial investment.

    a) True
    b) False
    a) True

    As the expectation of higher inflation materializes in the markets, lenders demand higher inflation premiums to compensate for the expected loss of purchasing power.
  16. The nominal rate of interest normally includes an inflation premium.

    a) True
    b) False
    a) True

    One element that makes up the nominal rate of interest is the inflation premium.
  17. According to the Fisher effect, an increase in inflation automatically increases real interest rates.

    a) True
    b) False
    b) False

    An increase in the expected inflation rate may increase nominal interest rates. However, real interest rates tend to be stable over time because they depend on long-term factors such as the productivity of capital.
  18. An inflation-risk premium represents compensation to lenders for the component of inflation that is expected.

    a) True
    b) False
    b) False

    The inflation risk premium is compensation that borrowers pay to lenders for uncertainty or unexpected inflation.
  19. In order for an investor to maintain his or her expected real after-tax rate of return, the nominal interest rate must rise by more than any rise in the expected inflation rate.

    a) True
    b) False
    a) True

    The nominal interest rate must rise faster than the rise in the expected inflation rate since part of the increased interest income must go to pay taxes. This is the inflation-caused income tax effect.
  20. Stock prices tend to fall when investors lower their dividend expectations due to unexpected inflation.

    a) True
    b) False
    a) True  

    Stock prices tend to fall when investors lower their dividend expectations.
  21. If inflation increases, the nominal interest payment and the nominal value at maturity of a TIPS bond will increase.

    a) True
    b) False
    a) True

    Both the nominal interest payment and the nominal value of the bond at maturity will increase to maintain the real value of the interest payment and the real value of the bond's principal.
  22. The classical theory of interest took into account the effect of which of the following factors?

    A) the declining marginal productivity of additional capital investments
    B) the fact that a family's income level is the main determinant of the level of its saving
    C) the fact that consumers and governments are important borrowers of funds
    D) the ability of commercial banks to create money
    A) the declining marginal productivity of additional capital investments

    The others are incorrect because the classical theory failed to recognize these factors as influencing interest rates.
    (this multiple choice question has been scrambled)
  23. Which of the following interest rate theories assumes that money and capital markets are highly efficient in digesting and reacting to new information that affects interest rates and security prices?

    A) classical theory
    B) liquidity-preference theory
    C) loanable-funds theory
    D) rational-expectations theory
    D) rational-expectations theory

    The others are incorrect because the as¬sumption of efficient markets is not part of the classical theory, the liquidity preference theory, or the loanable funds theory.
     
    (this multiple choice question has been scrambled)
  24. According to the loanable funds theory of interest rates, which of the following is a source of loanable funds for the domestic economy?

    A) lending to foreigners by domestic lenders
    B) destruction of money by the domestic banking system
    C) domestic dissaving by businesses, consumers, and governments
    D) domestic dishoarding of excess money balances held by the public
    D) domestic dishoarding of excess money balances held by the public

    The others are incorrect because they each reduce the supply of loanable funds available for the domestic economy.
     
    (this multiple choice question has been scrambled)
  25. The demand for funds by business firms is highly volatile from year to year for which of the following types of investment?

    I. replacement investment
    II. net investment

    A) I only
    B) II only
    C) Both I and II
    D) Neither I nor II
    B) II only

    I is incorrect because replacement investment is usually more predictable and grows at a more even rate than net investment.
     
    (this multiple choice question has been scrambled)
  26. Functions performed by the rate of interest in the economy include which of the following?
     
    I. to make credit available only to those projects with the lowest expected rates of return

    II. to help guarantee that the current savings of individuals and organizations will flow into investment projects

    A) Both I and II
    B) I only
    C) II only
    D) Neither I nor II
    C) II only

    I is incorrect because, although the rate of interest rations the supply of available credit, it generally makes that credit supply available only to investment projects that offer the highest expected rate of return.
    (this multiple choice question has been scrambled)
  27. Assumptions of the liquidity-preference theory of interest rates include which of the following?

    I. The public demands money for three sets of motives?the transactions motive, the precautionary motive, and the speculative motive.

    II. The supply of money is highly elastic relative to changes in the rate of interest.

    A) II only
    B) Neither I nor II
    C) I only
    D) Both I and II
    C) I only

    II is incorrect because the supply of money is assumed to be highly inelastic with respect to the rate of interest in the liquidity-preference theory. It is assumed that government decisions determine the size of the money supply and that those decisions are guided more by the public welfare than by interest rates.
     
    (this multiple choice question has been scrambled)
  28. All the following statements concerning the internal rate-of-return method of making investment decisions are correct EXCEPT

    A) The level of interest rates in the economy is an important consideration in investment decisions that are based on the internal rate of return.
    B) Anticipated future net cash flows from the investment are discounted back to their present values.
    C) If a firm must choose from several mutually exclusive investment projects, it generally will choose one with the highest expected internal rate of return.
    D) If an investment project's expected internal rate of return is equal to the firm's cost of capital, the project definitely should be accepted.
    D) If an investment project's expected internal rate of return is equal to the firm's cost of capital, the project definitely should be accepted.

    If the project's IRR is equal to the firm's cost of capital, the firm should be indifferent as to whether to accept the project.
     
    (this multiple choice question has been scrambled)
  29. The bulk of recent research suggests nominal (interest) rates rise by less than any given increase in the expected inflation rate. All the following tend to cause nominal interest rates to rise by less than the increase in the expected inflation rate EXCEPT

    A) the inflation-caused wealth effect
    B) the inflation-caused depreciation effect C) the inflation-caused income tax effect
    D) the inflation-caused income effect
    C) the inflation-caused income tax effect

    • Neither Fisher nor any of his contemporaries considered the effects of income taxation. Recent research indicates that there might be an inflation-caused income tax effect that may actually cause the nominal rate to widen more than the given change in expected inflation to compensate for the effect of taxes on the real after-tax rate of return.
    •  

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