This Document Contains Chapters 3 to 4 Chapter 3 What Is Money? 3.1 Meaning of Money 1) To an economist, ________ is anything that is generally accepted in payment for goods and services or in the repayment of debt. A) wealth B) income C) money D) credit Answer: C 2) Money is A) anything that is generally accepted in payment for goods and services or in the repayment of debt. B) a flow of earnings per unit of time. C) the total collection of pieces of property that are a store of value. D) always based on a precious metal like gold or silver. Answer: A 3) Currency includes A) paper money and coins. B) paper money, coins, and checks. C) paper money and checks. D) paper money, coins, checks, and savings deposits. Answer: A 4) Even economists have no single, precise definition of money because A) money supply statistics are a state secret. B) the Federal Reserve does not employ or report different measures of the money supply. C) the "moneyness" or liquidity of an asset is a matter of degree. D) economists find disagreement interesting and refuse to agree for ideological reasons. Answer: C 5) The total collection of pieces of property that serve to store value is a person's A) wealth. B) income. C) money. D) credit. Answer: A 6) A person's house is part of her A) money. B) income. C) liabilities. D) wealth. Answer: D 7) ________ is used to make purchases while ________ is the total collection of pieces of property that serve to store value. A) Money; income B) Wealth; income C) Income; money D) Money; wealth Answer: D 8) ________ is a flow of earnings per unit of time. A) Income B) Money C) Wealth D) Currency Answer: A 9) An individual's annual salary is her A) money. B) income. C) wealth. D) liabilities. Answer: B 10) When we say that money is a stock variable, we mean that A) the quantity of money is measured at a given point in time. B) we must attach a time period to the measure. C) it is sold in the equity market. D) money never loses purchasing power. Answer: A 11) The difference between money and income is that A) money is a flow and income is a stock. B) money is a stock and income is a flow. C) there is no difference—money and income are both stocks. D) there is no difference—money and income are both flows. Answer: B 12) Which of the following is a true statement? A) Money and income are flow variables. B) Money is a flow variable. C) Income is a flow variable. D) Money and income are stock variables. Answer: C 13) Which of the following statements uses the economists' definition of money? A) I plan to earn a lot of money over the summer. B) Betsy is rich—she has a lot of money. C) I hope that I have enough money to buy my lunch today. D) The job with New Company gave me the opportunity to earn more money. Answer: C 3.2 Functions of Money 1) Of money's three functions, the one that distinguishes money from other assets is its function as a A) store of value. B) unit of account. C) standard of deferred payment. D) medium of exchange. Answer: D 2) If peanuts serve as a medium of exchange, a unit of account, and a store of value, then peanuts are A) bank deposits. B) reserves. C) money. D) loanable funds. Answer: C 3) ________ are the time and resources spent trying to exchange goods and services. A) Bargaining costs. B) Transaction costs. C) Contracting costs. D) Barter costs. Answer: B 4) Compared to an economy that uses a medium of exchange, in a barter economy A) transaction costs are higher. B) transaction costs are lower. C) liquidity costs are higher. D) liquidity costs are lower. Answer: A 5) When compared to exchange systems that rely on money, disadvantages of the barter system include: A) the requirement of a double coincidence of wants. B) lowering the cost of exchanging goods over time. C) lowering the cost of exchange to those who would specialize. D) encouraging specialization and the division of labor. Answer: A 6) The conversion of a barter economy to one that uses money A) increases efficiency by reducing the need to exchange goods and services. B) increases efficiency by reducing the need to specialize. C) increases efficiency by reducing transactions costs. D) does not increase economic efficiency. Answer: C 7) Which of the following statements best explains how the use of money in an economy increases economic efficiency? A) Money increases economic efficiency because it is costless to produce. B) Money increases economic efficiency because it discourages specialization. C) Money increases economic efficiency because it decreases transactions costs. D) Money cannot have an effect on economic efficiency. Answer: C 8) When economists say that money promotes ________, they mean that money encourages specialization and the division of labor. A) bargaining B) contracting C) efficiency D) greed Answer: C 9) Money ________ transaction costs, allowing people to specialize in what they do best. A) reduces B) increases C) enhances D) eliminates Answer: A 10) For a commodity to function effectively as money it must be A) easily standardized, making it easy to ascertain its value. B) difficult to make change. C) deteriorate quickly so that its supply does not become too large. D) hard to carry around. Answer: A 11) All of the following are necessary criteria for a commodity to function as money except A) it must deteriorate quickly. B) it must be divisible. C) it must be easy to carry. D) it must be widely accepted. Answer: A 12) Whatever a society uses as money, the distinguishing characteristic is that it must A) be completely inflation proof. B) be generally acceptable as payment for goods and services or in the repayment of debt. C) contain gold. D) be produced by the government. Answer: B 13) All but the most primitive societies use money as a medium of exchange, implying that A) the use of money is economically efficient. B) barter exchange is economically efficient. C) barter exchange cannot work outside the family. D) inflation is not a concern. Answer: A 14) Kevin purchasing concert tickets with his debit card is an example of the ________ function of money. A) medium of exchange B) unit of account C) store of value D) specialization Answer: A 15) When money prices are used to facilitate comparisons of value, money is said to function as a A) unit of account. B) medium of exchange. C) store of value. D) payments-system ruler. Answer: A 16) A problem with barter exchange when there are many goods is that in a barter system A) transactions costs are minimized. B) there exists a multiple number of prices for each good. C) there is only one store of value. D) exchange of services is impossible. Answer: B 17) In a barter economy the number of prices in an economy with N goods is A) [N(N - 1)]/2. B) N(N/2). C) 2N. D) N(N/2) - 1. Answer: A 18) If there are five goods in a barter economy, one needs to know ten prices in order to exchange one good for another. If, however, there are ten goods in a barter economy, then one needs to know ________ prices in order to exchange one good for another. A) 20 B) 25 C) 30 D) 45 Answer: D 19) If there are four goods in a barter economy, then one needs to know ________ prices in order to exchange one good for another. A) 8 B) 6 C) 5 D) 4 Answer: B 20) Because it is a unit of account, money A) increases transaction costs. B) reduces the number of prices that need to be calculated. C) does not earn interest. D) discourages specialization. Answer: B 21) Dennis notices that jackets are on sale for $99. In this case money is functioning as a ________. A) medium of exchange B) unit of account C) store of value D) payments-system ruler Answer: B 22) As a store of value, money A) does not earn interest. B) cannot be a durable asset. C) must be currency. D) is a way of saving for future purchases. Answer: D 23) Patrick places his pocket change into his savings bank on his desk each evening. By his actions, Patrick indicates that he believes that money is a A) medium of exchange. B) unit of account. C) store of value. D) unit of specialization. Answer: C 24) ________ is the relative ease and speed with which an asset can be converted into a medium of exchange. A) Efficiency B) Liquidity C) Deflation D) Specialization Answer: B 25) Increasing transactions costs of selling an asset make the asset A) more valuable. B) more liquid. C) less liquid. D) more moneylike. Answer: C 26) Since it does not have to be converted into anything else to make purchases, ________ is the most liquid asset. A) money B) stock C) artwork D) gold Answer: A 27) Of the following assets, the least liquid is A) stocks. B) traveler's checks. C) checking deposits. D) a house. Answer: D 28) Ranking assets from most liquid to least liquid, the correct order is A) savings bonds; house; currency. B) currency; savings bonds; house. C) currency; house; savings bonds. D) house; savings bonds; currency. Answer: B 29) People hold money even during inflationary episodes when other assets prove to be better stores of value. This can be explained by the fact that money is A) extremely liquid. B) a unique good for which there are no substitutes. C) the only thing accepted in economic exchange. D) backed by gold. Answer: A 30) If the price level doubles, the value of money A) doubles. B) more than doubles, due to scale economies. C) rises but does not double, due to diminishing returns. D) falls by 50 percent. Answer: D 31) A fall in the level of prices A) does not affect the value of money. B) has an uncertain effect on the value of money. C) increases the value of money. D) reduces the value of money. Answer: C 32) A hyperinflation is A) a period of extreme inflation generally greater than 50% per month. B) a period of anxiety caused by rising prices. C) an increase in output caused by higher prices. D) impossible today because of tighter regulations. Answer: A 33) During hyperinflations, A) the value of money rises rapidly. B) money no longer functions as a good store of value and people may resort to barter transactions on a much larger scale. C) middle-class savers benefit as prices rise. D) money's value remains fixed to the price level; that is, if prices double so does the value of money. Answer: B 34) Because inflation in Germany after World War I sometimes exceeded 1,000 % per month, one can conclude that the German economy suffered from A) deflation. B) disinflation. C) hyperinflation. D) superdeflation. Answer: C 35) If merchants in the country Zed choose to close their doors, preferring to be stuck with rotting merchandise rather than worthless currency, then one can conclude that Zed is experiencing a A) superdeflation. B) hyperdeflation. C) disinflation. D) hyperinflation. Answer: D 36) Explain how cigarettes could be called "money" in prisoner-of-war camps of World War II. Answer: The cigarettes performed the three functions of money. They served as the medium of exchange because individuals did exchange items for cigarettes. They served as a unit of account because prices were quoted in terms of the number of cigarettes required for the exchange. They served as a store of value because an individual would be willing to save their cigarettes even if they did not smoke because they believed that they could exchange the cigarettes for something that they did want at some time in the future. 3.3 Evolution of the Payments System 1) The payments system is A) the method of conducting transactions in the economy. B) used by union officials to set salary caps. C) an illegal method of rewarding contracts. D) used by your employer to determine salary increases. Answer: A 2) As the payments system evolves from barter to a monetary system, A) commodity money is likely to precede the use of paper currency. B) transaction costs increase. C) the number of prices that need to be calculated increase rather dramatically. D) specialization decreases. Answer: A 3) A disadvantage of ________ is that it is very heavy and hard to transport from one place to another. A) commodity money B) fiat money C) electronic money D) paper money Answer: A 4) Paper currency that has been declared legal tender but is not convertible into coins or precious metals is called ________ money. A) commodity B) fiat C) electronic D) funny Answer: B 5) When paper currency is decreed by governments as legal tender, legally it must be ________. A) paper currency backed by gold B) a precious metal such as gold or silver C) accepted as payment for debts D) convertible into an electronic payment Answer: C 6) The evolution of the payments system from barter to precious metals, then to fiat money, then to checks can best be understood as a consequence of the fact that A) paper is more costly to produce than precious metals. B) precious metals were not generally acceptable. C) precious metals were difficult to carry and transport. D) paper money is less accepted than checks. Answer: C 7) Compared to checks, paper currency and coins have the major drawbacks that they A) are easily stolen. B) are hard to counterfeit. C) are not the most liquid assets. D) must be backed by gold. Answer: A 8) Introduction of checks into the payments system reduced the costs of exchanging goods and services. Another advantage of checks is that A) they provide convenient receipts for purchases. B) they can never be stolen. C) they are more widely accepted than currency. D) the funds from a deposited check are available for use immediately. Answer: A 9) The evolution of the payments system from barter to precious metals, then to fiat money, then to checks can best be understood as a consequence of A) government regulations designed to improve the efficiency of the payments system. B) government regulations designed to promote the safety of the payments system. C) innovations that reduced the costs of exchanging goods and services. D) competition among firms to make it easier for customers to purchase their products. Answer: C 10) Compared to an electronic payments system, a payments system based on checks has the major drawback that A) checks are less costly to process. B) checks take longer to process, meaning that it may take several days before the depositor can get her cash. C) fraud may be more difficult to commit when paper receipts are eliminated. D) legal liability is more clearly defined. Answer: B 11) Which of the following sequences accurately describes the evolution of the payments system? A) Barter, coins made of precious metals, paper currency, checks, electronic funds transfers B) Barter, coins made of precious metals, checks, paper currency, electronic funds transfers C) Barter, checks, paper currency, coins made of precious metals, electronic funds transfers D) Barter, checks, paper currency, electronic funds transfers Answer: A 12) During the past two decades an important characteristic of the modern payments system has been the rapidly increasing use of A) checks and decreasing use of currency. B) electronic fund transfers. C) commodity monies. D) fiat money. Answer: B 13) Which of the following is not a form of e-money? A) a debit card B) a credit card C) a stored-value card D) a smart card Answer: B 14) A smart card is the equivalent of A) cash. B) savings bonds. C) savings deposits. D) certificates of deposit. Answer: A 15) An electronic payments system has not completely replaced the paper payments system because of all of the following reasons except A) expensive equipment is necessary to set up the system. B) security concerns. C) privacy concerns. D) transportation costs. Answer: D 16) In explaining the evolution of money A) government regulation is the most important factor. B) commodity money, because it is valued more highly, tends to drive out paper money. C) new forms of money evolve to lower transaction costs. D) paper money is always backed by gold and therefore more desirable than checks. Answer: C 17) What factors have slowed down the movement to a system where all payments are made electronically? Answer: The equipment necessary to set up the system is expensive, security of the information, and privacy concerns are issues that need to be addressed before an electronic payments system will be widely accepted. 3.4 Measuring Money 1) Recent financial innovation makes the Federal Reserve's job of conducting monetary policy A) easier, since the Fed now knows what to consider money. B) more difficult, since the Fed now knows what to consider money. C) easier, since the Fed no longer knows what to consider money. D) more difficult, since the Fed no longer knows what to consider money. Answer: D 2) Defining money becomes ________ difficult as the pace of financial innovation ________. A) less; quickens B) more; quickens C) more; slows D) more; stops Answer: B 3) Monetary aggregates are A) measures of the money supply reported by the Federal Reserve. B) measures of the wealth of individuals. C) never redefined since "money" never changes. D) reported by the Treasury Department annually. Answer: A 4) ________ is the narrowest monetary aggregate that the Fed reports. A) M0 B) M1 C) M2 D) M3 Answer: B 5) The currency component includes paper money and coins held in ________. A) bank vaults B) ATMs C) the hands of the nonbank public D) the central bank Answer: C 6) The components of the U.S. M1 money supply are demand and checkable deposits plus A) currency. B) currency plus savings deposits. C) currency plus travelers checks. D) currency plus travelers checks plus money market deposits. Answer: C 7) The M1 measure of money includes A) small denomination time deposits. B) traveler's checks. C) money market deposit accounts. D) money market mutual fund shares. Answer: B 8) Which of the following is not included in the measure of M1? A) NOW accounts. B) Demand deposits. C) Currency. D) Savings deposits. Answer: D 9) Which of the following is not included in the M1 measure of money but is included in the M2 measure of money? A) Currency B) Traveler's checks C) Demand deposits D) Small-denomination time deposits Answer: D 10) Which of the following is included in both M1 and M2? A) Currency B) Savings deposits C) Small-denomination time deposits D) Money market deposit accounts Answer: A 11) Which of the following is not included in the monetary aggregate M2? A) Currency B) Savings bonds C) Traveler's checks D) Checking deposits Answer: B 12) Which of the following is included in M2 but not in M1? A) NOW accounts B) Demand deposits C) Currency D) Money market mutual fund shares (retail) Answer: D 13) Of the following, the largest is A) money market deposit accounts. B) demand deposits. C) M1. D) M2. Answer: D 14) If an individual redeems a U.S. savings bond for currency A) M1 stays the same and M2 decreases. B) M1 increases and M2 increases. C) M1 increases and M2 stays the same. D) M1 stays the same and M2 stays the same. Answer: B 15) If an individual moves money from a small-denomination time deposit to a demand deposit account, A) M1 increases and M2 stays the same. B) M1 stays the same and M2 increases. C) M1 stays the same and M2 stays the same. D) M1 increases and M2 decreases. Answer: A 16) If an individual moves money from a demand deposit account to a money market deposit account, A) M1 decreases and M2 stays the same. B) M1 stays the same and M2 increases. C) M1 stays the same and M2 stays the same. D) M1 increases and M2 decreases. Answer: A 17) If an individual moves money from a savings deposit account to a money market deposit account, A) M1 decreases and M2 stays the same. B) M1 stays the same and M2 increases. C) M1 stays the same and M2 stays the same. D) M1 increases and M2 decreases. Answer: C 18) If an individual moves money from currency to a demand deposit account, A) M1 decreases and M2 stays the same. B) M1 stays the same and M2 increases. C) M1 stays the same and M2 stays the same. D) M1 increases and M2 stays the same. Answer: C 19) If an individual moves money from a money market deposit account to currency, A) M1 increases and M2 stays the same. B) M1 stays the same and M2 increases. C) M1 stays the same and M2 stays the same. D) M1 increases and M2 decreases. Answer: A 20) Small-denomination time deposits refer to certificates of deposit with a denomination of less than ________. A) $1,000 B) $10,000 C) $100,000 D) $1,000,000 Answer: C 21) Which of the following statements accurately describes the two measures of the money supply? A) The two measures do not move together, so they cannot be used interchangeably by policymakers. B) The two measures' movements closely parallel each other, even on a month-to-month basis. C) Short-run movements in the money supply are extremely reliable. D) M2 is the narrowest measure the Fed reports. Answer: A 22) The decade during which the growth rates of monetary aggregates diverged the most is A) the 1960s. B) the 1970s. C) the 1980s. D) the 1990s. Answer: D 23) Why are most of the U.S. dollars held outside of the United States? Answer: Concern about high inflation eroding the value of their own currency causes many people in foreign countries to hold U.S. dollars as a hedge against inflation risk. 3.5 How Reliable are the Money Data? 1) The Fed revises its estimates of the monetary aggregates, sometimes by large amounts, because A) large depository institutions need only report their deposits infrequently. B) weekly monetary data need to be adjusted for the "weekend effect." C) monthly monetary data need to be adjusted for the "payday effect." D) seasonal adjustments become more precise only as more data becomes available. Answer: D 2) The Fed estimates initial monetary aggregate reports because ________ depository institutions report the amount of their deposits infrequently. A) all B) small C) large D) state Answer: B 3) The increase in holiday spending is not the same every year causing the Fed's adjustment for ________ to be revised as more data becomes available. A) seasonal variation B) reporting discrepancy C) market churning D) transactions discrepancy Answer: A 4) An examination of revised money supply statistics, when compared to the initial statistics, suggests that the initial statistics A) are pretty good. B) do not provide a good guide to short-run movements in the money supply. C) provide a poor guide of monetary policy because they are usually underestimates of the revised statistics. D) provide a good guide of monetary policy, though they are usually underestimates of the revised statistics. Answer: B 5) Generally, the initial money supply data reported by the Fed A) is not a reliable guide to the short-run behavior of the money supply. B) is not a reliable guide to the long-run behavior of the money supply. C) is a reliable guide to the short-run behavior of the money supply. D) usually underestimate the revised statistics. Answer: A 6) The initial money supply data reported by the Fed are not a reliable guide to short-run movements in the money supply such as a ________, but are reasonably reliable for longer periods such as a ________. A) month; year B) day; month C) year; decade D) decade; century Answer: A Chapter 4 Understanding Interest Rates 4.1 Measuring Interest Rates 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: A 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: A 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: A 4) With an interest rate of 6 percent, the present value of $100 next year is approximately A) $106. B) $100. C) $94. D) $92. Answer: C 5) 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: B 6) 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: D 7) A 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: A 8) A 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: B 9) 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: B 10) A fully amortized loan is another name for A) a simple loan. B) a fixed-payment loan. C) a commercial loan. D) an unsecured loan. Answer: B 11) A credit market instrument that pays the owner a fixed coupon payment every year until the maturity date and then repays the face value is called a A) simple loan. B) fixed-payment loan. C) coupon bond. D) discount bond. Answer: C 12) A ________ pays the owner a fixed coupon payment every year until the maturity date, when the ________ value is repaid. A) coupon bond; discount B) discount bond; discount C) coupon bond; face D) discount bond; face Answer: C 13) The ________ is the final amount that will be paid to the holder of a coupon bond. A) discount value B) coupon value C) face value D) present value Answer: C 14) When talking about a coupon bond, face value and ________ mean the same thing. A) par value B) coupon value C) amortized value D) discount value Answer: A 15) The dollar amount of the yearly coupon payment expressed as a percentage of the face value of the bond is called the bond's A) coupon rate. B) maturity rate. C) face value rate. D) payment rate. Answer: A 16) If a $5,000 coupon bond has a coupon rate of 13 percent, then the coupon payment every year is A) $650. B) $1,300. C) $130. D) $13. Answer: A 17) An $8,000 coupon bond with a $400 coupon payment every year has a coupon rate of A) 5 percent. B) 8 percent. C) 10 percent. D) 40 percent. Answer: A 18) All of the following are examples of coupon bonds except A) Corporate bonds B) U.S. Treasury bills C) U.S. Treasury notes D) U.S. Treasury bonds Answer: B 19) A bond that is bought at a price below its face value and the face value is repaid at a maturity date is called a A) simple loan. B) fixed-payment loan. C) coupon bond. D) discount bond. Answer: D 20) A ________ is bought at a price below its face value, and the ________ value is repaid at the maturity date. A) coupon bond; discount B) discount bond; discount C) coupon bond; face D) discount bond; face Answer: D 21) A discount bond A) pays the bondholder a fixed amount every period and the face value at maturity. B) pays the bondholder the face value at maturity. C) pays all interest and the face value at maturity. D) pays the face value at maturity plus any capital gain. Answer: B 22) Examples of discount bonds include A) U.S. Treasury bills. B) corporate bonds. C) U.S. Treasury notes. D) municipal bonds. Answer: A 23) Which of the following are true for discount bonds? A) A discount bond is bought at par. B) The purchaser receives the face value of the bond at the maturity date. C) U.S. Treasury bonds and notes are examples of discount bonds. D) The purchaser receives the par value at maturity plus any capital gains. Answer: B 24) The interest rate that equates the present value of payments received from a debt instrument with its value today is the A) simple interest rate. B) current yield. C) yield to maturity. D) real interest rate. Answer: C 25) Economists consider the ________ to be the most accurate measure of interest rates. A) simple interest rate. B) current yield. C) yield to maturity. D) real interest rate. Answer: C 26) For simple loans, the simple interest rate is ________ the yield to maturity. A) greater than B) less than C) equal to D) not comparable to Answer: C 27) If the amount payable in two years is $2420 for a simple loan at 10 percent interest, the loan amount is A) $1000. B) $1210. C) $2000. D) $2200. Answer: C 28) For a 3-year simple loan of $10,000 at 10 percent, the amount to be repaid is A) $10,030. B) $10,300. C) $13,000. D) $13,310. Answer: D 29) If $22,050 is the amount payable in two years for a $20,000 simple loan made today, the interest rate is A) 5 percent. B) 10 percent. C) 22 percent. D) 25 percent. Answer: A 30) If a security pays $110 next year and $121 the year after that, what is its yield to maturity if it sells for $200? A) 9 percent B) 10 percent C) 11 percent D) 12 percent Answer: B 31) The present value of a fixed-payment loan is calculated as the ________ of the present value of all cash flow payments. A) sum B) difference C) multiple D) log Answer: A 32) Which of the following are true for a coupon bond? A) When the coupon bond is priced at its face value, the yield to maturity equals the coupon rate. B) The price of a coupon bond and the yield to maturity are positively related. C) The yield to maturity is greater than the coupon rate when the bond price is above the par value. D) The yield is less than the coupon rate when the bond price is below the par value. Answer: A 33) The price of a coupon bond and the yield to maturity are ________ related; that is, as the yield to maturity ________, the price of the bond ________. A) positively; rises; rises B) negatively; falls; falls C) positively; rises; falls D) negatively; rises; falls Answer: D 34) The yield to maturity is ________ than the ________ rate when the bond price is ________ its face value. A) greater; coupon; above B) greater; coupon; below C) greater; perpetuity; above D) less; perpetuity; below Answer: B 35) A $10,000 8 percent coupon bond that sells for $10,000 has a yield to maturity of A) 8 percent. B) 10 percent. C) 12 percent. D) 14 percent. Answer: A 36) Which of the following $1,000 face-value securities has the highest yield to maturity? A) A 5 percent coupon bond selling for $1,000 B) A 10 percent coupon bond selling for $1,000 C) A 12 percent coupon bond selling for $1,000 D) A 12 percent coupon bond selling for $1,100 Answer: C 37) Which of the following $5,000 face-value securities has the highest to maturity? A) A 6 percent coupon bond selling for $5,000 B) A 6 percent coupon bond selling for $5,500 C) A 10 percent coupon bond selling for $5,000 D) A 12 percent coupon bond selling for $4,500 Answer: D 38) Which of the following $1,000 face-value securities has the highest yield to maturity? A) A 5 percent coupon bond with a price of $600 B) A 5 percent coupon bond with a price of $800 C) A 5 percent coupon bond with a price of $1,000 D) A 5 percent coupon bond with a price of $1,200 Answer: A 39) Which of the following $1,000 face-value securities has the lowest yield to maturity? A) A 5 percent coupon bond selling for $1,000 B) A 10 percent coupon bond selling for $1,000 C) A 15 percent coupon bond selling for $1,000 D) A 15 percent coupon bond selling for $900 Answer: A 40) Which of the following bonds would you prefer to be buying? A) A $10,000 face-value security with a 10 percent coupon selling for $9,000 B) A $10,000 face-value security with a 7 percent coupon selling for $10,000 C) A $10,000 face-value security with a 9 percent coupon selling for $10,000 D) A $10,000 face-value security with a 10 percent coupon selling for $10,000 Answer: A 41) A coupon bond that has no maturity date and no repayment of principal is called a A) consol. B) cabinet. C) Treasury bill. D) Treasury note. Answer: A 42) The price of a consol equals the coupon payment A) times the interest rate. B) plus the interest rate. C) minus the interest rate. D) divided by the interest rate. Answer: D 43) The interest rate on a consol equals the A) price times the coupon payment. B) price divided by the coupon payment. C) coupon payment plus the price. D) coupon payment divided by the price. Answer: D 44) A consol paying $20 annually when the interest rate is 5 percent has a price of A) $100. B) $200. C) $400. D) $800. Answer: C 45) If a perpetuity has a price of $500 and an annual interest payment of $25, the interest rate is A) 2.5 percent. B) 5 percent. C) 7.5 percent. D) 10 percent. Answer: B 46) The yield to maturity for a perpetuity is a useful approximation for the yield to maturity on long-term coupon bonds. It is called the ________ when approximating the yield for a coupon bond. A) current yield B) discount yield C) future yield D) star yield Answer: A 47) The yield to maturity for a one-year discount bond equals the increase in price over the year, divided by the A) initial price. B) face value. C) interest rate. D) coupon rate. Answer: A 48) If a $10,000 face-value discount bond maturing in one year is selling for $5,000, then its yield to maturity is A) 5 percent. B) 10 percent. C) 50 percent. D) 100 percent. Answer: D 49) If a $5,000 face-value discount bond maturing in one year is selling for $5,000, then its yield to maturity is A) 0 percent. B) 5 percent. C) 10 percent. D) 20 percent. Answer: A 50) A discount bond selling for $15,000 with a face value of $20,000 in one year has a yield to maturity of A) 3 percent. B) 20 percent. C) 25 percent. D) 33.3 percent. Answer: D 51) The yield to maturity for a discount bond is ________ related to the current bond price. A) negatively B) positively C) not D) directly Answer: A 52) In Japan in 1998 and in the U.S. in 2008, interest rates were negative for a short period of time because investors found it convenient to hold six-month bills as a store of value because A) of the high inflation rate. B) these bills sold at a discount from face value. C) the bills were denominated in small amounts and could be stored electronically. D) the bills were denominated in large amounts and could be stored electronically. Answer: D 53) If the interest rate is 5%, what is the present value of a security that pays you $1, 050 next year and $1,102.50 two years from now? If this security sold for $2200, is the yield to maturity greater or less than 5%? Why? Answer: PV = $1,050/(1. + .05) + $1,102.50/(1 + 0.5)2 PV = $2,000 If this security sold for $2200, the yield to maturity is less than 5%. The lower the interest rate the higher the present value. 4.2 The Distinction Between Interest Rates and Returns 1) The ________ is defined as the payments to the owner plus the change in a security's value expressed as a fraction of the security's purchase price. A) yield to maturity B) current yield C) rate of return D) yield rate Answer: C 2) Which of the following are true concerning the distinction between interest rates and returns? A) The rate of return on a bond will not necessarily equal the interest rate on that bond. B) The return can be expressed as the difference between the current yield and the rate of capital gains. C) The rate of return will be greater than the interest rate when the price of the bond falls between time t and time t + 1. D) The return can be expressed as the sum of the discount yield and the rate of capital gains. Answer: A 3) The sum of the current yield and the rate of capital gain is called the A) rate of return. B) discount yield. C) pertuity yield. D) par value. Answer: A 4) What is the return on a 5 percent coupon bond that initially sells for $1,000 and sells for $1,200 next year? A) 5 percent B) 10 percent C) -5 percent D) 25 percent Answer: D 5) What is the return on a 5 percent coupon bond that initially sells for $1,000 and sells for $900 next year? A) 5 percent B) 10 percent C) -5 percent D) -10 percent Answer: C 6) The return on a 5 percent coupon bond that initially sells for $1,000 and sells for $950 next year is A) -10 percent. B) -5 percent. C) 0 percent. D) 5 percent. Answer: C 7) Suppose you are holding a 5 percent coupon bond maturing in one year with a yield to maturity of 15 percent. If the interest rate on one-year bonds rises from 15 percent to 20 percent over the course of the year, what is the yearly return on the bond you are holding? A) 5 percent B) 10 percent C) 15 percent D) 20 percent Answer: C 8) If the interest rates on all bonds rise from 5 to 6 percent over the course of the year, which bond would you prefer to have been holding? A) A bond with one year to maturity B) A bond with five years to maturity C) A bond with ten years to maturity D) A bond with twenty years to maturity Answer: A 9) An equal decrease in all bond interest rates A) increases the price of a five-year bond more than the price of a ten-year bond. B) increases the price of a ten-year bond more than the price of a five-year bond. C) decreases the price of a five-year bond more than the price of a ten-year bond. D) decreases the price of a ten-year bond more than the price of a five-year bond. Answer: B 10) An equal increase in all bond interest rates A) increases the return to all bond maturities by an equal amount. B) decreases the return to all bond maturities by an equal amount. C) has no effect on the returns to bonds. D) decreases long-term bond returns more than short-term bond returns. Answer: D 11) Which of the following are generally true of bonds? A) The only bond whose return equals the initial yield to maturity is one whose time to maturity is the same as the holding period. B) A rise in interest rates is associated with a fall in bond prices, resulting in capital gains on bonds whose terms to maturity are longer than the holding periods. C) The longer a bond's maturity, the smaller is the size of the price change associated with an interest rate change. D) Prices and returns for short-term bonds are more volatile than those for longer-term bonds. Answer: A 12) Which of the following are generally true of all bonds? A) The longer a bond's maturity, the greater is the rate of return that occurs as a result of the increase in the interest rate. B) Even though a bond has a substantial initial interest rate, its return can turn out to be negative if interest rates rise. C) Prices and returns for short-term bonds are more volatile than those for longer term bonds. D) A fall in interest rates results in capital losses for bonds whose terms to maturity are longer than the holding period. Answer: B 13) The riskiness of an asset's returns due to changes in interest rates is A) exchange-rate risk. B) price risk. C) asset risk. D) interest-rate risk. Answer: D 14) Interest-rate risk is the riskiness of an asset's returns due to A) interest-rate changes. B) changes in the coupon rate. C) default of the borrower. D) changes in the asset's maturity. Answer: A 15) Prices and returns for ________ bonds are more volatile than those for ________ bonds, everything else held constant. A) long-term; long-term B) long-term; short-term C) short-term; long-term D) short-term; short-term Answer: B 16) There is ________ for any bond whose time to maturity matches the holding period. A) no interest-rate risk B) a large interest-rate risk C) rate-of-return risk D) yield-to-maturity risk Answer: A 17) Your favorite uncle advises you to purchase long-term bonds because their interest rate is 10%. Should you follow his advice? Answer: It depends on where you think interest rates are headed in the future. If you think interest rates will be going up, you should not follow your uncle's advice because you would then have to discount your bond if you needed to sell it before the maturity date. Long-term bonds have a greater interest-rate risk. 4.3 The Distinction Between Real and Nominal Interest Rates 1) The ________ interest rate is adjusted for expected changes in the price level. A) ex ante real B) ex post real C) ex post nominal D) ex ante nominal Answer: A 2) The ________ interest rate more accurately reflects the true cost of borrowing. A) nominal B) real C) discount D) market Answer: B 3) The nominal interest rate minus the expected rate of inflation A) defines the real interest rate. B) is a less accurate measure of the incentives to borrow and lend than is the nominal interest rate. C) is a less accurate indicator of the tightness of credit market conditions than is the nominal interest rate. D) defines the discount rate. Answer: A 4) When the ________ interest rate is low, there are greater incentives to ________ and fewer incentives to ________. A) nominal; lend; borrow B) real; lend; borrow C) real; borrow; lend D) market; lend; borrow Answer: C 5) The interest rate that describes how well a lender has done in real terms after the fact is called the A) ex post real interest rate. B) ex ante real interest rate. C) ex post nominal interest rate. D) ex ante nominal interest rate. Answer: A 6) The ________ states that the nominal interest rate equals the real interest rate plus the expected rate of inflation. A) Fisher equation B) Keynesian equation C) Monetarist equation D) Marshall equation Answer: A 7) If the nominal rate of interest is 2 percent, and the expected inflation rate is -10 percent, the real rate of interest is A) 2 percent. B) 8 percent. C) 10 percent. D) 12 percent. Answer: D 8) In which of the following situations would you prefer to be the lender? A) The interest rate is 9 percent and the expected inflation rate is 7 percent. B) The interest rate is 4 percent and the expected inflation rate is 1 percent. C) The interest rate is 13 percent and the expected inflation rate is 15 percent. D) The interest rate is 25 percent and the expected inflation rate is 50 percent. Answer: B 9) In which of the following situations would you prefer to be the borrower? A) The interest rate is 9 percent and the expected inflation rate is 7 percent. B) The interest rate is 4 percent and the expected inflation rate is 1 percent. C) The interest rate is 13 percent and the expected inflation rate is 15 percent. D) The interest rate is 25 percent and the expected inflation rate is 50 percent. Answer: D 10) If you expect the inflation rate to be 15 percent next year and a one-year bond has a yield to maturity of 7 percent, then the real interest rate on this bond is A) 7 percent. B) 22 percent. C) -15 percent. D) -8 percent. Answer: D 11) If you expect the inflation rate to be 12 percent next year and a one-year bond has a yield to maturity of 7 percent, then the real interest rate on this bond is A) -5 percent. B) -2 percent. C) 2 percent. D) 12 percent. Answer: A 12) If you expect the inflation rate to be 4 percent next year and a one year bond has a yield to maturity of 7 percent, then the real interest rate on this bond is A) -3 percent. B) -2 percent. C) 3 percent. D) 7 percent. Answer: C 13) The interest rate on Treasury Inflation Protected Securities is a direct measure of A) the real interest rate. B) the nominal interest rate. C) the rate of inflation. D) the rate of deflation. Answer: A 14) Assuming the same coupon rate and maturity length, the difference between the yield on a Treasury Inflation Protected Security and the yield on a nonindexed Treasury security provides insight into A) the nominal interest rate. B) the real interest rate. C) the nominal exchange rate. D) the expected inflation rate. Answer: D 15) Assuming the same coupon rate and maturity length, when the interest rate on a Treasury Inflation Protected Security is 3 percent, and the yield on a nonindexed Treasury bond is 8 percent, the expected rate of inflation is A) 3 percent. B) 5 percent. C) 8 percent. D) 11 percent. Answer: B 16) Would it make sense to buy a house when mortgage rates are 14% and expected inflation is 15%? Explain your answer. Answer: Even though the nominal rate for the mortgage appears high, the real cost of borrowing the funds is -1%. Yes, under this circumstance it would be reasonable to make this purchase. 4.4 Web Appendix: Measuring Interest-Rate Risk: Duration 1) Duration is A) an asset's term to maturity. B) the time until the next interest payment for a coupon bond. C) the average lifetime of a debt security's stream of payments. D) the time between interest payments for a coupon bond. Answer: C 2) Comparing a discount bond and a coupon bond with the same maturity, A) the coupon bond has the greater effective maturity. B) the discount bond has the greater effective maturity. C) the effective maturity cannot be calculated for a coupon bond. D) the effective maturity cannot be calculated for a discount bond. Answer: B 3) The duration of a coupon bond increases A) the longer is the bond's term to maturity. B) when interest rates increase. C) the higher the coupon rate on the bond. D) the higher the bond price. Answer: A 4) All else equal, when interest rates ________, the duration of a coupon bond ________. A) rise; falls B) rise; increases C) falls; falls D) falls; does not change Answer: A 5) All else equal, the ________ the coupon rate on a bond, the ________ the bond's duration. A) higher; longer B) higher; shorter C) lower; shorter D) greater; longer Answer: B 6) If a financial institution has 50% of its portfolio in a bond with a five-year duration and 50% of its portfolio in a bond with a seven-year duration, what is the duration of the portfolio? A) 12 years B) 7 years C) 6 years D) 5 years Answer: C 7) An asset's interest rate risk ________ as the duration of the asset ________. A) increases; decreases B) decreases; decreases C) decreases; increases D) remains constant; increases Answer: B Test Bank for The Economics of Money, Banking and Financial Markets Frederic S. Mishkin 9780321599797, 9780134734200, 9780133836790, 9780134734606, 9780134733821
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