Exam 4: The Level of Interest Rates

If a security's realized return is negative, the expected return was smaller than the required return.

Declining interest rates can be caused by an upward shift in the demand for loanable funds relative to the supply of loanable funds.

An increase in desired investment shifts the desired savings supply line upward to higher real rates of interest.

The expected real rate of interest is almost always negative.

If yields on thirty-year U. S. Treasury bonds are 8% and the real rate of interest is estimated at 3%, the historical rate of inflation is 5%.

Calculate the price of a $1000 face value bond, maturing in three years with a 9 percent coupon (paid semiannually) if current real rates of interest are 4 percent, historical inflation rates are 3 percent, and expected inflation rates are 4 percent. (Use if next chapter covered in exam)

The flow of funds forecasting method utilizes the concept of supply and demand of loanable funds.

An increase in the desired saving rate will increase real interest rates.

Economic models and flow-of-funds are two ways of forecasting interest rates.

Nominal interest rates reflect anticipated inflation.

In January 2011, a Japanese investor placing money in dollar denominated assets desires a 5% real rate of return. Then international expected inflation rate is about 2.5% and the dollar is expected to decline against Japanese Yen by 10% over the investment period. What is the approximate minimum required rate of return for this Japanese investor?

Deficit spending units supply loanable funds.

The realized real rate of interest can be negative if expected inflation is less than actual inflation.

The market rate of interest can be viewed as approximately equal to the real rate of interest plus a premium for the expected rate of inflation.

Economic models forecast interest rates then estimate measures of economic output.

TIPS yields pay investors a higher coupon rate when inflation increases.

Explain how price expectations influence the level of interest rates. What impact has inflation premiums had on interest rate levels in recent years?

Nominal rates generally exceed the real rate.

Interest rates are directly related to inflation expectations and inversely related to the level of economic activity.

An upward shift in the supply of loanable funds is likely to increase interest rates.