Exam 5: Understanding Interest Rates, Savings, and the Wealth Effect

If domestic savings rise, less foreign savings will be needed to support domestic living standards according to the textbook.

For households current saving is defined as equal to the difference between current income and current consumption expenditures.

According to the Rational Expectations Theory, interest rates follow predictable patterns that can be used to earn excess profits.

In the real world there are thousands of interest rates, but there is no such thing as "the interest rate."

Suppose a $1,000 par-value bond was issued last year with a promised annual rate of return (yield) of 6 percent when market interest rates on comparable securities were also 6 percent. Thus, the bond pays its holder $60 annually in interest. Today, one year later, market interest rates on comparable securities are 10 percent. The price of the 6 percent bond will approach what dollar figure?

The equilibrium rate of interest in the Liquidity Preference Theory is determined by:

The rational expectations view suggests that new information made available to market investors will tend to cause interest rates to fall temporarily below their equilibrium values, but rates will rapidly move back toward equilibrium.

Which of the following statements concerning the "pure" rate of interest is true?

The equilibrium rate of interest as determined in the loanable funds theory of interest will rise if:

For an individual or family heavily in debt a rise in interest rates will stimulate a greater amount of savings because of the wealth effect.

The majority of business expenditures for investment are to carry out net investment.

The wealth effect was very strong during the stock market and housing booms of the late 1990s when the personal savings rate went negative as households consumed more than their income. This effect has sense reversed itself due to the recent credit crisis.

Money demanded for transactions and precautionary purposes is dependent upon the level of and changes in interest rates.

Dishoarding of money leads to higher interest rates, ceteris paribus.

Suppose the total demand for money is described by the following equation: MD = 30 - 2i, where i is the prevailing market interest rate. The total supply of money is described by the equation: MS = 3 + 7i. According to the liquidity preference theory of interest rates, what is the prevailing equilibrium rate of interest?

According to the Liquidity Preference theory of interest, at a point above the equilibrium rate of interest, the supply of money exceeds the quantity demanded and some households, businesses and units of government will try to dispose of unwanted money balances by purchasing bonds.

As long as projects are mutually exclusive, NPV and IRR yield the same results.

Each project will last an estimated 5 years with no remaining significant scrap value. Determine the IRR and the NPV for each of these two projects. What should INLAC decide about each proposed project, assuming the above figures are truly accurate? INLAC Company, Ltd. is examining two investment projects as a part of its expansion plan for the coming year. These two projects are not mutually exclusive. The cost of Project A is $9,870 while the second project (B) is expected to cost $17,850. INLAC's cost of capital (required rate of return) is 12 %. Expected annual cash flows are projected to be as follows:

A new drill press is considered a possible new investment for EXRON Corporation if it generates an expected return of $2,000 per year for 10 years. Its expected purchase price (including installation) is $9,400. What is the drill press project's expected internal rate of return?

Factors influencing the investment decision-making process of business firms include all of the following except: