Exam 2: Determinants of Interest Rates

The one-year spot rate is currently 4 percent; the one-year spot rate one year from now will be 3 percent; and the one-year spot rate two years from now will be 6 percent. Under the unbiased expectations theory,what must today's three-year spot rate be? Suppose the three-year spot rate is actually 3.75 percent,how could you take advantage of this? Explain.

The traditional liquidity premium theory states that long-term interest rates are greater than the average of current and expected future short-term interest rates.

According to current projections,Social Security and other entitlement programs will soon be severely underfunded. If the government decides to cut social security benefits to future retirees and raise Social Security taxes on all workers,what will probably happen to the supply of funds available to the capital markets? What will be the effect on interest rates?

Explain the market segmentation theory of the term structure.

An investment pays $400 in one year,X amount of dollars in two years,and $500 in three years. The total present value of all the cash flows (including X)is equal to $1,500. If i is 6 percent,what is X?

Which of the following would normally be expected to result in an increase in the supply of funds,all else equal? I. The perceived riskiness of all investments decreases. II. Expected inflation increases. III. Current income and wealth levels increase. IV. Near term spending needs of households increase as energy costs rise.

Of the following,the most likely effect of an increase in income tax rates would be to

Suppose you can save $2,000 per year for the next ten years in an account earning 7 percent per year. How much will you have at the end of the tenth year if you make the first deposit today?

Convertible bonds will normally have lower promised yields than straight bonds of similar terms and quality.

The real risk-free rate is the increment to purchasing power that the lender earns in order to induce him or her to forego current consumption.

An improvement in economic conditions would likely shift the supply curve down and to the right and shift the demand curve for funds up and to the right.

Households generally supply more funds to the markets as their income and wealth increase,ceteris paribus.

An increase in the perceived riskiness of investments would cause a movement up along the supply curve.

An investor requires a 3 percent increase in purchasing power in order to induce her to lend. She expects inflation to be 2 percent next year. The nominal rate she must charge is about

What is the loanable funds theory of interest rates?

Everything else equal,the interest rate required on a callable bond will be less than the interest rate on a convertible bond.

Classify each of the following in terms of their effect on interest rates (increase or decrease): I. Perceived risk of financial securities increases. II. Near term spending needs decrease. III. Future profitability of real investments increases.

Inflation causes the demand curve for loanable funds to shift to the ________ and causes the supply curve to shift to the ________.

The unbiased expectations hypothesis of the term structure posits that long-term interest rates are unrelated to expected future short-term rates.

An increase in the marginal tax rates for all U.S. taxpayers would probably result in reduced supply of funds by households.