Deck 13: An Introduction to Interest Rate Determination and Forecasting

Question 1

An economic indicator that tends to follow changes in the business cycle is a:

A) coincident indicator.
B) lagging indicator.
C) leading indicator.
D) secondary indicator.

Answer 1

B

Question 2

In relation to economic indicators,a lagging indicator is:

A) an indicator that provides same-time tracking of the level of economic activity.
B) an indicator that changes after a change in the business cycle.
C) an indicator that measures from peak to peak of the business cycle.
D) an indicator that changes before changes in the business cycle.

Answer 2

B

Question 3

All of the following will generally make a central bank increase interest rates,except:

A) excessive credit growth.
B) increasing surplus balance of payments.
C) large changes in price levels.
D) heavy downward pressure in the foreign exchange.

Answer 3

B

Question 4

If a country's balance of payments is constantly in a large deficit,a central bank will generally:

A) lower interest rates.
B) buy government securities regularly.
C) increase interest rates.
D) encourage looser monetary policy.

Question 5

In the textbook,real gross domestic product (GDP)is shown as:

A) a leading indicator of the business cycle.
B) a lagging indicator of the business cycle.
C) a coincident indicator of the business cycle.
D) unrelated to the business cycle.

Question 6

An increase in the prices of goods and services causes the demand for funds to _____ and market interest rates should _______.

A) fall; increase
B) fall; decrease
C) rise; increase
D) rise; decrease

Question 7

The Reserve Bank increases interest rates to reduce the level of spending in the economy.As the rate of growth in economic activity slows,the demand for funds also slows.This impact of a change in interest rates is described as the:

A) inflation effect.
B) liquidity effect.
C) income effect.
D) monetary effect.

Question 8

A higher level of income in all sectors of the economy causes the demand for funds to _______ and the interest rate to _____.

A) increase; rise
B) decrease; fall
C) increase; fall
D) decrease; rise

Question 9

When interest rates increase and normal cash holdings are decreased and invested in securities,this is called:

A) consumption.
B) dishoarding.
C) reinvestment.
D) disintermediation.

Question 10

If a central bank decreases interest rates,then gradually:

A) the country's gross domestic product is likely to decrease.
B) foreign exchange rate is likely to appreciate.
C) demand for exported goods and services is likely to increase.
D) flows of investment funds into the country are likely to decrease.

Question 11

According to the loanable funds approach to interest rate determination,the demand curve slopes downward because:

A) when interest rates are low, inflation is low.
B) the lower the interest rates, the greater the demand for funds.
C) the higher the interest rates, the greater the demand for funds.
D) the lower the interest rates, the smaller the demand for funds.

Question 12

A decrease in the prices of goods and services causes the demand for funds to _____ and market interest rates should _______.

A) fall; increase
B) fall; decrease
C) rise; increase
D) rise; decrease

Question 13

If credit growth and associated debt levels are growing too quickly,a central bank will generally:

A) decease interest rates.
B) use open market operations and sell government securities.
C) increase interest rates.
D) loosen monetary policy.

Question 14

In relation to economic indicators,a leading indicator is:

A) one that provides same-time tracking of the level of economic activity.
B) one that measures from peak to peak of the business cycle.
C) an indicator such as unemployment data.
D) one that changes before changes in the business cycle.

Question 15

According to the loanable funds approach to interest rate determination,the supply curve slopes up because:

A) the lower the interest rates, the more loanable funds will be supplied.
B) higher interest rates reduce the inflation rate.
C) a rise in interest rates makes lenders more willing to supply funds.
D) when bond prices are high, more loanable funds will be supplied.

Question 16

If a central bank increases interest rates,then gradually:

A) the country's gross domestic product is likely to increase.
B) foreign exchange rate is likely to come under downward pressure.
C) demand for imported goods and services is likely to decrease.
D) flows of investment funds into the country are likely to decrease.

Question 17

When a change in monetary policy is implemented,the initial effect on interest rates is generally the:

A) income effect.
B) liquidity effect.
C) expected inflation effect.
D) wealth effect.

Question 18

If a central bank sells government securities as part of implementing monetary policy:

A) the liquidity in the financial system will increase.
B) interest rates are likely to increase.
C) spending in the economy is likely to increase.
D) the price of the currency is likely to depreciate.

Question 19

Consider the following graphs: Which of the following types of economic indicators do the above graphs depict?

A) Coincident indicator
B) Leading indicator
C) Price-index indicator
D) Lagging indicator

Question 20

A lower level of income in all sectors of the economy causes the demand for funds to _______ and the interest rate to _____.

A) increase; rise
B) decrease; fall
C) increase; fall
D) decrease; rise

Question 21

Which of the following would cause the quantity of loanable funds supplied to increase?

A) A decrease in inflationary pressures
B) An increase in inflationary pressures
C) An increase in interest rates
D) A decline in interest rates

Question 22

During a period of economic expansion,when expected profitability is high,the:

A) equilibrium price of bonds increases.
B) equilibrium interest rate falls.
C) supply curve for bonds shifts to the left.
D) demand curve for loanable funds shifts to the right.

Question 23

If there is an excess demand for loanable funds at a given interest rate:

A) bond prices will increase.
B) bond prices will decrease.
C) the interest rate will rise.
D) bond prices may rise or fall, depending on the cause for excess funds.

Question 24

Interest rates will fall when the demand curve for loanable funds:

A) shifts up.
B) shifts to the right.
C) is affected by poor growth prospects in the economy.
D) shifts sideways.

Question 25

All else being equal,the demand curve for loanable funds may shift to the left (decrease)as a result of:

A) an increase in the supply of loanable funds.
B) expectations of forthcoming economic growth.
C) an increase in the risk of bonds relative to other assets.
D) an improvement in business prospects.

Question 26

Under the loanable funds approach to explaining and forecasting interest rates,the concept of dishoarding is introduced.Which of the following statements regarding dishoarding is correct?

A) Dishoarding will occur as interest rates rise.
B) Dishoarding will occur as interest rates fall.
C) Dishoarding will change the slope of the demand curve.
D) Dishoarding is caused by government budget deficits.

Question 27

Which of the following determine(s)the level of interest rates?
I)The supply of savings by households and businesses
Ii)The demand for investment funds
Iii)The government's net supply of and/or demand for funds

A) i only
B) ii only
C) i and ii only
D) i, ii and iii

Question 28

Consider the following graph: Using the loanable funds approach to interest rate determination,what does the curve in the above graph represent?

A) Household sector supply of loanable funds
B) Business sector demand for loanable funds
C) Overseas sector and household sector supply of loanable funds
D) Government sector and business sector demand for loanable funds

Question 29

The term 'loanable funds' refers to:

A) only those funds loaned to banks by the central bank.
B) only those funds loaned by one bank to another bank.
C) only those funds loaned to banks by the public.
D) all those funds changing hands between the lenders and borrowers in the financial markets.

Question 30

It is argued that one of the weaknesses of the loanable funds approach is that a final equilibrium interest rate cannot be determined.Which of the following statements supports this argument?

A) An equilibrium interest rate will affect savings at that level, which will affect the loanable funds demand curve.
B) Dishoarding of loanable funds will continue for successive periods.
C) In the loanable funds approach, the supply and demand curves are interdependent.
D) Changes in the money supply in one period need to be matched in ensuing periods.

Question 31

In the loanable funds approach to interest rate determination,if the business sector _____ its demand for funds,then the demand curve would shift to the _____:

A) increase; to the left
B) increase; to the right
C) decrease; to the right
D) decrease; up

Question 32

If there is an excess supply of loanable funds at a given interest rate:

A) bond prices will increase.
B) bond prices will decrease.
C) the interest rate will rise.
D) bond prices may rise or fall, depending on the cause for excess funds.

Question 33

If inflation is expected to increase,this may cause:

A) interest rates to rise.
B) the demand for loanable funds to fall.
C) the supply of loanable funds to increase.
D) interest rates to fall.

Question 34

All other things being equal,a decrease in the demand for loanable funds:

A) drives the interest rate up.
B) drives the interest rate down.
C) results from an increase in business circumstances and a decrease in the level of savings.
D) might not have any effect on the interest rate.

Question 35

All else being equal,the demand curve for loanable funds may shift to the right (increase)as a result of:

A) a fall in the supply of loanable funds.
B) expectations of a forthcoming recession.
C) technological improvements.
D) a fall in business prospects.

Question 36

All else being equal,if a central bank buys government bonds from the market it would:

A) increase the money supply.
B) increase interest rates.
C) mean savings in the economy are likely to increase.
D) mean the supply of loanable funds would move to the left.

Question 37

If the equilibrium interest rate in the market is estimated to be 6%,which of the following is likely to occur if rates increase to 7%?

A) The supply of funds shifts to the right.
B) The total supply of lending shifts to the right.
C) The quantity of funds supplied is greater than the quantity of funds demanded.
D) The quantity of funds demanded is greater than the quantity of funds supplied.

Question 38

The term structure of interest rates is generally defined with respect to yields on which securities?

A) Commercial paper
B) Corporate bonds
C) Government securities
D) State securities

Question 39

All else being equal,the supply curve for loanable funds may shift to the left (decrease)as a result of:

A) government borrowing.
B) expectations of an increase in inflation.
C) businesses borrowing to finance profitable investments.
D) an increase in corporate taxes.

Question 40

All else being equal,if a central bank sells government bonds from the market it would:

A) decrease interest rates.
B) decrease the money supply.
C) most likely decrease savings in the economy.
D) mean the supply of loanable funds would move to the right.

Question 41

When a yield curve has a positive slope:

A) long-term yields are higher than short-term yields.
B) short-term yields are higher than long-term yields.
C) the bond market is expecting default by bond issuers.
D) the inflation rate is expected to fall.

Question 42

Which of the following is NOT a hypothesis or theory used to explain the general shape of the yield curve?

A) Expectations hypothesis
B) Liquidity premium hypothesis
C) Market segmentation theory
D) Capital markets theory

Question 43

In relation to the term structure of interest rates,the expectations theory assumes:

A) there are a large number of financial investors who hold heterogeneous expectations about future interest rates.
B) investors need to take into account costly transactions as they change their expectations.
C) long-term rates paid bonds will be equal to the average of short-term interest rates expected to prevail over the longer term period.
D) there is some impediment to market rates moving to equilibrium.

Question 44

The yield curve most frequently observed over the years is:

A) positively sloped.
B) negatively sloped.
C) flat.
D) hump-backed.

Question 45

Using the expectations theory of term structure,a positively sloped yield curve indicates that investors expect:

A) falling long-term interest rates.
B) rising long-term interest rates.
C) short-term interest rates to be lower in the near future.
D) short-term interest rates to be higher in the near future.

Question 46

If the yields on short-term securities are higher than comparable long-term securities,the yield curve will be:

A) level.
B) negative.
C) positive.
D) undefined.

Question 47

A yield curve where market participants expect lower future rates of interest is:

A) downward-sloping.
B) upward-sloping.
C) flat.
D) linear.

Question 48

At any time,the shape and slope of the yield curve is affected by:

A) the demand and supply conditions in the various segments of the market.
B) inflationary expectations.
C) liquidity preferences.
D) All of the given choices.

Question 49

The idea that a normal yield curve is most frequently observed can be explained by the __________ theory/theories.

A) expectations
B) segmented
C) expectations and liquidity premium
D) segmented and liquidity premium

Question 50

The yield curve theory that hypothesises that investors prefer short-term securities because of the risk associated with longer term securities is the:

A) expectations hypothesis.
B) liquidity premium hypothesis.
C) market segmentation theory.
D) capital markets theory.

Question 51

Because long-term securities face greater risk of capital loss than do short-term securities,investors generally:

A) pay a higher price for long-term securities.
B) require a higher yield on long-term securities.
C) require a lower yield on long-term securities.
D) stay away from long-term securities.

Question 52

When a yield curve has a negative slope:

A) long-term yields are higher than short-term yields.
B) short-term yields are higher than long-term yields.
C) the money market is expecting default by issuers of bank bills.
D) the inflation rate is expected to rise.

Question 53

A yield curve where the market participants expect higher future rates of interest is:

A) downward-sloping.
B) upward-sloping.
C) flat.
D) inverse.

Question 54

If the yields on short-term securities are lower than comparable long-term securities,the yield curve will be:

A) level.
B) negative.
C) positive.
D) undefined.

Question 55

If the yields on short-term securities are the same as those for comparable long-term securities,the yield curve will have a/an:

A) constant slope.
B) negative slope.
C) positive slope.
D) undefined slope.

Question 56

The expression 'term structure of interest rates':

A) reflects the differing tax treatment received by different securities.
B) represents the variation in yields for similar instruments differing in maturity.
C) always results in an upward-sloping yield curve.
D) generally results in a downward-sloping yield curve.

Question 57

In an economic period of high inflation,the yield curve would most likely be:

A) upward-sloping.
B) downward-sloping.
C) flat.
D) more curved.

Question 58

The following monthly data of yields on five-year Treasury bonds comes from the Reserve Bank Bulletin:
$$\begin{array} { | l | l | l | l | l | } \hline 20 \mathrm { xx } / \mathrm { xx } & \text { Jul. } & 7.65 \% & \text { Jan. } & 7.30 \% \\\hline & \text { Aug. } & 7.75 \% & \text { Feb. } & 7.15 \% \\\hline & \text { Sep. } & 7.80 \% & \text { Mar. } & 6.91 \% \\\hline & \text { Oct. } & 7.90 \% & \text { Apr. } & 6.80 \% \\\hline & \text { Nov. } & 7.75 \% & \text { May } & 6.65 \% \\\hline & \text { Dec. } & 7.50 \% & \text { Jun. } & 6.55 \% \\\hline\end{array}$$
What type of yield curve is indicated by the above data set?

A) Normal yield curve
B) Inverse yield curve
C) Humped yield curve
D) Variable yield curve

Question 59

The _______ show the term structure of interest rates as a graph.

A) risk-return curves
B) yield curves
C) supply and demand curves
D) total demand curves

Question 60

Using the expectations theory of term structure,a negatively sloped yield curve indicates that investors expect:

A) falling long-term interest rates.
B) rising long-term interest rates.
C) falling short-term interest rates.
D) rising short-term interest rates.

Question 61

The liquidity premium theory of the term structure proposes:

A) it is the relative supply and demand of securities in the various maturity ranges that determines yields.
B) investors have a preference for short-term bonds, as they have greater liquidity.
C) longer-term bonds have less default risk.
D) longer-term bonds are less volatile in price.

Question 62

According to the expectations theory of term structure,if next year's short-term interest rate is expected to be higher than the current short-term rate,the:

A) current short-term rate will be equal to the current long-term rate.
B) current short-term rate will be higher than the current long-term rate.
C) current short-term rate will be lower than the current long-term rate.
D) yield curve will be downward-sloping.

Question 63

The segmented markets theory for explaining the term structure of interest rates assumes that:

A) bond prices and yields are positively related.
B) the yield curve is upward-sloping.
C) the yield curve is flat.
D) securities in different maturity ranges are not alternatives for one another.

Question 64

To compensate for the uncertainty of future interest rates and the greater default risk for longer term loans,the lender generally:

A) charges a higher rate of interest on long-term loans.
B) includes a very high number of restrictive debt provisions.
C) is entitled to change the terms of the loan at any time.
D) is entitled to demand repayment of the loan at any time.

Question 65

The liquidity premium theory of the term structure assumes:

A) that interest rates on long-term bonds respond to supply and demand conditions for those bonds.
B) investors have a preference for short-term bonds, as they have lower interest-rate risk.
C) that an average of expected short-term rates is an important component of interest rates on long-term bonds.
D) all of the given answers are correct.

Question 66

Support for the addition of a liquidity premium to the expectations theory is derived from:

A) the slope of the observed normal yield curve is steeper than that of expectation theory.
B) the slope of the observed normal yield curve is flatter than that of expectation theory.
C) the liquidity premium decreases over time.
D) in times of tight monetary policy an inverse yield curve becomes more inverse.

Question 67

Which of the following statements about segmented markets theory of term structure is correct?

A) It assumes that lenders always lend for short periods.
B) It assumes that borrowers have particular periods for which they want to borrow.
C) It gives a good explanation of why yield curves usually slope upward.
D) It assumes that all bonds are perfect substitutes for each other.

Question 68

According to the expectations theory of term structure,if market participants expect future short-term rates to be higher than current short-term rates,the yield curve will:

A) be upward-sloping.
B) be downward-sloping.
C) be flat.
D) slope upward or downward or be flat, depending on risk and liquidity considerations.

Question 69

If the yield curve is observed to be flat,according to the liquidity premium theory,this indicates that the market is predicting:

A) a small rise in short-term rates in the near future and a small decline further out in the future.
B) constant short-term interest rates in the near future, and further out in the future.
C) a small decline in short-term interest rates in the near future, continuing to decline slowly further out in the future.
D) constant short-term interest rates in the near future and a small decline further out in the future.

Question 70

The risk structure of interest rates refers to the:

A) amount of extra interest necessary to compensate investors for the greater default risk of some bonds.
B) relationship among the interest rates on bonds with the same maturity.
C) relationship among the interest rates on similar bonds with different maturities.
D) amount of extra interest needed to compensate investors for the lesser liquidity of some bonds.

Question 71

The assumption that prices for short-term and long-term securities are determined in the different maturity ranges is the basis for the _____ approach to explaining the term structure.

A) liquidity premium
B) expectations
C) segmented markets
D) yield curve

Question 72

The expectations theory of term structure suggests that the:

A) yield curve should be upward-sloping.
B) yield curve should be downward-sloping.
C) shape of the yield curve reflects the risk premium incorporated into the yields on long-term bonds.
D) shape of the yield curve depends on the expected future path of short-term interest rates.

Question 73

The segmented markets theory rejects two of the assumptions of the expectations theory,namely:

A) there are a large number of financial investors who hold homogeneous expectations about future interest rates and no impediments to market rates moving to equilibrium.
B) there are no transactions costs and investors hold homogeneous expectations.
C) that investors are indifferent between short-term or long-term bonds and that all bonds are perfect substitutes.
D) there is no impediment to market rates moving to equilibrium and the goal of investors is to maximise their expected rate of return.

Question 74

Using the pure expectations approach to the determination of interest rates,what is the shape of the yield curve indicated in the following data?
(₀i₁)
9)47% per annum
(₁i₁)
8)45% per annum
(₀i₂)
8)96% per annum

A) Humped yield curve
B) Inverse yield curve
C) Normal yield curve
D) Variable yield curve

Question 75

The segmented markets theory of term structure:

A) has difficulty explaining why yield curves are usually upward-sloping.
B) has difficulty explaining why yield curves are usually downward-sloping.
C) ignores the existence of market participants who seek to take advantage of price differences.
D) provides a good explanation of why yields on bonds of varying maturities tend to move together.

Question 76

According to the expectations theory of term structure,if next year's short-term interest rate is expected to be lower than the current short-term rate,the:

A) current short-term rate will be equal to the current long-term rate.
B) current short-term rate will be higher than the current long-term rate.
C) current short-term rate will be lower than the current long-term rate.
D) yield curve will be upward-sloping.

Question 77

What is the most important contrast between the expectations theory and the segmented markets theory?

A) The segmented markets theory states that investors view similar instruments that differ only with respect to maturity as perfect substitutes.
B) The expectations theory states that investors view similar instruments that differ only with respect to maturity as perfect substitutes.
C) The expectations theory does a better job of explaining why yield curves are usually upward-sloping.
D) The segmented markets theory does a better job of explaining why the yields on bonds of different maturities tend to move together.

Question 78

The implication of the expectations theory that expected returns for a holding period must be the same for bonds of different maturities depends on the assumption that:

A) yield curves normally slope downward.
B) yield curves normally slope upward.
C) instruments with different terms to maturity are perfect substitutes.
D) lenders are generally risk-averse.

Question 79

According to the expectations theory of term structure,if investors believed that the average of the expected future short-term yields was greater than the long-term yield for a holding period,they would act so as to:

A) drive down the price of the short-term security and drive up the price of the long-term security.
B) drive up the price of the short-term security and drive down the price of the long-term security.
C) drive up the prices of both the short-term and long-term securities.
D) drive down the prices of both the short-term and long-term securities.

Question 80

The segmented markets theory of term structure:

A) explains upward-sloping yield curves as a result of the demand for long-term bonds being high, relative to the demand for short-term bonds.
B) explains upward-sloping yield curves as a result of the demand for long-term bonds being low, relative to the demand for short-term bonds.
C) explains upward-sloping yield curves as a result of the favourable tax treatment of long-term bonds.
D) is unable to explain upward-sloping yield curves.