Chapter 4

WhyDoInterestRatesChange?

.1

Multiple Choice Questions

1.

Asthepriceofabond_________andtheexpectedreturn_________,bondsbecome
moreattractivetoinvestorsandthequantitydemandedrises.
(a) falls;rises
(b) falls;falls
(c) rises;rises
(d) rises;falls
Answer: A

2.

Thesupplycurveforbondshastheusualupwardslope,indicatingthatastheprice
_________,ceterisparibus,the_________increases.
(a) falls;supply
(b) falls;quantitysupplied
(c) rises;supply
(d) rises;quantitysupplied
Answer: D

3.

Whenthepriceofabondisabovetheequilibriumprice,thereisexcess_________in
thebondmarketandthepricewill_________.
(a) demand;rise
(b) demand;fall
(c) supply;fall
(d) supply;rise
Answer: C

4.

Whenthepriceofabondisbelowtheequilibriumprice,thereisexcess_________in
thebondmarketandthepricewill_________.
(a) demand;rise
(b) demand;fall
(c) supply;fall
(d) supply;rise
Answer: A

5.

Whenthepriceofabondis_________theequilibriumprice,thereisanexcesssupply
ofbondsandthepricewill_________.
(a) above;rise
(b) above;fall
(c) below;fall
(d) below;rise
Answer: B

6.

Whenthepriceofabondis_________theequilibriumprice,thereisanexcess
demandforbondsandthepricewill_________.
(a) above;rise
(b) above;fall
(c) below;fall
(d) below;rise
Answer: D

7.

Whentheinterestrateonabondisabovetheequilibriuminterestrate,thereisexcess
_________inthebondmarketandtheinterestratewill_________.
(a) demand;rise

(b) demand;fall
(c) supply;fall
(d) supply;rise
Answer: B
8.

Whentheinterestrateonabondisbelowtheequilibriuminterestrate,thereisexcess
_________inthebondmarketandtheinterestratewill_________.
(a) demand;rise
(b) demand;fall
(c) supply;fall
(d) supply;rise
Answer: D

9.

Whentheinterestrateonabondis_________theequilibriuminterestrate,thereis
excess_________inthebondmarketandtheinterestratewill_________.
(a) above;demand;fall
(b) above;demand;rise
(c) below;supply;fall
(d) above;supply;rise
Answer: A

10.

Whentheinterestrateonabondis_________theequilibriuminterestrate,thereis
excess_________inthebondmarketandtheinterestratewill_________.
(a) below;demand;rise
(b) below;demand;fall
(c) below;supply;rise
(d) above;supply;fall

Answer: C
11. Whenthedemandforbonds_________orthesupplyofbonds_________,interestrate
rise.
(a) increases;increases
(b) increases;decreases
(c) decreases;decreases
(d) decreases;increases
Answer: D
12.

Whenthedemandforbonds_________orthesupplyofbonds_________,interest
ratesfall.
(a) increases;increases
(b) increases;decreases
(c) decreases;decreases
(d) decreases;increases
Answer: B

13.

Whenthedemandforbonds_________orthesupplyofbonds_________,bondprices
rise.
(a) increases;decreases
(b) decreases;increases
(c) decreases;decreases
(d) increases;increases
Answer: A

14.

Whenthedemandforbonds_________orthesupplyofbonds_________,bondprices
fall.

(a) increases;increases
(b) increases;decreases
(c) decreases;decreases
(d) decreases;increases
Answer: D
15.

Factorsthatdeterminethedemandforanassetincludechangesinthe
(a) wealthofinvestors.
(b) liquidityofbondsrelativetoalternativeassets.
(c) expectedreturnsonbondsrelativetoalternativeassets.
(d) riskofbondsrelativetoalternativeassets.
(e) alloftheabove.
Answer: E

16.

Thedemandforanassetrisesif_________falls.
(a) riskrelativetootherassets
(b) expectedreturnrelativetootherassets
(c) liquidityrelativetootherassets
(d) wealth
Answer: A

17. Thehigherthestandarddeviationofreturnsonanasset,the_________istheassets
_________.
(a) greater;risk

(b) smaller;risk
(c) greater;expectedreturn
(d) smaller;expectedreturn
Answer: A
18.

Diversificationbenefitsaninvestorby
(a) increasingwealth.
(b) increasingexpectedreturn.
(c) reducingrisk.
(d) increasingliquidity.
Answer: C

19.

Inarecessionwhenincomeandwealtharefalling,thedemandforbonds_________
andthedemandcurveshiftstothe_________.
(a) falls;right
(b) falls;left
(c) rises;right
(d) rises;left
Answer: B

20.

Duringbusinesscycleexpansionswhenincomeandwealtharerising,thedemandfor
bonds_________andthedemandcurveshiftstothe_________.
(a) falls;right
(b) falls;left
(c) rises;right
(d) rises;left

Answer: C
21.

Foraholdingperiodofoneyear,theexpectedreturnonaconsolis_________the
higheristhepriceoftheconsoltoday,and_________thehigheristhepriceofthe
consolnextyear.
(a) higher;higher
(b) higher;lower
(c) lower;higher
(d) lower;lower
Answer: C

22.

Higherexpectedinterestratesinthefuture_________thedemandforlongtermbonds
andshiftthedemandcurvetothe_________.
(a) increase;left
(b) increase;right
(c) decrease;left
(d) decrease;right
Answer: C

23. Lowerexpectedinterestratesinthefuture_________thedemandforlongtermbonds
andshiftthedemandcurvetothe_________
(a) increase;left.
(b) increase;right.
(c) decrease;left.
(d) decrease;right.
Answer: B
24.

Whenpeoplebegintoexpectalargestockmarketdecline,thedemandcurveforbonds
shiftstothe_________andtheinterestrate_________.

(a) right;falls
(b) right;rises
(c) left;falls
(d) left;rises
Answer: A
25.

Whenpeoplebegintoexpectalargerunupinstockprices,thedemandcurveforbonds
shiftstothe_________andtheinterestrate_________.
(a) right;rises
(b) right;falls
(c) left;falls
(d) left;rises
Answer: D

26.

Anincreaseintheexpectedrateofinflationwill_________theexpectedreturnon
bondsrelativetothaton_________assets,andshiftthe_________curvetotheleft.
(a) reduce;financial;demand
(b) reduce;real;demand
(c) raise;financial;supply
(d) raise;real;supply
Answer: B

27.

Adecreaseintheexpectedrateofinflationwill_________theexpectedreturnon
bondsrelativetothaton_________assets.
(a) reduce;financial
(b) reduce;real
(c) raise;financial

(d) raise;real
Answer: D
28.

Whentheexpectedinflationrateincreases,thedemandforbonds_________,the
supplyofbonds_________,andtheinterestrate_________.
(a) increases;increases;rises
(b) decreases;decreases;falls
(c) increases;decreases;falls
(d) decreases;increases;rises
Answer: D

29. Whentheexpectedinflationratedecreases,thedemandforbonds_________,thesupply
ofbonds_________,andtheinterestrate__________.
(a) increases;increases;rises
(b) decreases;decreases;falls
(c) increases;decreases;falls
(d) decreases;increases;rises
Answer: C
30.

Whenbondinterestratesbecomemorevolatile,thedemandforbonds_________and
theinterestrate_________.
(a) increases;rises
(b) increases;falls
(c) decreases;falls
(d) decreases;rises
Answer: D

31.

Whenbondinterestratesbecomelessvolatile,thedemandforbonds_________and
theinterestrate_________.
(a) increases;rises
(b) increases;falls
(c) decreases;falls
(d) decreases;rises
Answer: B

32.

Whenpricesinthestockmarketbecomemoreuncertain,thedemandcurveforbonds
shiftstothe_________andtheinterestrate_________.
(a) right;rises
(b) right;falls
(c) left;falls
(d) left;rises
Answer: B

33.

Whenstockpricesbecomelessvolatile,thedemandcurveforbondsshiftstothe
_________andtheinterestrate_________.
(a) right;rises
(b) right;falls
(c) left;falls
(d) left;rises
Answer: D

34.

Whenbondsbecomemorewidelytraded,andasaconsequencethemarketbecomes
moreliquid,thedemandcurveforbondsshiftstothe_________andtheinterestrate
_________.
(a) right;rises
(b) right;falls

(c) left;falls
(d) left;rises
Answer: B
35. Whenbondsbecomelesswidelytraded,andasaconsequencethemarketbecomesless
liquid,thedemandcurveforbondsshiftstothe_________andtheinterestrate_________.
(a) right;rises
(b) right;falls
(c) left;falls
(d) left;rises
Answer: D
36.

Factorsthatcausethedemandcurveforbondstoshifttotheleftinclude
(a) anincreaseintheinflationrate.
(b) anincreaseintheliquidityofstocks.
(c) adecreaseinthevolatilityofstockprices.
(d) alloftheabove.
(e) noneoftheabove.
Answer: D

37.

Factorsthatcausethedemandcurveforbondstoshifttotheleftinclude
(a) adecreaseintheinflationrate.
(b) anincreaseinthevolatilityofstockprices.
(c) anincreaseintheliquidityofstocks.

(d) alloftheabove.
(e) only(a)and(b)oftheabove.
Answer: C
38.

Duringaneconomicexpansion,thesupplyofbonds_________andthesupplycurve
shiftstothe_________.
(a) increases,left
(b) increases,right
(c) decreases,left
(d) decreases,right
Answer: B

39.

Duringarecession,thesupplyofbonds_________andthesupplycurveshiftstothe
_________.
(a) increases,left
(b) increases,right
(c) decreases,left
(d) decreases,right
Answer: C

40. Anincreaseinexpectedinflationcausesthesupplyofbondsto_________andthe
supplycurvetoshifttothe_________.
(a) increase,left
(b) increase,right
(c) decrease,left
(d) decrease,right

Answer: B
41.

Whenthefederalgovernmentsbudgetdeficitincreases,the_________curvefor
bondsshiftstothe_________.
(a) demand;right
(b) demand;left
(c) supply;left
(d) supply;right
Answer: D

42.

Whenthefederalgovernmentsbudgetdeficitdecreases,the_________curvefor
bondsshiftstothe_________.
(a) demand;right
(b) demand;left
(c) supply;left
(d) supply;right
Answer: C

43.

Whentheinflationrateisexpectedtoincrease,theexpectedreturnonbondsrelativeto
realassetsfallsforanygiveninterestrate;asaresult,the_________bondsfallsand
the_________curveshiftstotheleft.
(a) demandfor;demand
(b) demandfor;supply
(c) supplyof;demand
(d) supplyof;supply
Answer: A

44.

Whentheinflationrateisexpectedtoincrease,therealcostofborrowingdeclinesat
anygiveninterestrate;asaresult,the_________bondsincreasesandthe_________
curveshiftstotheright.
(a) demandfor;demand

(b) demandfor;supply
(c) supplyof;demand
(d) supplyof;supply
Answer: D

Figure4.1
45.

InFigure4.1,themostlikelycauseoftheincreaseintheequilibriuminterestratefrom
i1toi2is
(a) anincreaseinthepriceofbonds.
(b) abusinesscycleboom.
(c) anincreaseintheexpectedinflationrate.
(d) adecreaseintheexpectedinflationrate.
Answer: C

46.

InFigure4.1,themostlikelycauseoftheincreaseintheequilibriuminterestratefrom
i1toi2isa(n)_________inthe_________.
(a) increase;expectedinflationrate
(b) decrease;expectedinflationrate.
(c) increase;governmentbudgetdeficit
(d) decrease;governmentbudgetdeficit
Answer: A

47.

InFigure4.1,themostlikelycauseofadecreaseintheequilibriuminterestratefromi 2
toi1is
(a) anincreaseintheexpectedinflationrate.
(b) adecreaseintheexpectedinflationrate.

(c) abusinesscycleexpansion.
(d) acombinationofboth(a)and(c)oftheabove.
Answer: B
48.

Factorsthatcancausethesupplycurveforbondstoshifttotherightinclude
(a) anexpansioninoveralleconomicactivity.
(b) adecreaseinexpectedinflation.
(c) adecreaseingovernmentdeficits.
(d) alloftheabove.
(e) only(a)and(b)oftheabove.
Answer: A

49.

Factorsthatcancausethesupplycurveforbondstoshifttotheleftinclude
(a) anexpansioninoveralleconomicactivity.
(b) adecreaseinexpectedinflation.
(c) anincreaseingovernmentdeficits.
(d) only(a)and(c)oftheabove.
Answer: B

50.

TheeconomistIrvingFisher,afterwhomtheFishereffectisnamed,explainedwhy
interestrates_________astheexpectedrateofinflation_________.
(a) rise;increases
(b) rise;stabilizes
(c) rise;decreases
(d) fall;increases
(e) fall;stabilizes
Answer: A

51.

Anincreaseintheexpectedrateofinflationcausesthedemandforbondsto_________
andthesupplyforbondsto_________.
(a) fall;fall
(b) fall;rise
(c) rise;fall
(d) rise;rise
Answer: B

52.

Adecreaseintheexpectedrateofinflationcausesthedemandforbondsto_________
andthesupplyofbondsto_________.
(a) fall;fall

(b) fall;rise
(c) rise;fall
(d) rise;rise
Answer: C
53.

Whentheeconomyslipsintoarecession,normallythedemandforbonds_________,
thesupplyofbonds_________,andtheinterestrate_________.
(a) increases;increases;rises
(b) decreases;decreases;falls
(c) increases;decreases;falls
(d) decreases;increases;rises
Answer: B

54.

Whentheeconomyentersintoaboom,normallythedemandforbonds_________,
thesupplyofbonds_________,andtheinterestrate_________.
(a) increases;increases;rises
(b) decreases;decreases;falls
(c) increases;decreases;rises
(d) decreases;increases;rises
Answer: A

Figure4.2
55.

InFigure4.2,onepossibleexplanationfortheincreaseintheinterestratefromi 1toi2is
a(n)_________in_________.
(a) increase;theexpectedinflationrate

(b) decrease;theexpectedinflationrate
(c) increase;economicgrowth
(d) decrease;economicgrowth
Answer: C
56.

InFigure4.2,onepossibleexplanationfortheincreaseintheinterestratefromi 1toi2is
(a) anincreaseineconomicgrowth.
(b) anincreaseingovernmentbudgetdeficits.
(c) adecreaseingovernmentbudgetdeficits.
(d) adecreaseineconomicgrowth.
(e) adecreaseintheriskinessofbondsrelativetootherinvestments.
Answer: A

57.

InFigure4.2,onepossibleexplanationforadecreaseintheinterestratefromi 2toi1is
(a) anincreaseingovernmentbudgetdeficits.
(b) anincreaseinexpectedinflation.
(c) adecreaseineconomicgrowth.
(d) adecreaseintheriskinessofbondsrelativetootherinvestments.
Answer: C

QuestionsforChapter4,WebAppendix2:SupplyandDemandintheMarketforMoney:
TheLiquidityPreferenceFramework
58.

InKeynessliquiditypreferenceframework,individualsareassumedtoholdtheir
wealthintwoforms:
(a) realassetsandfinancialassets.
(b) stocksandbonds.

(c) moneyandbonds.
(d) moneyandgold.
Answer: C
59. Inhisliquiditypreferenceframework,Keynesassumedthatmoneyhasazerorateof
return;thus,wheninterestrates_________theexpectedreturnonmoneyfallsrelativetothe
expectedreturnonbonds,causingthedemandformoneyto_________.
(a) rise;fall
(b) rise;rise
(c) fall;fall
(d) fall;rise
Answer: A
60.

Theloanablefundsframeworkiseasiertousewhenanalyzingtheeffectsofchangesin
_________,whiletheliquiditypreferenceframeworkprovidesasimpleranalysisofthe
effectsfromchangesinincome,thepricelevel,andthesupplyof_________
(a) expectedinflation;bonds.
(b) expectedinflation;money.
(c) governmentbudgetdeficits;bonds.
(d) thesupplyofmoney;bonds.
Answer: B

61.

Whencomparingtheloanablefundsandliquiditypreferenceframeworksofinterest
ratedetermination,whichofthefollowingistrue?
(a) Theliquiditypreferenceframeworkiseasiertousewhenanalyzingtheeffectsof
changesinexpectedinflation.
(b) Theloanablefundsframeworkprovidesasimpleranalysisoftheeffectsofchanges
inincome,thepricelevel,andthesupplyofmoney.
(c) Inmostinstances,thetwoapproachestointerestratedeterminationyieldthesame
predictions.
(d) Alloftheabovearetrue.

(e) Only(a)and(b)oftheabovearetrue.
Answer: C
62.

Ahigherlevelofincomecausesthedemandformoneyto_________andtheinterest
rateto_________
(a) decrease;decrease.
(b) decrease;increase.
(c) increase;decrease.
(d) increase;increase.
Answer: D

63.

Alowerlevelofincomecausesthedemandformoneyto_________andtheinterest
rateto_________
(a) decrease;decrease.
(b) decrease;increase.
(c) increase;decrease.
(d) increase;increase.
Answer: A

64. Ariseinthepricelevelcausesthedemandformoneyto_________andthedemand
curvetoshifttothe_________
(a) decrease;right.
(b) decrease;left.
(c) increase;right.
(d) increase;left.
Answer: C

65.

Adeclineinthepricelevelcausesthedemandformoneyto_________andthe
demandcurvetoshifttothe_________
(a) decrease;right.
(b) decrease;left.
(c) increase;right.
(d) increase;left.
Answer: B

66.

Adeclineintheexpectedinflationratecausesthedemandformoneyto_________and
thedemandcurvetoshifttothe_________
(a) decrease;right.
(b) decrease;left.
(c) increase;right.
(d) increase;left.
Answer: B

67.

Holdingeverythingelseconstant,anincreaseinthemoneysupplycauses
(a) interestratestodeclineinitially.
(b) interestratestoincreaseinitially.
(c) bondpricestodeclineinitially.
(d) both(a)and(c)oftheabove.
(e) both(b)and(c)oftheabove.
Answer: A

68.

Holdingeverythingelseconstant,adecreaseinthemoneysupplycauses
(a) interestratestodeclineinitially.

(b) interestratestoincreaseinitially.
(c) bondpricestoincreaseinitially.
(d) both(a)and(c)oftheabove.
(e) both(b)and(c)oftheabove.
Answer: B

Figure4.3
69.

InFigure4.3,thefactorresponsibleforthedeclineintheinterestrateis
(a) adeclineinthepricelevel.
(b) adeclineinincome.
(c) anincreaseinthemoneysupply.
(d) adeclineintheexpectedinflationrate.
Answer: C

70.

InFigure4.3,thedecreaseintheinterestratefromi 1toi2canbeexplainedby
(a) adecreaseinmoneygrowth.
(b) anincreaseinmoneygrowth.
(c) adeclineintheexpectedpricelevel.
(d) only(a)and(b)oftheabove.
Answer: B

71.

InFigure4.3,anincreaseintheinterestratefromi2toi1canbeexplainedby
(a) adecreaseinmoneygrowth.

(b) anincreaseinmoneygrowth.
(c) adeclineinthepricelevel.
(d) anincreaseintheexpectedpricelevel.
Answer: A
72.

Ofthefoureffectsoninterestratesfromanincreaseinthemoneysupply,theonethat
worksintheoppositedirectionoftheotherthreeisthe
(a) liquidityeffect.
(b) incomeeffect.
(c) priceleveleffect.
(d) expectedinflationeffect.
Answer: A

73.

Ofthefoureffectsoninterestratesfromanincreaseinthemoneysupply,theinitial
effectis,generally,the
(a) incomeeffect.
(b) liquidityeffect.
(c) priceleveleffect.
(d) expectedinflationeffect.
Answer: B

74. Iftheliquidityeffectissmallerthantheothereffects,andtheadjustmentofexpected
inflationisslow,thenthe
(a) interestratewillfall.
(b) interestratewillrise.
(c) interestratewillinitiallyfallbuteventuallyclimbabovetheinitiallevelin
responsetoanincreaseinmoneygrowth.

(d) interestratewillinitiallyrisebuteventuallyfallbelowtheinitiallevelinresponse
toanincreaseinmoneygrowth.
Answer: C
75.

Whenthegrowthrateofthemoneysupplyincreases,interestratesendupbeing
permanentlylowerif
(a) theliquidityeffectislargerthantheothereffects.
(b) thereisfastadjustmentofexpectedinflation.
(c) thereisslowadjustmentofexpectedinflation.
(d) theexpectedinflationeffectislargerthantheliquidityeffect.
Answer: A

76.

Whenthegrowthrateofthemoneysupplydecreases,interestratesendupbeing
permanently
lowerif
(a) theliquidityeffectislargerthantheothereffects.
(b) thereisfastadjustmentofexpectedinflation.
(c) thereisslowadjustmentofexpectedinflation.
(d) theexpectedinflationeffectislargerthantheliquidityeffect.
Answer: D

77.

Whenthegrowthrateofthemoneysupplyisdecreased,interestrateswillrise
immediatelyiftheliquidityeffectis_________thantheothereffectsandifthereis
_________adjustmentofexpectedinflation.
(a) larger;rapid
(b) larger;slow
(c) smaller;slow
(d) smaller;rapid
Answer: B

78.

Whenthegrowthrateofthemoneysupplyisincreased,interestrateswillrise
immediatelyiftheliquidityeffectis_________thantheothereffectsandifthereis
_________adjustmentofexpectedinflation.

(a) larger;rapid
(b) larger;slow
(c) smaller;slow
(d) smaller;rapid
Answer: D
79. IftheFedwantstopermanentlylowerinterestrates,thenitshouldlowertherateof
moneygrowthif
(a) thereisfastadjustmentofexpectedinflation.
(b) thereisslowadjustmentofexpectedinflation.
(c) theliquidityeffectissmallerthantheexpectedinflationeffect.
(d) theliquidityeffectislargerthantheothereffects.
Answer: C
80.

IftheFedwantstopermanentlylowerinterestrates,thenitshouldraisetherateof
moneygrowthif
(a) thereisfastadjustmentofexpectedinflation.
(b) thereisslowadjustmentofexpectedinflation.
(c) theliquidityeffectissmallerthantheexpectedinflationeffect.
(d) theliquidityeffectislargerthantheothereffects.
Answer: D

81.

MiltonFriedmancontendsthatitisentirelypossiblethatwhenthemoneysupplyrises,
interestratesmay_________ifthe_________effectismorethanoffsetbychangesin
income,thepricelevel,andexpectedinflation.
(a) fall;liquidity
(b) fall;risk

(c) rise;liquidity
(d) rise;risk
Answer: C

Figure4.4
82.

Figure4.4illustratestheeffectofanincreasedrateofmoneysupplygrowth.Fromthe
figure,onecanconcludethattheliquidityeffectis_________thantheexpected
inflationeffectandinterestratesadjust_________tochangesinexpectedinflation.
(a) smaller;quickly
(b) larger;quickly
(c) larger;slowly
(d) smaller;slowly
Answer: A

83. Figure4.4illustratestheeffectofanincreasedrateofmoneysupplygrowth.Fromthe
figure,onecanconcludethatthe
(a) Fishereffectisdominatedbytheliquidityeffectandinterestratesadjustslowlyto
changesinexpectedinflation.
(b) liquidityeffectisdominatedbytheFishereffectandinterestratesadjustslowlyto
changesinexpectedinflation.
(c) liquidityeffectisdominatedbytheFishereffectandinterestratesadjustquicklyto
changesinexpectedinflation.
(d) Fishereffectissmallerthantheexpectedinflationeffectandinterestratesadjust
quicklytochangesinexpectedinflation.
Answer: C

Figure4.5
84.

Figure4.5illustratestheeffectofanincreasedrateofmoneysupplygrowth.Fromthe
figure,onecanconcludethattheliquidityeffectis_________thantheexpected
inflationeffectandinterestratesadjust_________tochangesinexpectedinflation.
(a) smaller;quickly
(b) larger;quickly
(c) larger;slowly
(d) smaller;slowly
Answer: C

85.

Figure4.5illustratestheeffectofanincreasedrateofmoneysupplygrowth.Fromthe
figure,onecanconcludethatthe
(a) Fishereffectisdominatedbytheliquidityeffectandinterestratesadjustslowlyto
changesinexpectedinflation.
(b) liquidityeffectisdominatedbytheFishereffectandinterestratesadjustslowlyto
changesinexpectedinflation.
(c) liquidityeffectisdominatedbytheFishereffectandinterestratesadjustquicklyto
changesinexpectedinflation.
(d) Fishereffectissmallerthantheexpectedinflationeffectandinterestratesadjust
quicklytochangesinexpectedinflation.
Answer: A

True/False
1.

Wheninterestratesdecrease,thedemandcurveforbondsshiftstotheleft.
Answer:

2.

FALSE

Whenaneconomygrowsoutofarecession,normallythedemandforbondsincreases
andthesupplyofbondsincreases.
Answer:

TRUE

3.

Whenthefederalgovernmentsbudgetdeficitdecreases,thedemandcurveforbonds
shiftstotheright.
Answer:

4.

Investorsmaketheirchoicesofwhichassetstoholdbycomparingtheexpectedreturn,
liquidity,andriskofalternativeassets.
Answer:

5.

FALSE

TheFisherEffectpredictsthataninceaseinexpectedinflationwilllowertheinterest
rateonbonds.
Answer:

10.

TRUE

Anincreaseintheinflationratewillcausethedemandcurveforbondstoshifttothe
right.
Answer:

9.

TRUE

Whenincomeandwealtharerising,thedemandforbondsrisesandthedemandcurve
shiftstotheright.
Answer:

8.

FALSE

Interestratesareprocyclicalinthattheytendtoriseduringbusinesscycleexpansions
andfallduringrecessions.
Answer:

7.

TRUE

Apersonwhoisriskaversepreferstoholdassetsthataremore,notless,risky.
Answer:

6.

FALSE

FALSE

Anincreaseinthefederalgovernmentbudgetdeficitwillraisetheinterestrateon
bonds.
Answer:

TRUE

Essay
1.

Identifyandexplainthefourfactorsthatinfluenceassetdemand.Whichofthese
factorsaffecttotalassetdemandandwhichinfluenceinvestorstodemandoneasset
overanother?

2.

Howistheequilibriuminterestratedeterminedinthebondmarket?Explainwhythe
interestratewillmovetowardequilibriumifitistemporarilyaboveorbelowthe
equilibriumrate.

3.

UsethebonddemandandsupplyframeworktoexplaintheFishereffectandwhyit
occurs.

4.

Ifinvestorsperceivegreaterinterestraterisk,whatwillhappentotheequilibrium
interestrateinthebondmarket?Explainusingthebonddemandandsupply
framework.

5.

Howwilladecreaseinthefederalgovernmentsbudgetdeficitaffecttheequilibrium
interestrateinthebondmaket?Explainusingthebonddemandandsupplyframework.

6.

Whatistheexpectedreturnonabondifthereturnis9%twothirdsofthetimeand3%
onethirdofthetime?Whatisthestandarddeviationofthereturnsonthisbond?
Wouldyoupreferthisbondoronewithanidenticalexpectedreturnandastandard
deviationof4.5?Why?