Final Exam Part 3
Lab Questions & Old Exam Questions for the Second Test
- 1.
Which of the following statements pertaining to the yield curve is not true?
- A.
Yield curves usually slope upwards
- B.
The yield curve shows the difference in default risk between securities
- C.
The yield curve shows the relationship among bonds with the same risk characteristics but different maturities
- D.
The yield curve can be flat or downward sloping depending on market conditions
Correct Answer
B. The yield curve shows the difference in default risk between securitiesExplanation
The yield curve does not show the difference in default risk between securities. Instead, it shows the relationship among bonds with the same risk characteristics but different maturities. The shape of the yield curve can provide insights into market conditions and expectations about interest rates, but it does not directly indicate default risk.Rate this question:
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- 2.
The yield on a 30-year U.S. Treasury security is 6.5%; the yield on a 2-year U.S. Treasury bond is 4.0%. This data:
- A.
Indicate the yield curve is downward sloping
- B.
Indicate the yield curve is flat since the risk premium needs to be added for longer maturities
- C.
Indicate the yield curve is upward sloping
- D.
Indicate that people expect inflation to decrease in the future
Correct Answer
C. Indicate the yield curve is upward slopingExplanation
The given information states that the yield on a 30-year U.S. Treasury security is higher (6.5%) than the yield on a 2-year U.S. Treasury bond (4.0%). This indicates that the longer-term bond has a higher yield, which suggests that the yield curve is upward sloping. In an upward sloping yield curve, longer-term bonds have higher yields compared to shorter-term bonds.Rate this question:
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- 3.
The Expectations Hypothesis suggests:
- A.
The yield curve should usually be downward sloping
- B.
The yield curve should usually be upward sloping
- C.
The slope of the yield curve reflects the risk premium associated with longer-term bonds
- D.
The slope of the yield curve depends on the expectations for future short-term rate
Correct Answer
D. The slope of the yield curve depends on the expectations for future short-term rateExplanation
The Expectations Hypothesis suggests that the slope of the yield curve depends on the expectations for future short-term rates. This means that if market participants expect short-term interest rates to increase in the future, the yield curve is likely to be upward sloping. Conversely, if market participants expect short-term interest rates to decrease in the future, the yield curve is likely to be downward sloping. The slope of the yield curve reflects the market's expectations and beliefs about future interest rate movements and can be used to gauge investor sentiment and economic outlook.Rate this question:
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- 4.
Assume the Expectation Hypothesis regarding the term structure of interest rates is correct. Then, if the current one-year interest rate is 4% and the two-year interest rate is 6%, then investors are expecting:
- A.
The future one-year rate to be 4%
- B.
The future one-year rate to be 8%
- C.
The future one-year rate to be 6%
- D.
The future one-year rate to be 5%
Correct Answer
B. The future one-year rate to be 8%Explanation
According to the Expectation Hypothesis, if the current one-year interest rate is 4% and the two-year interest rate is 6%, it implies that investors are expecting the future one-year rate to be 8%. This is because the Expectation Hypothesis suggests that long-term interest rates are determined by the market's expectations of future short-term interest rates. In this case, the higher two-year interest rate suggests that investors expect the future one-year rate to be higher than the current one-year rate.Rate this question:
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- 5.
According to the Expectations Hypothesis:
- A.
When short-term interest rates are expected to rise in the future, the long-term interest rates are equal to current short-term interest rates
- B.
When short-term rates are expected to remain constant in the future, the long-term interest rates are higher than current short-term interest rates
- C.
Short-term bonds are perfect substitutes for long-term bonds
- D.
Expectations of future short-term rates equal estimates of current short-term rates
Correct Answer
C. Short-term bonds are perfect substitutes for long-term bondsExplanation
Short-term bonds being perfect substitutes for long-term bonds means that investors view both types of bonds as equally attractive and are willing to hold either one. This implies that there is no preference or advantage for holding one type of bond over the other. It also suggests that investors do not expect any additional benefits or risks associated with holding long-term bonds compared to short-term bonds. Therefore, the statement supports the idea that short-term bonds can be easily exchanged for long-term bonds without any significant difference in terms of returns or risks.Rate this question:
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- 6.
The Expectations Hypothesis cannot explain:
- A.
Why yields on securities of different maturities move together
- B.
Why short-term yields are more volatile than long term yields
- C.
Why yield curves usually slope upward
- D.
Why yield curves usually slope downward
Correct Answer
C. Why yield curves usually slope upwardExplanation
The Expectations Hypothesis suggests that long-term yields are simply the average of current and expected short-term yields. However, it cannot explain why yield curves usually slope upward. This is because an upward-sloping yield curve indicates that long-term yields are higher than short-term yields, which contradicts the hypothesis. The Expectations Hypothesis assumes that investors have no preference for short or long-term bonds, but in reality, investors often demand higher yields for longer-term bonds due to the additional risk and uncertainty associated with them.Rate this question:
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- 7.
Under the Expectations Hypothesis, a downward-sloping yield curve suggests:
- A.
Investors expect future short-term interest rates to fall
- B.
Investors expect future short-term interest rates to rise
- C.
This is a trick question, the yield curve always slopes upward
- D.
Investors expect future short-term interest rates to remain constant
Correct Answer
A. Investors expect future short-term interest rates to fallExplanation
The Expectations Hypothesis states that long-term interest rates are determined by the market's expectations of future short-term interest rates. A downward-sloping yield curve suggests that investors expect future short-term interest rates to fall. This is because when short-term rates are expected to decrease, investors are willing to lock in higher long-term rates now, resulting in a downward-sloping yield curve.Rate this question:
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- 8.
Suppose that interest rates are expected to remain unchanged over the next few years. However, there is a risk premium for longer-term bonds. According to the liquidity premium theory, the yield curve should be:
- A.
Upward sloping and very steep
- B.
Upward sloping and relatively flat
- C.
Inverted
- D.
Vertical
Correct Answer
B. Upward sloping and relatively flatExplanation
According to the liquidity premium theory, the yield curve should be upward sloping and relatively flat when interest rates are expected to remain unchanged over the next few years but there is a risk premium for longer-term bonds. This means that the yields on longer-term bonds will be slightly higher than shorter-term bonds, but the overall slope of the yield curve will not be very steep. This is because investors require a higher return for holding longer-term bonds due to the risk premium, but the expectation of unchanged interest rates keeps the curve from being too steep.Rate this question:
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- 9.
Suppose the economy has an inverted yield curve. According to the Liquidity Premium Theory, which of the following interpretations could be used to explain this?
- A.
Interest rates are expected to rise in the future
- B.
Investors expect an economic slowdown
- C.
Investors are indifferent between bonds with different time horizons
- D.
The term spread has increased
Correct Answer
B. Investors expect an economic slowdownExplanation
According to the Liquidity Premium Theory, an inverted yield curve suggests that investors expect an economic slowdown. This is because in a normal yield curve, longer-term bonds have higher yields compared to shorter-term bonds, reflecting the expectation of higher interest rates in the future. However, in an inverted yield curve, shorter-term bonds have higher yields than longer-term bonds, indicating that investors are willing to accept lower yields in the short term due to their pessimistic outlook on the economy. Therefore, the correct interpretation is that investors expect an economic slowdown.Rate this question:
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- 10.
If a one-year bond currently yields 4% and is expected to yield 6% next year, the Liquidity Premium Theory suggests the yield today on a two-year bond will be:
- A.
More than 4% but less than 5%
- B.
5%
- C.
4%
- D.
More than 5%
Correct Answer
D. More than 5%Explanation
The Liquidity Premium Theory suggests that investors require a higher yield for longer-term bonds to compensate for the additional risk and uncertainty associated with holding them. In this case, if the one-year bond is expected to yield 6% next year, it implies that the two-year bond will have a higher yield to reflect the increased risk of holding it for an additional year. Therefore, the yield today on a two-year bond will be more than 5%.Rate this question:
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- 11.
Under the liquidity premium theory, if investors become less certain about future monetary policy, the yield curve should:
- A.
Become more upward sloping
- B.
Become flatter
- C.
Become inverted
- D.
Be vertical
Correct Answer
A. Become more upward slopingExplanation
According to the liquidity premium theory, if investors become less certain about future monetary policy, they will demand a higher premium for holding longer-term bonds. This increased demand for longer-term bonds will drive down their yields, causing the yield curve to become more upward sloping. This is because longer-term bonds will have lower yields compared to shorter-term bonds, resulting in a steeper yield curve.Rate this question:
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- 12.
We would expect the relationship between the risk spread on Baa bonds and U.S. Treasury securities of similar maturities to:
- A.
Vary directly with economic growth
- B.
Show no variation over the business cycle
- C.
Vary inversely with economic growth
- D.
Breakdown with economic growth
Correct Answer
C. Vary inversely with economic growthExplanation
The risk spread on Baa bonds refers to the additional yield that investors demand for holding these bonds compared to U.S. Treasury securities. When economic growth is strong, investors are more optimistic about the economy and therefore demand less compensation for taking on the risk of holding Baa bonds. As a result, the risk spread on Baa bonds tends to decrease, indicating an inverse relationship with economic growth. Conversely, during periods of economic downturn or uncertainty, investors become more risk-averse and demand higher compensation, leading to an increase in the risk spread on Baa bonds.Rate this question:
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- 13.
An inverted yield curve is a valuable forecasting tool because:
- A.
The yield curve usually is inverted so it reflects a growing economy
- B.
The yield curve seldom is inverted and can signal an economic slowdown
- C.
Investors are expecting higher short-term rates in the future, and this usually signals an economic slowdown
- D.
Inverted yield curves signal better economic times are expected
Correct Answer
B. The yield curve seldom is inverted and can signal an economic slowdownExplanation
An inverted yield curve is a valuable forecasting tool because it seldom occurs and when it does, it can signal an economic slowdown. This means that when the yield curve is inverted, with short-term interest rates higher than long-term interest rates, it suggests that investors are expecting lower economic growth in the future. This is because they are demanding higher returns for short-term investments, indicating a lack of confidence in the economy. Therefore, an inverted yield curve can be seen as a warning sign of an upcoming economic downturn.Rate this question:
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- 14.
A proposed increase in the federal income tax rate should:
- A.
Have no impact on the slope of the yield curve since the tax laws impact all maturities the same
- B.
Cause the slope of the yield curve to become negative
- C.
Increase the slope of the yield curve since it increases the risk premium of longer maturities
- D.
Flatten the yield curve
Correct Answer
A. Have no impact on the slope of the yield curve since the tax laws impact all maturities the sameExplanation
The correct answer is that a proposed increase in the federal income tax rate should have no impact on the slope of the yield curve since the tax laws impact all maturities the same. This means that regardless of the length of time until the maturity of a bond, the increase in the tax rate would affect all bonds equally. Therefore, there would be no change in the relative yields between short-term and long-term bonds, resulting in no impact on the slope of the yield curve.Rate this question:
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- 15.
If an American traveling abroad can obtain 115 euros for $100 U.S, the current euro per $ exchange rate is:
- A.
0.870 euros/$
- B.
1.15 euros/$
- C.
115euros/$
- D.
1euro/1.15$
Correct Answer
B. 1.15 euros/$Explanation
The current euro per $ exchange rate can be calculated by dividing the amount of euros obtained (115 euros) by the amount of dollars spent ($100). This gives a rate of 1.15 euros per dollar.Rate this question:
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- 16.
The answer to the question of whether or not a U.S. dollar will buy more in the U.S. or in a foreign country is determined by:
- A.
The nominal exchange rate
- B.
The real exchange rate
- C.
Whether the nominal exchange rate is > or < than 1
- D.
You cannot determine the answer until you travel to the foreign country and convert $ to the foreign currency
Correct Answer
B. The real exchange rateExplanation
The real exchange rate determines whether a U.S. dollar will buy more in the U.S. or in a foreign country. The real exchange rate takes into account the nominal exchange rate and adjusts it for inflation differences between the two countries. If the real exchange rate is higher in the foreign country, then a U.S. dollar will buy more there. Conversely, if the real exchange rate is higher in the U.S., then a U.S. dollar will buy more in the U.S. The nominal exchange rate alone is not sufficient to determine the purchasing power of a U.S. dollar in a foreign country.Rate this question:
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- 17.
If a Japanese Toyota sells for 2,500,000 yen and the nominal exchange rate is 110 yen/$U.S., then the dollar price of the Japanese automobile is:
- A.
22,727 yen
- B.
$20,000
- C.
$25,000
- D.
$22,727
Correct Answer
D. $22,727Explanation
The dollar price of the Japanese automobile can be calculated by dividing the price in yen by the nominal exchange rate. In this case, the price in yen is 2,500,000 yen and the nominal exchange rate is 110 yen/$U.S. Therefore, the dollar price of the Japanese automobile is 2,500,000 yen / 110 yen/$U.S. = $22,727.Rate this question:
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- 18.
Appreciation of the real exchange rate:
- A.
Makes U.S. exports more expensive to foreigners
- B.
Makes U.S. exports less expensive to foreigners
- C.
Means a basket of U.S. goods would exchange for fewer foreign goods
- D.
Benefits all U.S. residents
Correct Answer
A. Makes U.S. exports more expensive to foreignersExplanation
An appreciation of the real exchange rate means that the value of the U.S. currency increases relative to foreign currencies. This makes U.S. exports more expensive to foreigners because it takes more foreign currency to purchase the same amount of U.S. goods. As a result, foreign consumers may be less likely to buy U.S. exports, leading to a decrease in export sales.Rate this question:
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- 19.
Concrete likely does not follow the law of one price due to:
- A.
Technical differences
- B.
Lack of information regarding prices
- C.
Tariffs
- D.
High transportation costs
Correct Answer
D. High transportation costsExplanation
High transportation costs can explain why concrete likely does not follow the law of one price. The high costs of transporting concrete from one location to another can result in different prices in different regions. This is because the transportation expenses add to the overall cost of the product, making it more expensive in areas that are farther away from the source of production. As a result, the price of concrete can vary significantly depending on the transportation distance, leading to a deviation from the law of one price.Rate this question:
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- 20.
Purchasing power parity says that:
- A.
Differences in inflation rates between countries should have no impact on the exchange rate between those countries
- B.
Differences in inflation rates between countries will create changes in exchange rates
- C.
The changes in exchange rates move independently from inflation
- D.
For inflation to change the exchange rate, the rate of inflation has to be the same between countries
Correct Answer
B. Differences in inflation rates between countries will create changes in exchange ratesExplanation
According to the given answer, differences in inflation rates between countries will create changes in exchange rates. This means that if one country has a higher inflation rate compared to another country, the currency of the country with higher inflation will depreciate in value relative to the currency of the country with lower inflation. This is because higher inflation erodes the purchasing power of a currency, making it less desirable in the foreign exchange market. As a result, the exchange rate between the two countries will adjust to reflect the difference in inflation rates.Rate this question:
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- 21.
If inflation in the United States averages more than inflation in Europe over a long period of time, we should expect:
- A.
The dollar to appreciate relative to the euro
- B.
The euro dollar exchange rate to stay relatively fixed
- C.
The dollar to depreciate relative to the euro
- D.
No effect; there isn't a link between inflation and exchange rates over the long run
Correct Answer
C. The dollar to depreciate relative to the euroExplanation
If inflation in the United States averages more than inflation in Europe over a long period of time, we should expect the dollar to depreciate relative to the euro. This is because higher inflation in the United States would erode the purchasing power of the dollar, making it less valuable compared to the euro. As a result, the exchange rate between the two currencies would shift in favor of the euro, causing the dollar to depreciate.Rate this question:
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- 22.
Which of the following are reasons to supply dollars on the foreign exchange market?
- A.
To purchase goods and services produced abroad
- B.
To get a lower return paid on foreign currencies that is not subject to the risk associated with exchange-rate fluctuations
- C.
To invest in U.S. assets
- D.
To take advantage of higher inflation rates in other countries
Correct Answer
A. To purchase goods and services produced abroadExplanation
To purchase goods and services produced abroad, individuals or businesses need to supply dollars on the foreign exchange market in order to exchange their currency for the foreign currency required for the transaction. This allows them to make international purchases and engage in international trade.Rate this question:
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- 23.
Considering the dollar-euro market, as a dollar will purchase more euros, holding other factors constant:
- A.
We would expect the supply curve of dollars to slope downward
- B.
Foreign goods become relatively less expensive than American goods
- C.
Foreign assets become relatively more expensive than American assets
- D.
American goods become relatively less expensive than foreign goods
Correct Answer
B. Foreign goods become relatively less expensive than American goodsExplanation
When the dollar will purchase more euros, it means that the exchange rate between the two currencies has changed in favor of the dollar. This implies that foreign goods will become relatively less expensive compared to American goods. This is because with more euros, one can buy more foreign goods for the same amount of dollars. Therefore, the correct answer is that foreign goods become relatively less expensive than American goods.Rate this question:
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- 24.
An increase in the real interest rate on U.S. bonds, everything else equal, will have the following impact on the foreign exchange market:
- A.
The demand for dollars will decrease
- B.
The supply of dollars will increase
- C.
The dollar will depreciate relative to foreign currencies
- D.
The demand for dollars will increase
Correct Answer
D. The demand for dollars will increaseExplanation
An increase in the real interest rate on U.S. bonds would make holding U.S. dollars more attractive for foreign investors. This is because higher interest rates offer higher returns on investments. As a result, the demand for dollars will increase as more investors seek to acquire U.S. bonds and other dollar-denominated assets. Therefore, the correct answer is that the demand for dollars will increase.Rate this question:
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- 25.
An expected appreciation of the dollar, everything else held constant, should cause:
- A.
The supply of dollars to increase
- B.
The demand for dollars to increase
- C.
The demand for dollars to decrease
- D.
The dollar to depreciate now relative to other currencies
Correct Answer
B. The demand for dollars to increaseExplanation
An expected appreciation of the dollar would mean that the value of the dollar is expected to increase in the future. This would make the dollar more desirable and valuable, leading to an increase in the demand for dollars. People would want to hold more dollars in anticipation of its appreciation. Therefore, the correct answer is that the demand for dollars would increase.Rate this question:
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- 26.
If U.S. assets are seen as having greater risk relative to foreign assets in the market for foreign exchange, this should cause:
- A.
The demand for dollars to increase
- B.
The supply of dollars to decrease
- C.
The supply of dollars to increase
- D.
The dollar to appreciate
Correct Answer
C. The supply of dollars to increaseExplanation
If U.S. assets are perceived as riskier compared to foreign assets in the foreign exchange market, investors may want to sell their U.S. assets and buy foreign assets instead. This would lead to an increase in the supply of dollars in the market, as more people are selling their dollars.Rate this question:
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Mar 21, 2023Quiz Edited by
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Mar 10, 2012Quiz Created by
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