Practice Questions #2

ID's:

Basis Point
Beta
Consol
Coupon Bond
Coupon Rate
Current Yield
Discount Yield
Diversification
Expected Return
Fisher Effect
Fixed-Payment Loan
Indexed Bond
Interest-Rate Risk
Liquidity
Liquidity Preference Framework
Loanable Funds
Loanable Funds Framework
Nominal Interest Rate
Opportunity Cost
Par Value
Present Discounted Value
Present Value
Rate of Capital Gain
Rate of Return
Real Interest Rate
Reinvestment Risk
Systematic Risk
Wealth
Wealth Elasticity of Demand
Yield to Maturity
Zero Coupon Bond

True/False/Uncertain Statements:

1. An increase in wealth increases the demand for bonds.
2. An increase in the expected interest rate increases the demand for bonds.
3. An increase in expected inflation increases the demand for bonds.
4. An increase in the riskiness of bonds relative to other assets increases the demand for bonds.
5. An increase in the liquidity of bonds relative to other assets increases the demand for bonds.
6. A decrease in the profitability of other investments decreases the supply of bonds.
7. A decrease in the government budget deficit decreases the supply of bonds.
8. An increase in income decreases the interest rate.
9. An increase in the price level decreases the interest rate.
10. An increase in money supply decreases the interest rate.
11. The effect of an increase in the rate of money growth will have a definite effect in the interest rate in the long run.
12. If the real interest rate increases people have incentive to increase their expenditures.
13. If the real interest rate increases people have incentive to increase their holdings of bonds.
14. Volatility for long-term bonds is higher than that for short-term bonds.
15. The return of a bond is equal to the interest rate on that bond.
16. Current yield and yield to maturity are fancy names for the same thing, i.e. the interest rate.
17. The return on a bond will not necessarily equal the interest rate on that bond.
18. Bonds with a maturity that is as short as the holding period have no interest-rate risk.
19. Discount yield understates yield to maturity, and this understatement is increasing in maturity.
20. Diversification is always beneficial to the risk-averse investor.

Other Questions:

1. Discuss the importance of the interest rate to individuals; in particular, comment on how changes in the interest rate affect income allocation.
2. What is the relationship between interest rate risk and maturity?
3. Is the real interest rate as defined by the Fisher equation an accurate measure of the effective cost of borrowing for U.S. individuals and corporations?
4. What is the difference between current yield and yield to maturity for consols?
5. What are two benefits and one cost of indexed bonds? (Hint: the cost has to do with income taxes)
6. Under what circumstances does the yield to maturity equal the coupon rate of a coupon bond?
7. What is the relationship between the yield to maturity and the price of a coupon bond?
8. If mortgage rates rise from 5% to 10% but the expected rate of increase in housing prices rises from 2% to 9%, are people more or less likely to buy houses?
9. In Keynes' liquidity preference analysis, what two factors cause the demand curve for money to shift?  How do these effects work?
10. What is the liquidity effect of an increase in the money supply?  The income effect?  Price-level effect?  Expected-inflation effect?