The Economics of Money, Banking and Financial Markets, 13e (Mishkin)

Chapter 4 The Meaning of Interest Rates

4.1 Measuring Interest Rates

1) The concept of ________ is based on the common-sense notion that a dollar paid to you in the
future is less valuable to you than a dollar today.
A) present value
B) future value
C) interest
D) deflation
Answer: A
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2) The present value of an expected future payment ________ as the interest rate increases.
A) falls
B) rises
C) is constant
D) is unaffected
Answer: A
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3) An increase in the time to the promised future payment ________ the present value of the
payment.
A) decreases
B) increases
C) has no effect on
D) is irrelevant to
Answer: A
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4) With an interest rate of 6 percent, the present value of $100 to be received next year is
approximately
A) $106.
B) $100.
C) $94.
D) $92.
Answer: C
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5) What is the present value of $500.00 to be paid in two years if the interest rate is 5 percent?
A) $453.51
B) $500.00
C) $476.25
D) $550.00
Answer: A
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6) If a security pays $55 in one year and $133 in three years, its present value is $150 if the
interest rate is
A) 5 percent.
B) 10 percent.
C) 12.5 percent.
D) 15 percent.
Answer: B
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7) To claim that a lottery winner who is to receive $1 million per year for twenty years has won
$20 million ignores the process of
A) face value.
B) par value.
C) deflation.
D) discounting the future.
Answer: D
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8) A credit market instrument that provides the borrower with an amount of funds that must be
repaid at the maturity date along with an interest payment is known as a
A) simple loan.
B) fixed-payment loan.
C) coupon bond.
D) discount bond.
Answer: A
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9) A credit market instrument that requires the borrower to make the same payment every period
until the maturity date is known as a
A) simple loan.
B) fixed-payment loan.
C) coupon bond.
D) discount bond.
Answer: B
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10) Which of the following are TRUE of fixed payment loans?

A) The borrower repays both the principal and interest at the maturity date.
B) Installment loans and mortgages are frequently of the fixed payment type.
C) The borrower pays interest periodically and the principal at the maturity date.
D) Commercial loans to businesses are often of this type.
Answer: B
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11) A fully amortized loan is another name for

A) a simple loan.
B) a fixed-payment loan.
C) a commercial loan.
D) an unsecured loan.
Answer: B
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12) A credit market instrument that pays the owner a fixed coupon payment every year until the
maturity date and then repays the face value is called a
A) simple loan.
B) fixed-payment loan.
C) coupon bond.
D) discount bond.
Answer: C
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13) A ________ pays the owner a fixed coupon payment every year until the maturity date, when
the ________ value is repaid.
A) coupon bond; discount
B) discount bond; discount
C) coupon bond; face
D) discount bond; face
Answer: C
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14) The ________ is the final amount that will be paid to the holder of a coupon bond.
A) discount value
B) coupon value
C) face value
D) present value
Answer: C
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15) When talking about a coupon bond, face value and ________ mean the same thing.
A) par value
B) coupon value
C) amortized value
D) discount value
Answer: A
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16) The dollar amount of the yearly coupon payment expressed as a percentage of the face value
of the bond is called the bond's
A) coupon rate.
B) maturity rate.
C) face value rate.
D) payment rate.
Answer: A
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17) The ________ is calculated by multiplying the coupon rate times the par value of the bond.
A) present value
B) face value
C) coupon payment
D) maturity payment
Answer: C
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18) If a $1,000 face value coupon bond has a coupon rate of 3.75 percent, then the coupon
payment every year is
A) $37.50.
B) $3.75.
C) $375.00.
D) $13.75.
Answer: A
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19) If a $5,000 coupon bond has a coupon rate of 13 percent, then the coupon payment every
year is
A) $650.
B) $1,300.
C) $130.
D) $13.
Answer: A
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20) An $8,000 coupon bond with a $400 coupon payment every year has a coupon rate of
A) 5 percent.
B) 8 percent.
C) 10 percent.
D) 40 percent.
Answer: A
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21) A $1,000 face value coupon bond with a $60 coupon payment every year has a coupon rate
of
A) .6 percent.
B) 5 percent.
C) 6 percent.
D) 10 percent.
Answer: C
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22) All of the following are examples of coupon bonds EXCEPT

A) corporate bonds.
B) U.S. Treasury bills.
C) U.S. Treasury notes.
D) U.S. Treasury bonds.
Answer: B
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23) A bond that is bought at a price below its face value and the face value is repaid at a maturity
date is called a
A) simple loan.
B) fixed-payment loan.
C) coupon bond.
D) discount bond.
Answer: D
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24) A ________ is bought at a price below its face value, and the ________ value is repaid at the
maturity date.
A) coupon bond; discount
B) discount bond; discount
C) coupon bond; face
D) discount bond; face
Answer: D
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25) A discount bond

A) pays the bondholder a fixed amount every period and the face value at maturity.
B) pays the bondholder the face value at maturity.
C) pays all interest and the face value at maturity.
D) pays the face value at maturity plus any capital gain.
Answer: B
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26) Examples of discount bonds include

A) U.S. Treasury bills.
B) corporate bonds.
C) U.S. Treasury notes.
D) municipal bonds.
Answer: A
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27) Which of the following are TRUE for discount bonds?

A) A discount bond is bought at par.
B) The purchaser receives the face value of the bond at the maturity date.
C) U.S. Treasury bonds and notes are examples of discount bonds.
D) The purchaser receives the par value at maturity plus any capital gains.
Answer: B
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28) The interest rate that equates the present value of payments received from a debt instrument
with its value today is the
A) simple interest rate.
B) current yield.
C) yield to maturity.
D) real interest rate.
Answer: C
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29) Economists consider the ________ to be the most accurate measure of interest rates.
A) simple interest rate.
B) current yield.
C) yield to maturity.
D) nominal interest rate.
Answer: C
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30) For simple loans, the simple interest rate is ________ the yield to maturity.
A) greater than
B) less than
C) equal to
D) not comparable to
Answer: C
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31) If the amount payable in two years is $2,420 for a simple loan at 10 percent interest, the loan
amount is
A) $1,000.
B) $1,210.
C) $2,000.
D) $2,200.
Answer: C
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32) For a 3-year simple loan of $10,000 at 10 percent, the amount to be repaid is
A) $10,030.
B) $10,300.
C) $13,000.
D) $13,310.
Answer: D
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33) If $22,050 is the amount payable in two years for a $20,000 simple loan made today, the
interest rate is
A) 5 percent.
B) 10 percent.
C) 22 percent.
D) 25 percent.
Answer: A
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34) If a security pays $110 next year and $121 the year after that, what is its yield to maturity if it
sells for $200?
A) 9 percent
B) 10 percent
C) 11 percent
D) 12 percent
Answer: B
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35) The present value of a fixed-payment loan is calculated as the ________ of the present value
of all cash flow payments.
A) sum
B) difference
C) multiple
D) log
Answer: A
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36) The interest rate is 10% and you borrow a $2000, 2-year fixed payments car loan with two
annual payments. Then your loan payment each year is $________.
A) $1045.30
B) $1476.25
C) $1152.40
D) $1000.00
Answer: C
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37) Which of the following are TRUE for a coupon bond?
A) When the coupon bond is priced at its face value, the yield to maturity equals the coupon rate.
B) The price of a coupon bond and the yield to maturity are positively related.
C) The yield to maturity is greater than the coupon rate when the bond price is above the par
value.
D) The yield is less than the coupon rate when the bond price is below the par value.
Answer: A
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38) The ________ of a coupon bond and the yield to maturity are inversely related.
A) price
B) par value
C) maturity date
D) term
Answer: A
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39) The price of a coupon bond and the yield to maturity are ________ related; that is, as the
yield to maturity ________, the price of the bond ________.
A) positively; rises; rises
B) negatively; falls; falls
C) positively; rises; falls
D) negatively; rises; falls
Answer: D
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40) The yield to maturity is ________ than the ________ rate when the bond price is ________
its face value.
A) greater; coupon; above
B) greater; coupon; below
C) greater; perpetuity; above
D) less; perpetuity; below
Answer: B
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41) The ________ is below the coupon rate when the bond price is ________ its par value.
A) yield to maturity; above
B) yield to maturity; below
C) discount rate; above
D) discount rate; below
Answer: A
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42) A $10,000 8 percent coupon bond that sells for $10,000 has a yield to maturity of
A) 8 percent.
B) 10 percent.
C) 12 percent.
D) 14 percent.
Answer: A
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43) Which of the following $1,000 face-value securities has the highest yield to maturity?
A) a 5 percent coupon bond selling for $1,000
B) a 10 percent coupon bond selling for $1,000
C) a 12 percent coupon bond selling for $1,000
D) a 12 percent coupon bond selling for $1,100
Answer: C
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44) Which of the following $5,000 face-value securities has the highest yield to maturity?
A) a 6 percent coupon bond selling for $5,000
B) a 6 percent coupon bond selling for $5,500
C) a 10 percent coupon bond selling for $5,000
D) a 12 percent coupon bond selling for $4,500
Answer: D
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45) Which of the following $1,000 face-value securities has the highest yield to maturity?
A) a 5 percent coupon bond with a price of $600
B) a 5 percent coupon bond with a price of $800
C) a 5 percent coupon bond with a price of $1,000
D) a 5 percent coupon bond with a price of $1,200
Answer: A
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46) Which of the following $1,000 face-value securities has the lowest yield to maturity?
A) a 5 percent coupon bond selling for $1,000
B) a 10 percent coupon bond selling for $1,000
C) a 15 percent coupon bond selling for $1,000
D) a 15 percent coupon bond selling for $900
Answer: A
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47) Which of the following bonds would you prefer to be buying?
A) a $10,000 face-value security with a 10 percent coupon selling for $9,000
B) a $10,000 face-value security with a 7 percent coupon selling for $10,000
C) a $10,000 face-value security with a 9 percent coupon selling for $10,000
D) a $10,000 face-value security with a 10 percent coupon selling for $10,000
Answer: A
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48) The yield to maturity on a 10-year treasury note (with face value = $100 and annual coupon
rate = 2.625%) is 3.37%. The market price of this bond must be ________ $100.
A) less than
B) greater than
C) equal to
D) close to
Answer: A
Question Status: New
AACSB: Analytical Thinking

49) Last year you purchased a bond with an interest rate of 5 percent. Now the interest rate on
the bond market drops to 4%. Then which of the followings are correct?
I. The interest rate you are earning from this bond is lower.
II. The face value of your bond is lower.
III. You will receive the same amount of coupon payments from the issuer while you are holding
the bond.
IV. People can offer a lower price to buy your bond today.
V. You can sell your bond at today's market for a higher price.
A) III and V
B) I and III
C) III and IV
D) II, III, and IV
E) V only
Answer: A
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50) The yield to maturity on a 10-year coupon bond (with face value = $1,000 and annual
coupon rate = 3.25%) is 2.42%. This implies:
I. the price of this bond is $1,000.
II. the price of this bond is greater than $1,000.
III. the price of this bond is less than $1,000.
IV. the buyer of this bond will receive $32.5 from the bond issuer every year before maturity
while holding the bond.
A) II only.
B) I and IV.
C) III and IV.
D) II and IV.
E) III only.
Answer: D
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51) The yield to maturity on a 10-year coupon bond, with face value = $1,000 and annual coupon
rate = 3.25%, is 2.42%. This implies:
I. the price of this bond is $1,000.
II. the price of this bond is greater than $1,000.
III. the price of this bond is less than $1,000.
IV. the buyer of the bond will receive $24.2 payment from the bond issuer every year before
maturity while holding the bond.
V. the buyer of the bond will receive $32.5 payment from the bond issuer every year before
maturity while holding the bond.
A) I and IV.
B) II and IV.
C) II and V.
D) III and IV.
E) III and V.
Answer: C
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52) The yield to maturity on a 10-year treasury note (with face value = $100 and annual coupon
rate = 2.625%) is 3.37%. If the price of this treasury note goes up, its:
I. coupon rate drops below 2.625%.
II. coupon rate rises above 2.625%.
III. yield to maturity drops below 3.37.%.
IV. yield to maturity above 3.37%.
A) III.
B) I.
C) IV.
D) II and IV.
E) I and III.
Answer: A
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53) A coupon bond that has no maturity date and no repayment of principal is called a
A) consol.
B) cabinet.
C) Treasury bill.
D) Treasury note.
Answer: A
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54) The price of a consol equals the coupon payment

A) times the interest rate.
B) plus the interest rate.
C) minus the interest rate.
D) divided by the interest rate.
Answer: D
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55) The interest rate on a consol equals the

A) price times the coupon payment.
B) price divided by the coupon payment.
C) coupon payment plus the price.
D) coupon payment divided by the price.
Answer: D
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56) A consol paying $20 annually when the interest rate is 5 percent has a price of
A) $100.
B) $200.
C) $400.
D) $800.
Answer: C
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57) If a perpetuity has a price of $500 and an annual interest payment of $25, the interest rate is
A) 2.5 percent.
B) 5 percent.
C) 7.5 percent.
D) 10 percent.
Answer: B
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58) The yield to maturity for a perpetuity is a useful approximation for the yield to maturity on
long-term coupon bonds. It is called the ________ when approximating the yield for a coupon
bond.
A) current yield
B) discount yield
C) future yield
D) star yield
Answer: A
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AACSB: Reflective Thinking

59) The yield to maturity for a one-year discount bond equals the increase in price over the year,
divided by the
A) initial price.
B) face value.
C) interest rate.
D) coupon rate.
Answer: A
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60) If a $10,000 face-value discount bond maturing in one year is selling for $5,000, then its
yield to maturity is
A) 5 percent.
B) 10 percent.
C) 50 percent.
D) 100 percent.
Answer: D
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61) If a $5,000 face-value discount bond maturing in one year is selling for $5,000, then its yield
to maturity is
A) 0 percent.
B) 5 percent.
C) 10 percent.
D) 20 percent.
Answer: A
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62) A discount bond selling for $15,000 with a face value of $20,000 in one year has a yield to
maturity of
A) 3 percent.
B) 20 percent.
C) 25 percent.
D) 33.3 percent.
Answer: D
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63) The yield to maturity for a discount bond is ________ related to the current bond price.
A) negatively
B) positively
C) not
D) directly
Answer: A
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64) A discount bond is also called a ________ because the owner does not receive periodic
payments.
A) zero-coupon bond
B) municipal bond
C) corporate bond
D) consol
Answer: A
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AACSB: Application of Knowledge

65) Another name for a consol is a ________ because it is a bond with no maturity date. The
owner receives fixed coupon payments forever.
A) perpetuity
B) discount bond
C) municipality
D) high-yield bond
Answer: A
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AACSB: Application of Knowledge

66) Negative yields to maturity imply that bond purchasers are better off to hold cash.
Acceptance of slightly negative yields by purchasers in recent times suggest that the
A) convenience of storing large sums is also important to decisions.
B) inflation rate is positive.
C) governments have issued too many bonds.
D) decision makers are only concerned with yields.
Answer: A
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67) If the interest rate is 5%, what is the present value of a security that pays you $1, 050 next
year and $1,102.50 two years from now? If this security sold for $2,200, is the yield to maturity
greater or less than 5%? Why?
Answer: PV = $1,050/(1. +.05) + $1,102.50/(1 + 0.5)2
PV = $2,000
If this security sold for $2,200, the yield to maturity is less than 5%. The lower the interest rate
the higher the present value.
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4.2 The Distinction Between Interest Rates and Returns

1) The ________ is defined as the payments to the owner plus the change in a security's value
expressed as a fraction of the security's purchase price.
A) yield to maturity
B) current yield
C) rate of return
D) yield rate
Answer: C
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AACSB: Application of Knowledge

2) Which of the following are TRUE concerning the distinction between interest rates and
returns?
A) The rate of return on a bond will not necessarily equal the interest rate on that bond.
B) The return can be expressed as the difference between the current yield and the rate of capital
gains.
C) The rate of return will be greater than the interest rate when the price of the bond falls during
the holding period.
D) The return can be expressed as the sum of the discount yield and the rate of capital gains.
Answer: A
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3) The sum of the current yield and the rate of capital gain is called the
A) rate of return.
B) discount yield.
C) perpetuity yield.
D) par value.
Answer: A
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4) What is the return on a 5 percent coupon bond that initially sells for $1,000 and sells for
$1,200 next year?
A) 5 percent
B) 10 percent
C) -5 percent
D) 25 percent
Answer: D
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5) What is the return on a 5 percent coupon bond that initially sells for $1,000 and sells for $900
next year?
A) 5 percent
B) 10 percent
C) -5 percent
D) -10 percent
Answer: C
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6) The return on a 5 percent coupon bond that initially sells for $1,000 and sells for $950 next
year is
A) -10 percent.
B) -5 percent.
C) 0 percent.
D) 5 percent.
Answer: C
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AACSB: Analytical Thinking

7) Suppose you are holding a 5 percent coupon bond maturing in one year with a yield to
maturity of 15 percent. If the interest rate on one-year bonds rises from 15 percent to 20 percent
over the course of the year, what is the yearly return on the bond you are holding?
A) 5 percent
B) 10 percent
C) 15 percent
D) 20 percent
Answer: C
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8) I purchase a 10 percent coupon bond. Based on my purchase price, I calculate a yield to

maturity of 8 percent. If I hold this bond to maturity, then my return on this asset is
A) 10 percent.
B) 8 percent.
C) 12 percent.
D) there is not enough information to determine the return.
Answer: B
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9) A two-year bond with $1,000 face-value and 10% coupon rate is sold for $1,000 today. If one
year later the market interest rate increases to 15%, then this bond will have a market price of
________ next year .
A) $1043.48
B) $1047.62
C) $869.57
D) $956.52
Answer: D
Question Status: New
AACSB: Analytical Thinking

10) A two-year bond with $1,000 face-value and 10% coupon rate is sold for $1,000 today. If
one year later the market interest rate decreases to 5%, then this bond will have a market price of
________ next year .
A) $1043.48
B) $956.52
C) $952.38
D) $1047.62
Answer: D
Question Status: New
AACSB: Analytical Thinking

11) James buys a two-year bond with $1,000 face-value and 10% coupon rate for $1,000 today.
If one year later the market interest rate increases to 15% and Adam sells the bond, then his rate
of return on this investment is ________% (negative if it is a loss).
A) -4.3
B) 0
C) 4.3
D) 5.7
Answer: D
Question Status: New
AACSB: Analytical Thinking

12) A three-year bond with $1,000 face-value and 10% coupon rate is sold for $1,000 today. If
one year later the market interest rate increases to 15%, then this bond will have a market price
of ________ next year.
A) $1092.97
B) $1047.62
C) $956.52
D) $918.71
Answer: D
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13) A three-year bond with $1,000 face-value and 10% coupon rate is sold for $1,000 today
(2011). If one year later (2012) the market interest rate decreases to 5%, then this bond will have
a market price of $________ (round to the nearest integer) next year (2012).
A) $1092.97
B) $1047.62
C) $956.52
D) $918.71
Answer: A
Question Status: New
AACSB: Analytical Thinking

14) James buys a three-year bond with $1,000 face-value and 10% coupon rate for $1,000 today.
If one year later the market interest rate increases to 15% and James sells the bond, then his rate
of return on this investment is ________% (negative if it is a loss).
A) 1.9
B) -8.1
C) -5
D) 4.3
Answer: A
Question Status: New
AACSB: Analytical Thinking

15) Last year you purchased a bond with an interest rate of 5 percent. Now the interest rates on
the bond markets drop. Then
A) the face value of your bond is higher.
B) your return on this bond will be higher later when you hold it to the maturity date.
C) the interest rate you are earning from this bond is lower.
D) people can offer a lower price to buy your bond today.
E) you can sell your bond at today's market for a higher price.
Answer: E
Question Status: New
AACSB: Analytical Thinking

16) Last year you purchased a bond with an interest rate of 5 percent. Now the interest rate on
the bond market drops to 4%. Then
A) you will receive the same amount of coupon payments from the issuer while you are holding
the bond.
B) your return on this bond will be higher later when you hold it to the maturity date.
C) people can offer a lower price to buy your bond today.
D) the interest rate you are earning from this bond is lower.
E) the face value of your bond is lower.
Answer: A
Question Status: New
AACSB: Analytical Thinking

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17) The yield to maturity on a 10-year coupon bond (with face value = $1,000 and annual
coupon rate = 3.25%) is 2.42%. This implies:
I. the price of this bond is $1,000.
II. the price of this bond is greater than $1,000.
III. the price of this bond is less than $1,000.
IV. the buyer of the bond will have a return of 2.42% if she sells the bond next year.
V. the buyer of the bond will have a return of 3.25% if she sells the bond next year.
A) I and IV.
B) II and IV.
C) II and V.
D) III and IV.
E) II only.
Answer: E
Question Status: New
AACSB: Analytical Thinking

18) The yield to maturity on a 10-year coupon bond (with face value = $1,000 and annual
coupon rate = 3.25%) is 2.42%. This implies:
I. the bond is traded on the market for $1,000.
II. the buyer's return for holding the bond for 10 years will be 3.25%.
III. the buyer's return for holding the bond for 10 years will be 2.42%.
IV. the buyer of the bond will have a return of 2.42% if she sells the bond next year.
V. the buyer of the bond will have a return of 3.25% if she sells the bond next year.
A) I and IV.
B) II and IV.
C) II only.
D) III and IV.
E) III only.
Answer: E
Question Status: New
AACSB: Analytical Thinking

19) If the interest rates on all bonds rise from 5 to 6 percent over the course of the year, which
bond would you prefer to have been holding?
A) a bond with one year to maturity
B) a bond with five years to maturity
C) a bond with ten years to maturity
D) a bond with twenty years to maturity
Answer: A
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AACSB: Analytical Thinking

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20) An equal decrease in all bond interest rates
A) increases the price of a five-year bond more than the price of a ten-year bond.
B) increases the price of a ten-year bond more than the price of a five-year bond.
C) decreases the price of a five-year bond more than the price of a ten-year bond.
D) decreases the price of a ten-year bond more than the price of a five-year bond.
Answer: B
Question Status: Previous Edition
AACSB: Analytical Thinking

21) An equal increase in all bond interest rates

A) increases the return to all bond maturities by an equal amount.
B) decreases the return to all bond maturities by an equal amount.
C) has no effect on the returns to bonds.
D) decreases long-term bond returns more than short-term bond returns.
Answer: D
Question Status: Previous Edition
AACSB: Analytical Thinking

22) Which of the following are generally TRUE of bonds?

A) A bond's return equals the yield to maturity when the time to maturity is the same as the
holding period.
B) A rise in interest rates is associated with a fall in bond prices, resulting in capital gains on
bonds whose terms to maturity are longer than the holding periods.
C) The longer a bond's maturity, the smaller is the size of the price change associated with an
interest rate change.
D) Prices and returns for short-term bonds are more volatile than those for longer-term bonds.
Answer: A
Question Status: Previous Edition
AACSB: Reflective Thinking

23) Which of the following are generally TRUE of all bonds?

A) The longer a bond's maturity, the greater is the rate of return that occurs as a result of the
increase in the interest rate.
B) Even though a bond has a substantial initial interest rate, its return can turn out to be negative
if interest rates rise.
C) Prices and returns for short-term bonds are more volatile than those for longer term bonds.
D) A fall in interest rates results in capital losses for bonds whose terms to maturity are longer
than the holding period.
Answer: B
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AACSB: Reflective Thinking

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24) The riskiness of an asset's returns due to changes in interest rates is
A) exchange-rate risk.
B) price risk.
C) asset risk.
D) interest-rate risk.
Answer: D
Question Status: Previous Edition
AACSB: Application of Knowledge

25) Interest-rate risk is the riskiness of an asset's returns due to

A) interest-rate changes.
B) changes in the coupon rate.
C) default of the borrower.
D) changes in the asset's maturity.
Answer: A
Question Status: Previous Edition
AACSB: Application of Knowledge

26) Prices and returns for ________ bonds are more volatile than those for ________ bonds,
everything else held constant.
A) long-term; long-term
B) long-term; short-term
C) short-term; long-term
D) short-term; short-term
Answer: B
Question Status: Previous Edition
AACSB: Reflective Thinking

27) There is ________ for any bond whose time to maturity matches the holding period.
A) no interest-rate risk
B) a large interest-rate risk
C) rate-of-return risk
D) yield-to-maturity risk
Answer: A
Question Status: Previous Edition
AACSB: Analytical Thinking

28) All bonds that will not be held to maturity have interest rate risk which occurs because of the
change in the price of the bond as a result of
A) interest-rate changes.
B) changes in the coupon rate.
C) default of the borrower.
D) changes in the asset's maturity date.
Answer: A
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AACSB: Application of Knowledge

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29) Short-term bonds are subject to ________ risk because proceeds must be put into some
future asset at an unknown interest rate.
A) reinvestment
B) term
C) liquidity
D) default
Answer: A
Question Status: Previous Edition
AACSB: Reflective Thinking

30) Your favorite uncle advises you to purchase long-term bonds because their interest rate is
10%. Should you follow his advice?
Answer: It depends on where you think interest rates are headed in the future. If you think
interest rates will be going up, you should not follow your uncle's advice because you would then
have to discount your bond if you needed to sell it before the maturity date. Long-term bonds
have a greater interest-rate risk.
Question Status: Previous Edition
AACSB: Reflective Thinking

4.3 The Distinction Between Real and Nominal Interest Rates

1) The ________ interest rate is adjusted for expected changes in the price level.
A) ex ante real
B) ex post real
C) ex post nominal
D) ex ante nominal
Answer: A
Question Status: Previous Edition
AACSB: Application of Knowledge

2) The ________ interest rate more accurately reflects the true cost of borrowing.
A) nominal
B) real
C) discount
D) market
Answer: B
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AACSB: Analytical Thinking

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3) The nominal interest rate minus the expected rate of inflation
A) defines the real interest rate.
B) is a less accurate measure of the incentives to borrow and lend than is the nominal interest
rate.
C) is a less accurate indicator of the tightness of credit market conditions than is the nominal
interest rate.
D) defines the discount rate.
Answer: A
Question Status: Previous Edition
AACSB: Analytical Thinking

4) When the ________ interest rate is low, there are greater incentives to ________ and fewer
incentives to ________.
A) nominal; lend; borrow
B) real; lend; borrow
C) real; borrow; lend
D) market; lend; borrow
Answer: C
Question Status: Previous Edition
AACSB: Reflective Thinking

5) The interest rate that describes how well a lender has done in real terms after the fact is called
the
A) ex post real interest rate.
B) ex ante real interest rate.
C) ex post nominal interest rate.
D) ex ante nominal interest rate.
Answer: A
Question Status: Previous Edition
AACSB: Analytical Thinking

6) The ________ states that the nominal interest rate equals the real interest rate plus the
expected rate of inflation.
A) Fisher equation
B) Keynesian equation
C) Monetarist equation
D) Marshall equation
Answer: A
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AACSB: Application of Knowledge

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7) If the nominal rate of interest is 2 percent, and the expected inflation rate is -10 percent, the
real rate of interest is
A) 2 percent.
B) 8 percent.
C) 10 percent.
D) 12 percent.
Answer: D
Question Status: Previous Edition
AACSB: Analytical Thinking

8) In which of the following situations would you prefer to be the lender?

A) The interest rate is 9 percent and the expected inflation rate is 7 percent.
B) The interest rate is 4 percent and the expected inflation rate is 1 percent.
C) The interest rate is 13 percent and the expected inflation rate is 15 percent.
D) The interest rate is 25 percent and the expected inflation rate is 50 percent.
Answer: B
Question Status: Previous Edition
AACSB: Analytical Thinking

9) In which of the following situations would you prefer to be the borrower?

A) The interest rate is 9 percent and the expected inflation rate is 7 percent.
B) The interest rate is 4 percent and the expected inflation rate is 1 percent.
C) The interest rate is 13 percent and the expected inflation rate is 15 percent.
D) The interest rate is 25 percent and the expected inflation rate is 50 percent.
Answer: D
Question Status: Previous Edition
AACSB: Analytical Thinking

10) If you expect the inflation rate to be 15 percent next year and a one-year bond has a yield to
maturity of 7 percent, then the real interest rate on this bond is
A) 7 percent.
B) 22 percent.
C) -15 percent.
D) -8 percent.
Answer: D
Question Status: Previous Edition
AACSB: Analytical Thinking

11) If you expect the inflation rate to be 12 percent next year and a one-year bond has a yield to
maturity of 7 percent, then the real interest rate on this bond is
A) -5 percent.
B) -2 percent.
C) 2 percent.
D) 12 percent.
Answer: A
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AACSB: Analytical Thinking
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12) If you expect the inflation rate to be 4 percent next year and a one year bond has a yield to
maturity of 7 percent, then the real interest rate on this bond is
A) -3 percent.
B) -2 percent.
C) 3 percent.
D) 7 percent.
Answer: C
Question Status: Previous Edition
AACSB: Analytical Thinking

13) In the United States during the late 1970s, the nominal interest rates were quite high, but the
real interest rates were negative. From the Fisher equation, we can conclude that expected
inflation in the United States during this period was
A) irrelevant.
B) low.
C) negative.
D) high.
Answer: D
Question Status: Previous Edition
AACSB: Reflective Thinking

14) The interest rate on Treasury Inflation Indexed Securities can be roughly interpreted as
A) the real interest rate.
B) the nominal interest rate.
C) the rate of inflation.
D) the rate of deflation.
Answer: A
Question Status: Previous Edition
AACSB: Analytical Thinking

15) Assuming the same coupon rate and maturity length, the difference between the yield on a
Treasury Inflation Indexed Security and the yield on a nonindexed Treasury security provides
insight into
A) the nominal interest rate.
B) the real interest rate.
C) the nominal exchange rate.
D) the expected inflation rate.
Answer: D
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AACSB: Analytical Thinking

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16) Assuming the same coupon rate and maturity length, when the interest rate on a Treasury
Inflation Indexed Security is 3 percent, and the yield on a nonindexed Treasury bond is 8
percent, the expected rate of inflation is
A) 3 percent.
B) 5 percent.
C) 8 percent.
D) 11 percent.
Answer: B
Question Status: Previous Edition
AACSB: Analytical Thinking

17) Since the early 1950s, nominal interest rates and real interest rates in the United States
A) do not always move in the same direction.
B) always increase proportionally.
C) are never moving in the same direction.
D) are of no interest to decision makers.
Answer: A
Question Status: Previous Edition
AACSB: Reflective Thinking

18) Would it make sense to buy a house when mortgage rates are 14% and expected inflation is
15%? Explain your answer.
Answer: Even though the nominal rate for the mortgage appears high, the real cost of borrowing
the funds is -1%. Yes, under this circumstance it would be reasonable to make this purchase.
Question Status: Previous Edition
AACSB: Reflective Thinking

4.4 Web Appendix: Measuring Interest-Rate Risk: Duration

1) Duration is
A) an asset's term to maturity.
B) the time until the next interest payment for a coupon bond.
C) the average lifetime of a debt security's stream of payments.
D) the time between interest payments for a coupon bond.
Answer: C
Question Status: Previous Edition
AACSB: Application of Knowledge

2) Comparing a discount bond and a coupon bond with the same maturity
A) the coupon bond has the greater effective maturity.
B) the discount bond has the greater effective maturity.
C) the effective maturity cannot be calculated for a coupon bond.
D) the effective maturity cannot be calculated for a discount bond.
Answer: B
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AACSB: Reflective Thinking

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3) The duration of a coupon bond increases
A) the longer is the bond's term to maturity.
B) when interest rates increase.
C) the higher the coupon rate on the bond.
D) the higher the bond price.
Answer: A
Question Status: Previous Edition
AACSB: Reflective Thinking

4) All else equal, when interest rates ________, the duration of a coupon bond ________.
A) rise; falls
B) rise; increases
C) falls; falls
D) falls; does not change
Answer: A
Question Status: Previous Edition
AACSB: Reflective Thinking

5) All else equal, the ________ the coupon rate on a bond, the ________ the bond's duration.
A) higher; longer
B) higher; shorter
C) lower; shorter
D) greater; longer
Answer: B
Question Status: Previous Edition
AACSB: Reflective Thinking

6) If a financial institution has 50% of its portfolio in a bond with a five-year duration and 50%
of its portfolio in a bond with a seven-year duration, what is the duration of the portfolio?
A) 12 years
B) 7 years
C) 6 years
D) 5 years
Answer: C
Question Status: Previous Edition
AACSB: Analytical Thinking

7) An asset's interest rate risk ________ as the duration of the asset ________.
A) increases; decreases
B) decreases; decreases
C) decreases; increases
D) remains constant; increases
Answer: B
Question Status: Previous Edition
AACSB: Reflective Thinking

8) The duration of a portfolio of securities is the weighted ________ of the durations of the
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individual securities, with the weights reflecting the proportion of the portfolio invested in each
security.
A) average
B) maximum
C) minimum
D) median
Answer: A
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AACSB: Analytical Thinking

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