Finance Quiz: Interest Rates & Loan Growth

Questions and Answers

What does the term structure of interest rates state about long-term bonds?

Segmented markets theory

Expectations theory (correct)

Separable markets theory

Liquidity premium theory

According to expectations theory, which bond has the lowest interest rate today given the expected path of interest rates over the next five years?

Three years

Four years

Two years

One year (correct)

If expectations are formed adaptively, then people tend to do what?

Use more information than just past data on a single variable.

Often change their expectations quickly when faced with new information.

Use only the information from past data on a single variable. (correct)

Never change their expectations once they have been made.

What is the result of a monetary expansion on stock prices?

Increases; required rate of return; dividend growth rate Signup and view all the answers

Which of the following was not a factor impacting future inflation expectations?

Expectations of a strong dollar policy. Signup and view all the answers

Which is not a factor currently impacting the shape of the yield curve?

Rising value of the dollar Signup and view all the answers

When the expected inflation rate increases, what happens to the demand and supply for bonds and the interest rate?

Decreases; increases; rises Signup and view all the answers

What does the lower interest rate of municipal bonds relative to Treasury bonds suggest?

The benefit from the tax-exempt status of municipal bonds exceeds their default risk. Signup and view all the answers

In Keynes's liquidity preference framework, what does an excess supply of bonds imply?

An excess supply of bonds implies an excess demand for money. Signup and view all the answers

According to the Fisher effect, what happens to interest rates as the expected rate of inflation increases?

Rise; increases Signup and view all the answers

What type of information might lead to a decrease in a stock's price?

An expected decrease in the level of future dividends. Signup and view all the answers

In the generalized dividend model, why does a future sales price far in the future not affect the current stock price?

The present value is almost zero. Signup and view all the answers

What are financial intermediaries?

Provide a channel for linking those who want to save with those who want to invest. Signup and view all the answers

Markets in which funds are transferred from those who have excess funds available to those who have a shortage are called?

Financial markets. Signup and view all the answers

What is a financial market in which previously issued securities can be resold called?

Secondary market. Signup and view all the answers

Which of the following instruments are traded in a capital market?

Corporate bonds Signup and view all the answers

Which of them is not a type of financial market?

Securities market Signup and view all the answers

Which of the following is not a characteristic of bonds?

They pay dividends Signup and view all the answers

What parameter can be used to distinguish Money and Capital Markets?

Maturity. Signup and view all the answers

What is the main difference between Exchanges and Over-the-Counter (OTC) markets?

The location of buyers and sellers. Signup and view all the answers

How is the relationship between the price of a security and its interest rate?

Negative. Signup and view all the answers

What do brokers do?

They are agents of investors who match buyers with sellers of securities. Signup and view all the answers

What do dealers do?

Link buyers and sellers by buying and selling securities at stated prices. Signup and view all the answers

Why are secondary markets important?

They determine the price of a security that the issuing firm sells in the primary market. Signup and view all the answers

What is stock?

$ amount at a point in time. Signup and view all the answers

Consider a bank's balance sheet. Assets are of funds; liabilities are of funds.

uses; sources Signup and view all the answers

Banks collect deposits from and make loans to .

savers; borrowers Signup and view all the answers

What are possible solutions to the bank failure problem?

Bail-out; financial system regulation. Signup and view all the answers

What are U.S. Treasury Bills?

Liquid and less safe than other money market instruments. Signup and view all the answers

What are Eurobonds?

Any bond denominated in a currency other than that of the country in which it is sold. Signup and view all the answers

What is the federal funds rate?

The cost to banks of borrowing funds from other banks. Signup and view all the answers

If you want to invest your money in financial markets, but you do not like risk, what should you invest in?

Commercial papers. Signup and view all the answers

If you want to invest your money in financial markets and you love risk, what should you invest in?

Corporate stock. Signup and view all the answers

What is the formula that characterizes the yearly coupon payment for a coupon bond with maturity n = 1?

C = P(1 + i) - F. Signup and view all the answers

Study Notes

Financial Intermediaries

Financial intermediaries include commercial banks, credit unions, mutual funds, insurance companies, and pension funds.
Their role is to connect savers with investors, facilitating the flow of funds.

Financial Markets

Financial markets transfer funds from surplus units (savers) to deficit units (borrowers).
The secondary market involves the resale of previously issued securities.

Capital Markets and Instruments

Capital markets primarily trade corporate bonds.
Securities market is not categorized as a distinct financial market.

Characteristics of Bonds

Bonds differ from stocks as they do not pay dividends.
Bonds can have varying characteristics based on maturity and default risk.

Market Behavior and Interest Rates

Money and capital markets are distinguished by the maturity period of instruments.
An inverse relationship exists between the price of a security and its interest rate.

Brokers and Dealers

Brokers act as agents who match buyers and sellers of securities, while dealers engage in buying and selling securities at specific prices.

Importance of Secondary Markets

Secondary markets are vital as they help determine the price of securities during initial public offerings.

Treasury Securities and Risk

U.S. Treasury Bills are liquid but represent a higher risk compared to other safe money market instruments.
Bonds rated Baa and above are considered investment-grade; those below are referred to as junk bonds.

Economic Indicators and Expectations

The federal funds rate reflects borrowing costs between banks and influences overall monetary conditions.
Economic indicators like inflation expectations and unemployment impacts the demand and supply of bonds.

Investment Strategies

Conservative investors should consider low-risk options like U.S. Treasury bonds.
Investors open to risk might look towards corporate stocks or lower-rated corporate bonds.

Yield Curves and Interest Rates

Expectations theory suggests long-term interest rates reflect anticipated short-term rates plus any risk premium.
Segmented markets theory asserts that different maturities are not substitutes, leading to distinct demand dynamics.

Phillips Curve and Monetary Policy

Changes in monetary policy shift interest rates and investments significantly influence overall demand for goods.

Liquidity and Asset Value

The liquidity premium theory indicates that the long-term interest rates are shaped by expected short-term rates plus added risk for illiquidity.
An increase in interest rates usually lowers bond prices, leading to potential capital losses for long-term bonds.

Monetary Expansion Effects

A monetary expansion typically raises stock prices by decreasing interest rates and increasing available capital for investment.
The Greenbush Put refers to the phenomenon where Fed liquidity injections can influence asset prices adversely during financial instability.

Market Behaviors During Crises

Historical patterns indicate that during recessions, demand for bonds typically increases while supply does as well.
The Federal Housing Finance Administration intervened in 2008, affecting institutions like Fannie Mae.

Rational Expectations Theory

If past behaviors of a variable shift, rational expectations theory suggests that market participants will adjust their forecasts accordingly.
Adaptive expectations involve using historical data to forecast future trends, often leading to slower adjustments to new information.

Summary of Key Concepts

Default risk, liquidity, and maturity are critical aspects influencing bond pricing and yields.
Economic conditions and investor expectations significantly shape financial market behavior, impacting decision-making for both short-term and long-term investments.### Inflation Expectations
Expectations for future inflation have risen due to several factors, excluding expectations of a strong dollar policy.
Infrastructure spending, lower corporate taxes, and tariffs can contribute to inflation expectations.

Yield Curve Influences

Factors currently shaping the yield curve do not include the rising value of the dollar.
Key influences include the Federal Reserve reinvesting maturing treasury securities, treasury deficits, and inflation expectations.

Bond Market Dynamics

When expected inflation rates rise, there's a decrease in demand for bonds, increased supply, and a rise in interest rates.
This reflects a typical reaction of the bond market to changing inflation expectations.

Municipal Bonds

Municipal bonds carry default risk, yet they offer lower interest rates compared to default-free Treasury bonds.
This implies that the tax-exempt status of municipal bonds provides benefits that surpass their default risk.

Keynes's Liquidity Preference Theory

According to Keynes, an excess supply of bonds signals an excess demand for money.
This relationship showcases the interaction between bond supply and money demand.

Fisher Effect

Economist Irving Fisher’s concept indicates that interest rates rise as expected inflation increases, assuming other factors remain constant.
It illustrates the impact of inflation expectations on interest rate movements.

Stock Price Predictions

A potential decrease in a stock's price can be foreshadowed by an expected decline in future dividends.
This highlights how dividend expectations significantly influence stock valuations.

Generalized Dividend Model

In the generalized dividend model, a future sales price that is far off does not impact the current stock price because its present value is nearly zero.
This reflects the principle that future cash flows diminish in value when discounted back to the present.

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Description

Test your knowledge on the rapid growth of commercial and auto loan portfolios, as well as theories regarding interest rates. This quiz covers key concepts that affect the lending market and bond valuation. Prepare to explore the relationship between short-term and long-term interest rates.