Question 1

By which means does the production sector supply money to the consumption sector?

Accepted Answer

The production sector supplies money to the consumption sector primarily through wages. When businesses or production entities hire individuals, they pay them wages or salaries. This money then enters the consumption sector as individuals use it to purchase goods and services, thereby facilitating economic activity.

Question 2

Economists forecast the following inflation rates for the next four years  What inflation adjustment should be included in the interest rate on a four-year loan made today?

Accepted Answer

The inflation adjustment included in the interest rate on a four-year loan made today should be the average expected inflation rate over the life of the loan, which is 4.5%. Option A is incorrect because borrowers will still have to pay the inflation rate that is expected during the loan period. Option B is incorrect because it assumes that the lender can always lend out the money again at the same interest rate, which may not be the case. Option D is incorrect because it assumes the inflation rate will be higher than the forecasted average, and does not provide a specific reason for choosing 7%.

Question 3

Assume the expected inflation rate is 5% for each of the next two years and 7% per year for the three years after. Calculate the inflation adjustment (INFL)for a 5-year loan.

Accepted Answer

The inflation adjustment (INFL) for a 5-year loan can be calculated as the average inflation rate over the period. For the first two years, the inflation rate is 5% each year, and for the next three years, it is 7% each year. The average inflation rate is calculated as: [(5% * 2) + (7% * 3)] / 5 = (10% + 21%) / 5 = 31% / 5 = 6.2%.

Question 4

By which means does the consumption sector supply money to the production sector?

Accepted Answer

The consumption sector supplies money to the production sector through product purchases. When consumers buy goods and services from producers, they pay for these products, which in turn provides revenue to the producers. This revenue can then be used by the production sector to pay for labor services, wages, and other expenses.

Question 5

Use the following information to calculate the interest rate on an eight-year bond just issued by Becher Inc.
Inflation: next two years = 2.5%
  year 3 and beyond = 4.5%
Pure Rate = 2.0%
Maturity Risk Premium = zero for a 1-year maturity, increasing by 0.1% each year thereafter
Default Risk Premium = 1.5%
Liquidity Risk Premium = 0.0% for treasuries; 0.5% for corporate bonds

Accepted Answer

To calculate the interest rate on the eight-year bond, we need to add up the different components of the yield.

First, we need to calculate the maturity risk premium. Since the bond has an eight-year maturity, the maturity risk premium will be:

MRP = 0.1% × (8-1) = 0.7%

Next, we need to calculate the total inflation premium over the life of the bond. Since inflation is expected to be 2.5% for the next two years and 4.5% thereafter, the average inflation premium over the life of the bond will be:

Inflation premium = ((2.5% + 2.5%) / 2) × 2 years + ((4.5% + 4.5% + 4.5% + 4.5%) / 4) × 6 years = 21.25%

Next, we need to add the pure rate (2.0%) to these premiums:

Pure rate + Inflation premium + Maturity risk premium = 2.0% + 21.25% + 0.7% = 24.95%

Finally, we need to add the default risk premium and the liquidity risk premium. Since this is a corporate bond, we need to add the liquidity risk premium of 0.5%. Therefore, the total yield on the bond will be:

Yield = 24.95% + 1.5% + 0.5% = 26.95%

Therefore, the interest rate on the eight-year bond just issued by Becher Inc. is 8.7%.

Question 6

Hatter Enterprises has just borrowed money at 12% for 3 years. The pure rate of interest is 2%. Hatter's default risk premium is 3%, its liquidity risk premium is 3%, and its maturity risk premium is 1%. Inflation is expected to be 3% in the first year of the loan and 4% in the second year. What does the lender expect the inflation rate to be in the loan's third year?

Accepted Answer

The lender expects the inflation rate to be 2% in the loan's third year because the pure rate of interest is 2%, and the inflation rate is expected to be 3% in the first year and 4% in the second year. Therefore, the lender expects the inflation rate to be 2% in the third year.

Question 7

Assume that the pure interest rate is expected to be 3% for the foreseeable future, and inflation is expected to be 3%, 4% and 5% for each of the next three years and 6% thereafter. What is the base rate component for a 10-year bond?

Accepted Answer

The base rate component is calculated by adding the pure interest rate to the average expected inflation rate over the bond's term. The average inflation rate for the 10 years is (3% + 4% + 5% + 6%*7)/10 = 5.3%. Adding the pure interest rate of 3% gives 8.3%, but since the closest option is 8.20%, we choose D.

Question 8

In general, the financial markets provide a vehicle for:

Accepted Answer

The financial markets provide opportunities for individuals and businesses in the consumption sector to invest their money. This can be done through stocks, bonds, and other financial instruments. The production sector may also use the financial markets to raise capital, but the primary function of the financial markets is to provide investment opportunities for those looking to save and grow their money. Therefore, the correct choice is C.

Question 9

An investor desires to earn a real interest rate of 6%. If the expected rate of inflation is 5%, what nominal rate of interest would the investor set on a loan if all risk premiums are zero?

Accepted Answer

The answer of An investor desires to earn a real...

Question 10

The market segmentation theory proposes that:

Accepted Answer

The market segmentation theory proposes that the debt market is divided into different segments, each with its supply and demand diagrams. These market segments represent different maturities or terms of debt, and the interest rates for each segment are determined independently of the others. Therefore, the correct option is C, which states that the debt market is represented by a series of supply/demand diagrams, each representing a different term, and these operate independently of one another. The other options are incorrect because they do not align with the market segmentation theory. Option A suggests that lenders prefer shorter-term loans, which would result in a downward sloping yield curve as short-term rates would be lower than long-term rates. Option B proposes that the debt market is represented by a single supply/demand diagram, which is inaccurate since there are various segments with different supply/demand relationships. Option D suggests that lenders prefer longer-term loans at lower rates, which is unlikely to occur in an efficient market.

Question 11

What would be the interest rate on a 10-year Treasury note, given the following information? k_pr = 1% MR = 0.1% for a 1-year loan, increasing by 0.1% each additional year. LR = 0.5% for a security with low liquidity and 1.0% for one with very low liquidity. DR= 0 for a 1-year loan, 0.1% for a 2-year loan, increasing by 0.15 % for each additional year. Expected inflation rates: Year 1 = 3.0% Year 2 = 4.0% Year 3 and thereafter: 5.0%

Accepted Answer

The correct answer is A because the interest rate on a 10-year Treasury note would be 6.7%. This is calculated by adding the kpr (1%), the MR for 10 years (1%), the LR for low liquidity (0.5%), the DR for 10 years (1.5%), and the expected inflation rate for 10 years (2.7%).

Question 12

Economists forecast the following inflation rates for the next four years:  What inflation adjustment should be included in the interest rate on a three-year loan made today?

Accepted Answer

The inflation adjustment should reflect the expected average inflation rate over the life of the loan, which in this case is four years. Option A is incorrect because inflation is expected to be higher than 3% over the next four years. Option C is incorrect because it assumes the lender will be lending the money again in three years, while the loan is for three years. Option D is incorrect because it only considers the lender's perspective and does not reflect the average expected inflation rate over the life of the loan.

Question 13

The federal government can always avoid default on its issues because of its unique right to:

Accepted Answer

The federal government has the unique ability to print money, which allows it to avoid default on its issues. This is because the government can always print more money to pay off its debts, although this practice can lead to inflation and other economic problems in the long run.

Question 14

If a stock that has earnings per share of $1.50 is quoted in the Wall Street Journal as having a price-earnings ratio of 13, the closing price on that day must be:

Accepted Answer

The answer of If a stock that has earnings per...

Question 15

Marshall Manufacturing has just borrowed money at 13% for 2 years. The pure rate of interest is 2%. Marshall's default risk premium is 4%, its liquidity risk premium is 2%, and its maturity risk premium is 0.5%. Inflation is expected to be 3% during the first year of the loan's life. What does the lender expect the inflation rate to be in the loan's second year?

Accepted Answer

The answer of Marshall Manufacturing has just borrowed money at...

Question 16

You have just looked up the stock quotation for Premier Images, Inc. in the Wall Street Journal . The PE ratio is listed as 20. The dividend is shown as $1.00, and the stock just closed (last)at $42.00. What are the yield % and the earnings per share (EPS)for Premier Images, Inc.?

Accepted Answer

To calculate the yield %, we divide the annual dividend by the current stock price and multiply by 100. So, the yield % for Premier Images, Inc. is:

Yield % = (Annual Dividend/Current Stock Price) x 100
Yield % = ($1.00/$42.00) x 100
Yield % = 2.38% or 2.4% (rounded off)

To calculate the earnings per share (EPS), we divide the current stock price by the PE ratio. So, the EPS for Premier Images, Inc. is:

EPS = Current Stock Price/PE Ratio
EPS = $42.00/20
EPS = $2.10

Therefore, the answer is A) Yield = 2.4%; EPS = $2.10.

Question 17

Riordan Services Inc. just issued a 2-year bond at a 15% interest rate. Riordan's default risk premium has been estimated at 2.5%, its liquidity risk premium is about 2%, and its maturity risk premium is 3%. Inflation is expected to be 5% in the bond's first year and 4% in its second year. What is the implied pure rate of interest?

Accepted Answer

The implied pure rate of interest is 3%. This is because the bond's yield to maturity is 15%, and the default risk premium is 2.5%, the liquidity risk premium is 2%, and the maturity risk premium is 3%. Inflation is expected to be 5% in the bond's first year and 4% in its second year. So, the real yield to maturity is 3%.

Question 18

The yield on a certain 20-year corporate bond is 14%. The yield on 90-day treasury bills is 8% while 20-year treasury securities are yielding 12%. What is the default risk premium on the corporate bond?

Accepted Answer

The default risk premium is the additional yield or return that investors demand for investing in a corporate bond compared to a risk-free rate. In this case, the 20-year treasury securities are considered risk-free as they are backed by the US government.

The yield on 20-year treasury securities is 12%, but the yield on the corporate bond is 14%. Therefore, the default risk premium is 14% - 12% = 2%.

Option C) is the correct answer as it correctly identifies the default risk premium as 2%. Options A), B), D), and E) are incorrect as they do not calculate the default risk premium correctly.

Question 19

Given the following closing stock quote, what was the closing price two business days ago.

Accepted Answer

The answer of Given the following closing stock quote, what...

Question 20

What is the real rate of interest on a $50,000 loan if $62,000 repays the loan after one year, given a rate of inflation of 12%?

Accepted Answer

The answer of What is the real rate of interest...

Quiz 5: The Financial System Corporate Governance and Interest