Question 1

Interest rates are positive mainly because

Accepted Answer

People tend to prefer the present to the future and therefore require a higher amount of money in the future to compensate them for not being able to use it now. This creates a demand for interest rates to be positive. Inflation (choice A) is a factor that affects interest rates but is not the main reason for them being positive. Choice C is incorrect as it goes against the behavior of people preferring the present. Choice D is not a valid reason for positive interest rates.

Question 2

If savers require a 2% return and inflation is expected to be 3%,what approximate rate will banks offer savers?

Accepted Answer

To maintain the real value of savers' returns in the face of 3% inflation, banks need to offer an interest rate that compensates for both the desired real return of 2% and the expected inflation. This is calculated using the formula: nominal interest rate = real interest rate + inflation rate. Therefore, 2% (real return) + 3% (inflation) = 5%.

Question 3

Suppose a person has a discount rate of zero.This implies she

Accepted Answer

A discount rate of zero means that the person values the present and the future equally. They would be willing to wait an indefinite amount of time to receive a certain amount of value, and they would not require any additional compensation for delaying consumption. It does not necessarily mean that they do not value the future, but rather that they do not discount the future relative to the present.

Question 4

You can put your $100 in Bank A that pays 8% at the end of the year.You can also put your $100 in Bank B that pays 4% at the end of six months and then 4% again at the end of the year.You will keep your $100 and all interest in the bank.At the end of the year

Accepted Answer

If you put your money in Bank A, you will earn 8% interest at the end of the year, which means you will have $108 at the end of the year.

If you put your money in Bank B, you will earn 4% interest at the end of six months (which is half a year), which means you will have $104 at the end of six months. Then, you will earn another 4% interest at the end of the year, which means you will have $108.16 at the end of the year.

Therefore, the total at Bank B will be greater than the total at Bank A.

Question 5

For a given rate of interest,the total interest you receive from lending money

Accepted Answer

As the frequency of compounding increases, the interest earned on the principal also increases. This is because interest is earned not only on the initial principal but also on the accumulated interest. Therefore, the total interest you receive from lending money increases as the frequency of compounding increases.

Question 6

If your bank pays you 6% interest on a savings account and inflation is 2%,your approximate real rate of interest is

Accepted Answer

The real rate of interest is calculated by subtracting the inflation rate from the nominal interest rate. 
Real rate of interest = Nominal interest rate - Inflation rate
= 6% - 2% 
= 4%
Therefore, the approximate real rate of interest is 4%. 
Option B is the correct answer.

Question 7

As the interest rate rises,the present value of a given perpetual stream of income

Accepted Answer

As the interest rate rises, the value of future cash flows decreases in today's dollars. Therefore, the present value of a given perpetual stream of income will decrease.

Question 8

If you invest $500 today,and the value one year from today is $1000,then the annual interest rate must be

Accepted Answer

The formula for calculating the annual interest rate is:
Annual Interest Rate = (Ending Value / Beginning Value) - 1
Plugging in the given values, we get:
Annual Interest Rate = ($1000 / $500) - 1 = 1 or 100%
Therefore, the correct answer is C) 100%.

Question 9

If inflation is 10% and the nominal interest rate equals 16.6% the real interest rate is equal to

Accepted Answer

Real interest rate = Nominal interest rate - Inflation rate
Real interest rate = 16.6% - 10%
Real interest rate = 6.6%
Therefore, the real interest rate is 6%.

Question 10

If the interest rate is 10%,then $1 received one year from now is worth how much today?

Accepted Answer

This question is asking about the present value of $1 received one year from now at an interest rate of 10%. The formula for present value is PV = FV / (1 + r), where PV is the present value, FV is the future value, and r is the interest rate. Plugging in the values from the question, we get:
PV = 1 / (1 + 0.1)
PV = 0.9091
Therefore, $1 received one year from now is worth $0.91 today. So, the best choice is C.

Question 11

If inflation turns out to be higher than was anticipated,

Accepted Answer

Inflation erodes the value of money over time. Debtors who repay a fixed amount of money over time with dollars worth less than when they borrowed benefit from unexpected inflation because they pay back less in real terms. Therefore, in case of higher-than-anticipated inflation, debtors are helped.

Question 12

If the interest rate is 10%,then $1 today is worth how much one year from now?

Accepted Answer

If the interest rate is 10%, then $1 today will grow to $1.10 in one year. Therefore, $1 today is worth $1.10 one year from now.

Question 13

You place $100 in a bank account that pays 8%.If you remove the interest you receive each year you can turn your stock into a flow of

Accepted Answer

The interest earned each year is 8% of the initial deposit of $100, which is $8. Therefore, if you remove the interest each year, you will have a flow of $8 per year.

Question 14

If an individual wins a multimillion dollar lottery and chooses to receive annual payments equaling the total prize,this person has a

Accepted Answer

The answer of If an individual wins a multimillion dollar...

Question 15

If you agree to a long-term loan at a specified nominal rate of interest and inflation turns out to be higher than was anticipated,

Accepted Answer

Inflation erodes the purchasing power of money, so if inflation turns out to be higher than anticipated, the real value of the interest payments received will be lower. Therefore, the real rate of interest, which is the nominal rate of interest adjusted for inflation, falls.

Question 16

You invest an amount today for four years that pays 6% annually.The bank compounds annually.At the end of the four years you will have $150.What amount must you invest today?

Accepted Answer

The answer of You invest an amount today for four...

Question 17

If you place $100 in a bank account that pays 6% at the end of each year,and you leave your $100 and all your interest in the bank,how much will you have in the bank at the end of 7 years with annual compounding?

Accepted Answer

Using the formula for compound interest: A=P(1+r/n)^(n*t)

A= amount after time t
P= principal or initial amount
r= annual interest rate as a decimal
n= number of times interest is compounded per year
t= time in years

In this case, P=$100, r=0.06, t=7, compounded annually (n=1):

A= $100(1+0.06/1)^(1*7)
A= $100(1.06)^7
A= $100(1.5038)
A= $150.38

Therefore, the correct answer is D) 100*(1.06)^7.

Question 18

Four banks are offering the same interest rate of 4%.Where do you invest?

Accepted Answer

Compounding interest daily results in a slightly higher effective annual rate compared to monthly or yearly compounding, due to the principle of earning interest on interest more frequently.

Question 19

If inflation turns out to be higher than was anticipated,debtors are helped because

Accepted Answer

If inflation is higher than anticipated, the purchasing power of money decreases. This means that the real value of the amount owed to the debtor also decreases. As a result, debtors are benefited because the real present value of their payments decreases. Therefore, option B is the correct choice.

Question 20

Suppose two people with the same level of income and wealth have different discount rates.Joe has a very high discount rate and Jim has a very low discount rate.Which one of the following is TRUE?

Accepted Answer

Joe, with a high discount rate, values present consumption more than future consumption, making him more inclined to borrow to satisfy current needs or desires. Jim, with a low discount rate, values future consumption more closely to present consumption, making him less likely to borrow.

Quiz 16: Interest Rates, Investments, and Capital Markets