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**Unformatted text preview: **Economics 2411 Quiz 2 Name: __________________________ _____________ Instructions: Circle the letter that corresponds to the best Answer. 1. A discount bond is a debt security A) with just one payment. B) that pays interest forever and never repays the principal. C) that makes a regular interest payment until maturity, at which time the face value is repaid (so there is no amortization). D) that makes the same dollar payment every year, amortizing the principal. 2. If your after-tax realized real interest rate was 2 percent over the past year and you owned a one-year bond that paid 8 percent interest, what was the inflation rate if your tax rate was 15 percent? A) 4.8 percent B) 5.1 percent C) 5.4 percent D) 6.0 percent 3. A perpetuity is a debt security A) with just one payment. B) that pays interest forever and never repays the principal. C) that makes a regular interest payment until maturity, at which time the face value is repaid (so there is no amortization). D) that makes the same dollar payment every year, amortizing the principal. 4. According to _____, the long-term interest rate is equal to the average of current and expected future short-term interest rates. A) the expectations theory of the term structure of interest rates B) the rational-expectations hypothesis C) the segmented-markets hypothesis D) the yield curve theory Date:
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5. The ex-post real interest rate is also known as the A) realized real interest rate. B) expected real interest rate. C) after-tax real interest rate. D) ex-ante real interest rate. 6. When the yield curve is flat, then according to the complete theory of the term structure of interest rates (the theory that incorporates a term premium), investors expect shortterm interest rates in the future to A) rise. B) not change. C) fall. D) rise for a short time, then fall later. 7. The process of turning assets such as mortgages into securities sold to investors is A) default. B) standard deviation. C) standardization. D) securitization. 8. One way that homeowners and banks can share the risk of inflation is through A) fixed-rate mortgages. B) refinancing. C) default. D) adjustable-rate mortgages. 9. When a recession is about to begin, you are likely to observe that A) the yield curve is sharply upward sloping. B) the yield curve is somewhat upward sloping. C) the yield curve is flat or inverted. D) the yield curve is upward sloping for short times to maturity, then downward sloping for longer times to maturity. 10. According to the Fisher hypothesis, if the real interest rate is 5 percent and the inflation rate rises from 2 percent to 4 percent, then the nominal interest rate will rise by _____ percentage points and the real interest rate will change by _____ percentage points. A) 0; –2 B) 2; –2 C) 2; 0 D) 1; 1
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11. According to the Truth-in-Savings Act, the interest rate that banks are required to report when you deposit money in an account, which allows you to compare the returns on different accounts that compound interest with different frequencies, is known as A) capital-gains yield. B) annual percentage yield. C) current yield. D) total return. 12. Put the following securities in order according to their after-tax interest rates, from lowest to highest. The federal tax rate on interest income is 20 percent. A: A corporate bond pays an interest rate of 8 percent. B: A corporate bond identical in every way to bond A, but with an interest rate of 8.5 percent. C: A local government bond identical in every way to bond A, but with an interest rate of 7 percent. A) A, B, C B) B, A, C C) C, B, A D) C, A, B 13. The equation that allows us to compare dollar amounts to be received or paid at different dates is the A) present-value formula. B) Taylor rule. C) interest-rate parity equation. D) yield curve. 14. If the expected inflation rate was 7 percent and the actual inflation rate was 3 percent, then A) borrowers gained in real terms at the expense of lenders. B) lenders gained in real terms at the expense of borrowers. C) borrowers and lenders were not affected. D) the government gained because it collected more in taxes. 15. Which of the following would you rather have if your rate of discount is 20 percent? A) $300 in one year B) $350 in two years C) $420 in three years D) $1500 in ten years
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Essay Question (10 Points) 16. a. Suppose the Fisher hypothesis holds for an economy that has an expected real interest rate of 3 percent. For each of the expected inflation rates of 0, 3, 6, 9, and 12 percent, calculate the after-tax expected real interest rate (expressed in percentage points with two decimals), if the tax rate is 15 percent. Suppose the Fisher hypothesis does not hold, but instead that the after-tax expected real interest rate will be unchanged at 2.5 percent if the expected inflation r...