Chap005

# Chap005 - Chapter 5 History of Interest Rates and Risk...

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Chapter 5 History of Interest Rates and Risk Premiums Multiple Choice Questions 1. Over the past year you earned a nominal rate of interest of 10 percent on your money. The inflation rate was 5 percent over the same period. The exact actual growth rate of your purchasing power was A) 15.5%. B) 10.0%. C) 5.0%. D) 4.8%. E) 15.0% Answer: D Difficulty: Moderate Rationale: r = (1+R) / (1+I) - 1 ; 1.10% / 1.5% - 1 = 4.8%. 2. A year ago, you invested \$1,000 in a savings account that pays an annual interest rate of 7%. What is your approximate annual real rate of return if the rate of inflation was 3% over the year? A) 4%. B) 10%. C) 7%. D) 3%. E) none of the above. Answer: A Difficulty: Easy Rationale: 7% - 3% = 4%. 3. If the annual real rate of interest is 5% and the expected inflation rate is 4%, the nominal rate of interest would be approximately A) 1%. B) 9%. C) 20%. D) 15%. E) none of the above. Answer: B Difficulty: Easy Rationale: 5% + 4% = 9%. Bodie, Investments, Sixth Edition 1

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Chapter 5 History of Interest Rates and Risk Premiums 4. You purchased a share of stock for \$20. One year later you received \$1 as dividend and sold the share for \$29. What was your holding period return? A) 45% B) 50% C) 5% D) 40% E) none of the above Answer: B Difficulty: Moderate Rationale: (\$1 + \$29 - \$20)/\$20 = 0.5000, or 50%. 5. Which of the following determine(s) the level of real interest rates? I) the supply of savings by households and business firms II) the demand for investment funds III) the government's net supply and/or demand for funds A) I only B) II only C) I and II only D) I, II, and III (all of the above) E) none of the above Answer: D Difficulty: Moderate Rationale: The value of savings by households is the major supply of funds; the demand for investment funds is a portion of the total demand for funds; the government's position can be one of either net supplier, or net demander of funds. The above factors constitute the total supply and demand for funds, which determine real interest rates. 2 Bodie, Investments, Sixth Edition
Chapter 5 History of Interest Rates and Risk Premiums 6. Which of the following statement(s) is (are) true ? I) The real rate of interest is determined by the supply and demand for funds. II) The real rate of interest is determined by the expected rate of inflation. III) The real rate of interest can be affected by actions of the Fed. IV) The real rate of interest is equal to the nominal interest rate plus the expected rate of inflation. A) I and II only. B) I and III only. C) III and IV only. D) II and III only. E) I, II, III, and IV only Answer: B Difficulty: Moderate Rationale: The expected rate of inflation is a determinant of nominal, not real, interest rates. Real rates are determined by the supply and demand for funds, which can be affected by the Fed. 7.

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## This note was uploaded on 02/24/2010 for the course FINA 4310 taught by Professor Impson during the Spring '10 term at North Texas.

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Chap005 - Chapter 5 History of Interest Rates and Risk...

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