Chapter 4 – Determining Interest Rates

(Multiple-Choice Flashcards)

What are the main determinants of asset demand (portfolio choice)?
A) Wealth, expected return, risk, and liquidity
B) Supply, inflation, and taxes
C) Employment and imports
D) Savings and loans only

A) Asset demand depends on wealth, expected return, risk, and liquidity.

• Higher wealth → higher demand for assets.

• Higher expected return → higher demand.

• Higher risk → lower demand.

• Greater liquidity → higher demand.

Which factor would lead to higher asset demand?
A) Higher risk
B) Lower wealth
C) Higher expected return
D) Lower liquidity

C) An increase in expected return encourages investors to demand more of that asset since the reward outweighs risk.

What does the bond demand curve show?
A) Relationship between bond prices and quantity demanded
B) The money supply
C) Government bond issuance
D) Total interest paid

A) The bond demand curve shows how much investors want to buy at different prices — it slopes downward because lower prices (higher yields) make bonds more attractive.

At a high bond price, what happens to the quantity of bonds demanded?
A) Increases
B) Decreases
C) Stays constant
D) Doubles

B) At higher prices, the interest rate (yield) is lower, so investors buy fewer bonds → demand decreases.

At a low bond price, what happens to the quantity of bonds demanded?
A) Increases
B) Decreases
C) Unchanged
D) Undefined

A) When bond prices fall, yields rise, making bonds more attractive — quantity demanded increases.

What does the bond supply curve show?
A) How much borrowers (issuers) are willing to sell at each price
B) How much investors want to buy
C) Government spending
D) The money supply

A) The bond supply curve shows how much issuers are willing to sell at different prices. It slopes upward — higher prices make it cheaper to borrow.

Who are the suppliers of bonds?
A) Investors
B) Borrowers and firms issuing debt
C) The Federal Reserve only
D) Households

B) Borrowers, such as corporations and governments, supply bonds to raise funds.

At a high bond price, what happens to the quantity of bonds supplied?
A) Decreases
B) Increases
C) Stays the same
D) Falls to zero

B) Higher prices (lower yields) make borrowing cheaper, so issuers are willing to supply more bonds.

At a low bond price, what happens to the quantity of bonds supplied?
A) Increases
B) Decreases
C) Stays constant
D) Doubles

B) Lower prices mean higher yields, which make borrowing expensive — so bond supply decreases.

If wealth increases, what happens to equilibrium bond quantity (Q*), price (P*), and interest rate (IR*)?
A) Q*↑, P*↑, IR*↓
B) Q*↓, P*↓, IR*↑
C) Q*↑, P*↓, IR*↑
D) Q*↓, P*↑, IR*↑

A) More wealth boosts demand → higher prices and quantity, which lowers interest rates (inverse to price).

If expected returns on bonds decrease, what happens to Q*, P*, and IR*?
A) Q*↑, P*↑, IR*↓
B) Q*↓, P*↓, IR*↑
C) Q*↑, P*↓, IR*↑
D) No effect

B) Lower expected returns reduce demand → bond prices fall and interest rates rise.

If bond risk increases, what happens to Q*, P*, and IR*?
A) Q*↓, P*↓, IR*↑
B) Q*↑, P*↑, IR*↓
C) Q*↓, P*↑, IR*↓
D) Q*↑, P*↓, IR*↑

A) Higher risk lowers demand → prices fall and interest rates rise to compensate for risk.

If liquidity of bonds increases, what happens to Q*, P*, and IR*?
A) Q*↑, P*↑, IR*↓
B) Q*↓, P*↓, IR*↑
C) Q*↓, P*↑, IR*↑
D) Q*↑, P*↓, IR*↓

A) More liquidity makes bonds attractive → demand rises, pushing prices up and interest rates down.

If information costs on bonds decrease, what happens to bond demand?
A) Increases
B) Decreases
C) Unchanged
D) Eliminates risk

A) Lower information costs make bonds easier to evaluate and safer to buy → bond demand increases.

What are the main factors that shift the supply curve for bonds?
A) Profitability of investments, inflation expectations, and government deficits
B) Money supply, tax rate, and employment
C) Only interest rate
D) Wealth and liquidity

A) Bond supply rises with more profitable projects, higher expected inflation, and larger government deficits.

Which factor leads to higher bond supply?
A) Lower expected inflation
B) Smaller budget deficits
C) Higher expected profitability of investments
D) Lower taxes

C) Firms issue more bonds when expected profitability increases — they need more funding to expand.

What type of interest rate does bond market analysis focus on?
A) Nominal interest rate
B) Real interest rate
C) Discount rate
D) Federal funds rate

A) The bond market focuses on nominal interest rates, which determine bond prices.

What type of interest rate does money market analysis focus on?
A) Nominal
B) Real
C) After-tax
D) Prime rate

B) The money market focuses on real interest rates — crucial for understanding the true cost of borrowing after inflation.

Which type of interest rate is most relevant for monetary policy decisions?
A) Real interest rate
B) Nominal interest rate
C) Both equally
D) Effective annual rate

A) The real interest rate reflects the actual cost of borrowing and influences economic activity, so it’s key for policy.

What is the shape of the supply curve of money? Who controls it?
A) Upward sloping; controlled by banks
B) Vertical; controlled by the central bank (Federal Reserve)
C) Downward sloping; controlled by consumers
D) Flat; controlled by government

B) The money supply curve is vertical, set by the Federal Reserve, which fixes the quantity of money regardless of interest rate.

What is the shape of the demand curve for money? Who demands it?
A) Upward sloping; banks
B) Downward sloping; households and firms
C) Vertical; government
D) Flat; investors only

B) The money demand curve slopes downward — as interest rates fall, people hold more money instead of bonds. It’s demanded by households and businesses.

If real GDP rises, what happens to the equilibrium interest rate (IR*)?
A) Increases
B) Decreases
C) No change
D) Unstable

A) Higher real GDP raises income and spending → increases money demand, leading to higher interest rates.

If the price level decreases, what happens to IR*?
A) Increases
B) Decreases
C) No change
D) Depends on money supply

B) Lower prices reduce the demand for money (less cash needed for purchases), which lowers interest rates.