TUTORIAL 2

MONEY AND INTEREST RATES

Part 1: Review questions

1. Definition of money, measuring money
2. Distinguish major credit types, provide examples
3. Relationship between YTM and bond prices
4. Yield and returns

Part 2: Multiple-choice questions

1. Which of these is not a function of money in an economy?

A. Unit of account
B. Source of income
C. Store of value
D. Medium of exchange

2. Which of the following is not part of M1?

A. traveler's checks
B. savings accounts
C. checking accounts
D. currency

3. If Mary deposits $100 of her currency in her checking account, then:

A. M2 will fall by $100.
B. M1 will increase by $100.
C. M1 and M2 will not change.
D. M2 will increase by $100.

4. If Mary moves $100 from her savings account to her checking account, then:
A. M2 will not change.
B. M2 will fall by $100.
C. M1 will not change.
D. M1 will fall by $100

5. Inefficiencies that are created when using checks as money include:

A. Checks can transfer funds slowly and require paper shuffling.
B. Checks can be written for any amount.
C. Checkbooks can be stolen.
D. There are too many bad checks written

6. The liquidity of an asset is:

A. the amount of an asset sold at discount or premium.
B. the ability of an asset to earn interest income.
C. the relative ease with which an asset can be converted into a medium of
exchange.
 D. the relative ease with which an asset can be converted into a common stock.

7. As bond prices increase:

A. yields to maturity decrease.
B. yields to maturity increase.
C. yields to maturity can rise, fall, or not change.
D. yields to maturity do not change.

8. If a bond sells at a premium, where price exceeds face value, then we would
expect to see:
A. market interest rates could be the same, higher, or lower than the coupon
rate.
B. market interest rate the same as the coupon rate.
C. market interest rates below the coupon rate.
D. market interest rates above the coupon rate.

9. For a $1000 one-year discount bond with a price of $975, the yield to maturity is
A. ($1000 – $975)/($1000)
B. $975/$1000
C. ($1000 – $975)/$975
D. $1000/$975

10. Interest rate risk is:

A. the risk the coupon rate on the bond will fall.
B. the risk the government or firm will not make interest payments.
C. the risk associated with change in return with changes in interest rates.
D. the risk the coupon payment will rise.

11. The real interest rate is:

A. the nominal rate plus the expected inflation rate.
B. the nominal interest rate/the CPI.
C. the product of the nominal rate and the CPI.
D. the nominal rate minus the expected inflation rate

12. For a coupon bond, the yield to maturity is the:

A. difference between the bond's price and its face value.
B. annual interest payment divided by the bond's face value.
C. interest rate that equates the bond's present value with its price.
D. interest rate that equates the bond's present value with its face value.

13. When interest rates fluctuate, which bonds will experience the least price
volatility?
A. 20-year bonds
B. 1-year bonds
C. 5-year bonds
D. 10-year bonds
14. Why is the Rate of Return often the most relevant measure of a bond's benefit to
the buyer?
A. Because the Rate of Return uses the current yield.
B. Because the Rate of Return includes the return of the face value at maturity.
C. Because the Rate of Return uses the difference between the face value and
the purchase price to compute a capital gain on the bond.
D. Because the Rate of Return recognizes that many bond buyers do not plan to
hold to maturity, but will sell the bond before maturity.

15. If the amount payable in two years is $2420 for a simple loan at 10 percent
interest, the loan amount is
A) $1000.
B) $1210.
C) $2000.
D) $2200.

16. If $22,050 is the amount payable in two years for a $20,000 simple loan made tod
ay, the interest rate is
A) 5 percent.
B) 10 percent.
C) 22 percent.
D) 25 percent

17. If a security pays $110 next year and $121 the year after that, what is its yield to
maturity if it sells for $200?
A) 9 percent
B) 10 percent
C) 11 percent
D) 12 percent
.
18. Which of the following $5,000 face-value securities has the highest to maturity?
A) A 6 percent coupon bond selling for $5,000
B) A 6 percent coupon bond selling for $5,500
C) A 10 percent coupon bond selling for $5,000
D) A 12 percent coupon bond selling for $4,500

19. In which of the following situations would you prefer to be the lender?
A) The interest rate is 9 percent and the expected inflation rate is 7 percent.
B) The interest rate is 4 percent and the expected inflation rate is 1 percent.
C) The interest rate is 13 percent and the expected inflation rate is 15 percent.
D) The interest rate is 25 percent and the expected inflation rate is 50 percent.

20. In which of the following situations would you prefer to be the borrower?
A) The interest rate is 9 percent and the expected inflation rate is 7 percent.
B) The interest rate is 4 percent and the expected inflation rate is 1 percent.
 C) The interest rate is 13 percent and the expected inflation rate is 15 percent.
D) The interest rate is 25 percent and the expected inflation rate is 50 percent.

Part 3: End-of-chapter questions

Chapter 3: Questions 12, 13, 15
12. Explain the concept of liquidity. Rank the following assets from most liquid to least
12. Step 1. Introduction
liquid: The ease with which an asset, or security, can be changed into immediate cash without impacting its
a. Land market price is referred to as liquidity. The most liquid asset is cash, while tangible assets are less
liquid.
b. The inventory of a merchandiser Step 2. Explanation
1. Cash in Hand is most liquid asset.
c. Cash in hand 2. Savings at a local bank- this can be withdrawn whenever possible.
d. A savings account at a local bank 3.4. Inventory of a merchandiser- Can be converted into liquidity when stock is sold out.
Ordinary Shares- Can be converted into liquidity when market falls.
e. A one-year bond 6. Land- Whenever required to sell can convert into cash
f. Ordinary shares
7. One Year Bond- In one year it get into cash.

13. Which of the Federal Reserve’s measures of the monetary aggregates—M1 or M2—
is composed of the most liquid assets? Which is the larger measure?

15. For each of the following assets, indicate which of the monetary aggregates (M1 and
15. Step 1: Monetary aggregates
M2) includes them: A monetary aggregate, such as money or money market funds, is a formal manner of accounting for
money. The supply of money in a country is measured using monetary aggregates.
a. Currency
Step 2:Explanantion
b. Money market mutual funds (1) Currency is a component of M1, and because M2 contains all M1, it is included in both.
c. Small-denomination time deposits(2) Only M2 includes money market mutual funds.
d. Checkable deposits
(3) M2 includes time deposits with tiny denominations.
(4) Checkable deposits are part of M1, and since all of M1 is included in M2, they are both included.
Chapter 4: Questions 6, 11, 15, 18, 20, 24
6. If mortgage rates rise from 5% to 10% but the expected rate of increase in housing
prices rises from 2% to 9%, are people more or less likely to buy houses?
. People are more likely to buy houses now because the real interest rate they have to pay has fallen from 3% to
1%
11. If interest rates decline, which would you rather be holding, long-term bonds or
short-term bonds? Why? Which type of bond has the greater interest-rate risk?
if there is a decline in interest rates, you would rather be holding long-term bonds because their price would increase more than the price of the short-term bonds, giving
them a higher return. However, long-term bonds have a greater interest-rate risk.
15. Calculate the present value of a $1,300 discount bond with seven years to maturity if
the yield to maturity is 8%.
15. PV = FV /(1 + i)^n , where FV = 1300, i = 0.08, n = 7. PV = 1300/(1+0.08)^7 . Thus, PV = 758.54

18. What is the yield to maturity on a simple loan for $1,500 that requires a repayment of
..58.5%, derived as follows:
$15,000 in five years? The present value of the $15,000 payment five years from now is $15,000 /(1 + i)^5, which
equals the $1,500 loan. Thus 1500 = 15000 /(1 + i)^5. Solving for i = 0.585 = 58.5%

20.Consider a bond with a 6% annual coupon and a face value of $1,000. Complete the
following table. What relationships do you observe between years to maturity, yield to
maturity, and the current price?

Years to maturity Yield to maturity Current price

2 4%
2 6%
3 6%
5 4%
 5 8%

24. A $1,100-face-value bond has a 5% coupon rate, its current price is $1,040, and it is
expected to increase to $1070 next year. Calculate the current yield, the expected rate of
capital gains, and the expected rate of return.

13. Step 1. Introduction

The money supply is the entire amount of money in circulation, including cash, coins, and bank account balances. The money supply is typically characterized as a
collection of safe assets that people and companies can use to make payments or invest in the short term.

Step 2. Explanation
Cash is commonly regarded as the most liquid asset. A bank transfer or an ATM withdrawal can swiftly and simply access cash in a bank or credit union account.
M1 is the most the liquid asset and M2 is the larger measure of money supply because it comprises highly liquid assets that aren't cash.

11.
An interest rate indicates how much it costs to borrow money or how much it pays to save money. So, if you're a borrower, the interest rate is the cost of borrowing
money expressed as a percentage of the entire loan amount.

Step 2. Explanation
Long-term bonds would be a better investment since their price would rise faster than short-term bonds, offering you a bigger return. Longer-term bonds are more
vulnerable to price swings than shorter-term bonds, posing a higher risk of interest rate fluctuations.