Pad 4:55 PM xayimg.com 6 of 7 FNB 100 Topic 1 Practice & Self-Quiz 47. The liqui

Question

Pad 4:55 PM xayimg.com 6 of 7 FNB 100 Topic 1 Practice & Self-Quiz 47. The liquidity preference theory of interest rates suggests that: a. interest rates move randomly and without a patterrn b. the yield curve is inverted because lenders prefer longer-term, more expensive debt c. the yield curve is upward sloping because lenders prefer shorter-term loans d. none of the above 48. Economists forecast the following inflation rates for the next four years Year Inflation Rate 3% 4% 590 6% 4 What inflation adjustment should be included in the interest rate on a three-year loan made today? a. 3% because that's the rate at the time the loan is made and borrowers won't pay any more. b. 4%, because that's the average expected inflation rate over the life of the loan c. 6% because that's the rate that will exist when the lender is loaning the money out again d 6% because at a lower rte the lender will have lost purchasing power by the time it lends the money out again

Explanation / Answer

Question 47 Option c

Based on liquidity preference theory, an investor demands higher risk premium for a security with greater maturity. This implied investor prefers keeping cash for long term rather than investing in bonds. Higher risk premium implies higher yield and hence the answer. Yield curve is upward sloping when the long term yield is higher than short term yields.

Question 48 Option B

Interest rate on a loan is adjusted for inflation risk premium. Inflation risk premium is the average of the inflation over the life of loan. Average inflation = (3% + 4% + 5%)/3 = 4%. Inflation risk premium = 4%. Hence interest rate on loan should add up 4% as inflation .

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