1. When expected inflation increases, for any given nominal interest rate the: A
ID: 2713374 • Letter: 1
Question
1. When expected inflation increases, for any given nominal interest rate the:
A. cost of borrowing increases and the desire to borrow decreases.
B. real interest rate increases.
C. bond supply curve shifts to the left.
D. cost of borrowing decreases and the desire to borrow increases.
2. Consider a zero-coupon bond with a $1,100 payment in one year. Suppose the interest rate decreases from 10% to 8%. The price of this bond:
A.increases from $1,000 to $1,018.
B. increases from $1,000 to $1,375.
C. decreases from $110 to $88.
D. decreases from $1,210 to $1,188.
3. When the price of a bond is below the face value, the yield to maturity:
A. is below the coupon rate.
B. will be above the coupon rate.
C. will equal the current yield.
D. will equal the coupon rate.
Explanation / Answer
1. Increase in inflation rate will increase the interest rates and thus the cost of borrowings will increase and as the cost of borrowings will increase, the desire to buy a Bond will decrease. Thus, Option A.
2. Previous Bond Price = 1,100/(1+0.10) = $1,000
New Bond Price = 1,100/(1+0.08) = $1,018
The price is increasing from $1,000 to $1,018. Thus, Option A.
3. When Yield to Maturity(YTM) is below the coupon rate then Bond's price is above its Face value and if YTM is above the coupon rate then Bond's price is below its Face Value. Thus, Option B.
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