Chapter 5 Learning About Risk and Return From the Historical RecordMultiple Choice Questions1.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%.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 firmsII) the demand for investment fundsIII) the governments net supply and/or demand for funds A)I only B)II only C)I and II only D)I, II, and III 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 governments 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.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.Which of the following statements is true? A)Inflation has no effect on the nominal rate of interest. B)The realized nominal rate of interest is always greater than the real rate of interest. C)Certificates of deposit offer a guaranteed real rate of interest. D)None of the above is true. E)A, B and C Answer: D Difficulty: Moderate Rationale: Expected inflation rates are a determinant of nominal interest rates. The realized nominal rate of interest would be negative if the difference between actual and anticipated inflation rates exceeded the real rate. The realized nominal rate of interest would be less than the real rate if the unexpected inflation were greater than the real rate of interest. Certificates of deposit contain a real rate based on an estimate of inflation that is not guaranteed.8.Other things equal, an increase in the government budget deficit A)drives the interest rate down. B)drives the interest rate up. C)might not have any effect on interest rates. D)increases business prospects. E)none of the above. Answer: B Difficulty: Moderate Rationale: An increase in the government budget deficit, other things equal, causes the government to increase its borrowing, which increases the demand for funds and drives interest rates up.9.Ceteris paribus, a decrease in the demand for loanable funds A)drives the interest rate down. B)drives the interest rate up. C)might not have any effect on interest rate. D)results from an increase in business prospects and a decrease in the level of savings. E)none of the above. Answer: A Difficulty: Moderate Rationale: A decrease in demand, ceteris paribus, always drives interest rates down. An increase in business prospects would increase the demand for funds. The savings level affects the supply of, not the demand for, funds.10.The holding period return (HPR) on a share of stock is equal to A)the capital gain yield during the period, plus the inflation rate. B)the capital gain yield during the period, plus the dividend yield. C)