Question

According to the liquidity premium theory of the term structure,

	a) the interest rate for each maturity bond is determined by supply and demand for that maturity bond.
	b) because buyers of bonds may prefer bonds of one maturity over another, interest rates on bonds of different maturities do not move together over time.
	c) because of the positive term premium, the yield curve will not be observed to be downward sloping.
	d) the interest rate on long-term bonds will equal an average of short-term interest rates that people expect to occur over the life of the long-term bonds plus a term premium.

Which of the following would tend to lower the equilibrium interest rate on a bond issued by the ABC Corporation?

	a) a decrease in the liquidity of ABC’s bonds trading in the secondary market.
	b) an improvement in ABC’s bond rating from A to AA.
	c) an increase in the economy’s inflation rate.
	d) new information that ABC corporation is planning to file for bankruptcy protection.

If the average level of prices in the economy rises by 100 percent, then the purchasing power of money (the amount of goods and services on average a dollar can buy)

	a) doubles.
	b) rises but does not double, due to diminishing returns.
	c) becomes half of its previous value. e.stays constant because the value of money is unaffected by the price level/
	d) more than doubles, due to economies of scale.

The main reason for borrowing and lending in the economy is

	a) that revenues and expenditures are not exactly equal during each time period for most households and firms.
	b) the use of paper money instead of gold or silver which has a high intrinsic value.
	c) the desire of bondholders to be able to exchange their bonds for other claims.
	d) a shortage of money in the economy, making trade in other financial assets necessary.

Answer 1

Answer 1)

• .- d) the interest rate on long-term bonds will equal an average of short-term interest rates that people expect to occur over the life of the long-term bonds plus a term premium.

• The liquidity premium theory says that bond investors prefer highly liquid, short-dated securities over long-dated ones because short dated securities can be sold quickly . It also states that investors are compensated for higher default risk and price risk from the appropriate changes in interest rates.According to the liquidity premium theory, the long term interest rate is equal to the mean of short term rates plus a term premium

2)

• c)	an increase in the economy’s inflation rate

• ( in the bond market equilibrium is interest rate is determined by the relationship between demand & supply for bonds , overall the equilibrium price for bond would increase, which would reduce equilibrium interest rate)

3) sorry I don't know the answer

4).

The main reason for borrowing and lendng is people need money for buying stuff and the need may at times be met by there revenue and peoplehaving excess money can lend and earn some interest on them.

hence option a

Ok