burning0spear

Which of the following statements regarding interest rates and yields is most accurate?

A) An increase in short-term rates increases the yields on long-term bonds.

B) Short-term rates are independent of the yields on long-term bonds.

C) An increase in short-term rates may increase or decrease the yields on long-term bonds.

---

A change in short-term rates has unpredictable effects. Usually an increase in short-term rates increases the yields on bonds. Bond yields may actually fall though if the interest rate increase is sufficient to slow the economy.

burning0spear

If a cash manager thought the economy was going to have a robust recovery, (s)he would:

A) shift from longer-term cash instruments to shorter-term cash instruments and from more credit worthy instruments to less credit worthy instruments.

B) shift from shorter-term cash instruments to longer-term cash instruments and from more credit worthy instruments to less credit worthy instruments.

C) shift from longer-term cash instruments to shorter-term cash instruments and from less credit worthy instruments to more credit worthy instruments.

---

Interest rates will increase during a robust expansion. If a manager thought that interest rates were set to rise, (s)he would shift from say nine-month cash instruments down to three-month cash instruments. If (s)he thought that the economy was going to improve so that less creditworthy instruments would have less chance of default, (s)he would shift more assets into lower rated cash instruments. Longer maturity and less creditworthy instruments have higher expected return, but also more risk.

burning0spear

If inflation rises, the yields for TIPS will:

A) rise and their price will fall.

B) rise and their price will rise.

C) fall and their price will rise.

---

If inflation starts rising, the yields for U.S. Treasury Inflation Protected Securities (TIPS) will actually fall and their prices will rise because the demand for them increases as investors seek out their inflation protection.

manchester88

In the early expansion phase of the business cycle stock prices are:

A) stagnant as they are in the later stages of an expansion.

B) rising at a faster rate than they are in the later stages of an expansion.

C) rising at a slower rate than they are in the later stages of an expansion.

---

In the early expansion phase of the business cycle, stock prices are increasing. This is due to the fact that sales are increasing but inputs costs will be fairly stable. Labor will not ask for wage increases because unemployment is still high. Idle plant and equipment will be pushed into service at little cost. Furthermore, firms usually emerge from recession leaner because they have shed their wasteful projects and excessive spending. Later on in the expansion, the growth in earnings and stock returns slows because input costs start to increase. Interest rates will also increase during late expansion, which is a further negative for stock valuation.

manchester88

Which of the following approaches to forecasting currencies states that long-term investors will affect the values of currencies?

A) The PPP.

B) The savings-investment imbalances approach.

C) The capital flows approach.

---

The capital flows approach states that long-term capital flows will flow to where the best opportunities are, thus increasing that country’s currency value.

manchester88

Suppose the U.S. has a persistent current account deficit. Which of the following approaches to forecasting currencies best explains why the U.S. dollar will be strong during this time period?

A) The savings-investment imbalances approach.

B) The capital flows approach.

C) The relative economic strength approach.

---

The savings-investment imbalances approach begins by stating that a savings deficit exists when investment is greater than domestic savings. To compensate for a savings deficit, a country’s currency must increase in value and stay strong to attract and keep foreign capital. At the same time the country will have a current account deficit where exports are less than imports. Although a current account deficit would normally indicate that the currency would weaken, the currency must stay strong to attract foreign capital.

manchester88

Which of the following statements regarding the relationship between a domestic currency value and interest rates is most accurate?

A) An increase in short-term interest rates decreases the value of the domestic currency.

B) An increase in short-term interest rates increases the value of the domestic currency.

C) An increase in short-term interest rates may increase or decrease the value of the domestic currency.

---

Higher interest rates generally attract capital and increase the domestic currency value. At some level though, higher interest rates will result in lower currency values because the high rates may stifle an economy and make it less attractive to invest there.

manchester88

The savings-investment imbalances approach would most likely project a strong domestic currency during which phase of the economy?

A) Late recession.

B) Early expansion.

C) Slowdown.

---

A savings deficit exists when investment is greater than domestic savings. To compensate for a savings deficit, a country’s currency must increase in value and stay strong to attract and keep foreign capital. This scenario typically occurs during an economic expansion when businesses are optimistic and use their savings to make investments. Eventually though the economy slows, investment slows, and domestic savings increase. It is at this point that the currency will decline in value.

manchester88

Suppose a cash manager has an investment horizon of one-year. She has the choice of investing in either commercial paper with a maturity of six-months or commercial paper with a maturity of one-year. If she pursues the former, she will roll over her investment in six months to another six-month instrument. The current rates are 5% annually on the six-month commercial paper and 5.5% for the one-year maturity commercial paper. If in six months, the yield for six-month commercial paper is 5.2% annually, should she invest in the two six-month instruments or the one-year commercial paper? Also assume that she can utilize this strategy in either Country A or Country B. If Country A has a savings deficit and Country B has a savings surplus, which country should she invest in if she is using a savings-investment imbalances approach to forecast currency values?

A) One-year in Country A.

B) Six-month in Country A.

C) One-year in Country B.

---

She should invest in the one-year commercial paper. By locking in the higher rate of 5.5% over the one-year, she will earn a higher return than she would have if she had invested in two successive six-month commercial paper notes of 5.0% and 5.2% [=(1+.05/2)(1+.052/2)-1=5.17%]. The savings-investment imbalances approach to forecasting currency values states that countries with savings deficits will have to have strong currency values to attract foreign capital. A strong currency benefits the investor so she should invest in Country A.

manchester88

During which phase of the business cycle would TIPS be least useful to a portfolio manager?

A) Early expansion.

B) Slowdown.

C) Initial recovery.

---

U.S. Treasury Inflation Protected Securities (TIPS) are protected against increases in inflation. They would be needed the least when inflation is falling. During the initial recovery phase of the business cycle, inflation is falling.