Question

Financial managers monitor market interest rates in order to estimate investor's return expectations and to establish appropriate investment rates of returns for the company. Which of the following statements is most accurate?

A. Long term interest rates are generally lower than short term rates.

B. During recessions, both the demand for money and inflation tend to decrease, while money supply is increased.

C. During periods of high inflation, the general tendency is towards flat interest rates.

D. Observed market rates of return can be utilized in the Capital Asset Pricing Model ("CAPM") to estimate the expected return (or discount rate) to value financial assets.

E. B and D above

Answer 1

a. It is not true. Actually, short term interest rates are usually lower than long term rates

b. Please consider following points:

- During recession, people are afraid and tries to save money. This drives the interest rates low and the low interest rates increases the supply of money in the market.

- During recession, the GDP falls, output falls and hence inflation falls

- People don't want to spend money and keep their money in accounts only. So demand of money (to spend) decreases.

Hence this is true.

c. During high inflation, there is more demand than supply. This increases interest rates. Hence, this is false.

d. This is true.

Hence (E) is true. Both (b) and (d) are correct.