[hmesalguero]

So I am very confused about interest rates, can someone elaborate the following questions and answers for me?

1. Which one of the following has an inverse relationship with the demand for money?

A. Aggregate income

B. Price levels

C. Interest rates

D. Flow of funds

Answer is C but why?

2. Government borrowing to finance large deficits increases the demand for lendable funds and:

A. Increases the supply for lendable funds

B. Exerts downward pressure on interest rates

C. Has no impact on interest rates

D. Puts upward pressure on interest rates

Answer is D. But this contradicts question 1. Why?

3. If central bank of certain country raises interest rates sharply, the country’s currency will most likely:

A. Increase in relative value

B. remain unchanged in value

C. Decrease in relative value

D. Decrease sharply in value at first and then return to its initial value

Answer is A. Why?

FAR - 76
AUD - 74,84 🙂
REG - 76
BEC - 72, 80

Roger's CPA Review

[jaredo155]

1. The demand for money is inverse with interest rates because as interest rates get higher it gets more and more expensive to borrow money, so there is less demand for it.

2. Question 1 is referring to interest rates impact on the demand for money, while question 2 is referring to the impact of the demand for money on interest rates. The best way I know to explain it is if more people want something the price will go up, but also as the price goes up less people will want it. So while it seems to be contradictory, it is just explaining the relationship from two different directions which isnt always the same. I hope that kind of makes sense.

3. Well if a central bank increases interest rates it reduces consumption, because people don't want to borrow money. In turn this reduces inflation, and lowered inflation means that the relative value of the currency will be higher.

AUD - 2/2013 - Passed!
BEC - 5/2013 - Passed!
FAR - 8/2013 - Passed!
REG - 11/2013 - Passed!
"Do or do not, there is no try." - Yoda

[Author]

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