Question #33098

Which of the following statements is CORRECT?
If expected inflation increases, interest rates are likely to increase.
If individuals in general increase the percentage of their income that they save, interest rates are likely to increase.
If companies have fewer good investment opportunities, interest rates are likely to increase.
Interest rates on all debt securities tend to rise during recessions because recessions increase the possibility of bankruptcy, hence the riskiness of all debt securities.
Interest rates on long-term bonds are more volatile than rates on short-term debt securities like T-bills.

Expert's answer

The correct statement is "If expected inflation increases, interest rates are

likely to increase".

The relationship between interest rate and inflation is simple and logical:the interest earned on the deposited amount, increase it. In turn, the cost is

reduced by the action of inflation, i.e. impairment of funds occurs. This is an

ongoing process. Further cost reduction is already discounted cash flows. Thus,

the rate of inflation should be calculated according to the scheme of compound

interest.

likely to increase".

The relationship between interest rate and inflation is simple and logical:the interest earned on the deposited amount, increase it. In turn, the cost is

reduced by the action of inflation, i.e. impairment of funds occurs. This is an

ongoing process. Further cost reduction is already discounted cash flows. Thus,

the rate of inflation should be calculated according to the scheme of compound

interest.

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