Quiz: Test Your Interest Rate Knowledge
In December 2015, the Federal Reserve raised the federal
funds target rate to a range of 0.25% to 0.50%, the first rate increase from
the near-zero range where it had lingered for seven years. Many economists
viewed this action as a positive sign that the Fed had finally deemed the U.S.
economy healthy enough to withstand slightly higher interest rates.
It remains to be seen how rate increases will play out for the
remainder of 2016. In the meantime, try taking this short quiz to test your
interest rate knowledge.
1. Bond prices tend to rise when interest rates rise.
2. Which of the following interest rates is directly
controlled by the Federal Reserve Open Market Committee?
a. Prime rate
b. Mortgage rates
c. Federal funds rate
d. All of the above
e. None of the above
3. The Federal Reserve typically raises interest rates to
control inflation and lowers rates to help accelerate economic growth.
4. Rising interest rates could result in lower yields for
investors who have money in cash alternatives.
5. Stock market investors tend to look unfavorably on
increases in interest rates.
1. b. False. Bond prices tend to fall when
interest rates rise. However, longer-term bonds may feel a greater impact than
those with shorter maturities. That's because when interest rates are rising,
bond investors may be reluctant to tie up their money for longer periods if
they anticipate higher yields in the future; and the longer a bond's term, the
greater the risk that its yield may eventually be superceded by that of newer
bonds. (The principal value of bonds may fluctuate with market conditions.
Bonds redeemed prior to maturity may be worth more or less than their original
2. c. Federal funds rate. This is the interest rate
at which banks lend funds to each other (typically overnight) within the
Federal Reserve System. Though the federal funds rate affects other interest
rates, the Fed does not have direct control of consumer interest rates such as
3. a. True. Raising rates theoretically slows
economic activity. As a result, the Federal Reserve has historically raised
interest rates to help dampen inflation. Conversely, the Federal Reserve has
lowered interest rates to help stimulate a sluggish economy.
4. b. False. Rising interest rates could actually
benefit investors who have money in cash alternatives. Savings accounts, CDs,
and money market vehicles are all likely to provide somewhat higher income when
interest rates increase. The downside, though, is that if higher interest rates
are accompanied by inflation, cash alternatives may not be able to keep pace
with rising prices.
5. a. True. Higher borrowing costs can reduce
corporate profits and reduce the amount of income that consumers have available
for spending. However, even with higher rates, an improving economy can be good
for investors over the long term.