After falling to historic lows during the recession, interest rates have been rising. Try this short quiz to test your interest rate knowledge.
1. Which of the following interest rates is directly controlled by the Federal Reserve’s Federal Open Market Committee?
|A) Prime rate||D) All of the above|
|B) Federal funds rate||E) None of the above|
|C) Mortgage rates|
2. The Federal Reserve typically ________ interest rates to control inflation and ________ rates to help accelerate economic growth.
|A) raises / lowers||B) lowers / raises|
3. The stock market tends to applaud higher interest rates.
|A) True||B) False|
4. When interest rates rise, the value of _______ bonds generally decreases.
|A) municipal||D) existing|
|B) Treasury||E) new|
5. The longer a bond’s maturity date, the _______ sensitive its value is to fluctuations in interest rates.
|A) more||B) less|
The principal value of bonds may fluctuate with market conditions. Bonds redeemed prior to maturity may be worth more or less than their original cost. Investments seeking to achieve higher yields also involve a higher degree of risk.
1. B) Federal funds rate. This is the rate that Federal Reserve banks charge each other for overnight loans within the Federal Reserve system. It typically affects other interest rates, including the prime rate and adjustable mortgage rates, but the Fed does not directly control those rates.
2. A) raises/lowers. Raising rates theoretically slows economic activity, which helps to dampen inflation. Inflation remained slightly below the Fed’s 2% target rate through March 2017, so it seems that recent rate hikes are aimed at returning interest rates to a more typical historical range while guarding against future inflation.1 The Fed dropped rates to historic lows in 2008 to stimulate the slow economy.
3. B) False. Higher borrowing costs can reduce corporate profits and reduce the amount of income consumers have available for spending. However, even with higher rates, an improving economy could be good for companies, consumers, and investors in the long term.
4. D) existing. Because investors can buy new bonds with higher rates, existing bonds typically lose value.
5. A) more. Generally, the further out the maturity date, the greater the potential for events to occur that have a positive or negative effect on a bond’s value.