Question

Which of the following factors will tend to cause the risk free rate to rise?

I. an increase in the money supply
II. an increase in the federal budget deficit
III. an increase in the level of economic activity
IV. falling rates in foreign markets
A) I, II, III only
B) II, III only
C) I and IV
D) I, II, III and IV"

Answer 1

The risk-free rate can rise due to an increase in the money supply, federal budget deficit, level of economic activity, and falling rates in foreign markets.

Step-by-step explanation:

The factors that tend to cause the risk-free rate to rise are:

1. An increase in the money supply can lead to inflation, which erodes the purchasing power of money and increases the risk-free rate.
2. An increase in the federal budget deficit can lead to higher borrowing needs by the government, which increases the demand for borrowing and pushes up the risk-free rate.
3. An increase in the level of economic activity can lead to higher demand for credit and borrowing, which increases the risk-free rate.
4. Falling rates in foreign markets can lead to capital outflows and a decrease in the demand for domestic assets, which increases the risk-free rate.

Therefore, the correct answer is D) I, II, III, and IV.

Factors that tend to cause the risk-free rate to rise include an increase in the federal budget deficit and an increase in the level of economic activity. A rise in the federal budget deficit (Option II) can lead to the government issuing more debt, thereby increasing the supply of securities and putting upward pressure on interest rates.

An increase in the level of economic activity (Option III) can lead to higher demand for money and credit, also driving up interest rates.