Certified Financial Management Specialist Practice Exam

What do long-term interest rates typically reflect?

1. Current stock market performance

2. Future interest rate trends

3. Long-run inflation expectations

4. Short-term economic growth

The correct answer is: Long-run inflation expectations

Long-term interest rates primarily reflect long-run inflation expectations. When investors assess the future, they consider the potential for inflation over an extended period. If they anticipate higher inflation, they will demand higher long-term interest rates as compensation for the eroded purchasing power of their future interest payments. Conversely, if inflation is expected to be low or stable, long-term interest rates may be lower. This relationship arises because lenders want to ensure that their returns on loans will maintain their value over time against inflation. In regard to the other options, current stock market performance is typically more reflective of investor sentiment and market dynamics, rather than long-term interest rates comprehensively. While future interest rate trends can influence expectations, they do not solely define what long-term rates reflect. Short-term economic growth can impact interest rates, but long-term rates are more closely tied to inflation expectations over an extended horizon, rather than immediate economic conditions. Therefore, the focus on long-run inflation expectations sharply aligns with the behavior of long-term interest rates.