Certified Financial Management Specialist Practice Exam

Which of the following statements is true regarding interest rates?

1. All interest rates are unaffected by economic conditions

2. Long-term interest rates are usually lower than short-term rates

3. Interest rates typically rise in response to inflation

4. All borrowing costs are fixed regardless of inflation

The correct answer is: Interest rates typically rise in response to inflation

The statement that interest rates typically rise in response to inflation is correct because central banks, like the Federal Reserve in the U.S., often adjust monetary policy to combat inflation. When inflation increases, central banks may increase interest rates to curb spending and borrowing, which are primary drivers of inflation. Higher interest rates make borrowing more expensive and encourage saving, thus helping to stabilize prices. This relationship between inflation and interest rates is rooted in the principle that lenders need compensation for the decrease in purchasing power that results from inflation. Therefore, as inflation expectations rise, so do the rates at which lenders are willing to lend money. The other statements do not accurately reflect economic principles. While some interest rates can be fixed, many are variable and sensitive to broader economic conditions. Long-term interest rates being lower than short-term rates is generally contrary to the yield curve, which usually shows the opposite relationship. Lastly, borrowing costs being fixed regardless of inflation does not account for the adjustments lenders typically make in response to economic changes.