When a financial security's risk profile escalates and causes a leftward shift in the supply curve, the resulting impact on the equilibrium interest rate must ______________?
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Answer: B. increases
Explanation
When a financial security becomes riskier, investors demand a higher yield to compensate for uncertainty. A leftward shift in the supply curve reduces the overall availability of loanable funds in the market. Decreased supply combined with higher required returns drives equilibrium interest rates upward across transactions. Risk and return are positively correlated; riskier securities must offer higher expected yields to attract buyers. The supply curve for loanable funds represents capital made available by savers at various interest rates. Market equilibrium occurs where the supply of loanable funds intersects with total borrowing demand.
Firms with deteriorating credit ratings face higher borrowing costs when issuing new corporate bonds. Economic uncertainty prompts investors to withdraw capital from risky assets, restricting credit availability. Treasury yields fluctuate as market participants reassess default risks during periods of financial instability. Option A suggests interest rates decrease, which contradicts the higher compensation required for increased risk. Option C describes a positive designation rather than identifying the directional movement of the interest rate. Option D indicates a negative value, which is impossible for standard nominal interest rate levels.
- Subject
- Accounting and Finance
- Category
- Finance
- Topic
- —
- Difficulty
- medium
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