Chapter 6- Interest Rates
Suppose a new process was developed that could make oil out of sea water. The equipment is expensive but in time would lower gas prices electiricyy and other energy. what would this do to ir?
6-5 A significant increase in productivity would raise the rate of return on producers' investment, thus causing the demand curve (see Figure 6-1 in the textbook) to shift to the right. This would increase the amount of savings and investment in the economy, thus causing all interest rates to rise.
it is a fact that the federal gov't 1. encouraged the development of the savings and loan industry, 2. virtually fired the industry to make long-term fixed interest rate mortgages and 3. forced the savings and and loans to obtain most of their capital as deposits that were withdrawal on demand a. would the savings and loans have higher profits in a would with a normal or an inverted yield curve? b. would the savings and loans industy be better off if the individual instiuions sold their mortgages to federal agencies and then collected servicing fees or if the institutions held the mortgages that they originated
6-7 a. S&Ls would have a higher level of net income with a "normal" yield curve. In this situation their liabilities (deposits), which are short-term, would have a lower cost than the returns being generated by their assets (mortgages), which are long-term. Thus, they would have a positive "spread." b. It depends on the situation. A sharp increase in inflation would increase interest rates along the entire yield curve. If the increase were large, short-term interest rates might be boosted above the long-term interest rates that prevailed prior to the inflation increase. Then, since the bulk of the fixed-rate mortgages were initiated when interest rates were lower, the deposits (liabilities) of the S&Ls would cost more than the returns being provided on the assets. If this situation continued for any length of time, the equity (reserves) of the S&Ls would be drained to the point that only a "bailout" would prevent bankruptcy. This has indeed happened in the United States. Thus, in this situation the S&L industry would be better off selling their mortgages to federal agencies and collecting servicing fees rather than holding the mortgages they originated.
suppose interest rates on treasury bonds rose from 5% to 9% as a result of higher interest rates in Europe. What effect would this have on the price of an average company's commons stock?
6-8 Treasury bonds, along with all other bonds, are available to investors as an alternative investment to common stocks. An increase in the return on Treasury bonds would increase the appeal of these bonds relative to common stocks, and some investors would sell their stocks to buy T-bonds. This would cause stock prices, in general, to fall. Another way to view this is that a relatively riskless investment (T-bonds) has increased its return by 4 percentage points. The return demanded on riskier investments (stocks) would also increase, thus driving down stock prices. The exact relationship will be discussed in Chapter 8 (with respect to risk) and Chapters 7 and 9 (with respect to price).
What does it mean when it is said that the US is running a trade deficit? Wha impact will a trade deficit have on interest rates?
6-9 A trade deficit occurs when the U.S. buys more than it sells. In other words, a trade deficit occurs when the U.S. imports more than it exports. When trade deficits occur, they must be financed, and the main source of financing is debt. Therefore, the larger the U.S. trade deficit, the more the U.S. must borrow, and as the U.S. increases its borrowing, this drives up interest rates.
Suppose interest rates on residential mortgages of equal risk are 5.5% in Cali and 7% in NY. Could this differential persist? What forces might equalize rates? Would differentials inbowworing costs for businesses of equal risk located in Cali and NY be more ore less likely coexist than differntials in residential mortgage rates?WOuld differential in the cost of money for NY and cali firms be more likely to exist if the firms being compared were very large or is they were very small? What are the implications of all of this with respect to nationwide branching?
Regional mortgage rate differentials do exist, depending on supply/demand conditions in the different regions. However, relatively high rates in one region would attract capital from other regions, and the end result would be a differential that was just sufficient to cover the costs of effecting the transfer (perhaps ½ of one percentage point). Differentials are more likely in the residential mortgage market than the business loan market, and not at all likely for the large, nationwide firms, which will do their borrowing in the lowest-cost money centers thereby quickly equalizing rates for large corporate loans. Interest rates are more competitive, making it easier for small borrowers, and borrowers in rural areas, to obtain lower cost loans.
What if congress took away the indepencrenace of the federal reserve system and forced them to greatly expand money supply. What effect would this have? -Would the savings and loans have higher profits in a world with a "norma:" or an inverted yield curve? -Would the savings and loan industry be better off in the individual institutions sold their mortgaged to federal agencies and then collected servicing fees orin the instiutions held the mortgages that they originated?
The immediate effect on the yield curve would be to lower interest rates in the short-term end of the market, since the Fed deals primarily in that market segment. However, people would expect higher future inflation, which would raise long-term rates. The result would be a much steeper yield curve. b. If the policy is maintained, the expanded money supply will result in increased rates of inflation and increased inflationary expectations. This will cause investors to increase the inflation premium on all debt securities, and the entire yield curve would rise; that is, all rates would be higher.
Suppose you have noticed the the slope of the corporate yield curve has become steeper over the past few moths> What factors might explain the change in the slope?
The yield on corporates is equal to: rt = r* + IPt + MRPt + DRP + LP. Thus, a steeper corporate yield curve would indicate an increase in risk (as reflected by DRP and LP) and an increase in expected inflation (as reflected by IPt). MRPt is a premium that reflects interest rate risk and is higher on longer-term securities. Consequently, an increase in risk and expected inflation would impact MRPt as well.
Suppose the pop. of Area Y is relatively young and the population of Area O is relatively old, but everything else about the two areas is the same. -Would interest rated likely be the same or different in the two areas/ -Would a trend toward nationwide branching by banks and the development of nationwide diversified financial corporation affect your answer to part a?
transfers between the two markets are costly, interest rates would be different in the two areas. Area Y, with the relatively young population, would have less in savings accumulation and stronger loan demand. Area O, with the relatively old population, would have more savings accumulation and weaker loan demand as the members of the older population have already purchased their houses and are less consumption oriented. Thus, supply/demand equilibrium would be at a higher rate of interest in Area Y. b. Yes. Nationwide branching, and so forth, would reduce the cost of financial transfers between the areas. Thus, funds would flow from Area O with excess relative supply to Area Y with excess relative demand. This flow would increase the interest rate in Area O and decrease the interest rate in Y until the rates were roughly equal, the difference being the transfer cost.
