Chapter 2 ECO 3111

How do financial intermediaries benefit by providing​ risk-sharing services? A. Customers pay a fee to financial intermediaries for being able to invest in safer assets B. A collection of riskier assets is always more profitable for a bank or intermediary C. They are able to earn a profit on the spread between the returns they earn on risky assets and the payments they make on the assets they have sold D. They are able to turn safe assets into​ high-risk, high-return investments

C

When lenders have inferior knowledge relative to borrowers about the potential returns and risks associated with an investment​ project, it gives rise to the problem known as A. transaction costs\ B. asset transformation C. financial intermediation D. asymmetric information Before a loan is​ made, banks screenscreen their loan applicants to avoid the problem of A. moral hazard. B. risk sharing. C. asset transformation. D. adverse selection.

D, D

If the nominal rate of interest is 2 percent, and the expected inflation rate is − 10 percent, the real rate of interest is A. 2 percent. B. 8 percent. C. 10 percent. D. 12 percent.

D. 12 percent

What would happen to the demand for Rembrandt paintings if the stock market undergoes a boom? A. The demand for Rembrandt paintings would increase because bond values would decline B. The demand for Rembrandt paintings would decrease because people would want to use their wealth for other things C. The demand for Rembrandt paintings would increase because people would want to hold more stocks D. The demand for Rembrandt paintings would increase because of the increase in people's wealth

D. The demand for Rembrandt paintings would increase because of the increase in people's wealth

What is the price of a two-year discount bond with a face value of $1640 that has a YTM of 12%

$1307.40 P= 1640/(1.12)^2

What is the present value of $60 to be paid three years from now if the interest rate is 5%?

$51.83

Would you be more or less willing to buy a share of Microsoft stock in the following situations: 1. Your wealth falls. 2. You expect the stock to appreciate in value. 3. The bond market becomes more liquid. 4. You expect gold to appreciate in value. 5. Prices in the bond market become more volatile.

(1) Less willing (2) More willing (3) Less willing (4) Less willing (5) More willing

The (1) ______________ is the cost of borrowing or the price paid for the rental of funds expressed as a percentage per year. The chief financial officer (CFO) of a large corporation that wishes to borrow $100 million to construct a factory in the United States should use the (2)______________ market. (1) credit rate inflation rate interest rate (2) deposit stock bond

(1) interest rate (2) bond

Suppose the interest rates on one, five, and tenyear U.S. Treasury bonds are currently 3%, 6%, and 6%, respectively. Investor A chooses to hold only oneyear bonds, and Investor B is indifferent with regard to holding five and tenyear bonds. Which theories best explain the behavior of Investors A and B? Investor A's preferences are best explained by the (1) theory, while Investor B's are best explained by the (2) theory. (1) liquidity premium segmented markets expectations (2) preferred habitat expectations segmented markets

(1) segmented markets (2) expectations

A (1) ____________is a security that is a claim on the earnings and assets of a company. Stock prices, as measured by the Dow Jones Industrial Average, have: A. not changed much over time. B. declined substantially since they peaked in the mid 1980s. C. been extremely volatile over time. D. risen smoothly over time. (1)loan stock bond deposit

(1) stock C. been extremely volatile over time.

If the nominal rate of interest is 2%, and the expected inflation rate is 5%, the real rate of interest is ________________ %.

-3%

Yields for the following 10year corporate bonds are listed in the table below along with their Moody's bond rating. 10year Corporate Bond, Reference Moody's Number Rating and (%Yield annually) 1 C 8.50% 2 Baa 7.45% 3 Ca 7.75% 4 A 4.60% If the yield on a 10year Tnote is 4.00%, what is the risk premium1 on bond #4? What is a likely range of yields for a 10year corporate bond with a Ba rating? The minimum yield is % and the maximum yield is %.

0.60 7.45 and 7.75

​Let's assume that a carpenter borrowed ​$2,000 to be paid off in a year to finance a machine that would make him work faster. As a​ result, he is able to take on more projects and collect ​$400 more earnings in the first​ year, after paying off the principal of ​$2000. ​However, there is a 15​% rental fee​ (interest) on his loan that he also has to pay off. The carpenter earned an extra ​------- in the first year. ​(Round your response to the nearest​ dollar)

100

Suppose that you​ buy, and one year later​ sell, a foreign​ (British) bond under the following​ circumstances: When you buy the bond the exchange rate is ​$1.50 ​= pound£1. You pay pound£45​($67.50) for the British bond. You sell the bond for pound£5050. No interest payment was expected or received. When you sell the​ bond, the exchange rate is​ $1.80 ​= pound£1. What is your gain or loss in​ dollars? .

22.50

What is the yield to maturity1 (YTM) on a $5,000facevalue discount bond maturing in one year that sells for $4,761.90? The yield to maturity is %.

5

Choose the correct description for the following money market instrument. A Treasury bill is​: A. a short dash term debt instrument issued by the United States government to cover immediate spending obligations. B. a short dash term debt instrument issued by large banks and well dash known corporations. C. a short dash term money market instrument issued primarily by banks and funded by corporations and other banks through loans in which Treasury bills serve as collateral, with an explicit agreement to pay off the debtother banks through loans in the near future. D. a debt instrument sold by a bank to depositors that pays annual interest of a given amount and at maturity pays back the original purchase price

A

If you were going to get a loan to purchase a new​ car, which financial intermediary would you​ use? ​(Check all that​ apply.) A. A pension fund. B. A credit union C. An investment bank.

A &B

In which of the following situations do financial markets allow consumers to better time their​ purchases? ​(Select all that apply.​) A. Paying for tuition B. Buying groceries. C. Paying the cost of repairing a flooded basement. D. Purchasing a car or furniture.

A, C, D

Financial intermediaries A. allow for risk sharing for the lender-savers. B. increase transactions costs for lender-savers and borrower-spenders C. do not deal with asset transformation. D. exacerbate all of the problems caused by asymmetric information. An individual may find making a loan to another individual unprofitable due to the fact that A. hiring a lawyer to write a loan contract used only once is​ cost-effective. B. the ways to avoid asymmetric information are common knowledge. C. transaction costs are low. D. it is concentrating the loan risks

A, D

What is the present value of $500.00 to be paid in two years if the interest rate is 5 percent? A. $453.51 B. $476.25 C. $500.00 D. $550.00

A. $453.51

Which of the following is an example of indirect​ finance? A. You pay life insurance premiums to Franklin​ Life, and Franklin Life issues a mortgage loan to a homebuyer. B. You buy stock in Microsoft through a local OTC dealer. C. You buy a bond issued by General Electric through a broker at Smith Barney. D. You lend money to a small business owner to help expand his new firm. Individuals may find it efficient to save their funds in a financial intermediary because A. they help reduce the exposure of investors to risk. B. financial intermediaries have higher transactions costs when making loans. C. they cannot incorporate economies of scale. D. it is more difficult for them to provide liquidity services.

A. A

What effect will a sudden increase in the volatility of gold prices have on interest rates? A. Interest rates will decrease because bonds will become relatively less risky, which increases the demand for bonds B. Interest rates will decrease because bonds will become relatively more risky, which decreases the demand for bonds C. Interest rates will increase because bonds will become relatively more risky, which decreases the demand for bonds D. Interest rates will increase because bonds will become relatively less risky, which increases the demand for bonds

A. Interest rates will decrease because bonds will become relatively less risky, which increases the demand for bonds

Financial intermediaries A. allow for risk sharing for the lender savers. B. do not deal with asset transformation. C. exacerbate all of the problems caused by asymmetric information. D. increase transactions costs for lender savers and borrower spenders. An individual may find making a loan to another individual unprofitable due to the fact that A. the ways to avoid asymmetric information are common knowledge. B. hiring a lawyer to write a loan contract used only once is costeffective. C. it is diversifying the loan risks. D. transaction costs are high.

A. allow for risk sharing for the lender savers. D. transaction costs are high.

Real GDP2 is computed by adjusting nominal GDP for: A. changes in the price level B. exchange rate changes C. capital consumption allowances D. depreciation

A. changes in the price level

A lower level of income causes the demand for money to ________ and the interest rate to ________, everything else held constant. A. decrease; decrease B. decrease; increase C. increase; decrease D. increase; increase

A. decrease; decrease

Is it better for bondholders when the yield to maturity increases or decreases? Bondholders are better off when the yield to maturity: A. decreases, since this represents an increase in the price of the bond and a decrease in potential capital losses. B. increases, since this represents a decrease in the bond maturity and a decrease in potential capital losses. C. decreases, since this represents an increase in the coupon payment and an increase in potential capital gains. D. increases, since this represents a decrease in the price of the bond and an increase in potential capital gains.

A. decreases, since this represents an increase in the price of the bond and a decrease in potential capital losses.

The bond demand curve is ________ sloping, indicating a(n) ________ relationship between the price and quantity demanded of bonds, everything else equal. A. downward; inverse B. downward; direct C. upward; direct D. upward; inverse

A. downward; inverse

In the Keynesian liquidity preference framework, a rise in the price level causes the demand for money to ________ and the demand curve to shift to the ________, everything else held constant. A. increase; right B. decrease; right C. increase; left D. decrease; left

A. increase; right

The value of any investment is found by computing the A. present value of all future cash flows. B. future value of all future expenses. C. present value of all future liabilities. D. present value of all future sales.

A. present value of all future cash flows.

If a forecast is made using all available information, then economists say that the expectation formation is A. rational. B. irrational. C. reasonable. D. adaptive.

A. rational.

The ________ interest rate more accurately reflects the true cost of borrowing. A. real B. market C. discount D. nominal

A. real

Financial intermediaries A. reduce transactions costs for lender savers and borrower spenders. B. prevent risk sharing for the lender savers. C. exacerbate all of the problems caused by asymmetric information. D. do not deal with asset transformation. An individual may find making a loan to another individual unprofitable due to the fact that A. transaction costs are low. B. the ways to avoid asymmetric information are common knowledge. C. it is concentrating the loan risks. D. hiring a lawyer to write a loan contract used only once is cost-effective

A. reduce transactions costs for lender savers and borrower spenders. C. it is concentrating the loan risks.

In asset markets, an asset's price is A. set by the buyer willing to pay the highest price. B. set equal to the highest price a seller will accept. C. set equal to the lowest price a seller is willing to accept. D. set equal to the highest price a buyer is willing to pay.

A. set by the buyer willing to pay the highest price.

U.S. government bonds have no default risk because A. the federal government can increase taxes or print money to pay its obligations. B. they can be exchanged for silver at any time. C. they are backed with gold reserves. D. they are issued in strictly limited quantities.

A. the federal government can increase taxes or print money to pay its obligations.

When a bond denominated in dollars is sold in Great​ Britain, it is known as A. Eurodollars. B. a Eurobond. C. a foreign bond. D. foreign exchange. A lot can be said about the Eurobond except that A. it can be a bond sold in the U.S. and is denominated in euros. B. it is a bond denominated in euros and is sold inside a country that has adopted the euro. C. Eurocurrencies are a variant of them. D. it is a bond sold in the European Union but is denominated in dollars.

B, B

What would happen to the risk premium on corporate bonds if brokerage commissions were lowered in the corporate bond market? A. Lower brokerage commissions for corporate bonds would make them more desirable to hold and thus increase demand; consequently, this would raise interest rates and thus raise the risk premium B. Lower brokerage commissions for corporate bonds would make them more liquid and thus increase demand, which would lower the risk premium C. Lower brokerage commissions for corporate bonds would only reduce the cost of buying and selling the bonds, which would have no impact on the risk premium D. None of the above

B. Lower brokerage commissions for corporate bonds would make them more liquid and thus increase demand, which would lower the risk premium

Will there be an effect on interest rates if brokerage commissions on stocks fall? A. Yes, interest rates would fall because stocks would have a relatively higher rate of return than bonds, which would reduce the demand for bonds B. Yes, interest rates would rise because stocks become more liquid than before, which would reduce the demand for bonds C. No, interest rates would remain the same because the brokerage commissions would only affect the stock market D. Yes, interest rates would rise because people would want to hold more stocks and fewer bonds, which would increase the demand for bonds

B. Yes, interest rates would rise because stocks become more liquid than before, which would reduce the demand for bonds

If expectations of the future inflation rate are formed solely on the basis of a weighted average of past inflation rates, then economists would say that expectation formation is A. reasonable. B. adaptive. C. irrational. D. rational.

B. adaptive.

Factors that can cause the supply curve for bonds to shift to the right include A. a decrease in government deficits. B. an expansion in overall economic activity. C. a decrease in expected inflation. D. a business cycle recession.

B. an expansion in overall economic activity.

Pieces of property that serve as a store of value are called A. liabilities. B. assets. C. units of account. D. borrowings.

B. assests

A coupon bond that has no maturity date and no repayment of principal is called a A. Treasury note. B. consol. C. cabinet. D. Treasury bill.

B. consol

A credit market instrument that pays the owner a fixed coupon payment every year until the maturity date and then repays the face value is called a A. discount bond. B. coupon bond. C. simple loan. D. fixed − payment loan.

B. coupon bond

When the expected inflation rate increases, the demand for bonds ________, the supply of bonds ________, and the interest rate ________, everything else held constant. A. increases; increases; rises B. decreases; increases; rises C. increases; decreases; falls D. decreases; decreases; falls

B. decreases; increases; rises

Economists have focused more attention on the formation of expectations in recent years. This increase in interest can probably best be explained by the recognition that A. expectations influence many individuals, have little impact on the overall economy, but can have distributional effects. B. expectations influence the behavior of participants in the economy and thus have a major impact on economic activity. C. models that ignore expectations have little predictive power, even in the short run. D. expectations influence only a few individuals, have little impact on the overall economy, but can have important effects on a few markets.

B. expectations influence the behavior of participants in the economy and thus have a major impact on economic activity.

The typical shape for a yield curve is A. mound shaped. B. gently upward sloping. C. flat. D. bowl shaped.

B. gently upward sloping.

When the Fed decreases the money stock, the money supply curve shifts to the ________ and the interest rate ________, everything else held constant. A. left; falls B. left; rises C. right; rises D. right; falls

B. left; rises

The concept of ________ is based on the common − sense notion that a dollar paid to you in the future is less valuable to you than a dollar today. A. future value B. present value C. interest D. deflation

B. present value

When the federal government sells a Treasury bond in the primary market—via Treasury auction, it is: A. directly putting downward pressure on interest rates. B. seeking to finance government spending as an alternative to raising taxes. C. increasing the money supply. D. seeking a safe investment vehicle for the Social Security Trust Fund.

B. seeking to finance government spending as an alternative to raising taxes.

The interest rate on Treasury Inflation Indexed Securities can be roughly interpreted as A. the rate of deflation. B. the real interest rate. C. the rate of inflation. D. the nominal interest rate.

B. the real interest rate.

The agency that was created to protect depositors in reaction to the many banking failures of​ 1930-1933 is​ the: A. Securities and Exchange Commission. B. Comptroller of the Currency. C. Federal Deposit Insurance Corporation. D. Federal Reserve System.

C

Which of the following statements regarding direct finance is true​? A. Securities are assets for the firm that issues them and liabilities for the individual that buys them. B. Direct finance requires the use of financial intermediaries. C. Direct finance occurs when borrowers sell securities directly to lenders. D. In the United​ States, moremore funds flow through the direct financial channels than through indirect financial channels.

C, not true is B

________ in the money supply creates excess ________ money, causing interest rates to ________, everything else held constant. A. A decrease; supply of; fall B. An increase; supply of; rise C. A decrease; demand for; rise D. An increase; demand for; fall

C. A decrease; demand for; rise

Which of the following are true of fixed payment loans? A. The borrower repays both the principal and interest at the maturity date. B. The borrower pays interest periodically and the principal at the maturity date. C. Installment loans and mortgages are frequently of the fixed payment type. D. Commercial loans to businesses are often of this type.

C. Installment loans and mortgages are frequently of the fixed payment type.

What basic principle of finance can be applied to the valuation of any investment asset? A. Cash flow analysis B. Internal rate of return C. Present value D. Priceearnings ratio

C. Present value

When interest rates decrease, how might businesses and consumers change their economic behavior? A. Consumers and businesses will spend less and save more. B. Consumers and businesses will invest in bonds or similar debt instruments. C. There will be more consumption spending on interestsensitive items and more investment by businesses. D. Consumers and businesses will hold smaller (average) cash balances.

C. There will be more consumption spending on interestsensitive items and more investment by businesses.

Which of the following is an example of indirect finance? A. You buy stock in Microsoft through a local OTC dealer. B. You buy a bond issued by General Electric through a broker at Smith Barney. C. You pay life insurance premiums to Franklin Life, and Franklin Life issues a mortgage loan to a homebuyer. D. You lend money to a small business owner to help expand his new firm. Individuals may find it efficient to save their funds in a financial intermediary because A. they cannot incorporate economies of scale. B. it is more difficult for them to provide liquidity services. C. they help reduce the exposure of investors to risk. D. financial intermediaries have higher transactions costs when making loans.

C. You pay life insurance premiums to Franklin Life, and Franklin Life issues a mortgage loan to a homebuyer. C. they help reduce the exposure of investors to risk.

A plot of the interest rates on default − free government bonds with different terms to maturity is called A.a risk − structure curve. B. an interest − rate curve. C. a yield curve. D. a default − free curve.

C. a yield curve.

Keynes assumed that money has ________ rate of return. A. an increasing B. a positive C. a zero D. a negative

C. a zero

An increase in the time to the promised future payment ________ the present value of the payment. A. has no effect on B. is irrelevant to C. decreases D. increases

C. decreases

The ________ is the final amount that will be paid to the holder of a coupon bond. A. discount value B. present value C. face value D. coupon value

C. face value

If a corporation begins to suffer large losses, then the default risk on the corporate bond will A. decrease and the bond's return will become less uncertain, meaning the expected return on the corporate bond will fall. B. decrease and the bond's return will become less uncertain, meaning the expected return on the corporate bond will rise. C. increase and the bond's return will become more uncertain, meaning the expected return on the corporate bond will fall. D. increase and the bond's return will become less uncertain, meaning the expected return on the corporate bond will fall.

C. increase and the bond's return will become more uncertain, meaning the expected return on the corporate bond will fall.

An increase in an asset's expected return relative to that of an alternative asset, holding everything else constant, ________ the quantity demanded of the asset. A. has no effect on B. erases C. increases D. decreases

C. increases

In Keynes's liquidity preference framework, individuals are assumed to hold their wealth in two forms: A. stocks and bonds. B. real assets and financial assets. C. money and bonds. D. money and gold.

C. money and bonds.

The sum of the current yield and the rate of capital gain is called the A. pertuity yield. B. discount yield. C. rate of return. D. par value.

C. rate of return.

In the one − period valuation model, an increase in the required return on investments in equity A. reduces the expected sales price of a stock. B. increases the current price of a stock. C. reduces the current price of a stock. D. increases the expected sales price of a stock.

C. reduces the current price of a stock.

Everything else held constant, a decrease in wealth A. increases the demand for stocks. B. increases the demand for gold. C. reduces the demand for silver. D. increases the demand for bonds.

C. reduces the demand for silver.

A credit market instrument that provides the borrower with an amount of funds that must be repaid at the maturity date along with an interest payment is known as a A. coupon bond. B. discount bond. C. simple loan. D. fixed − payment loan.

C. simple loan

Financial intermediaries have a role to play in matching savers and borrowers for all of the following reasons except​: A. minimising transaction costs B. risk sharing C. economies of scale D. information symmetries

D

Financial markets improve economic welfare​ because: A. they allow consumers to time their purchases better B. they channel funds from savers to investors C. they eliminate the need for financial intermediaries D. both A and B are correct E. all of the above are correct

D

Financial markets perform the basic function​ of: A. assuring that governments need never resort to printing money to finance their expenditure B. providing a​ risk-free means of storing wealth C. mitigating the business cycle D. matching savers with funds to lend to people who want to borrow funds

D

One reason for the extraordinary growth of foreign financial markets is: A. decreased trade B. the recent introduction of the foreign bond C. lack of savings in foreign countries D. the deregulation of foreign financial markets

D

What is the difference between a mortgage and a ​mortgage-backed security​? A. Mortgages are provided to households or​ firms, whereas​ mortgage-backed securities are provided mainly to financial institutions. B. Mortgages are usually used to create a​ portfolio, whereas​ mortgage-backed securities are held separately. C. No interest is paid on​ mortgage-backed securities, whereas interest and principal payments are paid on mortgages. D. Mortgages are​ loans, whereas​ mortgage-backed securities are​ bond-like debt instruments.

D

In which of the following situations would you prefer to be the borrower? A. The interest rate is 13 percent and the expected inflation rate is 15 percent. B. The interest rate is 9 percent and the expected inflation rate is 7 percent. C. The interest rate is 4 percent and the expected inflation rate is 1 percent. D. The interest rate is 25 percent and the expected inflation rate is 50 percent.

D. The interest rate is 25 percent and the expected inflation rate is 50 percent.

Why are financial markets important to the health of the economy? A. They allow consumers to time their purchases better B. They identify and shut down inefficient firms C. They eliminate the need for financial intermediaries D. They channel funds from savers to investors

D. They channel funds from savers to investors

To pay for college, you have just taken out a $1,000 government loan that makes you pay $126 per year for 25 years. However, you don't have to start making these payments until you graduate from college two years from now. Why is the yield to maturity necessarily less than 12% (this is the yield to maturity on a normal $1,000 fixedpayment loan in which you pay $126 per year for 25 years)? A. This is the case because market interest rates are less than 12%. B. This is the case because the loan has a government guarantee. C. This is the case because of the known effects of inflation. D. This is the case because the first payment due begins at a future date.

D. This is the case because the first payment due begins at a future date.

Pieces of property that serve as a store of value are called A. liabilities. B. borrowings. C. units of account. D. assets.

D. assets

If housing prices are expected to increase, then, other things equal, the demand for houses will ________ and that of Treasury bills will ________. A. increase; increase B. decrease; increase C. decrease; decrease D. increase; decrease

D. increase; decrease

A discount bond A. pays the bondholder a fixed amount every period and the face value at maturity. B. pays the face value at maturity plus any capital gain. C. pays all interest and the face value at maturity. D. pays the bondholder the face value at maturity.

D. pays the bondholder the face value at maturity.

The ________ of a coupon bond and the yield to maturity are inversely related. A. maturity date B. par value C. term D. price

D. price

In the generalized dividend model, the current stock price is the sum of A. the actual value of the future dividend stream. B. the present value of the future sales price. C. the present value of the future dividend stream plus the actual future sales price. D. the present value of the future dividend stream.

D. the present value of the future dividend stream.

Economists consider the ________ to be the most accurate measure of interest rates. A. simple interest rate. B. current yield. C. real interest rate. D. yield to maturity.

D. yield to maturity.

Suppose that in a given country from one year to the next, the general price level rises while the quantity of goods produced also rises. What can we determine about the values of nominal and real GDP1? A. Nominal GDP will rise, but real GDP will remain unchanged. B. Both nominal and real GDP will rise, but real GDP will increase more. C. Nominal GDP will rise, but the change in real GDP cannot be determined. D. Nominal and real GDP will increase by the same amount. E. Both nominal and real GDP will rise, but nominal GDP will increase more.

E. Both nominal and real GDP will rise, but nominal GDP will increase more.

The US economy borrowed heavily from the British in the nineteenth century to build a railroad system. What was the principal debt instrument​ used? ------- were the principal debt instrument used to finance the railroad system.

Foreign Bonds

----- are firms that assist in the initial sale of securities in the primary market. ---- are agents for investors who help match buyers with sellers of securities while ----- are those who buy and sell securities at a specified price for buyers and sellers.

Investment banks Brokers dealers

---- are debts or financial obligations that must be repaid. ---- is wealth that is used to produce more wealth.

Liabilities Capital

life insurance company pension funds

contractual savings institution

1. A situation where the borrower might engage in activities that are undesirable from the​ lender's point of​ view, because they make it less likely that the loan will be paid back. 2. Investing in a collection​ (portfolio) of assets whose returns do not always move​ together, with the result that overall risk is lower than for individual assets. 3. Occurs when the potential borrowers who are the most likely to produce an undesirable​ (adverse) outcomelong dash—the bad credit riskslong dash—are the ones who most actively seek out a loan and are thus most likely to be selected. 4. A situation where one party often does not know enough about the other party to make accurate decisions. 5. A process of borrowing funds from the​ lender-savers and then using these funds to make loans to​ borrower-spenders.

adverse selection 3 asymmetric information 4 moral hazard 1

obama example: homework 4

answer on homework 4

If you suspect that an airline will go bankrupt next​ week, which would you rather​ hold, bonds issued by the​ company, or equities issued by the​ company? You would prefer to hold ------- .

bonds

A consol paying $20 annually when the interest rate is 5 percent has a price of A. $100. B. $200. C. $400. D. $800.

c. $400

Is it better for bondholders when the yield to maturity increases or decreases? (Remember that they have already paid the price at the time of the purchase, and they know what $ amount they'd be getting as coupon payments if they do not want to sell this bond. The changes in the YTM tell the bond holders how the price changes if they wish to sell this bond before it matures. In general, you want to buy things at a low price, and sell them at a high price. You should think about what would happen to capital gains or losses.)

decreases

commercial banks savings and loans credit unions

depository institution

You are given the following series of oneyear interest rates: 5%, 7%, 12%, 12% Assuming that the expectations theory3 is the correct theory of the term structure, calculate the interest rates in the term structure for maturities of one to four years, and plot the resulting yield curve. 1. Using the point drawing tool, plot the interest rate (calculated using the data above) for each of the four terms to maturity. Properly label each point according to its corresponding term. 2. Using the 4point curved line drawing tool, connect these points. Label your curve 'yield curve'. Carefully follow the instructions above, and only draw the required objects. How would your yield curve change if people preferred shorterterm bonds over longerterm bonds? The yield curve would become (1) inverted steeper flatter

graph: answer on homework 4 steeper

Refer to the figure on your right. Assume that the price level rose (normal money supply/demand curve) show the shift in money demand or money supply. Use the liquidity preference framework. A decrease in the price level causes A. money demand to shift to the left, and interest rates decrease. B. the money supply to shift to the left, and interest rates decrease. C. money demand to shift to the right, and interest rates increase. D. the money supply to shift to the right, and interest rates decrease.

graph: demand shift to the right A. money demand to shift to the left, and interest rates decrease.

The figure to the right depicts the market for shortterm bonds. (normal bond supply/demand curve) Suppose uncertainty about the future will lead investors to move to the short end of the market. (Assume this shock only affects the demand for shortterm bonds) show the effect of this shock on the shortterm bond market. Properly label your line. As a result, the difference between shortterm and longterm bond yields will: a. decrease b. not change c. increase

graph: demand shift to the right c. increase

The figure to the right depicts the bond market. (normal bond supply/ demand curve) Explain the effect that a large federal deficit will have on interest rates. show the effect of this shock on the bond market. Properly label your line. The effect of this shock will likely cause interest rates to (1) . (1) decrease remain unchanged increase

graph: supply shift to the right increase

Finance companies mutual funds investment banks

investment intermediary

Jessica applied for a student loan to go to medical school, but instead of attending classes, she took the money and spent the entire amount on a trip around the world. This is an example of an asymmetric information problem known as __________

moral hazard

If the yield curve suddenly becomes steeper, how would you revise your predictions of interest rates in the future? You would (1) ___________ your predictions of future interest rates. (1) raise lower not change

raise