ECO 301 Final Exam

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Suppose at the optimal choice for the household, the marginal utility from consumption at time t, MU(Ct), is 21.4 and the marginal utility from consumption at time t+1, MU(Ct+1), is 20. If the rate of interest is 9%, then what is the rate of time preference? Write your answer as a decimal, so .05 and not 5%.

.019

Suppose a saver buys a coupon bond that matures three years from now with a face value of $10,000 and a coupon rate of 5%. The saver clips the three coupons off and sells them individually. The coupon that matures one year from today sold for $479. The yield to maturity on this "coupon payment asset" is? Write your answer as a decimal to four places, so .0015, not 1.5 and not 1.5%

.0438

Suppose you borrow $100 million today and in 4 months you must repay $104 million. Then the interest rate on this loan on an annualized basis is? Write your answer as a decimal to four places, so .0015, not 1.5 and not 1.5%

.1249

Which of the following statements is most correct

1 + r is the relative price of current consumption and a change in r causes a change in the intertemporal choice of a household

pitfalls of PEH

1) PEH implies either a positive trend in ST rates must exist OR the market is very inefficient -> both are false so reject PEH 2) it also doesn't account for the fact LT bonds are more sensitive to price changes/more volatile than ST bonds

3 Key Points of Term Structure

1) bonds with longer maturities have higher rates 2) yields of bonds with different maturities tend to move in the same direction 3) the upward sloping yield curve can flatten out or invert at or near the beginning of a recession

Economic Profit

Accounting Profit - Implicit Costs

Suppose the marginal product of capital is 11%, the rate of depreciation is 4%, and real rate of interest is 9%. Then firms will

Decrease investment

Why is fractional reserve banking feasible?

Deposits and withdrawals are approximately equal leaving a relatively stable balance

Pt

Price level - a weighted average of prices of goods/prices of bundles whose weights depend on the relative quantities of goods/services produced or consumed

Money improves society's welfare by all of the following except

Providing a debt instrument that reduces transactions cost and makes the double coincidence of wants more likely to occur

If the interest rate on reserves is 2%, the discount rate is 5%, and the fed funds rate is in equilibrium at 4%, then if the Fed wants to lower the funds rate, it will

Purchase government securities

are higher interest rates generally good news or bad news

We cannot tell. Interest rates can increase from positive effects, like an increase in technology, or from negative aspects, like a plague that causes the amount of savings to be reduced.

Bubble

When price of asset is greater than the fundamental value

M1 Money Multiplier

[(1+k)/(rr*k)]

M1

[(1+k)/(rr*k)]*Base

When the U.S. government runs a budget deficit they sell government securities to raise the funds to cover the deficit. One type of Treasury securities is

a Treasury bill which is a discount bond

what is the intertemporal budget constraint

a budget constraint of consumption over time; how much to consume now versus in the future constrained by income

The yield curve typically flattens or inverts just before or near a recession. This observation has been explained by

a decrease in the supply of long term bonds and an increase in the supply of short term bonds associated with a weakening economy

what is capital

a produced means of production; an input to the production process

The pure expectations hypothesis together with the efficient markets hypothesis is inconsistent with

a yield curve that is typically upward sloping and no upward trend in the interest rate

how can irrational agent presence affect the behavior of markets

by making demand not perfectly elastic but rather downward sloping they make the stock price subject to increases or decreases that are not driven by relevant information on fundamentals

how can rational agents take advantage of animal spirit agents if an asset is priced above its fundamental value?

by shorting the asset; risky strategy though

Long and uncertain lags

by the time the policies fully kick in, the recession may be over as a result, monetary policy used to stabilize the economy may in fact have a destabilizing effect

what is financial capital

cash

how does the investment demand curve react to a change in variables that are held constant along it?

changes in r cause movement along ID curve factors that change MPK-d (like technology, input changes, regulations, taxes) will shift the ID curve

The efficient markets hypothesis strongly suggests that

changes in stock prices are not related to information available in the past

how does the supply of savings curve react to a change in variables that are held constant along it?

changes in the riskiness of income, temporary changes in income, or changes in demographics cause shifts in the Ss curve

When new reserves that are available to the banking system increase, then

credit increases by a multiple of the increase in reserves as deposits are loaned out, those loans are spent, and the expenditure is redeposited into the system

what is debt

debt is an IOU, a promise to pay in the future

how is debt different than capital

debt requires borrowing to produce

what is a steady state

economy with stable or mildly fluctuating size in the long-run there is equilibrium between production growth and population growth Ct = Ct+1

Suppose there is an increase in the tax rate on income from capital. Then the equilibrium interest rate will _____________ and the equilibrium quantity of saving will _________________ .

fall, fall

what is the fixed or sunk cost fallacy

fixed/sunk costs don't impact any of the decisions of a firm. It's the notion you shouldn't cry over spilt milk and make future investing decisions based off of money you have already put into an asset/security in the past and spent/lost.

The creation of the Fed was motivated by the need to address bank panics. To address bank panics, the Fed was given the power to

issue currency and lend at the discount window

how does a unit of account improve a society's welfare

it allows for prices of goods to be compared in the same unit; which leads to increases in trade

When the Fed was created, the principal way in which it conducted monetary policy was to

lend to banks who suffered liquidity problems

The liquidity premium hypothesis assumes long term and short term bonds are imperfect substitutes because

long term bond prices are more volatile than short term bond prices

The medium of exchange function of money improves a society's welfare by

lowering transactions cost and increasing the volume of trade

treasury note

maturity within 10 years of issue; coupon bonds

treasury bond

maturity within > 10 years from issue; max 30 years; coupon bond

treasury bill

maturity within one year of issue; ST; discount bond

does investment in new capital require trust in another person

no

where does the optimal intertemporal choice occur using the intertemporal budget constraint and indifference curves

occurs at point where the indifference curve is tangent to the IBC line on Ct and Ct+1 graph where 1+r = (1+rho)*MU(Ct)/MU(Ct+1)

News heard on business shows on cable television are unlikely to lead to above average returns because

of the efficient markets hypothesis

Assume the fundamental value theory of stock pricing holds. Suppose people expect that the Mastergolf corporation will have dividend payments that will be increasing for the next five years and then will level off and be constant forever. Given these expectations and a given rate of interest

people will expect the price of this stock to rise next year

China was the first country to introduce paper currency. The paper served as a warehouse certificate so that people did not have to carry heavy bags of copper coins. This occurred because copper coins lacked which of the desirable traits of money?

portability

Useful Physical Characteristics of Money

portable, durable, recognizable, divisible all monies haven't possessed these characteristics over time

what is held constant along an investment demand curve?

r is held constant to MPK-d changes in r cause movements along the ID curve

An interest rate is a _________________ that is almost always quoted _____________

rate of growth, as an annual rate

The unit of account function of money improves a society's welfare by

reducing the number of prices one needs to know to make efficient choices and increasing the volume of trade

term structure of interest rates

refers to the relationship between the term to maturity on the bond and its relative YTM

in equilibrium, theoretically Rt =

return on capital = MPK - d

Suppose there is a temporary rise in the price of energy causes decrease in income Then the equilibrium interest rate will _____________ and the equilibrium quantity of Investment will _________________ .

rise, fall

M1 explained

rr is chosen by the banks, k is chosen by the non-bank public. If K increases, money multiplier decreases IF rr <1. If rr increases, money multiplier decreases.

Suppose there is a sharp temporary decline in the price of oil that leads to an increase in income. Then,

savings will rise

Wyndham Worldwide has a p-e ratio of 22.12, while Hilton Worldwide has a p-e ratio of 47.49, but they have the same payout ratio. If we accept the fundamental value theory of stock pricing, then from this we can conclude with some confidence that

the market expects Hilton's dividends to grow more rapidly than Wyndham's dividends

Suppose you believe that the pure expectations hypothesis is correct, and the current yield to maturity on a bond that matures in two years is 7% and the yield to maturity on a bond that matures in one year is 5%. From this information, you can conclude that

the market expects next year's one year to be 9% and the yield curve is the typical shape.

Y K 121 15 161 19 209 25 244 30 254 32 Consider the production function described in the table above.

the mpk moving from 25 to 30 units of capital is 7, the mpk is diminishing for this production function.

If the yield to maturity on a coupon bond increases, then

the present value of the bond declines

If the yield to maturity of a bond increases, then

the price of the bond decreases

what is investment

the production of new capital

what is a financial investment

the purchase of a stocks/equity

Inflation Rate

the rate at which price levels are growing over a period of time. (Pt+1/Pt) - 1

If people expect inflation over the coming year to be 2% and the rate of interest on a one year bond is 1%, then

the real interest rate is about -1%

In the past year, the interest rate on a one year treasury bond has increased from a little over .8% to just under 2%. Over the same period expected inflation has been very stable, fluctuating between by only 3/10ths of a percentage point. Our models of intertemporal choice and the determination of the equilibrium interest rate predicts that

the return on capital has increased over the same period

Demographics vary from country to country. Currently, the U.S. has a large and growing proportion of people who are retired. In 1975, for the U.S. there were a relatively small fraction of people retired. In 1975, other things the same,

the savings curve in the U.S. was out and to the right of the savings curve in 2018

what is the slope of the inter temporal budget constraint

the slope is the absolute value of (1+r); it's the interest rate for the amount of borrowing/saving for the future "relative price of current consumption" or the opportunity cost of current consumption

If the interest rate is rising and dividends are expected to fall in the future, then according to the fundamental theory of stock pricing we can conclude that

the stock price must be falling

what is a unit of account

the unit in which prices are expressed

Some people have argued that new technology has led to a more rapid depreciation rate of capital. If this is true, then

there would be an initial surplus of savings, the equilibrium interest rate would fall, and equilibrium savings would decline

why can't you add $10 delivered today with $12 delivered one year from now and get a total of $22?

they aren't in the same units; one is dollars in time T and the other is dollars in time T + 1; $12 one year from now is not less than $12 today

In the traditional view of the deficit, future generations are harmed by a deficit because

they will inherit a smaller capital stock

what are the three major debt instruments that the US Treasury uses to borrow?

treasury bill, note, bond

In a fractional reserve banking system

welfare is generally increased, and multiple credit creation takes place because most loans are redeposited within the banking system

does debt require trust

yes

preferred habitat hypothesis

you reduce your exposure to risk but matching the maturity of your investments to the maturity of your liabilities

Commodity Money

Monetary value = commodity value

Fiat Money

Monetary value > Commodity value

Quantitative easing refers to

The purchase of the Fed of longer term to maturity government securities

In the steady state,

The rate of time preference equals the marginal product of capital less depreciation

key assumptions behind pure expectations hypothesis

-the long term rate is the average of the current and expected short term rates -LT and ST bonds are perfect substitutes -this implies that ST rates are typically rising so we should see a povisitve trend in the yield curve

in efficient markets, agents

-use all relevant and available info when making decisions -will not make systematic, persistent errors

Gresham's Law and why silver dimes disappeared

"good money" is driven out by "bad money"; occurs when monetary value < commodity value if a silver dollar is worth $1 but the actual value of the commodity is $2; people will end up holding onto the money and not using it, which will then cause the currency to disappear Fiat $ -> rapid $ growth -> inflation -> price of commodities increases -> if this increase is sustained, then monetary value < commodity value -> money vanishes

how do we compare interest rates for one month versus interest rates for one year

(1+R1/n)^n = (1+RA)(1/n)

Pt/Et

(1+g)/(r-g) x payout ratio

Deposit Multiplier

(1/rr) where rr is (reserves/deposits)

assumptions of CAPM

-all agents in the market have the same information and data processing tools -agents only care about the mean return and standard deviations of their portfolios -there are no transaction costs -all agents can borrow/lend infinitely at the risk-free rate -agents are rational and risk averse -markets are efficient

Quantity Theory of Money Explained

- M = Quantity of Money - V = Velocity of Circulation (The number of times the typical dollar changes hands in the purchase of a final good/service) - P = Price Level - Y = Real Output - P *Y = Nominal GDP / Output

The fundamental value theory of stock pricing

- claims that the value or market capitalization of a corporation equals the present value of its expected earnings stream - is inconsistent with bubbles - implies that an increase in interest rates causes stock prices to fall

Banks as the intermediaries between households and businesses:

- make profit from the difference in rates less the costs of being an intermediary - when this is equal to zero there is an increase in welfare due to the long run average cost being lowered due to a smaller spread

1982 Recession: "Volcker Recession"

- originally proposed by Paul Volcker - prevents banks from making certain types of investments that could cause a financial crisis - lets recessions go unchecked in order to drive down prices

Goal of Federal Reserve System

- stop bank panics - improve welfare

what is the slope of the indifference curve

-(1+Rho) * [MU(Ct) / MU(Ct+1)]

what is the degree of control the Fed has over the discount rate and the federal funds rate?

-Fed can set the discount rate -Fed can change the money supply, discount rate, and reserve interest rate to influence the FF rate, but cannot set it directly FF rate is determined in a private market using supply & demand

M1 & M2 Properties

-M2 is always larger than M1 -M1 includes readily spendable funds -M2 includes assets that households and businesses keep for short term savings

3 Key Pieces to Present Value

1. Interest Rates 2. PV Stream 3. Annual Payments

2 Reasons Banks Fail

1. Liquidity Failure - banks cannot give depositors their cash back on demand 2. Insolvency Failure - the value of a bank's assets is less than the value of a bank's liabilities

Monetary Policy Tools

1. The Discount Rate 2. Reserve Requirements 3. Open Market Operations

Suppose the commercial paper rate is 6% per year. Commercial paper typically matures in 6 months. What is the interest payment on $40 million of commercial paper when it matures in six months? Write you answer in millions to two decimals and no $, so 1.23 not $1230000

1.18

Suppose the price level today is 120, the current nominal interest rate is 4%, and the ex ante real rate of interest is 1.5%. Then, the expected price level next year is

123

Suppose you borrow $45,000 to buy a new truck today. You take out a fixed payment loan with three equally priced payments that begin in one year. If the interest rate is 4%, then what is your annual payment (to the nearest dollar)? Your answer should not include a dollar sign or comma, so 4200 and not $4,200

16,215

Consider the stable growth or steady state model of a stock price. If the yield on the relevant bond is 6%, the price of the stock is $102 per share, and the growth rate of dividends is expected to be 3%, then what is the current dividend per share to two decimals? Write your answer without a dollar sign, so 13.13, not $13.13.

2.97

Suppose the interest rate is 6%, and you would like to have $3500 in your saving account one year from now. How much would have to save today? Your answer should not have a comma or $ sign, so 3000 and not $3,000.

3301.89

if sold at discount, Pb is

< face value and YTM is > coupon rate

if sold at premium, Pb is

> face value and YTM is < coupon rate

Suppose there is a decrease in equilibrium savings and at the same time there is no change in the equilibrium rate of interest. These events may have been caused by

An decrease in the uncertainty of future consumption together with a decrease in the expected rate of capital gains on investment goods

Real Value =

At/Pt

Bank Panic of 1907

Because of it, Congress formed National Monetary Commission to study the cause of panics and figure out a solution. They concluded that the supply of money was inelastic and as a result formed the Federal Reserve System

what is the difference between a bid price and an ask price on a Treasury security?

Bid price - the price dealers buy treasuries at from sellers Ask price - the price buyers buy treasuries at from dealers

Suppose two countries have the same function, U(Ct) and U(Ct+1), face the same interest rate, have the same current consumption, but country J has a lower rate of time preference than country A. Then,

Consumption must grow faster in country J than in country A

Federal Reserve System

Create elastic currency through it's 3 powers: a) issue currency b) make loans to banks (Banker's Bank) c) buy, sell & hold govt securities

Real Variable

Expresses economic value of assets currency can buy; adjusted for inflation or differences in price levels over time. PEOPLE MAKE DECISIONS BASED ON REAL VARIABLES

Nominal Variable

Expresses value in terms of money/currency, based on dollars

Fractional Reserve Baking

Financial innovation where banker can keep a fraction of deposits in the vault and then lend out the remaining fraction and earn interest on it

Costs of Financial Intermediation

Financial intermediaries match buyers to sellers which can be costly. They derive their revenue from the Bid-Ask spread

Suppose MU(Ct ) = 17, MU(Ct+1)=16, rho= .03, and r = .05. Then,

Households will substitute Ct for Ct+1

Suppose MU(Ct) = 101, MU(Ct+1)=98, rho = .07, and r = .1. Then,

Households will substitute Ct for Ct+1

I. intertemporal choice II. a choice that may involve choosing both capital and debt III. a decision fundamentally about financial investment The saving decision is an example of:

I and II only

A real variable I. is expressed in units of bundles of goods and services II. is a nominal variable multiplied by the price level III. is the variable that decision makers actually care about when making choices

I and III only

Which of the following are facts about the yield curve? I. the yield curve is typically upward sloping II.the yield curve flattens out or inverts just before an economic recession III. yields on bonds of differing maturities tend to move in the same direction

I, II & III are all correct

Consider the following statements which are elements of the explanation for the value of a medium of exchange. I. gains from specialization II. medium of exchange reduces trading costs III. different production environments IV. comparative advantage V. increases in the volume of trade and therefore welfare When you make the argument for the value of a medium of exchange to a society, the best sequence in which order these elements is

III then IV then I then II then V

Reserve Requirements

If reserve requirements increase, bank profits decrease because the assets must be held instead of loans out so it won't earn interest. If reserve requirements decrease, the amount of lending banks can do increases

Money Vanishes

Monetary value < commodity value

"Corridor"

Interest rates on reserves can create a floor since the Fed is able to control the BaseD/P by changing interest rate paid on reserves. Discount rate can create a ceiling at the BaseS/P.

Quantity Theory of Money

M * V = P * Y

M2

M1 + Savings Deposits + Small Time Deposits + Money Market Deposits Accounts + Retail Money Market Funds

M2 differs from M1 in that

M2 is never smaller than M1

If the Fed purchases a government security, then

Multiple deposit creation will occur unless banks sharply increase their excess reserves. Releasing money into the monetary supply by purchasing securities would cause the monetary supply to increase and multiple deposit and credit creation to happen, unless the bank keeps all of that new money in their excess reserves. Then it is never lent out and no new deposits or credits occur

Multiple Deposit Creation

Multiple deposits made with same original deposit so the bank realized they can loan out that money and effectively allow multiple people to use it and redeposit it. Similar to the credit system of loans

Real Rate of Interest =

Nominal Rate - Inflation Rate

"Lags" impact on monetary policy

Recognition Lag: realizing there is actually a recession Implementation Lag: It takes time to write strategies to correct the recession Reactionary Lag: time it takes to react to situation

Accounting Profit

Revenue - Explicit Costs

Suppose the government invests in a smart grid that makes electricity more reliable and cheaper. As a result capital is more productive, and

The real interest rate will increase

Bank Panic

Sudden demand for withdrawals, typically associated with poor economic conditions and recessions. Bank panics end when banks suspend payments

Suppose people expect the relative price of homes to increase more rapidly in the future, and simultaneously, incomes in the country increase permanently. Other things the same,

The equilibrium interest rate and equilibrium savings will increase

Suppose technology improves and the marginal product of capital increases. Then,

The equilibrium interest rate will increase, and equilibrium investment will increase

Suppose a series of tragic natural disasters in foreign countries reduces foreign savings in the U. S. Then,

The equilibrium real interest rate in the U.S. will increase

Suppose technology improves and the marginal product of capital increases. At the same time, current income increases temporarily. Then,

The interest rate may rise or fall, but savings will increase

The Discount Rate

The interest rate the Fed charges on loans made by banks. If the money supply increases, the discount rate decreases

Open Market Operations

The most important policy tool. 3 key factors, its divisible, its anonymous, its reversible. When the Fed buys govt securities, money supply increases because more money is going into circulation.

Suppose there are four ounces of gold in a $10 gold coin. Then,

This coin will disappear when the price of gold exceeds $2.50/oz.

The yield to maturity last Wednesday on a bond that matures in April of 2020 was 2.36%. On the same day last week, a bond that matures in May of 2045 was 3%.

This is an example of a yield curve of the typical shape.

In 1979 the interest rate on Treasury bonds that matured in two years was 10%, while the interest rate on bonds that matured in 30 years was 8%.

This is an example of an inverted yield curve.

Monetary Base

all currency + bank deposits at the Fed

According to the traditional view of budget deficits, an increase in tax revenue will cause

an increase in equilibrium investment

If you are told that the federal funds rate and the supply of reserves have both increased, then which of the following could have happened?

an increase in the purchase of mortgage backed securities and an increase in the required reserve ratio

Liquidity premiums

arise because long term bond prices are volatile relative to short term bond prices and explain why the yield curve is typically upward sloping

why does the investment demand curve have a negative slope

as the interest rate increases demand for investment decreases; this is because the interest rate measurers the cost of borrowing money

why does r=rho in a steady state

at the steady state r = rho because a steady state causes MU(Ct)/MU(Ct+1) = 1 -> so at the optimal choice point (1+r) = 1(1+rho) -> which means that r = rho in the steady state

why does the supply of savings curve have a positive slope

because at a higher interest rate, individuals get a higher return on their money and are willing to save more; also positive because of an intertemporal substitution effect

why does the marginal product decline

because there are other fixed inputs that limit the amount of output that can be produced (ex. you need workers to do something with the capital to produce goods)

what is bitcoin and why is it attractive as an MOE

bitcoin is a blockchain of anonymous digital signatures on a public ledger that is decentralized it is useful as an MOE because the system is very hard to defraud, anonymous and transaction costs are low

Agents may reduce their exposure to risk if they ________________________ and this can create a preferred habitat for different types of agents.

hold assets with the same maturities as their liabilities

what is held constant along a savings supply curve?

household income

Liquidity Premium Hypothesis

implies that longer term bonds have higher volatilities and require a "liquidity premium" return to be paid to bondholders as compensation for added exposure to volatility

Suppose there is a decrease in equilibrium investment and at the same time there is no change in the equilibrium rate of interest rate. These events could be caused by a simultaneous

increase in the tax rate on capital income and an decrease the riskiness of households income streams

During the financial crisis of 2008-09, the Fed did all of the following except

increased the reserve ratio and so the excess reserves that banks hold fell. Increasing the reserve ratio would increase the amount that banks had to hold not reduce them.

An increase in the expected rate of capital gain

increases the expected rate of return on the asset

what are "animal spirit agents"?

irrational investors. They make investing decisions based off of fads, trends, and notions of popularity

M2,

is a broader measure of the public's holdings of liquid assets than is the monetary base

Suppose there are 10 ounces of gold in a $50 gold coin. If the price of gold is $4 per oz, then, in the absence of any cost to extract the gold from this coin, this coin

is a fiat money

The pure expectations hypothesis

is inconsistent with efficient markets and a yield curve that is usually upward sloping

why do net exports measure the flow of savings from domestic households to residents of foreign countries

say Home Country produces 2,000 units more than they consume so it will export those 2,000 to the ROW. If ROW has a surplus of 1,000 units, we import those units. Exports - imports = 2000 - 1000 = 1,000. Net exports of +1,000 units means that HC is lending to ROW/saving abroad. -Net Exports means that the ROW is lending to/saving in HC, which increases our overall Snet

If the Fed wants to reduce inflationary pressure, it can

sell mortgage backed securities or increase interest rate on reserves

when the yield curve is inverted, LPH predicts

short term rates will fall

fundamental value theory of stock prices

stock prices are equal to the present value stream of their future dividend payments; rational investors will pay for a stock what it's future CFs are worth today and only that

Suppose the MU(Ct) = 57, MU(Ct+1)=54, the rate of time preference = .05, and the interest rate =.08. Then households will

substitute Ct in place of Ct+1

Which of the following was not provided for in the Federal Reserve Act

the Fed has the power to set reserve requirements for member banks. Was not a power when originally created, but became a power in the 30s and then redefined in the 80s

Suppose the yield to maturity exceeds the coupon rate on a bond. Then we know that

the bond sells below par

what is the marginal product of capital (MPK)

the change in output brought about by an unit change in capital

Suppose that clam shells evolve to be a society's money, then

the clam shells that are easiest to get will be used as money

Interest Rate

the cost of borrowing money. (At+1/At) - 1

If the pure expectations hypothesis is correct and the current one year rate is 5% and the one year rate expected to prevail next year is 3%, then

the current two year rate is 4%

If all agents are rational, what does this imply about the shape of the demand curve for an asset?

the demand curve for an asset is perfectly elastic (a horizontal line stemming from point of fundamental value on Ps axis)

Suppose you are the advisor to a corporate leader. She calls you into her office, and says "Interest rates have decreased, yet savings is up. As my economic advisor, can you tell me what may have caused this change?" Using our model of savings and investment, you could hypothesize (guess)

the economy is experiencing a temporary boom in incomes

Suppose there is a spell of poor weather that decreases income and at the same time there is an increase in the tax rate on capital income. As a result of these shocks,

the equilibrium investment will definitely fall, but equilibrium interest rate may fall, rise, or stay the same

Suppose all of the agents in the market are rational. A finance professor discovers a new relationship in the data that identifies a systematically higher return on average from stocks purchased just before national holidays . The discovery is published in a leading research journal and the professor becomes famous. As a result of this discovery

the higher average return will disappear because rational agent will take it into account when making decisions


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