ECON 380 Chapter 4
An increase in expected inflation will ___ the nominal interest rate on both short-term and long-term bonds. The longer the maturity of a bond, the ___ the change in price as a result of a change in market interest rates. As a result, capital losses on long-term bonds will be ___ than capital losses on short-term.
- Increase - Greater - Greater
The government runs a large deficit, holding everything else constant. As a result, the new equilibrium interest rate on bonds will ____, and the equilibrium quantity of bonds will ___
- Increase - Increase Supply shifts to the right
An increase in expected inflation will shift the demand curve ___- and the supply curve ____, resulting in a new equilibrium with a ____ price.
- Leftward - Rightward - Lower
In the bond market, the good is the ___ and in the loanable funds market, the good is the ___
- Bond - Use of funds
In the bond market, the price is the ___ and in the loanable funds market, the price is the __-
- Bond price - Interest rate
In the bond market, the seller is the ___ and in the loanable funds market, the seller is the ___
- Borrower - Lender
Which of the following would shift the supply curve for bonds to the right?
- Government borrowing increases - Firm's expected profitability increases - Subsidies to business increase
Many economists assume that a boom in the stock market is a sign that profitable business opportunities are expected in the future. In other words, the expected return on stocks increases. As a result, the equilibrium interest rate will be ___.
- Higher Demand shifts to the left
In the bond market, the buyer is the ___ and in the loanable funds market, the buyer is the ___
- Lender - Borrower
The term black swan event refers to ___ events that have a ___ effect on society or the economy
- Rare - Large
What are the determinants of asset demand?
- The expected rate of return and the degree of risk for an investment compared to alternative investments. - The liquidity of the investment compared with other investments. - The total amount of savings to be allocated among investments.
How does diversification reduce the risk of a financial portfolio?
By allocating savings among many different assets, if one asset class performs poorly, the rest of the portfolio may perform well.
Many economists assume that a boom in the stock market is a sign that profitable business opportunities are expected in the future. In other words, the expected return on stocks increases. As a result, the equilibrium interest rate will be ___
- Higher The demand curve shifts to the left
Which of the following would shift the demand curve for bonds to the left?
- Households' wealth decreases - The expected return on stocks increases - Expected inflation increases
The higher the price of bonds, the greater the quantity of bonds demanded.
False - The higher the price of bonds, the lower the quantity of bonds demanded
If investors start to believe that the U.S. government might default on its bonds, the interest rate on those bonds will fall.
False - This would cause a shift to the left, pushing price down and yield up
Many U.S. cities increase business taxes to help close their budget deficits.
Net expected profitability would fall, so the demand for loanable funds would fall.
A natural disaster causes extensive damage to homes, bridges, and highways, leading to increased investment spending to repair the damaged infrastructure.
The demand for loanable funds would increase, increasing the interest rate.
As the wealth of investors increases, all else held constant, the interest rate on bonds should fall.
True - A shift to the right in the demand curve will push prices up and yield down
The lower the price of bonds, the smaller the quantity of bonds supplied.
True - The lower the price, the higher the yield, which increases the cost of borrowing
Why does the demand curve for bonds slope down? Why does the supply curve for bonds slope up?
As the price of bonds increases, the interest rates on the bonds will fall, thus reducing the quantity of bonds demanded. Likewise, as the price of bonds increases, the interest rates on the bonds will fall, thus holders of bonds will be more willing to sell them, increasing the quantity supplied.
The federal government imposes a tax of $10 per bond on bond sales and bond purchases.
Both the demand and supply curves shift to the left.
Widespread use of handheld computers helps reduce business costs.
Expected profitability would rise, so the demand for loanable funds would rise.
Is the risk that pertains to a particular asset rather than to the market as a whole.
Idiosyncratic Risk
Is the risk that is common to all assets of a certain type
Material Risk
By "negative real yield" Siegel and Schwartz:
Meant that the real interest rate on 10-year Treasury notes was negative, because even though there was a very small positive nominal yield, when inflation is considered the real yield actually becomes negative.
Taxes on businesses are expected to be increased in the future.
The demand for loanable funds would decrease, decreasing the interest rate.
Which of the following best describes the impact of the Fed's actions on the money market graph?
Supply shifts leftwards.
In the loanable funds model, why is the demand curve downward sloping? Why is the supply curve upward sloping?
The demand curve is downward sloping because the higher the interest rate, the less the demand for borrowing. The supply curve is upward sloping because the higher the interest rate, the more willing suppliers of loanable funds will be to lend money.
The Federal Reserve publishes a forecast that the inflation rate will average 5% over the next five years. Previously, the Fed had been forecasting an inflation rate of 3%.
The demand curve shifts to the left and the supply curve shifts to the right.
Investors believe that the level of risk in the stock market has declined.
The demand curve shifts to the left.
Suppose that in a large open economy, the quantity of loanable funds supplied domestically is initially equal to the quantity of funds demanded domestically. Then an increase in business taxes discourages investment. Show how this change affects the quantity of loanable funds and the world real interest rate. Does the economy now borrow or lend internationally?
The demand curve would shift to the left, thus creating excess supply and making the economy a net lender.
Briefly explain what typically happens to interest rates during a recession. Use a demand and supply graph for bonds to illustrate your answer.
The demand for bonds decreases, while the supply of bonds decreases by a greater magnitude than demand, resulting in a lower equilibrium interest rate.
In what sense do investors face a trade-off between risk and return?
The higher the risk that an asset has, the lower the demand for the asset. This raises the yield or return if the asset performs well. Low-risk assets have a high demand, which lowers their yield or return.
The government eliminates the tax deduction for interest homeowners pay on mortgage loans.
The increase in the expected after-tax real interest rate would reduce the demand for loanable funds.
Which of the following best describes the effect of a global savings glut?
The increased savings in the rest of the world increases international lending, lowering the world interest rate, and increasing international borrowing in the United States.
Why would German savers be more vulnerable to low interest rates than U.S. savers?
The percentage of household wealth held in bank deposits is higher in Germany than in the U.S.
The federal government runs a series of budget surpluses.
The supply curve shifts to the left.
The economy experiences a period of rapid growth, with rising corporate profits.
The supply curve shifts to the right.
The government proposes a new tax on saving, based on the value of people's investments as of December 31 each year.
The supply of loanable funds would decrease, increasing the interest rate.
The World Cup soccer matches are being televised, and many people stay home to watch them, reducing consumption spending.
The supply of loanable funds would increase, decreasing the interest rate.
Why should a debate over the cause of low interest rates matter to Alan Greenspan?
There is a debate over whether the Federal Reserve was responsible for low interest rates or whether the global savings glut was responsible. If the global savings glut was responsible, we could argue that the Federal Reserve should take less blame for the artificially low interest rates that helped facilitate the housing bubble.
In 2012 investors were willing to accept a negative real yield on 10-year Treasury notes because:
They were looking for a safe asset with any kind of nominal interest rate to purchase.
