Chapter 5

Using the numbers ​1, 2,​ 3, and ​4, rank the following four assets from most liquid ​(1​) to least liquid ​(4​). - A​ 10,000-square-foot office building ​- $2,000 in cash - A​ $10,000 Treasury bill - 100 shares of Google stock

- A​ 10,000-square-foot office building (4) ​- $2,000 in cash (1) - A​ $10,000 Treasury bill (2) - 100 shares of Google stock (3)

What is the opportunity cost of holding ​$1,500 in cash if the relevant interest rate is 8 ​percent? The opportunity cost is ​$______. ​(Round your response to the nearest​ dollar.) If interest rates​ rise, this opportunity cost will______ and individuals will hold ______

1500x.08 = 120 increase smaller

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 increase because bonds will become relatively more​ risky, which decreases the demand for bonds C. Interest rates will increase because bonds will become relatively less​ risky, which increases the demand for bonds D. Interest rates will decrease because bonds will become relatively more​ risky, which decreases the demand for bonds

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

What will happen to interest rates if the public suddenly expects a large increase in stock​ prices? A. Interest rates will rise because the expected increase in stock prices raises the expected return on stocks relative to bonds and so the demand for bonds decreases B. Interest rates will fall because the expected increase in stock prices raises the liquidity of stocks relative to bonds and so the demand for bonds decreases C. Interest rates will rise because the expected increase in stock prices raises the liquidity of stocks relative to bonds and so the demand for bonds decreases D. Interest rates will fall because the expected increase in stock prices raises the expected return on stocks relative to bonds and so the demand for bonds decreases

A. Interest rates will rise because the expected increase in stock prices raises the expected return on stocks relative to bonds and so the demand for bonds decreases

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 of the increase in​ people's wealth B. The demand for Rembrandt paintings would increase because people would want to hold more stocks C. The demand for Rembrandt paintings would increase because bond values would decline D. The demand for Rembrandt paintings would decrease because people would want to use their wealth for other things

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

​"The more​ risk-averse people​ are, the more likely they are to​ diversify." Is this statement​ true, false, or​ uncertain? A. True because the benefits to diversification are greater for a person who cares more about reducing risk. B. False because the larger the number of assets a person​ has, the higher the risk of loss on any of those assets. C. Uncertain because the propensity to diversify will vary depending on a​ person's income, professional​ skills, or legal requirements.

A. True because the benefits to diversification are greater for a person who cares more about reducing risk.

What will happen to interest rates if prices in the bond market become more​ volatile? A. When bond prices become more​ volatile, bonds become riskier and the demand for bonds will​ fall, which causes interest rates to rise B. When bond prices become more​ volatile, bonds become riskier and the demand for bonds will​ rise, which causes interest rates to rise C. When bond prices become more​ volatile, bonds become riskier and the demand for bonds will​ fall, which causes interest rates to fall D. When bond prices become more​ volatile, bonds become riskier and the demand for bonds will​ rise, which causes interest rates to fall

A. When bond prices become more​ volatile, bonds become riskier and the demand for bonds will​ fall, which causes interest rates to rise

Would fiscal policy makers ever have reason to worry about potentially inflationary​ conditions? A. Yes, higher inflation leads to a higher debt service burden and increases the costs of financing deficit spending. B. Yes, if people expect higher potential​ inflation, it increases spending and causes M1 and M2 to increase too rapidly. C. No, fiscal policy makers have enough policy instruments available to them to stave off or contain inflation. D. ​No, policy makers view potential inflation as a positive for the​ economy, as it increases demand on the most liquid assets such as Treasury bonds.

A. Yes, higher inflation leads to a higher debt service burden and increases the costs of financing deficit spending.

In the theory of portfolio​ choice, which of the following will increase the quantity demanded of an​ asset? A. an increase in the liquidity of the asset relative to alternative assets B. a decrease in the expected return on the asset relative to alternative assets C. a decrease in the wealth of the buyer D. an increase in the risk of the asset relative to alternative assets

A. an increase in the liquidity of the asset relative to alternative assets

Suppose there is an increase in the growth rate of the money supply. If the liquidity effect is smaller than the​ income, price-level, and expected inflation​ effects, and if inflationary expectations adjust​ slowly, then in the short​ run, interest rates A. fall. B. rise. C. become unpredictable. D. remain unchanged.

A. fall.

The following two assets and payout data are given​ below: Asset A​: Pays a return of​ $2,000 20% of the time and​ $500 80% of the time. Asset B​: Pays a return of​ $1,000 50% of the time and​ $600 50% of the time. If both assets can be acquired for the same​ price, as a​ risk-averse​ investor, you would prefer ▼

Asset B

If the next chair of the Federal Reserve Board has a reputation for advocating an even slower rate of money growth than the current​ chair, what will happen to interest​ rates? A. Slower money growth will lead to a liquidity​ effect, which will lower interest​ rates; however, the lower​ income, price​ level, and inflation will tend to raise interest rates. B. Slower money growth will lead to a liquidity​ effect, which will raise interest​ rates; however, the lower​ income, price​ level, and inflation will tend to lower interest rates. C. Slower money growth will lead to a liquidity​ effect, which will lower interest rates.​ Moreover, the lower​ income, price​ level, and inflation will reinforce the decrease in interest rates. D. Slower money growth will lead to a liquidity​ effect, which will raise interest rates.​ Moreover, the lower​ income, price​ level, and inflation will reinforce the increase in interest rates.

B. Slower money growth will lead to a liquidity​ effect, which will raise interest​ rates; however, the lower​ income, price​ level, and inflation will tend to lower interest rates.

​"No one who is​ risk-averse will ever buy a security that has a lower expected​ return, more​ risk, and less liquidity than another​ security." Is this statement​ true, false, or​ uncertain? A. False because by diversifying or hedging your​ portfolio, it is possible to avoid risks and increase your expected return. B. True because for a​ risk-averse person, those characteristics make a security less desirable. C. Uncertain because there may be other crucial characteristics to consider when purchasing a security.

B. True because for a​ risk-averse person, those characteristics make a security less desirable.

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

Along the supply curve for​ bonds, an increase in the price of bonds A. increases the interest rate and decreases the quantity of bonds supplied. B. decreases the interest rate and increases the quantity of bonds supplied. C. increases the interest rate and increases the quantity of bonds supplied. D. decreases the interest rate and decreases the quantity of bonds supplied.

B. decreases the interest rate and increases the quantity of bonds supplied.

Suppose there is​ a/an decrease in the growth rate of the money supply. If the liquidity effect is smaller than the​ output, price-level, and expected inflation​ effects, then in the long​ run, interest rates A. remain unchanged when compared to their initial value. B. fall compared to their initial value.fall compared to their initial value. C. rise when compared to their initial value.rise when compared to their initial value. D. become unpredictable.

B. fall compared to their initial value.fall compared to their initial value.

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

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

When an individual or institution buys a corporate bond in the primary​ market: A. no new borrowing or lending is taking place. B. she is making a loan to the corporation issuing the bond. C. she is taking out a loan from the corporation. D. she is becoming part owner in the corporation.

B. she is making a loan to the corporation issuing the bond.

A/an decrease in expected inflation causes

Bond demand will shift right, bond supply to shift left, and interest rates to fall.

How might a sudden increase in​ people's expectations of future real estate prices affect interest​ rates? A. Interest rates would increase because real estate would have a relatively lower rate of return compared to​ bonds, which would cause the demand for bonds to increase. B. Interest rates would decrease because real estate would have a relatively lower rate of return compared to​ bonds, which would cause the demand for bonds to increase. C. Interest rates would increase because real estate would have a relatively higher rate of return compared to​ bonds, which would cause the demand for bonds to decrease. D. Interest rates would decrease because real estate would have a relatively higher rate of return compared to​ bonds, which would cause the demand for bonds to decrease.

C. Interest rates would increase because real estate would have a relatively higher rate of return compared to​ bonds, which would cause the demand for bonds to decrease.

M1 money growth in the U.S. was about​ 16% in​ 2008, 7% in​ 2009, and​ 9% in 2010. Over the same time​ period, the yield on​ 3-month Treasury bills fell from almost​ 3% to close to​ 0%. Given these high rates of money​ growth, why did interest rates​ fall, rather than​ increase? A. The liquidity effect was working in the same direction as the​ income, price-level, and expected inflation effects. B. The​ income, price-level, and​ expected-inflation effects were large relative to the liquidity effect. C. The​ income, price-level, and​ expected-inflation effects were small relative to the liquidity effect. D. The liquidity effect did not dominate the other effects as the liquidity preference framework would suggest.

C. The​ income, price-level, and​ expected-inflation effects were small relative to the liquidity effect.

In the aftermath of the global economic crisis that started to take hold in​ 2008, U.S. government budget deficits increased​ dramatically, yet interest rates on U.S. Treasury debt fell sharply and stayed low for quite some time. Does this make​ sense? A. ​No, the large federal deficits required the Treasury to issue more​ bonds; thus, the supply curve for bonds shifted to the​ right, increasing the equilibrium interest rate. B. ​Yes, U.S. Treasury debt became a safe haven for​ investment, which shifted the demand curve for bonds to the right. ​ However, since the government was not able to secure all of its​ debt, the supply of bonds decreased and the supply curve shifted to the left. C. ​Yes, the decrease in investment opportunities and known risk factors significantly offset the wealth effect on demand and the deficit effect on supply. D. ​No, the effects of the economic crisis led to significantly lower wealth and income while increasing bond supply even more. This resulted in a decrease in bond prices and an increase in interest rates.

C. Yes, the decrease in investment opportunities and known risk factors significantly offset the wealth effect on demand and the deficit effect on supply.

In the long​ run, if the​ output, price-level, and expected inflation effects outweigh the liquidity​ effect, to reduce interest rates the Federal Reserve should A. increase the growth rate of the money supply. B. maintain the growth rate of the money supply. C. decrease the growth rate of the money supply. D. become unpredictable by varying the growth rate of the money supply without releasing the information to the public.

C. decrease the growth rate of the money supply.

If the demand for bonds shifts to the​ left, the price of bonds A. increases, and interest rates fall. B. decreases, and interest rates fall. C. decreases, and interest rates rise. D. increases, and interest rates rise.

C. decreases, and interest rates rise.

When the wealth of individuals increases​, A. both the price of bonds and interest rates increase. B. the price of bonds decreases while the interest rates increase. C. the price of bonds increases while the interest rates decrease. D. both the price of bonds and interest rates decrease.

C. the price of bonds increases while the interest rates decrease.

If the price of bonds is below the equilibrium​ price, there occurs an excess A. supply of bonds, the price of bonds will fall, and the interest rate will rise. B. demand for​ bonds, the price of bonds will​ fall, and the interest rate will rise. C. supply of​ bonds, the price of bonds will​ rise, and the interest rate will fall. D. demand for bonds , the price of bonds will rise, and the interest rate will fall.

D. demand for bonds , the price of bonds will rise, and the interest rate will fall.

Explain why you would be more or less willing to buy a house under the following​ circumstances: Prices in the gold market become more volatile. ▼ Less willing More willing

Less willing

Would you be more or less willing to buy a house under the following​ circumstances: You expect Microsoft stock to double in value next year. ▼ More willing Less willing

Less willing

Would you be more or less willing to buy a house under the following​ circumstances: You expect housing prices to fall. ▼ More willing Less willing

Less willing

Would you be more or less willing to buy a share of Microsoft stock in the following​ situations: Bond Market becomes more liquid ▼ More willing Less willing

Less willing

Would you be more or less willing to buy a share of Microsoft stock in the following​ situations: You expect gold to appreciate in value ▼ More willing Less willing

Less willing

Would you be more or less willing to buy a share of Microsoft stock in the following​ situations: Your wealth falls. ▼

Less willing

Would you be more or less willing to buy​ long-term AT&T bonds under the following​ circumstances: Brokerage commissions on stocks fall. ▼ More willing Less willing

Less willing

Would you be more or less willing to buy​ long-term AT&T bonds under the following​ circumstances: You expect interest rates to rise. ▼ Less willing More willing

Less willing

Asset Demand and Liquidity

Liquidity of an asset is a measure of how quickly it can be converted into cash at low costs. An asset is liquid if the market in which it is traded has depth and​ breadth; that​ is, if the market has many buyers and sellers. A house is not a very liquid​ asset, because it may be hard to find a buyer​ quickly; if a house must be sold to pay off​ bills, it might have to be sold for a much lower price. And the transaction costs in selling a house​ (broker's commissions,​ lawyer's fees, and so​ on) are substantial. A U.S. Treasury​ bill, by​ contrast, is a highly liquid asset. It can be sold in a​ well-organized market where there are many​ buyers, so it can be sold quickly at low cost.

Explain why you would be more or less willing to buy a house under the following​ circumstances: Gold again becomes acceptable as a medium of exchange. ▼ Less willing More willing

More willing

Explain why you would be more or less willing to buy a house under the following​ circumstances: You expect inflation to​ rise, and gold prices tend to move with the aggregate price level. ▼ Less willing More willing

More willing

Explain why you would be more or less willing to buy a house under the following​ circumstances: You expect interest rates to rise. ▼ Less willing More willing

More willing

Would you be more or less willing to buy a house under the following​ circumstances: Prices in the stock market become more volatile. ▼ More willing Less willing

More willing

Would you be more or less willing to buy a house under the following​ circumstances: Real estate commissions fall from​ 6% of the sales price to​ 5% of the sales price. ▼ Less willing More willing

More willing

Would you be more or less willing to buy a house under the following​ circumstances: You just inherited​ $100,000. ▼ Less willing More willing

More willing

Would you be more or less willing to buy a share of Microsoft stock in the following​ situations: Prices in the bond market become more volatile. ▼ More willing Less willing

More willing

Would you be more or less willing to buy a share of Microsoft stock in the following​ situations: You expect the stock to appreciate in value. ▼ More willing Less willing

More willing

Would you be more or less willing to buy​ long-term AT&T bonds under the following​ circumstances: Brokerage commissions on bonds fall. ▼ Less willing More willing

More willing

Would you be more or less willing to buy​ long-term AT&T bonds under the following​ circumstances: Trading in these bonds​ increases, making them easier to sell. ▼ More willing Less willing

More willing

Would you be more or less willing to buy​ long-term AT&T bonds under the following​ circumstances: You expect a bear market in stocks​ (stock prices are expected to​ decline). ▼ More willing Less willing

More willing

Suppose that an Exxon Mobil bond has a return of 16​% half the time and 8​% the other half. The expected return on this bond is ________ %. ​(Round your response to the nearest one decimal​ place)

The equation for the expected returns is given by E=(P1×a)+(P2×b) where E​ = Expected Returns a​ = first possible return b​ = second possible return P1​ = probability of having a P2​ = probability of having b (.5x16) + (.5x8) = 12

When Google stock has a higher expected​ return, relative to alternative​ assets, due to good business​ choices, the demand for the alternative assets​ (substitutes) ▼

declines

Continuing on the same train of​ thought, when the Fed decreases the growth rate of the money​ supply, the price level effect drives the interest rate ▼ down up while the expected inflation rate pushes the interest rate ▼ up down

down down

An increase in the money​ supply, other things held​ constant, causes interest rates to ▼ rise remain the same fall

fall

The president of the United States announces in a press conference that he will fight the higher inflation rate with a new​ anti-inflation program. Predict what will happen to interest rates if the public believes him. As a result of the​ president's announcement,​ people's expectations of inflation will ▼ fall rise which causes the demand for bonds to shift to the ▼ right left. ​ However, the lower expected inflation rate causes the cost of borrowing to ▼ fall rise​, so the supply of bonds will ▼ increase decrease​, which causes the supply curve for bonds to shift to the ▼ right left. The impact of this change in bond demand and supply will cause equilibrium interest rates to ▼ increase decrease.

fall right rise decrease left decrease

When the Federal Reserve decreases the growth rate of the money​ supply, the income effect causes the interest rate to ▼ rise fall while the liquidity effect drives the interest rate ▼ up down

fall up

If the supply of bonds shifts to the left, the price of bonds ▼ decreases increases remains the same and the interest rate ▼ remains the same increases decreases

increases decreases

Explain why you would be more or less willing to buy a share of Microsoft stock in the following​ situations: You would be ▼ less more willing to buy a share of Microsoft stock if you expect gold to appreciate in value because ▼

less the return on gold relative to stocks has improved

Explain why you would be more or less willing to buy a share of Microsoft stock in the following​ situations: You would be ▼ less more willing to buy a share of Microsoft stock if the bond market becomes more liquid because ▼

less you can now sell bonds easier than stocks

Explain why you would be more or less willing to buy a share of Microsoft stock in the following​ situations: You would be ▼ willing to buy a share of Microsoft stock if your wealth falls because ▼

less you have less money to spend on all of your potential assets

Explain why you would be more or less willing to buy a house under the following​ circumstances: You would be ▼ more less willing to buy a house if you expect housing prices to fall because ▼ the value of a house will increase houses are always a good investment to make

less the return on your house will actually be negative

Explain why you would be more or less willing to buy a house under the following​ circumstances: You would be ▼ less more willing to buy a house if it meant selling your substantial holdings of Microsoft​ stock, which you expect will double in value next year because ▼

less the stock will earn you a very large return

You would be ▼ less more willing to buy a share of Microsoft stock if prices in the bond market become more volatile because ▼ bonds have become relatively safer than stocks stocks have become relatively safer than bonds the returns on bonds have improved in value

more stocks have become relatively safer than bonds

Explain why you would be more or less willing to buy a house under the following​ circumstances: You would be ▼ more less willing to buy a house if prices in the stock market become more volatile because ▼ stocks have become relatively more risky stocks are still a good investment stocks have become relatively less risky .

more stocks have become relatively more risky

Explain why you would be more or less willing to buy a house under the following​ circumstances: You would be ▼ less more willing to buy a house if you just inherited​ $100,000 because ▼ you now have more money to just buy stocks and bonds the money inherited can only be spent on buying a house you now have more wealth to spend on all assets.

more you now have more wealth to spend on all assets.

Explain why you would be more or less willing to buy a share of Microsoft stock in the following​ situations: You would be ▼ less more willing to buy a share of Microsoft stock if you expect the stock to appreciate in value because ▼ -you feel bonds are a much better return on your investment -you believe the amount of the return on your investment will be positive -you think fewer people will want to buy the stock in future years.

more you believe the amount of the return on your investment will be positive

When the Federal Reserve increases the growth rate of the money​ supply, the income effect causes the interest rate to ▼ rise fall while the liquidity effect drives the interest rate ▼ down up

rise down

​A/an decrease in the volatility of the bond market causes the demand for bonds to ▼ fall remain the same rise and the demand curve to ▼ shift to the right shift to the left remain on the same place

rise shift to the right