chapter 3

You own a 10-year, $10,000 US Treasury bond with a coupon rate of 3%. There are two years left to maturity, and you are planning to sell the bond in the secondary market. If the interest rate is 5%, how much can you expect to get for the bond?

$9,628

An increase in the interest rate 1)______ the pool of loanable funds for which of the following reasons?

- 1) increases -Firms lend more of their cash through U.S. financial markets. -Foreigners bring more of their savings to the pool of loanable funds. -Households save more of their after-tax income.

A bond will sell at a premium if which of the following happened?

Interest rates fell below coupon rate.

Which of the following best describes the secondary market for bonds?

The market for debt instruments that were previously issued

When the bond matures in 2030, what payments will investors holding GFL bonds receive?

The principal of $2,000 plus the payment of $100 for the last coupon

The rate of interest a bond pays is called the bonds

coupon rate

An increase in business confidence

demand increase

The amount of money borrowed by a bond issuer

face value

Assume the loanable funds market is in equilibrium. An increase in the demand for loanable funds will result in a __________ equilibrium interest rate as the quantity of loanable funds demanded __________ and the quantity of loanable funds supplied __________ as the market moves to a new equilibrium.

higher; increases; increases

The line showing the relationship between bond prices and interest rates has a _______ slope; in other words, there is ________ relationship between bond prices and interest rates.

negative an inverse

In the loanable funds model, the price of loanable funds is also known as:

the interest rate

The coupon rate refers to:

the interest rate a bond pays.

The quantity of loanable funds supplied is directly related to interest rates because as interest rates increase

the opportunity cost of household consumption increases, causing households to bring more of their after-tax income to the pool of loanable funds.

In the loanable funds framework, savers are:

the suppliers of loanable funds.

Today, shoppers "clip coupons" before they go shopping. Explain how these modern coupons are similar and dissimilar to the "coupons" referred to in the bond market.

they are the same because both give a brief description on whats provided, they are not similar because the coupon in the market provides interest on the bonds that is the extra money to the bond holder.

In the bond market, the increase in the supply of and decrease in the demand for bonds associated with increased inflationary expectations lead to lower bond prices and thus higher nominal interest rates.

true

If a three-year bond with a $1,000 face value has a coupon rate of 3.5%, and the current market interest rate is 2%, what is the market price of the bond?

$1,043.25

Suppose that the market interest rate for bonds that are similar to the AirMaster bond has increased to 8%. The price of the AirMaster bond changes to______, which means that it sells at_____

$1,233.00 a discount

Suppose that instead of rising, the market rate decreases from 6% to 4%. The new price of the bond changes to______, which means that the bond sells at______

$1,372.15 a premium

AirMaster Corporation raises funds to build windmills by issuing 3-year bonds with a coupon rate of 6% and a face value of $1,300. Assume that the market interest rate for a 3-year bond issued by a firm like AirMaster is currently the same as the coupon rate. The price of each of these bonds is_______ , which means that the bonds sell at______

$13,000 par

Which of the following are sources of the demand for loanable funds? Check all that apply

-A household's utility-maximizing level of consumption exceeds its current after-tax income. -A government runs a budget deficit -A firm's profit-maximizing level of expenditures exceeds its profits in the current period.

Arnold & Goldman Corporation issues a 20-year bond with a fixed coupon rate of 4%. Suppose, that the inflation rate over the period is 5%. In 20 years, Arnold & Goldman _____ because

-in real terms will benefit -Inflation decreases the real value of the coupon payments and the principle

Initially, the government's budget is balanced; then the government significantly increases spending on national defense without changing taxes. This change in spending causes the government to run a budget 1)______ , which causes the interest rate to 2)______

1) deficit 2) rise

Suppose savers either buy bonds or make deposits in savings accounts at banks. Initially, the interest income earned on bonds or deposits is taxed at a rate of 20%. Now suppose there is a decrease in the tax rate on interest income, from 20% to 15%. This change in the tax treatment of saving causes the equilibrium interest rate in the market for loanable funds to 1) ____and the level of investment spending to

1) fall 2) increase

Which of the following best describes how the bond market works when there is a surplus?

Quantity supplied declines while quantity demanded increases until the market achieves equilibrium.

Which of the following best describes how the bond market works when there is a shortage?

Quantity supplied increases whereas quantity demanded declines until the market achieves equilibrium

If the market price for bonds is higher than the equilibrium price, what is the result, and what will change to bring about equilibrium as price falls, ceteris paribus?

Surplus; quantity demanded will decrease and quantity supplied will increase

If the market interest rate is the same as the coupon rate on a newly issued bond, then the bond will sell

at par

When a newly issued bond sells above its face value, it is said to sell

at premium

If the market interest rate is higher than the coupon rate on a newly issued bond, then the bond will sell

below par

The stated rate of interest that will be paid to the holder of the bond

coupon rate

Suppose interest rates rise. The market price of these GFL bonds will

decrease

The fact that the face value of a bond does not change over the life of the bond is generally considered a benefit to the borrower. Can you explain why?

if the market conditions change and the rates drop, the face value will not change

if the market for loanable funds is currently in equilibrium, a(n) __________ will cause an increase in the interest rate.

increase in business confidence

Coupon payments in finance refer to:

interest payment from owning a bond.

The coupon rate of a bond refers to the

interest rate to be paid to the holder of the bond

Suppose the interest payments and face value of bonds don't change. As the price of the bond sold in the bond marker decreases, the rate of return (or yield) __________

rise

________is the source of the supply of loanable funds. As the interest rate falls, the quantity of loanable funds supplied______

saving decreasing

______is the source of the supply of loanable funds. As the interest rate rises, the quantity of loanable funds supplied____

saving increases

Suppose the bond price has changed to $2, creating a ______ of ______ million bonds

shortage 6

A decrease in expected household income

supply decrease

A decrease in the number of savers

supply decrease

An increase in business profits and cash flows

supply increase

An increase in households' wealth

supply increase

Lower-than-expected inflation

supply increase and demand decrease

Suppose that instead the bond price has changed to $8. This creates a _____ of ______ million bonds.

surplus 6

Which of the following best explains the existence of the secondary market for bonds?

Bondholders may not wish to hold onto bonds until maturity and therefore may sell them for cash

Individual Retirement Accounts (IRAs) allow people to shelter some of their income from taxation. Suppose the maximum annual contribution to such accounts is $5,000 per person. Now suppose there is an increase in the maximum contribution, from $5,000 to $8,000 per year. This change in the tax treatment of saving causes the equilibrium interest rate in the market for loanable funds to 1)____ and the level of investment spending to 2)____

1) fall 2)increase

Suppose the interest rate is 5.5%. Based on the previous graph, the quantity of loanable funds supplied is 1)______ than the quantity of loans demanded, resulting in a 2)_____ of loanable funds. This would encourage lenders to 3)____ the interest rates they charge, thereby 4)______ the quantity of loanable funds supplied and 5)______ the quantity of loanable funds demanded, moving the market toward the equilibrium interest rate of 6)_______

1) greater 2)surplus 3)lower 4)decreasing 5)increasing 6)5%

When confidence in the future increases, bond prices 1)___ and yields 2)____ . As a result, the economy 3)_____ , which means that interest rates are 4)____

1)decrease 2)increase 3)expand 4)pro cyclical

An investment tax credit effectively lowers the tax bill of any firm that purchases new capital in the relevant time period. Suppose the government repeals a previously existing investment tax credit. The repeal of the previously existing tax credit causes the interest rate to 1)____ and the level of saving to 2) _____

1)fall 2)fall

An investment tax credit effectively lowers the tax bill of any firm that purchases new capital in the relevant time period. Suppose the government implements a new investment tax credit. The implementation of the new tax credit causes the interest rate to 1)____ and the level of investment to 2)___

1)rise 2)rise

Initially, the government's budget is balanced; then the government responds to the conclusion of a war by significantly reducing defense spending without changing taxes. This change in spending causes the government to run a budget 1)____ , which causes the interest rate to 2)____

1)surplus 2)fall

General Finance Ltd. (GFL) issues a 10-year bond in 2020 with a $2,000 face value and a $100 coupon. The interest rate at which GFL issues these bonds is_________

5%

You read in the financial press that the economy of Finland is sliding into a recession. What will happen in the bond market and the loanable funds market in Finland, ceteris paribus?

Bond prices will increase and interest rates will decrease.

Ceteris paribus, which of the following follows from the situation described in the previous question?

Generally, borrowers benefit from the fact that neither the coupon rate on a bond nor the face value of a bond change over the life of the bond.

A bond will sell at a discount if which of the following happened?

Interest rates rose above coupon rate

A legal promise to repay with interest

bond