ECO 029, chapter 5

Will there be an effect on interest rates if brokerage commissions on stocks fall? A-Yes, interest rates would rise because stocks become more liquid than before, which would reduce the demand for bonds. B-Yes, interest rates would fall because stocks would have a relatively higher rate of return than bonds, 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.

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

Using the formula R=(F-P)/P, if the market price of a $1,200-face-value discount bond changes from $925 to $900, the YTM increases by what amount?

3.60%

What is the opportunity cost of holding $750 in cash if the relevant interest rate is 10%?

Opportunity cost is $75

What will happen to interest rates if the public suddenly expects a large increase in stock prices? A-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. B-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. C-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. D-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.

(B) 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.

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 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. 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 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.

How might a sudden increase in people's expectations of future real estate prices affect interest rates? A-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. 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 increase 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.

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

(D) Bonds become riskier and the demand for bonds will fall, which causes interest rates to rise.

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

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

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, which asset would you prefer?

Asset B.

Would you be more or less willing to buy a share of Microsoft stock in the following situations:

Your wealth falls--Less willing You expect the stock to appreciate in value--More willing The bond market becomes more liquid--Less willing You expect gold to appreciate in value--Less willing Prices in the bond market become more volatile--More willing