Financial Markets and Monetary Policy, Chapter 3, Homework 3
if the market price of a $1 comma 200-face-value discount bond changes from $900 to $875, the yield to maturity increases by
3.81%
Will a U.S. Treasury bill have a risk premium that is higher than, lower than, or the same as that of a similar security (in terms of maturity and liquidity) issued by the government of Colombia?
A U.S. Treasury bill will have a lower risk premium since U.S. government issued securities are usually considered to be default free.
In the theory of portfolio choice, which of the following will decrease the quantity demanded of an asset? If a one-year discount bond that pays $1 comma 000 at maturity, is held for the entire year, and the purchase price is $950, then the interest rate is? A one-year discount bond for which the owner pays $937, holds it for the entire one year, and receives $1 comma 000 at maturity, generates an interest rate of
An increase in the risk of the asset relative to alternative assets 5% 6.7%
Risk premiums on corporate bonds are usually anticyclical; that is, they decrease during business cycle expansions and increase during recessions. Why is this so?
As the economy enters an expansion, there is greater likelihood that borrowers will be able to service their debt.
Suppose you observe a change in the relationship between short-term and long-term bonds. Specifically, you note that although interest rates on both short-term and long-term bond are rising together, as expected, the rate on long-term bonds is not rising by as much as has been observed in the past.
Assuming the liquidity premium theory of term structure, you conclude that the liquidity premium is decreasing. As a result, the yield curve becomes flatter.
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 - 4 $2,000 in cash - 1 A $10,000 Treasury bill - 2 100 shares of Google stock - 3
Match each of the following theories with its description. (Enter a value: 1-4.)
Expectations Theory: The interest rate on a long-term bond will equal an average of the short-term interest rates that people expect to occur over the life of the long-term bond. Preferred Habitat: The interest rate on a long-term bond will equal an average of short-term interest rates expected to occur over the life of the long-term bond plus a liquidity premium (also referred to as a term premium) that responds to supply and demand conditions for that bond. Segmented Markets: The interest rate for each bond with a different maturity is determined by the supply of and demand for that bond, with no effects from expected returns on other bonds with other maturities.
Using the information given the text, match the following descriptions of risk to the corresponding Standard and Poor's rating (i.e., AAA, AA, A, BBB, ... D).
High grade high quality - AA Highly speculative - D Upper medium grade - A Prime maximum safety - AAA Speculative - B
The demand curve and supply curve for one-year discount bonds with a face value of $1 comma 030 are represented by the following equations:
If the Fed increases the supply of bonds in the market by 70, at any given price, the bond supply equation will become Price=Quantity+620. The expected interest rate on a one-year discount bond will increase to 11.23%
Which of the following statements is true?
Interest rates on bonds of different maturities tend to move together over time. According to the segmented markets theory of the term structure of interest rates, if bondholders prefer short-term bonds to long-term bonds, the yield curve will be upward sloping.
How might a sudden increase in people's expectations of future real estate prices affect interest rates?
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.
If junk bonds are "junk," then why would investors buy them?
Junk bonds can provide high yields.
Raphael observes that at the current level of interest rates there is an excess supply of bonds, and therefore he anticipates an increase in the price of bonds. Is Raphael correct?
Raphael is incorrect. The supply and demand analysis tells us that interest rates will increase, creating a movement along both the demand curve (in the southeast direction) and the supply curve (in the southwest direction) in order to reach the equilibrium interest rate (and price). The bond's price will therefore fall.
Suppose you are in charge of the financial department of your company and you have to decide whether to borrow short or long term. Checking the news, you realize that the government is about to engage in a major infrastructure plan in the near future. Will you advise borrowing short or long term?
Since the government is a major player in the market for bonds, this will most likely result in a shift to the right in the supply curve, lowering the price of bonds and increasing interest rates. You would recommend locking in a long-term loan at the current interest rate.
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?
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.
The demand curve and supply curve for one-year discount bonds with a face value of $1 comma 050 are represented by the following equations: The expected equilibrium price of bonds is $
The expected equilibrium quantity of bonds is 276. $966 8.7%
Suppose that many big corporations decide not to issue bonds, since it is now too costly to comply with new financial market regulations.
The impact will translate into a shift to the left in the supply curve, increasing bond's prices (lowering interest rates) and lowering the quantity of bonds bought and sold in the market.
If expectations of future short-term interest rates suddenly fall, what would happen to the slope of the yield curve?
The yield curve would become flatter.
Following a policy meeting on March 19, 2009, the Federal Reserve made an announcement that it would purchase up to $300 billion of longer-term Treasury securities over the following six months. What effect might this policy have on the yield curve?
The yield curve would shift down, but mostly on medium- and long-term maturities.
The ------- is the spread between the interest rates on bonds with default risk and those of the default-free bonds when both types of bonds have the same maturity. The following three characteristics of a bond are collectively embedded in the risk structure of interest rates except
risk premium Difference in maturity