FIN 408 Homework 5
When expected inflation rises, causing interest rates to rise, we have seen a demonstration of the:
Fisher Effect
A business cycle expansion causes:
both bond demand and bond supply to shift right.
If the demand for bonds shifts to the left, the price of bonds:
decreases, and interest rates rise.
If the supply of bonds shifts to the right, the price of bonds _________, and the interest rate _________.
decreases, increases
There is a perceived increase in the riskiness of bonds. What will likely happen to corporate Baa bonds? What will likely happen to the 10-year Treasury note?
demand will shift to the left demand will shift to the right
There is a(n) _____ relationship between bond price and yields.
inverse
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 1. ______, which causes the demand for bonds to shift to the 2. _______. However, the lower expected inflation rate causes the cost of borrowing to 3. ______, so the supply of bonds will 4. ______, which causes the supply curve for bonds to shift to the 5. ______. The impact of this change in bond demand and supply will cause equilibrium interest rates to 6. ______.
1. fall 2. right 3. rise 4. decrease 5. left 6. decrease
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 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, pricelevel, and inflation will tend to lower interest rates.
What will cause interest rates to rise?
The government increases its budget deficit.
What is the opportunity cost of holding $1,000 in cash if the relevant interest rate is 10 percent?
The opportunity cost is $100.
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?
The income, price-level, and expected-inflation effects were small relative to the liquidity effect.
A/an decrease in expected inflation causes:
bond demand to shift right, bond supply to shift left, and interest rates to fall
Based on empirical evidence, because interest rates _________ when the economy is expanding, interest rates are said to be ___________.
increase, procyclical
If interest rates rise, this opportunity cost will _______, and individuals will hold ________ cash balances.
increase, smaller
Explain the effect that a large federal deficit will have on interest rates. Demand will _______. Supply will _______. The effect of this shock will likely cause bond yields to ________.
remain unchanged shift to the right increase
What will happen to interest rates if prices in the bond market become more volatile? Demand will _______. Supply will _______. The effect of this shock will likely cause bond yields to ________.
shift to the left remain unchanged increase
Suppose there is a downward revision of inflation expectations. What is the effect on the bond market? Demand will _______. Supply will _______. The effect of this shock will likely cause bond yields to ________.
shift to the right shift to the left decrease
Using the liquidity preference framework, when the economy expands:
the demand for money will increase, shifting the money demand curve to the right
When the wealth of individuals increases,
the price of bonds increases while the interest rates decrease
