Chapter 5: Q.17 (page 164)
Why should a rise in the price level (but not in expected inflation) cause interest rates to rise when the nominal money supply is fixed?
The decrease in money's purchasing power, interest rates will rise.
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Suppose you visit with a financial adviser, and you are considering investing some of your wealth in one of three investment portfolios: stocks, bonds, or commodities. Your financial adviser provides you with the following table, which gives the probabilities of possible returns from each investment.
a. Which investment should you choose to maximize your expected return: stocks, bonds, or commodities?
b. If you are risk-averse and had to choose between the stock and the bond investments, which would you choose? Why?
Explain why you would be more or less willing to buy long-term Delta Air Lines bonds under the following circumstances:
a. The company just released its financial statements, indicating that income decreased and liabilities increased.
b. You expect a bull market in stocks (stock prices are expected to increase).
c. You have analyzed your country’s monetary policy and expect interest rates to decrease.
d. Brokerage commissions on bonds fall.
e. Your income and wealth increased over the last two years.
The demand curve and supply curve for one-year discount bonds with a face value of are represented by the following equations:Suppose that, as a result of monetary policy actions, the Federal Reserve sells 90 bonds that it holds. Assume that bond demand and money demand are held constant.
a. How does the Federal Reserve policy affect the bond supply equation? b. Calculate the effect on the equilibrium interest rate in this market, as a result of the Federal Reserve action.
Using both the supply and demand for bonds and liquidity preference frameworks, show how interest rates are affected when the riskiness of bonds rises. Are the results the same in the two frameworks?
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. Predict what will happen to interest rates. Will you advise borrowing short or long term?
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