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Chapter 5: Q.9 (page 164)

How might a sudden increase in people’s expectations of future real estate prices affect interest rates?

Short Answer

Expert verified

This will lead the bond demand curve to shift to the left, resulting in a decrease in the equilibrium bond price as well as a rise in the interest rate.

Step by step solution

01

Introduction

The amount demanded of an asset is directly related to wealth, expected return on asset, and liquidity of the asset, and negatively proportional to expected return on alternative asset, liquidity of the alternative asset, according to the theory of portfolio choice.

02

Explanation

If future real estate values are expected to rise sharply, the demand for real estate will rise in compared to bond demand, and bond demand would fall as a result.

This will lead the bond demand curve to shift to the left, resulting in a decrease in the equilibrium bond price as well as a rise in the interest rate.

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Most popular questions from this chapter

1. Explain why you would be more or less willing to buy a share of Microsoft stock in the following situations:

a. Your wealth falls.

b. You expect the stock to appreciate in value.

c. The bond market becomes more liquid.

d. You expect gold to appreciate in value.

e. Prices in the bond market become more volatile.

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?

The demand curve and supply curve for one-year discount bonds with a face value of $$ 1050$ are represented by the following equations: $B^{d} : P r i c e = - 0.8 \times Q u a n t i t y + 1160 B^{s} : P r i c e = Q u a n t i t y + 720$ 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.

The demand curve and supply curve for one-year discount bonds with a face value of $$ 1000$ are represented by the following equations:

$B^{d} : P r i c e = - 0.8 \times Q u a n t i t y + 1100 B^{s} : P r i c e = Q u a n t i t y + 680$

a. What is the expected equilibrium price and quantity of bonds in this market?

b. Given your answer to part (a), what is the expected interest rate in this market?

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.

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