The economics of money, banking, and financial markets

Frederic S Mishkin

Chapter 5

The Behavior of Interest Rates - all with Video Answers

Educators

Chapter Questions

Problem 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.

NS

Nayeli Selkis

Numerade Educator

Problem 2

Explain why you would be more or less willing to buy a house under the following circumstances:
a. You just inherited $$\$ 100,000$$.
b. Real estate commissions fall from $6 \%$ of the sales price to $5 \%$ of the sales price.
c. You expect Microsoft stock to double in value next year.
d. Prices in the stock market become more volatile.
e. You expect housing prices to fall.

NS

Nayeli Selkis

Numerade Educator

Problem 3

Explain why you would be more or less willing to buy gold under the following circumstances:
a. Gold again becomes acceptable as a medium of exchange.
b. Prices in the gold market become more volatile.
c. You expect inflation to rise, and gold prices tend to move with the aggregate price level.
d. You expect interest rates to rise.

NS

Nayeli Selkis

Numerade Educator

Problem 4

Explain why you would be more or less willing to buy long-term AT&T bonds under the following circumstances:
a. Trading in these bonds increases, making them easier to sell.
b. You expect a bear market in stocks (stock prices are expected to decline).
c. Brokerage commissions on stocks fall.
d. You expect interest rates to rise.
e. Brokerage commissions on bonds fall.

NS

Nayeli Selkis

Numerade Educator

Problem 5

What will happen to the demand for Rembrandt paintings if the stock market undergoes a boom? Why?

NS

Nayeli Selkis

Numerade Educator

Problem 6

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?

Majid Borumand

Numerade Educator

Problem 7

Suppose Maria prefers to buy a bond with a $7 \%$ expected return and $2 \%$ standard deviation of its expected return, while Jennifer prefers to buy a bond with a $4 \%$ expected returm and $1 \%$ standard deviation of its expected return. Can you tell if Maria is more or less risk-averse than Jennifer?

Narayan Hari

Numerade Educator

Problem 8

What will happen in the bond market if the government imposes a limit on the amount of daily transactions? Which characteristic of an asset would be affected?

NS

Nayeli Selkis

Numerade Educator

Problem 9

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

NS

Nayeli Selkis

Numerade Educator

Problem 10

Suppose that many big corporations decide not to issue bonds, since it is now too costly to comply with new financial market regulations. Can you describe the expected effect on interest rates?

Rashmi Sinha

Numerade Educator

Problem 11

In the aftermath of the global economic crisis that started to take hold in 2008, U.S. government budget deficits increased dramatically, yet interest rates on U.S. Treasury debt fell sharply and stayed low for quite some time. Does this make sense? Why or why not?

NS

Nayeli Selkis

Numerade Educator

Problem 12

Will there be an effect on interest rates if brokerage commissions on stocks fall? Explain your answer.

NS

Nayeli Selkis

Numerade Educator

Problem 13

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.

Majid Borumand

Numerade Educator

Problem 14

Suppose that people in France decide to permanently increase their savings rate. Predict what will happen to the French bond market in the future. Can France expect higher or lower domestic interest rates?

NS

Nayeli Selkis

Numerade Educator

Problem 15

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?

Kaylee Mcclellan

Kaylee Mcclellan

Numerade Educator

Problem 16

Would fiscal policymakers ever have reason to worry about potentially inflationary conditions? Why or why not?

Majid Borumand

Numerade Educator

Problem 17

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?

NS

Nayeli Selkis

Numerade Educator

Problem 18

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? Discuss the possible resulting situations.

Majid Borumand

Numerade Educator

Problem 19

M1 money growth in the U.S. was about $15 \%$ in 2011 and 2012, and 10\% in 2013. Over the same time period, the yield on 3-month Treasury bills was close to $0 \%$. Given these high rates of money growth, why did interest rates stay so low, rather than increase? What does this say about the income, price-level, and expected-inflation effects?

Md.Daniyal Arshad

Md.Daniyal Arshad

Numerade Educator

Problem 20

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 have to choose between the stock and the bond investments, which should you choose? Why?
TABLE CANT COPY

Majid Borumand

Numerade Educator

Problem 21

An important way in which the Federal Reserve decreases the money supply is by selling bonds to the public. Using a supply and demand analysis for bonds, show what effect this action has on interest rates. Is your answer consistent with what you would expect to find with the liquidity preference framework?

NS

Nayeli Selkis

Numerade Educator

Problem 22

Using both the liquidity preference framework and the supply and demand for bonds framework, show why interest rates are procyclical (rising when the economy is expanding and falling during recessions).

Lottie Adams

Numerade Educator

Problem 23

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?

Lottie Adams

Numerade Educator

Problem 24

The demand curve and supply curve for one-year discount bonds with a face value of $$\$ 1,000$$ are represented by the following equations:
$$
\begin{aligned}
& B^d: \text { Price }=-0.6 \times \text { Quantity }+1140 \\
& B^{s:} \text { Price }=\text { Quantity }+700
\end{aligned}
$$
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?

Majid Borumand

Numerade Educator

Problem 25

The demand curve and supply curve for one-year discount bonds with a face value of $$\$ 1,000$$ are represented by the following equations:
$$
\begin{aligned}
& B^d: \text { Price }=-0.6 \times \text { Quantity }+1140 \\
& B^s: \text { Price }=\text { Quantity }+700
\end{aligned}
$$
Suppose that, as a result of monetary policy actions, the Federal Reserve sells 80 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 of the Federal Reserve's action on the equilibrium interest rate in this market.

Majid Borumand

Numerade Educator