4. Assume that the term premium is 0 and the expectations theory of the term structure is the correct framework. You observe that the interest rate on a 1-year Treasury 1 security is 2%, and the interest rate on a 2-year Treasury security is 4%. What is the market's expectation for 1-year interest rates next year? What does this say about the market's expectations for the future state of the economy?

4. Assume that the term premium is 0 and the expectations theory of the term structure is the correct framework. You observe that the interest rate on a 1-year Treasury 1 security is 2%, and the interest rate on a 2-year Treasury security is 4%. What is the market's expectation for 1-year interest rates next year? What does this say about the market's expectations for the future state of the economy?

MACROECONOMICS

14th Edition

ISBN:9781337794985

Author:Baumol

Publisher:Baumol

Chapter13: Monetary Policy: Conventional And Unconventional

Section: Chapter Questions

Problem 7DQ

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1. f the current interest rate on a 1-year bond is 2.80% while market participants expect a 1-year interest rate of 1.30% next year, then the expectations theory predicts that the interest rate on a 2-year bond will be ___ %: 2. If the current 1-year interest rate is 3% and the current interest rate on a 2-year bond is 4%, what is the expected 1-year rate starting a year from today? 3. You observe that currently, a 1-year bond has an interest rate of 3.00% while a 2-year bond has an interest rate of 3.00%. This means that, according to the expectations theory (no liquidity premium), market participants expect the 1-year interest rate in one year from now to be ___%:
Suppose that the interest rate on a one-year Treasury bill is currently 1%and that investors expect that the interest rates on one-year Treasury bills over thenext three years will be 2%, 3%, and 2%, respectively. Suppose that the expectationshypothesis holds. Calculate the current interest rates on two-year, three-year, andfour-year Treasury notes.
2. Suppose that real money demand is represented by the equation M"/P= 0.25×Y. Calculate the velocity of money. 3. Consider a five year $1000 semiannual coupon bond with a 5% coupon rate. If the bond is current trading for a price of $957.35, what is the bond's yield to maturity? If the bond's yield to maturity increase a little bit, what will the bond's price be? 4. Suppose a 7-year, $1,000 bond with an 8% coupon rate and semianmual coupons is trading with a yield to maturity of 6.75%. Is this bond currently trading at a discount, at par, or at a premium? Explain. If the yield to maturity of the bond rises to 7%, what price will the bond trade for? 5. Suppose that you want to take a loan and that your local bank wants to charge you an annual real interest rate equal to 3%. Assuming that the annualized expected rate of inflation over the life of the bond is 1%, determine the nominal interest rate that the bank will charge you. What happens if, over the life of the loan, actual…
• Suppose that a person’s wealth is $50,000 and that her yearlyincome is $60,000. Also suppose that her money demand functionis given by Md = $Y10.35 - i2Derive the demand for bonds. Suppose the interest rate increases by 10 percentage points. What is the effect on her demand for bonds?What are the effects of an increase in income on her demand for money and her demand for bonds? Explain in words
4. A common rule used for describing the conduct of monetary policy is the Taylor π = r + 0.5 (²-³) + 0.5(π — ñ), where r is the real rate of rule, given by i interest and it is a target rate of inflation. Assume that the real interest rate at full employment to be constant at 2%. Assume also that the same 2% represents target inflation. a. What is the nominal interest rate i when inflation and output are at their equilibrium target level? b. Suppose that the central bank observes a rate of inflation of 4%. With all other variables at the same level. What is the nominal interest rate the central bank would target according to the Taylor rule?
The accompanying graph represents the market for loanable funds in the hypothetical country of Bunko. Assume the market is initially in equilibrium and inflation expectations are 2%. a. Adjust the graph to demonstrate the effects of inflation expectations increasing from 2% to 4%. b. What is the real interest rate after the change in inflation expectations? 3% 2% 7% O 5% Interest rate (%) 10 9 8 7 5 3 2 1 0 0 2 Market for Loanable Funds D 4 6 8 10 12 14 16 Quantity of loanable funds (billions of $) 18 S 20
7. The Federal Reserve has raised the Federal Funds rate by 3.75 percent within the past year. Ifa bank had capital of 10 percent when the Fed began raising rates and has no loans at risk ofdefault, under what circumstances will its capital position be compromised? Please be specific.8. How do rising interest rates affect the size of real estate loans that lenders will advance?Again, be specific.9. Mortgage rates have risen by about 4 percent over the past year. Does that mean that theacceptable minimum appreciation rate for looking at owner housing relative to renting hasrisen by 4 percent? Why or why not? (Hint: think about our analysis of the buy-rent decision).10. You are evaluating a CMBS. Beyond the standard metrics (i.e., LTV, DCI, etc.), name twothings to consider in evaluating the security.
Let's denote the price of a nonmaturing bond (called a consol) as P. The equation that indicates this price is P, =-, where I is the annual net income the bond generates and r is the nominal market interest rate. a. Suppose that a bond promises the holder $200 per year forever. The nominal market interest rate is 6 percent. Calculate the bond's current price: $ 3333. (Round your answer to the nearest whole dollar.) b. Calculate the bond's price, if the market interest rate increases to 12 percent: $. (Round your answer to the nearest whole dollar.)
5. Consider the one-year interest rates known at the following dates:year 0: 2%year 1: 2.5year 2: 3%year 3: 3.5%year 4: 4%year 5: 4.5%year 6: 5%year 7: 5.5%year 8: 6%year 9: 6.5%Using the Expectations Theory, find the interest rates of maturities 1 through 10. Usethe arithmetic average method. What do they suggest about the shape of the yieldcurve? Make sure to show your work.
a) Assume that the nominal return on U.S. government T-bills was 10% during 2002, when the rate of inflation was 6%. The real risk-free rate of return on theseT-bills was: b) When individuals believe they have sufficient income and assets to cover their expenses while maintaining a reserve for uncertainties, they are most likely in the phase of the investment life cycle. gifting B. consolidation C. accumulation D. spending c) Find the duration of a 3-year bond with annual coupon payments of $80 and a par value of $1,000. The current market price of the bond is $950.25. If the YTM of the bond dropped by 1%, what would happen to the bond price?
A plot of the yields on bonds with different terms to maturity but the same risk, liquidity, and tax considerations is known as A. a term-structure curve. B. an interest-rate curve. C. a yield curve. D. a risk-structure curve. Suppose people expect the interest rate on one-year bonds for each of the next four years to be 4%, 4%, 5%, and 8%. If the expectations theory of the term structure of interest rates is correct, then the implied interest rate on bonds with a maturity of four years is %. (Round your response to the nearest whole number). Refer to the figure on your right. Suppose the expected interest rates on one-year bonds for each of the next four years are 4%, 5%, 6%, and 7%, respectively. 1.) Use the line drawing tool (once) to plot the yield curve generated. 2.) Use the point drawing tool to locate the interest rates on the next four years. Carefully follow the instructions above, and only draw the required objects. Interest Rate 1 2- 6- 2 3 Term to Maturity in Years 5 ♫
Assume that the real risk-free rate is r* = 2% and the average expected inflation rate is 3% for each future year. The DRP and LP for Bond X are each 1%, and the applicable MRP is 2%. What is Bond X’s interest rate? Is Bond X (1) a Treasury bond or a corporate bond and (2) more likely to have a 3-month or a 20-year maturity? SHOW WORK AND USE FINANCIAL CALCULATOR