8. Changes in supply and demand for bonds Identify which side of the bond market is affected by each of the following changes. Change Wealth levels in society Government budget deficits Liquidity of bonds Business expectations Information costs incurred by investors Relative returns on bonds Expected inflation Investment tax treatment Relative riskiness of bonds Supply Demand 00 о Suppose that business expectations in the economy decline. Adjust the following graph to illustrate the effect of the change on the bond market. PRICE QUANTITY Supply Demand Demand Supply

Table 5.1 1 year 2 years З years 1.50% 2.25% 3.25% Table 5.1 shows the interest rates for Treasury securities of different maturities. Assume that the liquidity premium theory is correct. 103) Refer to Table 5.1 On this day, what did investors expect the interest rate to be on the one -year 103) Treasury bill in two years if the term premium on a two-year Treasury note is 0.25%? A) 1.875% B) 2.25% C) 2.375% D) 2.5% 104) Refer to Table 5.1 On this day, what did investors expect the interest rate to be on the one-year Treasury bill in two years if the term premium on a two-year Treasury note is 0.25% and the term premium on a three-year Treasury note is 0.75%? A) 2.375% 104) B) 3.25% C) 3.50% D) 4.75%

1. Microsoft company is considering an investment project which costs $3 million today and it's payoff would be $5 at the end of year 7. If the interest rate is 9%, should Microsoft incest in the new project?  2. Using a graph of money market demonstrate what happens to the value of money and the price level if: a) The Fed sells government bonds in open-market operations. b) A decrease in real GDP decreases the demand for money

4. Bond prices and interest yields Consider a bond without expiration date that makes a fixed interest payment of $90 per year. Complete the following table by calculating the interest rate on the bond at different sale prices. (Hint: The effective interest rate on a bond is a ratio of the interest payment to the sale price of the bond times 100.) Price of Bond (Dollars) 1,200 1,000 750 600 Use the blue points (circle symbol) and the preceding table to plot the relationship between bond prices and interest rates on the following graph. Interest Rate (Percent) Note: Plot your points in the order in which you would like them connected. Line segments will connect the points automatically. 15.0 13.5 12.0 10.5 9.0 7.5 6.0 4.5 3.0 1.5 0 500 Interest Rate (Percent) 7.5 9 600 12 15 700 800 900 1000 1100 1200 1300 Price of Bond (Dollars) Relationship (?) The line showing the relationship between bond prices and interest rates has a other words, there is relationship between bond prices and…

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?

Thank You

7. Draw a yield curve where the short-term interest rate is expected to remain constant in the near term, and then fall later on (use the liquidity preference theory).

11. If a yield curve looks like the one shown in the figure below, what is the market predicting about the movement of future short-term interest rates? What might the yield curve indicate about the market's predictions for the inflation rate in the future? Yield to Maturity Term to Maturity

1. Which do you think would be more harmful to the economy—an inflation rate that averages 5 percent a year that has a high standard deviation or an inflation rate of 7 percent that has a standard deviation close to zero?  2.  Suppose a major bank needs to borrow $20 billion overnight that it cannot obtain from private creditors. The Fed is willing to make a discount loan of $20 billion provided that it will not alter the aggregate supply of reserves to the banking system. How can it do so?

7. Suppose the Federal Reserve wants to stimulate the economy, thereby increasing GDP. Which of the following policy change should be implemented?       Raising the reserve requirement ratio       Sell bonds through open market operations       Lower the discount rate       Only a & c are correct