US Treasury yield curve is plotted in the following graph: INTEREST RATE (%) 6 5 0 5 10 15 20 25 YEARS TO MATURITY 30 sed on an upward-sloping normal yield curve as shown, which of the following statements is correct? O Pure expectations theory must be correct. If the pure expectations theory is correct, future short-term rates are expected to be higher than current short-term rates. There is a positive maturity risk premium. O Inflation must be expected to increase in the future.

Use the table of data to answer the following question: Table 17.3 Nominal interest rate 7% Inflation rate 1.5% Risk premium 1% Suppose you have the option to purchase for $955 a two-year old bond with a $1,000 face value and one year left that has a coupon rate of 8-percent, or, purchase a new one-year bond for $1,000. What should you do? O a. Purchase used bond because the real interest rate is higher than the new bond's real interest rate. O b. Purchase new bond because the real interest rate is higher than the used bond's real interest rate. OC There is not enough information to determine the best investment option. O d. Purchase either bond because the real interest rate is the same for both options.

12. Inflation-induced tax distortions Loc receives a portion of his income from his holdings of interest-bearing U.S. government bonds. The bonds offer a real interest rate of 4.5% per year. The nominal interest rate on the bonds adjusts automatically to account for the inflation rate. The government taxes nominal interest income at a rate of 10%. The following table shows two scenarios: a low-inflation scenario and a high- inflation scenario. Given the real interest rate of 4.5% per year, find the nominal interest rate on Loc's bonds, the after-tax nominal interest rate, and the after-tax real interest rate under each inflation scenario. Inflation Rate Real Interest Rate Nominal Interest Rate After-Tax Nominal Interest Rate After-Tax Real Interest Rate (Percent) (Percent) (Percent) (Percent) (Percent) 3.5 4.5 8.5 4.5 Compared with lower inflation rates, a higher inflation rate will nominal interest income. This tends to the economy's long-run growth rate. saving, thereby the after-tax…

2. The inflation-unemployment relationship The following graph shows the combinations of unemployment and inflation that existed in the United States for selected years between 1961 and 1969. Click on any blue point (circle symbol) on the graph to get its exact coordinates. You can also use the black point (cross symbol) to find the coordinates of other points along the curve. (Note: You will not be graded for any adjustments made to the graph.) INFLATION RATE (Percent) 1969 5.2 4.5 1988 85 1967 20 1.5 10 0.5 1960 1984 1963 1981 0 2.0 3.5 40 4.5 5.0 5.5 GO 4.5 7.0 UNEMPLOYMENT RATE (Percent)