Question 3.( Diagram nesscesary) a. What is the distinction between Real and Nominal Interest rates?

b. Suppose we have an equilibrium in the bonds market with a given expected inflation (he). If inflation rate increases, What will happen to the demand and supply of bonds? Would you be able to say for sure (i.e. with certainty) what will happen to the price of bonds and what will be the quantity bought and sold? Why or why not?

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Beverley SmithLv2

11 Jun 2018

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Question 1.

a. What is the difference between interest rates and returns on a bond? Is the RET equal to the interest rate? Why or Why not?

b. What would be the rate of return on a coupon bond bought at face value of $1000 today( with a coupon rate of 15%) and sold for $1200 one year later ?

c. What is the method to calculate the rate of Capital Gain (g)? Is there a capital gain or loss in the above cae? How much?

Question 2.

Explain why you would be more or less willing to buy long-term Government bonds under the following scenarios: Use a demand and supply analysis for bonds, with a given initial equilibrium in the bonds market. ( Diagram necessary)

a.Trading in these bonds increases, making them easier to sell.

b.Relative risk of these bonds compared to other types falls

c.Suppose government has a surplus

Question 3.( Diagram nesscesary)

a. What is the distinction between Real and Nominal Interest rates?

b. Suppose we have an equilibrium in the bonds market with a given expected inflation (he). If inflation rate increases, What will happen to the demand and supply of bonds? Would you be able to say for sure (i.e. with certainty) what will happen to the price of bonds and what will be the quantity bought and sold? Why or why not?

Consider the following demand equation for money.

(M/P)^d = kY

a) In words, explain what the velocity of money is.

b) Let the supply of (real) money be given by M/P. Using the money demand equation, solve for the velocity of money.

c) Suppose that real GDP is expected to grow 3% over the next year and k is constant. What is the expected rate of inflation if the Fed holds the money supply constant?

d) Suppose that the Fed (Federal Reserve) targets inflation to be 2% over the coming year. What should be the targeted growth rate of the money supply?

e) Suppose that growth in real GDP ends up being 1%. Assuming the Fed carries out its open market operations, expecting a growth rate of 3%, what will happen to the rate of inflation?

f) Is there reason to think that demand for money should be a function of the nominal interest rate? Why?

g) Modify the money demand equation that is given to include the nominal interest rate.

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1. State whether you agree or disagree with the following statements and explain why?

a. When the real economy expands (Y rises), the demand for money expands. As a result, households hold more cash and the supply of money expands.

b. Inflation, a rise in the price level, causes the demand for money to decline. Because inflation causes money to be worthless, households desire to hold less of it.

c. If the Fed buys bonds in the open market and at the same time we experience a recession, interest rates will no doubt rise.