Question

The market forces in financial markets are determining that all asset yields (interest rates) are equal to 5% a year. A government bond issued today pays $10,000 a year for each of the next three years, and therefore, the price of the bond today is approximately $27,232.50. Suppose that you are the governor of the Reserve Bank of Australia and you want to reduce the interest rate to 2% implementing yield-curve control policy. What would you do?

a. Buy any quantity of bonds at the prevailing price.

b. Buy 50% of the stock of bonds.

c. Increase the supply of 3-year government bonds to reduce the price of the bonds.

d. Buy any quantity of bonds at $28,838.83 per bond.

e. Sell any quantity of bonds at $28,838.83 per bond.

Answer #1

At the price of $27,232.50 the YTM of the bond is 5% and at bond price of $28,838.83 , YTM of the bond is 2%.

As the governor of the Reserve Bank of Australia if I want to reduce the interest rate to 2% implementing yield-curve control policy , we will issue more bonds at the revised rate of 2% which will give indication to the market that the interest rates in the economy are going down yield curve will settle at 2%.

Correct answer is option e.

Sell any quantity of bonds at $28,838.83 per bond

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