Question

The market forces in financial markets are determining that all asset yields (interest rates) are equal...

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.

Homework Answers

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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