Question

(a) What will happen to the price of bond and interest rate when there is:

(i) an excess supply of bonds?

(ii) an excess demand for bonds?

Use diagrams to aid your explanation.

(b) (i) Why does the segmented market theory suggest the bonds of different maturities are not substitutes?

(ii) How does the segmented market theory explain the upward sloping curve? ( 7 marks)

Answer #1

Ans

1 supply shifts from so to S1. As a result price falls from p1 to po. Since prices and interest rates are inversely related, interest rate rises

2 demand rises from Do to D1. Consequently price rises from p1 to p2. As a result interest rate falls

3 Because investors match maturity of their assets with liabilities.They do not prefer to invest in assets whose maturity is different from their liabilities

4 Because most investors prefer short term assets. They will hold long term assets only if interest rate in longrun is greater

What is the most important contrast between the segmented
markets theory and the expectations theory
Select one:
a. The expectations theory does a better job of explaining why
yield curves typically are upward-sloping.
b. The expectation theory states that investors view similar
assets that differ only with respect to maturity as perfect
substitutes.
c. The segmented markets theory does a better job of explaining
why yields on instruments of different maturities tend to move
together.
d. The segmented markets theory...

The interest rate is 4% (and this is an equilibrium rate). Show
this with both bond market (demand for and supply of bonds) and
market for money (demand for and supply of money) diagrams. Next,
the Fed increases the supply of money. What are the market
conditions immediately after this action, that is at
i=4%. Is this a good time to be a bond holder? Explain.

5. a. Describe the relationship between the interest rates on
bonds of different maturities.
b. If we follow the Expectation Hypothesis, calculate the
interest rate on a 3-year bond if
a 1-year bond has an interest rate of 2% and is expected to
have an interest rate of 3% next year, and 5% in two years.
c. How does the Liquidity Premium Theory explain an
upward-sloping yield curve during normal economic
environment?
d. Explain the economic implications of an inverted...

a) What would happen to i if the government were to start
running a budget surplus which was used to repay debt/repurchase
government bonds? Explain how you know.
b) When the Fed carries out open market purchases with the
intent of reducing i it generally buys short-term government bonds
(i.e., T-bills). Explain why this will reduce the interest rate on
other types of bonds (e.g., corporate bonds) with different
maturities even though the Fed didn’t buy those bonds. (Think back...

I) For a given change in interest rates, bond prices will
increase more when rates decrease than they will decrease when
rates increase.
II) The curve is steeper for higher interest rates.
III) The curve is always downward sloping.
A)I is incorrect, II, III are correct.
B)I and II are correct, III is incorrect.
C)I, II and III are correct.
D)I, III are correct, II is incorrect.

Lecture 3:
Discuss in words and graphs what will happen to bond prices,
interest rates, and the dollar volume of bonds issued, due to
factors such as: rising inflationary expectation, increased
indebtedness, changes in taxation policies, etc. Think in terms of
both supply and demand.
Explain graphically, how increased government bond issuance
can result in a decrease of corporate bond issuance, and lower
corporate bond prices.

1. According to the new growth theory
the rate of technological progress is determined by chance.
the concept of a labor market is not necessary.
the labor demand curve does not shift rightward over time.
knowledge is not subject to diminishing returns.
2. If a rich country grows at a faster rate than a poor one,
then
the gap in their standard of living will close over time.
the gap in their standard of living will widen over time.
whether...

I would like to know what does owning a bond means ?along
with
Why is the yield curve usually upward when sloping?
what is the vocabulary term for the following
contractual rate of interest due to be paid by the issuer and
received by the bond investor
Owning a bond means

You observe the following market interest rates, for
both borrowing and lending:
One-year rate = 5%
two-year rate = 6%
one-year rate one year from now = 7.25%
How can you take advantage of these rates to earn a riskless
profit? Assume that the Pure Expectation Theory for interest rates
holds.
2. “If bonds of different maturities are close
substitutes, their interest rates are more likely to move
together.” Is this statement true, false, or uncertain? Explain
your answer.

if downward revision of inflation is expected what do we know
about the bond market? if inflation decreases interest rates
decrease if interest decreases price of bond increases bond demand
increases mean price of bond increases so shift demand curve to the
right what do we know about supply? also if supply moves more than
demand quantity decreases if demand moves more than supply quantity
increases. Please tell me if my assumptions are correct and what
else I should know...

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