Question

3. Corporations and banks become face failure when find they cannot sell their debt at less than confiscatory rates. Federal “bailouts” usually involve guarantees to pay creditors if the distressed organizations become bankrupt. Show the effects of the guarantees on the interest rates of bonds issued by these distressed companies. (draw graphs)

4. Show and explain how Christmas effects bond prices and money market interest rates.(draw graphs)

Answer 1

(3)

A bailout guarantee boosts investor confidence, which increases the demand for bonds. The bond demand curve shifts to right, increasing both price and quantity of bonds. Bond price and interest rate being inversely related, higher bond price decreases interest rate.

In following graph, D0 and S0 are initial bond demand and supply curves, intersecting at point A with initial price P0 and quantity of bonds Q0. When D0 shifts right to D1, it intersects S0 at point B with higher price P1 and higher quantity Q1.

(4)

During Christmas, consumer spending rises, which decreases the demand for bonds. The bond demand curve shifts to left, decreasing both price and quantity of bonds. Bond price and interest rate being inversely related, lower bond price increases interest rate.

In following graph, D0 and S0 are initial bond demand and supply curves, intersecting at point A with initial price P0 and quantity of bonds Q0. When D0 shifts left to D1, it intersects S0 at point B with lower price P1 and lower quantity Q1.

In money market, (transaction) demand for money increases during Christmas. The money demand curve shifts right, increasing interest rate.

In following graph, MD0 and MS0 are initial money demand and supply curves, intersecting at point A with initial interest rate r0 and quantity of money M0. When MD0 shifts right to MD1, it intersects MS0 at point B with higher interest rate r1.