Question 1

Consider a one-year bond with a principal value of $100 and a coupon value of $5. Which of the following statements is false?

Accepted Answer

When the market interest rate is higher than the coupon rate, the bond is traded at a discount, not with a capital gain. Capital gain would imply the bond's value has increased, which is not the case here.

Question 2

Consider a three-year bond with a principal amount of $5,000 and a 3% coupon rate paid annually. If this bond is sold one year from maturity, it will sell for _______(rounded to the nearest dollar) in the bond market, if current interest rates are 5%.

Accepted Answer

The bond will sell for a price that equals the present value of its future cash flows, which include the final year's coupon payment and the principal repayment. The future cash flows are $150 (3% of $5,000) as the coupon payment and $5,000 as the principal repayment. Using a discount rate of 5% (the current interest rate), the present value calculation is: PV = $150 / (1 + 0.05) + $5,000 / (1 + 0.05) = $142.86 + $4,761.90 ≈ $4,905. This is rounded to the nearest dollar.

Question 3

Consider a three-year bond with a principal amount of $5,000 and a 4% coupon rate paid annually. If this bond is sold one year from maturity, it will sell for _________ (rounded to the nearest dollar) in the bond market if current interest rates are 5%.

Accepted Answer

The bond will sell for a price that equals the present value of its future cash flows, which include the final year's coupon payment and the principal repayment. The coupon payment is $5,000 * 4% = $200. The cash flows in one year will be $200 (coupon) + $5,000 (principal) = $5,200. Discounting this back to the present value at the current interest rate of 5% gives: $5,200 / (1 + 0.05)^1 = $4,952 (rounded to the nearest dollar).

Question 4

Consider a three-year bond with a principal amount of $5,000 and a 4% coupon rate paid annually. If this bond is sold today, it will sell for _________ (rounded to the nearest dollar) in the bond market if current interest rates are 5%.

Accepted Answer

The bond's price can be calculated using the present value of its future cash flows, which include the annual coupon payments and the principal amount at maturity. The formula for the present value of an annuity (the coupon payments) plus the present value of a lump sum (the principal repayment) is used. Given a 4% coupon rate on a $5,000 bond, the annual coupon payment is $200. Using a discount rate of 5% (the current interest rate), the calculation is as follows: Present Value of Coupons = $200 * [(1 - (1 + 0.05)^-3) / 0.05] = $200 * 2.7232 = $544.64 Present Value of Principal = $5,000 / (1 + 0.05)^3 = $5,000 / 1.157625 = $4,319.47 Total Present Value = $544.64 + $4,319.47 = $4,864.11, which rounds to $4,864.

Question 5

One year before maturity, the price of a bond with a principal amount of $1,000 and a coupon rate of 5% paid annually was $981.31. Therefore, the market-interest rate in one year before maturity was:

Accepted Answer

The answer of One year before maturity, the price of...

Question 6

One year before maturity, the price of a bond with a principal amount of $1,000 and a coupon rate of 5% paid annually was $1,019.42. Therefore, the market interest rate in one year from maturity was:

Accepted Answer

The bond's price of $1,019.42 reflects a discount rate that equates the present value of the bond's cash flows (coupon payment of $50 and principal of $1,000) to its price. Solving for the discount rate gives a market interest rate of approximately 3%.

Question 7

Antonio holds a two-year bond issued by Jetson Corp with a principal amount of $10,000. The annual coupon rate is 6 percent. After receiving the first coupon payment, Antonio sold this bond at a price of $10,000. Immediately after selling the bond, he observed that the market interest rate increased. Therefore, Antonio could conclude:

Accepted Answer

When market interest rates increase, the prices of existing bonds decrease because new bonds are issued at the higher current interest rate, making the lower-rate existing bonds less attractive. Therefore, if Antonio observed an increase in market interest rates immediately after selling his bond, he could conclude that the bond's price decreased in the market.

Question 8

The demand for money does not include:

Accepted Answer

Investment demand refers to the demand for physical capital or financial investments, not the demand for money itself. Transactions, precautionary, and asset demands are all reasons why people hold money.

Question 9

The demand for money balances is part of:

Accepted Answer

The demand for money balances is primarily related to how individuals and institutions decide to allocate their financial assets, particularly between holding liquid assets (money balances) and investing in less liquid forms of assets like bonds. This involves considerations of liquidity preference, interest rates, and expectations about future financial market conditions.

Question 10

Your portfolio diversified between money and bond-holdings:

Accepted Answer

Diversifying a portfolio between money and bond holdings is a strategy aimed at reducing the overall risk of the portfolio. Money holdings (such as cash or cash equivalents) are typically very low risk, while bonds can offer higher returns but with increased risk. By balancing the two, an investor can mitigate the risk of their portfolio while still aiming for a reasonable return.

Question 11

If portfolio managers and private individuals expect market interest rates will rise in the near future, they will:

Accepted Answer

When market interest rates are expected to rise, the value of existing bonds (which have fixed interest rates) will decrease. To avoid losses, portfolio managers and private individuals would likely sell their bonds before the rates rise, shifting their portfolios from bonds to money or other assets not adversely affected by rising interest rates.

Question 12

In times of relative tranquility in economic and political conditions:

Accepted Answer

In times of relative tranquility in economic and political conditions, there is less uncertainty, so people feel less need to hold money as a hedge against economic uncertainty, leading to a decrease in the demand for money balances for this purpose.

Question 13

Suppose, the aggregate demand for money-holding is L = 0.25Y - 100i, where Y is the real GDP and i is the interest rate. In this equation:

Accepted Answer

The coefficient 0.25 in front of Y represents the fraction of real GDP that people wish to hold for transactions and precautionary reasons, indicating the sensitivity of money demand to changes in income.

Question 14

Suppose, the aggregate demand for money-holding is L = 0.25Y - 100i, where Y is the real GDP and i is the interest rate. When we draw the above money demand function with interest rate in the vertical axis, we can see one of the following outcomes:

Accepted Answer

DB) When the real money-balance-fraction increases from 0.25 to 0.50, it means that for a given level of income, people want to hold more money. This increases the demand for money at every interest rate, shifting the money demand curve to the right.D) The given function shows that the demand for money is inversely related to the interest rate (as indicated by the -100i term). When the interest rate increases, the cost of holding money (in terms of foregone interest) increases, leading to a decrease in the quantity of money demanded. This does not shift the money demand curve itself but moves along it. However, since the question's phrasing might suggest how the relationship between interest rate and money demand is visualized in terms of curve movement, it's important to clarify that an increase in interest rates is associated with a movement up along the curve, not a shift. The correct interpretation of how these dynamics are typically discussed in economics would be that higher interest rates lead to lower money demand, but the curve itself does not shift due to changes in the interest rate.

Question 15

The demand for real money balances rises when:

Accepted Answer

The demand for real money balances increases when the interest rate falls (making holding money more attractive compared to other investments), when real income rises (increasing transactions that require money), and when the real cash balance fraction increases (indicating a preference for holding more money).

Question 16

When the quantity of real money holdings falls this is often in response to interest rates:

Accepted Answer

When interest rates rise, the opportunity cost of holding money increases because individuals and businesses can earn more by saving or investing their money. Therefore, they are likely to hold less cash and more interest-bearing assets, leading to a decrease in the quantity of real money holdings.

Question 17

The demand for money balances is negatively related to the interest rate because a decline in the interest rate:

Accepted Answer

The demand for money balances is negatively related to the interest rate because a lower interest rate decreases the opportunity cost of holding money (which earns little to no interest) compared to investing in other assets that could potentially yield higher returns. Therefore, when interest rates fall, the cost of holding money instead of other assets decreases, making it more attractive to hold money balances.

Question 18

Suppose, the aggregate demand for money-holding is L = kY - hi, where Y is the real GDP, k is the real balance fraction, i is the interest rate and h is the extent by which interest rate affects money demand. We can conclude:

Accepted Answer

The given equation L = kY - hi shows that as h (interest coefficient) increases, the sensitivity of money demand to changes in the interest rate increases, making the curve flatter, not steeper. An increase in k (real cash balance fraction) shifts the money demand curve outward but does not affect its steepness. An increase in Y shifts the curve outward as well, without affecting its steepness. Therefore, none of the statements A, B, or C correctly describe the effects on the steepness of the money demand curve.

Question 19

Suppose, the aggregate demand for money-holding is L = kY - hi, where Y is the real GDP, k is the real balance fraction, i is the interest rate and h is the extent by which interest rate affects money demand. We can conclude:

Accepted Answer

Explanation: The equation L = kY - hi shows that the demand for money is directly proportional to the real GDP (Y) and inversely proportional to the interest rate (i). An increase in k (real cash balance fraction) means that for any given level of Y, people want to hold more money. This increases the demand for money at all levels of income, leading to a parallel rightward shift of the money demand curve. Increases in the interest-sensitivity (h) or changes in Y and i do not cause a parallel shift; instead, they change the slope or position based on the level of i and Y, respectively.

Question 20

The overall quantity of money balances demanded:

Accepted Answer

The answer of The overall quantity of money balances demanded:
...

Quiz 9: Financial Markets, Interest Rates, Foreign Exchange Rates & AD

Consider a one-year bond with a principal value of $100 and a coupon value of $5. Which of the following statements is false?

Consider a three-year bond with a principal amount of $5,000 and a 3% coupon rate paid annually. If this bond is sold one year from maturity, it will sell for _______(rounded to the nearest dollar) in the bond market, if current interest rates are 5%.

Consider a three-year bond with a principal amount of $5,000 and a 4% coupon rate paid annually. If this bond is sold one year from maturity, it will sell for _________ (rounded to the nearest dollar) in the bond market if current interest rates are 5%.

Consider a three-year bond with a principal amount of $5,000 and a 4% coupon rate paid annually. If this bond is sold today, it will sell for _________ (rounded to the nearest dollar) in the bond market if current interest rates are 5%.

One year before maturity, the price of a bond with a principal amount of $1,000 and a coupon rate of 5% paid annually was $981.31. Therefore, the market-interest rate in one year before maturity was:

One year before maturity, the price of a bond with a principal amount of $1,000 and a coupon rate of 5% paid annually was $1,019.42. Therefore, the market interest rate in one year from maturity was:

The demand for money does not include:

The demand for money balances is part of:

Your portfolio diversified between money and bond-holdings:

If portfolio managers and private individuals expect market interest rates will rise in the near future, they will:

In times of relative tranquility in economic and political conditions:

Suppose, the aggregate demand for money-holding is L = 0.25Y - 100i, where Y is the real GDP and i is the interest rate. In this equation:

Suppose, the aggregate demand for money-holding is L = 0.25Y - 100i, where Y is the real GDP and i is the interest rate. When we draw the above money demand function with interest rate in the vertical axis, we can see one of the following outcomes:

The demand for real money balances rises when:

When the quantity of real money holdings falls this is often in response to interest rates:

The demand for money balances is negatively related to the interest rate because a decline in the interest rate:

Suppose, the aggregate demand for money-holding is L = kY - hi, where Y is the real GDP, k is the real balance fraction, i is the interest rate and h is the extent by which interest rate affects money demand. We can conclude:

Suppose, the aggregate demand for money-holding is L = kY - hi, where Y is the real GDP, k is the real balance fraction, i is the interest rate and h is the extent by which interest rate affects money demand. We can conclude:

The overall quantity of money balances demanded: