ps3f09 - Econ 340, Fall 2009 Problem Set 3 Chapter 4:...

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Econ 340, Fall 2009 Problem Set 3 Chapter 4 : Questions 6, 11; 6. When the Fed sells bonds to the public, it increases the supply of bonds, thus shifting the supply curve B s (S 1 in the figure) to the right. At the old equilibrium price, P 1 , there is now excess supply of bonds measured by the distance AB= Q’’-Q 1 , in the figure below. An excess supply of bonds causes bond prices to fall. Because the price of a bond is just the present value of all future cash payments, and those cash payments are fixed, the falling bond price implies an increase in the yield to maturity on the bond. The new equilibrium bond price is shown as P 2 in the figure below. Thus, as the Fed reduces the supply of money by increasing its sale of bonds, market interest rates rise. 11. We know from the theory of asset demand that investors do not like risk. Therefore, an increased riskiness of bonds will reduce the demand for bonds. The demand curve shifts to the left. At the old equilibrium price, P 1 , there is now excess supply of bonds measured by the distance AB= Q’’-Q 1 , in the figure. An excess supply of bonds causes bond prices to fall. Because the price of a bond is just the present
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This note was uploaded on 02/07/2010 for the course ECON 101 taught by Professor Garton during the Spring '10 term at Edison College.

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ps3f09 - Econ 340, Fall 2009 Problem Set 3 Chapter 4:...

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