ch17 - CHAPTER 17 FINANCIAL MARKETS Solutions to Problems...

Info iconThis preview shows pages 1–3. Sign up to view the full content.

View Full Document Right Arrow Icon
CHAPTER 17 FINANCIAL MARKETS Solutions to Problems in the Textbook : Conceptual Problems: 1. Financial markets are markets in which assets are bought and sold. These markets transmit changes in government policies and other macroeconomic disturbances to the rest of the economy. For example, changes in interest rates affect peoples' wealth by changing the prices of stocks and bonds, peoples' ability to finance the purchase of a car or a house, and corporations' ability to finance investments. It is useful to look at financial markets to better understand this transmission mechanism. For example, many economists prefer to look at the flow of funds accounting rather than national income accounting when assessing the performance of the economy. 2. The concept of arbitrage implies that, in equilibrium, prices will make financial investors equally willing to buy or sell an asset. If investors are not equally willing to buy and sell an asset, then there is an opportunity for arbitrage. People buy or sell assets to take advantage of the resulting profit opportunity. But in doing so, they cause prices to adjust up to the point where no further arbitrage opportunity exists. If people always take advantage of profit opportunities, financial markets will always adjust to an equilibrium. 3.a. The expectations theory of the term structure says that long-term interest rates are determined by the average of current and future expected short-term interest rates. If short-term interest rates are higher than long-term interest rates, people must expect that interest rates will decline in the future. 3.b. Generally, interest rates decrease in a recession and increase in a boom. If people are expecting interest rates to decrease, they are probably anticipating a recession. However, this is not always the case. For example, if people expect interest rates to decline because of restrictive fiscal policy, then expectations about an upcoming recession may be warranted. But if they expect that interest rates may decline because of expansionary monetary policy, they should actually expect that the level of output will increase. 3.c. The yield curve shows interest rates for government bonds of different maturities. If short-term interest rates are higher than long-term interest rates, the yield curve is downward sloping as indicated below. yield 14
Background image of page 1

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full Document Right Arrow Icon
0 maturity 4. If stock prices follow a random walk, they cannot be predicted from existing information. Stock price changes only occur if (by surprise) new information becomes available. This implies that even the best-informed financial investors cannot make a killing in the stock market. In other words, either no riskless profit opportunities exits, or all such opportunities have already been taken advantage of. If stock prices did not follow a random walk, financial investors could find ways to reap great benefits by taking advantage of profit opportunities that have not yet been realized by others. 5.
Background image of page 2
Image of page 3
This is the end of the preview. Sign up to access the rest of the document.

{[ snackBarMessage ]}

Page1 / 8

ch17 - CHAPTER 17 FINANCIAL MARKETS Solutions to Problems...

This preview shows document pages 1 - 3. Sign up to view the full document.

View Full Document Right Arrow Icon
Ask a homework question - tutors are online