then a better store of value, and you would have been will-
ing to hold more of it.
9. Money loses its value at an extremely rapid rate in hyper-
inflation, so you want to hold it for as short a time as possi-
ble. Thus money is like a hot potato that is quickly passed
from one person to another.
11. Not necessarily. Although the total amount of debt has pre-
dicted inflation and the business cycle better than M1, M2,
or M3, it may not be a better predictor in the future. Without
some theoretical reason for believing that the total amount of
debt will continue to predict well in the future, we may not
want to define money as the total amount of debt.
13. M1 contains the most liquid assets. M3 is the largest measure.
15. Revisions are not a serious problem for long-run movements
of the money supply, because revisions for short-run (one-
month) movements tend to cancel out. Revisions for long-
run movements, such as one-year growth rates, are thus
typically quite small.
Chapter 4
Understanding Interest Rates
1. Less. It would be worth 1/(1
1
0.20)
5
$0.83 when the
interest rate is 20%, rather than 1/(1
1
0.10)
5
$0.91 when
the interest rate is 10%.
3. $1,100/(1
1
0.10)
1
$1,210/(1
1
0.10)
2
1
$1,331/(1
1
0.10)
3
5
$3,000.
5. $2,000
5
$100/(1
1
i
)
1
$100/(1
1
i
)
2
1
. . .
1
$100/(1
1
i
)
20
1
$1,000/(1
1
i
)
20
.
7. 14.9%, derived as follows: The present value of the $2 million
payment five years from now is $2/(1
1
i
)
5
million, which
equals the $1 million loan. Thus 1
5
2/(1
1
i
)
5
. Solving for
i,
(1
1
i
)
5
5
2, so that
i
5
5
2
1
5
0.149
5
14.9%.
9. If the one-year bond did not have a coupon payment, its
yield to maturity would be ($1,000
2
$800)/$800
5
$200/$800
5
0.25
5
25%. Since it does have a coupon pay-
ment, its yield to maturity must be greater than 25%.
However, because the current yield is a good approximation
of the yield to maturity for a 20-year bond, we know that the
yield to maturity on this bond is approximately 15%.
Therefore, the one-year bond has a higher yield to maturity.
11. You would rather own the Treasury bill, because it has a
higher yield to maturity. As the example in the text indicates,
the discount yield’s understatement of the yield to maturity
for a one-year bond is substantial, exceeding one percentage
point. Thus the yield to maturity on the one-year bill would
be greater than 9%, the yield to maturity on the one-year
Treasury bond.
13. No. If interest rates rise sharply in the future, long-term
bonds may suffer such a sharp fall in price that their return
might be quite low; possibly even negative.
15. The economists are right. They reason that nominal interest
rates were below expected rates of inflation in the late 1970s,
making real interest rates negative. The expected inflation
rate, however, fell much faster than nominal interest rates in
the mid-1980s, so nominal interest rates were above the
expected inflation rate and real rates became positive.
Chapter 5