Answers+to+Selected+Questions+and+Problems_Homework+3_ -...

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The demand curve B d will shift to the left, the price falls, and the equilibrium interest rate will rise. Chapter 6 The Risk and Term Structure of Interest Rates 2. U.S. Treasury bills have lower default risk and more liquid- ity than negotiable CDs. Consequently, the demand for Treasury bills is higher, and they have a lower interest rate. 4. True. When bonds of different maturities are close substi- tutes, a rise in interest rates for one bond causes the interest rates for others to rise because the expected returns on bonds of different maturities cannot get too far out of line. 6. (a) The yield to maturity would be 5% for a one-year bond, 6% for a two-year bond, 6.33% for a three-year bond, 6.5% for a four-year bond, and 6.6% for a five-year bond. (b) The yield to maturity would be 5% for a one-year bond, 4.5% for a two-year bond, 4.33% for a three-year bond, 4.25% for a four-year bond, and 4.2% for a five-year bond. The upward- sloping yield curve in (a) would be even steeper if people preferred short-term bonds over long-term bonds, because long-term bonds would then have a positive liquidity pre- mium. The downward-sloping yield curve in (b) would be less steep and might even have a slight positive upward slope if the long-term bonds have a positive liquidity premium. 8. The flat yield curve at shorter maturities suggests that short- term interest rates are expected to fall moderately in the near future, while the steep upward slope of the yield curve at longer maturities indicates that interest rates further into the future are expected to rise. Because interest rates and expected inflation move together, the yield curve suggests that the market expects inflation to fall moderately in the near future but to rise later on. 10. The reduction in income tax rates would make the tax- exempt privilege for municipal bonds less valuable, and they would be less desirable than taxable Treasury bonds. The resulting decline in the demand for municipal bonds and increase in demand for Treasury bonds would raise interest rates on municipal bonds while causing interest rates on Treasury bonds to fall. 12. Lower brokerage commissions for corporate bonds would make them more liquid and thus increase their demand, which would lower their risk premium. 14. You would raise your predictions of future interest rates, because the higher long-term rates imply that the average of the expected future short-term rates is higher. Chapter 7 The Stock Market, the Theory of Rational Expectations, and the Efficient Market Hypothesis 2. There are two cash flows from stock, periodic dividends and a future sales price. Dividends are frequently changed when firm earnings either rise or fall. The future sales price is also difficult to estimate, since it depends on the dividends that will be paid at some date even farther in the future. Bond cash flows also consist of two parts, periodic interest pay- ments and a final maturity payment. These payments are established in writing at the time the bonds are issued and
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This note was uploaded on 03/23/2011 for the course ECON 301 taught by Professor Hassan during the Spring '08 term at Rutgers.

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Answers+to+Selected+Questions+and+Problems_Homework+3_ -...

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