Ch 4 - Answers to End-of-Chapter Questions 1. a. b. c. d....

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Answers to End-of-Chapter Questions 1. a. Less, because your wealth has declined; b. more, because its relative expected return has risen; c. less, because it has become less liquid relative to bonds; d. less, because its expected return has fallen relative to gold; e. more, because it has become less risky relative to bonds. 2. a. More, because your wealth has increased; b. more, because it has become more liquid; c. less, because its expected return has fallen relative to Polaroid stock; d. more, because it has become less risky relative to stocks; e. less, because its expected return has fallen. 3. True, because the benefits to diversification are greater for a person who cares more about reducing risk. 4. Purchasing shares in the pharmaceutical company is more likely to reduce my overall risk because the correlation of returns on my investment in a football team with the returns on the pharmaceutical company shares should be low. By contrast, the correlation of returns on an investment in a football team and an investment in a basketball team are probably pretty high, so in this case there would be little risk reduction if I invested in both. 5. True, because for a risk averse person, more risk, a lower expected return and less liquidity make a security less desirable. 6. When the Fed sells bonds to the public, it increases the supply of bonds, thus shifting the supply curve B s to the right. The result is that the intersection of the supply and demand curves B s and B d occurs at a lower equilibrium bond price and thus a higher equilibrium interest rate, and the interest rate rises. 7. When the economy booms, the demand for bonds increases: the public’s income and wealth rises while the supply of bonds also increases, because firms have more attractive investment opportunities. Both the supply and demand curves ( B d and B s ) shift to the right, but as is indicated in the text, the demand curve probably shifts less than the supply curve so the equilibrium interest rate rises. Similarly, when the economy enters a recession, both the supply and demand curves shift to the left, but the demand curve shifts less than the supply curve so that the bond price rises and the interest rate falls. The conclusion is that bond prices fall and interest rates rise during booms and fall during recessions:
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Ch 4 - Answers to End-of-Chapter Questions 1. a. b. c. d....

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