Figure 4 5 illustrates the effect of an increased

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80) Figure 4-5 illustrates the effect of an increased rate of money supply growth. From the figure, one can conclude that the A) liquidity effect is smaller than the expected inflation effect and interest rates adjust quickly to changes in expected inflation. B) liquidity effect is larger than the expected inflation effect and interest rates adjust quickly to changes in expected inflation. C) liquidity effect is larger than the expected inflation effect and interest rates adjust slowly to changes in expected inflation. D) liquidity effect is smaller than the expected inflation effect and interest rates adjust slowly to changes in expected inflation. Answer: C 81) Figure 4-5 illustrates the effect of an increased rate of money supply growth. From the figure, one can conclude that the 4.2 True/False 1) When interest rates change, the demand curve for bonds shifts to the left. Answer: FALSE 2) When an economy grows out of a recession, normally the demand for bonds increases and the supply of bonds increases. Answer: TRUE 53 3) When the federal government’s budget deficit decreases, the demand curve for bonds shifts to the right. Answer: FALSE 4) When the price level falls, the demand curve for money shifts to the left and the interest rate falls. Answer: TRUE 5) When the Federal Reserve increases the money stock, the money supply curve shifts to the left and the interest rate falls. Answer: FALSE 6) When the growth rate of the money supply increases, interest rates end up being permanently higher if the expected inflation effect is larger than the liquidity effect. Answer: TRUE 7) When income and wealth are rising, the demand for bonds rises and the demand curve shifts to the right. Answer: TRUE 8) An increase in the inflation rate will cause the demand curve for bonds to shift to the right. Answer: FALSE 9) In Keynes’ liquidity preference framework, individuals are assumed to hold their wealth in the form of money and bonds. Answer: TRUE 10) An increase in the money supply will always lower interest rates. Answer: FALSE 4.3 Essay 1) Distinguish between interest rates, yield to maturity, and current yield. 2) Describe the cash flows received from ownership of a coupon bond. What are the sources of income? 3) What concept is used to value a bond? 4) Why are long-term bonds more risky than short-term bonds? 5) What is interest rate risk and how is it measured? 6) Explain why interest rates may rise when money supply growth increases. 54
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