Theory of Money

Homework Assignments
ECON 160
Question 6.13
According to the expectations theory of the
term structure, it is better to invest in one-
year bonds, reinvested over two years, than to
invest in a two-year bond, if interest rates on
one-year bonds are expected to be the same
in both years. Is this statement true, false or
uncertain?
Question 6.14
If bond investors decide that 30-year bonds
are no longer as desirable an investment,
predict what will happen to the yield curve,
assuming
The Unbiased Expectations Theory of the term
structure holds.
The Segmented Markets Theory of the term
structure holds.
Question 6.15
Suppose the interest rates on one, five and
ten year US Treasury bonds are currently 3%,
6% and 6%, respectively. Investor A chooses
to hold only one year bonds and Investor B is
indifferent with regard to holding five and ten
year bonds. How can you explain the
behavior of Investors A and B?

Question 6.23
Assuming that the Unbiased Expectations Theory
is the correct theory of the term structure,
calculate the interest rates in the term structure
for maturities of one to five years, and plot the
resulting yield curves for the following paths of
one year interest rates over the next five years.
5%, 7%, 7%, 7%, 7%
5%, 4%, 4%, 4%, 4%
How would your yield curves change if people
preferred shorter term bonds to longer term
bonds?

Question 6.24
Assuming that the Unbiased Expectations Theory
is the correct theory of the term structure,
calculate the interest rates in the term structure
for maturities of one to five years, and plot the
resulting yield curves for the following paths of
one year interest rates over the next five years:
5%, 6%, 7%, 6%, 5%
5%, 4%, 3%, 4%, 5%
How would your yield curves change if people
preferred shorter term bonds to longer term
bonds?
Question
A bond with a one year maturity has a return of
2%, while a bond with a two year maturity has
return of 4%.
According to the Unbiased Expectations Theory (UET),
what is the expected yield on a one year maturity
bond in year two?
Market expectations point to a one year maturity
bond in year two that is equal to 5.5%. What is the
liquidity premium in year two?
Using the same information, what is the liquidity
premium in year two if the expectation for a one year
maturity bond in year two is 6% (
Question 18.14
You often read in the newspaper that the Fed
has just lowered the discount rate. Does this
signal that the Fed is moving toward a more
expansionary monetary policy? Why or why
not?
Question 18.15
How can the procyclical movement of interest
rates (rising during business cycle expansions
and falling during business cycle contractions)
lead to a procyclical movement in the money
supply as a result of the Fed discount loans?
Why might this movement of the money
supply be undesirable?
Question 18.25
Using the supply and demand analysis of the market for reserves, indicate
what happens to the federal funds rate, borrowed reserves, and
nonborrowed reserves, holding everything else constant, under the
following situations. (Keep in mind that the Fed sets the Required Reserve
Ratio as a percentage of a banks total deposits).
a) The economy is surprisingly strong, leading to an increase in the amount of
checkable deposits (required reserve ratio.
b) Banks expect an unusually large increase in withdrawals from checking
deposit accounts in the future.
c) The Fed raises the target federal funds rate (through open market
operations).
d) The Fed raises the interest rate on reserves above the current equilibrium
federal funds rate.
e) The Fed reduces reserve requirements.
f) The Fed reduces reserve requirements and sterilizes this by conducting an
open market sale of securities. (The term sterilize means to leave the FFR
unchanged).