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Chapter 5: Q.11 (page 164)

In the aftermath of the global economic crisis that started to take hold in 2008, U.S. government budget deficits increased dramatically, yet interest rates on U.S. Treasury debt fell sharply and stayed low for quite some time. Does this make sense? Why or why not?

Short Answer

Expert verified

The interest rate fell because the leftward movement of a supply curve was greater than the leftward movement of a demand curve.

Step by step solution

01

Introduction

A bond is a financial instrument issued by a company in exchange for interest on the bond. Entity uses to fund its operations. The bond's return might be either fixed or variable.

02

Explanation

As a result of the economic crisis, the government's budget deficit expanded dramatically, raising the bond's risk, lowering demand and shifting the demand curve to the left. However, the economic crisis limited investment prospects, significantly reducing bond supply and shifting the supply curve of bonds to the left. The leftward movement of the supply curve was greater than the leftward movement of the demand curve, resulting in a price increase and a reduction in interest rates. Furthermore, the risk that the economic crisis poses to other security markets made the bond market appear safer than other assets, boosting demand for the bond.

The interest rate fell because the leftward movement of a supply curve was greater than the leftward movement of a demand curve.

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Most popular questions from this chapter

The demand curve and supply curve for one-year discount bonds with a face value of$1000are represented by the following equations:

Bd:Price=-0.8脳Quantity+1100Bs:Price=Quantity+680

a. What is the expected equilibrium price and quantity of bonds in this market?

b. Given your answer to part (a), what is the expected interest rate in this market?

If the next chair of the Federal Reserve Board has a reputation for advocating an even slower rate of money growth than the current chair, what will happen to interest rates? Discuss the possible resulting situations.

Suppose Maria prefers to buy a bond with a 7% expected return and 2% standard deviation of its expected return, while Jennifer prefers to buy a bond with a 4% expected return and 1% standard deviation of its expected return. Can you tell if Maria is more or less risk-averse than Jennifer?

Suppose you visit with a financial adviser, and you are considering investing some of your wealth in one of three investment portfolios: stocks, bonds, or commodities. Your financial adviser provides you with the following table, which gives the probabilities of possible returns from each investment.

a. Which investment should you choose to maximize your expected return: stocks, bonds, or commodities?

b. If you are risk-averse and had to choose between the stock and the bond investments, which would you choose? Why?

The demand curve and supply curve for one-year discount bonds with a face value of $1050are represented by the following equations:Bd:Price=-0.8脳Quantity+1160Bs:Price=Quantity+720Suppose that, as a result of monetary policy actions, the Federal Reserve sells 90 bonds that it holds. Assume that bond demand and money demand are held constant.

a. How does the Federal Reserve policy affect the bond supply equation? b. Calculate the effect on the equilibrium interest rate in this market, as a result of the Federal Reserve action.
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