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Chapter 5: Q.9 (page 164)

How might a sudden increase in people鈥檚 expectations of future real estate prices affect interest rates?

Short Answer

Expert verified

This will lead the bond demand curve to shift to the left, resulting in a decrease in the equilibrium bond price as well as a rise in the interest rate.

Step by step solution

01

Introduction

The amount demanded of an asset is directly related to wealth, expected return on asset, and liquidity of the asset, and negatively proportional to expected return on alternative asset, liquidity of the alternative asset, according to the theory of portfolio choice.

02

Explanation

If future real estate values are expected to rise sharply, the demand for real estate will rise in compared to bond demand, and bond demand would fall as a result.

This will lead the bond demand curve to shift to the left, resulting in a decrease in the equilibrium bond price as well as a rise in the interest rate.

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Most popular questions from this chapter

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?

What will happen to the demand for Rembrandt paintings if the stock market undergoes a boom? Why?

An important way in which the Federal Reserve decreases the money supply is by selling bonds to the public. Using a supply and demand analysis for bonds, show what effect this action has on interest rates. Is your answer consistent with what you would expect to find with the liquidity preference framework?

1. Explain why you would be more or less willing to buy a share of Microsoft stock in the following situations:

a. Your wealth falls.

b. You expect the stock to appreciate in value.

c. The bond market becomes more liquid.

d. You expect gold to appreciate in value.

e. Prices in the bond market become more volatile.

Go to the St. Louis Federal Reserve FRED database, and find data on net worth of households and nonprofits (HNONWRQ027S) and the 10-year U.S. Treasury bond (GS10). For the net worth indicator, adjust the units setting to 鈥淧ercent Change from Year Ago,鈥� and for the 10-year bond, adjust the frequency setting to 鈥淨uarterly.鈥�

a. What is the percent change in net worth over the most recent year of data available? All else being equal, what do you expect should happen to the price and yield on the 10-year Treasury bond? Why?

b. What is the change in yield on the 10-year Treasury bond over the last year of data available? Is this result consistent with your answer to part (a)? Briefly explain.
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