1) True, false or uncertain:

 

A) (5 points) “Because corporations do not actually raise any funds in secondary markets, they are less important to the economy than primary markets are.”

 

 

B) (5 points) “The bondholder is worse off when the yield to maturity increases.”

 

2: (15 points) How does risk sharing benefit both financial intermediaries and private investors? Explain with numerical examples.

 

 

3) (15 points) Using the supply and demand for bonds or liquidity preferences framework, predict what will happen to interest rates if the public believes Chair of the Federal Reserve when she announces that she will implement a new anti-inflation program.

 

4: (15 points) In the aftermath of the global economic crisis that started to take hold in 2008, US government budget deficit increased dramatically. However, the interest rates on US treasury debt fell sharply and stayed low for quite some time. How can you explain this using supply and demand for bonds framework?

 

5: (20 points) Consider a bond with a 7% annual coupon and a face value of $1000. Complete the following table. What relationship do you observe between years to maturity, yield to maturity, and the current price?

 

Ans:

 

years to maturity

yield to maturity

current price

2

5%

 

2

1000

3

7%

 

4

9%

 

5

9%

 

 

6: (20 points) The government wants to raise $1000 to finance its projects.

 

A) What would be the payment scheme for the following bonds? You need to calculate the amount of cash that the government should pay to the bondholders in each case and the exact timing for the payments.

 

 

 

a)     Perpetuity

 

b)     10-year fixed payment loan

 

c)     10-year Discount loan

 

d)     10-year 12% Coupon bond

 

e)     10-year 2% Coupon bond

 

 

 

The interest rate in the market is 12% over 10 years.

 

 

 

B) At the same time, the government wants to minimize sum of the first 10 years payment to the bondholders. Which one of the preceding bonds would you recommend the government to sell?

 

 

 

7: (20 points) The demand and supply curve for one-year bond with a face value of $1000 and coupon rate of 5% are represented by the following equations:

 

 

 

a)     Calculate the interest rate in this market.

Suppose that as a result of monetary policy action, the Federal Reserve sells 30 bonds that it holds. Assume that bond demand and money demand are held constant.

b)     How does the Federal Reserve policy affect the bond supply equation?

c)     Calculate the effect on the equilibrium interest rate in this market, as a result of the Federal Reserve action.

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