Chapter 4 - Determinants of Interest Rate

Question 1

Determinants of Asset Demand (4)

Answer 1

1. Wealth
2. Expected return
3. Risk
4. Liquidity

Question 2

Wealth

Answer 2

An increase in wealth, increases the demand of an asset.

Question 3

Expected return

Answer 3

Ceteris paribus, increase in ER, increases the demand of an asset. If not CP increase in ER, increases risk, decreasing asset demand

Question 4

Risk

Answer 4

We assume people are risk-averse: prefer an asset with a lower standard deviation for the same ER
Ceteris paribus, an increase in risk, decreases asset demand

Question 5

Liquidity

Answer 5

CP, increase in liquidity, increases asset demand

Question 6

Determinants of Demand (bond market) (5)

Answer 6

1. Wealth (in W, in D)
2. Expected ROI (in ExROI, de D)
3. Riskiness (in risk, de D)
4. Expected inflation (in ExInf, de D)
5. Liquidity (in L, in D)

Question 7

Determinants of Supply (bond market) (3)

Answer 7

1. Profitability of investment (in Prf, in S)
2. Expected inflation (in ExInf, in S)(cost of borrowing de)
3. Government deficit (in Gdef, in S)

Question 9

Fischer Effect

Answer 9

Increase in expected inflation leads to a decrease in D and increase in S, resulting in same Q. Therefore the price will decrease and i increase.

Question 10

Buy a government bond with negative yield because (2)

Answer 10

1. Safety

2. If inflation is low and other investment opportunities are scarce

Question 11

Business Cycle Expansion

Answer 11

Increase in wealth will increase D, increase in investment will increase S, P is the same, i is the same, Q increases