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Question

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1.Using loanable funds theory, discuss how changes in consumer savings, business investment, and in the money supply by the Federal Reserve System can influence the level of interest rates.

2.Explain how price expectations influence the level of interest rates. What impact has inflation premiums had on interest rate levels in recent years?

3.Explain why realized real rates of interest are sometimes negative, but expected real rates are always positive. Give an example.

4.Calculate the price of a $1000 face value bond, maturing in three years with a 9 percent coupon (paid semiannually) if current real rates of interest are 4 percent, historical inflation rates are 3 percent, and expected inflation rates are 4 percent. (Use if next chapter covered in exam)

5. Sam has just lent Mary $1000 for 1 year 6%. Sam and Mary expect inflation to be 3% over the next year. If inflation turns out to have been only 2%, what is the impact upon Sam and Mary?

6. You are the Chief Economist of Free Formosan Investment and are conducting research on inflation forecasting by using the information of the Treasury Inflation-Protected Securities (TIPS). The information that you have are as the following: Nominal yield on 10-year nonindexed Treasury bond is 4.5%; Real yield on 10-year TIPS is 2.25%; The market adjustment for inflation and liquidity risk is 45 basis-points. What is the expected annual inflation rate over the next decade?

7. In January 2011, a Japanese investor placing money in dollar denominated assets desires a 5% real rate of return. Then international expected inflation rate is about 2.5% and the dollar is expected to decline against Japanese Yen by 10% over the investment period. What is the minimum required rate of return for this Japanese investor?