Problem Set 2
Econ 333 (01) Summer 2002
(Dr. Tin-Chun Lin)
1. Which of the following are concerning the distinction between interest rates and
return?
(A) The rate of return on a bond will not necessarily equal the interest rate on that
bond.
(B) The return can be expressed as the difference between the current yield and the
rate of capital gains.
(C) The rate of return will be greater than the interest rate when the price of the bond
falls between time t and time t+1.
(D) All of the above are true.
(E) Only (A) and (B) of the above are true.
(Answer: (A))
2. The demand for Jackson Pollack paintings rise (holding everything else equal) when:
(A) Stocks become easier to sell.
(B) People expect a boom in real estate prices.
(C) Treasury securities become riskier.
(D) People suddenly expect gold prices to rise.
(Answer: (C))
3. You would be less willing to purchase U.S. Treasury bonds, other things equal, if
(A) Brokerage fees for trading stocks decline.
(B) You expect interest rates to rise.
(C) Gold becomes more liquid.
(D) Any of the above occurs.
(E) Either (B) or (C) of the above occurs.
(Answer: (D))
4. You would be more willing to buy AT&T bonds (holding everything else constant) if
(A) The brokerage commissions on bond sales become cheaper.
(B) Interest rates are expected to rise.
(C) You had suffered big losses in the stock market.
(D) You expected jewelry to appreciate sharply in value.
(E) None of the above.
(Answer: (A))
5. If fluctuations in interest rates become greater, then, other things equal, the demand
for common stocks ____ and that of long term bonds ____.
(A) Increases; increases
(B) Increases; decreases
(C) Decreases; Decreases
(D) Decreases; increases
(Answer: (B))
6. All else constant, an increase in wealth reduces the demand for an asset, and the
decrease in demand is greater if the asset is a ____ rather than a ____
(A) Luxury; luxury
(B) Luxury; necessity
(C) Necessity; luxury
(D) Necessity; necessity
(Answer: (C))
7. In terms of the theory of portfolio choice, explain why you would be more or less
willing to buy a share of Polariod stock in the following situations:
a.
b.
c.
d.
e.
Your wealth falls. (Answer: Less)
You expect it to appreciate in value. (Answer: More)
The bond market becomes more liquid. (Answer: Less)
You expect gold to appreciate in value. (Answer: Less)
Prices in the bond market become more volatile. (Answer: More)
8. In terms of the theory of portfolio choice, explain why you would be more or less
willing to buy a house under the following circumstances:
a. You just inherited $100,000. (Answer: More)
b. Real estate commissions fall from 6 percent of the sales price to 4 percent of the
sales price. (Answer: More)
c. You expect Polaroid stock to double in value next year. (Answer: Less)
d. Prices in the stock market become more volatile. (Answer: More)
e. You expect housing prices to fall. (Answer: Less)
9. When a recession occurs, normally the demand for bonds ____ and the supply of
bonds ____.
(A) Increases; increases
(B) Increases; decreases
(C) Decreases; decreases
(D) Decreases; increases
(E) No change; no change.
(Answer: (C))
10. Why should a rise in the price level (but not in expected inflation) cause interest rates
to rise when the nominal money supply is fixed? (Answer: When the price level
rises, the quantity of money in real terms falls (holding the nominal supply of money
constant); to restore their holdings of money in real terms to their former level, people
will want to hold a greater nominal quantity of money. Thus the money demand
curve shifts to the right, and the interest rate rises.)