TCHE 303 – MONEY AND BANKING

TUTORIAL ASSIGNMENT 3

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.
 When stock is appreciated in value, there’s more return for me to own a stock
than before so I would be more willing to buy a share of Microsoft stock
c. The bond market becomes more liquid.
 If the bond market becomes more liquid, the quantity for bond demanded will
increase, thus leads to a decrease in stock demand so I’d be less willing to…
d. You expect gold to appreciate in value. Decrease
 Gold appreciates in value will lead to an increase in gold demand, which
causes the stock demand to fall so I’d be less willing…
e. Prices in the bond market become more volatile.
 Bond prices become more volatile meaning that it’s more risky to hold a bond
than previously so I’d more willing to buy a share of Microsoft stock

2. Explain why you would be more or less willing to buy a house under the following
circumstances:
a. You just inherited $100,000.
 Become wealthier -> More willing
b. Real estate commissions fall from 6% of the sales price to 5% of the sales
price.
 Liquidity in real estate market increases -> More willing
c. You expect Microsoft stock to double in value next year => Less willing
d. Prices in the stock market become more volatile => More willing
e. You expect housing prices to fall
 Expected return decreases => Less willing
3. Explain why you would be more or less willing to buy gold under the following
circumstances:
a. Gold again becomes acceptable as a medium of exchange => More willing
 b. Prices in the gold market become more volatile => Less willing
c. You expect inflation to rise, and gold prices tend to move with the aggregate
price level => Expected return decreases => Less willing
d. You expect interest rates to rise => Same as c
4. Explain why you would be more or less willing to buy long-term Microsoft bonds under
the following circumstances:
a. Trading in these bonds increases, making them easier to sell.
b. You expect a bear market in stocks (stock prices are expected to decline).
 More willing because bond’s expected return has increased relative to stock
c. Brokerage commissions on stocks fall.
d. You expect interest rates to rise.
e. Brokerage commissions on bonds fall.
5. What would happen to the demand for Picasso paintings if the stock market undergoes a
boom? Why?
 If the stock market undergoes a boom, the demand for stock increases leading to the
decrease in the demand for Picasso paintings
6. Predict the supply and/or demand change in the market for long term Treasury bonds after
the following events occur. Draw supply and demand curves in the bond market before
and after the change, describe impact on quantity and prices of bonds.
a. The economy comes out of recession and resumes strong growth.
b. Corporate bonds and stocks become more risky
c. Government borrows more to finance its rising deficits
7. Draw a supply and demand graph in the market for money, with interest rate on the
vertical axis and the quantity of money on the horizontal axis. Describe how each of the
following will affect demand or supply of money and the resulting interest rates:
a. Incomes decrease in recession
b. Price level rises (higher inflation)
c. The Federal reserve increases money supply
8. “The more risk-averse people are, the more likely they are to diversify.” Is this statement
true, false, or uncertain? Explain your answer.
 True, because the benefits to diversification are greater for a person who cares more
about reducing risk.
9. “No one who is risk-averse will ever buy a security that has a lower expected return, more
risk, and less liquidity than another security.” Is this statement true, false, or uncertain?
Explain your answer.
 True because for a risk-averse person, those characteristics make a security less
desirable than any other security
10. An important way in which the central bank 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?
 Bond supply increases and the bond supply curve shifts to the right. The new
equilibrium bond price is lower and thus interest rates will increase. With the liquidity
preference framework, decreasing the money supply also rises the interest rate – the
same result as in the bond market that has been analysed above. Therefore, my answer
is consistent.
11. Will there be an effect on interest rates if brokerage commissions on stocks fall? Explain
your answer.
-> Liquidity in stock market increase, liquidity in bond market decline -> bond demand
decrease -> price of bond decline -> interest rate increase
12. 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?
 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 Md shifts to the right, and the interest rate rises.
13. What effect will a sudden increase in the volatility of gold prices have on interest rates?
 Gold demand decreases -> Bond demand increases -> Price increases -> interest rate
decreases
14. How might a sudden increase in people’s expectations of future real estate prices affect
interest rates?
 When future real estate prices increase, expected return will increase, real estate
demand also increases, causing interest rate to fall.
15. Explain what effect a large federal deficit should have on interest rates.
 A large federal deficit will lead to the increase in the quantity of bond supplied ->
Price decreases -> i increases.
16. In the aftermath of the global economic crisis that started to take hold in 2008, U.S.
government budget deficits increased dramatically, yet interest rates on U.S. Treasury debt
fell sharply and stayed low for quite some time. Does this make sense? Why or why not?
=> In theory, large budget deficits make interest rate increase but in this case, interest rates
on U.S. Treasury debt fell sharply and stayed low for quite some time. This makes sense
because there’s no holding other things constant and this is the recession time so interest rate
drop. Some economists believe that when the Treasury issues more bonds, the demand for bonds
increases because the issue of bonds increases the public's wealth. If this is the case, the demand
curve, Bd, will also shift to the right, and it is no longer clear that the equilibrium interest rate will
rise. Thus there is some potential ambiguity in the answer to this question.

16. Using both the supply and demand for bonds and liquidity preference frameworks, show
what the effect is on interest rates when the riskiness of bonds rises. Are the results the
same in the two frameworks?
17. The prime minister announces in a press conference that he will fight the higher inflation
rate with a new anti-inflation program. Predict what will happen to interest rates if the
public believes him.
 If the public believes him, the expected inflation rate will reduce causing the expected
return to increase and also the bond demand. The bond demand curve shift to the
right. At the same time, with the same fixed nominal interest rate, expected inflation
rate decrease meaning that the cost of borrowing is higher so there’s a decrease in the
quantity of bond supplied, the supply curve shifts leftward. The rightward shift in
demand curve and leftward shift in supply curve causes bond price to increase and
interest rate to fall.
18. The chairman of the Fed announces that interest rates will rise sharply next year, and the
market believes him. What will happen to today’s interest rate on AT&T bonds, such as
the 8s of 2022?
 Interest rates rise cause the expected return to decrease, thus the bond demand
declines. Bond demand curve therefore shifts to the right causing the equilibrium
bond price to be lower, interest rate on AT&T bonds is higher.
19. Predict what will happen to interest rates if the public suddenly expects a large increase in
stock prices => increase
20. Predict what will happen to interest rates if prices in the bond market become more
volatile => increase
21. If the next governor of the central bank has a reputation for advocating an even slower
rate of money growth than the current governor, what will happen to interest rates?
Discuss the possible resulting situations.
 The slower rate of money growth will lead to a liquidity effect, which raises interest
rates, while the lower price level, income, and inflation rates in the future will tend to
lower interest rates. There are three possible scenarios for what will happen. So there
will be 3 scenarios:
- Liquidity effect is smaller than the other effects, then interest rates will rise.
 - Liquidity effect is larger than the other effects and expected inflation adjusts slowly,
then interest rates will rise at first but will eventually fall below their initial level.
- Liquidity effect is larger than the expected inflation effect and there is rapid adjustment
of expected inflation, then interest rates will immediately fall.

22. Would fiscal policymakers ever have reason to worry about potentially inflationary
conditions (điều kiện lạm phát)? Why or why not?
 Yes, fiscal policymakers should worry about potentially inflationary conditions. If
people expect higher inflation, this increases the yield on Canadian government debt,
meaning that the interest rates paid to debt holders increase. In other words, higher
inflation leads to a higher debt service burden and increases the costs of financing
deficit spending.
23. If the next chair of the Federal Reserve Board has a reputation for advocating an even
slower rate of money growth than the current chair, what will happen to interest rates?
Discuss the possible resulting situations. Same as 21
24. (Slide 45) M1 money growth in the U.S. was about 15% in 2011 and 2012, and 10%
in 2013. Over the same time period, the yield on 3-month Treasury bills was close to 0%.
Given these high rates of money growth, why did interest rates stay so low, rather than
increase? What does this say about the income, price-level, and expected-inflation effects?
-> In theory, money supply increases, interest rate reduces. However, here interest rate vẫn
giảm vì ở đây có chính sách của ngân hang trung ương. In financial crisis, các nc có cam
kết sẽ giữ interest rate low, giá mặt bằng của các nc đều low, expected inflation cũng low.
25. Study the graph below and explain the movement of the lending rates in Vietnam.

Lending rates of Vietnamese commercial banks