Answer:1. Suppose a candidate who runs on a platform of “soak the rich” wins the 2016 presidential election. After being elected, he or she persuades Congress to raise the top marginal tax rate on the federal personal income tax to 65%.
2. Suppose it is 2020 and 1-year interest rate is 5 percent. You observe that the interest rate on 2-year bond is 4.5%. Assume there is no liquidity premium and the interest rates are determined according to expectation hypothesis of the yield curve
a. Based on the interest rates above, what is the expected 1-year interest rate, starting one year from today?
b. If the interest rate on 3-year bond is 4%., what is the expected 1-year interest rate starting 2 years from today?
c. If the interest rate on 4-year bond is 4%., what is the expected 1-year interest rate starting 3 years from today?
d. Draw the yield curve for the next four years.
e. Is the yield curve for the next four years upward sloping or downward sloping? Explain why
f. What might the yield curve today indicate about future interest rates?
g What might the yield curve today indicate about future economic activity? Explain why?
h. What might the yield curve indicate about the markets’ prediction for inflation rate in the next four years?
i. What might the yield curve indicate about monetary policy today?
j. What might the yield curve indicate about a long-term bonds price? Expected return on long-term bonds? Explain
k. Given the slope of the yield curve today, would you rather be lender or borrower in the next five years? Why?
3. The following is from an article in the Wall Street Journal, describing events in the market for Treasury securities on the given day: “Treasury prices were mixed, with the shorter end of the yield curve falling and the longer- dated Treasury rising in prices”.
a. Draw Treasury yield curve, showing the situation on that day as described in the sentence above.
Explain why prices of Treasury were mixed with the shorter end of the yield curve rising in prices and the longer- dated Treasury falling in prices.
Given the latest data on the state of the U.S. economy, assume that the Fed signals the next increase in the target for the federal funds. The increase won’t happen until the Fed’s meeting in summer of 2016.
Will the Treasury yield curve become more or less steep today?
Which of the following would you expect in the market for Treasury? Explain your choice
- There will be an increase in demand for bond today?
There will be a decrease in supply of bonds today?
There will be a decrease in demand for bonds today?
There will be an increase in supply of bonds today?
What will happen to the yields on Treasury? Explain
4. The table below shows current and expected future one-year interest rates, as well as current interest rates on n-year bonds
Year One-year Bond Rate N-Year Bond Rate Liquidity premium
1 2% 2% _______
2 3% 3% _______
3 4% 5% _______
4 6% 6% _______
5 7% 8% _______
Assume the expectation theory of the term structure and calculate interest rates in the term structure for maturities of one to five years.
Draw the yield curve for the next four years.
Is the yield curve for the next four years upward sloping or downward sloping? Explain why
What might the yield curve today indicate about future interest rates?
What might the yield curve today indicate about future economic activity? Explain why?
What might the yield curve indicate about the markets’ prediction for inflation rate in the next four years?
Calculate the liquidity premium for each n-year bond
What does the liquidity premium stay for?
Compare the liquidity premium in 2-year bond and 5-year bond. Why is the liquidity premium on 2-year bond lower than the liquidity premium on 5-year bond?
5. Suppose that you are the manager of Bank One. Assume required reserve ratio 10 percent. The bank has the following balance sheet:
Assets Liabilities
Reserves $ 65 million Deposits $ 400 million
Loans $ 425 million Bank capital $ 90 million
Is Bank One meeting the reserve requirement?
By how much can Bank One increase its loans?
Suppose Bank One suffers a deposit outflow of $40 million .Illustrate numerically the effect of the deposit outflow of $40 million on the bank’s deposits and reserves
Does the bank now hold excess reserves?
Is the bank meeting a required reserve ratio of 10 percent?
What action must you take to meet the reserve requirement? List three or more actions. work
If a borrower defaults on a loan of $10 million, will be the bank able to sustain the loss?
Why no, why yes?
If Bank One ROA is 7%, what is the bank profit? What is the bank ROE?
How can you increase the bank’s ROE, what trade –off do you face?