Money and banking homework

Homework Assignment #2 ECO 3223, Spring 2015 Instructions: Answer each of the following questions, showing your work where appropriate. Due: Thursday, March 19th at the beginning of class 1. What are the four primary determinants of demand for an asset? Which of those determinants would be affected by an increase in the current price of an asset, all else equal? What would happen to the quantity of the asset demanded as a consequence? Explain. 2. At the onset of recessions, the “spread” between Treasury bonds and corporate bonds increases – i.e. the yields offered by corporate bonds rise relative to T-bond yields. Use the textbook’s supply/demand model of the bond market to explain this observation. 3. Use the textbook’s supply/demand model of the bond market to predict how each of the following shocks would likely affect bond prices and the overall level of interest rates, all else equal. In each case, be sure to (1) clearly state the predicted direction of change for both bond prices and interest rates, (2) depict the impact of the shock on bond prices with a supply/demand diagram, and (3) explain your predictions intuitively in words. a. The price of gold suddenly becomes more volatile. b. The tax rate on capital gains from the sale of bonds (collected from bond buyers if they sell prior to maturity) is increased c. Federal income tax rates are decreased d. An economic upturn increases the expected profitability of investment opportunities for businesses 4. What is meant by “money demand” in Keynes’ Liquidity Preference Theory? According to that theory, what determines a nation’s aggregate money demand? Explain. 5. Use the Keynesian model of “Liquidity Preference Theory” to predict how each of the following shocks would likely affect a nation’s overall level of interest rates in the short run, all else equal. In each case, be sure to (1) clearly state the predicted direction of change for interest rates, (2) depict the impact of the shock with a supply/demand diagram, and (3) explain your predictions intuitively in words. a. An economic downturn causes real aggregate income to fall b. The central bank reduces the size of the money supply c. An energy price shock increases the overall level of prices for goods and services 6. What is a “yield curve”? Do yield curves normally slope up or down? Why? 7. Suppose that 1-year bonds currently offer a nominal yield to maturity of 4% (