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Week 2 Assignment

This document provides answers and explanations to 10 questions about economic concepts such as Keynes' liquidity preference framework, the opportunity cost of holding money, bond ratings, and yield curves. Key points covered include: - With excess demand for money, there is excess supply of bonds. - The opportunity cost of holding money is the interest rate. - A bond with no default risk is called a default-free bond. - In a liquidity trap, monetary policy has no impact on interest rates. - Political instability may lead to poor sovereign ratings.

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Arunim Yadav
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Download as PDF, TXT or read online on Scribd
58 views

Week 2 Assignment

This document provides answers and explanations to 10 questions about economic concepts such as Keynes' liquidity preference framework, the opportunity cost of holding money, bond ratings, and yield curves. Key points covered include: - With excess demand for money, there is excess supply of bonds. - The opportunity cost of holding money is the interest rate. - A bond with no default risk is called a default-free bond. - In a liquidity trap, monetary policy has no impact on interest rates. - Political instability may lead to poor sovereign ratings.

Uploaded by

Arunim Yadav
Copyright
© © All Rights Reserved
Available Formats
Download as PDF, TXT or read online on Scribd
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Week 2: Assignment 2: Solutions

Q1. In Keynes’s liquidity preference framework, if there is excess demand for money, there is

A. excess demand for bonds.


B. equilibrium in the bond market.
C. excess supply of bonds.
D. too much money

Answer: C. excess supply of bonds.

Explanation: With an excess demand for money, people sell bonds to adjust their money
balances. Therefore, there will be excess supply of bonds.

Q2. The opportunity cost of holding money is

A. zero.
B. the interest rate.
C. inflation rate
D. the discount rate.

Answer: B. the interest rate.

Explanation: The opportunity cost of holding money is the potential interest or returns you
give up by not investing it in assets like bonds. The higher the interest rate, the greater the
cost of holding money instead of investing.

Q3. A bond with no default risk is called,

A. no risk bond.
B. zero risk bond.
C. premium bond.
D. default-free bond.

Answer: D. default-free bond.

Explanation: Self-Explanatory straightforward answer. Question just asks the name of the
bond.

Q4. The speculative demand for money will be zero at an interest rate of _____. (Assume
critical interest rate = 3%)
A. 4%
B. 2%
C. 2.5%
D. 1.5%

Answer: A. 4%

Explanation: The speculative demand for money will be zero at any interest rate above the
critical interest rate, which is 3% in this case.

Q5. In the liquidity trap, monetary policy ________.

A. has a large impact on interest rates


B. has a small impact on interest rates
C. has no impact on interest rates
D. has a proportionate impact on interest rates

Answer: C. has no impact on interest rates

Explanation: In a liquidity trap, interest rates are already very low, and people prefer holding
onto cash. People's focus on holding cash instead of spending lead the impact of attempts to
increase the money supply have no impact on interest rates.

Q6. Which of the following statements is true?

A. Bond ratings are irrelevant and tell nothing about the risk associated with bonds.
B. Political instability may lead to poor sovereign ratings.
C. Higher the bond rating, higher will be the rate of interest.
D. Low sovereign ratings will lead to more FDI.

Answer: B. Political instability may lead to poor sovereign ratings.

Explanation: Political instability creates uncertainty, inconsistent policies, weak institutions,


and potential capital flight, leading to poor sovereign ratings due to higher risk for investors
and lenders.

Q7. Consider US treasury bills as benchmark bonds. The yield associated with the benchmark
bond is 3%. Suppose bond yield in India is 6%. The associated default risk premium is
______.

A. 3%
B. 9%
C. 2%
D. 1.8%

Answer: A. 3%

Explanation: yield of the bond with associated risk premium= yield of the benchmark bond
+ Risk premium

• yield of the benchmark bond= 3%


• yield of the bond with associated risk premium =6%
• Risk premium = 3%

Q8. A bond’s liquidity increases if

A. The cost of selling bond is high.


B. The numbers of sellers and buyers in the bond market is very less.
C. The suppliers of the bond have to pay a high rate of interest.
D. The brokerage to sell the bond is low.

Answer: D. The brokerage to sell the bond is low.

Explanation: The easier it is to sell the bond, the higher the bond’s liquidity. When the
brokerage to sell the bond is low, selling the bond becomes easier and cheaper.

Q9. In Keynes’ liquidity preference analysis, identify the factors that cause shifts in the
demand curve for money,

a. Income effect.
b. price level effect.
c. printing more money by the central bank.
d. expected inflation effect.

A. a, b
B. a, b, c
C. b, c
D. a, b, d
Answer: D. a, b, d
Explanation: a. Income effect: An increase in income shifts the money demand curve
because people generally want to hold more money for transactions as their income rises.

b. price level effect: Price level changes affect the purchasing power of money, which in turn
influences the demand for money. An increase in the price level leads to a higher demand for
money, shifting the money demand curve to the right. A decrease in the price level leads to a
lower demand for money, shifting the curve to the left.

d. expected inflation effect: Expected inflation effect shifts the money demand curve because
higher anticipated inflation makes people want to hold less money, leading to a leftward shift
in the curve as they prefer spending or investing rather than holding onto cash.

c. printing more money shifts the supply curve.

Q10. A plot of the interest rates on default-free government bonds with different terms to
maturity is called

A. a risk-structure curve.
B. a default-free curve.
C. a yield curve.
D. an interest-rate curve.

Answer: C. a yield curve.

Explanation: Self-Explanatory straightforward answer. Question just asks the name of the
curve that defined by the plot.

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