Assignment VII

Chapter 27

1) If Janet expects interest rates to rise in the near future, she will probably be willing to
A) buy bonds now, and hold less money.
B) buy bonds now, but only if their price falls.
C) sell bonds now, and hold more money.
D) put her money under her mattress rather than in a bank account.
E) maintain only the current holding of bonds.
Answer: C

2) If the annual market rate of interest is 5%, an asset that promises to pay $100 after
each of the next two years has a present value of
A) $90.70.
B) $95.24.
C) $181.40.
D) $185.94.
E) $200.00.
Answer: D

3) Consider a bond that promises to make coupon payments of $100 each year for three
years (beginning in one year's time) and also repays the face value of $2000 at the end of
the third year. If the market interest rate is 6%, what is the present value of this bond?
A) $267.30
B) $283.02
C) $1763.22
D) $1854.67
E) $1946.53
Answer: E

4) An analyst is considering the purchase of a Government of Canada bond that will pay
its face value of $10 000 in one year's time, but pay no direct interest. The market interest
rate is 4% and the bond is being offered for sale at a price of $9800. The analyst should
recommend
A) purchasing the bond because the buyer will earn a profit of $185.
B) purchasing the bond because the bond price is equal to its present value.
C) not purchasing the bond because the price is lower than its present value.
D) not purchasing the bond because the buyer could earn an additional $192 by investing
the $9800 elsewhere.
E) not purchasing the bond because the buyer could earn an additional $392 by investing
the $9800 elsewhere.
Answer: D

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5) Suppose the market interest rate is stable at 4% and we see a decline in bond prices
(and thus a rise in bond yields). One explanation for this is that
A) bond issuers are facing an excess demand for their bonds.
B) bond purchasers perceive a reduction in riskiness and thus a higher expected present
value from those bonds.
C) there is no causal relationship between market interest rates and bond prices.
D) bond purchasers perceive an increase in riskiness and thus a lower expected present
value from those bonds.
E) there is a positive relationship between interest rates and bond prices.
Answer: D

6) Consider two bonds, Bond A and Bond B, offered for sale in the same market for
financial assets:
- Bond A has a face value of $1000, a market price of $971, and matures in one year.
- Bond B has a face value of $1000, a market price of $926, and matures in one year.

Which of the following statements about Bonds A and B are correct?

A) Bond B has a higher present value than Bond A.
B) Bond A has a lower present value than Bond B.
C) The yield on Bond B is 3%; the yield on Bond A is 3%.
D) The yield on Bond A is 3%; the yield on Bond B is 8%.
E) There is a disequilibrium in this market for financial assets.
Answer: D

7) Suppose a financial analyst suggests that investors should now hold cash instead of
stocks or bonds. The analyst is probably encouraging an increase in money holdings for
which reason?
A) transaction demand
B) precautionary demand
C) speculative demand
D) present value demand
E) portfolio demand
Answer: C

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 8)

FIGURE 27-1

Refer to Figure 27-1. A rightward shift of the money demand curve can be caused by
wA) an increase in the price level.

B) a decrease in the price level.

C) a decrease in real GDP.
D) an increase in the rate of interest.
E) a decrease in the rate of interest.
Answer: A

9) According to the "liquidity preference" theory of the rate of interest, if the supply of
money increases, then, ceteris paribus, bond prices will
A) fall as the rate of interest rises.
B) rise as the rate of interest rises.
C) fall as the rate of interest falls.
D) rise as the rate of interest falls.
E) stay the same.
Answer: D

10) Suppose that at a given interest rate and money supply, all firms and households
simultaneously try to add to their money balances. They do this by trying to ________,
which causes an excess ________, which causes a(n) ________, and finally a(n)
________ in the interest rate.
A) sell bonds; supply of bonds; increase in the price of bonds; decrease

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B) buy bonds; supply of bonds; decrease in the price of bonds; increase
C) sell bonds; demand for bonds; increase in the price of bonds; decrease
D) buy bonds; demand for bonds; increase in the price of bonds; decrease
E) sell bonds; supply of bonds; decrease in the price of bonds; increase
Answer: E

11) Ceteris paribus, a rightward shift of the money demand curve could indicate which of
the following:
1) an increase in demand for bonds;
2) an increase in the price level;
3) an increase in real GDP.
A) 1 only
B) 2 only
C) 3 only
D) 1 and 2 only
E) 2 and 3 only
Answer: E

12) Consider a money market in which there is an excess demand for money at the
prevailing interest rate. The likely response is ________ until the quantity demanded of
money equals the quantity supplied of money.
A) the corresponding excess demand of bonds will cause the price of bonds to decrease
and the interest rate to rise
B) the money supply curve will shift to the left
C) the money supply curve will shift to the right
D) the money demand curve will shift to the right, causing the price of bonds to increase,
and the interest rate to fall
E) the corresponding excess supply of bonds will cause the price of bonds to decrease
and the interest rate to rise
Answer: E

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13)

FIGURE 27-2

Refer to Figure 27-2. Suppose the market interest rate is i1. The situation in this market is
as follows:
A) Firms and households are attempting to increase their money holdings by selling
bonds.
B) Firms and households are attempting to decrease their money holdings by selling
bonds.
C) Firms and households are attempting to increase their money holdings by buying
bonds.
D) Firms and households are attempting to decrease their money holdings by buying
bonds.
E) The market is in equilibrium and no change will occur.
Answer: A

14) The linkage between changes in monetary equilibrium and changes in aggregate
demand is called the
A) monetary transmission mechanism.
B) simple multiplier.
C) equilibrium mechanism.
D) transactions mechanism.

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E) liquidity preference function.
Answer: A

19)

FIGURE 27-3

Refer to Figure 27-3. The increase in desired investment expenditure, as shown by the
movement from point A to point B, occurs because of
A) a fiscal policy designed to encourage investment.
B) an increase in the money supply.
C) a change in sales, which increases inventory investment.
D) an improvement in business confidence.
E) a tax-rate induced change in desired investment.
Answer: B

20) The monetary transmission mechanism describes the process by which changes in
A) personal consumption affect real GDP through changes in disposable income.
B) business investment influence real GDP.
C) monetary equilibrium influence real GDP through changes in desired investment.
D) monetary equilibrium influence the interest rate.
E) interest rates affect the demand for money and the supply of money.
Answer: C

21) Consider monetary equilibrium and the monetary transmission mechanism. An

exogenous rise in the price level, with no change in the supply of money, will
A) increase the demand for money and increase desired aggregate expenditure.

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B) increase the demand for money and decrease desired aggregate expenditure.
C) decrease the demand for money and increase aggregate demand.
D) decrease the demand for money and decrease aggregate demand.
E) decrease aggregate demand but not affect the demand for money.
Answer: B

22) Consider the monetary transmission mechanism in an open economy. Other things
being equal, an increase in the domestic money supply leads to
A) an appreciation of the domestic currency, thereby inhibiting net exports and raising
aggregate demand.
B) a depreciation of the domestic currency, thereby inhibiting net exports and raising
aggregate demand.
C) a depreciation of the domestic currency, thereby stimulating net exports and raising
aggregate demand.
D) an appreciation of the domestic currency, thereby stimulating net exports and raising
aggregate demand.
E) an appreciation of the domestic currency, thereby stimulating net exports and reducing
aggregate demand.
Answer: C

23) Changes in the money supply in an open economy, as compared to a closed economy,
A) are the same in either situation.
B) affect investment to a greater degree because foreign investors can create new
investment in an open economy.
C) are likely to have a greater effect on AD because of the secondary effect that exchange
rates have on exports.
D) are likely to have a smaller effect on AD because the secondary effect of exchange
rates will offset the changes created by monetary disturbances.
E) cannot be determined with the available information.
Answer: C

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24)

FIGURE 27-4

Refer to Figure 27-4. The economy begins in equilibrium at E 0. Now consider an

expansion of the money supply. The initial effect is
A) a shift of the AD curve to AD1 and an increase in real GDP to Y1.
B) a shift of the AS curve to AS1 and a decrease in real GDP to Y2.
C) a shift of the AD curve to AD1, and then a shift back to AD0 to restore equilibrium at
E 0.
D) a simultaneous shift of AD to AD1 and AS to AS1, resulting in a new equilibrium at
E 2.
E) no change in the short-run equilibrium or level of real GDP.
Answer: A

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25)

FIGURE 27-5

Refer to Figure 27-5. This economy begins in equilibrium with MS0, MD0 and real GDP
equal to potential GDP (with and ). Now suppose there is an increase in the
money supply to $540 billion. The initial response in this economy is
A) an increase in the demand for money, causing a shift of the money demand curve to
MD1, and a fall in interest rate to 3%.
B) an increase in the demand for money, causing a shift of the money demand curve to
MD1, and a fall in the interest rate to 2%.
C) the AD and AS curves shift up simultaneously.
D) a movement down along the money demand curve to a lower interest rate at 2%.
E) an increase in the demand for money, causing a shift of the money demand curve to
MD2 and the interest rate remains at 4%.

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Answer: D

26 The Strength of Monetary Forces

1)

FIGURE 27-6

Refer to Figure 27-6. The famous debate from the the 1950s and 1960s between
Keynesians and Monetarists centred around the slopes of the money demand and
investment demand curves. The Keynesians believed
A) the diagrams in part (ii) were more realistic than those in part (i), and therefore fiscal
policy was a more effective method of stimulating aggregate demand than monetary
policy.
B) the diagrams in part (ii) were more realistic than those in part (i), and therefore
monetary policy was a more effective method of stimulating aggregate demand than
fiscal policy.
C) the diagrams in part (i) were more realistic than those in part (ii), and therefore fiscal
policy was a more effective method of stimulating aggregate demand than monetary
policy.
D) the diagrams in part (i) were more realistic than those in part (ii), and therefore
monetary policy was a more effective method of stimulating aggregate demand than
fiscal policy.
Answer: C

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