1. For each statement below answer true or false. The first word of your answer has to be either true or falseIf the first word of your answer is not true or false, you receive 0 points. If the statement is true you are finished answering. If your answer is false, briefly explain why it is false.

a. The future value in n years of a dollar today is

b. An inverted yield curve refers to the situation when long term treasury yields are higher

than short term treasury yields.

c. If n = 0, PV = FV

d. An increase in the interest rate from 10% to 13% can be described as a 3% increase.

e. Paying more attention to nominal values instead of real values is called nominal illusion.

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2. Give 3 reasons why interest rates on bonds of the same maturity may differ.

3. Which would you expect to have a higher price, a corporate bond with a Moody’s Baa rating

or a corporate bond with a C rating? Why?

4. a. Draw a supply and demand graph to illustrate the following:

A fall in inflationary expectations in the economy, evoking a much weaker response

from issuers of bonds than investors in bonds. Make sure to label your axes. In the diagram label the

initial equilibrium E1 and the new equilibrium after the change in inflationary expectations E2

b. Based on your diagram what happens to the equilibrium interest rate after the change in inflationary expectations? For more information visit, https://en.wikipedia.org/wiki/Money

5. For the following problems use the numbers provided to write out the formula you would use to find the answer, but do not carry out the actual calculation.

For example, if I said find the value one year from now of $100 invested today at i = 5%,

the correct answer would be: 100 (1 + .05)

a. How much money would you need to start out with today to have $X in

12 years if i = 8.4% .

b. Find the present value of $500 received 3 years from now if i = .6%

c. Find the yield to maturity of a coupon bond selling for $390 that has annual coupon payments of $80, a face value of $100 and a maturity of four years.

6. A borrower and lender agree that the expected inflation rate for the next year is 3 percent.

Based on this, they enter into a loan agreement where the nominal interest rate to be charged

is 8 percent.

a. Find the ex ante real interest rate.

b. Find the ex post real interest rate if the inflation rate turns out to be 6%

c. Which party to the transaction gains when the inflation rate turns out to be 6%

d. Find the ex post real interest rate if the inflation rate turns out to be 12%

FRED QUESTION

30-year fixed rate mortgage average in the U.S. I’ll refer to this as the 30-year rate

Fred Code: MORTGAGE30US

For this problem you will need the annual inflation rate. Compute the

annual inflation rate the same way we did in HW1

7. For the following question the only part you should submit a graph with your answers

is part d. For the other parts do not submit graphs or excel files you may have used to derive your

answers.

a. What was the 30-year rate on 12/24/20?

b. Change the frequency of the 30-Year Rate data to annual. Where it says aggregation

use “average.” What was the average annual rate in 1981?

c. What was the average annual rate in 1987?

d. Generate a graph for the real 30 year rate.

e. What was the real rate in 1987?

f. What was the real rate in 1981?

g. How do explain the fact that the real rate was higher in 1987 than it as in 1981?

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