TUTORIAL 3

THE BEHAVIOR OF INTEREST RATES

Part 1. Review questions

1. Explain the theory of asset demand. Provide example
• Wealth: the total resources owned by the individual, including all assets
=) positive relationship
• Expected Return: the return expected over the next period on one asset relative to
alternative assets (when Er higher than alternative assets ( gold , …)=) demand for asset
tang
=) positive relationship
• Risk: the degree of uncertainty associated with the return on one asset relative to
alternative assets
rui ro cao =) luong cau giam
=) negative relationship
• Liquidity: the ease and speed with which an asset can be turned into cash relative to
alternative asset
khi tính thanh khoản của tài sản đang xem xét cao hơn so với liquip of alternative assets
=) demand asset incre
=) positive ralationship

2. Loanable fund framework:

- Explain how the interest rate is determined
- Distinguish movement and shift of demand and supply curves;
- Factors affecting interest rates.

3. Liquidity preference framework:

- Demand for money
Income Effect: a higher level of income causes the
demand for money at each interest rate to increase
and the demand curve to shift to the right
▪ The rises in income cause wealth to increase
▪ People need to carry out more transactions
– Price-Level Effect: a rise in the price level causes the
demand for money at each interest rate to increase
and the demand curve to shift to the right
▪ People care about their money of holding in real
terms
- Supply of money;
Assume that the supply of money is controlled by the
central bank.
– An increase in the money supply engineered by the
Federal Reserve will shift the supply curve for money
to the right.
- Change in equilibrium interest rate
• Income incre =) D money incre =) interest rate incre

• Price level incre =) D money incre =) …

• Money supply incre =) DM incre =) … decre

Part 2. Multiple-choice questions

1. If gold becomes acceptable as a medium of exchange, the demand for gold will
 and the demand for bonds will , everything else held
constant.
A) decrease; decrease
B) decrease; increase
C) increase; increase
D) increase; decrease ( liquidity)

2. The demand curve for bonds has the usual downward slope, indicating that at
prices of the bond, everything else equal, the is higher.
A) higher; demand
B) higher; quantity demanded
C) lower; demand
D) lower; quantity demanded

3. Everything else held constant, if the expected return on U.S. Treasury bonds
falls from 10 to 5 percent and the expected return on GE stock rises from 7 to 8
percent, then the expected return of holding GE stock relative to U.S.
Treasury bonds and the demand for GE stock _ .
A) rises; rises ( expect rate )
B) rises; falls
C) falls; rises
D) falls; falls

4. An increase in the expected rate of inflation will the expected return

on bonds relative to the that on assets, everything else held constant.
A) reduce; financial
B) reduce; real
C) raise; financial
D) raise; real
Expected Inflation: an increase in the expected rate of inflations lowers the
expected return for bonds, causing the demand curve to shift to the left
5. The theory of asset demand tells us that
A) The demand for an asset will increase if the expected return on an asset rises.
B) Risky assets have higher liquidity.
 C) Risky assets bring higher returns.
D) The higher the return on an asset, the lower the liquidity.

6. At a bond price above the equilibrium

A) there is an excess supply and the price will tend to fall.
B) there is an excess demand and the price will tend to rise.
C) there is an excess demand and the price will tend to fall.
D) there is an excess supply and the price will tend to rise.

7. Suppose the price of bond J rises. This will:

A) increase the supply of bond K and reduce the interest rate on bond K.
B) increase the demand for bond K and decrease the interest rate on bond K.
C) increase the demand for bond K and increase the interest rate on bond K.
D) increase the supply of bond K and increase the interest rate on bond K
When Bd > Bs , there is excess demand, price will rise and
interest rate will fall
8. Which of the following will increase the supply of bonds (shift the supply
curve to the right)?
A) A government budget surplus.
B) An increase in the bond prices.(movement )
C) A business cycle expansion.
D) A decrease in the expected inflation rate (

9. At interest rates below the equilibrium rate of interest

A) there is an excess demand for money and the interest rate will rise.
B) there is an excess demand for bonds and the interest rate will fall.
C) there is an excess supply of bonds and the interest rate will fall.
D) there is an excess demand for money and the interest rate will fall.

10. Why does the supply curve for bonds slope upward?
A) Because as the price falls, firms are more willing to supply bonds.
B) Because as the interest rate falls, firms are more willing to borrow money.
C) Because as the price rises, firms are more willing to buy bonds.
D) Because as the interest rate rises, firms are more willing to borrow money

11. Increasing government deficits causes

A) The supply curve for bonds to shift right because government bonds pay
higher interest relative to other bonds
B) The supply curve for bonds to shift right because the U.S. Treasury will issue
bonds to pay for the deficit
C) The supply curve for bonds to shift left because government bonds slow expected
inflation
D) The supply curve for bonds to shift left because corporations will borrow less due
 to decreased profitability when the government is in debt

12. When the price of a bond decreases, all else equal, the bond demand curve
.
A) shifts right
B) shifts left
C) does not shift
D) inverts
13. Everything else held constant, if interest rates are expected to fall in the future,
the demand for long-term bond today and the demand curve
shifts to the .
A) rises; right
B) rises; left
C) falls; right
D) falls; left

14. In a business cycle expansion, the of bonds increases and the

curve shifts to the as business investments are expected to be more
profitable.
A) supply; supply; right
B) supply; supply; left
C) demand; demand; right
D) demand; demand; left

15. The bond supply and demand framework is easier to use when analyzing the
effects of changes in , while the liquidity preference framework
provides a simpler analysis of the effects from changes in income, the price level,
and the supply of .
A) expected inflation; bonds
B) expected inflation; money
C) government budget deficits; bonds
D) government budget deficits; money

16. In his Liquidity Preference Framework, Keynes assumed that money has a
zero rate of return; thus,
A) when interest rates rise, the expected return on money falls relative to the
expected return on bonds, causing the demand for money to fall.
B) when interest rates rise, the expected return on money falls relative to the expected
return on bonds, causing the demand for money to rise.
C) when interest rates fall, the expected return on money falls relative to the expected
return on bonds, causing the demand for money to fall.
D) when interest rates fall, the expected return on money falls relative to the expected
return on bonds, causing the demand for money to rise.

17. In Keynes's liquidity preference framework,

A) the demand for bonds must equal the supply of money.
B) the demand for money must equal the supply of bonds.
C) an excess demand of bonds implies an excess demand for money.
D) an excess supply of bonds implies an excess demand for money.

18. In the Keynesian liquidity preference framework, an increase in the interest

rate causes the demand curve for money to , everything else held
constant.
A) shift right
B) shift left
C) stay where it is
D) invert
19. When the price level , the demand curve for money shifts to the
and the interest rate , everything else held constant.
A) falls; left; falls
B) rises; right; falls
C) falls; left; rises
D) rises; right; rises

20. When the Fed _ the money stock, the money supply curve shifts to
the and the interest rate , everything else held constant.
A) decreases; right; rises
B) increases; right; falls ( liquidity effect )
C) decreases; left; falls
D) increases; left; rises

21. Of the four effects on interest rates from an increase in the money supply, the
one that works in the opposite direction of the other three is the
A) liquidity effect.
B) income effect.
C) price level effect.
D) expected inflation effect.

22. When the growth rate of the money supply increases, interest rates end up
being permanently lower if
A) the liquidity effect is larger than the other effects.
B) there is fast adjustment of expected inflation.
C) there is slow adjustment of expected inflation.
D) the expected inflation effect is larger than the liquidity effect.

23. If the liquidity effect is smaller than the other effects, and the adjustment to
expected inflation is immediate, then the
A) interest rate will fall.
B) interest rate will rise.
C) interest rate will fall immediately below the initial level when the money supply
grows.
D) interest rate will rise immediately above the initial level when the money supply
grows.

24. When the growth rate of the money supply is increased, interest rates will fall
immediately if the liquidity effect is than the other money supply
effects and there is adjustment of expected inflation.
A) larger; fast
B) larger; slow
C) smaller; slow
D) smaller; fast
25. In the figure above, illustrates the effect of an increased rate of money supply
growth at time period 0. From the figure, one can conclude that the
A) Liquidity effect is smaller than the expected inflation effect and interest rate adjust
quickly to changes in expected inflation
B) Liquidity effect is larger than the expected inflation effect and interest rate adjust
quickly to changes in expected inflation
C) Liquidity effect is larger than the expected inflation effect and interest rate adjust
slowly to changes in expected inflation
D) Liquidity effect is smaller than the expected inflation effect and interest rate adjust
slowly to changes in expected inflation

Part 3. End-of-chapter questions

Chapter 5: Questions 1, 4, 6, 12, 13, 18
1. Explain why you would be more or less willing to buy a share of Microsoft stock
in the following situations:
a. Your wealth falls. Less ( wealth )
b. You expect the stock to appreciate in value. (mong doi co phieu tang gia tri )
(expect return =) more
c. The bond market becomes more liquid.( mean bond more liquid than bond =) p
tent to buy less stock )
d. You expect gold to appreciate in value. =) invest less ( because a person can earn
more money by purchasing gold now and selling it at a profit later)
e. Prices in the bond market become more volatile ( bien dong ) =) more invest stock

4. Explain why you would be more or less willing to buy long-term Delta Air Lines
bonds under the following circumstances:=) higher interest rate
a. The company just released its financial statements, indicating that income
decreased and liabilities increased. Bond trading increase =) more liquipdity =)
invest more
b. You expect a bull market in stocks (stock prices are expected to increase). Expect
of return relative incre =) invest more
c. You have analyzed your country’s monetary policy and expect interest rates to
decrease. ( expect ) =) invest more
d. Brokerage commissions ( hoa hong moi gioi ) on bonds fall.=) invest more ( more
liquid , more return
e. Your income and wealth increased over the last two years. ( weath )
=) invest more
 6. Raphael observes that at the current level of interest rates there is an excess supply
of bonds, and therefore he anticipates an increase in the price of bonds. Is Raphael
correct?
Incorrect . When Bd < Bs , there is excess supply, price will fall and
interest rate will rise to the equilibrium
12. Will there be an effect on interest rates if brokerage commissions on stocks fall?
Explain your answer.
Brokerage commission on stock fall=) return increase =) demand for stock increase
=) demand for bond decrease =) shift demand for bond to the left =) interest rate
increase

13.The president of the United States announces in a press conference that he will fight
the higher inflation rate with a new anti-inflation program. Predict what will happen to
interest rates if the public believes him.
Expected inflation use bond model

18. If the next chair of the Federal Reserve Board has a reputation for advocating an
even slower rate of money growth than the current chair, what will happen to interest
rates? Discuss the possible resulting situations.

 tính thanh khoản ( liquidity ) dùng để chỉ khả năng chuyển đổi thành tiền mặt của một tài
sản hoặc một sản phẩm.