Answers to End-of-Chapter Questions

42 Part 2 Fundamentals of Financial Markets
9. Interest rates fall. The increased volatility of gold prices makes bonds relatively less risky relative to
gold and causes the demand for bonds to increase. The demand curve, B d , shifts to the right and the
equilibrium interest rate falls.
10. Interest rates would rise. A sudden increase in people’s expectations of future real estate prices raises
the expected return on real estate relative to bonds, so the demand for bonds falls. The demand curve
B d shifts to the left, and the equilibrium interest rate rises.
11. Interest rates might rise. The large federal deficits require the Treasury to issue more bonds; thus the
supply of bonds increases. The supply curve, B s , shifts to the right and the equilibrium interest rate
rises. Some economists believe that when the Treasury issues more bonds, the demand for bonds
increases because the issue of bonds increases the public’s wealth. In this case, the demand curve, B d ,
also shifts to the right, and it is no longer clear that the equilibrium interest rate will rise. Thus there
is some ambiguity in the answer to this question.
12. The increased riskines of bonds lowers the demand for bonds. The demand curve shifts to the left and
the equilibrium interest rate rises.
13. In the loanable funds framework, the increased riskiness of bonds lowers the demand for bonds. The
demand curve B d shifts to the left, and the equilibrium interest rate rises. The same answer is found in
the liquidity preference framework. The increased riskiness of bonds relative to money increases the
demand for money. The money demand curve M d shifts to the right, and the equilibrium interest rate
rises.
14. Yes, interest rates will rise. The lower commission on stocks makes them more liquid than bonds, and
the demand for bonds will fall. The demand curve B d will therefore shift to the left, and the
equilibrium interest rate will rise.
15 If the public believes the president’s program will be successful, interest rates will fall. The
president’s announcement will lower expected inflation so that the expected return on goods
decreases relative to bonds. The demand for bonds increases and the demand curve, B d , shifts to the
right. For a given nominal interest rate, the lower expected inflation means that the real interest rate
has risen, raising the cost of borrowing so that the supply of bonds falls. The resulting leftward shift
of the supply curve, B s , and the rightward shift of the demand curve, B d , causes the equilibrium
interest rate to fall.
16. The interest rate on the AT&T bonds will rise. Because people now expect interest rates to rise, the
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expected return on long-term bonds such as the 8 s of 2022 will fall, and the demand for these
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bonds will decline. The demand curve B d will therefore shift to the left, and the equilibrium interest
rate will rise.
17 Interest rates will rise. The expected increase in stock prices raises the expected return on stocks
relative to bonds and so the demand for bonds falls. The demand curve, B d , shift to the left and the
equilibrium interest rate rises.
18. Interest rates will rise. When bond prices become volatile and bonds become riskier, the demand for
bonds will fall. The demand curve B d will shift to the left, and the equilibrium interest rate will rise.