Strategy & Managerial Decision-Making FIN 123
PRACTICE QUESTION SET #3
INTEREST RATES AND THE FEDERAL RESERVE
Q1: According to Fisher, nominal interest rate is the actual interest rate reflecting the monetary growth of some given amount money owed to a financial lender overtime while the real interest rate is the amount that reflects the purchasing power of borrowed money for a particular period it grows.
Q2: The Inverted curve is often described as the downward-sloping shape in a yield curve. The normal is the upward sloping yield. The downward or upwards shape of the yield curve changes by economic state.
Q3: The typical shape of the yield curve would usually prevail because the upward slope reflects that financial markets anticipate that a rise in the short-term interest rates in the future. The more extended the period of maturity of the security yields rises. Long-term securities pay high returns.
Q4: The series of maturities is an essential feature in an upward sloping curve. As the slope moves upward it represents higher yields that are achieved in the longer period of time it investment take to mature. The expected shift in yields as the date of maturity extend is the series of maturity.
Q5: Cash and Cash Equivalents is the item on the balance sheet that Campbell believes explains very low-interest rates on Commercial certificates on deposits. Cash and cash equivalents are in the form of commercial paper, marketable securities, Treasury bills and short-term government bonds that come with a maturity period of three months maximum.
Q6: Federal funds are excess of reserve requirements that banks borrow or lend amongst themselves to preserve their reserves found at the Federal Reserve. The Reserve uses federal money flow to control interest rates. This is because when banks borrow from each other, they pay an interest rate. Borrowing bank does not need collateral for the loan.
Q7: Commercial Paper refers to short-term promissory note issued by large corporations sold at a discount with maturities of 30 to 270 days only used as an unsecured money market instrument for companies with excellent credit ratings
Q8: The Federal Reserve defines discount rate as rate of interest charged to commercial bank. The fund are loaned from Federal Reserve Bank’s lending facility. Discounts are also known as federal bank’s discount window interest rate
Q9. Government focus on macroeconomic stabilization such as cutting taxes can help stimulate an ailing economy. It can also raise taxes to combat rising inflation. Fiscal Policy changes in the longer term foster sustainable growth achieved through supply-side actions that improve education and infrastructure.
Q10: Campbell’s two primary objectives of Fed Monetary policy is to manage inflation and reduce unemployment, after controlling inflation to foster economic conditions that and maximum sustainable employment and stable prices
Q11: Tightening policy changes is associated with increases in market interest rates as it attempts to head off future inflation. The policy involves cutting in the government spending and increasing the rate of taxation. The Federal Reserve calls it deflationary fiscal policy aimed at reducing inflationary pressure through the reduction of growth of aggregate demand.
Q12: Tightening policies changes would are likely to increase the quantity of M1. It is achieved through raising interest rates for federal funds in short-term. Tightening policies reduce investment and consumer spending in an economy.
Q13: Weak economic growth. The Federal Reserve would pursue a more restrictive policy of managing inflation to foster economic conditions. Federal Reserve responds to with restrictive policy of changing the level of price inflation.
Q14: A reduced rate of price inflation as measured by the CPI would increase the probability that the Fed would pursue a more restrictive monetary policy. Reduced rate of price inflation reflect an increase in money supply as a result of lower interest rates. Restrictive Monetary policy serves the short-term need for controlling money supply.
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