Question

PART B

The RBA intends to use open market operations in addition to reducing the cash rate.

Assume that a bond with no expiration date pays a fixed $300 annual interest and is selling for its face value of $10,000.

1. Calculate the interest yield on the bond.

2. Will the RBA buy or sell bonds if it uses open market operations? Briefly explain.

3. As a result of the RBA’s decision above which of these two outcomes is more likely or correct?

1. The market value of the bond will increase to $15,000 OR
2. The market value of the bond will decrease to $6,000.

Explain your answer by calculating the new interest yield after the RBA’s open market operations; show your workings.

Answer 1

Hi,

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Question:

Answer:

Coupon amount ( the annual interest payment) = $300

Face Value = $10,000

Interest Yield = (Bond's coupon rate/Bond's purchase price)*100

(300 /10,000)*100

= 0.03*100 = 3%

Interest Yield = 3%

As per question the RBA intends to use open market operations in addition to reducing the cash rate. Open market operation is a monetary tool that is use by the central bank bank to control the money supply. At a time of boom or healthy economic condition when inflation rate is high that time the central bank sell the government securities and reduce the money supply. When the central bank reduce the money supply then loan become costly and its control or reduce the inflation rate. At the time of economic downturn or recession central bank purchase government securities and increase the money supply. When the central bank increase the money supply then loan become cheaper and boost the economic growth.

Here, As per question the RBA intends to use open market operations in addition to reducing the cash rate so, RBA will purchase the government securities. It will increase the money supply and reduce the rate.

According to the question the RBA intends to use open market operations in addition to reducing the cash rate. So, RBA will purchase the bond. Because the RBA will purchase the bond so, it will increased the demand of bonds and increased the price of the bonds.

So, As a result of the RBA’s decision the market value of the bond will increase to $15,000

  

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