Question

[Related to the Making the Connection LOADING... ] Writing in the Wall Street Journal , economists Jeremy Siegel and Jeremy Schwartz made the following prediction: "We believe that when investors awake from their depressed state, they will realize that they don't have to lend the U.S. government money for 10 years at a negative real yield."

Source: Jeremy J. Siegel and Jeremy Schwartz, "The Bond Bubble and the Case for Stocks," Wall Street Journal , August 22, 2012. By "negative real yield" Siegel and Schwartz:

A. meant that the nominal interest rate on 10-year Treasury notes was negative, because investors had to pay more for bonds then they would get in return when the bonds were repayed.

B. meant that the real interest rate on 10-year Treasury notes was negative, because after taking into account the risk of default, the nominal yield would need to be adjusted causing a negative real yield.

C. meant that the nominal interest rate on 10-year Treasury notes was negative, because the interest rate after paying brokerage fees would be negative.

D. meant that the real interest rate on 10-year Treasury notes was negative, because even though there was a very small positive nominal yield, when inflation is considered the real yield actually becomes negative.

In 2012 investors were willing to accept a negative real yield on 10-year Treasury notes because:

A. they always need to hold some Treasury notes in their portfolios.

B. they were looking for a safe asset with any kind of nominal interest rate to purchase.

C. they did not know that the real interest rate was negative.

D. they were influenced by the media and oversees investors.

Answer 1

Solution-

1. Writing in the Wall Street Journal , economists Jeremy Siegel and Jeremy Schwartz made the following prediction: "We believe that when investors awake from their depressed state, they will realize that they don't have to lend the U.S. government money for 10 years at a negative real yield."

Source: Jeremy J. Siegel and Jeremy Schwartz, "The Bond Bubble and the Case for Stocks," Wall Street Journal , August 22, 2012. By "negative real yield" Siegel and Schwartz:

The correct option is D. meant that the real interest rate on 10-year Treasury notes was negative, because even though there was a very small positive nominal yield, when inflation is considered the real yield actually becomes negative.

Reason-

Siegel and Schwartz did not mean that the nominal interest rate on 10-year Treasury notes was negative, but instead that the real interest rate was negative. That is, that the nominal interest rate was less than the inflation rate.

2. In 2012 investors were willing to accept a negative real yield on 10-year Treasury notes because: they were looking for a safe asset with any kind of nominal interest rate to purchase.

The correct option is B. they were looking for a safe asset with any kind of nominal interest rate to purchase.

Reason-

Federal Reserve monetary policy in response to the financial crisis of 2007 – 2009 had pushed other interest rates to low levels and investors were concerned about risk following that financial crisis. Because Treasury notes are free of default risk, investors were willing to buy them even at very low nominal interest rates.