Question

1. Consider the following statement: “The 10 year Treasury yield fell below 2% after a lackluster jobs report, signaling the bond market’s skepticism that the Federal Reserve will be in a position to lift interest rates this year.”

What is the logic behind this statement?

a. Weak jobs data is a signal of slowing growth and if the fed raised rates now it might further slow growth since a firm's cost of capital would remain unchanged.

b. Weak jobs data is a signal of slowing growth and if the fed raised rates now it might further slow growth since a firm's cost of capital would increase.

c. Weak jobs data is a signal of slowing growth and if the fed raised rates now it might further slow growth since a firm's cost of capital would decrease

2. An upward sloping term structure indicates that Treasury securities with ____ maturities offer ____ annualized yields.

a. longer; lower

b. longer; higher

c. shorter; lower

d. shorter; higher

e. b and c

3. You need to choose between investing in a one year municipal bond with an 8.5% yield and a one year corporate bond with a 10.5% yield. Assume your marginal federal income tax rate is 15% and no other differences exist between these two securities. What is the after tax yield on the corporate bond and which would you invest in?

a. 1.575%, invest in the municipal bond

b. 8.925%, invest in the municipal bond

c. 8.925%, invest in the corporate bond

4. Explain how the Fed changes the money supply through open market operations.

a. The Fed can increase the money supply by selling securities in the secondary market.

b. The Fed can decrease the money supply by selling securities in the secondary market.

c. The Fed can decrease the money supply by purchasing securities in the secondary market.

5. The main goals of the FOMC are:

a. to promote high employment, economic growth, and price stability.

b. to promote high employment, economic growth, and a steady increase in prices.

c. to promote high employment, economic growth, and a steady decrease in prices.

Answer 1

1]

A lackluster jobs report means that economic growth has slowed.

If the Federal Reserve raises interest rates, it will be become more expensive for businesses to borrow, and will increase their cost of capital. This would slow economic growth.

The answer is (b)

2]

The term structure of interest rate shows the relationship between maturities of Treasury securities (on the x-axis) and annualized yields (on the y-axis).

An upward sloping term structure means that yields are higher for longer maturities, and lower for shorter maturities.

The answer is (e) - b and c

3]

after tax yield on corporate bond = before tax yield * (1 - tax rate)

after tax yield on corporate bond = 10.5% * (1 - 15%) = 8.925%

You should invest in the corporate bond as the after tax yield on corporate bond is higher than the yield on the municipal bond

The answer is (c)

4]

b. The Fed can decrease the money supply by selling securities in the secondary market.

When the Fed sells securities in the secondary market, financial institutions have to pay for the securities. Thus, money is taken out of the system. This decreases money supply

5]

The main goals of the FOMC are:

a. to promote high employment, economic growth, and price stability.