FIN201e Homework Assignment – Chapter 6
Questions:
6-2 Which fluctuate more – long-term or short-term interest rates? Why?
Short-term rates fluctuate more, because they rise and fall rapidly during booms and
recessions, which shows that they’re more volatile on the graph when compare to long-term.
6-3 Suppose you believe that the economy is just entering a recession. Your firm must raise capital
immediately, and debt will be used. Should you borrow on a long-term or a short-term basis? Why?
Short-term. Because a decreased demand for credit usually occurs during recession, which
lead to an increase in the monetary supply and a decline in interest rates.
6-5 Suppose a new process was developed that could be used to make oil out of seawater. The
equipment required is quite expensive; but it would, in time, lead to low prices for gasoline,
electricity, and other types of energy. What effect would this have on interest rates?
Initially the expensive equipment would lead to an increase of demand in capital which
pushes rates up. But in the long-run the interest rates would fall because of dropping prices.
6-6 Suppose a new and more liberal Congress and administration are elected. Their first order of
business is to take away the independence of the Federal Reserve System and to force the Fed to
greatly expand the money supply. (increase in expected inflation) What effect will this have:
a. On the level and slope of the yield curve immediately after the announcement?
By greatly expand the money supply, long-term rates will rise and short-term rates will fall.
Yield Curve for short-term rates is downward sloping.
b. On the level and slope of the yield curve that would exist 2 or 3 years in the future?
Lowered short-term rates will hopefully motivate businesses to borrow more capital; this
increased demand for capital pushes rates back up. YC is upward sloping again.
6-8 Suppose interest rates on Treasury bonds rose from 5% to 9% as a result of higher interest
rates in Europe. What effect would this have on the price of an average company’s common stock?
Higher interest rates translate to drop in demand for loans and an average company will be
less likely to expand their capital to invest, the price of their stock should decrease.
6-9 What does it mean when it is said that the United States is running a trade deficit? What impact
will a trade deficit have on interest rates?
Trade deficit is when U.S. export < import, they must be financed (borrowing from nations
with export surpluses) It hinders the Fed’s ability to combat a recession by lowering rates.
