This assignment is for Module 4 and covers Chapter 23 from the text. Students should answer all questions. All questions
are of equal value.
Question 1
a) Suppose you could buy a bond today for $90 that you could redeem in exactly one year for $100, leaving you with
$10 in profit. Calculate your rate of return in percent. (Show your calculations and round to two decimals (X.XX%).
b) Now suppose you could buy a bond today for $95 that you could redeem in exactly one year for $100, leaving you
with $5 in profit. Calculate your rate of return in percent. (Show your calculations and round to two decimals (X.XX%).
c) Based on your answers from parts a) and b) above, explain the relationship between the bond prices and the rates
of return.
d) What could happen to change the price that people would be willing to pay for a bond that would be worth $100 a
year from its date of purchase?
Question 2
a) Why do firms demand loanable funds?
b) Give an example of investment as it relates to the loanable funds market.
c) Sketch a loanable funds demand/supply diagram that illustrates the impact on the equilibrium quantity of loanable
funds and the real interest rate resulting from an increase in expected profits by firms.
Question 3
Use a loanable funds diagram to illustrate the impact of increased default risk on real interest rate and the quantity of
loanable funds demanded. Be sure to explain your diagram.
Question 4
a) Use a loanable funds diagram to illustrate the impact of government budget deficits on the interest rate.
b) Define and precisely identify the “crowding out effect” on your diagram.
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