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Chapter 5: Q.9 (page 164)

How might a sudden increase in people’s expectations of future real estate prices affect interest rates?

Short Answer

Expert verified

This will lead the bond demand curve to shift to the left, resulting in a decrease in the equilibrium bond price as well as a rise in the interest rate.

Step by step solution

01

Introduction

The amount demanded of an asset is directly related to wealth, expected return on asset, and liquidity of the asset, and negatively proportional to expected return on alternative asset, liquidity of the alternative asset, according to the theory of portfolio choice.

02

Explanation

If future real estate values are expected to rise sharply, the demand for real estate will rise in compared to bond demand, and bond demand would fall as a result.

This will lead the bond demand curve to shift to the left, resulting in a decrease in the equilibrium bond price as well as a rise in the interest rate.

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Most popular questions from this chapter

Using both the supply and demand for bonds and liquidity preference frameworks, show how interest rates are affected when the riskiness of bonds rises. Are the results the same in the two frameworks?

In the aftermath of the global economic crisis that started to take hold in 2008, U.S. government budget deficits increased dramatically, yet interest rates on U.S. Treasury debt fell sharply and stayed low for quite some time. Does this make sense? Why or why not?

If the next chair of the Federal Reserve Board has a reputation for advocating an even slower rate of money growth than the current chair, what will happen to interest rates? Discuss the possible resulting situations.

1. Explain why you would be more or less willing to buy a share of Microsoft stock in the following situations:

a. Your wealth falls.

b. You expect the stock to appreciate in value.

c. The bond market becomes more liquid.

d. You expect gold to appreciate in value.

e. Prices in the bond market become more volatile.

Go to the St. Louis Federal Reserve FRED database, and find data on net worth of households and nonprofits (HNONWRQ027S) and the 10-year U.S. Treasury bond (GS10). For the net worth indicator, adjust the units setting to “Percent Change from Year Ago,” and for the 10-year bond, adjust the frequency setting to “Quarterly.”

a. What is the percent change in net worth over the most recent year of data available? All else being equal, what do you expect should happen to the price and yield on the 10-year Treasury bond? Why?

b. What is the change in yield on the 10-year Treasury bond over the last year of data available? Is this result consistent with your answer to part (a)? Briefly explain.
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