eco financial markets
Part 2. Total 50 marks ( 10 marks each).
1. Explain why you would be more or less willing to buy gold under the following circumstances:
a. Gold again becomes acceptable as a medium of exchange. (2 marks)
b. Prices in the gold market become more volatile. (2 marks)
c. You expect inflation to rise, and gold prices tend to move with the aggregate price level.
(3 marks)
d. You expect interest rates to rise. (3 marks)
Outline of solutions:
(a) More, because it has become more liquid; (b) less, because it has become more risky; (c) more, because its expected return has risen; (d) more, because its expected return has risen relative to the expected return on long-term bonds, which has declined.
2. Demonstrate graphically the effect of a decrease in the personal savings rate combined with a simultaneous increase in the government deficit. Show and explain the effect of these two effects on bond prices, interest rates, investment, and GDP, using a written and graphical explanation. (10 marks)
Outline of solutions:
A decrease in the savings rate will lead to a shift in of the demand curve for bonds, as there is a decrease in savings by lenders, decreasing the demand for all assets, including bonds (2 marks). A rise in the government deficit will shift out the supply of bonds curve, as the government increases the amount it wished to borrow. (2 marks). The net effect on interest rates is that they rise (the price of bonds declines). The diagram shows the decrease in demand and increase in the supply curve. Since interest rates rise, investment declines, and GDP falls. The amount of bonds traded depends on the relative magnitude of the demand and supply curve. ( 3 marks graph; 3 marks explanations).
3. Of the 3 ways in which firms finance their investment, state in order the most common to the least common way in which the finance, and also explain why this is so. (10 marks)
Outline of answer:
Bank loans most common, second is bond,
1. Explain why you would be more or less willing to buy gold under the following circumstances:
a. Gold again becomes acceptable as a medium of exchange. (2 marks)
b. Prices in the gold market become more volatile. (2 marks)
c. You expect inflation to rise, and gold prices tend to move with the aggregate price level.
(3 marks)
d. You expect interest rates to rise. (3 marks)
Outline of solutions:
(a) More, because it has become more liquid; (b) less, because it has become more risky; (c) more, because its expected return has risen; (d) more, because its expected return has risen relative to the expected return on long-term bonds, which has declined.
2. Demonstrate graphically the effect of a decrease in the personal savings rate combined with a simultaneous increase in the government deficit. Show and explain the effect of these two effects on bond prices, interest rates, investment, and GDP, using a written and graphical explanation. (10 marks)
Outline of solutions:
A decrease in the savings rate will lead to a shift in of the demand curve for bonds, as there is a decrease in savings by lenders, decreasing the demand for all assets, including bonds (2 marks). A rise in the government deficit will shift out the supply of bonds curve, as the government increases the amount it wished to borrow. (2 marks). The net effect on interest rates is that they rise (the price of bonds declines). The diagram shows the decrease in demand and increase in the supply curve. Since interest rates rise, investment declines, and GDP falls. The amount of bonds traded depends on the relative magnitude of the demand and supply curve. ( 3 marks graph; 3 marks explanations).
3. Of the 3 ways in which firms finance their investment, state in order the most common to the least common way in which the finance, and also explain why this is so. (10 marks)
Outline of answer:
Bank loans most common, second is bond,