1. Could the Canadian dollar still function as Canada’s unit of account if Canadians stopped using cash in transactions and only used demand deposits held at banks? Briefly explain.
2. You transfer $1000 from your chequing account at your bank to your savings account. What impact would your action have on the M1 measure of the Canadian money supply and the M2 measure of the Canadian money supply? Briefly explain in a couple of sentences.
3. One year ago you bought a $10,000, 4-year Government of Canada Treasury Bill (discount bond) at the then market yield of 2%. Today the market yield on the bond is 5% and now you find that must sell the bill.
(a) What is the current market price of the bill?
(b) What is your one period holding period return on your investment?
4. You receive a paper cheque for $10,000 drawn on a bank,other than your own, and deposit it into your chequing account at your bank. Even though this is a “demand deposit” account the funds are not typically not made available to you immediately by your bank. Why? Briefly explain.
5. As a result of the war in Ukraine the United States (U.S.) government has increased its defence spending to provide military equipment to support Ukraine. Other things equal, what impact would this increased military spending have on the market for U.S. government bonds? Briefly explain with the aid of a supply and demand diagram. Would the yield to maturity of U.S. government bonds increase or decrease?
6. Risk premiums on corporate bonds are usually countercyclical, that is they decrease during business cycle expansions and increase during recessions. Briefly explain why this occurs.
7. Suppose that the yield curve for government bonds shows that the one-year bond yield is 4%, the two-year yield is 7%, and the three-year yield is 9%. Assume that the liquidity (term) premium on the one-year bond is 0%, the liquidity premium on the two-year bond is 2%, and the liquidity premium on the three-year bond is 2.5%.
According to the liquidity premium theory, what is the expected one-year interest rate next year and the following year? Briefly explain.
8. When short term (ie. one year) interest rates (bond yields) move, whether up or down, long term interest rates (bond yields) generally move in the same direction, but by less. According to the Expectations Theory of the term structure what is the likely explanation of this observation? Explain.