Suppose that a commercial bank wants to buy Treasury bills. These instruments pay $6,500 in one year

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Question:

Suppose that a commercial bank wants to buy Treasury bills. These instruments pay $6,500 in one year and are currently selling for $6,541. What is the yield to maturity of these bonds? Is this a typical situation? Why or why not? (7)

Question 1b)

Suppose the Australian government bond has a 6% annual coupon and a face value of $1000. Complete the following table. What relationships do you observe among years to maturity, yield to maturity, and the current price?

(8)

Years to Maturity	Yield to Maturity	Price
4	4%
4	6%
8	8%
10	4%
10	10%

Question 2a)

An important way in which the central bank of a country decreases the money supply is by selling bonds to the public. Using a supply and demand analysis for bonds (draw a graph), show what effect this action has on interest rates. Is your answer consistent with what you would expect to find with the liquidity preference framework? (8)

Question 2b)

Suppose that people in China decide to permanently increase their savings rate. Predict what will happen to the Chinese bond market in the future. Can China expect higher or lower domestic interest rates?

Question 3 (Module 1):

The two prominent measures of money are M1 and M2. Suppose the following table shows the values of M1 and M2 in the Australian economy (in billions of dollars).

(i) What are the values of M1 and M2 for each year? What are the growth rates of the M1 and M2 money supplies from the previous year? (7)

(ii) Why are the growth rates of M1 and M2 so different? Explain.

Helpful information:

M1 = currency + demand deposits + checkable deposits + travellers checks

M2 = M1+ savings deposits + time deposits + money market deposit accounts + money market mutual fund shares

(8)

	2017	2018	2019	2020
Currency	688	705.2	709.5	715
Current (cheque) deposits	624	625	584	630
Saving account deposits	2400	2960	2764	3285
Money market deposits	1619	1659	1685	1933
Demand deposits	1450	1421	1340	1539
Small denomination time deposits	780	811	1082	1368
Traveler's checks	5	2	6	3
Three-month Australian treasury bills	2101	1937	2166	2207