Hi i've tried these 2 questions but i'm not sure if i'm doing it right- could someone pls give me a hand? Below is the question. Thanks
1.
The following addresses the impact of a change in the cash rate (the interest rate in the overnight cash market (OCM)) on the one year bond market.
a) Assume that the RBA decreases the cash rate from 3% to 2.75%.
i) What profit opportunities initially exist in the one year bond market after the RBA announces a decrease in the cash rate? What happens to the market price of bonds in the one year bond market? Illustrate using a diagram showing the demand and supply of bonds (i.e. the demand and supply of loans)? Assume, for simplicity that the interest rate in the OCM and the interest rate in the 1 year bond market are initially equal. (1 mark)
ii) What is the impact on the market price of the following bonds arising from the decrease in the cash rate? Assume the following: Principal = $10m; Coupon rate = 3%; Market interest rate = Cash Rate = 2.75%. (1 mark)
2.
Assume that a central bank in the past when determining the cash rate placed equal weight on the output gap and the inflation rate. Also assume that the long-run equilibrium interest rate in this country is 2% ( ̅r= 2%).
Let’s assume that the nominal interest rate (i) = 5%. Will the central bank decrease or increase the nominal interest rate for each of the above scenarios? (1 mark) What is the direction of the impact of the change in the nominal interest rate on the output gap and the rate of inflation for each of the above scenarios? (1 mark) Is the economic situation improved by the change in the interest rate? (1 mark)
Situations:
1.Output Gap = 3%
Inflation (π) = 5%
2.Output Gap = -3%
Inflation (π) = -1%
3.Output Gap = -2%
Inflation (π) = 5%
1.
The following addresses the impact of a change in the cash rate (the interest rate in the overnight cash market (OCM)) on the one year bond market.
a) Assume that the RBA decreases the cash rate from 3% to 2.75%.
i) What profit opportunities initially exist in the one year bond market after the RBA announces a decrease in the cash rate? What happens to the market price of bonds in the one year bond market? Illustrate using a diagram showing the demand and supply of bonds (i.e. the demand and supply of loans)? Assume, for simplicity that the interest rate in the OCM and the interest rate in the 1 year bond market are initially equal. (1 mark)
ii) What is the impact on the market price of the following bonds arising from the decrease in the cash rate? Assume the following: Principal = $10m; Coupon rate = 3%; Market interest rate = Cash Rate = 2.75%. (1 mark)
2.
Assume that a central bank in the past when determining the cash rate placed equal weight on the output gap and the inflation rate. Also assume that the long-run equilibrium interest rate in this country is 2% ( ̅r= 2%).
Let’s assume that the nominal interest rate (i) = 5%. Will the central bank decrease or increase the nominal interest rate for each of the above scenarios? (1 mark) What is the direction of the impact of the change in the nominal interest rate on the output gap and the rate of inflation for each of the above scenarios? (1 mark) Is the economic situation improved by the change in the interest rate? (1 mark)
Situations:
1.Output Gap = 3%
Inflation (π) = 5%
2.Output Gap = -3%
Inflation (π) = -1%
3.Output Gap = -2%
Inflation (π) = 5%