7) Which of the following will cause a reduction in the amount of money individu
ID: 1110355 • Letter: 7
Question
7) Which of the following will cause a reduction in the amount of money individuals wish to hold? A) an increase in the interest rate B) an increase in income C) an increase in the price level D) all of the above 8) If you initially pay $1,000 for a bond with an annual interest rate of 5 percent, but then the market interest rate rises to 6 percent, A) the market price of the bond is still $1,000. ) the bond's annual interest payment remains equal to $50. C) the market price of the bond has increased. D) the market price of the bond has decreased.Explanation / Answer
7. An increase in the interest rate will cause a reduction in the amount of money individuals wish to hold.
People hold money for their household expenditures called transactions demand for money.People also hold money for contigencies called precautionary demand for money.But when interest rates rise people will hold less amount of money for satisfying their transactions & precautionary demands. They will invest rest amount of money in bond fund or some other investment strategy so that they can earn higher amount of interest rate.
8. If you initially pay $1,000 for a bond with an annual interest rate of 5%,but then the market interest rate rises to 6% , the market price of the bond has decreased.
It is so becoz, when interest rate rises to 6%, new bonds are issued with 6% coupon. Our bond which has a 5% coupon isn't worth as much as it was when we bought it.Becoz investors can invest the same $1,000 & purchase a bond that pays a higher interest rate, so why would they pay $1,000 for our lower interest rate. In this case, the value of our bond would be less than $1,000.
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