1) Suppose that the U.S. Treasury decides to finance its deficit with mostly lon
ID: 2775282 • Letter: 1
Question
1) Suppose that the U.S. Treasury decides to finance its deficit with mostly long-term funds, departing from its previous policy of using short-term and intermediate-term funds. The Treasury will also use long-term funds to refinance maturing bonds issued in prior years. Briefly explain how this decision could impact the yield curve. You may use graphs or you may explain your answer in two or three sentences.
2) Investors had been expecting 2% inflation during the current year. Unfortunately, the actual inflation rate has turned out to be 4%, and investors now expect this higher rate to continue over the next few years. How will this change affect the following interest rates:
The nominal rate on previously issued (fixed interest rate) loans
The real interest rate on previously issued (fixed interest rate) loans
The real interest rate on new (fixed interest rate) loans issued today
The nominal interest rate on new (fixed interest rate) loans issued today
3) A $10,000 T-bill has a required return (stated as an EAR) of 3.7 percent and will mature in 77 days.
What is the current price of the T-bill?
What is the T-Bill Yield?
What is the T-Bill Discount?
Explanation / Answer
1) Suppose that the U.S. Treasury decides to finance its deficit with mostly lon
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