ECOS2004, Money and Banking
Tutorial 3
Information sources: Mishkin (Chapter 5), Macfarlane (2001), and lecture notes from week 3
Provide short answers to the following questions. Suggested length:
• Discussion-type questions: average of 100 words per question.
• Calculation-type questions: show workings and provide explanations as appropriate. (Where
relevant, calculations can be rounded to two decimal places)
1. Consider a bond market where the demand for a particular bond is given by the equation
𝐵! = 2360 − 0.8𝑃
where 𝐵! is the number of bonds demanded and P is the price of the bond.
Suppose the supply of this bond is fixed at 1400.
(a) Calculate the price of the bond
(b) Suppose the bond is a consol with an annual coupon of 45. What is the yield on this
security?
2. Suppose there is a one-year discount bond trading in the Australian market with a face value
of $1000 and supply and demand curves given by the following equations:
𝐵! = 1240 − 0.6𝑃
𝐵 " = 1.4𝑃 − 720
where P is the price of the bond, 𝐵! and 𝐵 " represent the number of bonds supplied or demanded.
Calculate the following:
(a) The equilibrium price of the bond
(b) The yield to maturity
(c) The number of bonds supplied and demanded
(d) The yield to maturity if this had been a two-year bond rather than one-year.
3. Using the same supply and demand equations as the previous question, and assuming this is
a one-year bond, what would be the effect on (a) the price and (b) the yield to maturity if
the RBA decided to sell 120 of these bonds from its own holdings to the market?
4. Consider a simple economy with only one form of money, which is currency. In this
economy, the demand for money is given by the equation:
$100
𝑀! =
𝑟
where r is the interest rate. Calculate (a) the equilibrium interest rate if the supply of
currency is fixed at $2000 and (b) the change in the interest rate that would occur if the
central bank increased the supply of currency by 10% (calculate to two decimal places).
5. Consider the same economy as in the previous question with the supply of money fixed at
$2000. Now suppose there is a shift in the money demand equation such that households in
aggregate desire to hold an additional $150 in cash balances for any given level of interest
rates. (a) Calculate the effect this has on the equilibrium interest rate (to two decimal
places). (b) What would the central bank have to do to offset this effect?
6. Why does the demand curve for bonds slope downwards? What factors could cause this
curve to shift to the left and what effect would this have on the interest rate? In your
answer, explain how this could be equivalently described in terms of the money market
rather than the bond market.
7. Consider two hypothetical economies (Country A and Country B) where the central bank
undertakes operations to increase the money supply by 5 per cent. In Country A the interest
rate falls, but in Country B the interest rate rises. What sorts of differences between
conditions in the two countries could explain these differing responses?
8. Suppose you are seeking to analyse the influence of interest rates on Australian homebuyers
during the one-year period from December 2019 to December 2020. Use data from the RBA
website to obtain measures of the nominal interest rate and the ex ante and ex post real
interest rates that you think would have been most relevant to these decision makers.
Explain the reasons for your choices and identify any possible shortcomings in these
measures.
9. In recent years, when the RBA has made a change in the cash rate, the change has been 25
basis points (0.25 percentage point) or less. Using information from the RBA web site, when
was the last time the RBA changed the cash rate by 100 basis points (1.0 percentage point)
in a single move? What was happening at the time and what reasons were given for the
decision?
10. In the period following the global financial crisis government deficits increased in most of
the major economies, resulting in a substantially increased supply of bonds, yet government
bond yields fell. How could this be explained?