MACROECONOMICS
14th Edition
ISBN: 9781337794985
Author: Baumol
Publisher: CENGAGE L
expand_more
expand_more
format_list_bulleted
Question
Chapter 14, Problem 1TY
To determine
To evaluate: The interest rate on the mortgage-backed security.
Expert Solution & Answer
Answer to Problem 1TY
The interest rate on a mortgage-backed security is higher than the treasury securities.
Explanation of Solution
With the help of given information, it is clear that the expected default rate on a mortgage-backed security is 4% per year and the corresponding Treasury Security annual interest rate is 3%. Investments in houses or securities depend on the interest rate. If the home mortgage interest rates are less, then the prices of the houses will increase. Therefore, as the purchase of houses is more profitable, investors would prefer doing it then investing in the securities. So, here, in this case, the interest rate on a mortgage-backed security is higher than the treasury securities and is a suitable situation to encourage investment in houses.
Further, if the expected default rate is 8% then the house prices will fall as people won’t be in a position to invest in the purchase of houses. A higher interest rate on a home loan will not attract the customers.
A low mortgage interest rate will always increase house prices.
Economics Concept Introduction
Introduction:
Mortgage-backed security: A mortgage-backed security is supposed to be an investment similar to a bond. The only difference is that this represents a bunch of home loans taken from a bank.
Want to see more full solutions like this?
Subscribe now to access step-by-step solutions to millions of textbook problems written by subject matter experts!
Students have asked these similar questions
If expectations of future short-term interest rates suddenlyfell, what would happen to the slope of the yield curve?
Why are bond prices and interest rates inversely related?
The following are data on the Treasury yield curve for July 17, 2012:
Time to maturity
Interest rate
6 months
0.15%
1 year
0.18%
2 years
0.25%
5 years
0.62%
10 years
1.53%
30 years
2.59%
Source: U.S. Department of the Treasury, "Daily Treasury Yield Curve Rates," July 17, 2012.
Given these data, why would an investor have been willing to buy a one-year Treasury bill with an interest rate of only 0.18% when the investor could have bought a
30-year Treasury bond with an interest rate of 2.59%?
O A. An investor would expect interest rates on short-term bonds to be higher in the future.
O B. Investors are exposed to greater interest-rate risk when they buy long-term bonds versus buying short-term bonds.
OC. Most investors have a life expectancy for investing purposes of less than 30 years.
O D. A andB only.
O E. All of the above.
Knowledge Booster
Similar questions
- An FI has purchased a $201 million cap of 8 percent at a premium of 0.70 percent of face value. A $201 million floor of 4.1 percent is also available at a premium of .75 percent of face value. a. If interest rates rise to 9 percent, what is the amount received by the FI? What are the net savings after deducting the premium? b. If the Fl also purchases a floor, what are the net savings if interest rates rise to 10 percent? What are the net savings if interest rates fall to 3.1 percent? (Negative amounts should be indicated by a minus sign.) c. If, instead, the Fl sells (writes) the floor, what are the net savings if interest rates rise to 10 percent? What if they fall to 3.1 percent? (Negative amounts should be indicated by a minus sign.) a. Amount received Net savings b. Net savings if interest rates rise to 10 percent Net savings if interest rates fall to 3.1 percent c. Net savings if interest rates rise to 10 percent Net savings if they fall to 3.1 percentarrow_forwardBelow you will find the Demand and Supply Curves for $250,000 bonds that mature in 18 years: Qd = 400,000 – 2(P) Qs = 3(P) – 100,000 If the Fed wants to move the interest rate to 5%, what would the bond price have to change to in order to achieve this?arrow_forwardAnswer question 50arrow_forward
- Answer question 47arrow_forwardQ1: “If the bonds of different maturities are perfectly substituted, their interest rates are more likely to move together”. Is this statement true or false or uncertain? Discuss using the theory of expectation.arrow_forwardA shift in the demand curve for bonds occurs when the quantity demanded changes at each given interest rate. When a shift takes place, there will be a new equilibrium value for the interest rate. Explain how expected returns result in a shift in the demand for bonds.arrow_forward
- Using both the liquidity preference framework and the supply and demand for bonds framework, show why interest rates are procyclical ( rising when the economy is expanding and falling during recessions DRAW THE GRAPHS (there will be 2 of them) and explain EACH grapharrow_forwardfrom December 2015 through December 2018, , the Fed raised the target level for the federal funds rate nine times. While short-term interest rates increased substantially, long-term rates increased only slightly (making the yield curve flatter, or even inverted). Show and explain why short-term and long-term interest rates have not moved togetherarrow_forwardShow graphically the effect of a sudden increase in the volatility of gold prices on interest rates in the bond market.arrow_forward
- 1.) Briefly define and explain how fractional reserve banking works. Both the textbook and the Segment 305 video on the Chapter 16 Resource Page may be of some help here (see the Federal Reserve Bank of Philadelphia - Educational Playlist.) 2.) Go to the Chapter 17 Resource page and watch the videos (Khan Academy and Investopedia) on the yield curve. Then, briefly describe what it is, the different types of yield curves, and what those different types of yield curves portend for the economy.arrow_forwardThe Bank of Key West is not going to have enough reserves at the end of the business day to meet its reserve requirement of 10%. It currently has two options to borrow money overnight in order to meet the requirement. First, it could borrow money from the Federal Reserve at a rate of 1.35%. Second, it could borrow money from other banks at a rate of 0.55%. What is the federal funds rate, and what is the discount rate? 1.35 federal funds rate: Incorrect I 1.55 discount rate: Incorrect What will happen to other short-term interest rates if the Fed increases its federal funds rate target? They will also increase. They will remain unchanged.. They will become irrelevant. They will decrease.arrow_forwardFind readings or videos on the internet with information on the factors that move the demand and supply curves of bonds, their effect on interest rates. Answer the following questions: 1. One way the Fed decreases the money supply is by selling bonds to the public. Using supply and demand analysis for bonds, show what effect this action has on interest rates. 2. Using the supply and demand of bonds, show why interest rates are pro-cyclical (they increase when the economy is expanding and decrease during recession). 3. What effect can a sudden increase in gold price volatility have on interest rates? 4. Using a supply and demand analysis for bonds, show the effect on interest rates when the risk of the bond increases.arrow_forward
arrow_back_ios
SEE MORE QUESTIONS
arrow_forward_ios
Recommended textbooks for you
Macroeconomics: Private and Public Choice (MindTa...EconomicsISBN:9781305506756Author:James D. Gwartney, Richard L. Stroup, Russell S. Sobel, David A. MacphersonPublisher:Cengage Learning
Economics: Private and Public Choice (MindTap Cou...EconomicsISBN:9781305506725Author:James D. Gwartney, Richard L. Stroup, Russell S. Sobel, David A. MacphersonPublisher:Cengage Learning
Economics (MindTap Course List)EconomicsISBN:9781337617383Author:Roger A. ArnoldPublisher:Cengage Learning
Macroeconomics: Principles and Policy (MindTap Co...EconomicsISBN:9781305280601Author:William J. Baumol, Alan S. BlinderPublisher:Cengage Learning
Macroeconomics: Private and Public Choice (MindTa...
Economics
ISBN:9781305506756
Author:James D. Gwartney, Richard L. Stroup, Russell S. Sobel, David A. Macpherson
Publisher:Cengage Learning
Economics: Private and Public Choice (MindTap Cou...
Economics
ISBN:9781305506725
Author:James D. Gwartney, Richard L. Stroup, Russell S. Sobel, David A. Macpherson
Publisher:Cengage Learning
Economics (MindTap Course List)
Economics
ISBN:9781337617383
Author:Roger A. Arnold
Publisher:Cengage Learning
Macroeconomics: Principles and Policy (MindTap Co...
Economics
ISBN:9781305280601
Author:William J. Baumol, Alan S. Blinder
Publisher:Cengage Learning