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    Exercises 2 - C

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    Exercices in Financial Institutional Markets

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    Exercises 2 - C

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    Exercices in Financial Institutional Markets

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    Exercices in Financial Institutional Markets

    Copyright:

    © All Rights Reserved
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    Download as docx, pdf, or txt
    9 views1 page

    Exercises 2 - C

    Uploaded by

    2dkdrmmq6r
    Exercices in Financial Institutional Markets

    Copyright:

    © All Rights Reserved
    Download as DOCX, PDF, TXT or read online from Scribd
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    Exercices 2

    1 - Explain the relationship between risk-loving and risk-averse investors, and the strategy of
    diversification.

    Risk-loving investors are those who seek risk with the aim to achieve higher returns, such as
    investing in equity shares. Risk-averse investors avoid risk to achieve normal returns, such as
    investing in bonds. The relationship between risk-loving and risk-averse investors is that
    sometimes investors can switch their attitude from risk-averse to risk-loving and vice versa
    based on the situation that they are facing. A wise investor should seize every possible
    opportunity and take calculated risks which reflect in his or her investment behavior and
    attitude. Diversification is a strategy used to reduce the overall risk in a portfolio.
    Diversification is described as the holding of many risky assets in a portfolio.

    2 - Using the supply-and-demand for bonds framework, show why interest rates are
    procyclical (rising when the economy is expanding and falling during recessions).

    When the economy booms, the demand for bonds increases: The public’s income and
    wealth rises while the supply of bonds also increases, because firms have more attractive
    investment opportunities. Both the supply and demand curves (B d and B s) shift to the right,
    but as is indicated in the text, the demand curve probably shifts less than the supply curve so
    the equilibrium interest rate rises. Similarly, when the economy enters a recession, both the
    supply and demand curves shift to the left, but the demand curve shifts less than the supply
    curve so that the bond price rises and the interest rate falls. The conclusion is that bond
    prices fall and interest rates rise during booms and fall during recessions, that is, interest
    rates are procyclical.

    3 - What will happen in the bond market if the government imposes a limit on the amount of
    daily transactions? Which characteristic of an asset would be affected?

    If the government imposes a limit on the amount of daily transactions in the bond market,
    then bonds will become less liquid with respect to alternative assets. Such a regulation will
    mean that it will now be more difficult to find buyers and sellers in the bond market, thereby
    affecting the liquidity of bonds and the demand curve (which will shift to the left), increasing
    the interest rate and lowering bond´s prices (for a given supply curve).

    4 - How might a sudden increase in people’s expectations of future real estate prices affect
    interest rates?

    Interest rates would rise. A sudden increase in people’s expectations of future real estate
    prices raises the expected return on real estate relative to bonds, so the demand for bonds
    falls. The demand curve B d shifts to the left, and the equilibrium bond price falls, so the
    interest rate rises.

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