Suppose the current one-year interest rate is 3, and financial ...

[stephzh]

Suppose the current one-year interest rate is 3, and financial markets expect the one-year interest rate next year to be 5. Given this information, the yield to maturity on a two-year bond will be approximately
 
  A) 4.
  B) 6.
  C) 8.
  D) 12.
  E) none of the above

Question 2

Use the market for central bank money to answer this question. Graphically illustrate and explain what effect an increase in the reserve deposit ratio () will have on this market and on the equilibrium interest rate.
 
  What will be an ideal response?

[pratush dev]

Answer to Question 1

A

Answer to Question 2

An increase in the parameter  will cause an increase in banks' demand for reserves and, therefore, an increase in the demand for central bank money. This will cause an excess demand for central bank money at the initial interest rate. In this case, the interest rate will rise to restore equilibrium.

[stephzh]

TYSM

[matt95]

Excellent