The yield curve indicates that the two-year interest rate will be ...

[nramada]

The yield curve indicates that the two-year interest rate will be a function of what variables? Include in your answer an explanation of how changes in these variables will affect the two-year interest rate.
 
  What will be an ideal response?

Question 2

Graphically illustrate and explain what effect a sale of bonds by the Federal Reserve will have on the money market.
 
  What will be an ideal response?

[sylvia]

Answer to Question 1

The two-year rate will be a function of the current one-year rate and the future expected one-year rate. In fact, it will be approximately equal to the average of these two rates. So, an increase in either rate will cause the two-year rate to rise.

Answer to Question 2

A Fed purchase of bonds will cause a decrease in H and an decrease in the money supply. At the initial interest rate, there will be an excess demand for money. The interest rate will increase to restore money market equilibrium. All else fixed, there will be no change in money demand.