On January 1, 2000 Tanya purchases three (3) newly issued two-year government no

Question

On January 1, 2000 Tanya purchases three (3) newly issued two-year government notes with each having a principal amount of $1,000 and each with a coupon rate of 5% paid annually. If Tanya decides to sell her notes on January 1, 2001 (after receipt of the first interest payments from the three notes) and if new one-year government debt at that time pays at a simple annual interest rate of 12.5% (12.5% coupon rate on newly issued one-year debt), people would be willing to pay and Tanya would be willing to accept for Tanya's old notes (rounded to the nearest dollar). $3000 $3150 $2800 $2700 $2917 An open - market purchase of government securities by the Federal Reserve results in an increase in bank reserves. True False

Explanation / Answer

18. $ 2,800

Payment made to Tanya at the end of year January 1, 2001 on one note = 1,000 + 5% of 1,000 = $ 1,050

Payment made to Tanya at the end of year January 1, 2001 on 3 notes = $ 3,150

To get interest of 12.5%, Tanya is willing to sell her note :

P (1 + 12.5%) = 1050

P (1 + 0.125) = 1050

P = 1050/1.125 = 933.33

So, price of 3 notes = 3 X 933..3 = 2799.99 = $ 2,800

19. True

Open market operation is the sale and purchase of government securities by the Federal Reserve. Purchase of government securities inject money into the system and due to this bank reserves increases.

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