Weird monetary policy MC? (1 Viewer)

[swagmeister]

Hi guys,

Just looking at this question and I thought the answer would be D for sure, but the marking criteria says C:

18. What is the effect of the RBA selling short-term securities in the overnight money market?
(a) The price and yields of short-term securities would decrease.
(b) The price of the short-term security would increase and the yield would decrease.
(c) The price of the short-term security would decrease and the yield would increase.
(d) The price and yields of short-term securities would decrease.



Can anyone explain why it would be C?

Cheers,
swagmeister

 

[si2136]

Pretty sure it's D. In another thread, BOS users were discussing about the wrong answers in the multiple choice.

 

[piethepker]

Could someone explain why its D, especially in reference to the yield of the bonds?

Thanks

 

[swagmeister]

Could someone explain why its D, especially in reference to the yield of the bonds?

Thanks

Sure man. So when the RBA sells the second hand securities to banks, it will withdraw money from the banks exchange settlement accounts. This then decreases the total value of money in the ESA’s, and with less supply, the price of borrowing goes up. Then we come to yield, which just means return on investment. When the price of borrowing goes up, this will lead to an interest rate increases as money is more expensive to borrow because there is less of it. Because of this, the yield on investing in the overnight money market should increase.

Can anyone offer a valid explanation of C being the correct answer?

 

[piethepker]

Thank you.

 

[elkedag]

It is true that short-term security prices are inversely related to interest rates, so higher interest rates should result in lower short-term security prices as the opportunity cost of holding the security (as opposed to money) is higher. However, the coupon rate of bonds is unaffected by changes in interest rates. Therefore, the yield which is calculated by the ratio between the coupon payment of the bond and the price of the bond will increase (since the price decreases). Thus I think short-term security prices should decrease and percentage yields would increase, as the coupon payment is a greater proportion of the market price for the security.

Although I probably wouldn't be able to answer this with HSC level economics

Because of this, the yield on investing in the overnight money market should increase.

It's a yield on alternative short-term securities, not the yield on investing in the overnight money market

 

[swagmeister]

It is true that short-term security prices are inversely related to interest rates, so higher interest rates should result in lower short-term security prices as the opportunity cost of holding the security (as opposed to money) is higher. However, the coupon rate of bonds is unaffected by changes in interest rates. Therefore, the yield which is calculated by the ratio between the coupon payment of the bond and the price of the bond will increase (since the price decreases). Thus I think short-term security prices should decrease and percentage yields would increase, as the coupon payment is a greater proportion of the market price for the security.

Although I probably wouldn't be able to answer this with HSC level economics



It's a yield on alternative short-term securities, not the yield on investing in the overnight money market

Thanks for the correction there and explanation. I agree with you in that from a HSC perspective, it's extremely unreasonable to expect students to achieve C.