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5 Cards in this Set
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All else being equal, which of the following would cause an increase in the demand for an asset, assuming that investors are risk-averse?
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Decrease in risk
Risk measures the uncertainty (or variance) in an asset's expected rate of return. Because risk-averse investors prefer assets with less risk, their demand for an asset rises when the risk associated with that asset falls. The remaining choices cause a decrease in asset demand. A decrease in expected future price or a capital loss will cause a decrease in expected rate of return. |
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The variance in an asset's rate of return measures this asset's risk; the more volatile the return, the more difficult it is to predict.
All else being equal, when the variance of an asset's rate of return falls, the demand for an asset will: |
Rise when investors are risk-averse
If the expected rate of return is easier to predict, this exposes the investor to less risk. If investors are risk-averse, demand for this asset increases when the asset's risk decreases. Notice that risk-neutral investors are indifferent to risk, so their demand would not change. Risk lovers would respond to the lower risk with a decrease in demand. Changes in the variance of an asset's rate of return does not imply a change in the average or expected rate of return. |
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The theory of asset demand is used to show how the quantity demanded of a bond, the bond price, and the bond yield to maturity are related. The question below applies this theory to a one-year discount bond with a given face value.
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As the bond price rises, the quantity demanded falls. When the price of the bond rises, buyers are willing to purchase fewer bonds because the rate of return on bonds is lower. (In this model the rate of return is equal to the yield to maturity, because the assumption is the bond is held to maturity.)
For a coupon bond, the coupon payments and the face-value payment are fixed. Therefore, when the price of the bond rises, the buyer pays more but receives the same dollar amount in future interest and principal payments. Measured per dollar invested, therefore, the return is lower. |
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The theory of asset demand is used to show how the quantity demanded of a bond, the bond price, and the bond yield to maturity are related. The question below applies this theory to a one-year discount bond with a given face value.
When a one-year discount bond's yield to maturity increases, its current price also goes up. True of Flase |
False-
The relationship between yield to maturity (i), bond price (P), and face value (F) for a one-year bond is shown in the value relationship: P = F / (1 + i) Therefore, if the price rises, the yield to maturity falls (for a given face value F). Intuitively, when the yield to maturity rises, this means the bond owner forgoes more interest until the face value payment is made. This decreases the bond's present value, and hence its price. |
