1. Interest rates typically fall in a recession because the demand for money depends______ on changes in real income.

2. If interest rates are 9 percent per year, the price of a bond that promises to pay $109 next year will be equal to ______.

3. Through its effect on money demand, an increase in prices will______ interest rates.

4. Open market purchases lead to rising bond prices and ______interest rates.

5. Pricing a Bond. If a bond promises to pay $110 next year and the interest rate is 5 percent per year:

a. What will the price of the bond be?

b. What will the new price of the bond be if the interest rate falls to 3 percent?

6. Buy or Sell Bonds? If you strongly believed the Federal Reserve was going to surprise the markets and raise interest rates, would you want to buy bonds or sell bonds?

7. Recessions and Interest Rates. The economy starts to head into a recession. Using a graph of the money market, show what happens to interest rates. What happens to bond prices?

8. A Decrease in the Riskiness of the Stock Market. If investors began to think the stock market is becoming less risky, how will this belief affect the demand for money? Would this more likely affect M1 or M2?

9. Rising Prices and the Money Market. Draw a graph of the money market to show the effects of an increase in prices on interest rates.