1.The demand curve and supply curve for one-year discount bonds with a face value of $1000 are as follows, respectively.

B^d: P = 1200 - 0.5 Q

B^s: P = 400 + 0.3 Q

Where P = price and Q = quantity.

a.What is the expected equilibrium price and quantity of bonds in this market?

(2.5 marks)

b.Given your answer to part (a), what is the expected interest rate in this market?

(2.5 marks)

As a monetary policy action, suppose the central bank purchases 100 of the bonds. Assuming the bond demand and money demand are held constant, answer the next two questions.

c.How does the central bank's action affect the bond demand and supply equations?(2.5 marks)

d.Calculate the effect on the equilibrium interest rate in this market as a result of the central bank's action.(2.5 marks)

2.State the expectations theory and explain its significance.(3 marks)