Question 1 Some economic forecasters are predicting higher average interest rates, and higher asset retum volatility, in the months ahead (a) Consider the Tobin Portfolio Demand for Money Model (not the Baumol-Tobin Transactions Demand for Money Model), and assume that, as in the original Tobin model interest is not paid on money holdings. Assume that the individual is initially at her utility maximizing position Suppose then that, in the notation of Lecture 2. rand o both double How will these changes affect the individual's optimal holdings of bonds and money? Ilustrate diagrammatically (3 marks) (b) Now suppose instead that a net interest rate of > is paid on money holdings as well, and that the individual is initially at hier utility-maximizing position corresponding to this value of ry as well. Suppose now that r, o, and all double. How will these changes affect the individual's optimal holdings of bonds and money? Illustrate diagrammaticallyAssume that, in the language of basic Microeconomics, portfolio return stability is a superior good as an individual's wealth increases, other things being equal, she desires a lower of (4 marks) (c) in which of the above cases will the individual's desired holdings of bonds change by more, and what is the economic rationale for this difference? Answer in not more than 4 sentences. (2 marks) (You are advised to carefully review all specifications of the Model before attempting to answer the above questions - they are not as straightforward as they may appear) Question 1 Some economic forecasters are predicting higher average interest rates, and higher asset retum volatility, in the months ahead (a) Consider the Tobin Portfolio Demand for Money Model (not the Baumol-Tobin Transactions Demand for Money Model), and assume that, as in the original Tobin model interest is not paid on money holdings. Assume that the individual is initially at her utility maximizing position Suppose then that, in the notation of Lecture 2. rand o both double How will these changes affect the individual's optimal holdings of bonds and money? Ilustrate diagrammatically (3 marks) (b) Now suppose instead that a net interest rate of > is paid on money holdings as well, and that the individual is initially at hier utility-maximizing position corresponding to this value of ry as well. Suppose now that r, o, and all double. How will these changes affect the individual's optimal holdings of bonds and money? Illustrate diagrammaticallyAssume that, in the language of basic Microeconomics, portfolio return stability is a superior good as an individual's wealth increases, other things being equal, she desires a lower of (4 marks) (c) in which of the above cases will the individual's desired holdings of bonds change by more, and what is the economic rationale for this difference? Answer in not more than 4 sentences. (2 marks) (You are advised to carefully review all specifications of the Model before attempting to answer the above questions - they are not as straightforward as they may appear)
