Use this information to answer questions 3 and 4. Imagine that the economy is doing well and that economic growth is in line with the long run potential growth rate of the economy and that inflation is running close the Fed's preferred target. The Fed is currently happy with the stance of monetary policy and the market believes that the Fed is unlikely to change the Fed Funds target for the next 2 years. The current yield curve is modestly upward sloping with a normal shape. Suddenly a strong hurricane strikes the Northeast US causing widespread economic damage and market comes to believe that the Fed will react to limit the damage by cutting rates at its next policy meeting in 6 weeks.

Q3: Describe what you believe would happen to yields on US Treasuries on the day following the hurricane at these three maturity points on the yield curve: 1 month, 2 years, and 10 years . Pick only one answer.

Interest rates will fall by roughly the same amount at all 3 maturity points.

The one month yield will fall modestly, the 2 year yield will fall by a greater amount than the 1 month yield and the 10 year yield will fall by less than the 2 year yield.

All three yields will fall. The drop in the one month rate will be larger than the drop in the 2 year rate which in turn will be less than the drop in the 10 year rate.

Q4: When the Fed meets, it decides to cut rates by 0.50%, and it indicates that this will be the only rate cut needed in response to the hurricane impacts on the economy. What happens in the market when this is announced.

The 1 month rate falls by 0.50%, the 2 year falls by less than than the 1 month yield, and the 10 year yield falls by an even smaller amount.

All three yields fall by 0.50%.

The 1 month rate falls by less than 0.50%, the 2 year falls by less than than the 1 month yield, and the 10 year yield falls by an even smaller amount.