Money and Banking – Spring 2026_Section 1
Midterm 1
Name:______________________________________ Net Id (not N #)______________________
WHEN HANDING IN PUT YOUR BUBBLE SHEET IN THE ENVELOPE
WITH THE TA’S NAME and TIME OF THE RECITATION YOU ATTEND
Please don’t start the exam until you are given the go ahead.
exactly as it appears in Brightspace
On the bubble sheet write your name
and your net id (not N #).
Write your name and net id on ALL parts of the exam.
Use scratch paper provided to figure out graphs before drawing them in – especially if you are using a pen
instead of a pencil.
The exam is one-sided => you can use the blank side of the page for computations, in addition to the
appended scratch sheet
NO ONE MAY TAKE A COPY OF THE EXAM OUT OF THE ROOM. THE EXAM WILL BE
POSTED WITH THE SOLUTIONS AFTER THE GRADES ARE OUT.
For Instructor/TA use only:
Section Points
Q1 / 34
Q2 / 24
Page4
Bubble Sheet / 42
TOTAL / 100
Part 1
, Question 1 (34 points)
(a) (16 points)
After raising the interest rates 11 times over the past couple of years to control inflation, the Fed paused
rate hikes/increases in 2024 and held interest rates steady for most of 2025. The graph below shows the
demand and supply of bonds and loanable funds right after the last rate hike.
Predict what will happen if the public believes the Fed’s forecast that inflation rate during 2026 will trend
downwards. Use graphs below to show:
How the supply and/or demand of bonds and/or loanable funds changes given the public expects
the inflation rate to decline
The post-announcement interest rate and bond price – label them i1 and p1 respectively
Provide a brief explanation of the shifts based on lender and borrower reactions.
FIRST FINALIZE YOUR ANSWER ON THE ATTACHED SCRATCH SHEET BEFORE COPYING IT IN BELOW
Bond Market Loanable Funds Market
Do So Do So
p1
po io
i1
Q Q
Lender reaction:
Supply of loanable funds curve shifts right => demand for bonds shifts right
Why? i= r + expected inflation. With lower expected inflation lenders will accept a lower i
Borrower reaction:
Supply of bonds curve shifts left => demand for loanable funds falls.
Why? Real cost of borrowing is expected to increase.
(b) How does the Treasury benefit from the TIPS program? Explain in two or three bullet points. (8
Page4
points)
Investors typically demand a higher return on nominal debt securities to compensate for the risks
associated with future inflation.
By issuing inflation-indexed debt, the Treasury would eliminate inflation risk for investors and therefore
avoid having to pay the “inflation risk premium,” which compensates for the uncertainty associated with
the future inflation rate.
(c) TIPS like other bonds issued by the Treasury have little or no default risk. Unlike nominal bonds they
have no inflation risk. They are regarded as the safest investment. During the 2008 financial crises
Midterm 1
Name:______________________________________ Net Id (not N #)______________________
WHEN HANDING IN PUT YOUR BUBBLE SHEET IN THE ENVELOPE
WITH THE TA’S NAME and TIME OF THE RECITATION YOU ATTEND
Please don’t start the exam until you are given the go ahead.
exactly as it appears in Brightspace
On the bubble sheet write your name
and your net id (not N #).
Write your name and net id on ALL parts of the exam.
Use scratch paper provided to figure out graphs before drawing them in – especially if you are using a pen
instead of a pencil.
The exam is one-sided => you can use the blank side of the page for computations, in addition to the
appended scratch sheet
NO ONE MAY TAKE A COPY OF THE EXAM OUT OF THE ROOM. THE EXAM WILL BE
POSTED WITH THE SOLUTIONS AFTER THE GRADES ARE OUT.
For Instructor/TA use only:
Section Points
Q1 / 34
Q2 / 24
Page4
Bubble Sheet / 42
TOTAL / 100
Part 1
, Question 1 (34 points)
(a) (16 points)
After raising the interest rates 11 times over the past couple of years to control inflation, the Fed paused
rate hikes/increases in 2024 and held interest rates steady for most of 2025. The graph below shows the
demand and supply of bonds and loanable funds right after the last rate hike.
Predict what will happen if the public believes the Fed’s forecast that inflation rate during 2026 will trend
downwards. Use graphs below to show:
How the supply and/or demand of bonds and/or loanable funds changes given the public expects
the inflation rate to decline
The post-announcement interest rate and bond price – label them i1 and p1 respectively
Provide a brief explanation of the shifts based on lender and borrower reactions.
FIRST FINALIZE YOUR ANSWER ON THE ATTACHED SCRATCH SHEET BEFORE COPYING IT IN BELOW
Bond Market Loanable Funds Market
Do So Do So
p1
po io
i1
Q Q
Lender reaction:
Supply of loanable funds curve shifts right => demand for bonds shifts right
Why? i= r + expected inflation. With lower expected inflation lenders will accept a lower i
Borrower reaction:
Supply of bonds curve shifts left => demand for loanable funds falls.
Why? Real cost of borrowing is expected to increase.
(b) How does the Treasury benefit from the TIPS program? Explain in two or three bullet points. (8
Page4
points)
Investors typically demand a higher return on nominal debt securities to compensate for the risks
associated with future inflation.
By issuing inflation-indexed debt, the Treasury would eliminate inflation risk for investors and therefore
avoid having to pay the “inflation risk premium,” which compensates for the uncertainty associated with
the future inflation rate.
(c) TIPS like other bonds issued by the Treasury have little or no default risk. Unlike nominal bonds they
have no inflation risk. They are regarded as the safest investment. During the 2008 financial crises
