ECO 202 MOD 3 CA - Essay Example

Q3..For the past 3 years a major department store chain has averaged approximately $10 billion in long-term debt. Their debt is in the form of bonds that have been sold to investment funds and the public (If you are not sure what a corporate bond is look it up on the internet). For the sake of argument, let us assume that either now or one-year from now they will add an additional $5 billion to finance store expansion. This is a given, management has already made this expansion decision and it does not need to be commented on.

The objective of management is to issue bonds at the lowest interest rate. Given this objective, should they issue the bonds now or wait for one year if they feel the Federal Reserve will follow:  1. The Federal Reserve policy makers use monetary policy to influence demand and supply of money. Changes in demand and supply of money cause interest rates to fluctuate as illustrated in the below diagrams: The Federal Reserve can set the discount rate, as well as achieve the desired federal funds rate by open market operations.

These rates have significant effect on other market interest rates, but there is no perfect relationship. In the United States open market operations are a relatively small part of the total volume in the bond market(monetary policy,Wikipedia,2011) Federal Reserve uses expansionary monetary policy to boost up economics activity in the economy and remove recessionary gap. An increase in the nominal money supply or a decrease in the demand for money results in excess supply of money. This change attempts to reduce money holdings by buying bonds and results in a fall if interest rates .

Decrease in interest rate results in an increase in interest-sensitive expenditure and hence there is an increase in equilibrium real National Income. Opposite of expansionary policy is the Contractionary policy which is aimed to remove inflationary gap. A decrease in money supply or a n