solution

Assume that you maintain bonds and money market securities in your portfolio, and you suddenly believe that long-term interest rates will rise substantially tomorrow (even though the market does not share the same view), while short-term interest rates will remain the same.

1. How would you rebalance your portfolio between bonds and money market securities?

   Based on your expectations, bond prices will (decline or rise). You should rebalance your portfolio by selling (bond or money market securities ) and purchasing more (bonds or money market securities)

2. If the market suddenly recognizes that long-term interest rates will rise tomorrow, and that they respond in the same manner as you, explain how prices and yields of these securities (bonds and money market securities) will be affected.

   Bond prices will (rise or decline), while the prices of money market securities will (rise or declineI)as investors rebalance their portfolios. Consequently, the yield offered on bonds will (rise or decline), and the yield offered on money market securities will (rise or decline)

3. Assume that the yield curve is flat today. Explain how the slope of the yield curve will change tomorrow in response to the market activity.

   The yield curve will become (upward-sloping or downward-sloping)because the yield offered on bonds will (rise or decline) while the yield offered on money market securities will (rise or decline)