Liquidity Premium and Efficient Market Theories and the Nominal and Real Exchange Rate

Chapter Questions
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Chapter Questions
The six questions on Chapters 7-12 from the book Money, Banking, and Financial Markets, Sixth Edition, by Stephen G. Cecchetti, are answered below.
Chapter 7. The liquidity premium theory posits that bond investors expect the investment in long-term bonds to come with two parts of risk; the risk-free and the risk premium. The risk-free is the minimum rate of return that a long-term bondholder expects, but this comes with a risk premium having two components of inflation and interest-rate risks. Inflation risk creates uncertainty of the real return from changes in purchasing power. In contrast, interest-rate risk is the changes in the interest rates of a long-term bond that results in changes in the bond price that can lead to capital gains or losses on the sale of the bond before maturity.
Chapter 8. The theory of efficient markets suggests that the future prices of various investments are unpredictable and that the prevailing prices of such investments mirror the available investment information. It means that one cannot accurately forecast the future values of investments.
Chapter 9. A forward is a private buy or sale agreement involving a specific amount of currency exchange, entered between a seller and a buyer to be effective on a predetermined date in the future. A future is a standardized agreement between a seller and a buyer, effected through an organized exchange, that specifies that the short position seller will deliver to the long position buyer on specified settlement date (Gecchetti & Schoenholtz, 20...