1. Suppose Adam, Ben and Carl each received an inheritance of $200,000 and each used it immediately to purchase a house. Each person sold his house after 1 year. Economic conditions were different in each case.

- During the time Adam owned the house, there was 25% deflation. A year after Adam bought the house, he sold it for $154,000 (23% less than what he had paid).
- During the time Ben owned the house, there was no inflation or deflation. A year after Ben bought the house, he sold it for $198,000 (1% less than what he had paid).
- During the time that Carl owned the house, there was a 25% inflation. A year after Carl bought the house, he sold it for $246,000 (23% than what he had paid).

Please rank Adam, Ben and Carl in terms of the success of their housing transactions. Assign "1" to the person who made the best deal, and "3" to the person who made the worst deal. Explain your rankings.

2. (a) Jason deposits $600 in Bank A. Show the impact (changes only) on Bank A's balance sheet, shown below. Let R = 5%.

(b) Trace the impact through the banks shown below:

(c) What assumptions did you make? What is the total effect on the deposits in the banking system? Explain.

3. The First Knox National Bank is concerned about its use of leverage. Is the bankright to be worried if it faces a loss on its portfolio of loans equal to 10%? [let R=10%].

(b) Can the loss to depositors be calculated? If it can, please compute it.

(c) If the depositors are insured (by the FDIC), explain the potential role of moral hazard inthis case.

4. (a) Investor A has a portfolio of assets that contains all government bonds. Is she ignoring any principles of portfolio choice? Explain.

(b) Investor B has a portfolio of assets that contains all Apple stock. Is she considering all the principles of portfolio choice? Explain.

(c) Investor C has a portfolio comprised of 50% low-risk bonds and 50% Apple stock.Is this a preferable choice for a risk-averse person? Explain why or why not.

5. (a) In your own words, explain the three main tools of the U.S. central bank (the Fed).

(b) If the Fed wanted to raise the money supply,how should it use each tool?

6. (a) "Inflation does not reduce the purchasing power of most workers." Do you agree or disagree? Explain in your own words.

(b) Use the three functions of money to explain why credit cards are not a part of the money supply. Answer in your own words.