Practice Questions #1

Goal:

• Review introductory material
• Provide numerical examples of material presented in class
• Provide a list of relevant terms

1. Below is a list of terms discussed in class. Provide a definition for each and where appropriate use the terms in an example. In addition, write a brief statement of the term's significance.

Aggregate Output                         GDP Deflator

Aggregate Income                         Consumer Price Index (CPI)

Securities                                    Financial Markets

Budget Deficits                             Asset

Business Cycles                            Liability

Inflation                                      Indirect Finance

Money                                        Direct Finance

Interest Rates                              Debt

Monetary Policy                            Equity

Financial Intermediation                 Maturity

GDP                                           Primary Market

Doublecounting problem                 Secondary Market

Factors of Production                    Liquidity

Factor Market                              Money Market

Real Values                                  Capital Market

Nominal Values                             Output Market

Sectors of the Economy

2. Suppose you purchase a one-year discount bond with a face value of $10,000 for $8000. What is the interest rate you will earn at the maturity date?

3. Suppose interest rates increase to 28%. If you decide to sell the bond you purchased in problem 2 before its maturity date, what will be the maximum price people will pay for it?

4. Suppose interest rates fall to 20%. Someone offers to buy the bond you purchased in problem 2 for $8200. Should you sell it to them?

5. Suppose the tax rate for the marginal investor is 10%. If the interest rate paid on certificates of deposit is 5.25%, what must the interest rate on municipal bonds be in order for the marginal investor to be indifferent between purchasing municipal bonds or CDs?

6.

a. Suppose the tax rate for the marginal investor decreases to 5%. If the interest rate on certificates of deposit remains at 5.25%, what must the rate on municipal bonds be in order for the marginal investor to be indifferent between purchasing municipal bonds or CDs?

b. Suppose an investor has a tax rate of 3%. Given your answer in (a), which investment will this investor prefer?

7. If a dollar is worth one dollar when the price index is 100,

1. what is the value of the dollar if the price index increases to 200?
2. What is the value of the dollar if the price index increases to 300?
3. What is the value of the dollar if the price index increases to 400?
4. What is the value of the dollar if the price index increases to 170?
5. What is a generalized formula for the problems a) through d)?