Week 5

In answering these questions, be sure to write down your work.

1. Calculate the growth rate of real wage per hour between 1992 and 2002 from the following table.

2. Consider a consol with coupon payment $200. Assume the real interest rate is 5%, tax rate on interest is 50%, the expected inflation rate is 5%, and they will be constant forever. Calculate the present value of this consol.

3. Consider a one-year discount bond that promises to pay you $2,000 in a year. If the nominal interest is 25%, what should the price of this bond be?

4. Assume a firm's total revenue is $6,000, total expense is $5,000, and dividends payment is $100. Calculate the retained earning. If this firm wants to invest $2000 and uses all the retained earning for investment, the retained earning will be insufficient to finance. How much does this firm need to borrow in that case?

5. Consider a three-year coupon bond with coupon payments of $120 and a face value of $250. If the price of this bond is $276, what is the premium above par (face value) of this bond?

6. Consider a CD and a tax-free municipal bond. Assume the rate on the CD is 15% and the rate on the tax-free municipal bond is 5%. Calculate the tax rate such that the CD and the tax-free municipal bond are indifferent in terms of after-tax rate.

7. Consider a two-year coupon bond with a coupon of $200 and a coupon rate of 20%. If the nominal interest rate is 15% for the first year and 20% for the second year, what should the price of this bond be?

8. What is the price on a discount basis of a 90-day Treasury bill with a discount yield of 5% on an annual basis, and face value of $200?

9. Consider a two-year coupon bond with a coupon of $110 and a face value of $1210. Assume the real interest rate for the first year is 4%, the real interest rate for the second year is 5%, the expected inflation rate for the first year is 6%, the tax rate on interest for the first year is 0%, and the tax rate on interest for the second year is 50%. If the price of this bond is $1,100, what should the expected inflation rate for the second year be?

10. Suppose a higher rate of growth of the money supply causes the interest rate to increase. Compare the size of the liquidity effect, the income effect, the price-level effect, and expected inflation effect. Which effect(s) would be larger than other(s)? Is the adjustment to expected inflation slow or fast?

11. Draw diagrams representing the bond market and the loanable funds market in equilibrium. On your diagram, explain what would happen to the price of bonds, the interest rate, the quantity of bonds and the quantity of loanable funds if both liquidity of bonds relative to other assets and the expected profitability of investments decrease simultaneously.

12. Draw diagrams representing the bond market and the loanable funds market in equilibrium. On your diagram, explain what would happen to the price of bonds, the interest rate, the quantity of bonds and the quantity of loanable funds if wealth increases and the government deficit shrinks simultaneously.