1. According to the loanable funds framework, what would happen to the equilibrium interest rate and the equilibrium quantity of bonds if, simultaneously,the liquidity of bonds relative to other assets decreases and the profitability of investment increases? Be sure to draw a diagram to illustrate whether the demand curve or/and the supply curve would shift and in what direction. In your graph you should label both the x axis and the y axis, any curves that you draw, the initial equilibrium interest rate and quantity of bonds, and the new equilibrium interest rate and quantity of bonds once the loanable funds market has adjusted. Be sure that your labels are clear (do not assume that the grader will recognize your abbreviations!). Provide a written summary of the effects of these changes on the equilibrium interest rate and the equilibrium quantity of bonds.
2. Consider an asset that gets a return of 0% thirty percent of the time, a return of 10% thirty percent of the time, and a return of 20% forty percent of the time. Calculate the asset’s expected return and risk. Remember to show your work (no full credit for just answers!) and to indicate what abbreviations stand for in you work. Partial credit is not possible unless we can follow the work that you are doing in the problem: i.e., neatness and organization matter.
a. Expected return calculation:
c. Risk Calculation:
3. This question relaxes the assumption of a constant discount rate throughout a bond’s maturity period. Suppose your uncle wishes to buy a newly issued 2-year bond with a face value of $1000 and a coupon rate of 10%. You expect the real interest rate to hold steady at 4% from now until the bond’s maturity date. You also expect the inflation rate to hold steady for the first year, then change to another rate (and stay at that rate) for the second year of the bond’s life. If inflation was 2.5% for the first year and you computed a bond price of $1050, what inflation rate did you expect for the final year when pricing the bond? Remember to show your work (no full credit for just answers!) and to indicate what abbreviations stand for in you work. Partial credit is not possible unless we can follow the work that you are doing in the problem: i.e., neatness and organization matter.
4. Suppose the leaders of Canada, The United States, and Mexico meet to design a single currency for the continent. Suppose, furthermore, that these leaders have learned a lesson from the experience of the European Monetary Union (recall the article you read “Why is Europe forming a Monetary Union?”). In your essay,
a. Identify and discuss three distinct advantages to a monetary union.
b. Identify and discuss the primary disadvantage to a monetary union.
c. Assess the potential effects of this proposed monetary union: in making this assessment take either a pro or con side and argue that position.
Quick Reply
