ECON 411 Problem Set 1: Asymmetric Information, Bond and Stock Prices | Assignments Economic policy

ECON 411 Problem Set 1

Dr. Luo

Carrick Zhu

09/14/2021

1. In the first scenario where the owner has a total wealth of $1.2 million, it is better

for him to issue stocks in the corporation. Issuing stock is a way of risk sharing,

which can minimize the owner’s rick if the investment fails.

In the second scenario where the owner’s wealth is $1 billion, it is better for him

to use his own funds for the investment. On one hand, the $1 million is only a tiny

portion of his total, which means he can bear the loss. On the other hand, he can

also completely control the company.

2. This question demonstrates a key concept of Asymmetric information, which

means that one participant in the economic transaction has more information than

the other participant. By publishing the ratings for these bonds, these firms solve

this problem for the savers. If the rating companies went out of business, it would

create a negative impact on the bond market because the demand for these bonds

would decrease. To be more specific, savers will reduce their investment due to

the lack of information regarding these bonds in order to reduce their risk.

However, this will have a positive impact for the banks because more savers will

invest their money into the banks since they have more information regarding the

financial market. In addition, with the decrease of the price of the bonds, the

interest rates will increase, which will also benefit the banks.

3. Based on my research, the three biggest ones are Experian, Equifax, and

TransUnion. If a new privacy law makes it illegal for credit bureaus to collect this

information, this would have a negative impact on the banks because an

asymmetric information will occur, and the issue of adverse selection will also

rise. To be more specific, without knowing the credit histories of everyone, banks

can no longer determine how much money should be loaned to each individual,

Thus, they don’t dare to loan out their money because they are not sure whether

the borrower has a good credit or not. For the borrowers, they might have a good

credit history, but they can’t prove to the banks that they can borrow too much

money.

a) Bonds issued by the U.S. government is liquid because the U.S. government

bond very large and it is very convenient for the buyers to sell it for cash.

b) Bonds issued by corporations is less liquid because it is smaller than the U.S.

government bond. As a result, people can’t sell it for cash that easily. They

can only find a buyer through broker or online, which means you usually

can’t get your money that fast.

c) A post-impressionist painting will be very less liquid because although it

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ECON 411 Problem Set 1 Dr. Luo Carrick Zhu 09/14/

In the first scenario where the owner has a total wealth of $1.2 million, it is better for him to issue stocks in the corporation. Issuing stock is a way of risk sharing, which can minimize the owner’s rick if the investment fails. In the second scenario where the owner’s wealth is $1 billion, it is better for him to use his own funds for the investment. On one hand, the $1 million is only a tiny portion of his total, which means he can bear the loss. On the other hand, he can also completely control the company.
This question demonstrates a key concept of Asymmetric information, which means that one participant in the economic transaction has more information than the other participant. By publishing the ratings for these bonds, these firms solve this problem for the savers. If the rating companies went out of business, it would create a negative impact on the bond market because the demand for these bonds would decrease. To be more specific, savers will reduce their investment due to the lack of information regarding these bonds in order to reduce their risk. However, this will have a positive impact for the banks because more savers will invest their money into the banks since they have more information regarding the financial market. In addition, with the decrease of the price of the bonds, the interest rates will increase, which will also benefit the banks.
Based on my research, the three biggest ones are Experian, Equifax, and TransUnion. If a new privacy law makes it illegal for credit bureaus to collect this information, this would have a negative impact on the banks because an asymmetric information will occur, and the issue of adverse selection will also rise. To be more specific, without knowing the credit histories of everyone, banks can no longer determine how much money should be loaned to each individual, Thus, they don’t dare to loan out their money because they are not sure whether the borrower has a good credit or not. For the borrowers, they might have a good credit history, but they can’t prove to the banks that they can borrow too much money.
a) Bonds issued by the U.S. government is liquid because the U.S. government bond very large and it is very convenient for the buyers to sell it for cash. b) Bonds issued by corporations is less liquid because it is smaller than the U.S. government bond. As a result, people can’t sell it for cash that easily. They can only find a buyer through broker or online, which means you usually can’t get your money that fast. c) A post-impressionist painting will be very less liquid because although it

typically has a high value, it is very hard to find a buyer right away because there are only few buyers in the market. As a result, it is very hard to convert the painting into real U.S. dollar. d) British pounds are very liquid because they can be exchanged into dollars everywhere in the U.S.

a) If the economy enters a recession, two phenomena will occur. First, with the economy entering a recession, the central bank will increase the money supply, which will decrease the interest rate based on the formula. As a result, the bond price and the stock price will increase. However, with economy going downhill, people’s will lose their faith in the economy, and they will save their money rather than investing. As a result, the bond price and the stock price will decrease. Comparing these two phenomena, the second effect is greater, which plays a bigger role. As a result, the bond and stock price will decrease in general. b) If a genius invents a new technology that makes factories more productive, the productivity of the company will increase, which will generate more profit. As a result, the stock price will increase will the increase of the dividends. However, increasing productivity will not impact the coupon value or the face value, as a result, the bond price will remain unchanged. c) If the Federal Reserve’s raises its target for interest rates, the bond and stock price will decrease because the higher the target interest rate, the lower the prevent value of the money.
d) If unknown major news about the economy will be announced in a few days, the bond and the stock price will decrease. For uncertain future payments, the risk-adjusted interest needs to be used, which is higher than the risk-free interest rate with the risk premium. As a result, high interest rate will decrease the bond and stock price.

ECON 411 Problem Set 1: Asymmetric Information, Bond and Stock Prices, Assignments of Economic policy

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