Download Money & Banking Problem Set 3 Answers, Spring 2002 by J. Scott Sperling and more Assignments Banking and Finance in PDF only on Docsity!
ECON 310 009 Money & Banking J. Scott Sperling Spring 2002 [email protected]
Problem Set 3 Answers
Due: February 21, 2002
1. In class we talked about two ways of businesses obtaining financing. One way is through financial markets, the other through financial intermediaries. Name both types of finance and give an example of each. - Direct finance, e.g. issuing stock or bonds in the primary market - Indirect finance, e.g. obtaining a loan from a bank 2. Would M&M’s make a good commodity money?
You could answer either yes or no, just as long as you argued using the five characteristics of a commodity money: standardized, widely accepted, easily divisible, transportable, and does not deteriorate quickly.
3. Name the three main types of financial intermediaries, and give an example of each type. - Depositority institutions, e.g. bank, credit union, etc. - Contractual savings institutions, e.g. insurance company, pension fund, etc. - Investment intermediaris, e.g. finance company 4. What are the three functions of money? - Medium of exchange - Unit of account - Store of value 5. Suppose your discount rate is 5%. What is the present value of $500 to you three years from now?
Present Value =
(1 + 0.05)^3
6. If your discount rate is 7%, what is the present value of $300 two years from now?
P V =
(1 + 0.07)^2
7. Suppose somebody said they would give you $215.74 five years from now if you gave them $200 today. Suppose your discount rate is 4.5%. Would you do it?
You should not make the deal. Your future value of $200 in 5 years is:
(1 + 0.045)^5 $200 = $249. 24.
8. Suppose you buy a new sofa from Fabulous Furniture at their big sale for $700 1-year same-as-cash (i.e. you buy it on credit and don’t have to make a payment for 1 year). As you read the fine print, you find out that if you don’t pay off the balance in a year, they will charge you annual rate of interest of 22.5%, compounded daily from the date of your purchase. If you don’t pay off the balance in a year, what will be the amount of interest you will be charged? (Use 365 days in a year)
You would have to pay a total (principal and interest) of:
V 365 (1) =
Thus your interest would amount to:
$876. 57 − $700 = $176. 57
9. Using the following table (Table 1) of U.S. Treasury bonds and notes, calculate the current yield for each instrument. When is the current yield a good approximation of the yield to maturity? When is it a bad approximation?
To get the current yield: ic = CP. For example the July 01 note’s coupon payment is $100 × 6 58 = $6.625 and the price is $100 329. Thus the current yield is:
(^6 ) 100 329
Current yield is a better approximation of yield to maturity when price is closer to par value and the longer the term to maturity.
RATE MATURITY MO/YR
BID ASKED CHG ASKED YLD.
ic
6 5/8 Jul 01n 100:07 100:09 — 3.08 6. 6 3/8 Sep 01n 100:19 100:21 -1 3.62 6. 3 7/8 Jun 03n 99:10 99:11 -2 4.22 3. 5 Feb 11n 97:01 97:02 -15 5.39 5. 5 3/8 Feb 31 94:24 94:25 -24 5.74 5.
Table 1: Source: The Wall Street Journal, July 2, 2001
10. When is yield on a discount basis a good approximation of yield to maturity? When is it a bad approximation?
Yield on a discount basis is a better approximate of yield to maturity the closer price is to par value and the shorter the term to maturity.
13. Using the following statement from The Wall Street Journal, explain the effects on the price and interest rates of U.S. Treasury bonds using the loanable funds framework. Explain why the demand or supply of bonds shifts. Draw and carefully label a graph to support your answer.
[On Thursday, October 4,] the U.S. Treasury department took the unprecedented move of hold- ing an unscheduled auction of 10-year Treasury bonds... The department decided in the morning to sell the $6 billion in 10-year notes, six weeks before the regular quarterly refunding.
Source: The Wall Street Journal, 5 October, 2001, p. C1.
The unscheduled auction (unexpectedly) increased the supply P i
Q (bonds)
DB
S 0 B
S 1 B
P 0 i 0 P 1 i 1
Q 0 Q 1
of bonds in the market, shifting the supply curve (SB 0 ) to the right to SB 1. Thus price decreases from P 0 to P 1 and the interest rate increases from i 0 to i 1.
