ECON 310 C01 Money & Banking J. Scott Sperling
Problem Set 2
Due 9:30am 16 July, 2001†
Answer the following questions from the “Questions and Problems” sections of your textbook.
•Ch 4: # 3, 4, 6, 9, 12
•Ch 5: # 1, 3, 7, 16
•Ch 6: # 3, 7, 11, 15
1. 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)
2. Using the following table of U.S. Treasury bonds and notes, calculate the current yield for each instru-
ment. When is the current yield a good approximation of the yield to maturity? When is it a bad
approximation?
RATE MATURITY
MO/YR
BID ASKED CHG ASKED
YLD.
6 5/8 Jul 01n 100:07 100:09 — 3.08
6 3/8 Sep 01n 100:19 100:21 -1 3.62
3 7/8 Jun 03n 99:10 99:11 -2 4.22
5 Feb 11n 97:01 97:02 -15 5.39
5 3/8 Feb 31 94:24 94:25 -24 5.74
Table 1: Source: The Wall Street Journal, July 2, 2001
3. When is yield on a discount basis a good approximation of yield to maturity? When is it a bad
approximation?
4. Use the Loanable Funds framework to show the results of the following scenario. Clearly label your
graph and state what happens to the price of bonds and the interest rate given your graphical analysis.
On Friday, most Treasury maturities [i.e. most bonds] suffered a fifth straight day of price
declines amid an assortment of bond-unfriendly events. They included data showing the
strength in the economy and Treasury Secretary Paul O’Neill’s remark that federal-tax rev-
enues look somewhat lower than expected. The Wal l Street Journal, July 2, 2001.
†If you find any errors or have any questions about these notes, please email me at [email protected].