Econ 315 Exam 1

If a bond has a face value of $1000 and a coupon rate of 4.25%, the bond owner will receive annual coupon payments of:

Coupon payment= 1,000(.0425)= 42.5

Consider two scenarios. In the first, the nominal interest rate is 6 percent and the expected rate of inflation is 4 percent. In the second, the nominal interest rate is 5 percent and the expected rate of inflation is 2 percent. In which situation would you rather be a lender? In which would you rather be a borrower?

In the first situation we expect the real interest rate is 2% and in the second situation we expect the real interest rate to be 3%. As a ledner you ultimately want to make more money so you chose the invest with the higher interest (3%) and a borrower you would want a lower interest rate in order to save more money so you would choose scenario 1.

What are the three characteristics of Money

Means of Payment, Unit of account, Store of Value

What are the six parts of financial systems

Money Financial Instruments Financial Markets Financial Institutions Government Regulation Central Banks

If money growth is related to inflation, what would you expect to happen to the inflation rates of countries that join a monetary union and adopt a common currency such as the Euro?

Once a country joins a monetary union, they effectively share a common money supply. Given the link between money growth and inflation, you would expect the inflation rates of these countries to converge.

The standard deviation is usually more useful than variance because

Standard deviation is calculated in the same units of payoffs and variance isn't.

Why do you think has become more globally integrated over time?Can you think of any downside towards integration?

Technological advancements progress is one obvious reason.According to core Principle 3, information is the basis for decisions. Improvements in technology have allowed for huge volumes of information to be collected and processes easily and cheaply. On a global basis, facilitating long distance transactions. Increased integration allows for countries with economic hardships to spread across the globe.

If an investment has a 20% (0.20) probability of returning$1,000;a30% (0.30) probability of returning$1,500;anda50% (0.50) probability of returning$1,800;the expected value of the investment is:

The expected value of the investment equals 1000(.20) +1500(.30) + 1800(.50) which equals 1550

A Financial institution offers you a one year certificate deposit with an interest rate of 5%. You expect the rate of inflation to be 3%. What is the real return on your deposit

The real interest rate equals the nominal interest rate equals the nominal interest rate minus the expected rate of inflation. We get 5%-3% which gets us 2%

What are the 5 core principles of money and banking

Time has value Risk requires Compensation Information is the basis for decisions markets determine prices and allocation resources stability improves welfare

What are the characteristics of commodity money

Useable by most people in some way standardized quantity durable easily transportable easily divisible into smaller bills

Identify at least three possible sources of risk an individual may face when planning for retirement

When planning for retirement individuals these risk: Lifespan-there is uncertainty how long someone may live for so making sure you have enough money to last you for the rest of your life Unexpected inflation- no one knows what the inflation rate will be in the future. This makes targeting the real rate of inflation difficult. Health problems of unforeseen events that can use up funds that were set for retirement.

If time has value, why are financial institutions more willing to extend your 30 year mortgage at a lower annual interest rate than they would charge you for a one year loan.

With a mortgage, the house you purchase acts as collateral on your loan. In the event of a default the bank can sell the house and recoup from it. The existence of collateral reduces the risk associated with the loan. and so reduces the compensation the bank requires.

financial innovation has reduced the need to carry cash explain how

With the advancement of financial innovation such as credit and debit cards along side other forms of electronic ways of payment with credit and debit cards being by far the most popular.

Could the dollar still function as a unit of account in a totally cashless society?

Yes it can, using dollars to quote prices and record debts does not depend on cash being used as a means of payment. dollars and cents will still be used a standard value of measurement even if they are not being exchanged.

Under what circumstances might you expect barter to reemerge in an economy that has a fiat money as a means of payment?

You might see an economy revert back to a system of barter when the value of the currency is diminished to be worth very little. Or loss in public confidence, due to over printing or hyperinflation.

1.Assume that the economy can experience high growth, normal growth, or recession. Under these conditions, you expect the following stock market returns for the coming year:(LO2, LO3)State of the EconomyProbabilityReturnHigh Growth0.2+30%Normal Growth0.7+12%Recession0.1-15%a.Compute the expected value of a $1,000 investment over the coming year.If you invest $1,000 today, how much money do you expect to have next year?What is the percentage expected rate of return?b.Compute the standard deviation over the coming year.c.If the risk-free return is 7 percent, what is the risk premium for a stock market investment?d.In dollar terms, what is the value at risk?

a. First,we need to calculate the returns:High growth: return = $1,000 x (1+ 0.30) = $1,300Normal growth: return = $1,000 x (1+ .12) = $1,120Recession: return = $1,000 x (1 -.15) = $850Expected Value = 0.2($1,300) + 0.7($1,120) + 0.1($850) = $1,129Expected Percentage Returni.$1,000 x (1 + i) = $1,129Solve for i: i= .129 or 12.9% Money and BankingECON 315Page 2of 3ii.= .2(.30) + .7(.12) + .1(-.15) = .129 or 12.9 %b. sd = √0.2($1300−$1129)2+0.7($1120−$1129)2+0.1($850−$1129)2= $119.67c. Risk Premium= 12.9% -7% = 5.9%d. VaR = $1,000 x 0.15 = $150 The worst outcome is a loss of 15%2.

For each of the following events, explain whether it represents systematic risk or idiosyncratic risk and explain why.a.Your favorite restaurant is closed by the county health department.b.The government of Spain defaults on its bonds, causing the breakup of the euro-area.c.Freezing weather in Florida destroys the orange crop.d.Solar flares destroy earth-orbitingcommunications satellites, knocking out cellphone service worldwide.

a.This is idiosyncratic risk since it is unique to this particular establishment.b.This is a systematic risk that affects entire economies within the euro-area and beyond.c.This is idiosyncratic risk as only one of several orange-growing areas in the country is affected. For example, orange groves in California are not damaged by the Florida freeze.d.This is systematic risk as communications around the globe are disrupted, perhaps until new satellites can be constructed and put into orbit.

Assuming that the current interest rate is 3%, compute the present value of a five-year, 5 percent coupon bond with a face value of $1,000

𝑃𝐶𝐵=𝑃𝐶𝑃+𝑃𝐵𝑃=[𝐶(1+𝑖)1+𝐶(1+𝑖)2+𝐶(1+𝑖)3+𝐶(1+𝑖)4+𝐶(1+𝑖)5+𝐹(1+𝑖)5𝐶=1,000(0.05)=$50𝑃𝐶𝐵=50(1+0.03)1+50(1+0.03)2+50(1+0.03)3+50(1+0.03)4+50(1+0.03)5+ 1000(1+0.03)5=$1,091.59