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Questions Review Midterm 1, Fall, 2008 Econ 215/Waters The following questions are representative of the essay problems on the first midterm. The midterm will have 10-15 multiple choice questions and 4-5 essay questions. It covers chapters 1-5 from Mishkin. A coupon bond has a face value of $100, a coupon rate of 5%, time to maturity of 3 years and the yield is 6%. What is the price of the bond? What is the current yield? Joe and Jane each buy a two year bond with a 10% yield. After one year yields have fallen to 5%. Joe needs money for a new car so he sells his bond after one year but Jane holds hers to maturity. Who received the higher rate of return on his or her bond? Explain. Use the supply and demand for bonds to show the possible affects of a recession on interest rates. (You ll will need to show 2 graphs) Give an example of moral hazard and an example of adverse selection in financial markets. A one year discount bond has a face value of $100. Find the market price of the bond if the yield is 5%. Find the price if the yield is 20%. Explain in words why price and yields of bonds are inversely related. 1) 2) 3) 4) 5) 6) The government gives a tax cut to the public, which is financed purely by the deficit. Use the bond market graph to explain the affect on interest rates. Practice Problems. The following are problems to help you test you knowledge of fundamental terms and concepts that will be tested on the first midterm. 1) A discount bond has a face value of $200, a market price of $150 and 2 years to maturity. Find the yield. 2) A coupon bond has a face value of $1000, a coupon rate of 5%, a market price of $980 and one year to maturity. Find the yield. 3) A coupon bond has a face value of $1000, a coupon rate of 10%, a yield of 9% and 3 years to maturity. Find the market price. 4) A coupon bond has a face value of $1000, a coupon rate of 10% and two years to maturity. You buy it at par at issue (2 years to maturity) and sell it after 1 year. If interest rates after one year are now 12%, what is your rate of return? 5) Use a supply and demand for money graph to explain what the Fed does if it want to raise interest rates. 6) Use a supply and demand for bonds graph to explain the effect of increased wealth on interest rates. 7) Use the loanable funds market to show how increased expected business profit would affect interest rates. 8) Name the four determinants of asset demand. Name the three determinants of bond supply. 9) If the nominal interest rate is 5% and the real interest rate is 2%, what is expected inflation? 10) Explain why the demand for money slopes down and the supply of money slopes up (slightly).

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