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PART A:
Answer 5 of 7 questions
.Eachquest
ionisworth6marks
.
Provide short, clear answers to the following:
1. Sarah has been given the following choice of inheritance packages by her parents:
Package
A
is composed of $20
,
000 today and $70
,
000 one year from today. Package
B
is composed of $60
,
000 today and $35
,
000 one year from today. Sarah considers
both of the choices and decides that she prefers package
B
to package
A
.Whena
sk
ed
her reasoning, she explains that by borrowing or lending at the current interest rate,
r
,
package
B
is equivalent to a
f
xed payout of $50
,
000 in each year (today and one year
from now), while package
A
only gives her $40
,
000eachyear
.Drawagraphtoshow
how Sarah is making her choice and explain whether comparing the present value of
the two packages would lead to the same conclusion. Determine the interest rate
r.
1
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View Full Document 2. Draw a graph that shows the (gross) payo
f
of a call option with strike price
K
at
maturity
T
as a function of the stock price at time
T
(
S
T
)
.
Suppose the current market
price of the stock is
S
t
<K
and the call option has a price
C
t
>
0
.
Explain why the
value of the option is positive even though the strike price is greater than the current
stock price,
S
t
.
3. Describe the ‘lemons’ problem in the used car market. How can the use of a warranty
help to solve the problem.
2
4. A monopolist sets a single price,
P
M
in a market with two types of consumers. At
price
P
M
the lowdemand consumers do not purchase the good. Explain how surplus
will change if the monopolist can price discriminate in the market. (Look at the e
f
ects
of discrimination on the consumer surplus of both types, the producer surplus and the
total surplus).
5. Given a duopoly market where
f
rms compete in quantities, explain why the Cournot
equilibrium seems like a reasonable equilibrium in the market. Starting at any arbitrary
output for both
f
rms (
q
1
,q
2
)
,
use a graph to argue why
f
rm
swou
ldendupa
tthe
Cournot equilibrium.
3
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View Full Document 6. Find a Nash equilibrium to the following game:
II
LR
IU(
4
,
7)
(8
,
3)
M(
2
,
11)
(6
,
6)
D(
5
,
2)
(2
,
5)
4
7. If a bond will provide a certain payment of
C
= $100 every year in perpetuity (
t
=
1
,
2
,
3
,...
)aswe
l
lasaonet
imepaymento
f
D
=$500
f
ve years from now (
t
=5)
,at
what price,
P
B
0
should this bond trade today, (
t
= 0) if the discount rate is
r
=12%?
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This note was uploaded on 10/21/2010 for the course STATISTICS Stat 200 taught by Professor Eee during the Spring '10 term at The University of British Columbia.
 Spring '10
 eee

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