Spring 2011 Midterm I Answer Key

Spring 2011 Midterm I Answer Key - Department of Economics...

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Unformatted text preview: Department of Economics Professor O’Brien Lehigh University Spring 2011 Eco 29 Midterm I A {4 e7/ Recitation (Time and TA): 1. Take time to think before answering. Make sure your answers to the short-answer questions are clear and legible. In order to receive full credit, you must Show your work. 2. To ensure that everyone has the same amount of information available to answer the problems, we won’t be able to respond to requests for clarification or elaboration. Honor Code: PLEASE READ AND SIGN: The work on this midterm exam is entirely my own. During this exam I have not received assistance from anyone, nor have I given assistance to anyone. I have not cheated in any way. (Your signature) 2 l. (4 pts) a. Suppose that you just bought a four-year $1 ,000 coupon bond with a coupon rate of 6% when the market interest rate is 6%. One year later, the market interestrate falls to 4%. What rate of return did you earn on the bond during the year? . Hoe Me No + 32000 ?: {+1.00 l“ Ut-O‘i);+ CH-O‘bwb “+0953 A $60531“) ‘— NEED [Yd-:— -Ob + V2600 120.552 b. The following information from the close of trading on January 15, 2010 is for an iBM bond with a face value of $1,000 and a maturity date of October 22, 2012: Coupon rate: 5.050% Price: $1,096.20 Yield to maturity: 2.101% i. What was the bond’s current yield? (“So-n: . "- T HELD o Cc. WIOQG‘M ii. Briefly explain why E the bond’s yield to maturity is less than its coupon rate. Because bombs “emu f3 Spreadti/ Wmflri ‘ C (*9 QAQ undue {*5 watt “mafia!er 5 lg W 1 V’OL'iip. 2. a. (4 pts) Use the following information from the Wall Street Journal to calculate the bid price for this Treasury bill: . Days to . é ‘ Asked Maturity maturity Bld Asked ; Chg : yield 2011 Dec 15 314 0.238 f 0.233 MOIEOS I 0.234 if 0 ’- P ' /‘ d U 3 (a O -:: o . o 0 3—3 E 2‘ 3m 1:). Suppose on January 1, 201 1 the price of a one-year Treasury bill is $961.54. Investors expect that the inflation rate will be 3 percent during 2011, but at the end of the year the inflation rate turns out to have been —1 percent. What is the nominal interest rate on the bill (measured as the yield to maturity), the ex ante real interest rate, and the ex post real interest rate? ,$!/K 000 F $96!: 51‘ g 7 1:. M: ,o C Wars 0 a, d ... Liar. (3/0 '— C1270 ’“ (“‘70) 3 $2 I 3. (2 pts) a. Suppose that you pay $400 for a $1,000 face value bond that will pay no coupons for the first ten years and then pay 7% coupons for the remaining 20 years. Write down an equation showing the relationship between the price of the bond, the coupon (in dollars), and the yield to maturity, 1'. You don’t have to show every term in the equation, but be sure to show enough terms so that we know that you understand the relationship. $70 $70 WU ‘X/WO ham- —--~-"" +"—""""’ “2’00 “5-” (m3qu rial” (wth (mm 4. (2 pts) Suppose that in exchange for allowing a road to pass through his farmland, George Pequod has been paid $150 per year by the township he lives in. He had been promised that he and future owners of his land would receive this payment in perpetuity. Now, however, the township has offered, and he has accepted, a one-time payment of $1,200 in exchange for his giving up the right to receive the annual $150 payment. Calculate the implicit interest rate that George and the township used in arriving at this settlement. ’3 r “M- KQJP£TM£r{I P3“? 5. (4 pts) Your company is evaluating whether to purchase iPads. The iPads are expected to reduce your company’s costs by $20,000 per year for two years. At the end of two years, the iPads are expected to have a zero value. If you decide to purchase the laptops, you have the choice of leasing them for $19,000 per year or buying them for $35,000. You can borrow money at 8% per year and your firm has a required rate of return on investment of 15%. Should you purchase the iPads? If so, should you lease them or buy them? Show your work. meMj VaLlLLL 06 "m C03,“ Sayiwéi W0” remmw (Maid f C Ham} I>UWO0ULS€ W- 5 Mud“ me: value. ‘76 wiwm kw 030 fiia/i-JUO 03 . C U 773.5% Jr WW ’ II. Multiple Choice. Select the best answer. 1/2 point each. 1. Recently, the yield on the Treasury 10-year note a. 0.088%. b. 1.137%. @3.662%. d. l3.127%. 2. Recently, the value of the London FTSE 100 was about 6050 b. 12106 c. 2769 d. 1311 3. The following appeared in an article in the New York Times: “Yields fell on the benchmark 10-year bonds of those euro zone countries with weaker finances, notably Spain, Portugal, Belgium, and Italy.” From this excerpt we can conclude that a. the prices of Spanish bonds declined and investors who held these bonds suffered capital losses. _ b. the prices of Spanish bonds increased and investors who held these bonds suffered capital losses. @the prices of Spanish bonds increased and investors who held these bonds received capital gains. _ d. the prices of Spanish bonds declined and investors who held these bonds received capital gains. 4. The financial writer Andrew Tobias has made the following observation: “Ordinarily, if you believe in the issuing company, you might as well buy its stock and really profit from its success.” Tobias’s reasoning is probably that a. stock dividends are not taxed, while bond coupons are taxed. b. bond coupons are not taxed, while stock dividends are taxed. stock dividends can increase as the firm’s profits increase, while bond coupons are fixed. d. the yield to maturity on bonds falls as a firm becomes more profitable. 5. In the United States, during some years in the 19705, the real rate of interest on many bonds was negative. The best explanation for why lenders were willing to accept a negative real rate of interest during the i970s is a. the tax breaks investors receive on bonds makes them a better investment than stocks, even if the real interest rate is negative. b. the expected inflation rate must have been higher than actual inflation rate. @he expected inflation rate must have been lower than the actual inflation rate. d. although the real interest rate was negative, the coupon rate was still positive. 6. Which of the following is fixed on a coupon bond? a. The current yield ® The par value c. The market price (1. The yield to maturity 7. If Jose Withdraws $1,000 from a certificate of deposit taking the funds as currency, the immediate result of this action will be to cause a. M1 to fall and M2 to rise. b. M2 to fall and M1 to rise. M1 to rise, but to leave M2 unaffected. . neither M1 nor M2 to change. 8. Suppose that your marginal federal income tax rate is 30%, the sum of your marginal state and local tax rates is 5%, and the yield on thirty-year US. Treasury bonds is 10%. You would be indifferent between buying a thirty-year Treasury bond and buying a thirty-year municipal bond (ignoring differences in liquidity, risk, and costs of information) if the municipal bond has a yield of a. 6.5%. 7.0%. c. 9.5%. d. 10.0%. ...
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Spring 2011 Midterm I Answer Key - Department of Economics...

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