PS2 - University of California, Davis ECN 135 - FALL 2010 -...

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University of California, Davis ECN 135 - FALL 2010 - Problem Set 2 Due Date: Tuesday October 19 Problem 1: Explain why you would be more or less willing to buy a house under the following circumstances: a) You just inherited 100,000 dollars. b) Real estate commissions fall from 6 per cent to 5 per cent of the sales price. c) You expect Microsoft stock to double in value next year. d) Prices in the stock market become more volatile. e) You expect housing prices to fall. Problem 2: An important way in which the Federal Reserve decreases the money sup- ply is by selling bonds to the public. Using a supply and demand analysis for bonds, show what effect this action will have on interest rates. Is your answer consistent with what you would expect to find if you used the ”Liquidity Preference” framework? Problem 3: Consider a coupon bond with maturity date n = 2 and face value F = 40. If you know that the supply of this bond is given by S : P = 2 Q and the demand by D : P = 100 - 2 Q a) Calculate the interest rate of this bond if the coupon payments are given by c=10. b) If you know that the equilibrium interest rate of the bond in question is i=0.1,
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PS2 - University of California, Davis ECN 135 - FALL 2010 -...

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