Chap4 - 4.4 There would be too much borrowing The borrowers...

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Chapter 4: Financial Markets and Net Present Value: First Principles of Finance 4.1 $120,000 - ($150,000 - $100,000) (1.1) = $65,000 In order to consume $150,000 this year Jean will borrow $50,000 and pay $55,000 ($50,000 principal and $5,000 interest) next year, leaving him $65,000 potential consumption next year. 4.2 $40,000 + ($50,000 - $20,000) (1.12) = $73,600 Rich will earn $3,600 interest on the $30,000 he lends out this year, which will increase his potential consumption by $33,600 to $73,600 next year. 4.3 Financial markets arise to facilitate borrowing and lending between individuals. By borrowing and lending, people can adjust their pattern of consumption over time to fit their particular preferences. This allows corporations to accept all positive NPV projects, regardless of the inter-temporal consumption preferences of the shareholders.
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Unformatted text preview: 4.4 There would be too much borrowing. The borrowers would have to be given limited access to the market. This would also be an irresistible arbitrage opportunity that could not last long and a new equilibrium would be set. 4.5 a. Since the PV of labour income is $60, and $60 = $40 + $22 / (1 + r), r must be equal to 10%. b. NPV = $75 - $60 = $15 b. Her wealth is $75. Letting C denote consumption, she wants $75 = C + C/(1 + r) where r = 0.10. Solve for C; C = $39.29 4.6 a. $90,000 / $80,000 - 1 = 0.125 = 12.5% b. He will invest $10,000 in financial assets (i.e. put this much in the bank) and $30,000 in productive assets (i.e. spend this much on the investment opportunity) today. c. NPV = -$30,000 + $56,250 / 1.125 = $20,000 Answers to End-of-Chapter Problems B-20...
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