F08_midterm_with_answers - York University Economics 4400...

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York University Economics 4400, Midterm Examination October 30, 2008 Instructions. Write your name and student number at the top of this page. Answer four out of six questions below. Each question answered is worth 10 points, the total is 40 points.Be clear what formulas you use to arrive at a solution, the actual numerical answers are not important. If you think a question is ambiguous or not enough information is provided to answer it, explain why.You have 75 minutes. Update: Total marks when applying the above rules were rather low so the following changes were made: two extra marks for writing down name, two extra marks for writing down student number. 1. Consider an investor who thinks about implementing a business project. The separation the- orem states that under certain conditions (a) What are those conditions? (b) Explain why degree of patience may matter if these conditions are not satis±ed. Answers: a. The condition is that ±nancial markets are perfect, meaning the investor can borrow and lend any amount at the same interest rate. b. For example, consider a world with imperfect ±nancial markets, where lending rate is 0% and borrowing rate is 20%, a project which requires investing $1,000 now and will generate $1,100 next year (a return of 10%), and an individual who has $1,000 now. If the individual is impatient and wishes to spend it on consumption now, implementing the project would require borrowing $1,000 at 20% only to invest it at 10%. If the individual is patient, wishes to consume next year, and would otherwise save the $1,000 at market lending rate, investing it in the project with 10% return beats that option. 1
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2. You have no savings today but wish to accumulate wealth over next 40 years and then spend it. Each year, you can either work in a salaried job or manage your savings accumulated up to that year. A year in which you work at a job generates income of $1,000, which you entirely save (you do not consume anything until 40 years from now) but in such a year your savings generate no interest. Each year when you manage your assets increases your previously saved funds by 10%. (a) Your plan is as follows: you will work at the job in years 1 to n and then manage your assets from year n + 1 to 40 . What is your total wealth accumulated in year 40 as function of n ? (b) What is the optimal n ? Characterize as sharply as you can. (c) Explain verbally why your optimal wealth accumulation plan should have the form as
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This note was uploaded on 02/05/2012 for the course ECON 4140 taught by Professor A during the Spring '11 term at York University.

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F08_midterm_with_answers - York University Economics 4400...

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