York University
Economics 4400, Midterm Examination
November 1, 2005
Instructions.
Write your name and student number at the top of this page. Answer all questions
below. Be clear what formulas you use to arrive at a solution, the actual numerical answers are less
important. If you think a question is ambiguous or not enough information is provided to answer
it, explain why. There are 8 questions, worth in total 30 points. You have 75 minutes.
1. (3pts). You live for three periods. Your income stream in periods 0,1,2 is $100, $110, $121.
The interest rate is 10% .Capital markets are perfect: You can borrow and lend any amount
at that rate.
(a) Assue you do not wish to consume anything in periods 1 and 2, so that you spend all
your wealth in period 0. How much can you a/ord to spend in period 0?
(b) If you wish to spend only in period 1, how much can you a/ord?
(c) If you wish to spend only in period 2, how much can you a/ord?
Answers:
a) PV of the income stream in period zero dollars is
$100 +
$110
(1+10%)
+
$121
(1+10%)
2
= $300
b)PV in terms of period one dollars is
$100(1 + 10%) + $110 +
$121
(1+10%)
= $330
c) PV in terms of period two dollars is
$100(1 + 10%)
2
+ $110(1 + 10%) + $121 = $363
1

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2. (3 pts) In the same framework as in Problem 1, assume that in addition to your income
stream you have a risk-free business opportunity that requires investing $100 in period zero
and produces $120 in period one. Capital markets are still perfect - you can save and borrow
in each period at 10%.
(a) Will you invest in the project if you want to spend only in period 2?
(b) If your answer in
(a)
was yes, how much more can you a/ord to spend in period two,
compared to your answer in
1c
?
(c) Does your answer in
(a)
change if you want to spend only in period 0 (instead of period
2)?. If no, just write "no". If yes, explain.

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