Midterm_Fall_2005_Answers

Midterm_Fall_2005_Answers - York University Economics 4400,...

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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. a. Yes you will. The project has positive NPV as
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Midterm_Fall_2005_Answers - York University Economics 4400,...

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