Final Practice Answer 2011

# Final Practice Answer 2011 - Econ 352 Intermediate...

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Econ 352 YiLi Chien Intermediate Macroeconomics Spring 2011 Practice Final Exam Answer Part One (25 pts) Instruction: answer the following questions using analytical frameworks. Depict appropriate diagrams if needed. 1. (10 pts) Use , it P for the price for asset i in period t , ,1 P + for the price for asset i in period t+1, D + for the cash payment for asset i in period t+1 and r for the interest rate between period t and t+1 . a) (6 pts) Write down the basic asset pricing formula. Describe the economic intuition behind the formula. b) (4 pts) Suppose the interest rate is 10 percent per year, and there is an asset that pays off \$100 next year with 80% probability, and pays off \$1,000 with 20% probability. Use the asset pricing formula to price this asset. Answer : a. The basic formula is: , 1 PD P r ++ + = + The intuition is that the marginal cost of acquiring the asset ( , P ) is equal to the marginal benefit of acquiring the asset, which is price of asset plus the dividend

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Final Practice Answer 2011 - Econ 352 Intermediate...

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