Chapter 15 - Answers to Questions for Review 1 Real capital...

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Answers to Questions for Review 1. Real capital represents the actual physical capital used in production. Financial capital refers to the monetary assets whose rate of return explains the opportunity cost of real capital. To determine how much physical capital to use, one must think in financial terms. 2. Depreciation represents a cost to the firm since it would have to replace the asset at the new current price. 3. Higher discount rates reduce the present value of any given nominal income stream. In other words we will attach a lower weight to future events. 4. Lenders and borrowers are concerned with real rates, not nominal rates. To keep real rates constant when prices rise, one must raise nominal rates an amount equal to the level of the increase in inflation. This will happen when the incomes of both borrowers and lenders rise proportionately with inflation. 5. Example: Suppose a $1000 bond pays 10% in perpetuity, or $100 a year. If interest rates fall to 5%, then any new bond issued for $2000 will yield $100 a year. Thus the price of the old bond will rise to
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Chapter 15 - Answers to Questions for Review 1 Real capital...

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