Question

# Suppose there is a three-person economy consisting of Walter, Jessie, and Saul.

Walter produces candy and

consumes hats, Jessie produces pens and consumes

candy, and Saul produces hats and consumes pens. Assume that Jessie has poor self

control and is more willing to undergo hardship than the other two.

a. Strictly limiting attention to this three-person economy, which good do you

expect to become the medium of exchange?

b. Now suppose that these three individuals are part of a larger economy. Of

these three goods, which would you argue has the best chance of becoming

money and why? There can be more than one correct answer to this

question, what matters is how well you defend your position.

2. This question deals with treasury bills and bonds.

a. Suppose that a T-bill pays out $10,000 in 25 days and the discount rate is

currently 1%. What is the market price of this T-bill to the nearest cent?

b. Suppose a $100,000 T-bond maturing in 17 years offers a coupon payment of

$2,500 every year and is being sold in the market for $110,000. What are the

current yield and yield to maturity? Round to the nearest hundredth of a

percent.

3. Suppose that the U.S. interest rate is 10% and the European interest rate is 13%.

The current exchange rate is €0.90 per $1. Holding interest rates constant, what do

you expect the exchange rate to be in 1 year? Round your answer to the nearest

penny.

Suppose that long-term interest rates are expected to increase in the next few

months.

a. What should the yield curve look like if the Pure Expectations model holds?

b. Conversely, what would the yield curve look like if the Segmented Markets

theory holds?

5. Suppose a 3-year, $100 investment has a 60% chance of a 100% net return, a 30%

chance of 50% net return, and a 10% chance of a 1% net return.

a. What is the expected gross return on this investment?

b. If the relevant interest rate is 5% per year, what is the present value of the

expected gross return? Round your answer to the nearest penny.