For maximum credit: write legibly in full sentences, label
all numbers with appropriate units, show all work to get maximum partial
credit. Essays and
True-False-Uncertain/Explain questions should be answered with at least one full paragraph. Points are indicated in parentheses, 70 points total.
ESSAY QUESTIONS - WRITE A MINIMUM OF ONE FULL PARAGRAPH
1. (10 points) Evidence shows that interest rates are procyclical (interest rates rise during economic expansions, and fall during economic contractions). Explain the statement above using either the S & D for Bonds or the S & D for Credit model in your answer, showing what happens to interest rates both during an expansion and during a contraction, showing separate graphs. Clearly label your graph.
2. (10 points) Assume the Federal Reserve implements
expansionary monetary policy by performing an open market operation (buying
bonds from the public).
a. Using both the S and D for Bonds model and the S and D for Money model, graphically show the initial “liquidity effect” of expansionary monetary policy and explain in words what happens to interest rates initially (Short run).
b. Show what most often happens to interest rates over time (Long run) as a result of expansionary monetary policy, with a detailed diagram and discussion.
3. (10 points) T-F-Uncertain/Explain. State
an answer (True, False or Uncertain) and then completely explain your answer
in a short essay of a minimum of one full paragraph. “Inflation will
always benefits debtors.”
PROBLEMS - SHOW ALL WORK TO RECEIVE FULL CREDIT, and LABEL ALL NUMBERS WITH APPROPRIATE UNITS!!
1. (30 points total, as indicated) You are given the following
information on bonds in the year 2001 when the CPI is 172. Assume
annual coupon payments.
Bond Type Coupon Rate FV Term Price
Zero Coupon --- $1000 8 years $575
Regular T-bond 6.45% $1000 5 years $975
Indexed T-bond 3.5% $1028 5 years $1005
Municipal bond 4.65% $1000 5 years $968
a. calculate the yield to maturity (YTM) for each of the
four bonds above (quote the YTM to 2 decimal places, e.g. 5.28%). (6 points)
b. Calculate the current yield (PMT / Price ) for each bond above except the zero coupon bond (quote the current yield to 2 decimal places, e.g. 5.28%). (6 points)
c. use the bond information above and calculate the expected rate of inflation over the next five years. Explain your answer in a short essay. (6 points)
d. Use your answer from part c, and assume the CPI in 2006 is 190. Calculate and report the actual, annual, compounded rate of inflation over the next five years using the time value of money calculation. Would a person who bought a Regular T-bond in 2001 and held it until maturity be helped or harmed by the actual rate of inflation? Why or why not? Explain in a short essay. (6 points)
e. assuming that Regular T-notes are fully taxable, would a person in the 28% marginal tax bracket prefer the municipal bond (tax-free) or the Regular T-bond? Explain your answer and show calculations to support your answer. (Assume that there is no difference in default risk) (6 points)
2. (10 points total, 2 points for each part ) Given the
a. Calculate the annualized, compounded nominal rate of return for each country’s stock index over this period using a) the formula: PV (1+i)n =FV, or b) the calculator.
b. Calculate the annualized, compounded rate of inflation in each country using the same procedure as in part a.
c. Calculate the real rate of return for each stock market.
d. Which country had the highest nominal return?
e. Which country had the highest real return? Explain your answer in words in a short essay.
UK Stock Index 1650 2825
CPI 762 988
Turkey Stock Index
CPI 998 2096