For maximum credit: write legibly in full sentences, label all numbers with appropriate units, show all work. Essays and T-F-U/Explain questions should be answered with at least one full paragraph. The exam is worth 75 points, and five extra credit points are included (80 points total). Points are indicated in parentheses.
ESSAYS
1. (10) The Federal Reserve has raised interest rates
four times in the last year to slow down the economy, and yet the economy
continues to experience strong growth. Give several reasons (with
explanations) why the interest rate increases have failed to slow down
the economy.
2. (10) Several weeks ago, the Federal Reserve raised its target rate for the Federal Funds rate from 5.5% to 5.75%. In response to the rate increase, long term interest rates (30 year bond rate) actually fell. Explain why.
3. (10) Discuss the advantages and disadvantages of a dollar-based monetary policy for a country like Argentina, which formerly was a high inflation country.
T-F-Uncertain, Explain in a short essay of at least
one full paragraph.
4. (10) A carefully diversified portfolio with 50 or
more stocks in many different industries eliminates risk.
PROBLEMS
1. (10) Assume that over the last five years, M1 has
grown from $1082B to $1448B. Real output (Real GDP) has grown from
$8200B to $9740B during this period.
a. Calculate the compounded growth rate of M1 and the
compounded growth rate of real output over this period.
b. Using the quantity theory of money (MV = PY) and assuming
that Velocity is constant, predict the rate of inflation over this period.
Explain your answer in words, specifically addressing what caused inflation.
c. Use the information above. Under a fixed growth rate
rule for monetary policy, what should the approximate money growth rate
be? Explain your answer.
2. (10) Over a 6 year period, nominal GDP has gone from
$5200B to $8252B while CPI has gone from 145 to 188. a. Calculate
the nominal, compounded growth rate of nominal GDP and inflation rate over
this period.
b. Calculate the growth rate in real output during this
period.
c. Explain you answer in words, addressing the difference
between nominal and real GDP growth.
3. (20) You are given the following information on bonds.
Type
Coupon Rate
FV
Term
Price
Zero Coupon
-
$1000
10 years $500
Regular T-bond
8.5% $1000
5 years
$950
Index T-bond
4%
$1050
5 years
$975
Muni-bond
5%
$1000
5 years
$925
a. calculate the yield to maturity (YTM) for each bond.
(2 points each)
b. using the information above, what
is the expected rate of inflation over the next five years? Explain your
answer in words. (3 points)
c. Using our answer from part b, if actual inflation
rate over the next five years is 6% per year, would a person who bought
the Regular T-bond benefit? Why or why not? (3 points)
d. assuming that Regular T-bonds are fully taxable, would
a person in the 35% tax bracket prefer the muni bond (tax-free) or the
Regular T-bond? Explain your answer (Assume that there is no difference
in risk) (3 points)
e. Explain in a short essay why the Regular T-bond above
is selling at a discount. (3 points)