ECON 209 Lecture Notes - Lecture 14: Market Price

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maroonyak232

13 Mar 2016

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Lecture - march 8: present value and interest rate: A. if money is offered between now and in the future, it is better to take it now because it is worth more now due to interest rate. > the pv of a bond is negatively related to the market interest rate. > the market price for a bond should equal its pv. Coupon payment on a bond is a constant number of $/year but the yield is that coupon payment as % of the bond"s market price. Bond riskiness = an increase in the riskiness of any bond leads to a decline in its expected pv and a decline in the bond"s price. In canada, government bonds are not perceived as risky but in the eu they are because of low pv. People lose confidence in the country when there is risk.

Related Questions

a) How much will be in your bank account at the end of five years if you invest $10,000 now at 12% per annum, compounded annually? And what if the interest rate is 12% per annum, but compounded monthly?

b) In the poor areas of many cities around the world, we find people offering pay-day loans. One loan agency in Dacca offers to loan Gita $20 till her pay cheque arrives in two weeks time. When it arrives, she must pay back the $20 plus a $2 service charge. What is the effective annual interest rate she is paying on the loan?

c) An oil pipeline is about to be constructed across BC. Some environmentalists are concerned that with the present design, there is a high probability that oil will leak in about 100 years time. If that happens, about 10 billion dollars worth of arable land will be rendered unusable. What is the most it is worth spending now in order to prevent this loss in the future? (Assume that if the money is not spent now, it can be invested at 5% interest.)

erinmallard94

Consider an economy in which the demand for money is of the form Y /(1+i_t) for t = 0, 1, 2, . . ., where Y denotes a constant level of output and it denotes the nominal interest rate in period t. The real interest rate, denoted r, is constant and equal to 4%. In period 0, the nominal interest rate is 15%, and the money supply is 100. People have rational expectations. In period 1, the central bank surprises people and sets the money supply to 104 and announces that starting in period 2 the money supply will grow at 2 percent forever, that is, M_t/M_t1 = 1.02 for t = 2, 3, . . .. Find the inflation rate in period 1. Compare it to E₀₁.

Now consider the same economy as in the previous question, except that people do not have rational expectations. Assume instead that E₁2 = E₀₁, where E_t_t+1 1 denotes the expected value in period t of inflation in period t + 1. Find the inflation rate in period 1.

erinotter443

I am having problems with this problem from my Econcoursework. Iunderstand how to do parts 1 and 2, but amhaving trouble with parts3 and 4. For part 3, how do I dothe calculation for an infiniteperiod? As the time becomeslonger the present value goes to zero,so do i assume a period, oris there an actual method for infiniteperiods? For part 4,do I simply do the sum for the future value andplug it into thePresent value equation? Not really looking for thesolutionhere, but I need some help getting the third and fourthpartssolved.

Congratulations! You just won the lottery! You can elect toreceiveyour prize in one of four
payment streams:
(i) $1,000,000 now
(ii) $1,500,000 at the end of five years
(iii) $60,000 per year in perpetuity (for ever), with paymentsmadeat the end of each year (so your
first payment comes one year from today)
(iv) $150,000 per year for the next ten years, with payments madeatthe end of each year (so your
first payment comes one year from today)

Suppose the annual interest rate is 5% with certainty andinperpetuity. Calculate the present value of
each of the four payment options (i.e., in todayâs dollars).Rankfor four options from most to least
valuable. You can use Excel or a calculator to solve this, butyoumust show the formulas you use.

ECON 209 Lecture Notes - Lecture 14: Market Price

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