ECON 209 Chapter Notes - Chapter 28: Canadian Dollar, Retained Earnings, Capital Outflow

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burgundygnat930

12 May 2013

School

McGill University

Department

Economics (Arts)

Course

ECON 209

Professor

Mayssun El- Attar Vilalta

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Document Summary

Economics chapter 28 summary: money, interest rates and economic activity. Bonds: financial wealth including interest earning financial assets and claims on real capital (equity) Bond: financial asset promising to make one or more specified payments at specified dates in the future. Present value: value now of one or more payments or receipts made in the future; aka discounted present value depends on interest rate. You subtract the interest rate from the value that is meant to be loaned in order to get back the exact value of the loan a year (etc. ) later. Present value x (interest rate) = what you want to get back. What you want to get back/ interest rate= how much you should loan out today (present value) Higher interest rate = lower present value r1 is. Pv = r1/ (1+i) where r1 is amount we receive a year from now and i is annual interest rate.

Related Questions

This assignment requires the following knowledge: For k different events, if the probability that each of them happens is p (0 < p < 1) and all events happen independently, the probability that all events happen together is p^k.
1. Five firms, namely A, B, C, D and E, issue discounted bonds with face value $1,000 and maturity 5 years in the market. All firms are pretty risky and each of them has a chance of 0.5 of collapse during the five years (thus bankrupted and can not pay back the bond accordingly). The bonds are all sold at an interest rate of 50% (the value is not surprising due to the extremely high risk of default).
(1) What is the present value of the bond given the interest rate, the face value and the maturity? Hint: we temporarily do not consider the issue of default.
(2) Say now you buy one bond from each of the five firms, what is the total amount you lend out today? Eventually only one firm does not fail and pays back the bond, what is the money you collect back 5 years later? You gain or loss in this case? If more than one firm pays back the bond, will you get more money back?
(3) What is the chance (probability) that you get nothing back assuming that firms fail independently? Together with the answer in (2), is it a good deal to buy one bond from each of the five firms?
(4) Repeat (2) and (3) with the only difference that now you buy 5 bonds from a single firm.
(5) Now we assume that the five firms all have similar businesses in Greece (and those are their only businesses), therefore, all firm fail together if the economy in Greece fails. Will you answer in (3) change?

Dr. Harold Wolf of Medical Research Corporation (MRC) was thrilledwith the response he had received from drug companies for hislatest discovery, a unique electronic stimulator that reduces thepain from arthritis. The process had yet to pass rigorous FederalDrug Administration (FDA) testing and was still in the early stagesof development, but the interest was intense. He received the threeoffers described below this paragraph. (A 10 percent interest rateshould be used throughout this analysis unless otherwisespecified.)

Offer I $1,000,000 now plus $200,000 from year 6 through 15. Alsoif the product did over $100 million in cumulative sales by the endof year 15, he would receive an additional $3,000,000. Dr. Wolfthought there was a 70 percent probability this would happen.

Offer II Thirty percent of the buyerâs gross profit on the productfor the next four years. The buyer in this case was ZbayPharmaceutical. Zbayâs gross profit margin was 60 percent. Sales inyear one were projected to be $2 million and then expected to growby 40 percent per year.

Offer III A trust fund would be set up for the next 8 years. At theend of that period, Dr. Wolf would receive the proceeds (anddiscount them back to the present at 10 percent). The trust fundcalled for semiannual payments for the next 8 years of $200,000 (atotal of $400,000 per year).

The payments would start immediately. Since the payments are comingat the beginning of each period instead of the end, this is anannuity due. To look up the future value of an annuity due in thetables, add 1 to n (16 + 1) and subtract 1 from the value in thetable. Assume the annual interest rate on this annuity is 10percent annually (5 percent semiannually). Determine the presentvalue of the trust fundâs final value.

Required: Find the present value of each of the three offers andindicate which one has the highest present value.

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 Chapter Notes - Chapter 28: Canadian Dollar, Retained Earnings, Capital Outflow

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