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Anybody good at Economics?

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Anybody good at Economics?

Postby The_Met_Threat » Thu Mar 13, 2008 9:08 pm

Just having a really tough time with this stuff. Even the least bit of help would be great, dont really need explanations but theyd help.

2. On April 20, 2008 your wealthy aunt will give you a bond with a par value (or a maturity value) of $10,000. Your aunt purchased the bond in 2003, and it matures on April 20, 2009. The bond pays a coupon rate of 8 percent. When it arrives, the bond will have one remaining coupon.

a. If the current relevant rate of interest is 6 percent for the type of bond your aunt is giving you, what will the market value of the bond be on the day you receive it? Why?

b. Given the prospect of new wealth, you decide to check the business section of the newspaper. It suggests that the Bank of Canada soon will reduce interest rates in Canada by one half of one percentage point. If the relevant interest rate for the bond you will receive drops by one half of one percentage point, what will be its market value on the day you receive it? Why?

c. You read further in the business section and discover that the company that issued the bond in 2003 used the $10,000 it received tissue subprime mortgages in the U.S. In other words, the company used the funds it received by issuing bonds to give mortgages to homebuyers who had very poor credit ratings. Participants in the bond market now fear that defaults on mortgages have greatly increased the risk that the original issuer will not be able to pay the par value of the bonds when they mature. As a result, a large risk premium has raised the market rate of interest on your type of bond to 20 percent. What will its value be on the day you receive it?



3. Suppose you sell the bond and then deposit $5000 in a savings account that pays an annual rate of interest of 4%. You know that the chartered banks keep reserves against both savings accounts and chequing accounts equal to 10% of deposits; they loan the rest out as chequing accounts, which pay no interest. All new loans are redeposited in the banking system as chequing accounts. The banks charge an interest rate on their loans of 9%, and their administrative costs are 3% of the loan portfolio. Assume that your deposit is new reserves to the banking system.


a. What is the increase in the money supply if you use the definition for M1? What is the increase if you use the definition for M2? Explain.

b. What are the profits of the banking system? Explain.
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Re: Anybody good at Economics?

Postby RugbyD » Thu Mar 13, 2008 10:10 pm

a) a bond that vpays a higher rate than the current interest rate will be worth more because it pays more. It will be worth the time-discounted difference in remaining payments. your bond has 2 paymants remaining, par value at maturity and the one remaining interest payment on the same date. discount those payments to the present using the prevailing interest rate and the time until payment.

b) reduced rate will increase the value of your bond b/c it pays more. use above methodology.

c) the prevailaing rate (or in this case, an issue-specific required rate of return) is now much higher than what your bond pays, so the price of your bond will go down. use above methodology to determine the new price.

3) look up definitions of M1, M2, and the multiplier effect
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Re: Anybody good at Economics?

Postby willy-t » Fri Mar 14, 2008 7:46 am

Maybe wrong but I think (a) is £10,200 (b) £10,250 and (c) £9,600 for the reasons ruby states.
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