Download Macroeconomics Principles: Spring 2008 Exam on Bonds, National Income, and Monetary Policy and more Exams Introduction to Macroeconomics in PDF only on Docsity! Economics 132.03 Principles of Macroeconomics Spring 2008 Professor Peter Ireland http://www2.bc.edu/~irelandp/ec132.html Second Midterm Exam This exam has 12 questions on 5 pages; before you begin, please check to make sure your copy has all 12 questions and all 5 pages. Each of the 12 questions will receive equal weight in determining your overall exam score. You can work on the questions in any order, but please be sure to keep your answers to all of the parts of a specific question together in your exam book. 1. Suppose that you are an investment advisor and, after checking the latest interest rates in the bond market, you collect the following information: Issuer Maturity Date Interest Rate (per year) US Government December 2008 1.75% US Government December 2028 4.50% General Motors February 2038 11.00% General Electric February 2038 6.25% State of Massachusetts December 2028 3.25% Explain briefly (no more than a sentence or two for each case) which of these bonds you would recommend, and why, to a client who tells you: a. “I’m saving for retirement, so I won’t need the money for many years, but above all I don’t want to risk losing my money.” b. “I’m saving to buy a new house. I may need the money next year, and I don’t want to take any risk either.” c. “I’m in a high federal income tax bracket and would really benefit from a tax break on the income from my savings.” d. “I want to aim for a high return and don’t care if that means taking on a lot of risk.” e. “I want a decent return and am willing to tolerate some risk, but not too much risk.” 2 2. Consider a closed economy in which GDP equals $15 billion, consumption equals $9 billion, government purchases equal $2 billion, and tax revenue equals $1 billion. Use this information to answer the following questions (note: if you show your calculations and use the correct formulas, we can give you partial credit even if you make a mistake with the arithmetic): a. What is investment equal to in this economy? b. What is national saving equal to in this economy? c. What is public saving equal to in this economy? d. What is private saving equal to in this economy? e. What are net exports equal to in this economy? 3. Suppose that after the 2008 elections, the new President and Congress act to cut government spending and, by doing so, eliminate the current federal government budget deficit. a. Does this change in policy shift the demand curve or the supply curve in the market for loanable funds? b. Use a supply‐and‐demand diagram for loanable funds to show in which direction the relevant curve shifts. c. Does the interest rate rise or fall as a result of this change in policy? d. What happens to private investment as a result of this change in policy? e. What effect would this policy have on the productivity of US workers? 4. Suppose that you are the CEO of a large corporation, and one of your vice presidents finds an investment project that costs $100 million today, but promises to pay off $200 million 7 years from now. a. Write down a formula for the present value of the $200 million that your firm stands to receive from the project 7 years from now, assuming that the interest rate is 10 percent per year (note: all you need to do for this part is to write down the formula, since actually computing the numerical value of this present value isn’t possible without the help of a calculator). b. Suppose the present value from part (a) turns out to be greater than $100 million. Should you use your corporation’s funds to undertake the project? c. Suppose that the interest rate falls to 5 percent per year between the time that the vice president alerts you to the project and the time at which you actually have to make the decision of whether to undertake the project. Would that change the answer that you gave in part (b) above: yes, no, or maybe?