Question 1

Suppose that a dispute in the Persian Gulf halts the sale of oil from the Persian Gulf for one year.At the same time an important new oil field is found in a place where nobody expected there to be oil.What does economic theory predict will be the effect on the future price of oil to be delivered two years from now?

Accepted Answer

The answer of Suppose that a dispute in the Persian...

Question 2

If the rate of inflation is greater than the interest rate,

Accepted Answer

The answer of If the rate of inflation is greater...

Question 3

A large (subterranean)pool of oil lies in a remote region of Ohio.Oil companies have explored this region and know how much oil there is.They have purchased the rights to drill and extract oil when they wish to do so.Because of the extremely forbidding geography and the savagery of the natives, the companies have decided to postpone extraction until the price of oil is higher.The theory of intertemporal arbitrage predicts that

Accepted Answer

The theory of intertemporal arbitrage predicts that the price of the rights to this oil must rise at the interest rate, reflecting the opportunity cost of not extracting the oil now and the expected future profits from extraction.

Question 4

Ashley, from your workbook, has discovered another wine, wine D.Wine drinkers are willing to pay 40 dollars to drink it right now.The amount that wine drinkers are willing to pay will rise by 20 dollars each year that the wine ages.The interest rate is 10%.How much would Ashley be willing to pay for the wine if he buys it as an investment? (Pick the closest answer.)

Accepted Answer

The future value of the wine increases by $20 each year. The present value of these future cash flows, discounted at 10%, is closest to $93.

Question 5

Bank 1 offers a deal on deposits of $1,000 or more.You must leave your money in the bank for three years, but bank 1 will pay you 8% interest for the first year, 8% interest for the second year, and 7% interest for the third year.In response, bank 2 offers a deal that it claims is even better.It also requires you to deposit at least $1,000 and to leave it in the bank for three years, but it will pay 12% interest in the first year and then 8% in the second and third year.After three years, you can take your money out of either bank and do what you want with it.Both banks compound interest annually.

Accepted Answer

The answer of Bank 1 offers a deal on deposits...

Question 6

The interest rate is 10% and will remain so forever.You do not drink wine but are interested in buying some for investment purposes.Assume that there are no transactions costs or storage costs and that a certain bottle of wine will be worth $55 one year from now, $58 two years from now, and $64 three years from now.After that it turns to worthless vinegar.How much should you be willing to pay for a bottle? (Pick the closest answer.)

Accepted Answer

The answer of The interest rate is 10% and will...

Question 7

If the interest rate is 17%, and will remain 17% forever, how much would a rational investor be willing to pay for an asset that will pay him 7,020 dollars 1 year from now, 1,368 dollars 2 years from now, and nothing at any other time?

Accepted Answer

To find the present value of the future cash flows, we discount each payment back to the present value using the formula PV = FV / (1 + r)^n, where PV is the present value, FV is the future value, r is the interest rate, and n is the number of periods. For the payment of 7,020 dollars 1 year from now: PV = 7,020 / (1 + 0.17)^1 = 7,020 / 1.17 ≈ 6,000 dollars. For the payment of 1,368 dollars 2 years from now: PV = 1,368 / (1 + 0.17)^2 = 1,368 / 1.3689 ≈ 1,000 dollars. Adding these together gives a total present value of approximately 7,000 dollars.

Question 8

Ashley, from your workbook, has discovered another wine, wine D.Wine drinkers are willing to pay 45 dollars to drink it right now.The amount that wine drinkers are willing to pay will rise by 15 dollars each year that the wine ages.The interest rate is 10%.How much would Ashley be willing to pay for the wine if he buys it as an investment? (Pick the closest answer.)

Accepted Answer

The future value of the wine increases by $15 each year, and the present value is calculated using the formula for present value of a growing annuity. The closest answer to the calculated present value is $76.

Question 9

A bond has a face value of 5,000 dollars.It will pay 500 dollars in interest at the end of every year for the next 45 years.At the time of the last interest payment, 45 years from now, the company that issued the bond will redeem the bond at face value.That is, the company will buy back the bond from its owner at a price equal to the face value of the bond.If the interest rate is 10% and is expected to remain at 10%, how much would a rational investor pay for this bond right now?

Accepted Answer

The answer of A bond has a face value of...

Question 10

Bank 1 offers a deal on deposits of $1,000 or more.You must leave your money in the bank for three years, but bank 1 will pay you 4% interest for the first year, 4% interest for the second year, and 7% interest for the third year.In response, bank 2 offers a deal that it claims is even better.It also requires you to deposit at least $1,000 and to leave it in the bank for three years, but it will pay 7% interest in the first year and then 4% in the second and third years.After three years, you can take your money out of either bank and do what you want with it.Both banks compound interest annually.

Accepted Answer

The future value of the deposit in bank 1 is $1,000 * (1.04) * (1.04) * (1.07) = $1,159.38. The future value of the deposit in bank 2 is $1,000 * (1.07) * (1.04) * (1.04) = $1,159.38. So the two offers are equally valuable.

Question 11

The sum of the terms of the infinite geometric series 1, 0.86, 0.86², 0.86³, ..., is closest to which of the following numbers?

Accepted Answer

The common ratio is 0.86, and the first term is 1, so the sum can be calculated using the formula $S = \frac{a_1}{1-r}$, where $a_1$ is the first term and $r$ is the common ratio.

Plugging in, we get:

$S = \frac{1}{1-0.86} = \frac{1}{0.14} = \frac{100}{14} = \frac{50}{7} \approx 7.14$

Therefore, the sum is closest to $\boxed{	extbf{(C) }7.14}$.

Question 12

A zero coupon bond is a bond that pays no return until it comes due and then pays the holder of the bond its face value.Suppose that a $2,000 zero coupon bond will come due on January 1, 2020.If the interest rate is 5% and will remain 5% forever, what will this bond be worth on January 1, 2005?

Accepted Answer

To calculate the value of the bond in 2005, we need to discount the face value of $2,000 back to 2005 using the interest rate of 5%. We can use the formula:
Present Value = Future Value / (1 + Interest Rate)^Number of Years
Number of Years = 15 (from 2005 to 2020)
Present Value = $2,000 / (1 + 0.05)^15
Present Value = $2,000 / 1.5204
Present Value = $1,314.81 (rounded to the nearest cent)
Therefore, the bond will be worth $1,314.81 in 2005. Option D is the closest to this value: $2,000/1.05 = $1,904.76, but it is still higher than the actual value because it assumes annual compounding of interest.

Question 13

A bond has a face value of 7,000 dollars.It will pay 700 dollars in interest at the end of every year for the next 50 years.At the time of the last interest payment, 50 years from now, the company that issued the bond will redeem the bond at face value.That is, the company will buy back the bond from its owner at a price equal to the face value of the bond.If the interest rate is 10% and is expected to remain at 10%, how much would a rational investor pay for this bond right now?

Accepted Answer

The answer of A bond has a face value of...

Question 14

Shivers's annual fuel bill for home heating is 800 dollars per year.He considers three alternative plans for insulating his house.Plan A would reduce his annual fuel bill by 15%, plan B would reduce it by 20%, and plan C would eliminate his need for heating fuel altogether.The plan A insulation job would cost Shivers 800 dollars, plan B would cost him 1,100, dollars, and plan C would cost him 8,800 dollars.If the interest rate is 10% and his house and the insulation job last forever, which plan is the best for Shivers?

Accepted Answer

To calculate the present value of each option, we need to use the formula:

Present Value = Future Value / (1+interest rate)^n

where n is the number of years it will take for the option to break even (i.e. for the savings on the fuel bill to equal the cost of the insulation job).

For Plan A:
Savings = $800 x 15% = $120
Present Value = $120 / (1+0.1)^1 = $109.09
Net Present Value (NPV) = -$800 + $109.09 = -$690.91

For Plan B:
Savings = $800 x 20% = $160
Present Value = $160 / (1+0.1)^1 = $145.45
NPV = -$1100 + $145.45 = -$954.55

For Plan C:
Savings = $800
Present Value = $800 / (1+0.1)^1 = $727.27
NPV = -$8800 + $727.27 = -$8072.73

Since Plan B has the highest NPV (i.e. the smallest loss), it is the best option for Shivers.

Question 15

The price of an antique is expected to rise by 8% during the next year.The interest rate is 12%.You are thinking of buying an antique and selling it a year from now.You would be willing to pay a total of 800 dollars for the pleasure of owning the antique for a year.How much would you be willing to pay to buy this antique?

Accepted Answer

The answer of The price of an antique is expected...

Question 16

The price of an antique is expected to rise by 4% during the next year.The interest rate is 6%.You are thinking of buying an antique and selling it a year from now.You would be willing to pay a total of 400 dollars for the pleasure of owning the antique for a year.How much would you be willing to pay to buy this antique?

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The answer of The price of an antique is expected...

Question 17

The interest rate is 10% and will remain so forever.You do not drink wine but are interested in buying some for investment purposes.Assume that there are no transactions costs or storage costs and that a certain bottle of wine will be worth $44 one year from now, $51 two years from now, and $55 three years from now.After that it turns to worthless vinegar.How much should you be willing to pay for a bottle? (Pick the closest answer.)

Accepted Answer

The answer of The interest rate is 10% and will...

Question 18

The sum of the terms of the infinite geometric series 1, 0.85, 0.85², 0.85³, ..., is closest to which of the following numbers?

Accepted Answer

The answer of The sum of the terms of the...

Question 19

Shiver's annual fuel bill for home heating is 900 dollars per year.He considers three alternative plans for insulating his house.Plan A would reduce his annual fuel bill by 15%, plan B would reduce it by 20%, and plan C would eliminate his need for heating fuel altogether.The plan A insulation job would cost Shivers 900 dollars, plan B would cost him 1,600 dollars, and plan C would cost him 9,900 dollars.If the interest rate is 10% and his house and the insulation job last forever, which plan is the best for Shivers?

Accepted Answer

Plan A offers the best return on investment when considering the cost of insulation versus the annual savings and the interest rate.

Question 20

A zero coupon bond is a bond that pays no return until it comes due and then pays the holder of the bond its face value.Suppose that a $4,000 zero coupon bond will come due on January 1, 2020.If the interest rate is 5% and will remain 5% forever, what will this bond be worth on January 1, 2005?

Accepted Answer

The present value of the bond in 2005 can be calculated using the formula: 
Present Value = Face Value / (1+interest rate)^number of years 
Here, face value = $4,000, interest rate = 5%, and number of years = 15 (from 2005 to 2020). 
So, Present value = $4,000 / (1+0.05)^15 = $1,951.81 
Therefore, the correct option is D, which is the closest to this value, after adjusting for rounding.

Quiz 10: Asset Markets-Part A