Intro to Macro Worksheet #2

1)
A 5-year $10,000 bond that is issued with a yield of
10% when interest rates are 10% has a present value of $10,000. If after 2 years the interest rate is
still 10% then the present value of the bond at the beginning of year 3 would
still be $10,000. Alternatively,
if the interest rate decreases to 8% after 2 years (and is expected to remain
at 8% for the next three years) what is the net present value of the bond __for
the remaining three years__? In
general, what kind of relationship exists between the interest rate and the
price of bonds?

2) A firm is deciding whether to undertake the following investment opportunity. By incurring a current cost of $5,000 they would then receive $2,000 per year over the next three years. If the interest rate is currently 15% should they invest or not invest? If the interest rate changed to 8% should they invest or not invest? (Hint: Find the net present value of receiving $2,000 over the next three years.)

3) a.) In the 1980's U.S. business saving increased. Using a properly labeled diagram of the loanable-funds market, what effect would you expect this to have on the interest rate?

4) In the 1980's U.S. personal (household) saving decreased. Using a separate diagram of the loanable-funds market, what effect would you expect this to have on the interest rate?