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?