Download Econ 161A: Money and Banking Spring 2017: Jenkins Exam 1

Econ 161A: Money and Banking
Spring 2017: Jenkins
Exam 1: Version A Key
1. (a) In principle, bananas could be the basis for a unit of account or they could be used as a
medium of exchange, but a banana is not a good store of value because it rots quickly
and is easily damaged.
(b) Money promotes specialization by eliminating the requirement that both parties in a
transaction in a transaction have what the other party produces. In a barter economy, the heavy metal musician would have to hope that the grocer and the pharmacist
wanted a heavy metal performance whenever the musician wanted groceries or medication. Without money, the musician might likely would have specialized in producing
something more widely-enjoyed. Heavy metal music is only one of the many benefits of
using money.
2. From top to bottom: F, G, E, A, D, C, H, B
3. (a) PZB = $99,667.78.
(b) PCB = 87,537.79
(c) The rate of return on a coupon bond:
r1 =
C + P1 − P0
P0
(1)
Even in the coupon C is paid with certainly, the future price of the bond is unknown
and therefore risky. In particular, if interest rates in the future rise, then the price of
the bond will fall and so will the rate of return. That’s why we say that all long-term
bonds are subject to interest rate risk including US Treasury bonds.
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4. (a) F P = $33,966.98.
(b) i = 0.03.
5. (a) If the wealth of investors rises, then the demand for bonds (and all other assets) increases.
(b) A well-labeled diagram:
Bond Market Equilibrium
Yield on
Bonds
B2d
B1d
i0
i1
Bs
Quantity of
Bonds
0
B0
B1
6. (a) An reduction in the inflation rate decreases the supply of bonds and increases the demand
for bonds.
(b) A well-labeled diagram:
Bond Market Equilibrium
Yield on
Bonds
B1d
i0
B0d
i1
B1s
B0s
Quantity of
Bonds
0
B0 = B1
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7. (a) Income earned from muni bonds is not subject to federal income tax while income earned
on US Treasury bonds is subject to federal income tax.
(b) Most likely, the rising risk premium on muni bonds reflects the perception that state/local
governments have been becoming more likely to default on their bonds.
(c) State/local governments preparing to issue new bonds. An increase in the muni bond
rate will not affect a borrower who has previously-sold bonds in the market because the
coupon and face value are fixed in advance. However, the higher muni rate will make
borrowing in the bond market more expensive for state/local governments looking to
sell new bonds.
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