Deck 27: Essay

Question 1

Suppose you place $500 into a savings account that will pay you 6% interest per year.What will be the future value of the savings account in 15 years?

Answer 1

The present value of the future payoff will be equal to the initial investment when the interest rate is 8.45%.

Question 2

Write the formula for finding the future value in n years of $x today.

Answer 2

It is worth more if it is received in 5 years.It's worth about $8626.09 if it is paid in 5 years and $7440.94 if it is paid in ten years.So,its worth about $1185.15 more if its paid in 5 years rather than 10.

Question 3

Write the formula to find the present value of $x to be paid in n years.

Answer 3

The present value is $2,315.97.

Question 4

Anthony closes out his account in which he deposited $500 five years ago at an interest rate of 5%.Mark closes out his account in which he deposited $500 ten years ago at an interest rate of 5%.Who had more in their account? About how much more did he have?

Question 5

A company has an investment project that will cost $2 million today and yield a payoff of $3 million in 5 years.What interest rate represents the cutoff between profitability and nonprofitability for this project?

Question 6

If the interest rate is 8 percent,then what is the present value of $5,000 to be received in ten years?

Question 7

Suppose the interest rate is 3% and that you are to receive three annual payments of $1,000,with the first payment today,the second payment one year from now,and the third payment two years from now.What is the present value of this stream of payments?

Question 8

The nation of Zambonia experiences the same rate of population growth every year.If the population of Zambonia doubles every 35 years,then what is the approximate annual rate of population growth?

Question 9

A payment of $10,000 is to be made in the future.The interest rate 3%.Is this payment worth more if it is paid in 5 years or 10 years? How much more is it worth?

Question 10

If the interest rate is 5 percent,then what is the present value of $2,000 to be received in three years?

Question 11

If a savings account pays 7% interest,then according to the rule of 70 how long will it take for the account balance to double?

Question 12

A company has an investment project that will cost $2 million today and yield a payoff of $3 million in 5 years.If the interest rate is 7%,should the firm undertake the project? Show evidence to support your answer.

Question 13

Jack's Lock and Key is considering remodeling.It estimates that the remodeling will cost $6,000 and that as a result revenues will rise by $3,000 the first year,$2,500 the second year,$1,500 the third year and have no effect after then.If the interest rate is 5%,should Jack's remodel? Defend your answer by showing your work.

Question 14

Suppose you place $1,000 into a savings account that will pay you 4% interest per year.What will be the future value of the savings account in 10 years?

Question 15

Suppose the interest rate is 5% and that you are to receive three annual payments of $10,000,with the first payment one year from now,the second payment two years from now,and the third payment three years from now.What is the present value of this stream of payments?

Question 16

Write the formula for finding the future value of $1,000 today in 10 years if the interest rate is 4 percent.

Question 17

A company has an investment project that will cost $2 million today and yield a payoff of $3 million in 5 years.If the interest rate is 9%,should the firm undertake the project? Show evidence to support your answer.

Question 18

Write the formula to find the present value of $750 to be paid in 5 years if the interest rate is 3 percent.

Question 19

Suppose you invest $10,000 at 7% interest to be withdrawn by your heirs in 100 years.According to the rule of 70,approximately how much will your heirs be able to withdraw?

Question 20

If a savings account pays 3.5% interest,then according to the rule of 70 how long will it take for the account balance to double?

Question 21

Your boss asks you to do fundamental analysis of a corporation.What value is she asking for and how would you estimate this value?

Question 22

Until recently,shares of stock accounted for 40 percent of Jimmy's savings.A few days ago,Jimmy sold some bonds and bought some additional shares of stock.Now shares of stock account for 70 percent of Jimmy's savings.How did this change affect Jimmy's expected retun on his savings? How did it affect the risks he faces?

Question 23

Can insurance be thought of as diversification? Defend your answer.

Question 24

You are a financial advisor and a client tells you he is concerned about the amount of risk in his portfolio.Assuming your client hasn't already done them,what two things can you suggest to reduce your client's risk? What additional information about reducing risk should you provide?

Question 25

From the standpoint of the economy as a whole,the role of insurance is not to eliminate the risks inherent in life.Then what is its purpose?

Question 26

Thompson Corporation is considering the purchase of a new piece of machinery.Thompson expects the new machinery to increase its revenues by $70,000 at the end of year 1,$60,000 at the end of year 2,and $50,000 at the end of year 3 at which point the machinery will have exhausted its useful life.If the interest rate is 4%,what is the most Thompson should be willing to pay today for this piece of machinery?

Question 27

Scenario 27-1
Lisa has a utility function where W is Lisa's wealth in millions of dollars and U is the utility she obtains.
Refer to Scenario 27-1.Suppose Lisa is faced with a choice between two options.With option A Lisa receives a guaranteed $9 million.With option B Lisa faces a lottery that pays $16 million with probability P and pays $4 million with probability (1-P).Given Lisa's utility function,how high does P need to be before Lisa will prefer option B?

Question 28

How does moral hazard matter in the market for insurance?

Question 29

Suppose your bank account pays a 4% interest rate.You are considering purchasing a share of stock in ABC Corporation for $500.The stock will pay you a $10 dividend at the end of years 1,2,and 3.You expect to be able to sell the stock at the end of year 3 for $550.Is ABC a good investment? Provide evidence to support your answer.

Question 30

List two ways a risk adverse person may attempt to reduce risks.

Question 31

At about what number of companies does the reduction in risk from adding stocks of more companies to a portfolio do little to reduce risk?

Question 32

Bill gets medical insurance and then exercises less.Lilly has health concerns and so applies for medical insurance.Identify each of these as moral hazard or adverse selection.

Question 33

Scenario 27-1
Lisa has a utility function where W is Lisa's wealth in millions of dollars and U is the utility she obtains.
Refer to Scenario 27-1.Use the following diagram to graph Lisa's utility function for
. C:\Users\user\Dropbox\Quizplus Parsing Documents\To Be Parsed\NEW Files\TB2297,Principles of Macroeconomics 8th Edition by N.Gregory Mankiw\TB2297,Principles of Macroeconomics 8th Edition by N.Gregory Mankiw\Images\Sec-All-Short-Answer-and-Essay-Ch-27--2.jpg

Question 34

Suppose your bank account pays a 5% interest rate.You are considering purchasing a share of stock in DH Corporation for $250.The stock will pay you a $10 dividend at the end of years 1,2,3,4,and 5.You expect to be able to sell the stock at the end of year 5 for $300.Is DH a good investment? Provide evidence to support your answer.

Question 35

How does adverse selection affect the insurance market?

Question 36

The objective of diversification is to reduce risk.How does a person diversify a stock portfolio? How is risk measured?

Question 37

Should a person who is risk averse hold a portfolio with no stock and only bonds?
Explain.

Question 38

Describe the shape of the utility function of a risk averse person.

Question 39

Scenario 27-1
Lisa has a utility function where W is Lisa's wealth in millions of dollars and U is the utility she obtains.
Refer to Scenario 27-1.Suppose Lisa is faced with a choice between two options.With option A Lisa receives a guaranteed $9 million.With option B Lisa faces a lottery that pays $4 million with probability 0.4 and pays $16 million with probability 0.6.Given Lisa's utility function,will she prefer option A or option B? Provide evidence to support your answer.

Question 40

Scenario 27-1
Lisa has a utility function where W is Lisa's wealth in millions of dollars and U is the utility she obtains.
Refer to Scenario 27-1.Is Lisa risk averse? Explain.

Question 41

Demonstrate that whether you would prefer to have $225 today or wait five years for $300 depends on the interest rate.Show your work.

Question 42

Define the efficient markets hypothesis.

Question 43

Scenario 27-2
Suppose Dave has a utility function where W is his wealth in millions of dollars and U is the utility he obtains.
Refer to Scenario 27-2.Suppose Dave is faced with a choice between two options.With option A Dave receives a guaranteed $2 million.With option B Dave faces a lottery that pays $10 million with probability P and pays $0 with probability (1-P).Given Dave's utility function,how high does P need to be before he will prefer option B over option A?

Question 44

Give an example of adverse selection and an example of moral hazard using homeowners insurance.

Question 45

Scenario 27-2
Suppose Dave has a utility function where W is his wealth in millions of dollars and U is the utility he obtains.
Refer to Scenario 27-2.Use the following diagram to graph Dave's utility function for
. C:\Users\user\Dropbox\Quizplus Parsing Documents\To Be Parsed\NEW Files\TB2297,Principles of Macroeconomics 8th Edition by N.Gregory Mankiw\TB2297,Principles of Macroeconomics 8th Edition by N.Gregory Mankiw\Images\Sec-All-Short-Answer-and-Essay-Ch-27--7.jpg

Question 46

Scenario 27-2
Suppose Dave has a utility function where W is his wealth in millions of dollars and U is the utility he obtains.
Refer to Scenario 27-2.Is Dave risk averse? Explain.

Question 47

What's the difference between firm-specific risk and market risk? Will diversification eliminate one or both? Explain.

Question 48

What does "random walk" mean? According to the efficient markets hypothesis,should stock prices follow a random walk?

Question 49

If a friend tells you that he is certain a stock price will rise based on information he heard on television or saw on the Internet,should you be skeptical? Explain.

Question 50

What is meant by an asset bubble?

Question 51

Scenario 27-2
Suppose Dave has a utility function where W is his wealth in millions of dollars and U is the utility he obtains.
Refer to Scenario 27-2.Suppose Dave is faced with a choice between two options.With option A Dave receives a guaranteed $2 million.With option B Dave faces a lottery that pays $0 with probability 0.8 and pays $10 million with probability 0.2.Given Dave's utility function,will he prefer option A or option B? Provide evidence to support your answer.

Question 52

As the interest rate increases,what happens to the present value of a future payment? Explain why changes in the interest rate will lead to changes in the quantity of loanable funds demanded and investment spending.

Question 53

Draw graphs showing the following three relationships.
1.The relation between utility and wealth for a risk averse consumer.
2.The relation between standard deviation and the number of stocks in a portfolio.
3.The relation between return and risk.

Question 54

Suppose the Johnson Corporation releases an earnings report that beats the market's expectations.What does the efficient markets hypothesis predict will happen to Johnson's stock price.

Question 55

Give two conditions that are important to the efficient market theory.List one implication of the efficient market theory.

Question 56

Why might someone be willing to pay more than the fundamental value for a stock?

Question 57

Suppose the McCormick Corporation releases an earnings report that fails to meet the market's expectations.What does the efficient markets hypothesis predict will happen to McCormick's stock price?

Question 58

Write the rule of 70.Suppose that your great-great-grandmother put $50 in a savings account 100 years ago and the account is now worth $1,600.Use the rule of 70 to determine about what interest rate she earned.

Question 59

According to the efficient markets hypothesis,what changes the price of a share of a corporation's stock? Make up an example.