Question 1

Explain why the Fisher equation is not highly accurate at high rates of inflation. Use an example.

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Question 2

Suppose you negotiate a one-year loan with a principal of $1000 and the nominal interest rate is currently 7%. You expect the inflation rate to be 3% over the next year. When you repay the principal plus interest at the end of the year, the actual inflation rate is 2.5%. Compute the ex ante and ex post real interest rate. Who benefits from this unexpected decrease in inflation? Who loses?

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Question 3

In the data, we observe that countries with high inflation rates tend to have high nominal interest rates. What does this imply, if anything, about real interest rates in countries with very high inflation rates?

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Question 4

If a borrower and a lender agree on a long-term loan at a nominal interest rate that is fixed over the duration of the loan, how will a higher-than-expected rate of inflation impact the parties if at all?

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Question 5

An individual is currently 30 years old, wants to work until the age of 65 and plans on dying at the age of 85. How much will the individual need to have saved by the time he or she is
65 if he or she plans on spending $40,000 per year while retired? You can assume the individual can earn an interest rate of 5.0% and the $40,000 is in addition to any Social Security that may be received.

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Question 6

Discussions in recent years about the vulnerability of the Social Security System cause some people to feel the payments promised will not materialize. Discuss the possible changes we might observe now.

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Question 7

Historically, many cultural groups have outlawed usury, or the practice of levying interest on loans. Some groups oppose usury because it exacerbates problems of income inequality (as wealthier individuals can afford to lend to poorer individuals), while others claim investment and loans should be made charitably. Evaluate these arguments against usury based on your knowledge of present value. Do such prohibitions make sense?

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Question 8

How might the behavior of professional investment managers prior to the financial crisis of
2007-2009 contributed to the depth of the plunge of corporate and mortgage security prices during the crisis?

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Question 9

Explain why, if real interest rates are so important, we see most interest rates quoted in nominal terms.

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Question 10

Explain why countries with high and volatile inflation rates are likely to have volatile nominal interest rates.

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Question 11

During the early 1980s, the U.S. economy experienced an increase in interest rates quoted on U.S. Treasury debt, business loans, and mortgages. At the same time the inflation rate gradually declined more than expected. What happened to ex ante versus ex post real interest rates during this period? Use the Fisher equation to support your answer.

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Question 12

Explain why countries that have volatile inflation rates are likely to have high nominal interest rates.

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Question 13

How has Islamic banking redefined lending to deal with Islam's prohibition of usury?

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Question 14

Explain why an investor cannot simply compare the size of promised payments from different investments, even if the interest rates and other risk factors are the same.

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Question 15

Suppose a two-year coupon bond has payments of $40 and a face value of $800. The interest rate is 8%. Compute the present value of the coupon payments and the principal payment of the bond. What is the price of this bond?

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Question 16

A bond offers a $40 coupon, has a face value of $1,000, and 10 years to maturity. If the interest rate is 5.0%, what is the value of this bond?

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Question 17

Explain the suggestion that people may have their own "personal discount rate" and how that may affect decisions about borrowing and other financial matters.

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Question 18

Explain why an increase in expected inflation will result in an increase in nominal interest rates, holding other factors constant.

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Quiz 4: Future Value, Present Value and Interest Rates