EC223OC - PRACTICE MIDTERM FALL 2023 - SA SOLUTIONS

EC223OC – PRACTICE MIDTERM FALL 2023 – SHORT ANSWERS SOLUTIONS Short Answer Questions Question 31 Calculate the fixed payment on a $100 000 loan with an annual interest rate of 5 percent and 15 years to maturity. (Show your work) (5 marks) Answer: LV = FP i ( 1 − 1 ( 1 + i ) n ) ❑ 100000 = FP 0.05 ( 1 − 1 ( 1 + .05 ) 15 ) ❑ 100000 = FP 0.05 ( 1 − 1 2.078928179 ) ❑ 100000 = FP 0.05 ( 1 − 0.481017098 ) ❑ 100000 = FP 0.05 ( 0.518982902 ) ❑ 100000 0 . 518982902 ¿ FP 0 . 05 ❑ 192684 . 58 = FP 0 . 05 ❑ 0.05 ( 192684.58 ) = FP ❑ FP = 9634.23 Note – this formula will be on the formula sheet Question 32 a) Everything else held constant, would an increase in the volatility of stock prices have any impact on the demand for rare coins? Why? or why not? (3 marks) 1

EC223OC – PRACTICE MIDTERM FALL 2023 – SHORT ANSWERS SOLUTIONS Yes, an increase in the volatility of stock prices would cause the demand for rare coins to increase. When stock prices become more volatile, this means there is more risk in owning stock than there is previously and so the demand for alternative assets such as rare coins increases. b) How would the impact on the demand for rare coins be illustrated graphically? (2 marks) The demand curve for rare coins will shift to the right. See E-text Chapter 5 pages 93-97 ‘Changes in Equilibrium Interest Rates’ 2

EC223OC – PRACTICE MIDTERM FALL 2023 – SHORT ANSWERS SOLUTIONS Question 34 (5 marks) i) Define electronic money (e-money) (1 mark) ii) What was the first form of e-money? (1 mark) iii) What is a more advanced form of e-money? (1 mark) iv) Define a smart card (1 mark) v) Define e-cash (1 mark) See e-text Pages 52-54 Evolution of the Payments System See discussion on E-Money 4

EC223OC – PRACTICE MIDTERM FALL 2023 – SHORT ANSWERS SOLUTIONS Question 35 You are presented with two alternatives: i) You can buy a three-year bond with a yield to maturity of 7% ii) You can buy a one-year bond with a yield to maturity of 6%, then purchase another one-year bond with a yield to maturity of 7%, and when the second bond matures, purchase another one-year bond with a yield to maturity of 8%. Based on the above information: a) What is your expected annual rate of return for the first strategy? (1 mark) 7% b) What is your expected annual rate of return for the second strategy? (1 mark) (6% + 7% + 8%)/3 = 7% c) What can you say about the expected return in part a) and b)? (1 marks) The expected returns are the same d) If the liquidity premium theory of the term structure of interest rates is correct, which one of those choices would you pick? Why? (2 marks) The three one-year bonds are preferred. Other things the same, people prefer short-term securities. Thus, people require a liquidity premium (a higher interest rate) to be induced to hold longer-term bonds, and this three- year bond does not pay a liquidity premium 5