Question

Chapter Four: Q4: Assume you just deposited $1,250 into a bank account. The current real interest rate is 1% and the inflation is expected to be 5% over the next year. What nominal rate would you require from the bank over the next year? How Much money will you have at the end of one year? If you are saving to buy a fancy bicycle that currently sells for $1,300, will you have enough money to buy it? Chapter Five: Q5: In the after man of the global economic crisis that started to take hold in 2008, US Government budget deficits increased dramatically, yet interest rate on US Treasury debt fell sharply and stayed low for quite some time. Does this make sense? Why or why not? Chapter Six: Q6: Suppose the interest rates on one, five and ten year US Treasury bonds are currently 3%, 6% and 6% respectively. Investor A chooses to hold only one year bonds and Investor B is indifferent with regard to holding 5 and 10 year bonds. How can you explain the behavior of Investors A and B? Chapter Seven: Q7: Suppose the increase in the money supply lead to a rise in stock prices. Does this mean that when you see that the money supply has sharply increased in the past week, you should go out and buy stocks? Why or why not?

Answer 1

Answer 4

Real interest rate = 1%, Inflation rate = 5%

Nominal rate = real interest rate + inflation rate = 1% + 5% = 6%

Amount to be deposited = 1250

Using nominal rate of interest, amount at end of one year = Amount deposited * nominal rate of interest

=1250*1.06 = 1325

If we account for inflation in the cost of cycle :

Cost of cycle at present = 1300.

Cost of cycle after one year = cost of cycle * inflation = 1300*1.05 = 1365

Amount of savings after one year = 1325

So you will be short by 1365-1325 = $40 for buying the cycle.

If we consider the cost of cycle to remain at current price:

cost of cycle = 1300 , savings = 1325

In this case, you are in a situation to buy the cycle.

Hope this helps!!

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