Exam 10: Asset Markets

The interest rate is 10%. A certain piece of land can be used for a parking lot, in which case there are no construction costs and it will yield a net return of $5,000 per year forever starting one year from now. Or it can have a house built on it. Building a house would cost $50,000 now. If a house is built on the lot, it will yield a stream of net income equal to $12,000 per year starting one year from now. No other uses are contemplated. The theory of asset markets predicts that the lot will sell for

If the interest rate is r and will remain r forever, then a bond that will pay 95 dollars a year forever, starting one year from now, is worth how much today?

According to the theory of asset markets, if the interest rate is constant, then the competitive market price of a bottle of wine will rise at a constant rate per year until it is consumed, even if the amount that wine drinkers are willing to pay for it does not rise at a constant rate.

The price of an antique is expected to rise by 8% during the next year. The interest rate is 12%. You are thinking of buying an antique and selling it a year from now. You would be willing to pay a total of 800 dollars for the pleasure of owning the antique for a year. How much would you be willing to pay to buy this antique?

If everybody has the same information, then a well-functioning market for assets would, in equilibrium, leave no opportunities for arbitrage.

A bond has a face value of 7,000 dollars. It will pay 700 dollars in interest at the end of every year for the next 50 years. At the time of the last interest payment, 50 years from now, the company that issued the bond will redeem the bond at face value. That is, the company will buy back the bond from its owner at a price equal to the face value of the bond. If the interest rate is 10% and is expected to remain at 10%, how much would a rational investor pay for this bond right now?

A bond has a face value of 5,000 dollars. It will pay 500 dollars in interest at the end of every year for the next 45 years. At the time of the last interest payment, 45 years from now, the company that issued the bond will redeem the bond at face value. That is, the company will buy back the bond from its owner at a price equal to the face value of the bond. If the interest rate is 10% and is expected to remain at 10%, how much would a rational investor pay for this bond right now?

The sum of the terms of the infinite geometric series 1, 0.85, 0.85², 0.85³, . . . , is closest to which of the following numbers?

If the interest rate is 18%, and will remain 18% forever, how much would a rational investor be willing to pay for an asset that will pay him 9,440 dollars 1 year from now, 1,392 dollars 2 years from now, and nothing at any other time?

The interest rate is 10% and there is no inflation. A bond is available that can be redeemed either after one year or after two years. If it is redeemed after one year, the investor gets $110. If it is redeemed after two years, the investor gets $117.70. The investor gets no other payments than what she receives when she redeems the bond. In equilibrium, investors will be willing to pay more than $100 for this bond.

Vincent Smudge's paintings are unappreciated now. Nobody is willing to pay anything to have them on the walls. In 5 years Smudge's work will gain enduring popularity. People will suddenly be willing to pay $1,000 a year to have an original Smudge on their walls and will continue to be willing to do so ever after. If investors realize that this is the case and if the interest rate is and always will be r, a painting by Smudge will currently be worth about

The price of an antique is expected to rise by 4% during the next year. The interest rate is 6%. You are thinking of buying an antique and selling it a year from now. You would be willing to pay a total of 400 dollars for the pleasure of owning the antique for a year. How much would you be willing to pay to buy this antique?

If the nominal interest rate is 80% and the rate of inflation is 50%, then the exact real rate of interest is

Suppose that the cost of cutting down a tree is zero and the tree grows on land that is useless for anything else, that the interest rate is constant, and that the price of lumber does not change. The optimal time to cut the tree is when the difference between its growth rate and the interest rate is maximized.

The interest rate will be 10% for one more year, but a year from now, it will fall to 5% and stay at 5% forever. What is the market value of an investment that is sure to pay $440 a year forever, starting two years from today?

Suppose that a dispute in the Persian Gulf halts the sale of oil from the Persian Gulf for one year. At the same time an important new oil field is found in a place where nobody expected there to be oil. What does economic theory predict will be the effect on the future price of oil to be delivered two years from now?

The interest rate is 9% and there is no inflation. A bond is available that can be redeemed either after one year or after two years. If it is redeemed after one year, the investor gets $109. If it is redeemed after two years, the investor gets $115.54. The investor gets no other payments than what she receives when she redeems the bond. In equilibrium, investors will be willing to pay more than $100 for this bond.

The interest rate will be 10% for one more year, but a year from now, it will fall to 5% and stay at 5% forever. What is the market value of an investment that is sure to pay $220 a year forever, starting two years from today?

The amount people are willing to pay to drink a bottle of a certain vintage of wine when it is t years old is $2 + 3t. It costs $.50 a bottle per year to store this wine. The interest rate is 5%. If the annual cost of storing the wine rises to $1, what will be the effect on the price of this wine when it is consumed and on the length of time for which it is stored before it is consumed?

If the interest rate is r and will remain r forever, then a bond that will pay 75 dollars a year forever, starting one year from now, is worth how much today?