Exam 10: Asset Markets

You buy a painting for $1,280. Its market value will rise by $80 per year for the next 30 years. It is worth $80 a year to you to have it hanging on the wall. The interest rate is 10%. In how many years will you sell it?

A consumer who can borrow and lend at the same interest rate should prefer an endowment with a higher present value to an endowment with a lower present value, no matter how he plans to allocate consumption over the course of his life.

A large (subterranean) pool of oil lies in a remote region of Ohio. Oil companies have explored this region and know how much oil there is. They have purchased the rights to drill and extract oil when they wish to do so. Because of the extremely forbidding geography and the savagery of the natives, the companies have decided to postpone extraction until the price of oil is higher. The theory of intertemporal arbitrage predicts that

If the interest rate is 17%, and will remain 17% forever, how much would a rational investor be willing to pay for an asset that will pay him 7,020 dollars 1 year from now, 1,368 dollars 2 years from now, and nothing at any other time?

Today is January 1. The interest rate is 8% and investors are convinced that it will stay at 8% for the next 10 years. A corporate bond comes on the market that for the next 7 years will pay $160 on December 31 to whoever owns the bond on that date. On January 1, 7 years from today, the issuer of the bond will redeem the bond by buying it back from the bondholder for $2,000. What should this bond sell for?

The interest rate is 10% and is expected to stay constant at that level forever. The present discounted value of $50,000 a year forever starting today is

A zero coupon bond is a bond that pays no return until it comes due and then pays the holder of the bond its face value. Suppose that a $4,000 zero coupon bond will come due on January 1, 2020. If the interest rate is 5% and will remain 5% forever, what will this bond be worth on January 1, 2005?

The interest rate is 10% and will remain so forever. You do not drink wine but are interested in buying some for investment purposes. Assume that there are no transactions costs or storage costs and that a certain bottle of wine will be worth $55 one year from now, $58 two years from now, and $64 three years from now. After that it turns to worthless vinegar. How much should you be willing to pay for a bottle? (Pick the closest answer.)

A certain wine costs $3 a bottle to produce. It improves in taste if stored properly for a period of time. When it is newly bottled, people are willing to pay only $2 a bottle to drink it. But the amount that people are willing to pay to drink a bottle of this wine will rise by $3 a year for the next 50 years. Storage costs, not including interest, are $.50 per year. If the interest rate is 5% and the wine is kept by rational investors, how old will it be when it is drunk and what will be its price at that time?

Ashley, from your workbook, has discovered another wine, wine D. Wine drinkers are willing to pay 40 dollars to drink it right now. The amount that wine drinkers are willing to pay will rise by 20 dollars each year that the wine ages. The interest rate is 10%. How much would Ashley be willing to pay for the wine if he buys it as an investment? (Pick the closest answer.)

According to a recent story in the New York Times, the South African gold strike has been costing South African mining companies about $7.5 million per day. Assuming that this number is the value of the gold that was not mined because of the strike, minus the labor costs (and other operating costs) that are saved by shutting down the mines, what is wrong with this calculation?

If the rate of inflation is greater than the interest rate,

In a perfect asset market, it is known with certainty that an asset will sell for $24 in one year. If the annual interest rate is 10%, then the asset will sell for $26.40 right now.

Ashley, from your workbook, has discovered another wine, wine D. Wine drinkers are willing to pay 45 dollars to drink it right now. The amount that wine drinkers are willing to pay will rise by 15 dollars each year that the wine ages. The interest rate is 10%. How much would Ashley be willing to pay for the wine if he buys it as an investment? (Pick the closest answer.)

The sum of the terms of the infinite geometric series 1, 0.86, 0.86², 0.86³, . . . , is closest to which of the following numbers?

Bank 1 offers a deal on deposits of $1,000 or more. You must leave your money in the bank for three years, but bank 1 will pay you 8% interest for the first year, 8% interest for the second year, and 7% interest for the third year. In response, bank 2 offers a deal that it claims is even better. It also requires you to deposit at least $1,000 and to leave it in the bank for three years, but it will pay 12% interest in the first year and then 8% in the second and third year. After three years, you can take your money out of either bank and do what you want with it. Both banks compound interest annually.

The interest rate is 10% and will remain so forever. You do not drink wine but are interested in buying some for investment purposes. Assume that there are no transactions costs or storage costs and that a certain bottle of wine will be worth $44 one year from now, $51 two years from now, and $55 three years from now. After that it turns to worthless vinegar. How much should you be willing to pay for a bottle? (Pick the closest answer.)

If the interest rate is 10%, then an asset that returns $1 a year forever is worth .

The interest rate is 10% and will remain 10% forever. Suppose that you do not drink wine but are interested in buying it for investment purposes. How much would you be willing to pay for each of the following? a. A bottle of wine that will be worth $22 a year from now and will then go bad and be worthless. b. A bottle of wine that will be worth $22 a year from now and will rise in value by $1 a year forever? Explain your answer.

Art Dreck's paintings are terribly unpopular now. In fact nobody would pay a dime to have one of his paintings on the wall now. But experts believe that 10 years from now, there will be a craze for Dreck paintings. The craze will last for 2 years and then nobody will ever want to see a Dreck again. During this 2-year period, people will be willing to pay $1,100 a year to have an original Dreck on the wall. The interest rate is r. If the experts' belief is widely held among investors, today's market value of Dreck should be about