EC 232 Exam 2 - Questions and Answers

EC 232 Exam 2 - Questions and Answers S/B? Nissan wants to expand its current operations to a new country. It chooses to finance its expansion through equity financing. Stocks S/B? Roberta purchased a financial asset that gives her partial ownership of a company Stocks S/B? Mars Inc. wants to build a new factory but does that have the cash on hand to pay for it. it chooses to finance its new factory through debt financing Bonds S/B? Raymundo owns a financial asset that he purchased from his local government and it matures in five years Bonds A claim to ownership of part of firm Stock A legal obligation to repay a debt at a specified date in the future Bond Failure to repay a debt Default A group of investments packaged together and sold as one investment opportunity Mutual Fund Profits distributed to a firms owners Dividend The length of time that elapses before a bond matures Term The likelihood that the borrower will repay the lender according to the agreement explained by the bond credit risk The manner in which income earned from a bond is subject to taxation tax treatment Bonds with higher interest rates tend to - be issued by organizations that are less likely to default - be safer financial assets than bonds with lower interest rates - have a higher credit risk than bonds with lower interest rates - have a lower credit risk than bonds with lower interest rates When a nation has a close economy like this (consumption spending of 5134, investment spending of 356, and GDP of 12555) what variable is not relevant in the national income identity equation? - consumption - government purchases - net exports -GDP Nation with a closed economy has a consumption spending of 5134, investment spending of 356, and GDP of 12555. What do government purchases equal? 7065 In a closed economy, how are investment and national saving related? They are equal Using the public savings equation, calculate public savings when tax revenue that the government received is 15.5 billion and government spending on goods and services is 10.5 billion. Based on the above calculation, in terms of public savings, we find that the government is running: 5 billion a surplus National savings is calculated as (in a closed economy): S= (Y-T-C)+(T-G) National saving identity, private savings is: (Y-T-C) Based on national saving identity, public saving is: (T-G) Compound interest rate FV= PV x (1+R)^n Suppose you have 11,000 to invest in a mutual fund that offers a yearly return of 7%. How many years would it take to reach 1,000,000? 67 You have 10,000 to invest: rank in terms of diversification 1. 10,000 in one stock 2. 10,000 in a mutual fund 3. 3400 in MF, 3300 in Bonds, 3300 in land purchases 4. 5000 in one stock and 5000 in another stock 3, 2, 4, 1 People who might need to retrieve part or all of their investment relatively soon (such as the elderly) are often advised to invest a higher percentage of their money in bonds, and thus a lower percentage in stocks, than are people who can leave the investment untouched for decades. We know, however, that bonds typically have a lower rate of return than do stocks. Why would these people be advised to invest in assets that give lower rates of return (on average) than do other assets? While stocks have a higher rate of return in the long run, they are much more volatile (riskier) in the short run. As such, they have a higher probability of having less than the original value of the investment for people who might need to withdraw the investment in the short run. In the stock market, there are buyers and sellers. One stock market hypothesis relates to how an investor cannot earn returns that outperform the overall stock market if they only have public stock market information. Which of these options best represents this concept? Efficient Market Hypothesis The labor force is comprised of; the number of people who are counted as employed and unemployed Unemployment caused by recessions cyclical unemployment Unemployment that normally occurs due to turnover as workers switch jobs frictional unemployment The unemployment that still exists when the economy is operating at its full potential natural unemployment Describe the theory of efficiency wages firms may pay wages above what the market dictates in order to increase worker productivity Closed economy equation y = c+i+g (NO IM OR EX) The total income in the economy that remains after paying for consumption and government purchases y-c-g What is substituted for national savings? S What is equal in the closed economy? s = I or savings equals investment What denotes private savings? y -t-c What denotes public savings? t –g Why is y-t-c the private savings? y = income, t = taxes, c = consumption Why is t -g public savings? the amount of tax revenue the government has left after paying for its spending. t = taxes, g = goods and services tG Budget surplus tg budget deficit What is the entirety of the national savings equation? s = (y-t-c) + (t-g) What is the role of the financial system? Name and describe two markets that are part of the financial system in the U.S. economy. Name and describe two financial intermediaries The role of the financial system is that it moves the economy's scarce resources from savers to borrowers. Markets 1. Bond Market-Financial Asset, Fixed periodic payment to bond holders, redemption payment when the bond matures 2. Stock Market- partial ownership of a firm, Equity Finance Intermediaries 1. Commercial Banks- accept deposits and make loans 2. Mutual Funds- sells shares to savers and then use these funs to buy a portfolio of stocks and bonds Why is it important for people who own stocks and bonds to diversify their holdings? What type of financial institution makes diversification easier? The main reason why it is important to diversify your stocks and bonds is because of the level of risk. It is way more risky to hold a single kind of stock or bond. However, if you have a diverse portfolio then you have less risk because you only have small stake in each company. Mutual funds are what makes diversification much easier. What is an investment? How is it related to national saving in a closed economy An investment is the purchase of goods that will be used in the future to produce more goods and services. Investment is equal to national saving in a closed economy Which bond would you expect to pay a higher interest rate? US government or bond of an eastern European government? the EE government because its higher and riskier Which bond would you expect to pay a higher interest rate? A bond that repays the principal in year 2020 or a bond that repays the principal in 2040? Explain the bond in 2040 pays a higher interest rate because of the commitment Which bond would you expect to pay a higher interest rate? A bond from cocoa cola or a bond from a software company you run from your garage? Explain a company that is run from your garage Which bond would you expect to pay a higher interest rate? a bond issued by the federal government or a bond issued by NY state? Explain the higher interest rate would be the federal government due to federal tax income. NY would be lower due to municipalities. Many workers hold large amounts of stock issued by the firms at which they work. Why do you suppose companies encourage this behavior? Why might a person not want to hold stock in the company where he works? If I'm investing in a company, I want that company to do well. This motivates the company to be productive and increase the price of the stock. If I work at the company, then I will do my best to be productive and this will cause me to do gain from my investment. If a person works within the company, they may have insider information that the company is not productive. This may cause a worker to not hold stock within the company he works for because he knows they will not be productive. Supposed GDP is 8 trillion, taxes are 1.5, private savings is .5, and public savings is .2. Assuming a closed economy, calculate - consumption - government purchases - national saving - investment private savings = .5 GDP = 8 Taxes = 1.5 public saving = .2 consumption: s = y - t- c. (.5 = 8-1.5-c) 6 government purchases = t-g (.2 = 1.5-g) 1.3 national savings = public + private (.2+.5) = .7 investment = .7 because investment = national savings Economists in Funlandia, a closed economy, have collected the following information about the economy for a particular year: Y = 10,000 C = 6,000 T = 1,500 G = 1,700 The economists also estimate that the investment function is: I = 3,300 - 100r where r is the country's real interest rate, expressed as a percentage. Calculate private saving, public saving, national saving, investment, and the equilibrium real interest rate. private savings= y-t-c = 2500 public savings = t-g = -200 national savings = y-c-g = 2300 real interest rate = S=I 2300= 3300-100 (r) -1000= 100r 10% Suppose that Intel is considering building a new chipmaking factory: assuming that intel needs to borrow money in the bond market, why would an increase I interest rates affect Intel's decision about whether to build the factory? If interest rates increase, the costs of borrowing money to build the factory become higher, so the returns from building the new plant may not be sufficient to cover the costs. Thus, higher interest rates make it less likely that Intel will build the new factory Suppose that Intel is considering building a new chip making factory: if intel has enough of its own funds to finance the new factory without borrowing, would an increase in interest rates still affects intel's decision about whether to build the factory or not?