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NAME: ___________________________ (as it appears on your Ryerson ID)

FIRST NAME: ___________________________

STUDENT #: ____________________________

ECN506 Assignment
F2016
Due Monday, Oct. 17th , 3pm

Note: This is a hard deadline. No exceptions, whatsoever

Hand in options:
1) In class in advance of due date.
2) In Economics drop box on second floor of JOR, with this cover page
3) No late hand-ins accepted. No exceptions.

Circle your section:

You lose 20% automatically if you dont circle your section

WED (002)

THURS (001)

Note: This assignment is being marked on: Neatness,

Orderliness, Correct-ness, Completeness and Succinct-ness.

Note: Keep a copy for yourself because you wont get this back
in time for the midterm!

Note: No (photo- or identical) copies accepted. Do your own
work!!

Q#1: (Chapter 3)

You purchase a 20-year bond in the primary market with a 5% YTM, annual coupon
payments and $1000 face value. Immediately before the 5th payment you need to
sell the bond and the competitive market rate has risen to 9%.

a) Draw the cash flow diagram for the bond. Indicate where the new buyer
enters the problem





b) What does the bond sell for?





c) What is the new YTM of the bond? Explain.




d) What is the rate of return for the seller? (write out the problem/equation you
intend to solve and hazard an approximate guess here. Its sufficient to say:
between x% and x+1%, for example: between 10% and 11%. By the way,
thats not the answer.)

Q#2: Two Period Consumption-Savings Model

Y1 = 80,000
Y2 = 50,000
r = 25%
a) Carefully draw the inter-temporal budget constraint. Fully label the axes, both
intercepts and all points of interest. Label the budget constraint BC0.
Suppose Y1 increases by 20k. Repeat the above on the same graph. Label this one
BC1. (I want BC0 and BC1 with all relevant points clearly labelled). Completeness
matters here! Do not make the graph so small that it is difficult to read/mark!

b) Now Y1 is 80k again and instead suppose Y2 increases by 20k. Repeat the
exercise on the same graph as BC0. Label this one BC2.
Here I want you to show BC0, BC1, and BC2, all relevant points (for example you
will want to point out the points: No,No1 , No,No2, and No,No3)

c) Back to the original problem: Suppose the borrowing rate is 30% and the savings
rate is 20%. Draw this Budget Constraint (labeling everything, etc.). The individual
is a perfect consumption smoother (C1 = C2). How much does this person save?
Point out the consumption point on the graph, calling it A. What do you think
would happen to savings, S1, as the spread between the borrowing and savings rates
increases?

S1 = _________________________________

d) Back to the original problem and the borrowing and savings rates are identical,
r=25%. Retirement and health care costs just got more expensive so the individual
consumes twice as much in period 2 as in period 1 (C2 = 2C1). Find their
consumption point labeling it A.
Note: You do not need Indifference Curves here, so if you do draw them, you should
make sure you are drawing the correct ones!
Show what happens when the real interest rate falls to 10%. Draw what happens to
the curve. You dont need to calculate the new intercepts, but you do need to find the
new consumption point. Label it C.
What is:

S0LD (r=25%) = ________________;

SNEW (r=10%) = ________________;

The person is ________________. (better off or worse off)

Q#3: Consumption-Savings Model

a) Draw the following graph below: An inter-temporal Budget Constraint on
(C1, C2). Make the BC relatively steep (around a 60-degree slope). Have the
individual chose a consumption bundle that is situated near the center of the
BC. The no borrowing-no lending point should be to the upper left (around
midway to the axis) of the consumption point. Justify the consumption choice
(c1, c2) by drawing a smooth, well-rounded, convex-to-the-origin indifference
curve.
Mark the consumption point A. Point out the consumption levels (c1, c2)
and income levels (y1, y2) on each axes. Point out where the savings level can
be found on the graph.

The person is a _______________________ (borrower/saver)

b) Here we will decompose the effects of an decrease in the real rate into two
separate effects: the income effect and substitution effect.
Draw the graph again, but this time also show what happens when the real
rate falls. You should consider drawing the new BC in such a way that there is
room to do the analysis described above. Label the original BC as BC0 and the
new BC as BCN. Draw a fake BC using a dashed line, label it BCFAKE. It should
be parallel to BCN (show this using parallel markings) but tangent to the IC
curve from part a).
Show where the original consumption point A is. Label the intermediate
consumption point B. Use arrows to mark the SE on C1 and C2, showing how
theyve changed.

Is the individual better off, yes or no? Explain why or why not (be succinct):

________________________________________________________________________________________

Mark up or down arrows in the spaces below:

C1 ________
C2 _________
S ___________

c) To finish the decomposition, Draw the graph from part b) again but now
point out the final consumption point C. This time, in addition to pointing out
the SE, also point out the IE similarly using arrows.

Below fill in the spaces with one of the words: increases, decreases or
indeterminate. Note, these refer to the general case and NOT how youve
drawn them!!!

From A to B: c1 _______________ , S _________________, and c2 __________________.

From B to C: c1 _______________ , S _________________, and c2 __________________.

From A to C: c1 _______________ , S __________________, and c2 __________________.

Below show the savings curve on (S,r) suggested by the analysis above.

d) Below show how a decrease in the real rate affects a saver. Be complete,
indicating all the information described above in one clear, carefully drawn
graph. You should show BC0, BCN, and BCFAKE, consumption points A,B and C,
the No-No point, and the SE and IE (using labeled arrows). The original BC
should be at relatively steep like in part (a), and consumption point C should
be located in the middle of the BC, and justified by a similar IC.
Below show the Savings curve suggested by your analysis. Show the Savings
curve over the range of preferences where SE>IE, and also over the range of
preferences where IE>SE (in terms of the shape of the curve).

Below fill in the spaces with one of the words: increases, decreases or
indeterminate. Note, these refer to the general case and NOT how youve
drawn them!!!

From A to B: c1 _______________ , S _________________, and c2 __________________.

From B to C: c1 _______________ , S _________________, and c2 __________________.

From A to C: c1 _______________ , S __________________, and c2 __________________.

Q#4: Savings and Investment in Differing Economies.

a) Closed Economy: S = 660 + 2000r and I = 1500 5000r. Find the equilibrium
real interest rate that clears the market, and equilibrium levels of Savings
and Investment. Show in a fully labeled graph.

b) Small Open Economy: Consider the equations given above as SWORLD and
IWorld, whereas SCanada = 90 + 250r and ICanada = 400 2500r.

Find the following equilibrium values:

SWORLD = ______________

SCanada = ______________

IWorld = _______________

ICanada = _______________

rWORLD = _______________

rCANADA = _____________

NCOCanada = ______________

Show the information graphically below. Care and completeness matter here (as
usual)

c) Graphically show the case of two large open economies, U.S. and China,
where China is a NFL and the U.S. is a NFB. Point out the levels of Savings and
Investment in each country, the equilibrium real interest rate and indicate
the NFL and NFB in each country. Draw this scenario twice, one on top and
once below.
On top: show the effects of a large government program of infrastructure
spending in the U.S., concentrating on the government spending side of the
story. Show what happens to the levels of NFL, NFB, and r*.
Below: Show the effects of a large government program of infrastructure
spending in China concentrating on the effects on Investment Demand in
China. Show what happens to the levels of NFL, NFB, and r*.