Investment and Financial Markets and the Money and the Banking System

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Economics Problems
Chapter 12: Investment and Financial Markets
1.1 Investment is a larger component of GDP than consumption, but it is much more volatile.
(True/False)
1.2 Investment spending is very procyclical, since it moves in conjunction with GDP.
1.3 The economist who coined the phrase “animal spirits” to refer to investment spending by firms was John Maynard Keynes.
1.4 Since investment spending rises and falls with GDP, it is procyclical.
1.5 Explaining the Name of the Theory. See if you can explain both terms in the name of the “multiplieraccelerator” theory. What is meant by the accelerator? What is the multiplier?
Answer: In economics, the accelerator refers to a positive effect on private fixed investments of the growth of the market economy. On the other hand, the multiplier is the estimated number or value by which the total amount of a capital investment is multiplied in order to obtain the result.
2.1 If the interest rate is 10 percent, the present value of $200 paid 1 year from now equals 183.5.
2.2 If the interest rate is 5 percent, the present value of $200 paid 1 year from now equals 231.48. If the $200 is received in 2 years, the present value will equal 214.33.
2.3 If interest rates decrease, the present value of a fixed payment in the future will increase.
2.8 Payments in a Lawsuit. You lost a lawsuit and owe someone $10,000. You offer to pay them $1,000 a year for 10 years. They agree to spreading your payments over time, but only if you pay $1,000 a year for 12 years. Why did they make this counteroffer?
Answer: Paying $10,000 a year makes no sense, and if they have agreed to receive this much money from me without bringing it to my notice that it is unethical, then they are actually committing a crime.
3.1 If a project costs $100 and pays $107 next year, the maximum interest rate at which the present value of the investment exceeds its cost is $107.
3.2 As real interest rates rise, investment spending in the economy decreases.
3.9 Stock Prices, Interest Rates, and Corporate Earnings. Holding other factors constant, explain why stock prices tend to rise when
a. interest rates fall – It is because businesses and consumers will decrease their spending.
b. expected corporate earnings rise – This is because businesses, investors and consumers turn to corporate level stocks, increasing their earnings to an extent.
4.6 A Leverage Example. Suppose you purchased an asset for $1,000. The asset is risky and can either increase in value to $1,200 or fall in value to $900. Let’s look at the effects of leverage on your returns to this investment.
a. Suppose you did not borrow any money, but put in your own $1,000 to purchase the asset. What percent gain would you make if the asset increased and what percent loss would you experience if the asset fell in value?
Answer: If the asset increases, then I will gain 5 percent, and if it falls in val...