1. Suppose a family member approaches you to borrow $2,000 for the down payment on an automobile. You have the cash available in a savings account that currently earns 5% annual interest. You and the family member consider the following repayment options:

(i) Borrower repays you $100 each year indefinitely. (ii) Borrower repays $259 each year over the next ten years (iii) Borrower repays $300 each year over the next five years, plus a lump-sum payment of $895 in the fifth year. (iv) Borrower repays you $2,100 at the end of one year. 1) Relate each of the options above to four types of bonds, indicating which option is equivalent to which type of bond. 2) For each of the options above, show that the present values of each option are approximately equal.

2. In each situation given, explain what happens to bond prices and interest rates and why. a) Expected inflation increases. b) The return on bonds rises relative to other assets. c) The federal government deficit increases.