1. The following figure depicts the financial situation of Ms. J. Morris. In period 0, her labour income and current consumption are $40. Later, in period 1, her labour income and current consumption will be $33.30. She has an opportunity to make the investment represented by point D. By borrowing and lending, she will be able to reach any point along the line EDF.

(a) [1] What is the market rate of interest? Hint: The new market interest rate line EF is parallel to AH.

(b) [1] What is the NPV of point D?

(c) [1] If Ms. Morris wishes to consume twice as much in period 1 as compared to period 0 with the new investment, how much should she consume in period 0?

(d) [2] If Ms. Morris wishes to consume twice as much in period 1 as compared to period 0 with the new investment, should she borrow or lend in period 0? By how much?

Note:

C lies on the line AH.

D lies on the line EF.

The coordinates of point A are (70, 0).

The coordinates of point B are (40, 0).

The coordinates of point C are (40, 33.30).

The x-coordinate of point D is 40.

The coordinates of point E are (95, 0).

Period 1 (S) 33.30 40 70 95 Period 0 (S)