Congratulation! You are the winning entry in the OSC Sweepstakes. As the lucky winner you receive the opportunity to receive one of the following three prize packages:

1. A $25,000 lump sum payment today;
2. A $4,000 payment today and a $22,500 payment one year from now;
3. A $9,000 payment at the end of this year and a $20,000 payment at the end of the next year.

You may assume that all payments are quoted in after-tax dollars.

1. If the interest rate is 7% and inflation is expected to be zero over the next two years, which of the above three options would you choose?

(12 marks)

2. If the interest rate is actually 10%, which option would you choose? Would your choice be different than the choice you made in part a?

(13 marks)

QUESTION 2

Suppose that a profit-sharing plan has invested a substantial portion of your savings in your employers bonds. A news story reports that your employers auditor is issuing a qualified report because of the use of questionable accounting practices.

1. Will the risk premium on your employers bonds increase or decrease? Why?

(12 marks)

2. What will happen to the market value of your investment in your employers bonds?

(13 marks)

QUESTION 3

Suppose that you are the credit manager for a small clothing manufacturer. You main responsibility is deciding to whom your company should extend credit. Respond to the following question.

1. Dulls Department Store, Inc., is a large publicly traded corporation that issues commercial paper. How can you inexpensively access its creditworthiness?

(12 marks)

2. Will the strategy in a. work as well if markets are inefficient? (13 marks)

Question 4

1. The Fed decides to increase the money supply. What would be the appropriate open market operation?

(9 marks)

2. Assumptions: (1) The initial open market operation increases reserves by $100; (2) the required reserve ration is 0.20; (3) no currency is held by the nonbank public; (4) no excess reserves are held by banks. Fill in the Table 1 below for deposit expansion.

(16 marks)

Table 1: Deposit Expansion

Step	Total Money Created	Money Created	Excess Reserves	Required Reserves
1
2
3
4
-	-	-	-	-
-	-	-	-	-
-	-	-	-	-
-	500	0	0	100

(16 marks)