Module 7: Savings and Investment

1. For each of the following pairs, which bond would you expect to pay a higher interest rate? Explain.

A. A bond the U.S. government or a bond of an Eastern European government.

B. A bond that repays the principal in year 2023 or a bond that repays the principal in year 2043

C. A bond from Coca-Cola or a bond from a software company you run in your garage

D. A bond issued by the federal government or a bond issued by New York State

2. Ralph purchases a newly-issued, two year government bond with a principal amount of $10,000 and a coupon rate of 7% paid annually.

a. What is the annual coupon payment that Ralph should receive after year one?

b. What is the payment that Ralph should expect to receive after year two (after the bond matures?

3. What are the two main sources firms use to raise external funds? Explain the differences.

4. Discuss the relationship between interest rate offered on a bond and the credit rating of the firm offering the bond.

5. What is national saving? What is private saving? What is public savings? How are these three variables related?

6. Describe a change in tax code that might increase private saving. If this policy were implemented, how would it affect the market for loanable funds?

7. Suppose GDP is $8 trillion, taxes are $1.5 trillion, private saving is $0.5 trillion, and public saving is $0.2 trillion. Assuming this economy is closed, calculate consumption, government purchases, national savings, and investment.

8. This module explains that investment can be increased both by reducing taxes on private saving and by reducing the government budget deficit.

a. Why is it difficult to implement both of these policies at the same time?

b. What would you need to know about private saving to determine which of these two policies would be the more effective way to raise investment?