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During the period when the carried interest is being repaid, Northern Fields will retain 35% of his equity interest in the production from the field and will pay the costs directly associated with this production. f. When the debt has been repaid in full, Northern Fields will be entitled to their full equity interest and Opportunity Company Ltd will have no further claim on Northern Fields. g. Any unpaid carried amount at the end of each year before taking the assigned revenue will attract interest at the rate of 6.5% per annum. A full year's interest is to be paid at the end of the year on the outstanding balance before offsetting the assigned net revenue. By agreement interest charges will start accruing from the end of year two 1 h. Shouldtherevenuesfromthefieldfailtobesufficientfortherepayment of monies paid by Opportunity Company Ltd on behalf of Northern Fields, then Opportunity Company Ltd will have no claim against Northern Fields for any balance that may be outstanding. i. Based on the lifting schedule Northern Fields only lift once in a year and the revenue from the sale of the product is only realized at the end of his financial year which is 31st December j. Northern Fields's bankers have approached him to finance his share of the development and production costs at an annual interest rate of 5.5% for the same 65% revenue to be assigned until the debt is fully paid. k. Northern Fields is expected to pay an arrangement fees at a rate of 0.5% on all facilities up to $ 500 million dollars. Any financing in excess of this amount will attract an arrangement fees of 0.2%. l. Based on the offer from the bankers' arrangement fees payable by Northern Fields on the entire facility will be accrued at the beginning of year one and interest charges would start accruing at the end of year one. m. Interestchargesonthefacilityistobepaidattheendoftheyearonthe outstanding balance after offsetting the assigned net revenue n. Assume all annual development and production cost are to be paid in advance at the beginning of January. o. The following are additional data relating to the field. All figures are in thousands of dollars, except for oil price. Year Capital Operating Expenditure Costs Production Oil Price Mmbbls 40,000 50 42,000 51 47,000 52 50,000 53 51,500 55 1 680,000 2 690,000 3 657,000 4 620,000 5 6 7 8 152,000 185,000 208,000 252,000 249,800 Required: From the following data: 1. Calculate when the carry will have been repaid [13 marks] 2 2. Northern Fields's yearly net cash flow in the period in which the Company was carried and the period after it was carried. [5 marks] 3. AsaFinanceDirectorforNorthernFields,wouldyouadvisehimto opt for the bank financing? What will be the gain or loss if he opts for the bank financing instead of being carried by Opportunity Company Ltd. Demonstrating this by showing the yearly bank financing, repayment amounts and the net cashflows [12 marks] Helpful hint: In the year in which the carry is finally repaid, it is advisable to calculate the profit per barrel (oil price minus the average production cost per barrel) and the divide the amount owing by the profit figure in order to derive the number of barrels needed to repay Opportunity Company Ltd. Once these barrels have been handed over, the carry has been repaid and all other barrels relating to Northern Fields's 30% remains with Northern Fields.

Assume that a consumer with only equity wealth must choose periodby-period consumption in a discrete-time dynamic optimization problem. Specifically, consider the sequence problem: (0) = sup {}=0 0 X =0 exp()() subject to the constraints: +1 = exp(++122)() = +1 ( ) iid and (0 1) [0 ] 0 0 Here represents equity 2 wealth at period and represents consumption at period . The consumer has discount rate and the consumer can only invest in a risky asset with expected return = exp( + 22) = exp() Finally, assume that the consumer has an isoelastic utility function: () = 1 1 , with [0] 6= 1 Note that this utility function has the property of constant relative risk aversion 00() 0 () = This scaling property enables us to analytically solve this problem. The associated Bellman equation for this problem is given by () = sup [0] ( ) + exp()(exp( + 2 2)) The value function takes the special form () = 1 1 We previously showed that the consumption function takes the form, = 1 where, ln(1 1 ) = 1 [(1 ) ] + 1 2 ( 1)2 We also showed that, ln +1 = 1 ( ) + 2 2 2 We are now going to reconsider the issues posed at the end of the first problem set. In particular, we are going to use the Euler Equation to price a risk free bond that is in zero net supply (i.e., every long position in this bond must be offset by a short position). We will ask what interest rate would make a consumer just willing to hold an arbitrarily small amount of the risk 3 free bond. In particular, we will assume that the amount is sufficiently small that it does not effect the properties of the consumption process. Hence, we can use the stochastic dynamics of the consumption process, which were derived above, to price the bond. 1. Note that the Euler Equation must hold for all assets in the consumer's portfolio. Explain intuitively why this is the case. 2. If the risk free bond has interest rate (with ln = ) show that the Euler Equation for the risk free asset will be, 0 () = exp()0 (+1) 3. Manipulate the Euler Equation to show that, 1 = exp { ln +1} 4. Show that ln +1 is distributed normally with mean 1 ( )+ 22 2 and variance 2 Note that we usually just assume that ln +1 is distributed normally. For this problem, we can show it exactly. You can use the intermediate results derived on the first problem set (which are summarized above). 5. Use the result of questions 3 and 4 to derive the equilibrium interest rate of the risk free bond. Now use the Consumption Capital Asset Pricing Equation (previous problem) to derive the equilibrium interest rate of the risk free bond. Your results should be the same, since both derivations are based on the Euler Equation. 6. Defend the assumption that the amount of risk free bond is in zero net supply (i.e., that the net amount available is zero). 7. In this model economy = 2 Is this true in the real world? Why or why not?

1. (10 points) In Cambridge, shoppers can buy apples from two sources: a local orchard, and a store that ships apples from out of state. The orchard can produce up to 50 apples per day at a constant marginal cost of 25 per apple. The store can supply any remaining apples demanded, at a constant marginal cost of 75 per unit. When apples cost 75 per apple, the residents of Cambridge buy 150 apples in a day. (a) (5 points) Draw the marginal cost curve of apple production in Cambridge. (b) (5 points) Assume that the city of Cambridge sets the price of apples within its borders. What price should it set, and should the price vary depending on where you purchase your apples? Problem 1 by MIT OpenCourseWare. 2. (20 points) Tariffs are usually imposed in order to decrease imports, but they don't always have the same effect. Please draw graphs that demonstrate how shifts in the domestic supply curve for a product subject to a tariff could result in the following scenarios. (a) (10 points) No imports at all of that product. (b) (10 points) The country becoming an exporter of that product. Problem 2 by MIT OpenCourseWare. 3. (35 points) (Suggestion: It may be helpful to read section 9.6 before doing this question.) Moldavia is a small country that currently trades freely in the world barley market. Demand and supply for barley in Moldavia is governed by the following schedules: Demand: QD = 4 P Supply: QS = P The world price of barley is $1/bushel. (a) (12 points) Calculate the free trade equilibrium price and quantity of barley in Moldavia. How many bushels do they import or export? On a well-labeled graph, depict this equilibrium situation, and shade the gains from trade relative to the autarkic (no trade) equilibrium in Moldavia. (b) (12 points) The Prime Minister of Moldavia, sympathetic as always, believes he can help those hurt by free trade in barley relative to the situation in autarky. He taxes the party that has benefited from free trade (either consumers or producers) an amount per bushel that is the difference between the autarkic price of barley and the free trade price. Furthermore, he rebates the entire government revenue of the tax back to the party harmed by free trade (again, either consumers or producers). In a new, well-labeled diagram, show this post-tax equilibrium situation. Calculate and show: The new equilibrium price and quantity of barley in Moldavia Changes in the quantity of imports or exports The amount of revenue collected by the Prime Minister Who pays the larger burden of this tax, consumers or producers in Moldavia? Why? (c) (11 points) Are the free trade losers better off or worse off after the rebate than they were under autarky? Why? On your diagram from (b), shade the DWL (if any) of this tax rebate policy, relative to the free trade equilibrium you found in (a).

2. (24 points) Consider the following version of model 5. Except where indicated, variables are expressed in current year terms thus the "t" subscript has been suppressed. Be sure to show your work for all parts.

IS Curve: Y = Yp - (r - ) + NX+ Net Exports NX = x0 - x1*E Fisher Equation: r = i - e Phillips Curve: = e + (Y - Yp) + v Inflation Expectations: e = -1 Monetary Rule: i= + + *( - *) + (1- )*(Y-Yp) 0 < < 1

Endogenous variables: Y, r, NX, , e, i Exogenous variables: Yp, , , E, x0,v, *

(6) a. Derive the dynamic aggregate demand curve. Indicate its slope. (3) b. Determine the dynamic aggregate supply curve and indicate its slope. (8) c. Paul Krugman, Olivier Blanchard and others have suggested that the inflation target (*) be raised to 4%. What would happen to the paths for output and inflation if monetary policy reflected this new inflation target? (7) d. How would the results in d change if inflation expectations were rational?

Part II (12 points each) Answer three of the following questions. Indicate any noteworthy assumptions.

1. Evaluate the quotation at the beginning of the exam. If you believe that it is true, provide evidence to support your assertion. If you believe that it is false, how would you change the statement to make it true? Provide evidence to support your claim.

2. Use Model 4 to determine the effect of an exogenous increase in net exports on GDP, P, L, U, W/P and r. Assume Y < Yp . Provide graphics to support your claim.

3. Use Model 5 to determine the paths of output and inflation if there is a positive aggregate supply shock in period t (i.e., vt < 0). Provide graphics to support your claim.

4. The Iron Triangle or Impossible Trilogy a. In terms of policy making regarding openness of the economy, what three policy options must be jointly considered by macroeconomic policy makers? Explain why the third policy depends upon the choice of the first two. b. In light of the Iron Triangle, why might large countries and small countries make different policy choices?