Question 1: A website offers a place for people to buy and sell emeralds, but information about emeralds can be quite imperfect. The website then enacts a rule that all sellers in the market must pay for two independent examinations of their emerald, which are available to the customer for inspection.
a) What impact would this have on the demand for emeralds in this market?
b) What impact would this have on the supply of emeralds in this market?
c) What would happen to the equilibrium price?
d) Is the new equilibrium more efficient or less efficient than it was before the new rule? Explain.
Question 2: An insurance company is selling a life insurance policy that will pay $100,000 if the purchaser dies within the next year. Imagine that there are two groups of people follows:
| Group 1 |
200 people |
Family history of cancer |
1 in 50 (2%) chance of dying w/in a year |
| Group 2 |
800 people |
No family history of cancer |
1 in 200 (0.5%) chance of dying w/in a year |
a) If the insurance company were selling life insurance separately to each group, what would be the actuarially fair premium for each group?
b) If the insurance company were offering life insurance to the entire group without knowing the family histories, what would be the actuarially fair premium for the group as a whole?
c) What will happen to the insurance company if it tries to charge the actuarially fair premium to the group as a whole rather than to each group separately?
Question 3: Briefly describe the difference between corporate stocks and corporate bonds. What are the main advantages and disadvantages of each from the perspective of the firm?
Question 4: Briefly describe three possible investment options from the perspective of a household. What is a benefit and disadvantage of each from the perspective of an investor?
Question 5: Suppose Ford Motor Company issues a five year bond with a face value of $5,000 that pays an annual coupon payment of $150.
a) What is the interest rate Ford is paying on the borrowed funds?
b) If the market interest rate rises from 3% to 4% a year after Ford issues the bonds, will the value of the bond increase or will it decrease?