Question

1. Economists have developed three major theories of consumption and saving behavior. Discuss each one of them. a) The life-cycle hypothelis (Modigliani and Brumberg, 1954; Modigliani and Ando, 1957, Ando and Modigliani, 1963); b) The permanent income hypothesis (Friedman, 1957); c) The relative income hypothesis (Dusenberry, 1949). 2. An accounting firm will need $17,000 in 5 years to replace its computer system. What periodic deposits to a sinking fund paying quarterly interest at a 9% annual rate will achieve that goal? 3. Mary have saving plan with replacement rate equal to 75% of her preretirement income $60,000.00. She expect to live 15 years after retiring at age 65 and her age now is 40 years. If the real interest rate is 3% then a. What will be her total target replacement income? b. How much does she need to save annually to reach her goal? 4. Using Discounted Dividend Model, compute the price of a stock if You hold the stock for one year • Expected dividend per share (D1)= $15 • Expected ex-dividend price at the end of the year (P1) = $100.00 Risk adjusted discount rate or market capitalization (expected rate of return in order to invest) (k)= 12% 5. What is the current yield of a coupon bond of 12% if the face value is $2000 and its price is $2100? 6. What is the yield to maturity on a one-year, $1000 Treasury bill with a current price of $850? 7. What is the difference between interest rates and rate of returns?

Answer 1

The Life cycle hypothesis- This hypothesis has two variables namely consumption and savings. The test explains that, in an individual, the income he receives,he/ she earns it, saves it and then spends it in a balanced manner. Every individual tried to save money and then spends it after retirement that makes them feel their consumption is balanced. They do not try to reduce the buying behaviour. For example, a middle class earning member does not buy things that are too costly and beyond the income earned. They purchase according to their capacity only. This cycle gets repeated in every individual life. There are several factors also involving such as age, income, preferences during pre-work life, etc.

The permanent income hypothesis- The test relates that there are individuals who tries to spend money consistently and fixed upon the income they receive. The money they receive may be average and they try to satisfy upon it for a very long period of time. They will not change their habit unless their income has any change in it.

The relative income hypothesis - In this test relates that,the money spent by an individual is related due to income earned when its income distribution remains unchanged. When the income increase the individual standard quality of life increases. It focuses on long run..