56:054 Engineering Economy

Prof. O'Grady

Quiz #3 Solutions

1. (30 points)

Machine X

EUAC = 6000(A/P, 9%,4) = 600x0.3087 = 1852.2

Machine Y

EUAC = 10000(A/P,9%,8) - 2000(A/F,9%,8) + 150 = 10000x0.1807-2000x0.0907 +150 = 1775.6

2. (20 points)

  1. You have purchased a $100,000 30 year bond from Shady Enterprises at
    an interest rate of 12% per year. If interest rates rise and you decide to
    sell the bond after three years, what can the bond sell at?

    2. Answer: less than 100k, goes down

  2. If interest rates remain the same but the rating agency re-rates Shady
    Enterprises from a CC to an AA, what now happens to the selling price of the
    bond?

    3. Answer: Goes up

  3. What is a yield curve? Why is the yield curve inverted at present?
    A curve that shows the relationship between yields and maturity dates for a set of similar bonds, usually Treasuries, at a given point in time. For normal situation, long-term debt instruments have higher yields than short-term debt instruments.

An inverted yield curve is an uncommon situation in which long-term interest rates have lower yields than short-term interest rates. The present yield curve is inverted because the Federal Reserve Board raised the short term interest rate in order to reduce economy growth to prevent possible inflation.

 

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  [ Professor O'Grady ]