Chapter 17 Problem 1: What monetary and fiscal policies might be prescribed for an economy in a deep recession?

In truth, these two policies work very well and especially play very important roles in helping recover the economy in a deep recession. For instance, they have been exercised by many countries during the recent global financial crisis. When the economy gets stuck in a deep recession, most economic activities in it seem stagnant, stand still and find hard to operate well due to many factors that are attributable to shortage of operating capital, striking decrease in demand and natural resources scare, etc. Therefore, the monetary and fiscal policies are viewed as useful tools to encourage investment and consumption demand by adjusting interest rate and increase the government s spending.

Problem 4: What are the differences between bottom-up and top-down approaches to security valuation? What are the advantages of a top-down approach? Differences between bottom-up and top-down approaches to security valuation BOTTOM-UP APPROACH The bottom-up investor starts with specific businesses, regardless of their industry/region. TOP-DOWN APPROACH The top-down investor starts analysis with global economics, including both international and national economic, such as GDP growth rates, inflation, interest rates, exchange rates, productivity, and energy prices. Then, it comes to narrow search down to regional/industry analysis of total sales, price levels, the effects of competing products, foreign competition, and entry or exit from the industry.

The advantages of a top-down approach: The top-down approach allows an investor to make an informed investment decision based on a keen understanding of the economy and industry and how that relates the stock, versus comparing the stocks fundamentally against the other investors without thinking about the overall movement in the market. In other words, given the starting point of understanding the world economies, an investor is able choose an appropriate stock based on areas of the world that may be doing better.

b. Which firm s stock will have a higher beta? Answer: a. Construction Answer: Believing that Fed is going to loosen the monetary policies. One uses a highly automated robotics process whereas the other uses workers on the assembly line and pay overtime when there is heavy production demand.Problem 6: Unlike other investors. a. Stock of the company with highly automated robotics process will have a higher beta because it may be moving together with the market more than the other. investing in the gold mining industry will be potentially profitable. Hence. Which firm will have higher profits in a recession? In a boom? b. . However. it means there will be a money supply shock and then probability of abnormal inflation will be high. What would be your recommendations about the investments in the following industries? a. I will consider investing in the gold mining industry because there is a logical and obvious thing that most of us can realize easily that when money policy is loose. The preference on gold of customers will push gold price to rise. in a recession the firm using workers in the assembly line will have a higher profit when this firm does not have to incur as high fixed cost as the firm with highly automated robotics process and it can cut off the variable cost easily to adapt to decline in demand of market. In a boom. Hence.000 fixed costs of $30. you believe that Fed is going to loosen the monetary policy. Problem 8: Consider two firms producing DVD recorders. Gold mining b.000 and variable costs equal to one-third of revenue. the firm with highly automated robotics process will have higher profits because it can take better advantage of economy scale of modern fixed asset to produce more products in a faster manner to meet high demand of market. then the gold will be regarded as the premier hedging property against inflation. Problem 15: Your business plan for your proposed start-up firm envisions first-year revenues of $Your 120.

000) = 1.6.000/50.000 = -0.000/50.6 = 62. Or in short way we can take advantage of DOL to derive the percentage decrease in profits: DOL = percentage change in profits/percentage change in sales = 1.000 + 1/3(0.000 b. The answer can be proved as below: Profit = 0.16 =-16% And (-16%) is considered as the percentage decrease in profit when the sales expectation changes. the profit will go down at the rate of 16%. prior to turning negative.5% .000 Change in profits = 42. what will be the decrease in profits? d.6 Therefore. when the sales decline by 10%.000)] = $42. what is the largest percentage shortfall in sales relative to original expectations that the firm can sustain before profits turn negative? What are break-even sales at this point? f. E. What is the degree of operating leverage based on the estimate of fixed costs and expected profits? c.6 = 100%/1.000 [30.000 50.6 c.000) = $50. e. Show that the percentage decrease in profits equals DOL times the 10% drop in sales.a. What are expected profits based on these expectations? b.000 (30. we have: DOL = percentage change in profits/percentage change in sales = 1. Based on DOL. The degree of operating leverage is based on the estimate of the fixed costs and expected profits are: DOL = 1 + (fixed assets / profits) = 1 + (30. Based on the DOL.6%. Answer: a.6 =>percentage change in profits = 1. the profits will reach zero which means that percentage decrease in profits is 100%. According to the assumption above. The expected profit = expected revenue (Fixed cost + Variable cost) = 120. the degree of operating leverage is 1. Inversely. then: Percentage decrease in sales = percentage decrease in profits / 1. d.000 + 1/3*120.6*percentage change in sales =1. Confirm that your answer to (E) is correct by calculating profits at the break-even level of sales.9*120.9*120. If sales are 10% below expectation. It means that every 1% increase in sales will put profits of the company increase by 1.6*(-10%) = -16% e.

000) = 0 .5% The break-even sales at this point is 120.000 62.000 = $45.000 (30.Profits at the break-even level of sales = 45.5%*120.So. the largest percentage shortfall in sales relative to original expectations that the firm can sustain before profits turn negative is 62.000 f.000 + 1/3*45.

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