Trần Tấn Phát S3878775 (G13)

Question 1a

Ms. Kim wants to receive 50,000 USD after 5 years with interest rate of 8%

In order to calculate the present value having known the future value we can use this
compound interest equation:

Compound Interest Formula: A=P×(1+r/n)^n×t

Where:
- A = the future value of the investment/loan, including interest
- P = the principal amount (initial deposit)
- r = the annual interest rate (expressed as a decimal)
- n = the number of times interest is compounded per year
- t = the number of years the money is invested or borrowed for

(1) Annual compounding:

n=1
t=5
r = 0.08
A = 50,000
And we need to find P
The formula becomes
50,000 = P * (1+ 0.08/1)^5
Then P=50,000/(1.08)^5
P(annual) =39,940.31
(2) Quarterly Compounding:
n=4
t=5
r = 0.08
A = 50,000
And we need to find P
The formula becomes
50,000 = P * (1+ 0.08/4)^(4*5)
Then P=50,000/(1.02)^20
P(quarterly) =39,754.75
(3) Monthly Compounding:
n = 12
t=5
r = 0.08
A = 50,000
 And we need to find P
The formula becomes
50,000 = P * (1+ 0.08/12)^(12*5)
Then P=50,000/(1.00067)^60
P(quarterly) =39,732.13
(4) According to the calculations we can state that with higher compounding frequency, the
required initial deposit decreases.
The reason for this is the more frequent compounding periods, which allows the present
value of the investment to compound more times in the span of 5 years thus allows the
PV to grow more rapidly.
With annual compounding (n=1) the interest added to the principal only once per year.
With quarterly compounding (n=4) the interest added to the principal four times per
year.
With monthly compounding (n=12) the interest added to the principal twelve times per
year.
As the result the investment grows faster with the more times it compound a year, thus
resulting in less initial investment needed to achieve the final value.

Question 1b:

With Semi- annual compounding and change in interest rate from 8% to 8.25% we have to
change the following values
n=2
t=5
r = 0.0825
A = 50,000
And we need to find P
The formula becomes
50,000 = P * (1+ 0.0825/2)^(2*5)
Then P=50,000/(1.04125)^10
P(semi-annual) =39,841.64

The value of P(semi-annual)= 39,841.64 is larger than P(quarterly)= 39,754.75 so Ms. Kim
should choose to invest on the conditions of option 2.

Question 2:

a) Possible effects of the Fed's signal on the behavior of surplus and deficit economic units:
- Surplus Economic units:
o Increase Savings: Higher interest rates will make saving money more attractive as
the return on savings may increase. Surplus economic units might opt to save
more of their income to take advantage of higher interest rates.
 o Reduce Borrowing: High interest rates will increase the cost of borrowing.
Surplus economic units will be less willing to take out loans as high interest rates
will make them pay more in the future.
o Increase Loaning: High interest rates will increase the incentives for surplus
economic units to loan out the money as the return on the investment will
increase due to increased interest rate.
- Deficit Economic units:
o Higher Interest Expenses: Deficit Economic unit especially those ones with
variable-rate debt will experience the increase in the expenses related to their
debt. Thus decreasing the incentive to take out loans and will witness additional
financial stress in their spending.
o Reduced Borrowing and spending: Higher interest rates will deter DEUs from
borrowing thus we should witness businesses delay on expanding and spending
capital in this period. In addition to that the consumer will postpone large
purchases and credit card usage.
b)
- When FED is increasing interest rates its usually done to reduce the inflationary pressure
and maintain the stability in price of goods in the economy. This will lead to decrease in
spending and borrowing which will decrease demand for money thus decreasing the price
of goods in the economy, shifting the demand curve for money to the left.
- The supply of money is controlled by a central bank which is the FED. In the case of FED
increases the interest rate signals that there will be more strict and tighter monetary policy
which will lessen the supply of money which will move the supply curve to the left.
- Combining two factors above we can conclude that the equilibrium in interest rate will be
higher.

Question 3:

a) The shape of the USA bond yield curve provided is has a downward shape as its
decreasing over time. Inverted yield curve shape. whereby bonds of longer maturities
provide a lower yield, reflecting investors' expectations for a decline in long-term
interest rates
b)

- Expectations for a Recession: An inverted yield curve is frequently regarded as a warning

of upcoming recessions. Investors may predict lower future short-term interest rates if
they anticipate poorer economic growth or a recession. As a result, they ask for higher
returns on long-term bonds, which inverts the yield curve.
- Expectations Theory: According to this hypothesis, market expectations for upcoming
short-term interest rates influence long-term interest rates. A downward-sloping yield
curve results from investors locking in higher yields on short-term bonds when they
anticipate that short-term interest rates will drop in the future.
- Liquidity Preference Theory by John Mayer Kaynes: This hypothesis contends that
because short-term securities are more liquid and less susceptible to interest rate risk,
 investors prefer to hold them. Therefore, the yields on these bonds must be greater
than short-term rates to persuade investors to keep longer-term bonds. The yield curve
consequently tends to slope down.
Question 4:
There are several important elements that contributed to commercial banks being the largest
group in the financial markets. Due to these factors, it is clear how crucial commercial banks are
to the financial system and how important they are in facilitating indirect financing. The
following are a few of the main causes:
- Commercial banks serve as a middleman between surplus units (people or entities with
extra money) and deficit units (those in need of money). They assemble deposits from
people and companies with extra cash, then they lend these monies to borrowers.
Commercial banks are essential players in the financial system because of their ability to
facilitate indirect financing through this intermediation function.
- Deposit Mobilization: Commercial banks can mobilize a significant number of deposits
from consumers, companies, and other financial organizations. Due to banks' ability to
lend out a sizable amount of the deposits they receive, these deposits serve as the
foundation for the development of credit. The potential of the banks for indirect
financing is increased by their capacity to draw and pool deposits from numerous
sources.
- Risk Management and Diversification: Commercial banks are equipped with risk
management expertise and tools, allowing them to assess the creditworthiness of
borrowers and manage lending risks. By diversifying their loan portfolios across various
sectors and industries, banks can spread risk, making them more resilient and stable in
the face of economic fluctuations.
- Wide Range of Services: Commercial banks offer a broad range of financial services to
individuals, businesses, and governments. Besides lending and deposit-taking, they
provide services like trade finance, foreign exchange, wealth management, and
payment processing. This versatility and comprehensive service offerings attract a wide
customer base, further bolstering their status as the largest group in financial markets.