a. You are with your best friend at the bank when she cashes her paycheck for ca
ID: 2659466 • Letter: A
Question
a. You are with your best friend at the bank when she cashes her paycheck for cash. She takes $500 of currency, and with a frown on her face she says, "Money is just becoming paper these days. I should go to the United States Treasury and demand that they give me gold in exchange for this paper. Then I'd have some real money."
1. Explain to your friend what type of money she just received.
2. What are some of the advantages & disadvantages of this type of money?
3. In the modern high-technology world, has money moved beyond paper? Explain.
b. Your friend just won a state lottery that claims to pay the winner $30,000. The lottery actually pays the holder of the winning ticket $10,000 per year for the next three years. The first $10,000 payment arrives immediately. The second $10,000 arrives one year from today and the third payment arrives two years from today. Your friend excitedly says to you, "I need all he money right now because I wan to make a down payment on a house. Since you have saved the money, why don' you just give me $30,000 and I'll give you the ticket. Then you can collect $30,000 and we'll be even."
1. Should you give your friend $30,000 for the winning lottery ticket? Why or why not?
2. Suppose the interest rate is 5%. What price would you pay for the winning lottery ticket?
3. Suppose he interest rate is 8%. What price would you pay for the winning lottery ticket?
Which interest rate implies a greater present value for the lottery ticket and why?
You are with your best friend at the bank when she cashes her paycheck for cash. She takes $500 of currency, and with a frown on her face she says, "Money is just becoming paper these days. I should go to the United States Treasury and demand that they give me gold in exchange for this paper. Then I'd have some real money." Explain to your friend what type of money she just received. What are some of the advantages & disadvantages of this type of money? In the modern high-technology world, has money moved beyond paper? Explain. Your friend just won a state lottery that claims to pay the winner $30,000. The lottery actually pays the holder of the winning ticket $10,000 per year for the next three years. The first $10,000 payment arrives immediately. The second $10,000 arrives one year from today and the third payment arrives two years from today. Your friend excitedly says to you, "I need all he money right now because I wan to make a down payment on a house. Since you have saved the money, why don' you just give me $30,000 and I'll give you the ticket. Then you can collect $30,000 and we'll be even." Should you give your friend $30,000 for the winning lottery ticket? Why or why not? Suppose the interest rate is 5%. What price would you pay for the winning lottery ticket? Suppose he interest rate is 8%. What price would you pay for the winning lottery ticket? Which interest rate implies a greater present value for the lottery ticket and why?Explanation / Answer
A1.) She recieved fiat currency, which is currency backed by nothing, except the belief that someone else will accept it for services.
A2.) The disadvantage to it is that when nothing backs it, if everybody decided that the currency has no value, it will have no value. The advantage is that it allows the central bank to be much more flexible in adjusting the money supply, and thus being better able to balance managing inflation and unemployment.
A3.) There are still quite a few places, such as casinos, where paper currency is still preferred over electronic money. But nowadays, even place that use to deal in only physical currency, such as vending machines, now take electornic currency. I think that money hasn't fully moved beyond paper, but we're getting close.
B1.) No, as the winning ticket is worth less than 30,000 real dollars, even if it is worth 30,000 nominal dollars. This is because the second two payments are accruing interest, so that they will be worth $10,000 in one year and two years, respectively.
B2.) You should pay him $10,000 + ($10,000/1.05) + ($10,000/1.05/1.05) = $28594.10
B3.) You should pay him $10,000 + ($10,000/1.08) + ($10,000/1.08/1.08) = $27832.65
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