BROCK UNIVERSITY

ECONOMICS 3F03 Money and Banking

Assignment 4

Instructor: Zisimos Koustas March 21, 2000

Due Date: March 31, 2000

1. Consider an investor choosing a portfolio consisting of a riskless asset with a positive rate of return and a risky asset with a higher rate of return. Determine the effect on the proportion of wealth held in the risky asset of an increase in its risk.

2. Derive an aggregate demand function for consols and plot it on a graph given the following information:

(i) Investors hold either all one-period bonds or all consols depending on which has the higher one-period yield

(ii) The rate on one-period bonds is 6% p.a.

(iii) Investors have different expectations concerning the future consol rates as shown below

Wealth of Group	Expected Future Rate
100	4%
200	6%
100	8%

3. Assume that a person has a choice between two assets: non-interest-bearing demand deposits or bonds. Every cheque written on the demand deposits costs 10 cents; a conversion from bonds to money costs $2.50. Nominal income is $1,000 per month, all of which is spent at a constant rate during the month, and the interest rate on bonds is 10% per annum.

(i) Calculate the optimal number of conversions and the optimal average balance in the demand deposit.

(ii) How are these changed if there are integer constraints?

(iii) Consider a 1% increase in nominal income and show how it affects the optimal average balance in the demand deposit with and without integer constraints.

(iv) If there are no bonds, but instead a non-checkable savings account that pays 10% interest on the minimum monthly balance, what is the optimal strategy?

(v) If there are no bonds, but instead a checkable daily-interest account which pays 6% interest with a 10 cent charge per cheque, what is the best strategy?