5. Suppose that asset returns satisfy this Euler equation: 1 1 = E10.96(1+r). C₁ C2 where r denotes the real return from period 1 to period 2 and C is real consumption in the world. Suppose that C₁ = 1 and that C₂ can take on two values, 1.00 and 1.04, each with probability 0.5. (a) Solve for the world real interest rate, on a one-period, real, discount bond that is free of default risk. (b) Now suppose there is inflation, with P₁ = 1 and P2 = 1.04. Solve for the nominal interest rate on a one-period, nominal discount bond that is free of default risk. (c) Now imagine an emerging market debt issuer, whose nominal discount bonds pay 1 with probability 1 - A and 0.8 with probability A. Will this debt have a higher expected, real return than the asset you studied above?

5. Suppose that asset returns satisfy this Euler equation: 1 1 = E10.96(1+r). C₁ C2 where r denotes the real return from period 1 to period 2 and C is real consumption in the world. Suppose that C₁ = 1 and that C₂ can take on two values, 1.00 and 1.04, each with probability 0.5. (a) Solve for the world real interest rate, on a one-period, real, discount bond that is free of default risk. (b) Now suppose there is inflation, with P₁ = 1 and P2 = 1.04. Solve for the nominal interest rate on a one-period, nominal discount bond that is free of default risk. (c) Now imagine an emerging market debt issuer, whose nominal discount bonds pay 1 with probability 1 - A and 0.8 with probability A. Will this debt have a higher expected, real return than the asset you studied above?

Microeconomic Theory

12th Edition

ISBN:9781337517942

Author:NICHOLSON

Publisher:NICHOLSON

Chapter17: Capital And Time

Section: Chapter Questions

Problem 17.7P

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