Carleton University

• ECON 3607

• ECON 3607 Monetary and Financial Institutions Midterm Exam Feb. 27, 2018 Answer ALL Questions in both Sections Time Allowed: 2.5 hours 1. Explain briefly what the following terms/concepts mean. a. Time value of money [3 marks] The time value of money is the idea that money available now is worth more than the same amount in the future - thus any amount of money is worth more the sooner it is received. b. Risk premium [3 marks] This is the payment to a buyer of an asset for taking on risk. The risk premium is given by the expected return less the risk-free rate of return. c. Real interest rate [3 marks] This is the interest rate measured in constant dollars - it accounts for the effects of inflation. The real interest rate is given by the nominal interest rate less the inflation rate. d. Systematic risk [3 marks] Economy-wide risk that affects everyone - for example a drought that affects all the farmers in an area, an economic recession that affects all the economic agents in a region. Because these risks affect everyone they cannot be diversified. e. Annuity [3 marks] An annuity is a financial instrument that pays out a fixed stream of payments to an individual. Annuities are created and sold by financial institutions which accept and invest funds from individuals and then later issue a stream of payments. f. Internal rate of return [3 marks] This is the interest rate that equates the present value of an investment to its cost. In general, a project or investment should