L 11 Intertermporal Choice II Intertemporal Choice u

L 11 Intertermporal Choice II

Intertemporal Choice u Two periods: u Consumption smoothing u Today: Many periods

3 Periods u Cash flows

Many Periods u Cash u E: flow T=3, r=100%. Choose: $1 in each of the three period or $8 in the third

Translation u Cashflow

Important cashflow: Perpetuity u Gives constant payment x forever u Cashflow

Perpetuity (Example) u You can rent an apartment for $1000 each month (r=0. 5%=0. 005) u You can buy it P=300. 000 u Renting vs buying?

Quiz u Consider consol that pays $10, 000 per year. (r=5%=0. 05) u Q: In terms of todays dollars consol is worth A) $ 10, 000 B) $100, 000 C) $ 200, 000 D) $1000, 000

Important cashflow: Annuity u “Tree” that gives constant payment in T following periods u Cashflow

Quiz: Leasing or Buying A Car Lease T=3, x=$800, r=100% or buy P=750 You should A) Buy a car B) Lease a car C) Both options are equally attractive

Loan Payment u Take a loan (how much do you pay monthly) Loan=1000, T=3, r=100% and x=?

Asset Valuation: Bonds u Treasury u PV bill: Face, Coupon, Maturity of T-bills (F, c, T) and r

Asset Valuation: Example u T-bond (F=100, c=10, T=6) and r=5%

Life cycle problems u Consumption – savings problem u Pension: – How much to put aside? – How much am I going to get?

Consumption Smoothing u Income: 100 in the first 40 years u Consumption C during 60 years, u Constant consumption! Find C if r=5%

Pension Plan u You want C=100 when retired (61 -80) u How much do you have to save if r=5%,

Pension Plan u You save S=100 (21 -60) u How much will you get (per year) if r=5%,