Homework #1

1. Suppose you hire a real estate agent and tell him to sell your house to the highest

bidder. You pay the real estate agent a flat fee of $50,000 when the house is sold.

You learn that, unfortunately, the agent sells the house to the first bidder at a low

price.

a. What is this type of problem called?

b. What is one way to change the real estate agent’s incentive so he does sell

to the highest bidder, instead of to the first one?

a. This type of problem is known as an agency problem

b. One way to change the real estate agent’s incentive so that he is motivated to find the highest bidder is instead of paying him a flat fee of $50,000 you offer him a commission that pays him a percentage of the house’s sales price. This way he will try to find the highest bidder so he can maximize the amount of money he gets and you can get the best possible price for your house.

2. Suppose you own one share of stock in ABC Inc. and one share of stock in XYZ

Co. You can sell both shares at $100, but it will take you much longer to find a

buyer willing to pay $100 for XYZ compared to ABC.

a. Which stock is more liquid?

b. If you had to sell both stocks today, which one would sell for a higher

price?

a. The stock for ABC Inc. is more liquid because it can be sold more quickly with limited price impact.

b. The stock for ABC Inc. would sell for a higher price because it is the most liquid out of the two.

3. National Bank pays 3% simple interest on its savings account balances, whereas

First City Bank pays 3% simple interest compounded annually. If you made a

$165,000 deposit in each bank, how much more money would you earn from your

First City Bank account at the end of 6 years?

National Bank Simple Interest: 165,000(1+.03(6)) = $194,700

First City Bank Compound Interest: N: 6 Years I/Yr: 3% PV: $165,000= FV: $197,018.63

You would earn $2,318.63 more with the First City Bank account than the National Bank account.

4. Assume you will...

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