3. Suppose Jack’s wage rate is $20 and that he can produce $10 per hour of household “goods”. Suppose Jill’s wage rate is $30 and that she can produce $15 per hour of household “goods”. Who should specialize in the market sector? Suppose now, Jack’s wage goes up to $25 per hour. How does this affect the answer? 4. Suppose the government grants $2500 per child to households that have more than 2 children. How would this affect fertility?

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3. Suppose that country I increases its willingness to trade at the same time that trading partner country II decreases its willingness to trade. What can be said about the resulting impact on the terms of trade and on the volume of trade? (Note: You will not be able to say anything concrete about one of these impacts. Why not?)

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3. Suppose the portfolio of a large institutional investor ‘Animal has a beta of 1.25, and the standard deviation of the rate of return on its portfolio is 15 percent and its expected rate of return is 15 percent. The portfolio of another institutional investor Beast’ has a beta of 0.75. The market portfolio may be expressed as a portfolio comprising the portfolios of Animal and Beast. Suppose there is a firm called Cunning corporation’, whose stock’s beta is 2 and it can borrow at the risk free rate, which is 2.5 percent. Cunning’s equity value is £1.5 million and its debt is £1 million. The present value of Cunning’s tax shield is £0.3 million. Assuming that both CAPM and the Modigliani-Miller theorem with corporate taxes hold, answer the following questions. a) What is the expected return on the market portfolio? [5 marks] b) What is the standard deviation of the rate of return on Beast’s portfolio? [5 marks] c) What is the weight attached to Beast if we express the market portfolio as a portfolio [5 marks] [5 marks] Total 20 marks] comprising the portfolios of Animal and Beast? d) What is the after-tax WACC of Cunning? 2. A firm ‘Kappa Industries’ is a very young business, which is growing rapidly and to which intangible assets are very important. In contrast, another firm ‘Gorgeous Food’, whose business is profitable and stable, but has limited growth opportunities and most of its assets are tangible. With this setup, answer the following questions. a) Assuming that the predictions of the pecking order theory hold, which firm should have [20 marks] b) Assuming that the predictions of the trade-off theory hold, which firm should have a [20 marks] a higher payout ratio? Explain concisely why. higher debt-equity ratio? Explain concisely why.

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3. Suppose we would like to estimate the effect of city credit ratinglon the municipal bond interest rate mbr. Other factors affecting mbr are tax rate tr, unemployment rate ue, and the ratio of citizens in working age to total population of the city watp. Credit rate classes are indicated as B, BB, BBB, A, AA, AAA, with B the lowest and AAA the highest. a) Define appropriate dummy variables for the credit rating classes and form a (linear) regression model to test whether credit rating affects mbr. b) Present in terms of the model parameter the null hypothesis for testing the hypothesis. c) Given that there are n observations (cities), what test statistic would you use and what are/is the degrees of freedom?

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3.The Chung Chemical Corporation is considering the purchase of a chemical analysis machine. Although the machine being considered will result in an increase in earnings before interest and taxes of

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