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Intertermporal Choice II

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Presentation on theme: "Intertermporal Choice II"— Presentation transcript:

1 Intertermporal Choice II

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

3 3 Periods Cash flows

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

5 Translation Cashflow

6 Important cashflow: Perpetuity
Gives constant payment x forever Cashflow

7 Perpetuity (Example) You can rent an apartment for $1000 each month (r=0.5%=0.005) You can buy it P= Renting vs buying?

8 Quiz Consider consol that pays $10,000 per year. (r=5%=0.05)
Q: In terms of todays dollars consol is worth A) $ 10,000 B) $100,000 C) $ 200,000 D) $1000,000

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

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

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

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

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

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

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

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

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


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