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On November 1, 2018, Dandelion Company purchased a debt security at face value of P1, 000,000. This financial asset is to be measured at Fair Value Through Other Comprehensive Income (FvoCI). The contractual term is 10 years with an annual coupon of 6%. At December 31, 2018, the debt security's fair value has decreased to P950,000 due to increases in market interest rates. There has not been a significant increase in the credit risk of this debt investment. Hence, Dandelion decided to recognize a 12- month Expected Credit SS (ECL) of P30,000.

On December 31, 2019, the debt security's fair value has decreased further to P925,000 as a result of increases in market interest rates. There has not been a significant increase in the credit risk of the debt security since initial recognition; hence, Dandelion decided to recognize a 12-month ECL amounting to P40,000

On January 1, 2020, Dandelion sold the debt security for its fair value of P925,000.

a. The cumulative gain (loss) in OCI at December 31, 2018 is?

b. The cumulative loss in OCI at December 31, 2019 is?

c. What amount should be reported as loss on sale of the debt security on January 1, 2020?

Assume that a consumer with only equity wealth must choose periodby-period consumption in a discrete-time dynamic optimization problem. Specifically, consider the sequence problem: (0) = sup {}=0 0 X =0 exp()() subject to the constraints: +1 = exp(++122)() = +1 ( ) iid and (0 1) [0 ] 0 0 Here represents equity 2 wealth at period and represents consumption at period . The consumer has discount rate and the consumer can only invest in a risky asset with expected return = exp( + 22) = exp() Finally, assume that the consumer has an isoelastic utility function: () = 1 1 , with [0] 6= 1 Note that this utility function has the property of constant relative risk aversion 00() 0 () = This scaling property enables us to analytically solve this problem. The associated Bellman equation for this problem is given by () = sup [0] ( ) + exp()(exp( + 2 2)) The value function takes the special form () = 1 1 We previously showed that the consumption function takes the form, = 1 where, ln(1 1 ) = 1 [(1 ) ] + 1 2 ( 1)2 We also showed that, ln +1 = 1 ( ) + 2 2 2 We are now going to reconsider the issues posed at the end of the first problem set. In particular, we are going to use the Euler Equation to price a risk free bond that is in zero net supply (i.e., every long position in this bond must be offset by a short position). We will ask what interest rate would make a consumer just willing to hold an arbitrarily small amount of the risk 3 free bond. In particular, we will assume that the amount is sufficiently small that it does not effect the properties of the consumption process. Hence, we can use the stochastic dynamics of the consumption process, which were derived above, to price the bond. 1. Note that the Euler Equation must hold for all assets in the consumer's portfolio. Explain intuitively why this is the case. 2. If the risk free bond has interest rate (with ln = ) show that the Euler Equation for the risk free asset will be, 0 () = exp()0 (+1) 3. Manipulate the Euler Equation to show that, 1 = exp { ln +1} 4. Show that ln +1 is distributed normally with mean 1 ( )+ 22 2 and variance 2 Note that we usually just assume that ln +1 is distributed normally. For this problem, we can show it exactly. You can use the intermediate results derived on the first problem set (which are summarized above). 5. Use the result of questions 3 and 4 to derive the equilibrium interest rate of the risk free bond. Now use the Consumption Capital Asset Pricing Equation (previous problem) to derive the equilibrium interest rate of the risk free bond. Your results should be the same, since both derivations are based on the Euler Equation. 6. Defend the assumption that the amount of risk free bond is in zero net supply (i.e., that the net amount available is zero). 7. In this model economy = 2 Is this true in the real world? Why or why not?

1. (10 points) In Cambridge, shoppers can buy apples from two sources: a local orchard, and a store that ships apples from out of state. The orchard can produce up to 50 apples per day at a constant marginal cost of 25 per apple. The store can supply any remaining apples demanded, at a constant marginal cost of 75 per unit. When apples cost 75 per apple, the residents of Cambridge buy 150 apples in a day. (a) (5 points) Draw the marginal cost curve of apple production in Cambridge. (b) (5 points) Assume that the city of Cambridge sets the price of apples within its borders. What price should it set, and should the price vary depending on where you purchase your apples? Problem 1 by MIT OpenCourseWare. 2. (20 points) Tariffs are usually imposed in order to decrease imports, but they don't always have the same effect. Please draw graphs that demonstrate how shifts in the domestic supply curve for a product subject to a tariff could result in the following scenarios. (a) (10 points) No imports at all of that product. (b) (10 points) The country becoming an exporter of that product. Problem 2 by MIT OpenCourseWare. 3. (35 points) (Suggestion: It may be helpful to read section 9.6 before doing this question.) Moldavia is a small country that currently trades freely in the world barley market. Demand and supply for barley in Moldavia is governed by the following schedules: Demand: QD = 4 P Supply: QS = P The world price of barley is $1/bushel. (a) (12 points) Calculate the free trade equilibrium price and quantity of barley in Moldavia. How many bushels do they import or export? On a well-labeled graph, depict this equilibrium situation, and shade the gains from trade relative to the autarkic (no trade) equilibrium in Moldavia. (b) (12 points) The Prime Minister of Moldavia, sympathetic as always, believes he can help those hurt by free trade in barley relative to the situation in autarky. He taxes the party that has benefited from free trade (either consumers or producers) an amount per bushel that is the difference between the autarkic price of barley and the free trade price. Furthermore, he rebates the entire government revenue of the tax back to the party harmed by free trade (again, either consumers or producers). In a new, well-labeled diagram, show this post-tax equilibrium situation. Calculate and show: The new equilibrium price and quantity of barley in Moldavia Changes in the quantity of imports or exports The amount of revenue collected by the Prime Minister Who pays the larger burden of this tax, consumers or producers in Moldavia? Why? (c) (11 points) Are the free trade losers better off or worse off after the rebate than they were under autarky? Why? On your diagram from (b), shade the DWL (if any) of this tax rebate policy, relative to the free trade equilibrium you found in (a).

2. (24 points) Consider the following version of model 5. Except where indicated, variables are expressed in current year terms thus the "t" subscript has been suppressed. Be sure to show your work for all parts.

IS Curve: Y = Yp - (r - ) + NX+ Net Exports NX = x0 - x1*E Fisher Equation: r = i - e Phillips Curve: = e + (Y - Yp) + v Inflation Expectations: e = -1 Monetary Rule: i= + + *( - *) + (1- )*(Y-Yp) 0 < < 1

Endogenous variables: Y, r, NX, , e, i Exogenous variables: Yp, , , E, x0,v, *

(6) a. Derive the dynamic aggregate demand curve. Indicate its slope. (3) b. Determine the dynamic aggregate supply curve and indicate its slope. (8) c. Paul Krugman, Olivier Blanchard and others have suggested that the inflation target (*) be raised to 4%. What would happen to the paths for output and inflation if monetary policy reflected this new inflation target? (7) d. How would the results in d change if inflation expectations were rational?

Part II (12 points each) Answer three of the following questions. Indicate any noteworthy assumptions.

1. Evaluate the quotation at the beginning of the exam. If you believe that it is true, provide evidence to support your assertion. If you believe that it is false, how would you change the statement to make it true? Provide evidence to support your claim.

2. Use Model 4 to determine the effect of an exogenous increase in net exports on GDP, P, L, U, W/P and r. Assume Y < Yp . Provide graphics to support your claim.

3. Use Model 5 to determine the paths of output and inflation if there is a positive aggregate supply shock in period t (i.e., vt < 0). Provide graphics to support your claim.

4. The Iron Triangle or Impossible Trilogy a. In terms of policy making regarding openness of the economy, what three policy options must be jointly considered by macroeconomic policy makers? Explain why the third policy depends upon the choice of the first two. b. In light of the Iron Triangle, why might large countries and small countries make different policy choices?