Question & Answer

Why might a foreign government’s policies be closely monitored by investors in other countries, even if the investors plan no investments in that country? Explain how monetary policy in one country can affect interest rates in other countries. (LO6)

Assess the economic situation today. Is the current presidential administration more concerned with reducing unemployment or inflation? Does the Fed have a similar opinion? If not, is the administration publicly criticizing the Fed? Is the Fed publicly criticizing the administration? Explain. (LO2; LO3)

When the Fed lowers the federal funds rate target, will the cost of capital of U.S. companies be reduced? Explain how the segmented markets theory regarding the term structure of interest rates (as explained in Chapter 3) could influence the degree to which the Fed’s monetary policy affects long-term interest rates. (LO2)

Explain how the Fed’s monetary policy could depend on the fiscal policy that is implemented. (LO4)

Which factors might be considered by financial market participants who are assessing whether an increase in money supply growth will affect inflation? (LO5)

Explain why an increase in the money supply can affect other short-term interest rates in different ways. Include the potential impact of the money supply on the supply of and the demand for loanable funds when answering this question. (LO2)

Describe the Fed’s monetary policy response to the credit crisis that began in 2008. (LO2)

Why do financial market participants closely monitor money supply movements? (LO5)

Assume that the Fed’s primary goal is to reduce inflation. How can it implement monetary policy to achieve this goal? What is a possible adverse effect of such action by the Fed (even if it achieves this goal)? (LO3)

Compare the recognition lag and the implementation lag. (LO2)

Why might the Fed have difficulty in controlling the economy in the manner desired? Be specific. (LO2; LO3)

Describe a passive monetary policy. (LO2; LO3)

Describe an active monetary policy. (LO2; LO3)

When does the Fed use a stimulative monetary policy, and when does it use a restrictive monetary policy? What is a criticism of a stimulative monetary policy? What is the risk of using a monetary policy that is too restrictive? (LO2; LO3)

Describe the economic trade-off faced by the Fed in achieving its economic goals. (LO4)

How does the Fed’s monetary policy affect economic conditions? (LO5)

Jimmy has fallen on hard times recently.  Last year he borrowed $250,000 and added an additional $50,000 of his own funds to purchase $300,000 of undeveloped real estate.  This year the value of the real estate dropped dramatically and Jimmy’s lender agreed to reduce the loan amount to $230,000.  For each of the following independent situations, indicate the amount Jimmy must include in gross income and explain your answer:

a.       The real estate is worth $175,000 and Jimmy has no other assets or liabilities.

b.       The real estate is worth $235,000 and Jimmy has no other assets or liabilities.

c.       The real estate is worth $200,000 and Jimmy has $45,000 in other assets but no other liabilities.

a.       Because Nikki’s 28.57% discount ($14,000 – $10,000/$14,000) is less than Shine Company’s gross profit percentage, the bargain purchase from her employer does not result in taxable income.

b.     Nikki will recognize $25 of taxable income from the discounted services provided by Shine Company.  Discounts more than 20% for services are taxable. Thus, Nikki’s taxable discount is $25 ($125 Discount received – (20% x $500)=$25). 

a.       Because Nikki’s 28.57% discount ($14,000 – $10,000/$14,000) is less than Shine Company’s gross profit percentage, the bargain purchase from her employer does not result in taxable income.

b.     Nikki will recognize $25 of taxable income from the discounted services provided by Shine Company.  Discounts more than 20% for services are taxable. Thus, Nikki’s taxable discount is $25 ($125 Discount received – (20% x $500)=$25). 

George and Weezy received $30,200 of Social Security benefits this year ($12,000 for George; $18,200 for Weezy).  They also received $5,000 of interest from jointly owned City of Ranburne Bonds and dividend income. What amount of the Social Security benefits must George and Weezy include in their gross income under the following independent situations?

a.       George and Weezy file married joint and receive $8,000 of dividend income from stocks owned by George.

b.       George and Weezy file married separate and receive $8,000 of dividend income from stocks owned by George.

c.       George and Weezy file married joint and receive $30,000 of dividend income from stocks owned by George.

d.     George and Weezy file married joint and receive $15,000 of dividend income from stocks owned by George

Grady received $8,200 of Social Security benefits this year.  Grady also reported salary and interest income this year.  What amount of the benefits must Grady include in his gross income under the following two independent situations?

a.       Grady files single and reports salary of $12,100 and interest income of $250.

b.       Grady files single and reports salary of $22,000 and interest income of $600.

c.       Grady files married joint and reports salary of $75,000 and interest income of $500.

d.       Grady files married joint and reports salary of $44,000 and interest income of $700.

e.            Grady files married separate and reports salary of $22,000 and interest income of $600

For each of the following independent situations, indicate the amount the taxpayer must include in gross income and explain your answer:

a.       Phil won $500 in the scratch-off state lottery.  There is no state income tax.

b.       Ted won a compact car worth $17,000 in a TV game show.  Ted plans to sell the car next year.

c.       Al Bore won the Nobel Peace Prize of $500,000 this year.  Rather than take the prize, Al designated that the entire award should go to Weatherhead Charity, a tax-exempt organization.

d.       Jerry was awarded $2,500 from his employer, Acme Toons, when he was selected most handsome employee for Valentine’s Day this year.

e.       Ellen won a $1,000 cash prize in a school essay contest.  The school is a tax-exempt entity, and Ellen plans to use the funds to pay her college education.

f.       Gene won $400 in the office March Madness pool. 

Planning} Todd and Margo are seeking a divorce and no longer live together.  Margo has offered to pay Todd $42,000 per year for five years if Margo receives sole title to the art collection.  This collection cost them $100,000, but is now worth $360,000.  All other property is to be divided equally.

a.       If Margo’s payments cease in the event of Todd’s death, how are the payments treated for tax purposes? 

b.       How much of the gain would be taxed to Todd if Margo sells the art at the end of five years?

c.       Compute the tax cost (benefit) to Todd (Margo) if the payments qualify as alimony.  Assume that Todd (Margo) has a marginal tax rate of 15 percent (35 percent) and ignore the time value of money.

d.       How much more over the five year period should Todd demand in order to agree to allow the payments to cease in the event of his death?  (How much more will make him indifferent between receiving $42,000 a year in non alimony payments and receiving higher payments that are considered to be alimony?)

Lanny and Shirley are recently divorced and do not live together.  Shirley has custody of their child, Art, and Lanny pays Shirley $22,000 per year.  All property was divided equally.

a.       How much should Shirley include in income if Lanny’s payments are made in cash but will cease if Shirley dies or remarries?

b.       How much should Shirley include in income if $12,000 of Lanny’s payments is designated as “nonalimony” in the divorce decree?

c.       How much should Shirley include in income if Lanny’s payments drop to $15,000 once Art reaches the age of 18?

{Research} Gramps purchased a joint survivor annuity that pays $500 monthly over his remaining life and that of his wife, Gram.  Gramps is 70 years old and Gram is 65 years old.  Gramps paid $97,020 for the contract.  How much income will Gramps recognize on the first payment?