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Money Banking and Financial Markets 4th edition Stephen Cecchetti, Kermit Schoenholtz - Solutions

Suppose the risk premium on U.S. corporate bonds increases. How would the change affect your forecast of future economic activity, and why?
Suppose a country with a struggling economy suddenly discovered vast quantities of valuable minerals under government-owned land. How might the government’s bond rating be affected? Using the model of demand and supply for bonds, what would you expect to happen to the bond yields of that
How do you think the abolition of investor protection laws would affect the risk spread between corporate and government bonds?
Do you think the term spread was an effective predictor of the recession that started in December 2007? Why or why not?
Did the financial crisis of 2007-2009 affect financial and nonfinancial firms to the same extent? For the period beginning in 2006, plot the spread between the interest rates on three-month non-financial commercial paper (FRED code: CPN3M) and three-month Treasury bills (FRED code: TB3MS). Plot a
The Federal Reserve Bank of St. Louis publishes a weekly index of financial stress (FRED code: STLFSI) that summarizes strains in financial markets, including liquidity problems. For the period beginning in 1994, plot this index and, as a second line, the difference between the Baa bond yield (FRED
How did the Great Depression (1930-33) and the Great Recession of 2007-2009 affect expectations of corporate default? To investigate, construct for each of those periods a separate plot of the corporate bond yield spread. For the depression period, plot from 1930 to1933 to the difference between
How reliably does an inverted yield curve anticipate a recession? How far in advance? Plot from 1970 (as in Figure) the difference between the 10-year Treasury yield (FRED code: GS10) and the three-month Treasury bill rate (FRED code: TB3MS). Discuss the variability of the time between an inversion
Download the data used in Data Exploration Problem 4 and (a) find the most recent period for which the yield curve was (approximately) flat and (b) the longest time period for which yield curve was inverted.
Explain why being a residual claimant makes stock ownership risky.
Do individual shareholders have an effective say in corporate governance matters?
Consider the following information on the stock market in a small economy.a. Compute a price-weighted stock price index for the beginning of the year and the end of the year. What is the percentage change?b. Compute a value-weighted stock price index for the beginning of the year and the end of the
To raise wealth and stimulate private spending, suppose the central bank lowers interest rates, making stock market investment relatively attractive. Which stock market index would you monitor to judge the effectiveness of the policy: the Dow Jones Industrial Average or the S&P 500? Why?
Suppose you see evidence that the stock market is efficient. Would that make you more or less likely to invest in stocks for your 401(k) retirement plan when you get your first job?
Professor Siegel argues that investing in stocks for retirement may be less risky than investing in bonds. Would you recommend this approach to an individual in his or her early 60s?
How do venture capital firms, which specialize in identifying and financing promising but high-risk businesses, help the economy grow?
What are the advantages of holding stock in a company versus holding bonds issued by the same company?
If Professor Siegel is correct that stocks are less risky than bonds, then the risk premium on stock may be zero. Assuming that the risk-free interest rate is 2½ percent, the growth rate of dividends is 1 percent and the current level of dividends is $35, use the dividend-discount model to compute
Why is a booming stock market not always a good thing for the economy?
The financial press tends to become excited when the Dow Jones Industrial Average rises or falls sharply. After a particularly steep rise or fall, newspapers may publish tables ranking the day’s results with other large advances or declines. What do you think of such reporting? If you were
Consider again the stock described in Problem. What might account for the difference in the market price of the stock and the price you are willing to pay for the stock?
You are trying to decide whether to buy stock in Company X or Company Y. Both companies need $1000 capital investment and will earn $200 in good years (with probability 0.5) and $60 in bad years. The only difference between the companies is that Company X is planning to raise all of the $1000
Your brother has a $1000 and a one-year investment horizon and asks your advice about whether he should invest in a particular company’s stock. What information would you suggest he analyze when making his decision? Is there an alternative investment strategy to gain exposure to the stock
Given that many stock market indices across the world fell and rose together during the financial crisis of 2007-2009, do you think investing in global stock markets is an effective way to reduce risk? Why or why not?
Do you think a proposal to abolish limited liability for stockholders would be supported by companies issuing stock?
You peruse the available records of some public figures in your area and notice that they persistently gain higher returns on their stock portfolios than the market average. As a believer in efficient markets, what explanation for these rates of returns seems most likely to you?
Do you think that widespread belief in the efficient markets theory was a significant contributor to the 2007-2009 financial crisis? Why or why not?
Based on the dividend-discount model, what do you think would happen to stock prices if there were an increase in the perceived riskiness of bonds?
Use the dividend-discount model to explain why an increase in stock prices is often a good indication that the economy is expected to do well.
Howwell does the stock market anticipate the behavior of the economy? Plot since 1950 the percentage change from a year ago of the Dow Jones Industrial Average. Is the index a reliable predictor of business cycle downward turns (depicted by the graph by vertical, shaded bars)?
Why might the stocks of small firms outperform large firms over long periods of time?Will this hold over short periods of time, too? Plot since 1979 the stock indexes for small firms (FRED code: WILLSMLCAP) and large firms (FRED code: WILLLRGCAP) using annual data scaled to a common base year of
Compareand contrast the evolution of two leading stock indexes. Plot since 1960 on a quarterly basis the Dow Jones Industrial Average (FRED code: DJIA) and the S&P 500 (FRED code: SP500) scaled to a common base quarter of 1960 Q1=100
The Dow Jones Industrial Average (FRED code: DJIA) is a price-weighted index of 30 stocks and the S&P 500 index (FRED code: SP500) is a value-weighted average of 500 stocks. Find out which is more volatile. Plot on a quarterly basis since 1970 the percent change from a year ago of each index.
Have stock dividends become a more important source of income to U.S. households? Plot since 1959 the share of dividend income (FRED code: B703RC1Q027SBEA) in personal disposable income (FRED code: DSPI). Can you explain the 50-year trend?
How is entering into a forward contract similar to barter? Can you think of costs associated with forward contracts that are minimized or eliminated with futures contracts?
Explain why trading derivatives on centralized exchanges rather than in over-the-counter markets helps to reduce systemic risk.
What are the risks and rewards of writing and buying options? Are there any circumstances under which you would get involved? Why or why not? (Hint: Think of a case in which you own shares of the stock on which you are considering writing a call.)
Suppose XYZ Corporation's stock price rises or falls with equal probability by $20 each month, starting where it ended the previous month. What is the value of a three-month at-the-money European call option on XYZ’s stock if the stock is priced at $100 when the option is purchased?
Why might a borrower who wishes to make fixed interest rate payments and who has access to both fixed- and floating-rate loans still benefit from becoming a party to a fixed-for-floating interest rate swap?
How does the existence of derivatives markets enhance an economy’s ability to grow?
Credit-default swaps provide a means to insure against default risk and require the posting of collateral by buyers and sellers. Explain how these “safe-sounding” derivative products contributed to the 2007-2009 financial crisis?
Of the following options, which would you expect to have the highest option price? a. A European three-month put option on a stock whose market price is $90 where the strike price is $100. The standard deviation of the stock price over the past five years has been 15 percent.b. A European
What kind of an option should you purchase if you anticipate selling $1 million of Treasury bonds in one year’s time and wish to hedge against the risk of interest rates rising?
Suppose you have $8,000 to invest and you follow the strategy you devised in question 16 to leverage your exposure to the copper market. Copper is selling at $3 a pound and the margin requirement for a futures contract for 25,000 pounds of copper is $8,000. a. Calculate your return if copper prices
The table below shows the yields on the fixed and floating borrowing choices available to three firms. Firms A and B want to be exposed to a floating interest rate while Firm C would prefer to pay a fixed interest rate. Which pair(s) of firms (if any) should borrow in the market they do not want
Suppose you were the manager of a bank that raised most of its funds from short-term variable-rate deposits and used these funds to make fixed-rate mortgage loans. Should you be more concerned about rises or falls in short-term interest rates? How could you use interest-rate swaps to hedge
Basis swaps are swaps where, instead of one payment stream being based on a fixed interest rate, both payment streams are based on different floating interest rates. Why might anyone be interested in entering a floating-for-floating interest rate swap? (You should assume that both payment flows are
An agreement to lease a car can be thought of as a set of derivative contracts. Describe them.
In spring 2002, an electronically traded futures contract on the stock index, called an E-mini future, was introduced. The contract was one-fifth the size of the standard futures contract, and could be traded on the 24-hour CME Globex electronic trading system. Why might someone introduce a futures
A hedger buys a futures contract, taking a long position in the wheat futures market. What are the hedger’s obligations under this contract? Describe the risk that is hedged in this transaction and give an example of someone who might enter into such an arrangement.
A futures contract on a payment of $250 times the Standard and Poors’ 500 Index is traded on the Chicago Mercantile Exchange. At an index level of $1,000 or more, the contract calls for a payment of over $250,000. It is settled by a cash payment between the buyer and the seller. Who are the
Concerned about possible disruptions of the supply of oil from the Middle East, the chief financial officer (CFO) of American Airlines would like to hedge the risk of an increase in the price of jet fuel. What tools could the CFO use to hedge this risk?
You sell a bond futures contract and, one day later, the clearinghouse informs you that it had credited funds to your margin account. What happened to interest rates over that day?
You are completely convinced that the price of copper is going to rise significantly over the next year and want to take as large a position as you can in the market but have limited funds. How could you use the futures market to leverage your position?
Central banks occasionally engage in “liquidity swaps” with each other. Plot and interpret the Fed’s provision of dollar liquidity swaps (FRED code: SWPT) to other central banks since 2007. To facilitate your interpretation, view the FRED “Notes” about this data series.
Define the swap rate and then plot the five-year swap rate (FRED code: MSWP5). Describe a transaction involving the swap rate and the actions of the participating parties.
The swap spread is the difference between the swap rate and the equivalent-maturity Treasury bond yield. Explain why a widening swap spread may be a signal of deteriorating economic conditions. Plot since 2000 the difference between the five-year swap rate (FRED code: MSWP5) and the five-year
Risk-averse investors care greatly about asset price volatility. Using the FRED “Notes” about the data series, briefly define the (VIX) Volatility Index (FRED code:VIXCLS) of the Chicago Board Options Exchange (CBOE). Plot since 2004 the VIX and the percent change from a year ago of the S&P 500
Commercial banks trade trillions of dollars of derivative contracts, but what is their net exposure in derivatives markets? Plot the difference between what commercial banks are owed (FRED code: DFVACBW027SBOG) and what they owe (FRED code: DNVACBW027SBOG) on their derivative positions.
If the U.S. dollar-British pound exchange rate is $1.50 per pound, and the U.S. dollar-euro rate is $0.90 per euro:a. What is the pound per euro rate?b. How could you profit if the pound per euro rate were above the rate you calculated in part a? What if it were lower?
If a computer game costs $30 in the United States and £26 in United Kingdom, what is the real “computer game” exchange rate? Look up the current dollar-pound exchange rate in a newspaper or an online source, and compare the two prices. What do you conclude?
Suppose the euro-dollar exchange rate moves from $0.90 per euro to $0.92 per euro. At the same time, the prices of European-made goods and services rise 1 percent, while prices of American-made goods and services rise 3 percent. What has happened to the real exchange rate between the dollar and
Can purchasing power parity help predict short-term movements in exchange rates?
During the 1990s, the U.S. Secretary of the Treasury often stated, “a strong dollar is in the interest of the United States.”a. Is this statement true? Explain your answer.b. What can the Secretary of the Treasury actually do about the value of the dollar relative to other currencies?
The following table gives selective data on nominal exchange rates, price levels, and real exchange rates for Country A and several other countries. Country A uses the dollar (A$) as its currency. Fill in the blanks in thetable.
If the price (measured in a common currency) of a particular basket of goods is 10 percent higher in the U.K. than it is in the United States, which country’s currency is undervalued, according to the theory of purchasing power parity?
You hear an interview with a well-known economist who states that she expects the U.S. dollar to strengthen against the British pound over the next five to ten years. This economist is known for her support of the theory of purchasing power parity. Using an equation to summarize the relationship
Using the model of demand and supply for U.S. dollars, what would you expect to happen to the U.S. dollar exchange rate if, in light of a worsening geopolitical situation, Americans viewed foreign bonds as more risky than before? (You should quote the exchange rate as number of units of foreign
Suppose that the Chinese central bank has been intervening in the foreign exchange market, buying U.S. dollars in an effort to keep its own currency, the yuan, weak. Use the model of demand and supply for dollars to show what the immediate effect would be on the yuan/dollar exchange rate of a
Consider again the situation described in Problem 13 where China decided to allow the yuan to float. What would you expect to happen toa. U.S. exports to Chinab. U.S. imports from Chinac. the U.S. trade deficit with ChinaExplain your answers.
Use the model of demand for and supply of foreign currency to analyze the following scenarios:a. Impressed with the magnificent scenery from Vancouver during the coverage of the Winter Olympics, French and German tourists flock to the west coast of Canada. Explain the impact on the euro-Canadian
Suppose an Italian bank has short-term borrowings of 400 million euro and 100 million U.S. dollars and made long term loans of 300 million euro and 250 million U.S. dollars. The euro-dollar exchange rate is initially $1.50 per euro.a. Ignoring other assets and liabilities, place each item on the
Most countries do not attempt to manage their exchange rates with intervention in the foreign currency markets, but some do. Under which circumstances is such an intervention likely to be ineffective?
Suppose you see the following newspaper headline: “Japan’s Finance Ministry Sells Yen for U.S. Dollars.” What is the objective of this policy? If the policy goal is achieved, what will happen to the prices of Japanese imports to the U.S.? What will happen to the prices of U.S. goods purchased
The same television set costs $500 in the United States, €450 in France, £300 in the United Kingdom, and ¥100,000 in Japan. If the law of one price holds, what are the euro-dollar, pound-dollar, and yen-dollar exchange rates? Why might the law of one price fail?
What does the theory of purchasing power parity predict in the long run regarding the inflation rate of a country that fixes its exchange rate to the U.S. dollar?
Suppose the interest rate on a one-year U.S. bond is 10 percent and the interest rate on an equivalent Canadian bond is 8 percent. If the interest-rate parity condition holds, is the U.S. dollar expected to appreciate or depreciate relative to the Canadian dollar over the next year? Explain your
Exchange rates can experience sudden changes as well as long-run patterns. a. Plotthe U.S. dollar-Australian dollar exchange rate (FRED code: EXUSAL) without recession bars and identify long-run swings and short-term spikes. Which currency is appreciating when the plotted exchange rate falls?b.
Plot since 1999, without recession bars, the real exchange rate between U.S. goods and euro-area goods according to equation (2) in the text. Use the consumer price index (divided by 1.95 to set a common base year of 2005=100 for the U.S. and euro-area indexes) for the price of U.S. goods (FRED
Write in algebraic form a calculation of U.K pounds per euro that uses U.S. dollars per U.K pound (FRED code: EXUSUK) and U.S. dollars per euro (FRED code: EXUSEU). Then plot since 1999 the exchange rate of U.K. pounds per euro using these two U.S. dollar exchange rates. Select “Add Data
Examine an episode of large-scale interventions by the Bank of Japan’s (BOJ) in the yen-dollar foreign exchange market. Plot between January 2003 and January 2005 a measure of BoJ intervention (FRED code: JPINTDUSDJPY). Do positive values of the intervention indicator reflect purchases or sale of
Describe the problem of asymmetric information that an employer faces in hiring a new employee. What solutions can you think of? Does the problem persist after the person has been hired? If so, how and what can be done about it? Is the problem more or less severe for employees on a fixed
In some cities, newspapers publish a weekly list of restaurants that have been cited for health code violations by local health inspectors. What information problem is this feature designed to solve, and how?
What problem associated with asymmetric information was central to Bernard Madoff’s success in cheating so many investors for so long?
The Internet can have a significant influence on asymmetric information problems.a. How can the Internet help to solve information problems?b. Can the Internet compound some information problems?c. On which problem would the Internet have a greater impact, adverse selection or moral hazard?
The financial sector is heavily regulated. Explain how government regulations help to solve information problems, increasing the effectiveness of financial markets and institutions.
Deflation causes the value of a borrower’s collateral to drop. Define deflation and explain how it reduces the value of a borrower's collateral. How might a lender who anticipates deflation alter the terms of a loan?
You are in charge of setting policies for implementing construction loans at a bank once the loan officer has approved the borrowers’ applications. (Construction loans finance the development of a structure during the building process and are later converted to mortgages.) How would you protect
Your parents give you $2,000 as a graduation gift and you decide to invest the money in the stock market. If you are risk averse, should you purchase some stock in a few different companies through a web site with low transaction fees or put the entire $2,000 into a mutual fund? Explain your
Suppose a new website was launched providing up-to-date, credible information on all firms wishing to issue bonds. What would you expect to see happen to the overall level of interest rates in the bond market?
Suppose two types of firms wish to borrow in the bond market. Firms of type A are in good financial health and are relatively low risk. The appropriate premium over the risk-free rate for lending to these firms is 2 percent. Firms of type B are in poor financial health and are relatively high risk.
Consider again the low-risk type A firm described in Problem. If you were the financial advisor to such a firm, what suggestions would you make to the firm’s management about obtaining borrowed funds?
The island of Utopia has a very unusual economy. Everyone on Utopia knows everyone else and knows all about the firms they own and operate. The financial system is well developed on Utopia. Everything else being equal, how would you expect the mix on Utopia between internal finance (where
You and a friend visit the headquarters of a company and are awestruck by the expensive artwork and designer furniture that graces every office. Your friend is very impressed and encourages you to consider buying stock in the company, arguing that it must be really successful to afford such elegant
Under what circumstances, if any, would you be willing to participate as a lender in a peer-to-peer lending arrangement?
Financial intermediation is not confined to bank lending but is also carried out by non-bank firms such as mutual fund companies. How do mutual funds help overcome information problems in financial markets?
In some countries it is very difficult for shareholders to fire managers when they do a poor job. What type of financing would you expect to find in those countries?
One of the solutions to the adverse selection problem associated with asymmetric information is the pledging of collateral. However, the collateral may be riskier than initially thought. As an example, explain why the collateral did not work adequately to mitigate the mortgage securitization
Consider a small company run by a manager who is also the owner. If this company borrows funds, why might a moral hazard problem still exist?
Financial intermediaries connect savers and borrowers. Examine growth in intermediation from the following perspectives. a. Plot the ratio of total credit market debt owed (FRED code: TCMDO) to population (FRED code: POP). Because credit market debt is expressed in billions and population in

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