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business
economics of money banking and financial markets

Questions and Answers of Economics Of Money Banking And Financial Markets

How can financial innovation lead to financial crises?
Why do bank panics worsen asymmetric information problems in credit markets?
What causes bank panics to occur?
What is a credit spread? Why do credit spreads rise significantly during a financial crisis?
How does a general increase in uncertainty as a result of the failure of a major financial institution lead to an increase in adverse selection and moral hazard problems?
How does a deterioration in balance sheets of financial institutions and the simultaneous failures of these institutions cause a decline in economic activity?
How can a decline in real estate prices cause deleveraging and a decline in lending?
How does an unanticipated decline in the price level cause a drop in lending?
How can the bursting of an asset-price bubble in the stock market help trigger a financial crisis?
How does the concept of asymmetric information help to define a financial crisis?
You own a house worth $400 000 that is located on a river. If the river fl oods moderately, the house will be completely destroyed. Moderate fl ooding happens about once every 50 years. If you build
You wish to hire Ron to manage your Calgary operations.The profi ts from the operations depend partially on how hard Ron works, as follows.If Ron is lazy, he will surf the Internet all day, and he
Now you believe the dealer knows more about the car than you do. How much A P P L I E D P R O B L E M S are you willing to pay? Why? How can this asymmetric information problem be resolved in a
Refer to Problem
If you believe the dealer knows as much about the car as you do, how much are you willing to pay?Why? Assume that you care only about the expected value of the car you will buy and that the car
You are in the market for a used car and decide to visit a used car dealership. You know that the Red Book value of the car you are looking at is between $20 000 and$24
Gustavo is a young doctor who lives in a country with a relatively ineffi cient legal and fi nancial system. When Gustavo applied for a mortgage, he found that banks usually required collateral for
Many policymakers in developing countries have proposed the implementation of a system of deposit insurance similar to the system that exists in Canada. Explain why this might create more problems
Explain how the separation of ownership and control in Canadian corporations might lead to poor management.
“The more collateral there is backing a loan, the less the lender has to worry about adverse selection.” Is this statement true, false, or uncertain? Explain your answer.
How can the existence of asymmetric information provide a rationale for government regulation of fi nancial markets?
Which fi rms are most likely to use bank fi nancing rather than issue bonds or stocks to fi nance their activities? Why?
How do standardized accounting principles help fi nancial markets work more effi ciently?
Would moral hazard and adverse selection still arise in fi nancial markets if information were not asymmetric?Explain.
How does the free-rider problem aggravate adverse selection and moral hazard problems in fi nancial markets?
In December 2001, Argentina announced it would not honour its sovereign (government-issued) debt. Many investors were left holding Argentinean bonds priced at a fraction of their previous value. A
How can asymmetric information problems lead to a bank panic?
What steps can the government take to reduce asymmetric information problems and help the fi nancial system function more smoothly and effi ciently?
What specifi c procedures do fi nancial intermediaries use to reduce asymmetric information problems in lending?
Would you be more willing to lend to a friend if she had put all of her life savings into her business than you would be if she had not done so? Why?
Do you think the lemons problem would be more severe for stocks traded on the Toronto Stock Exchange or for those traded over-the-counter? Explain.
Wealthy people often worry that others will seek to marry them only for their money. Is this a problem of adverse selection?
Suppose you go to your local bank intending to buy a certifi cate of deposit with your savings. Explain why you would not off er a loan, at an interest rate that is higher than the rate the bank pays
Why are fi nancial intermediaries willing to engage in information collection activities when investors in fi nancial instruments may be unwilling to do so?
Describe two ways in which fi nancial intermediaries help lower transaction costs in an economy.
How can economies of scale help explain the existence of fi nancial intermediaries?
For each of the following countries, identify the single most important (largest) and least important(smallest) source of external funding: Canada; United States; Germany; Japan. Comment on the
A company has just announced a 3-for-1 stock split, effective immediately. Prior to the split, the company had a market value of $5 billion with 100 million shares outstanding. Assuming the split
The current price of a stock is $65.88. If dividends are expected to be $1 per share for the next five years, and the required return is 10%, then what should the price of the stock be in 5 years
After careful analysis, you have determined that a firm’s dividends should grow at 7%, on average, in the foreseeable future. The firm’s last dividend was $3.Compute the current price of this
Compute the price of a share of stock that pays a$1 per year dividend and that you expect to be able to sell in one year for $20, assuming you require a 15% return.
Why might the efficient market hypothesis be less likely to hold when fundamentals suggest stocks should be at a lower level?
In the late 1990s, as information technology advanced rapidly and the Internet was widely developed, U.S.stock markets soared, peaking in early 2001. Later that year, these markets began to unwind
“Human fear is the source of stock market crashes, so these crashes indicate that expectations in the stock market cannot be rational.” Is this statement true, false, or uncertain? Explain your
Can we expect the value of the dollar to rise by 2%next week if our expectations are rational?
“Foreign exchange rates, like stock prices, should follow a random walk.” Is this statement true, false, or uncertain? Explain your answer.
If higher money growth is associated with higher future inflation, and if announced money growth turns out to be extremely high but is still less than the market expected, what do you think will
“An efficient market is one in which no one ever profits from having better information than the rest of the market participants.” Is this statement true, false, or uncertain? Explain your answer.
“If most participants in the stock market do not follow what is happening to the monetary aggregates, prices of common stocks will not fully reflect information about them.” Is this statement
Can a person with rational expectations expect the price of a share of Google to rise by 10% in the next month?
If your broker has been right in her five previous buy and sell recommendations, should you continue listening to her advice?
If you read in the Globe and Mail that the “smart money” on Bay Street expects stock prices to fall, should you follow that lead and sell all your stocks?
If the public expects a corporation to lose $5 per share this quarter and it actually loses $4, which is still the largest loss in the history of the company, what does the efficient market
Suppose that increases in the money supply lead to a rise in stock prices. Does this mean that when you see that the money supply has sharply increased in the past week, you should go out and buy
“If stock prices did not follow a random walk, there would be unexploited profit opportunities in the market.” Is this statement true, false, or uncertain?Explain your answer.
If a forecaster spends hours every day studying data to forecast interest rates, but his expectations are not as accurate as predicting that tomorrow’s interest rate will be identical to today’s
“Anytime it is snowing when Joe Commuter gets up in the morning, he misjudges how long it will take him to drive to work. When it is not snowing, his expectations of the driving time are perfectly
“Forecasters’ predictions of inflation are notoriously inaccurate, so their expectations of inflation cannot be rational.” Is this statement true, false, or uncertain?Explain your answer.
If monetary policy becomes more transparent about the future course of interest rates, how will stock prices be affected, if at all?
Some economists think that central banks should try to prick bubbles in the stock market before they get out of hand and cause later damage when they burst. How can monetary policy be used to prick a
What are the two main sources of cash flows for a stockholder? How reliably can these cash flows be estimated?Compare the problem of estimating stock cash flows to the problem of estimating bond cash
What basic principle of finance can be applied to the valuation of any investment asset?
The table below shows current and expected future one-year interest rates, as well as current interest rates on multi-year bonds. Use the table to calculate the liquidity premium for each multi-year
Assuming that the expectations theory is the correct theory of the term structure, calculate the interest rates in the term structure for maturities of one to five years, and plot the resulting yield
Assuming that the expectations theory is the correct theory of the term structure, calculate the interest rates in the term structure for maturities of one to five years, and plot the resulting yield
In 2010 and 2011, the government of Greece risked defaulting on its debt due to a severe budget crisis.Show, using bond market graphs, the effect on the risk A P P L I E D P R O B L E M S premium
Suppose that the Bank of Canada made an announcement that it would purchase up to $300 billion of longer-term Canada securities over the following six months. What effect might this policy have on
If expectations of future short-term interest rates suddenly fell, what would happen to the slope of the yield curve?
If the yield curve suddenly became steeper, how would you revise your predictions of interest rates in the future?
If yield curves, on average, were flat, what would this say about the liquidity (term) premiums in the term structure? Would you be more or less willing to accept the expectations theory?
If a yield curve looks like the one shown in the figure below, what is the market predicting about the movement of future short-term interest rates? What might the yield curve indicate about the
If a yield curve looks like the one shown in the figure below, what is the market predicting about the movement of future short-term interest rates? What might the yield curve indicate about the
If a yield curve looks like the one shown in the figure below, what is the market predicting about the movement of future short-term interest rates? What might the yield curve indicate about the
Suppose the interest rates on one-, five-, and 10-year Canada bonds are currently 3%, 6%, and 6%, respectively.Investor A chooses to hold only one-year bonds and Investor B is indifferent between
If bond investors decide that 30-year bonds are no longer as desirable an investment, predict what will happen to the yield curve, assuming (a) the expectations theory of the term structure holds and
“Using the expectations theory of the term structure, it is better to invest in one-year bonds, reinvested over two years, than to invest in a two-year bond, if interest rates on one-year bonds are
Prior to 2008, mortgage lenders in the United States required a house inspection to assess its value, and often used the same one or two inspection companies in the same geographical market.
If the income tax exemption on U.S. municipal bonds were abolished, what would happen to the interest rates on these bonds? What effect would the change have on interest rates on U.S. Treasury
During 2008, the difference in yield (the yield spread )between three-month AA-rated financial commercial paper and three-month AA-rated nonfinancial commercial paper steadily increased from its
Predict what would happen to the risk premiums on corporate bonds if brokerage commissions were lowered in the corporate bond market.
Predict what will happen to interest rates on a corporation’s bonds if the federal government guarantees today that it will pay creditors if the corporation goes bankrupt in the future. What will
The Canadian government offers some of its debt as Real Return Bonds, in which the price of bonds is adjusted for inflation over the life of the debt instrument. Real Return Bonds are traded on a
“If bonds of different maturities are close substitutes, their interest rates are more likely to move together.” Is this statement true, false, or uncertain? Explain your answer.
Risk premiums on corporate bonds are usually countercyclical; that is, they decrease during business cycle expansions and increase during recessions. Why is this so?
In the fall of 2008, AIG, the largest insurance company in the world at the time, was at risk of defaulting due to the severity of the global financial crisis. As a result, the U.S. government
Why do Canadian Treasury bills have lower interest rates than large-denomination negotiable bank CDs have?
Which should have the higher risk premium on its interest rates, a corporate bond with a Moody’s Baa rating or a corporate bond with a C rating? Why?
If junk bonds are “junk,” why would investors buy them?
The demand curve and supply curve for one-year discount bonds with a face value of $1000 are represented by the following equations:Bd: Price = -0.6 * Quantity + 1140 Bs: Price = Quantity + 700
The demand curve and supply curve for one-year discount bonds with a face value of $1000 are represented by the following equations:Bd: Price = -0.6 * Quantity + 1140 Bs: Price = Quantity + 700a.
Using both the supply and demand for bonds and liquidity preference frameworks, show how interest rates are affected when the riskiness of bonds rises. Are the results the same in the two frameworks?
Using both the liquidity preference framework and the supply and demand for bonds framework, show why interest rates are procyclical (rising when the economy is expanding and falling during
An important way in which the Bank of Canada decreases the money supply is by selling bonds to the public. Using a supply and demand analysis for bonds, show what effect this action has on interest
Suppose you visit with a financial advisor, and you are considering investing some of your wealth in one A P P L I E D P R O B L E M S of three investment portfolios: stocks, bonds, or commodities.
M1 money growth in the United States was about 15%in 2011 and 2012, and 10% in 2013. Over the same time period, the yield on 3-month Treasury bills was close to 0%. Given these high rates of money
If the next governor of the Bank of Canada has a reputation for advocating an even slower rate of money growth than the current governor does, what will happen to interest rates? Discuss the possible
Why should a rise in the price level (but not in expected inflation) cause interest rates to rise when the nominal money supply is fixed?
Would fiscal policymakers ever have reason to worry about potentially inflationary conditions? Why or why not?
Predict what will happen to interest rates if prices in the bond market become more volatile.
Predict what will happen to interest rates if the public suddenly expects a large increase in stock prices.

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