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money banking financial markets

Questions and Answers of Money Banking Financial Markets

3. Describe the Federal Open Market Com¬ mittee. How many voting members are on this committee? How often does a mem¬ ber of the Board of Governors get to vote on the FOMC? How often do the presi¬
2. Describe a Federal Reserve System re¬ gional bank. How is it like a private cor¬ poration? How is it like a government agency?
1. Describe the Board of Governors of the Federal Reserve System. With no resignations, how many members of the Board of Governors could a two-term president appoint?
What is there in the structure of the Fed to explain why the Fed would be more opposed to inflation than a member of Congress would?
Figure 13.4 showed the effects of an open market purchase on a bank’s balance sheet. Now consider a bank that goes to the discount window to borrow $100 from the Fed, thus incurring a liability of
The structure of the Fed is unique among central banks worldwide. The system of 12 Federal Reserve banks was originally set up to avoid concen¬ trating too much power in Washington, although the
Throughout banking history, there have been various calls for an end to fractional reserve banking. The rationale for 100 percent reserve banking is that a run on the deposits of a bank would never
15. Suppose you used your model in problem 14 to predict future interest rates. Do you think you could make money by using this forecast in financial markets? Explain.
14. Suppose you wanted to form rational ex¬ pectations of future short-term interest rates. What variables would economic theory suggest are relevant for this under¬ taking?
13. Can it ever be “rational” to use some¬ thing other than rational expectations to form future expectations? Explain care¬ fully.
12. Complete the following table to illustrate how the speed of adjustment affects the formation of adaptive expectations. De¬ scribe verbally the difference in adaptive expectations when X = .2
11. Now suppose the investment banker in problems 9 and 10 forms rational expecta- tions of inflation based on the simple quantity theory, ggy. Complete the following table. Are the banker's ex-
10. Suppose the investment banker in problem 9 forms adaptive expectations of inflation and the speed of adjustment parameter is\ = .5. Complete the following table. Are the banker’s expectations
9. An investment banker forms Markov ex¬ pectations of inflation for period t based on information available in period t — 1. Complete the following table for the Actual Inflation Period Rate (t)
8. What is the efficient market hypothesis? What does it imply about using past trends to “beat the market?”
7. What are the primary advantages of ra¬ tional expectation formation? What are the primary disadvantages?
6. What are the primary advantages of adap¬ tive expectation formation? What are the primary disadvantages (i.e., when do they lead to systematic forecast errors)?
5. What are the primary advantages of Mar¬ kov expectation formation? What are the primary disadvantages (i.e., when do they lead to systematic forecast errors)?
4. Last year, both real output and the money supply increased by 6 percent. The infla¬ tion rate was 10 percent. What would you expect the inflation rate to be this year? Why?
3. Last year, both real output and the money supply increased by 6 percent. The infla¬ tion rate was 10 percent.(a) . What is the Markov expectation of inflation this year?(b) . If the adjustment
2. Determine whether the following exam¬ ples most closely conform to Markov, adaptive, or rational expectations.(a) . When Sue wakes up in the morning, she expects her husband to fix the same
1. Provide, at an intuitive level, an explana¬ tion of Markov, adaptive, and rational ex¬ pectations.
Suppose two bonds with identical risks and terms to maturity have different yields, (a) If the market is efficient, what would you expect to happen to the yields and prices of these bonds? (b) If you
(a) Suppose money growth, inflation, and the growth in real output remain constant for a long period of time. Would inflationary expectations depend on which of the three methods were used to form
Last period, real output increased by 4 percent and the money supply in¬ creased by 5 percent. The inflation rate last period was 10 percent, (a) What is the Markov expectation of inflation this
13. In light of problem 12, what actions could you recommend to the Mexican central bank to remedy the depreciation of the peso? Could your policy be sustained for very long? Explain.
12. During the past decade, the Mexican peso and various South American currencies have depreciated against the currency of virtually every western industrialized country. Why do you think this has
11. Based on what you learned in this chapter, provide three possible explanations for each of the following events:(a) . Over the last four years, the dollar depreciated against the pound.(b) .
10. Between 1985 and 1990, the dollar depre¬ ciated considerably against the British pound. Do you think this contributed to a decline in the number of Americans who visited Britain? Explain.
9. Suppose the government imposed a tax on income earned by non-residents on U.S. debt obligations. Would you expect the dollar to appreciate or depreciate relative to the yen? Explain.
8. Suppose interest rates in the United States increase from 4 to 8 percent, while those in Japan fall from 4 to 2 percent. What affect would you expect this to have on the long-run exchange rate
7. Determine the impact of the following on the exchange rate between U.S. dollars and Italian lire:(a) . Italy experiences a minor recession, while the U.S. enjoys an economic boom.(b) . Interest
6. Use a diagram to illustrate the impact of the following on the supply of dollars to Italians: (a) a decrease in Italians’ real in¬ comes, (b) a decrease in the Italian price level, and (c) a
5. Use a diagram to illustrate the impact of the following on the demand for dollars by Italians: (a) a decrease in Italians’ real incomes, (b) an increase in the Italian price level, and (c) an
4. How would your answer in problem 2 change if the exchange rate changed to 1.5 guilders per dollar? Has the dollar appreciated or depreciated against the guilder? Has the guilder appreciated or
3. How would your answer in problem 2 change if the exchange rate changed to three guilders per dollar? Has the dollar appreciated or depreciated against the guilder? Has the guilder appreciated or
2. Suppose the exchange rate between Dutch guilders (DF) and U.S. dollars is 1.7 guil¬ ders per dollar.(a) . How much would it cost in dollars to purchase a box of rare tulips that sell for 980
1. Based on what you learned in this chapter, why do you think exchange rates tend to fluctuate over long periods of time? Over short periods of time?
Late in the summer of 1992, the EMS experienced difficulty because Ger¬ many raised its interest rates to new heights. The British government was under great pressure to devalue its currency,
The yield to maturity on a one-year U.S. Treasury bill is 4.5 percent, and that on an equally safe one-year Canadian Treasury bill is 7 percent. The spot exchange rate is 1.25 Canadian dollars per
(1) Assuming other things remain constant, determine the likely long-term impact of the following on the exchange rate between the U.S. dollar and the British pound, (a) Due to a long recession in
(a) Suppose the exchange rate between British pounds (£) and U.S. dollars is .75 pounds per U.S. dollar. How much would it cost in dollars to purchase a watch that sells for 28 pounds? (b) If the
15. A mortgage applicant was perplexed when he learned that the mortgage company was charging a lower rate on a 15-year mortgage than on a 30-year mortgage. Ex¬ plain to the applicant why a mortgage
14. Suppose a company’s bonds have recently been downgraded from Aaa to C. Assum¬ ing the firm has outstanding bonds matur¬ ing in 1, 5, and 10 years, how will this announcement affect the yield
13. Suppose investors expect inflation to re¬ main stable this year but increase dramati¬ cally next year.(a) . What impact will this have on expec¬ tations of next year’s short-term interest
12. Determine whether the following scenar¬ ios are most consistent with the expecta¬ tions, segmented-markets, or preferred- habitat hypothesis.(a) . Natalie’s sole criteria in choosing among
11. Suppose investors prefer one-year bonds to two-year bonds and will purchase a two-year bond only if they expect to re¬ ceive an additional 4 percent over the re¬ turn from holding one-year
10. The interest rate on a one-year govern¬ ment bond is 4 percent, the rate on a two- year government bond is 7 percent, and the rate on a three-year government bond is 9 percent.(a) . Describe the
9. The interest rate on a one-year govern¬ ment bond is 4 percent, the rate on a two- year CD is 7 percent, and the rate on a three-year corporate bond is 9 percent. What can you infer about the
8. Explain how the expectations and segmented-markets hypotheses are ex¬ treme versions of the preferred-habitat hypothesis. Give an example to illustrate your explanation.
7. According to the preferred-habitat hypoth¬ esis, if the market expects future one-year interest rates to be the same as today’s one-year interest rate, will the term struc¬ ture of interest
6. Explain the rationale for the segmented- markets hypothesis. What are this theory’s major weaknesses?
5. Get a current issue of the Wall Street Journal and look up the interest rate on three-month, six-month, and one-year Treasury bills. Is the term structure of in¬ terest rates increasing,
4. According to the expectations hypothesis, when would the yield curve slope up¬ ward? When would it slope downward?
3. Suppose that on January 1, 1995, the in¬ terest rate on a one-year government bond is 5 percent, the interest rate on a two- year government bond is 6 percent, and the interest rate on a
2. Explain the rationale for the expectations hypothesis. What are the theory’s major weaknesses?
1. What is held constant along a yield curve? What is allowed to vary?
Suppose investors prefer one-year bonds to three-year bonds and will pur¬ chase a three-year bond only if they expect to receive an additional 2 percent over the return from holding one-year bonds.
Suppose the interest rate on a one-year CD is 5 percent, on a two-year CD is 4 percent, and on a three-year CD is 8 percent, (a) Describe the shape of the yield curve, (b) Use the expectations
Given the following information, graph the relevant yield curves: A three- year government bond yields 7 percent; a three-year Aaa corporate bond yields 8 percent; a seven-year government bond yields
15. You work for a major computer firm and face the risk that a rival company will earn huge profits at the expense of your firm. Can you suggest a method for diver¬ sifying the risk you face of
14. What are the similarities between futures contracts and option contracts? What is the major difference?
13. 4 ‘Risk-neutral investors do not care about the variance in returns; they care only about the expected value of a risky pros¬ pect. Thus, risk-neutral investors will pay the same amount for
12. Provide two reasons risky bonds sell at lower prices (and higher yields) than default-free bonds.
11. “If one person gains from a financial transaction, someone else loses. Thus, fu¬ tures markets benefit either buyers or sell¬ ers, but not both.” Is this statement true or false? Explain.
10. One of the stocks in Joe’s portfolio is sell¬ ing at an all-time high. Joe would like to wait six months to sell to postpone paying taxes on his capital gains.(a) . What does Joe risk by
9. Explain why an investor who purchases a callable bond requires a call premium.
8. Consider the same scenario in problem 7, but suppose a recent report reveals a 2 percent chance that BUS will not make any debt payments.(a) . How much will a risk-neutral inves¬ tor pay for a
7. BUS, Inc., has a $1 million bond out¬ standing that will mature in one year. The bond pays a coupon rate of 10 percent, which equals the default-free market inter¬ est rate.(a) . If investors
6. Bonds issued by two different companies have the same face value, coupon rate, and maturity date, yet one bond is selling at a much higher price than the other bond.(a) . Provide three potential
5. Moody’s recently downgraded XYZ’s bonds from Aaa to C. What impact would you expect this to have on (a) the price of XYZ’s bonds, (b) the interest rate XYZ must pay for additional loanable
4. At one point in the late 1970s, the interest rate on one-year U.S. Treasury bills was 12 percent, while the interest rate on one- year debt issued by the Swiss government was only 3 percent.(a) .
3. Use supply and demand graphs to illus¬ trate the impact of the following changes on the interest rate a firm pays for loan¬ able funds.(a) . An increase in the firm’s default risk(b) . A
2. Suppose you roll a single die and receive $1 for each dot that appears on your first roll.(a) . What is the expected value of this risky prospect?(b) . What is the variance?(c) . How much would a
1. Briefly explain the difference between risk and uncertainty.
Natalie, a long-time family friend, has accumulated $3 million in her com¬ pany’s stock through an employee stock ownership plan. Under the terms of the agreement, she cannot liquidate the stock
(a) National Trash Collection has $10 million in outstanding bonds that will mature in one year. Each bond has a coupon rate of 15 percent on its face value of $1,000, and the current default-free
You are considering two investments. Investment A (xA) is certain to yield profits of $100. Investment B (v5) will yield profits of $910 with probability .1 and $10 with probability .9. (a) What are
15. Who receives funds when a stock or a bond is purchased in the primary market? In the secondary market?
14. Suppose a firm announces a two-for-one stock split; that is, for every share of stock owned by investors, the firm gives them another share for free. What impact does this practice have on the
13. Young-R-Us Company (problem 12) pres¬ ently pays no dividends, even though it had earnings of $2 per share last year. If the growth rate in earnings is expected to be 4 percent per year forever,
12. Young-R-Us Company presently does not pay out dividends, even though it had earnings of $2 per share last year.If the interest rate is 4 percent, what is the price of the firm’s stock if
11. Why would anyone purchase a stock that does not pay dividends?
10. A utility company is expected to have earnings of $5 million each year from now to eternity. The company pays out all of its annual earnings as dividends to owners of its 2 million shares of
9. Suppose a one-year Treasury bill has a discount yield of 5 percent. If your alter¬ native to purchasing this bond is to de¬ posit the funds in a bank account that pays 5 percent interest, what
8. Suppose the government enacted a policy that prevented corporations from deduct¬ ing interest payments on coupon bonds from their income taxes. How would this affect prices of corporate coupon
7. You just purchased a coupon bond that has a face value of $1,000 and a coupon rate of 8 percent. The bond matures in one year.(a) . If the interest rate was 6 percent when you purchased the bond,
6. Carefully explain what would happen to the price and quantity of Treasury bills traded in the money market if inflationary expectations increased.
5. If the market interest rate is 8.5 percent, how much would you be willing to pay for a Treasury bill that matures in one year? Given this price, determine the dis¬ count yield and the yield to
4. Suppose you paid $9,000 for a Treasury bill that matures in one year. Determine (a) the discount yield and (b) the yield to maturity.
3. A recent advertisement offers a two-year subscription to a magazine for $20. If a one-year subscription costs $11 and you can invest your money at an interest rate of 9 percent, would you save
2. Based on your results in problem 1, graph the relationship between the interest rate and the present value of $20,000 received in five years.
1. Suppose you plan to purchase a new house at the end of five years. How much would you have to deposit in the bank to¬ day to have enough for the $20,000 down payment if the interest rate is (a) 1
Suppose you read that the growth in Beta Company’s earnings will be lower than expected. Looking at the stock market—the secondary market in stocks—and assuming other things remain the same,
Suppose a firm’s earnings were $5 million last year. There are 5 million shares of the company’s stock outstanding, and the market interest rate is 4 percent. Determine the price of a share of
(a) Determine the impact of an increase in inflationary expectations on interest rates and bond prices, (b) Suppose the government passed a law that exempted interest income from federal taxes but
Assuming the market interest rate is 9 percent, determine the price and yields of the following: (a) a $10,000 Treasury bill that matures in one year and (b) a $1,000 corporate bond that has a coupon
Your uncle plans to purchase a $50,000 Mercedes Benz when you graduate three years from now. If the interest rate is 5 percent, how much will he have to deposit in the bank today to be able to
15. What practices do banking supervisory agencies undertake to mitigate the situa¬ tion in problem 14?
14. Explain how deposit insurance can actu¬ ally increase the likelihood that a troubled bank will fail.

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