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money banking financial markets

Questions and Answers of Money Banking Financial Markets

In 1991, the prime interest rate was 8.46 percent. Between December 31, 1990, and December 31, 1991, the price level increased from 112.87 to 116.98. What was the real prime interest rate in 1991?
Recall that T-bills are zero coupon bonds issued by the federal government that are sold at a discount. Suppose a T-bill with a maturity of one year and a face value of $10,000 is offered for sale at
Suppose you invest $2,000 today at an interest rate of 10 percent. How much will you have in 10 years?
In 1980 the price level was 71.73, Ml was $397.9 billion, and nominal output was $2,708 billion. In 1981 the price level increased to 78.88 and Ml increased to $426.8 billion, (a) Assuming the base
15.Why are credit cards not included in any of the definitions of the money stock pre¬ sented in this chapter?
14. Suppose the economy has $100 million in currency, $50 million in demand deposits, $150 million in savings deposits, $25 mil¬lion in Eurodollars, and $75 million in Treasury securities. Determine
13. Which of the monetary aggregates con¬ tains only those financial instruments that serve as media of exchange?
12. Why are municipal bonds attractive to in¬ dividuals and corporations with high in¬ comes or profits?
11. A 30-year ARM with an initial interest rate of 8 percent, a 2 percent margin, a 15 percent ceiling, a 7 percent floor, and a 3- percent-per-year cap is available. The cur¬ rent interest rate
10. Explain the terms of an 8 percent, 30-year fixed-rate mortgage that requires 10 per¬ cent down and 2 points to a person wish¬ ing to buy a $200,000 house.
9. If a corporation needs short-term funds, does it obtain the funds in the money mar¬ ket or in the capital market?
8. “Federal funds are dollars loaned to banks by the Federal Reserve at the fed¬ eral funds rate.” Is this statement true or false? Explain.
7. Explain how a banker’s acceptance differs from an ordinary bank draft.
6. As we move toward a more global econ¬ omy, would you expect Eurodollars to be¬come more important sources of funds for banks? Why or why not?
5. Rank the following financial instruments from most liquid to least liquid.(a) . A $1 bill(b) . A share of IBM stock(c) . A municipal bond issued by a small town in Alaska(d) . A U.S. Treasury bill
4. How do depository financial institutions differ from nondepository institutions?
3. Critically evaluate and interpret the fol¬ lowing statement: “Since firms do not re¬ ceive money when their stock is sold in the secondary stock market, they would benefit from the elimination
2. Critically evaluate and interpret the fol¬ lowing statement: “Since corporate bond¬ holders do not own a share of the under¬ lying company, they don’t care whether the company earns profits
1. How are financial intermediaries similar to supermarkets? How do they differ?
What is the primary difference in the monetary aggregates Ml, M2, M3, and L?
For each of the following transactions, determine (1) the type of financial instrument and (2) whether the trade occurred through direct finance, a primary market transaction, or a secondary market
Would you think commercial banks’ or life insurance companies’ assets are more liquid? Why?
Is the market for used cars a primary or a secondary market? How are financial brokers similar to car dealers? How do they differ?
15. Can something serve as money without serving as the unit of account? (Hint: How many checks does it take to buy a shirt? A suit? A house?)
14. “U.S. dollars are backed by the gold in Fort Knox, Kentucky.” Is this statement true or false? Explain.
13. Is one dollar or one dollar’s worth of gold more valuable? Explain carefully.
12. What is the difference between full-bodied money and representative full-bodied money? Between representative full- bodied money and fiat money?
11. Explain how the banking system reduces transactions costs. Are there any other ad¬ vantages to the banking system? Are there any disadvantages?
10. Explain why money reduces transactions costs. Are there any other advantages to a monetary economy? Are there any disad¬ vantages?
9. In the example of fractional reserve bank¬ ing presented in the chapter, the bank de¬ cided to keep only 20 percent of its lia¬ bilities in reserve. What would the final T-account look like if
8. Your brother-in-law wants to borrow $1,000. Relationship aside, why might you prefer to deposit the $ 1,000 in a sav¬ ings and loan and have your brother-in- law borrow the funds there instead of
7. What would happen to your bank if all depositors showed up at 9:00 a.m. next Thursday and demanded payment for their deposits?
6. In the early days of banking, goldsmiths promised to pay a specified quantity of gold to anyone presenting a bank note or an endorsed check at their place of busi¬ ness. What does your bank
5. How would your answers to Problem 4 change if you lived in London, England?
4. Suppose you live in Llano, Texas, a small town with a population of 2,500. Rank the following assets from most liquid to least liquid, and explain why you ranked them as you did.(a) . One hundred
3. Discuss the advantages and disadvantages of using the following commodities as money.(a) . Bricks(b) . Wine(c) . Com(d) . Pearls(e) . Platinum(f) . Uranium
2. On the island of Maka, the government has been unable to control the counterfeit¬ ing of its bills. Consequently, individuals and merchants rely almost exclusively on barter as a means of
1. Look up the definition of money in your dictionary. Does this definition agree with an economist’s definition? Why or why not?
How did bank loans evolve?
Do modern-day checks satisfy the desired properties of money?
Determine whether the following episodes involve full-bodied money, rep¬ resentative full-bodied money, or fiat money: (a) During World War II, prisoners of war used cigarettes as the medium of
Credit cards are often used to pay for items purchased at retailing outlets. Are credit cards “money”?
Most dictionaries include variations of one or more of the following definitions of money: (1) portable pieces of metal used as a medium of exchange; Most dictionaries include variations of one or
Consider again the bet in Example 21.3. Suppose the bet is S - $106.184 if the price is above $106.184, and $106.184S if the price is below $106.184. What is the value of this bet to each party?
a. In this bet, note that $106.184 is the forward price. A bet paying $1 if the share price is above the forward price is worth less than a bet paying $1 if the share price is below the forward
Consider Joe and Sarah's bet in Examples 21.2 and LO.1
Verify that e-r(-1) N(d2) satisfies the Black-Scholes equation. LO.1
Verify that S(t)e-8(T-1) N(d) satisfies the Black-Scholes equation. LO.1
Assuming that the stock price satisfies equation (20.27), verify that Ke-r(T-1) + S(t)e (T-1) satisfies the Black-Scholes equation, where K is a constant. What is the boundary condition for which
Use the Black-Scholes equation to verify the solution in Chapter 20, given by Proposition 20.3, for the value of a claim paying S. LO.1
Assume So www.www $100, r = 0.05, _ 0.25, _ 0, and T 1. Use Monte Carlo valuation to compute the price of a claim that pays $1 if ST > $100, and 0 otherwise. (This is called a cash-or-nothing call
For stocks 1 and 2, S Let r 0.08, 1 wwwwww. $40, S $100, and the return correlation is 0.45. 0.30, 2 = 0.50, and 81 82 0. Generate 1000 1-month prices for the two stocks. For each stock, compute the
Assume that the market index is 100. Show that if the expected return on the market is 15%, the dividend yield is zero, and volatility is 20%, the probability of the index falling below 95 over a
If x ~N(2, 5), what is E(e)? What is the median of e"? LO.1
Suppose x ~ N(1, 5), x2 xi ~ N(2, 3) and x3 N(2.5, 7), with correlations P1,2 = 0.3, P1.3 = 0.1, and 023 = 0.4. What is the distribution of x1 + x2+x3? x1 + (3 2) + x3? x1 + x2 + (0.5 x3)? LO.1
Suppose x ~ N(2, 0.5), and x2 ~N(8, 14). The correlation between x and x2 is 0.3. What is the distribution of x1 + x2? What is the distribution of X1 X2? LO.1
Suppose x ~N(1, 5) and x2 ~N(-2, 2). The covariance between x and x2 x1 is 1.3. What is the distribution of x1 + x2? What is the distribution of x1 - x2? LO.1
You draw these five numbers from a standard normal distribution: (-1.7, 0.55, -0.3, -0.02, .85). What are the equivalent draws from a normal distribution with mean 0.8 and variance 25? LO.1
You draw these five numbers randomly from a normal distribution with mean -8 and variance 15: (-7,-11, -3, 2, -15). What are the equivalent draws from a standard normal distribution? LO.1
Select a stock or index and obtain at least 5 years of daily or weekly data. Estimate the annualized mean and volatility, using all data and 1 year at a time. Compare the behavior of your estimates
Consider Prob(S, < K), equation (18.23), and E(S,|S, < K), equation (18.28). Verify that it is possible to pick parameters such that changes in t can have ambiguous effects on Prob(S, < K)
Let KT = Soe". Compute Prob(ST < KT) and Prob(ST > K7) for a variety of T's from 0.25 to 25 years. How do the probabilities behave? How do you reconcile your answer with the fact that both call and
Let t www.www. 1. What is E(S,[S, < $98)? What is E(S,|S, < $120)? How do both expectations change when you vary from 0.05 to 5? Let = 0.1. Does either answer change? How? : LO.1
What is Prob(S, < $98) for t = 1? How does this probability change when you change t? LO.1
What is E(S,|S, > $105) for t = 1? How does this expectation change when you change t, , and r? LO.1
What is Prob(S, > $105) for t = 1? How does this probability change when you change t? How does it change when you change ? LO.1
Consider Panels B and D in Figure 16.4. Using the information in each panel, compute the share price at each node for each bond issue. LO.1
Using the assumptions of Example 16.3, suppose you were to perform a "naive" valuation of the convertible as a risk-free bond plus 50 call options on the stock. How does the price you compute compare
In the absence of an explicit formula, we can estimate the change in the option price due to a change in an input-such as -by computing the following for a small value of : Vega = BSCall(S, K, +, r,
b. Compute the Black-Scholes price of a call for which S = $100 e-0.03x0.75, K = $95 e -0.080.75 0.3, T 0.75, 8 = 0, r = 0. How does your answer compare to that for (a)? LO.1
Suppose S = $100, K = $95, = : 30%, r = 0.08, Sa. Compute the Black-Scholes price of a call. 0.03, and T _ : LO.1
a. What is the price of a 105-strike call option with 1 year to expiration?b. What is the 1-year forward price for the stock?c. What is the price of a 1-year 105-strike option, where the underlying
Suppose XYZ is a nondividend-paying stock. Suppose S = $100, = 40%, 8 = 0, and r LO.1
Obtain at least 5 years of daily data for at least three stocks and, if you can, one currency. Estimate annual volatility for each year for each asset in your data. LO.1
Obtain at least 5 years' worth of daily or weekly stock price data for a stock of your choice.a. Compute annual volatility using all the data.b. Compute annual volatility for each calendar year in
Suppose S = $100, K = $95,8% (continuously compounded), t = 1, = 30%, and 8 = 5%. Explicitly construct an 8-period binomial tree using the lognormal expressions for u and d: (r8.50)h+oti u = e
11.16. Suppose S = $100, K = $95, r = 8% (continuously compounded), t = 1, = 30%, and 8 = 5%. Explicitly construct an 8-period binomial tree using the Cox-Ross-Rubinstein expressions for u and d: Un
Compute the 1-year forward price using the 50-step binomial tree in Prob- lem LO.1
a. Using S = $100, r = 0.08, and 8 = 0, what are the 4-month, 8-month, and 1-year forward prices?b. Verify your answers in (a) by computing the risk-neutral expected stock price in the first, second,
We saw in Section 10.1 that the undiscounted risk-neutral expected stock price equals the forward price. We will verify this using the binomial tree in Fig- ure LO.1
Repeat the previous problem for n = 50. What is the risk-neutral probability that S < $80? S > $120? LO.1
Let S = $100, = 0.30, r = 0.08, t = 1, and 8 0. Using equation (11.17) to compute the probability of reaching a terminal node and Su'd"-i to compute the price at that node, plot the risk-neutral
Using the information in Table 8.9, verify that it is possible to derive the 8- quarter dollar interest swap rate from the 8-quarter euro interest swap rate by using equation (8.9). LO.1
Using the information in Table 8.9, what are the euro-denominated fixed rates for 4- and 8-quarter swaps? LO.1
Using the assumptions in Tables 8.5 and 8.6, verify that equation (8.9) equals 6%. LO.1
What 8-quarter dollar annuity is equivalent to an 8-quarter annuity of 1? LO.1
Using the zero-coupon bond yields in Table 8.9, what is the fixed rate in a 4-quarter interest rate swap? What is the fixed rate in an 8-quarter interest rate swap? LO.1
What is the fixed rate in a 5-quarter interest rate swap with the first settlement in quarter 2? LO.1
Using the zero-coupon bond prices and natural gas swap prices in Table 8.9, what is the implicit loan amount in each quarter in an 8-quarter natural gas swap? LO.1
Using the zero-coupon bond prices and natural gas swap prices in Table 8.9, what are gas forward prices for each of the 8 quarters? LO.1
Given an 8-quarter oil swap price of $20.43, construct the implicit loan balance for each quarter over the life of the swap. LO.1
Using the information in Table 8.9, what is the swap price of a 4-quarter oil swap with the first settlement occurring in the third quarter? LO.1
Using the information about zero-coupon bond prices and oil forward prices in Table 8.9, construct the set of swap prices for oil for 1 through 8 quarters. LO.1
a. Suppose that ro(1, 2) = 6.8%. Show how buying the 2-year zero-coupon bond and borrowing at the 1-year rate and implied forward rate of 6.8% would earn you an arbitrage profit.b. Suppose that
Consider the implied forward rate between year 1 and year 2, based on Table LO.1
What is the rate on a synthetic FRA for a 90-day loan commencing on day 90? A 180-day loan commencing on day 90? A 270-day loan commencing on day 90? LO.1
Using the same information as the previous problem, suppose the interest rate on the borrowing date is 7.5%. Determine the dollar settlement of the FRA assuminga. Settlement occurs on the date the
Using the information in Table 7.1,a. Compute the implied forward rate from time 1 to time 3.b. Compute the implied forward price of a par 2-year coupon bond that will be issued at time 1. LO.1
Using the information in the previous problem, find the price of a 5-year coupon bond that has a par payment of $1,000.00 and annual coupon payments of $60.00. LO.1
Using Table 6.10, what is your best guess about the current price of gold per ounce? LO.1

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