1. Explain the problems of adverse selection and moral hazard. How financial intermediaries can reduce these problems?

2.

(a) Why are people willing to hold money even if it is not the most attractive store of value compared to other types of assets? (2 marks)

(b) Which of the Bank of Canada's measures of the monetary aggregates - M1+ or M2+ - is composed of the most liquid assets? (2 marks)

(c) If an individual moves money from a chequing account to a money market mutual fund, how does this affect the M1+ money supply and M2+ money supply? (2 marks)

(d) If an individual moves money from a chequing account to a money market mutual fund, how does this affect the M2+ money supply and M2 money supply?

3. If the interest rates is 20%, what is the Present Value of a security that has a face value of $8640, maturing in 3 years, and pays out $1800 a year from now, $2160 two years from now, and $2592, three years from now? The face value will be paid at the end of the maturity.

4.

Suppose you are faced with the option of purchasing Asset A: a five-year Treasury note with a $1,000 face value and a 5% coupon rate.

a. Calculate the coupon payment you receive if you purchase this five year Treasury note (Asset A). (2 marks)

b. Assume the yield to maturity of Asset A, the Treasury note, equals 4%. Compute the price of this five-year Treasury note. [Hint: Use the coupon payment calculated in part (a) above and the yield to maturity to find the present value of the entire stream of payments.] (4 marks)

c. Suppose that the yield to maturity rises from 4% to 6%. Calculate the new price of the five-year Treasury note. (4 marks)

d. Given your answer to part (b) and (c), what do you notice about the correlation between the price of the bond and the yield to maturity?

5. Explain why the effect of increased money supply on interest rate is ambiguous according to Milton Friedman.