A. For each of the following four statements, indicate whether the given statement is true, false, or uncertain. You will need to provide an explanation for your choice for each statement.

(i) Units of a mutual fund, held by investors represent debt of the mutual fund to the investors.

(ii) If the nominal interest rate rises from 4% to 8%, and simultaneously the expected rate of inflation rises from 2% to 4%, then corporations will raise less funds by issuing bonds. (iii) Selling wheat futures contracts to hedge against the price risk of wheat is not always economically beneficial to the seller of the wheat.

(iv) Off balance sheet activities of a bank do not create any risk to the bank.

B. At a given point of time, the ask price of a dealer in a financial security is always higher than his/her bid price. Explain how a dealer can still incur a loss in his/her business.

C. Why does diversification create only a partial hedge not a full hedge against risk of the portfolio? Explain.

D. What are the benefits and costs for a bank when it decides to increase the amount of its equity?