Eco812 answer all questions
Practice Final 1) Suppose that the demand for loans depends on the annual interest rate charged (r,). Each loan is a $100,000, 30 year fixed APR mortgage. Q =150-700r, The bank has a monthly fixed cost of $12,000 plus an annual variable cost (interest paid on deposits plus various administrative expenses equal to 4% of the loans created) a) Solve for the profit maximizing interest rate. What are the banks monthly profits? b) Calculate the interest elasticity of loan demand at the profit maximizing point. c) Suppose that the banks cost of funds rose from 4% of loans to 6% of loans. Calculate the new profit maximizing point? d) Suppose that the bank's fixed cost rose to $15,000. How would this influence the bank's decision? 2) Suppose that you are the manager of a bank. Your balance sheet is as follows: Assets Liabilities Cash/Reserves: $10,000 Checking Accounts: $100,000 15 Year Mortgages: $150,000 5 Year CDs: $200,000 30 Year Mortgages: $200,000 10 year CDs: $300,000 The reserve requirement is 6% while the equity capital requirement is 4% of non-cash assets. a) Calculate the bank's equity capital. b) Is the reserve requirement satisfied? c) Calculate the bank's duration gap. If the bank remains un-hedged, how much of an interest rate change could the bank withstand before it is undercapitalized? 2) Suppose that the Federal Reserve is maintaining a fed funds target of 2%. Explain how the fed would need to respond (i.e increase or decrease the money supply) to the following events. a) GDP is projected to increase by 3%. b) Inflation is higher than previously expected. c) Electronic banking allows households to carry less cash. d) What tools does the Fed have at its disposal to alter the money supply? 3) Suppose that the Federal Reserve is following a policy of maintaining full employment. How would the Fed need to respond to the following events? a) Consumer confidence drops by 5% (consumer confidence is a measure of the average household's feelings about the economy) b) President Bush offers a $2000 per person tax cut. c) High oil prices causes firms to layoff workers and scale back planned investment expenditures. d) Some FOMC members have advocated an inflation rule. That is, they would like the Fed to commit to maintaining a constant inflation rate. Is this a good idea? Why or why not?3.1. 3.2. 3.3. Consider Figure l, a graph of the yield spread, in percentage points. Explain why we observe this pattern ofspreads. Figtlot:EtaanimnAaa corporate yield. Soiree: Moody's via St. Lou's Fed. 1971] 1W5 ISIID 1955 1990 1995 21110 2005 Consider the corporate bonds associated with Ford Motor Company. If the U.S. Government were to declare that it would ensure that Ford would not go bankrupt, what would happen to yields on Ford Motor Company bonds? Use diagrams to explain what happens. Assume the expectations theory of the terrnstnicture is correct. Draw the yield curves (at 1,3 and 5 years} for the following series ofone year interest rates: a) .04, .05. .06, .05, .04 b} .04, .01, .02, .03, .04 (Where the interest rates are expressed in decimal form,i.e.,15% =0.15}. Suppose in case (b), igjmnped by .02 (2 percentage point), while i,remained constant. Can you say when and by how much future expected short term interest rates changed? Why or why not? Returning to the gures given to you in part 3.1., suppose to: 0,173,: .01, and t5, = .02. Recalculate the yield curves. 4. Consider the Figure 2, a graph of yield curves on September 2?, 2005. Compare it against Figure 3, a graph of the yield curves on September 22, 2006. 4.1 What has happened at the shor1 end (3 n'tonth), 5 year, 10 year and 20 year manu'ities. relative to September 27, 2005'? Fugue 3: Yield Dans M2105. Source: Bleacher-g. 4.2. Can you explain economically why the slope of the yield curve has changed since one year ago? Problem Set 3 Due in lecture on Monday, October 30th. No late submissions will be accepted. Make sure your name is on your problem set, as well as the name of your (official) TA. 1. Consider the following information, drawn from the Economist, October 21-27 issue. Money supply' Interest rates % p.a. (Oct 18th 2006) % change on year ago 3-mth money market 2-year 10-year gov't bonds corporate narrow broad latest year ago gov't bonds latest year ago bonds Australia +10.2 +11.2 Aug 6.28 5.62 6.06 5.71 5.40 6.87 Britain 5.0 +13.7 Aug 5.08 4.53 5.02 4.64 4.37 5.69 Canada +13.6 + 6.9 Aug 4.16 3.03 4.04 4.15 4.10 5.30 Denmark + 8.2 + 7.4 Aug 3.62 2.20 3.73 3.78 3.18 5.14 Japan + 1.5 + 0.6 Sep 0.34 0.02 0.77 1.79 1.50 1.99 Sweden + 0.1 +13.7 Aug 2.56 1.4 3.36 3.69 3.13 3.85 Switzerland - 2.4 + 1.6 Sep 1.85 0.80 2.00 2.48 1.96 2.59 United States - 1.1 + 4.4 Sep 5.24 3.95 4.85 4.76 4.46 5.75 Euro areat + 7.2 + 8.2 Aug 3.51 2.19 3.66 3.77 3.23 4.41 *Narrow: M1 except Britain notes and coin and Sweden MD, broad: M2 or M3 except Britain Me. fGermany for bonds. Benchmarks: US 30-year 4.91%, Japan No. 282 1.80%. Central bank rates: US fed funds 5.25%, ECB refinancing 3.25%, 803 overnight call 0.25%, BOE repo 4.75%. Sources: Bank of Canada, Commerzbank, Danske Bank, Global Insight, JPMorgan Chase, Lehman Brothers, Stockholmsborsen, UBS, Westpac, Thomson Datastream. Rates cannot be construed as banks' offers. Trade balance", son Current account balance Exchange rate Currency units Budget Latest 12 The Economist poll trade weighted! per months latest 12 maths of GDP, forecast 2000-100 eure of cop 2004 Oct 18th your age Oct 1ath year ago Australia 10.6 Aug - 5.6 - 5.1 118. 112.9 1.33 1.33 2.48 1.11 Austria 1.6 Jud + 0.8 + 18 106 09 105.1 0.80 0.83 0.67 - 1.9 Belgium 15.9 Aug 6.5 Jun # 1.8 + 20 107.61 106.8 0.80 0.83 0.67 -0.4 Britain 142.D AUE 14.4 08 - 10 102-2 0.54 0.ST 0.45 - 1.4 Canada 57.8 Aug 24.6 62 # 1.5 $ 10 127_2 121.4 1.14 1.18 2.12 1.42 0.95 . 2.2 Denmark 7.9 Aug 7.0 Aug + 1.9 + 18 1056 105.8 5.96 6.23 11.1 5,00 France 35.0 Aug - 39.8 Aug - 1.8 108.54 107 .5 0.80 0.83 1.40 0.67 - 2.9 Germany # 185.9 Aug +101.5 Aug - 1.1 Italy 25.5 Aug - 34.3 Jul - 1.8 - 1.7 107.1. 0.80 0.83 1.49 0.63 -4.2 Japan + 78.9 Aug +106-9 Aug + 3.5 79.3 83.2 119 116 149 -5.2 Netherlands 38.2 Aug 4 46.2 62 # 6.3 108.54 107 .5 0.80 0.83 0.67 -0.5 Spain -104.8 0.8.3 # 1.1 Sweden 19.7 Aug # 6.5 97-9 94.6 7.40 7.89 13.8 6.22 #1.7 Switzerland Sep 02 +140 104.5 106.3 1.27 1.30 2.38 1.59 1.07 United States -850.9 Aug - 6.6 - 6.6 85.0 36.6 1.87 1-25 0.84 -3.6 Fur area 24.6 AUD 17-3 Jul - 0.A - .a 1.49 -2.3 MORE COUNTRIES Data for the countries below are not provided in printed edition of The Feunoise Finland 11.1 A Aug 109 24 108.. 0.80 0.83 1:49 + 2.2 Greece - 39.5 Jud 25.1 Jul 19 105 09 104. 0.80 0.83 1.49 0.67 -3.0 Iceland 1.9 Aug 100.9 68.2 127 $7.3 $2.0 Ireland 10.1 J.4 6.0 02 113-86 112.4 0.80 1,49 0.67 Lomeinbourg 107 64 106.8 0.80 0.83 1.49 0.67 -1.7 New Zealand 4.4 Aug - 10.2 62 19 131-6 139.4 1.51 1.43 1-89 +4.6 Herway 4 50.8 Sep 56.5 02 10343 112.1 6.78 6.51 13.7 5.60 18.5 Portugal 105,0"# 105.0 0.80 1,49 0.67 - 5.0 "Merchandise. Australia, Britain, France, Canada, Japan and Whited States Inparts Mob, exports fob. All others cryfat. Bank of England exige Mit, August average. FORCD forecast. :"DIF, Juma average. 1.1 Using the Interest Parity Condition, calculate the expected annual rate of depreciation (or appreciation) of the US dollar against the UK pound over the next two years. 1.2 What is the exchange rate (UK pound per US dollar) expected one year from now, assuming the interest parity condition holds
