Let us say both ABC Corp. and XYZ Corp. have issued 5-year bonds. Even though the maturities of both bonds are same, the bond of ABC has higher yield than XYZ. XYZ issued bond is more liquid and less risky. What theory can explain the higher yield of ABC term structure or risk structure? Explain. (5 points)

7. Suppose there are two types of borrowers in the market good quality borrowers and bad quality borrowers. The good quality borrowers are willing to pay 3% interest rate, whereas the bad ones do not mind borrowing at a higher rate of 5%. Who would ultimately get the loans from the banks if the banks cannot differentiate the good quality borrowers from the bad quality borrowers? Why? Is it a moral hazard problem or adverse selection problem? (5 points)

8. State whether a statement is true or false. Then explain why you think the statement true or false.

a. The Fed policy of making interest on reserves down to zero would decrease the federal funds rate. (5 points)

b. For a given level of net profit, higher the bank capital, higher the return on equity. (5 points) c.

A large deposit outflow from the banking system would ultimately decrease the federal funds rate. (5 points)

d. The problem of moral hazard in a contract becomes a concern before the problem of adverse selection occurs. (5 points) e.

The yield to maturity and the interest rates are same. (5 points)

f. Interest rates and the rate of return are the same concept with two different names. (5 points)