True-False Questions 1. The abolition of the Interest Equalization Tax, Regulation M, the cold war, and the US and UK foreign exchange controls have taken away most of the reasons why euromarkets exist. As a result, we can expect these markets to decline in the near future. 2. Without the US trade deficit, the euromarkets would have developed more slowly. 3. With a floating-rate loan, the bank is free to adjust at every reset date the interest rate in light of the customer's creditworthiness. 4. One of the tasks of the lead bank under a syndicated bank loan is to make a market, at least initially. 5. The purpose of using a paying agent is to reduce exchange risk. 6. Caps and floors are options on interest rates. Because interest rates are not prices of assets, one cannot price caps and floors using an option pricing model that is based on asset prices. 7. Because euroloans are unsecured, the spread over the risk-free rate is a very reliable indicator of the borrower's general creditworthiness. 8. FRAs are not really a good hedge against future interest rates because one does not actually make the deposit or take up the loan. 9. A note issuing facility forces the borrowing company to borrow at a constant spread, while a revolving underwritten facility gives the borrower the benefit of decreased spreads without the risk of increasing spreads. 10. The fact that eurobonds are bearer securities makes this instrument less attractive to most investors. 1 1. Bond stripping is mostly done with a pair of scissors: you just clip off the coupons. 12. Disintermediation is the cause of the lower creditworthiness of banks, and has lead to capital adequacy rules. 13. Ignoring the small effects of marking to market, the standard quote for a curocurrency futures price is basically a forward price on a CD.ES. On January 2, you signed a six-to-nine FRA for LUF 100m at 10 percent p.a.. Three months later the LIBOR rate for three, six, and nine months are at 8.75, 8.9, and 9.5 percent, respectively. What is the market value of the outstanding FRA?E7. You bought an option that limits the interest rate on a future six-month deposit to at least 10 percent p.a.. If, at the beginning of the six-month period, the interest rate is 11 percent, what is the market value of this option? What is the option's value if the interest rate turns out to be 8 percent?Q5. Matching Questions: Choose from the following list of terms to complete the sentences below: paying agent, managing banks, trustee bank, placing agents, market, lead bank (or lead manager), participating banks, prospectus, gray market, fiscal agent, buy forward. underwrite, lead manager, red herring. A consortium (or syndicate) that extends a euroloan consists of many banks that could play different functions. In a euroloan, the (a) negotiates with the borrower for tentative terms and conditions, obtains a mandate, and looks for banks that provide the money or undertake to provide the money if there is any shortfall in funds. The banks that provide the actual funding are called (b). Because, at the time of the negotiations, the funding is not yet arranged, the (c) often contacts a smaller number of (d) banks who (e) the loan, that is, guarantee to make up for the shortage of funds if there is any such shortfall. The (f), finally, is the bank that receives the service payments from the borrower and distributes them to the participating banks. Placement of eurobonds is most often via a syndicate of banks or security houses. The lead bank or (g) negotiates with the borrower, brings the syndicate together, makes a (h) (at least initially), and supports the price during and immediately after the selling period. There are often, but not always, (D) that underwrite the issue and often buy part of the bonds for24. Suppose Congress wishes to reduce the budget deficit by reducing government spending. Use the /S- LM model to illustrate graphically the impact of the reduction in government spending on output and interest rates. Be sure to label: i. the axes; ii. the curves; ill. the initial equilibrium values; iv. the direction the curves shift; and v. the terminal equilibrium values. 25. The monetary transmission mechanism in the IS-LMmodel is a process whereby an increase in the money supply increases the demand for goods and services: Aj directly. B) by lowering the interest rate so that investment spending increases. C) by raising the interest rate so that investment spending increases. D) by increasing government spending on goods and services. 26. One policy response to the U.S. economic slowdown of 2001 was a tax cut. This policy response can be represented in the /S-LMmodel by shifting the _ curve to the A) LM right B) LM, left C) IS; right D) IS; left 27. A given increase in taxes shifts the /Scurve more to the left the: A) larger the marginal propensity to consume. smaller the marginal propensity to consume. larger the government spending. D) smaller the government spending. 28. If the short-run /S-LMequilibrium occurs at a level of income above the natural rate of output, in the bng run the will in order to return output to the natural rate. A) price level; increase interest rate; decrease money supply; increase consumption function; decrease 29. It MPC= 0.75 (and there are no income taxes but only lump-sum taxes) when 7 decreases by 100. then the /S curve for any given interest rate shifts to the right by: A) 100. 200 300 400. 30. If the government wants to raise investment but keep output constant, it should: adopt a loose monetary policy but keep fiscal policy unchanged. adopt a loose monetary policy and a loose fiscal policy adopt a loose monetary policy and a tight fiscal policy. keep monetary policy unchanged but adopt a tight fiscal policy. 31. According to the imperfect-information model, when the price level rises and the producer expects the price level to rise, the producer: A) increases production. B) does not change production. decreases production. hires more workers. Page 4 32. If the equation for a country's Phillips curve is a =.02 - .8(u- .05), where * is the rate of inflation and u is the unemployment rate, what is the short-run inflation rate when unemployment is 4 percent (.04)? A) above 2 percent (.02) B) below 2 percent (.02) C) 2 percent (.02) D) -2 percent (-.02) 33. All of the following are exogenous variables in the big, comprehensive model except the: A) world interest rate labor force. world real interest rate. price level. 34. According to the natural-rate hypothesis, fluctuations in aggregate demand affect output in: A) both the short run and the long run. only in the short run. only in the long run. in neither the short run nor the long run. 35, Assume that an economy is initially at the natural rate of unemployment. a. Use a Phillips curve diagram to illustrate graphically how the inflation rate and unemployment rate change both in the short run and in the long run to an unexpected expansionary monetary policy. b. Use a Phillips curve diagram to illustrate graphically how the inflation rate and unemployment rate change both in the short run and in the long run to the announcement of a credible plan of expansionary monetary policy when people have rational expectations. 36 Assume that the sacrifice ratio for an economy is 4 If the central hank wishes to reduce inflation from 10 percent to 5 percent, this will cost the economy _ percent of one year's GDP.5. [15 pts] What happens to Eyyp, the home-foreign spot exchange rate, in both the short- and long-run? Explain your answer using whatever figures and equations you find suitable