Questions and Answers of Economics Of Money Banking And Financial Markets

For potential lenders, investigating borrowers’ trustworthiness is costly. This problem, known as asymmetric information, occurs both before and after a transaction.a. Before a transaction, the
Financial intermediaries can manage the problems of adverse selection and moral hazard.a. They can reduce adverse selection by collecting information on borrowers and screening them to check their
Describe a commercial bank’s assets and liabilities.
Define bank capital and key measures of bank profits and returns.
Identify the types and sources of bank risk and explain how to control them.
Consider a bank with the following balance sheet, as shown on the next page.You read online that the bank’s return on assets (ROA) was 1 percent. What were the bank’s after-tax profits? Bank
Based on the following information about Banks A and B, compute for each bank its return on assets (ROA), return on equity (ROE), and leverage ratio.a. Bank A has net profit after taxes of $1.8
Why are checking accounts no longer the primary source of funds for commercial banks in the United States?
Explain how a bank uses liability management to respond to a deposit outflow.Why do banks prefer liability management to asset management in this circumstance?
A bank with a two-year investment horizon has issued a one-year certificate of deposit for $50 million at an interest rate of 3 percent. With the proceeds, the bank has purchased a two-year Treasury
In response to changes in banking legislation, recent decades have seen a significant increase in interstate branching by banks in the United States. How do you think a development of this type would
Consider the balance sheets of Bank A and Bank B. Suppose that reserve requirements are 10 percent of transaction deposits and both banks have equal access to the interbank market and funds from the
Suppose you operate a bank in a country where the central bank is expected to embark on a series of interest rate increases. Based on gap analysis, would this scenario be more likely to hurt or help
Cyber risk has been recognized as a growing source of operational risk for financial institutions. Why might managing this risk at an individual firm level not be adequate?
Bank assets equal bank liabilities plus bank capital.a. Bank assets are the uses for bank funds.i. They include reserves, securities, and loans.ii. Over the years, commercial and industrial loans
Banks face several types of risk in day-to-day business. They include:a. Liquidity risk—the risk that customers will demand cash immediately.i. Liability-side liquidity risk arises from deposit
Explain the structure, current trends, and future prospects of the banking industry.
Discuss the functions and characteristics of non depository institutions.
How do you think a well‐functioning financial system serves to improve economic well‐being?
How does the life cycle of earnings and spending result in the household sector’s being a net supplier—or surplus unit—of funds to the financial system? Are all households suppliers of funds at
How does the profit maximization condition imply that business investment will move inversely with the level of interest rates?
How would a balanced budget amendment to the U.S. Constitution affect the demand for funds by deficit spending units? What would happen to the level of interest rates in the United States?
If the amount of savings outside the United States were to shrink, how would this affect conditions in the U.S. financial system? Interest rates in the United States?
How does a reliable, efficient payment system affect the level of economic wellbeing in the United States?
What is the current slope of the Treasury yield curve—flat, upward sloping, or downward sloping?
What is the current value of the British pound? Euro? Japanese yen? (All measured against the U.S. dollar.)
What is the price/earnings (trailing) for Cisco Systems?
What was the amount of securities held outright by the Federal Reserve in the most recent week?
What was the volume of securities lent by the Federal Reserve in the most recent week?
What is the level of the yield on the three‐month Treasury bill? The 10‐year Treasury note?
Chart the level of the 10‐year Treasury note from January 1970 to the current period. (Hint: Use the FRED database.) What has been the recent trend? Identify the period of the highest levels of
What was the most recent interest rate on 10‐year interest rate swaps?
What is the actual level of the federal funds rate? The target level?
What is meant by a fiduciary institution? In this regard, is a sporting goods store comparable to a financial institution? Is Bernard Madoff a good example of a fiduciary?
What is the significance of the legal and payments infrastructure for the functioning of the financial system? The economy?
List and describe three financial instruments that are issued in direct forms of finance. How are each of these placed with investors?
Look for a recent IPO of stock. Who was the underwriter? What was the pricing of the shares? How did they fare in subsequent (secondary market) trading?
List and describe three types of financial institutions that provide indirect forms of finance. How does each intermediary transform claims?
Do both primary and secondary markets transfer resources from surplus to deficit units? Why or why not? Money and capital markets? Why or why not?
What are the implications of asymmetric information for direct or indirect forms of finance?
What is moral hazard? How does it relate to asymmetric information? How does adverse selection relate to asymmetric information?
Look for recent stories in the financial press about private equity funds or hedge funds. Explain the transactions that are being discussed and how this relates to the basic objective of the fund.
What is the difference between mutual funds and hedge funds? Are the investors in each the same?
Contrast the economic function of hedge funds, private equity funds, and venture capital funds. In other words, how does each create economic value added and how does this differ from the others?
Explain the relationships among corporate shareholders, boards of directors, and managers? Why has such a system of governance proven to be essential for efficiency?
Explain what happens to an order to buy shares of stock in an OTC system. A specialist system. An electronic communications system. What is the role of the broker in this transaction?
What is the difference between a securities dealer and a securities broker? How do they differ from a securities underwriter?
If a commercial bank were to face a loss on an asset (its value drops), what are the implications for shareholder net worth?
What distinguishes cash and securities on a bank’s balance sheet from loans? Retail deposits from wholesale deposits?
What is meant by shocks hitting commercial bank balance sheets? How do banks deal with these?
How does a reliable, efficient, and low‐cost payment system affect overall economic well‐being?
How did coins lower transactions costs when they were first introduced?
What are the advantages to governments of issuing their own notes (typically through their central banks)? How is seigniorage earned?
What is meant by a payment instruction? How are they submitted to banks?
What does “netting” in the context of the payment system mean? What is the role of a clearinghouse? How are net balances settled between banks?
Why might a measure of aggregate transaction balances be regarded as useful for a central bank for monetary policy purposes? What is the label given to this measure? What is the label given to a
Using the FRED website, chart the level of M1 and M2. Chart 12‐month growth rates for each. What might you infer about the performance of the economy based on these growth rates?
What is meant by commercial banks providing liquidity to the financial system, businesses, and households? What role is played by lines of credit in this process? What is a line of credit offered by
How do commercial banks address the problem of asymmetric information?How do you suppose they get remunerated for their efforts?
How does maturity transformation pose risks for commercial banks? Does it make any difference whether the bank’s assets have longer or shorter maturities than its liabilities? Is one more risky
What is the safety net provided to the commercial banking system? How might this be related to moral hazard? In this regard, what is the role of regulatory policy?
What is meant by “shadow banking”? How has it posed systemic risk concerns?Do regulatory authorities have authority to deal with problems caused by shadow banks?
A zero‐coupon security pays $100,000 in 8 years. What is the current price of this security if the current interest rate is 4 percent? The current interest rate is 7 percent? What is the percent
A 5‐year Treasury note has a coupon rate of 2.50 percent. What price would you pay for such a security having a principal (par value) of $1 million if the current interest rate is 2.25 percent? The
What is the current price of a security that pays its owner $1,000 per year into perpetuity if the interest rate is 5 percent? The interest rate is 8 percent? What is the percent change in its price
What is the value of $1,000 in 1 year if the current interest rate is 5 percent? The current interest rate is 8 percent? What is the percent change in its price when the interest rate goes from 5 to
You negotiate the price of a new Toyota to be $26,062, including taxes and tags.You put $5,000 down and borrow the rest at an interest rate of 6 percent for 5 years. What will be your annual payment
You win the $1 million lottery and must decide whether to take $1 million in 10 years or $500,000 today. Which would you choose if the interest rate is 5 percent? The interest rate is 10 percent?
A 10‐year Treasury note has a coupon rate of 2.75 percent. The current price of this note is $102. Explain how you would go about calculating the yield to maturity on this note. Will the current
Using Bloomberg, what is the current price and yield on a 30‐year Treasury bond? Is the bond selling above or below par? Is the yield to maturity (current yield) above or below the coupon rate?
Using Bloomberg, what is the current real interest rate on a 30‐year Treasury bond? Inflation compensation?
Under what conditions is an investor exposed to interest rate (or price) risk?Reinvestment (rollover) risk?
What is the duration of a three‐year Treasury note with a coupon rate of 3 percent if the note is selling for par? What is its duration if the current yield to maturity is 10 percent? (Assume only
How will an increase in perceived credit risk on a risky bond affect its price? Its yield? How will it affect the price and yield of a riskless bond?
What is the role of credit rating agencies? What economic problem do they address?How does the yield on a C‐rated bond differ from that of a Aaa‐rated bond? Which is the highest and why?
How does the spread between a Caa‐rated bond over a Aaa‐rated bond vary over the business cycle? Why? A Aaa‐rated bond over a comparable maturity Treasury security?
What is a speculative‐grade bond? How does it differ from an investment‐grade bond? What is a “fallen angel”?
How does the yield on an on‐the‐run Treasury security change as it goes off the run? Why does this occur?
How would an increase in marginal federal income tax rates affect yields on muni securities? Treasury yields? Illustrate.
When short‐term interest rates are very low, what is the slope of the yield curve?When short‐term rates are high? Why do these patterns exist?
Under the expectations hypothesis of the term structure, what does a positively sloped yield curve imply for the expected path of short‐term interest rates? A negatively sloped yield curve?
How would your answer to question 9 change under the term premium hypothesis?Data from question 9Under the expectations hypothesis of the term structure, what does a positively sloped yield curve
Which of these two hypotheses can best explain the pattern of yields on different maturities? Explain.
Suppose that the current yield on a five‐year Treasury note is 1.25 percent. What can you say about market expectations of short‐term interest rates over the next five years?
Why has the Federal Reserve frequently mentioned that economic conditions are likely to warrant exceptionally low interest rates for an extended period? What are they trying to achieve through this
What is a forward market?
Suppose that the current yield on a two‐year Treasury note is 1.20 percent and the yield on a three‐year note is 1.44 percent. What is the implicit one‐year forward rate for two years ahead?
Using Bloomberg, what is the shape of the Treasury yield curve? What can you infer about market expectations of the path of the federal funds rate over the next several years?
Using the St. Louis Fed website (FRED), chart the Merrill Lynch High‐Yield (speculative grade) Master II option‐adjusted corporate bond spread. How has it behaved over the business cycle?
If an investor were only concerned about maximizing expected return, would that person select a portfolio of assets or a single asset? If the latter, which asset would that be?
Why do investors hold portfolios of securities instead of a single security? Would a portfolio manager ever consider acquiring a security that, by itself, is very risky? Why or why not? What would
Calculate the expected return and risk (standard deviation of returns) on a portfolio consisting of two assets. Asset 1 has an expected return of 0.09 and a standard deviation of returns of 0.08. For
Should asset 3 be selected for the portfolio discussed in question 3? Its expected return is 0.12 and its measure of risk is 0.20. The correlation between its returns and those of asset 1 is 0, and
What is a security’s beta? Does a high beta make a security attractive or unattractive for a portfolio? A low (or negative) beta? Why or why not?
What is an efficient financial market? A random walk? Does the evidence, on balance, favor market efficiency? Random walks?
Why do many investors seek to acquire an investment portfolio representative of the broad market, such as the S&P 500 index of stocks?
How do securities in foreign markets—stocks and bonds—figure into investment choice? What must be taken into account when considering such foreign assets for a portfolio?
How did Galleon Investment Group consistently achieve above-market returns?
Can you expect to earn extraordinary returns by picking “hot” stocks?
Your friend gives you a hot tip on a stock from a broker. What is the expected return on this stock? Will it exceed or fall short of market returns?

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