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Questions and Answers of Money Banking Financial Markets

An article in the Economist notes that: “From an insurance perspective, the co-payments that patients must sometimes make when receiving treatment are a waste; it would be better for people to be
How is the principal–agent problem related to the concept of moral hazard?
Countries that are above the line in Figure 9.1 have relatively high levels of real GDP per capita for their levels of financial development, and countries that are below the line have relatively low
Consider the possibility of income insurance. With income insurance, if a person loses his job or doesn’t get as big a raise as anticipated, he would be compensated under his insurance coverage.
Why was the Securities and Exchange Commission (SEC) founded? What effect has the SEC had on the level of asymmetric information in the U.S. financial system?
Economist Richard Sylla of New York University has argued that in the 1790s, Treasury Secretary Alexander Hamilton “established the financial foundations that would make the United States the most
Go to the web site of the Federal Reserve Bank of St. Louis (FRED) (fred.stlouisfed.org) and download and graph the data series for the net worth of nonfinancial corporations (TNWMVBSNNCB) from the
List the three key features of the financial system and provide a brief explanation for each.
What is the difference between moral hazard and adverse selection? Explain the “lemons problem.” How does the lemons problem lead many firms to borrow from banks rather than from individual
A 2016 article in the Wall Street Journal notes that banks in China have been experiencing problems with business borrowers defaulting on loans and have had difficulty attracting enough deposits to
Briefly explain why a country without a strong financial system might struggle to achieve high rates of economic growth.
What is the most important method of debt financing for corporations?
Why are financial intermediaries important to the financial system?
What do the World Bank’s data tell us about the relationship between the level of a country’s financial development and the level of its real GDP per capita?
Online brokerages generally charge transaction fees per trade. This means that a $5,000 stock purchase is charged the same fee as a $100 stock purchase. Go to the following online brokerages and
What is the most important source of funds for small to medium-sized firms? What is the most important source of external funds for small to medium-sized firms?
Why do savers with small amounts to invest rarely make loans directly to individuals or firms?
Suppose you are convinced that the value of the Canadian dollar will rise relative to the U.S. dollar. What steps could you take to make a profit based on this conviction?
Suppose that the U.S. firm Halliburton buys construction equipment from the Japanese firm Komatsu at a price of ¥250 million. The equipment is to be delivered to the United States and paid for in
Suppose that the U.S. firm Alcoa sells $2 million worth of aluminum to a British firm. Answer the following questions, assuming that the exchange rate is currently $1.50 = £1 and the British firm
An article in the New York Times discusses the consequences in financial markets of Brexit, the vote in a 2016 referendum in the United Kingdom to leave the European Union: “Investors have dumped
Borrowing at a low interest rate in one currency to lend at a higher interest rate in another currency is sometimes called a “carry trade.” An article in the New York Times observes: “China has
Suppose that the current exchange rate is є1.50 = £1 but it is expected to be є1.35 = £1 in one year. If the current interest rate on a oneyear government bond in Germany is 4%, what does the
An article on the web site of the Financial Times describes Eurodollars as “dollars which somehow escaped the US system.” Briefly explain what the author means.
An article in the New York Times observes that the high value of the yen “is dealing crippling blows to [Japan’s] once all-important export machine.” The article also observes, though, that
According to the theory of purchasing power parity, what should happen to the value of the U.S. dollar relative to the Mexican peso if each of the following occurs?a. Over the next 10 years, the
Suppose that an Apple iPhone costs $400 in the United States, £130 in the United Kingdom, and ¥70,000 in Japan. If the exchange rates are $1.50 = £1 and ¥100 = $1, what are the real exchange
Suppose that the current exchange rate between the yen and the dollar is ¥100 = $1 and that the interest rate is 4% on a one-year bond in Japan and 3% on a comparable bond in the United States.
The Economist magazine tracks the prices of the McDonald’s Big Mac hamburger in countries around the world. The following table shows the prices of Big Macs in the United States and in six other
If the exchange rate between the pound and the dollar changes from £1.45 = $1 to £1.30 = $1, is this good news for British firms such as Brompton Bicycle? Is it good news for U.S. consumers? Is it
An article in the Wall Street Journal contained the following observation: “Falling interest rates tend to boost bond prices … but weigh on currencies.”a. Why do falling interest rates increase
A column in the New York Times discussed estimates by the International Monetary Fund (IMF) of growth in total world output, or GDP. The column noted that after adding up the value of each
A student makes the following observation:This month the euro depreciated sharply against the U.S. dollar. That was good news for attendance at Disneyland Paris and bad news for attendance at Walt
Go to the web site of the Federal Reserve Bank of St. Louis (FRED) (fred.stlouisfed.org) and download and plot the difference between the interest rate on the U.S. 3-month Treasury bill (TB3MS) and
Draw a graph of the demand and supply of U.S. dollars in exchange for Japanese yen to illustrate each of the following situations:a. Sales of Apple iPhones and iPads soar in Japan.b. The interest
Writing in the Wall Street Journal, economist William Easterly of New York University notes:“Around 2010, … the domestic currency in Brazil was so overvalued that tourists from Rio visiting
A student makes the following observation:It currently takes 100 yen to buy 1 U.S. dollar, which shows that the United States must be a much wealthier country than Japan. But it takes more than 1
How can exchange-rate risk be hedged using forward, futures, and options contracts? How might an investor use forward, futures, and options contracts to speculate on the future value of a currency?
According to a survey of professional foreign exchange traders, the theory of purchasing power parity is considered to be “academic jargon.” Why might foreign exchange traders not find PPP to be
What does it mean to describe the foreign exchange market as an “over-the-counter market”?
What is the difference between a spot transaction and a forward transaction in the foreign exchange market? What are the key differences between forward contracts in foreign exchange and futures
According to the theory of purchasing power parity, if the inflation rate in Japan is lower than the inflation rate in Canada, what should happen to the exchange rate between the Japanese yen and
Suppose that the euro falls in value relative to the dollar. What is the likely effect on European exports to the United States? What is the likely effect on U.S. exports to Europe?
How does the interest-rate parity condition account for differences in interest rates on similar bonds in different countries? What are the main reasons that interest-rate parity may not hold exactly?
Is PPP a theory of exchange rate determination in the long run or in the short run? Briefly explain.
What is the difference between a direct quotation of an exchange rate and an indirect quotation? If the exchange rate between the yen and the dollar changes from ¥80 = $1 to ¥90 = $1, has the yen
Look again at Figure 8.3 and answer the following questions.Figure 8.3a. Why is the demand curve for foreign exchange downward sloping?b. Why is the supply curve for foreign exchange upward
How is the law of one price related to the theory of purchasing power parity (PPP)?
What is the difference between the nominal exchange rate and the real exchange rate? When a newspaper article uses the phrase “the exchange rate,” is the article typically referring to the
Consider the hypothetical listing below for 10-year Treasury note futures on the Chicago Board of Trade. One futures contract for Treasury notes = $100,000 face value of 10-year 6% notes.a. If today
According to an article in the Economist magazine:In 1958 American onion farmers, blaming speculators for the volatility of their crops’ prices, lobbied a congressman from Michigan named Gerald
The CBOE web site quotes the CEO of an investment advisory firm as saying: “The VIX Index is an important and popular tool for measuring investor sentiment.” Briefly explain in what sense the VIX
Suppose that you are an investor who owns $10,000 in U.S. Treasury notes.a. Will you be more worried about market interest rates rising or falling? Briefly explain.b. How might you hedge against the
Suppose that the Dow Jones Industrial Average is above the 20,000 level. If the Dow were to fall to 17,000, who would gain the most: investors who had bought call options, investors who had sold call
An article in the Wall Street Journal quoted a young investor who works for the social network site LinkedIn as explaining that after losing money trading securities linked to crude oil futures
According to an article in the Wall Street Journal, options traders were expecting a large move in the price of Facebook stock. They were buying both call options and put options with strike prices
Suppose that you are a wheat farmer. Answer the following questions.a. It is September, and you intend to have 50,000 bushels of wheat harvested and ready to sell in November. The current spot market
In one of his annual letters to shareholders of Berkshire Hathaway, Warren Buffett wrote that: “Even experienced investors and analysts encounter major problems in analyzing the financial condition
An article in the Wall Street Journal observes: “When volatility is low, options are cheaper.” Briefly explain the reasoning behind this observation.
According to an article in the New York Times, “millions of amateur investors continue to actively buy and sell securities regularly.”a. Why might buying and selling securities regularly not be a
An article in the Wall Street Journal in 2016 noted:“After decades of spending billions of dollars to hedge against rising fuel costs, more airlines, including some of the world’s largest, are
In one of his annual letters to shareholders of Berkshire Hathaway, Warren Buffett wrote that trading derivatives has much more counterparty risk than does trading stocks or bonds because “a normal
Use the following information on call and put options for Facebook to answer the questions.a. What is the intrinsic value of the call option that expires in June and has a $100.00 strike price?b.
An article in the Wall Street Journal noted: “U.S. oil producers … are using hedges to lock in prices.”a. Would oil producers be worried about prices rising or falling? Briefly explain.b. How
In 2016, the Federal Reserve proposed a new rule that would limit how exposed a large bank could be to the risk of counterparty default by another large bank. At the same time, a report by a
An article in the New York Times with the headline “For Investors, ‘Portfolio Insurance’ Against Market Declines,” observes: “You can, for example, buy ‘put’ options on a single stock
An article in the Wall Street Journal on the futures market for oil in the United Kingdom noted that on the day the article was published, “the number of long positions … fell by 6%.”a. What is
After the United Kingdom’s electorate voted on June 23, 2016, to leave the European Union, an article in the Wall Street Journal noted: “Creditdefault swaps on the debt of Bank of America and
An article in the New York Times described how federal prosecutors accused a money manager of swindling his friends, family, and other investors out of $40 million. The article described the money
According to an article in the Wall Street Journal, Canadian firms that import goods that are priced in U.S. dollars “buy futures contracts that guarantee that they can exchange Canadian dollars
A column in the Wall Street Journal observes: “Many regulators, politicians and academics consider credit default swaps to be insurance contracts.” Briefly explain the reasoning behind this
A columnist on marketwatch.com offers the following advice: “If I were to hedge Apple, I’d use … 90-day puts as I’ve done at times in the past.”a. What does the columnist mean by “hedge
Why did futures markets originate in agricultural markets? Would a farmer buy or sell futures contracts? What would a farmer hope to gain by doing so? Would General Mills buy or sell futures
Suppose that oil prices decline by 50%. Which counterparty to a forward contract in oil has an incentive to default on the contract? Briefly explain.
Suppose that you manage a bank that has made many loans at a fixed interest rate. You are worried that inflation might rise and the value of the loans will decline.a. Why would an increase in
How can investors use options to manage risk?
In each of the following situations, what risk do you face from price fluctuations? What would have to be true of a derivative security if the security were to help you to hedge this risk?a. You are
Give an example of speculating using commodity futures and speculating using financial futures.
Suppose that you are a wealthy investor. Although you have no connection with the oil industry, you are convinced from studying the determinants of demand and supply in the oil market that the price
How does a credit default swap differ from the other swap contracts discussed in this chapter? What difficulties did credit default swaps cause during the financial crisis of 2007–2009?
What is an option premium? What is an option’s intrinsic value? What other factors, besides intrinsic value, can affect the size of an option premium?
Would derivatives markets be better off if the only people buying and selling derivatives contracts were hedgers? Briefly explain.
Briefly explain why a firm might take a long position in the futures market for oil. Briefly explain why a firm might take a short position in the futures market for oil.
Go to finance. yahoo.com and in the search box type in Facebook options. Find the data on call and put options for Facebook. Find the calls and puts with a strike price within $5 of Facebook’s
Why do forward contracts have counterparty risk?
In what ways is a credit swap different from an interest-rate swap?
How do the rights and obligations of options buyers and sellers differ from the rights and obligations of futures buyers and sellers?
What is the difference between hedging and speculating?
What are the key differences between forward contracts and futures contracts? What is the difference between a commodity future and a financial future? Give two examples of each.
In addition to the VIX index based on S&P 500, there are VIX indexes available for some individual stocks. Go to the web site of the Federal Reserve Bank of St. Louis (FRED) (fred.stlouisfed.org)
What service do forward contracts provide in the financial system?
In what ways is a swap contract different from a futures contract?
What is the difference between a call option and put option? What role does an option writer play?
Why do investors buy and sell derivatives rather than the underlying assets?
Many investors who bought stocks in 2000 and held them through 2010 found that they had received a negative real return on their investment over the 10-year period. Why would investors have invested
An article in the Economist in 2016 noted that since 2000, an investor in the United Kingdom would have earned a higher return from buying British government bonds than from buying stock issued by
An article in the Wall Street Journal described “a sea change in the fund business in which investors are increasingly opting for products that track the market rather than relying on managers to
Suppose that Coca-Cola is currently paying a dividend of $1.75 per share, the dividend is expected to grow at a rate of 5% per year, and the rate of return investors require to buy Coca-Cola’s
The business writer Michael Lewis has quoted Michael Burry, a fund manager, as saying: I also immediately internalized the idea that no school could teach someone how to be a great investor. If that
A column in the Wall Street Journal asks the question: “Are capital gains so different from earned income that they should be taxed at a different rate?”a. What is a capital gain?b. In what ways

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