金融市场习题

.Moral hazard: The risk that one party to a transaction will engage in behavior that is undesirable from theother partys point of view.Yield to maturity: The interest rate that equates the present value of payments received from a credit market instrument with its value today.Option contracts: Contracts that give the purchaser the option to buy or sell the underlying financial instrument at a specified price, called the exercise price or strike price,within a specific period of time.Capital market: A financial market in which longer-term debt <maturity of greater than one year> and equity instruments are traded.If there is a decline in interest rates, which would you rather be holding, long-term bonds or short-term bonds? Why? Which type of bond has the greater interest-rate risk?You would rather be holding long-term bonds because their price would increase more than the priceof the short-term bonds, giving them a higher return.What effect will a sudden increase in the volatility of gold prices have on interest rates?Interest rates would rise. A sudden increase in peoples expectations of future real estate prices raisesthe expected return on real estate relative to bonds, so the demand for bonds falls. The demand curveBd shifts to the left, and the equilibrium interest rate rises.What characteristics define the money markets?The money markets can be characterized as having securities that trade in one year or less, are oflarge denomination, and are very liquid.1. Why are finance markets important to the health of the economy?Because they channel funds from those who do not have a productive use for them to those who do,thereby resulting in higher economic efficiency.2. When interest rate rise,how might businesses and consumers change their economic behavior? Businesses would cut investment spending because the cost of financing this spending is now higher,and consumers would be less likely to purchase a house or a car because the cost of financing their purchase is higher.3. How can a change in interest rates affect the profitability of financial institutions?A change in interest rates affects the cost of acquiring funds for financial institutions as well as changes the income on assets such as loans,both of which affect profits.In addition,changes in interest rates affect the price of assets such as stock and bonds that the financial institution owns which can lead to profits or losses.4. Is everybody worse off when interest rates rise?No.People who borrow to purchase a house or a car are worse off because it costs them more to finance their purchase;however,savers benefit because they can earn higher interest rates on their savings.5. What effect might a fall in stock prices have on business investment?The lower price for a firms shares means that it can raise asmaller amount of funds, and so investment in plant and equipment will fall.6. What effect might a rise in stock prices have on consumers decisions to spend?Higher stock prices mean that consumers wealth is higher and so they will be more likely to increase their spending.7. How does a decline in the value of the pound sterling affect British consumers?It makes foreign goods more expensive and so British consumers will buy less foreign goods and more domestic goods.8. How does a decline in the value of the pound sterling affect American businesses?It makes British goods more expensive relative to American goods.America businesses will find it easier to sell their goods in the United States and abroad,and the demand for their products will rise.9. How can changes in foreign exchange rates affect the profitability of financial institutions?Changes in foreign exchange rates change the value of assets held by financial and thus lead to gains and losses on these assets.Also changes in foreign exchange rates affect the profits made by traders in foreign exchange who work for financial institutions.10. Looking at Figure 3.in what years would you have chosen to visit the Grand Canyon in Arizona rather than the Tower of London?In the mid- to late 1970s and the late 1980s and early 1990s, the value of the dollar was low, makingtravel abroad relatively more expensive; that would have been a good time to vacation in the UnitedStates and see the Grand Canyon. As the dollars value rose in the early 1980s, travel abroad becamerelatively cheaper, making it a good time to visit the Tower of London.11. What is the basic activity of banks?Banks accept deposits and then use the resulting funds to make loans.12. What are the other important financial intermediaries in the economy besides banks?Savings and loan associations, mutual savings banks, credit unions, insurance companies, mutualfunds, pension funds, and finance companies.13. Can you think of any financial innovation in the past ten years that has affected you personally?Has it made you better or worse off?In what way?Answers will vary.14. What types of risks do financial institutions face?The profitability of financial institutions is affected by changes in interest rates, stock prices, andforeign exchange rates; fluctuations in these variables expose these institutions to risk.15. Why do managers of financial institutions care so much about the activities of the Federal Reserve System?Because the Federal Reserve affects interest rates, inflation, and business cycles, all of which have animportant impact on the profitability of financial institutions.1. Why is a share of IBM common stock an asset for its owner and a liability for IBM?The share of IBM stock is an asset for its owner because it entitles the owner to a share of the earnings andassets of IBM. The share is a liability for IBM because it is a claim on its earnings and assets by theowner of the share.2. IF I can buy a car today for $5000 and it is worth $10000 next year in extra income to me because it enables me to get a job as a traveling anvil seller,should I take out a loan from Larry the Loan Shark at a 90% interest rate if no one else will give me a loan?Will I be better or worse off as a result of taking out this loan?Can you make a case for legalizing loan-sharking?Yes, I should take out the loan, because I will be better off as a result of doing so. My interest paymentwill be $4,500 <90% of $5,000>, but as a result, I will earn an additional $10,000, so I will be ahead ofthe game by $5,500. Since Larrys loan-sharking business can make some people better off, as in thisexample, loan sharking may have social benefits. <One argument against legalizing loan sharking,however, is that it is frequently a violent activity.>3. Some economists suspect that one of the reasons that economies in developing countries grow so slowly is that they do not have well-developed financial markets.Does this argument make sense?Yes, because the absence of financial markets means that funds cannot be channeled to people who havethe most productive use for them. Entrepreneurs then cannot acquire funds to set up businesses thatwould help the economy grow rapidly.4. In the nineteenth century the U.S. economy borrowed heavily from the British to build a railroad system.What was the principal debt instrument used?Why did this make both countries better off?The principal debt instruments used were foreign bonds which were sold in Britain anddenominatedin pounds. The British gained because they were able to earn higher interest rates as a result oflending to Americans, while the Americans gained because they now had access to capital to start upprofitable businesses such as railroads.5. "Because corporations do not actually raise any funds in secondary markets,they are less important to the economy than primary markets."Comment.This statement is false. Prices in secondary markets determine the prices that firms issuing securitiesreceive in primary markets. In addition, secondary markets make securities more liquid and thuseasier to sell in the primary markets. Therefore, secondary markets are, if anything, more importantthan primary markets.6. If you suspect that a company will go bankrupt next year,which would you rather hold-bonds issued by the company or equities issued by the company?Why?You would rather hold bonds, because bondholders are paid off before equity holders, who are theresidual claimants.7. How can the adverse selection problem explain why you are more likely to make a loan to a family member than to a stranger?Because you know your family member better than a stranger, you know more about theborrowershonesty, propensity for risk taking, and other traits. There is less asymmetric information than witha stranger and less likelihood of an adverse selection problem, with the result that you are more likelyto lend to the family member.8. Think of one example in which you have had to deal with the adverse selection problem.9. Why do loan sharks worry less about moral hazard in connection with their borrowers than some other lenders do?Loan sharks can threaten their borrowers with bodily harm if borrowers take actions that mightjeopardize paying off the loan. Hence borrowers from a loan shark are less likely to engage in moralhazard.10. If you are an employer,what kinds of moral hazard problems might you worry about with your employees?They might not work hard enough while you are not looking or may steal or commit fraud.11. If there were no asymmetry in the information that a borrow and a lender had,could there still be moral hazard problem?Yes, because even if you know that a borrower is taking actions that might jeopardize paying off the loan,you must still stop the borrower from doing so. Because that may be costly, you may not spend thetime and effort to reduce moral hazard, and so moral hazard remains a problem.12. "In a world without information and transaction costs, financial intermediaries would not exist." Is this statement true, false, or uncertain? Explain your answer.True. If there are no information or transactions costs, people could make loans to each other at nocost and would thus have no need for financial intermediaries.13. Why might you be willing to make a loan to your neighbor by putting funds in a savings account earning a 5% interest rate at the bank and having the bank loan her the funds at a 10% interest rate, rather than loan her the funds yourself?Because the costs of making the loan to your neighbor are high <legal fees, fees for a credit check,and so on>, you will probably not be able to earn 5% on the loan after your expenses even though ithas a 10% interest rate. You are better off depositing your savings with a financial intermediary andearning 5% interest. In addition, you are likely to bear less risk by depositing your savings at the bankrather than lending them to your neighbor.14. How does risk sharing benefit both financial intermediaries and private investors?Risk sharing enabling them to earn a profit on the spread between the returns they earn on risky assets andthe payments they make on the assets they have sold, and helping individuals to diversify and therebylower the amount of risk to which they are exposed。15. Discuss some of the manifestations of the globalization of world capital markets.Increased discussion of foreign financial markets in the U.S. press and the growth in markets forinternational financial instruments such as Eurodollars and Eurobonds.1. Write down the formula that is used to calculate the yield to maturity on a 20-year 10% coupon bond with $1000 face value that sells for $2000.$2000 = $100/<1 + i> + $100/<1 + i>2 + . . . + $100/<1 + i>20 + $1000/<1 + i>20.2. If there is a decline in interest rates, which would you rather be holding, long-term bonds or short-term bonds? Why? Which type of bond has the greater interest-rate risk?You would rather be holding long-term bonds because their price would increase more than the priceof the short-term bonds, giving them a higher return.3. A financial adviser has just given you the following advice: "Long-term bonds are a great investment because their interest rate is over 20%."Is the financial adviser necessarily right?No. If interest rates rise sharply in the future, long-term bonds may suffer such a sharp fall in pricethat their return might be quite low, possibly even negative.4. If mortgage rates rise from 5% to 10% but the expected rate of increase in housing prices from 2% to 9%, are people more or less likely to buy house?People are more likely to buy houses because the real interest rate when purchasing a house has fallenfrom 3 percent <=5 percent 2 percent> to 1 percent <=10 percent 9 percent>. The real cost offinancing the house is thus lower, even though mortgage rates have risen. <If the taxdeductibility ofinterest payments is allowed for, then it becomes even more likely that people will buy houses.>1. Explain why you would be more or less willing to buy a share of Polaroid stock in the following situations:a. Your wealth falls.b. You expect it to appreciate in value.c. The bond market becomes more liquid.d. You expect gold to appreciate in value.e. Prices in the bond market become more volatile.<a> Less, because your wealth has declined;<b> more, because its relative expected return has risen;<c> less, because it has become less liquid relative to bonds;<d> less, because its expected return has fallen relative to gold;<e> more, because it has become less risky relative to bonds.2. Explain why you would be more or less willing to buy a house under the following circumstances:a. You just inherited %100,000.b. Real estate commissions fall from 6% of the sales price to 4% of the sales price.c. You expect Polaroid stock to double in value next year.d. Prices in the stock market become more volatile.e. You expect housing prices to fall.<a> More, because your wealth has increased;<b> more, because it has become more liquid;<c> less, because its expected return has fallen relative to Polaroid stock;<d> more, because it has become less risky relative to stocks;<e> less, because its expected return has fallen.3. "The more risk-averse people are, the more likely they are to diversify." Is this statement true, false, or uncertain? Explain your answer.True, because the benefits to diversification are greater for a person who cares more about reducingrisk.4. I own a professional football team, and I plan to diversify by purchasing shares in either a company that owns a pro basketball team or a pharmaceutical company. Which of these two investments is more likely to reduce the overall risk I face? Why?Purchasing shares in the pharmaceutical company is more likely to reduce my overall risk becausethe correlation of returns on my investment in a football team with the returns on thepharmaceuticalcompany shares should be low. By contrast, the correlation of returns on an investment in a footballteam and an investment in a basketball team are probably pretty high, so in this case there would belittle risk reduction if I invested in both.5. "No one who is risk-averse will ever buy a security that has a lower expectedreturn, more risk, and less liquidity than another security." Is this statement true, false, or uncertain? Explain your answer.True, because for a risk averse person, more risk, a lower expected return and less liquidity make asecurity less desirable.6. An important way in which the Federal Reserve decreases the money supply is by selling bonds to the public. Using a supply and demand analysis for bonds, show what effect this action has on interest rates.When the Fed sells bonds to the public, it increases the supply of bonds, thus shifting the supplycurve Bs to the right. The result is that the intersection of the supply and demand curves Bs and Bdoccurs at a higher equilibrium interest rate, and the interest rate rises. With the liquidity preferenceramework, the decrease in the money supply shifts the money supply curve Ms to the left, and theequilibrium interest rate rises. The answer from the loanable funds framework is consistent with theanswer from the liquidity preference framework.7. Using the supply and demand for bonds framework, show why interest rates are procyclical <rising when the economy is expanding and falling during recessions>.When the economy booms, the demand for bonds increases: the publics income and wealth riseswhile the supply of bonds also increases, because firms have more attractive investment opportunities.Both the supply and demand curves <Bd and Bs> shift to the right, but as is indicated in the text, thedemand curve probably shifts less than the supply curve so the equilibrium interest rate rises.Similarly, when the economy enters a recession, both the supply and demand curves shift to the left,but the demand curve shifts less than the supply curve so that the interest rate falls. The conclusion ishat interest rates rise during booms and fall during recessions: that is, interest rates are procyclical8. Why should a rise in the price level <but not in expected inflation> cause interest rates to tise when the nominal money supply is fixed?When the price level rises, the quantity of money in real terms falls <holding the nominal supply ofmoney constant> to restore their holdings of money in real terms to their former level, people willwant to hold a greater nominal quantity of money. Thus the money demand curve Md shifts to theright, and the interest rate rises.9. Find the "Credit Markets" column in the Wall Street Journal. Underline the column that explain bond price movements, and draw the appropriate supply and demand diagrams that support these statements.Interest rates fall. The increased volatility of gold prices makes bonds relatively less risky relative togold and causes the demand for bonds to increase. The demand curve, Bd, shifts to the right and theequilibrium interest rate falls.10. What effect will a sudden increase in the volatility of gold prices have on interest rates?Interest rates would rise. A sudden increase in peoples expectations of future real estate prices raisesthe expected return on real estate relative to bonds, so the demand for bonds falls. The demand curveBd shifts to the left, and the equilibrium interest rate rises.11. How might a sudden increase in peoples expectations of future real estate price affect interest rates?Interest rates might rise. The large federal deficits require the Treasury to issue more bonds; thus thesupply of bonds increases. The supply curve, Bs, shifts to the right and the equilibrium interest raterises. Some economists believe that when the Treasury issues more bonds, the demand for bondsincreases because the issue of bonds increases the publics wealth. In this case, the demand curve, Bd,also shifts to the right, and it is no longer clear that the equilibrium interest rate will rise. Thus thereis some ambiguity in the answer to this question.12. Explain what effect a large federal deficit might have on interest rates.The increased riskiness of bonds lowers the demand for bonds. The demand curve shifts to the left andthe equilibrium interest rate rises.13. Using a supply and demand analysis for bonds, show what the effect is on interest rates when the riskiness of bonds rises.In the loanable funds framework, the increased riskiness of bonds lowers the demand for bonds. Thedemand curve Bd shifts to the left, and the equilibrium interest rate rises. The same answer is found inthe liquidity preference framework. The increased riskiness of bonds relative to money increases thedemand for money. The money demand curve Md shifts to the right, and the equilibrium interest raterises.14. Will there be an effect on interest rates if brokerage commissions on stocks fall? Explain your answer.Yes, interest rates w