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Money, Banking, and Financial Institutions

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You are on page 1of 7

Spring 2006

Midterm Exam 1

Name____________________________________

The exam consists of 11 problems and it is worth 100 points.

Please write in the space provided. If necessary, write on the back of the page.

Please ask me if you have any questions.

To receive full credit you have to carefully explain all your answers and show all

your work.

General advice: If you get stuck in the early parts of a problem, do not stop there. You

can receive substantial partial credit by explaining how you would solve the rest of

problem if you had the necessary answers from its previous parts.

1. (20 points) Determine whether each of the statements below is True or False:

Money is defined as anything that is generally accepted in payment for goods

and services or in the repayment of debt.

U.S. Treasury is responsible for the conduct of monetary policy in the United

States.

The monetary aggregate M3 includes fewer types of assets than the monetary

aggregate M1.

Of moneys three functions, the one that distinguishes money from other

assets is its function as a store of value.

efficiency by reducing the cost of exchange.

People find money a convenient store of value because its value remains fixed

to the price level; that is, if prices double so does the value of money.

According to the liquidity premium theory, if the upward sloping yield curve

signals that the interest rates are expected to rise.

2. (5 points) The Chicago Tribune ran a story on February 9, 2006 saying that the

Chicago Mercantile Exchange will introduce financial instruments based on the

amount of snow that falls in New York's Central Park and Boston's Logan

International Airport. Although the details have yet to be released, it is possible

that one of the contracts will specify that the seller of the contract agrees to pay

the buyer of the contract $100 for every inch of snowfall above the first 3 inches

in a month of January. Who could benefit from buying and selling such a

contract?

3. (10 points) You purchase a consol with annual coupon payments of $50, the

interest rate is 6%. One year later the interest rate has changed to 5% and you

decide to sell the consol. What is your one-year holding period return?

4. (5 points) What are the three main risks associated with holding bonds? Which of

them affect bond ratings?

5. (20 points) Suppose that the following yield curve is observed today:

Yield to Maturity (%)

6

5.5

5

interest rates.

yield on 1-year bonds, 2-year bonds, 3-year bonds, and 4-year bonds?

1-year bonds one year from today, two years from today, and three years

from today? Would you be able answer this question without assuming

that the expectations hypothesis is true?

addresses this drawback? Briefly outline the main idea of this theory?

6. (5 points) If $1102.50 is the amount payable in two years for a $1000 simple loan

made today, what is the internal rate of return of this loan?

7. (5 points) Suppose you are holding a 5 percent coupon bond maturing in one year

with a yield to maturity of 15 percent. If the interest rate on one-year bonds rises

from 15 percent to 20 percent over the course of the year, what is the one-year

holding period return on this bond?

8. (5 points) Name at least two reasons why bonds with the same maturity would

have different returns?

9. (10 points) Explain the difference between direct and indirect finance. What role

do financial intermediaries and financial markets play in this process? Explain

whether direct or indirect finance is a more important source of funds and why

this is the case.

10. (5 points) Which of the following 1-year, $1,000 face-value securities has highest

yield to maturity?

i. A 5 percent coupon bond selling for $1,000

ii. A 10 percent coupon bond selling for $1,000

iii. A 12 percent coupon bond selling for $1,000

iv. A 12 percent coupon bond selling for $1,100

11. (10 points) Using the supply-demand graph explain what will happen to the longterm bond prices and interest rates if interest rates are expected to rise in the

future.

PV=[C/i] * [1 1/(1+i)n],

PV=FV/(1+i)n,

Expected value= value*prob(value) + value*prob(value)+

Variance = (value expected value)2*prob(value) + (value expected

value)2*prob(value) +.

in(t)=( i1(t) + i1(t+1) + i1(t+2) ++ i1(t+n-1))/n.

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