Professional Documents
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What are three things to measure for in evaluating the performance of the capital markets? A. Level of Intertemporal Trade, International Trade, Portfolio Diversification . Level of Portfolio Diversification, alanced !apital Accounts, "lo#al Inflation !. Level of Portfolio Diversification, Intertemporal Trade, $fficienc% of &oreign $'change D. (nshore)(ffshore Interest *ate Parit%, Level of Portfolio Diversification, +ta#ilit% of $urocurrenc% ,arket $. (nshore)(ffshore Interest *ate Parit%, Interest Parit% and &oreign $'change, alanced !apital Accounts Ans-er. ! /. In the Interest Parit% !ondition, *t)*0t 1 2$et31)$t45$t3't, -here *t)*0t is the interest rate differential and 2$et31)$t45$t is the e'pected change in the e'change rate, -hat does 't stand for if it potentiall% is a market efficient difference #et-een the t-o? A. ,arket inefficienc% . *isk premium !. &orecast error D. Tracking error $. $'cessive volatilit% Ans-er. 6. As a countr% #egins to li#erali7e its capital account, -hat -ould %ou e'pect to happen to the difference #et-een the interest rates for similar assets in this countr% and another countr% -ith open capital markets? A. It -ould get larger. . It -ould get smaller. !. It -ould sta% the same. D. 8one of the a#ove. $. 8ot enough information. Ans-er.
9:
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If %ou are offered a gam#le in -hich %ou -in <:: dollars 65= of the time and %ou lose <:: dollars <5= of the time, -hat is %our e'pected pa%off and %our #ehavior given that %ou are a risk)lover? A. ><::, take the gam#le . )>1/<, take the gam#le !. )>1/ , %ou are indifferent D. ><::, decline the gam#le $. )>1/<, decline the gam#le Ans-er.
<.
The t-o t%pes of trade, intertemporal and pure asset s-ap ????? perfect su#stitutes, #ecause A. are@ the% #oth offer considera#le pa%off and are eAual in the long run. . are@ the% #oth involve the smoothing out of current and future consumption. !. are not@ asset s-apping is immediate and involves onl% assets, -hile intertamporal trade takes t-o time periods and involves #oth assets and goods5services. D. oth and !. $. could possi#l% #e, as different economic states occur at different points in time. Ans-er. $
B.
A shado- price is A. a time)lagged varia#le that is onl% apparent after the current period. . something that has to do -ith trees out the -indo-. !. a price neither in nor determined #% a market. D. the discounted price of a foreign asset in the home countr%. $. the marginal utilit% of future consumption. Ans-er. !
91
C.
&or the follo-ing Auestion assume the follo-ing facts. 1. alance of Pa%ments 1 : prior to the transactions. /. Person A 2-ho lives in the Dnited +tates4 purchases an airplane from ritish Air-a%s for >1<:,:::. 6. Person A pa%s -ith a check from his account at &irst Dnion ank in the Dnited +tates. ;. ritish air-a%s, since it -ill need dollars in 1 month, deposits the check at the ank of $ngland. <. ank of $ngland deposits the >1<:,::: at !ommon-ealth ank, -hich is located in the Dnited +tates. Due to the transactions a#ove, -hat are the effects on the #alance of pa%ments? A. )>1<:,::: due to import of good 2current account de#it4 . 3>1<:,::: due to import of good 2current account credit4 !. )>1<:,::: due to deposit of ank of $ngland 2capital account de#it4 D. 3>1<:,::: due to deposit of ank of $ngland 2capital account credit4 $. 8o effect 21<:,::: current account de#it and 1<:,::: capital account credit4. Ans-er. $
=.
&or the follo-ing Auestions ,assume the follo-ing facts. 1. alance of Pa%ments 1 : prior to the transactions. /. Person A 2-ho lives in the Dnited +tates4 purchases an airplane from ritish Air-a%s for >1<:,:::. 6. Person A pa%s -ith a check from his account at &irst Dnion ank in the Dnited +tates. ;. ritish Air-a%s, #ecause it -ill need dollars in 1 month, deposits the check at the ank of $ngland. <. ank of $ngland deposits the >1<:,::: at !ommon-ealth ank, -hich is located in the Dnited +tates. Due to the transactions a#ove, -hat are the effects on the reserve at the &ed? A. 8o effects at all. . &act 6 is a decrease of >1<:,:::, &act < is an increase of >1<:,:::, a net effect of : !. &act 6 is an increase of >1<:,:::, &act < is a decrease of >1<:,:::, a net effect of : D. oth &act 6 and &act < result in increases of >1<:,:::, a net effect of 3 >6::,::: $. oth &act 6 and &act < result in decrease of >1<:,:::, a net effect of ) >6::,::: Ans-er.
9/
9.
&or the follo-ing Auestion, assume the follo-ing facts. 1. !hase 2-hich is located in the Dnited +tates4 has a /:E reserve reAuirement imposed #% the government. /. ank of "erman% has no reserve reAuirements. 6. oth #anks ma% invest at an =E interest rate. ;. oth #anks have fi'ed costs of >6 per deposit made. What is the difference #et-een the minimum interest rates each #ank can offer and still make a profit if the deposit is ><:: for 1 %ear? A. : F #oth #anks can offer the same rate . 1E !. 1.BE D. .;E $. /:E Ans-er. ! $'planation for the ans-er. ,inimum !hase rate. *evenue from deposit. 2<::0.=40.:=)6 1 /9 ,inimum rate it can offer 1 /95<:: 1 <.=E ,inimum ank of "erman% rate. *evenue from deposit. 2<::40.:=)6 1 6C ,inimum rate it can offer 1 6C5<:: 1 C.;E Difference in rates. 1.BE
1:.
+uppose %ou are offered a gam#le in -hich %ou -in >1,::: half the time #ut lose >1,::: half the time. +ince in this case %ou are as likel% to -in as to lose the >1,:::, the average pa%off on this gam#le F its e'pected value) is. :.<0>1,::: 3 :.<0 2)>1,:::4 1 :. Dnder such circumstances. A. 8o one -ill take the gam#le. . *isk averse individuals -ill take the gam#le. !. *isk lovers -ill take the gam#le. D. *isk neutral individuals -ill take the gam#le. $. 8ot enough information. Ans-er. !
96
11.
+uppose %ou are offered a gam#le in -hich %ou -in >1::,::: half the time #ut lose >1::,::: half the time. +ince in this case %ou are as likel% to -in as to lose the >1::,:::, the average pa%off on this gam#le F its e'pected value) is. :.<0>1::,::: 3 :.<0 2)>1::,:::4 1 :. Dnder such circumstances. A. 8o one -ill take the gam#le. . *isk averse individuals -ill take the gam#le. !. *isk lovers -ill take the gam#le. D. *isk neutral individuals -ill take the gam#le. $. 8ot enough information to ans-er. Ans-er. !
1/.
&or most practical matters, economists assume that A. individuals are risk neutral. . individuals are risk lovers. !. individuals are risk averse. D. most individuals are risk lovers. $. most individuals are risk neutral. Ans-er. A
16.
People -ho are risk averse A. value a collection of assets onl% on the #asis of their e'pected returns. . value a collection of assets onl% on the #asis of the risk of that return. !. value a collection of assets not onl% on the #asis of its e'pected returns, #ut also on the #asis of the risk of that return. D. 8o clear cut criteria e'ist. $. 8one of the a#ove. Ans-er. !
1;.
The idea of risk aversion A. is at odds -ith the idea of insurance. . help e'plain the profita#ilit% of insurance companies. !. has nothing to do -ith insurance companies. D. helps e'plain the losses suffers #% the insurance industr%. $. helps e'plain -h% insurance companies in the long run are 7ero profit companies. Ans-er.
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1<.
*isk aversive people A. -ill never hold #onds denominated in several different currencies #ecause of transaction costs. . -ill al-a%s hold #onds denominated in several different currencies #ecause of transaction costs. !. ma% hold #onds denominated in several different currencies. D. ma% hold #onds denominated in several different currencies onl% if satisf%ing the -ell kno-n interest part% condition . $. -ill hold onl% domestic #onds #ecause of the home #ias effect. Ans-er. !
1B.
In general, for a risk averse individual A. a portfolio -hose return fluctuates -idel% from %ear to %ear is more desira#le than one that offers the same average return -ith onl% mild %ear)to)%ear fluctuations. . a portfolio -hose return fluctuates -idel% from %ear to %ear is less desira#le than one that offers the same average return -ith onl% mild %ear)to)%ear fluctuations. !. a portfolio -hose return fluctuates -idel% from %ear to %ear is more desira#le. D. a portfolio -hose return fluctuates less from %ear to tear is more desira#le. $. 8one of the a#ove. Ans-er.
1C.
"enerall%, for a risk)loving individual, A. a portfolio -hose return fluctuates -idel% from %ear to %ear is more desira#le than one that offers the same average return -ith onl% mild %ear)to)%ear fluctuations. . a portfolio -hose return fluctuates -idel% from %ear to %ear is less desira#le than one that offers the same average return -ith onl% mild %ear)to)%ear fluctuations. !. a portfolio -hose return fluctuates -idel% from %ear to %ear is more desira#le. D. a portfolio -hose return fluctuates less from %ear to tear is more desira#le. $. 8one of the a#ove. Ans-er. A
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1=.
"enerall%, for a risk neutral individual, A. a portfolio -hose return fluctuates -idel% from %ear to %ear is more desira#le than one that offers the same average return -ith onl% mild %ear)to)%ear fluctuations. . a portfolio -hose return fluctuates -idel% from %ear to %ear is less desira#le than one that offers the same average return -ith onl% mild %ear)to)%ear fluctuations. !. a portfolio -hose return fluctuates -idel% from %ear to %ear is more desira#le. D. a portfolio -hose return fluctuates less from %ear to tear is more desira#le. $. 8ot enough information. Ans-er. $
19.
"enerall%, A. a portfolio -hose return fluctuates -idel% from %ear to %ear is more desira#le than one that offers the same average return -ith onl% mild %ear)to)%ear fluctuations. . a portfolio -hose return fluctuates -idel% from %ear to %ear is less desira#le than one that offers the same average return -ith onl% mild %ear)to)%ear fluctuations. !. a portfolio -hose return fluctuates -idel% from %ear to %ear is more desira#le. D. a portfolio -hose return fluctuates less from %ear to tear is more desira#le. $. 8ot enough information Ans-er. $
/:.
Investment #anks in the Dnited +tates are A. regular #anks speciali7ing in investment proGects. . not #anks at all #ut institutions -hich speciali7e in under-riting sales of stocks and #onds. !. special arms of the D.+. government for D.+. #anks operating outside the D.+. D. regular #anks speciali7ing in investment proGects, #ut allo-ed to offer limited domestic transactions. $. 8one of the a#ove. Ans-er.
9B
/1.
&irst oston !orporation, "oldman +achs, and La7ard &reres are e'amples of A. commercial #anks. . corporations. !. non)#ank financial institutions, such as insurance companies, pension funds, and mutual funds. This includes investment #anks, -hich speciali7e in under-riting sales of stocks and #onds #% corporations and in some cases governments. D. central #anks and other government agencies $. 8one of the a#ove. Ans-er. !
//.
!iticorp, ,organ "uarant%, and ankers Trust are e'amples of A. commercial #anks. . corporations. !. non)#ank financial institutions, such as insurance companies, pension funds, and mutual funds. This includes investment #anks, -hich speciali7e in under-riting sales of stocks and #onds #% corporations and in some cases governments. D. central #anks and other government agencies. $. 8one of the a#ove. Ans-er. A
/6.
A countr% can control A. fi'ed e'change rates onl%. . monetar% polic% oriented to-ard domestic goal.s !. freedom of international capital movements. D. An% t-o of the a#ove three. $. (nl% A and . Ans-er. D
/;.
Dnder a gold standard, countries control A. fi'ed e'change rates onl%. . monetar% polic% oriented to-ard domestic goals. !. freedom of international capital movements. D. (nl% A and !. $. (nl% A and . Ans-er. D
9C
/<.
After the retton Woods period, countries chose to control A. fi'ed e'change rates onl% . monetar% polic% oriented to-ard domestic goals. !. freedom of international capital movements. D. (nl% and !. $. (nl% A and . Ans-er. D
/B.
Dnder the unified $uro regime, the $uropean countries control A. fi'ed e'change rates onl%. . monetar% polic% oriented to-ard domestic goals. !. freedom of international capital movements. D. (nl% and !. $. (nl% A and !. Ans-er. $
/C.
Which one of the follo-ing possi#ilities is true? A. ,uch of eurocurrenc% trading occurs in $urope. . ,uch of eurocurrenc% trading occurs in the Dnited +tates. !. $urocurrenc% trading occurs ever%-here e'cept the Dnited +tates. D. $urocurrenc% trading occurs ever%-here e'cept $urope. $. 8one of the a#ove. Ans-er. !
/=.
$urodollars are A. dollar deposits located in the Dnited +tates. . dollar deposits located in $urope. !. dollar deposits located outside $urope. D. dollar deposits located outside the united +tates. $. dollar deposits located outside #oth $urope and the Dnited +tates. Ans-er. D
/9.
$uro#anks are A. all $uropean anks. . all non)American #anks. !. #anks that accept deposits denominated in $urocurrencies e'cluding $urodollars. D. #anks that accept deposits denominated in $urocurrencies including $urodollars. $. 8one of the a#ove. Ans-er. D
9=
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The leading center of $urocurrenc% trading is A. 8e- Hork !it%. . !hicago. !. London. D. Paris. $. &rankfurt. Ans-er. !
61.
The &edIs *egulation J A. placed a ceiling on the interest rates D.+. #anks could pa% on time deposits to foreigners. . placed a ceiling on the interest rates D.+. #anks could pa% on time deposits. !. placed a ceiling on the amount D.+. residents can deposits in $uro #anks. D. placed a ceiling on the amount foreign residents can deposits in domestic American #anks. $. 8one of the a#ove. Ans-er.
6/.
Which of the follo-ing statements is true? A. ank failure is limited to #anks that have mismanaged their assets. . ank failure is limited to #anks that have invested in real estate. !. ank failure is limited to #anks that have invested in government #onds. D. ank failure is limited to a fe- #anks. $. ank failure is not limited to #anks that have mismanaged their assets. Ans-er. $
66.
Which of the follo-ing statements is true? A. ank failures inflict serious financial harm on individual depositors. . ank failures do not inflict serious financial harm on individual depositors. !. ank failures inflict not onl% serious financial harm on individual depositors, #ut also harm the macroeconomic sta#ilit% of the econom%. D. ank failures inflict serious financial harm on individual depositors, #ut fortunatel% do not harm the macroeconomic sta#ilit% of the econom%. $. 8one of the a#ove. Ans-er. !
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6;.
Which of the follo-ing statements is true? A. anks -ith cautious investment strategies never fail if unconfirmed rumors of financial trou#le #egin circulating. . anks -ith cautious investment strategies never fail if rumors of financial trou#le #egin circulating. !. anks -ith cautious investment strategies ma% fail if unconfirmed rumors of financial trou#le #egin circulating. D. anks -ith cautious investment strategies ma% fail if rumors of financial trou#le #egin circulating. $. 8one of the a#ove. Ans-er. !
6<.
Which of the follo-ing statements is true for the Dnited +tates? A. The &ederal Deposit Insurance !orporation 2&DI!4 insures #ank deposits against losses up to >1::,:::. . The &ederal Deposit Insurance !orporation 2&DI!4 insures #ank deposits against floods up to >1::,:::. !. The &ederal Deposit Insurance !orporation 2&DI!4 insures #ank deposits against losses up to >1:,:::. D. The &ederal Deposit Insurance !orporation 2&DI!4 insures #ank deposits against natural disaster up to >1::,:::. $. 8one of the a#ove. Ans-er. A
6B.
Which of the follo-ing statements is true for the Dnited +tates? A. anks are reAuired to make contri#utions to the &DI! to cover the cost of #ank deposits insurance. . anks are not reAuired to make contri#utions to the &DI! to cover the cost of #ank deposits insurance. !. The states are not reAuired to make contri#utions to the &DI! to cover the cost of #ank deposits insurance for #anks -ith their main #ranch in that state. D. The states are reAuired to make contri#utions to the &DI! to cover the cost of #ank deposits insurance for #anks -ith their main #ranch in that state. $. The specific municipalit% -here the main #ranch of the #ank is located is reAuired to make contri#utions to the &DI! to cover the cost of #ank deposit insurance. Ans-er. A
1::
6C.
Which of the follo-ing statements is true for the Dnited +tates? A. The &DI! does not provide insurance for deposits for +avings and Loans 2+KL4 associations. . The &DI! does provide insurance for deposits for +avings and Loans 2+KL4 associations, #ut onl% up to ><:,:::. !. The &DI! does provide insurance for deposits for +avings and Loans 2+KL4 associations up to >1::,:::. D. The &DI! does provide insurance for deposits for +avings and Loans 2+KL4 associations up to >1<:,:::. $. 8one of the a#ove. Ans-er. !
6=.
anks in the Dnited +tates A. face rules against lending too large a fraction of their assets to a single private customer onl%. . face rules against lending too large a fraction of their assets to a single private customer or to a single foreign government #orro-er. !. face rules against lending too large a fraction of their assets to a single foreign government #orro-er onl%. D. Although a good idea, #anks are not restricted at all as far as -hom the% lend mone% to as long as other safeguards e'ist. $. ecause this is a #ad idea, #anks are not restricted at all as far as -hom the% lend mone% to as long as other safeguards e'ist. Ans-er.
69.
anks in the Dnited +tates A. cannot hold common stocks. . can hold common stocks. !. cannot hold common stocks of companies the% do #usiness -ith. D. cannot hold common stocks of companies that have their headAuarters in the same state. $. 8one of the a#ove. Ans-er. A
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anks in the Dnited +tates A. are prevented from holding assets that are Ltoo risk%.M . are not prevented from holding assets that are Ltoo risk%.M !. are encouraged not to hold assets that are Ltoo risk%.M D. are not encouraged not to hold assets that are Ltoo risk%.M $. 8one of the a#ove. Ans-er. A
1:1
;1.
In the Dnited +tates, the follo-ing agencies have the right to e'amine the #ankIs #ooks. A. &ed and the &DI!. . &DI! and the (ffice of the !omptroller of the !urrenc%. !. &ed and the office of the !omptroller of the !urrenc%. D. oth and !. $. (nl% the &ed. Ans-er. D
;6.
In the Dnited +tates, #anks A. cannot #e forced to sell assets that the #ank e'aminer deems too risk%. . can #e forced to sell assets that the #ank e'aminer deems too risk%. !. can #e forced to sell assets that the #ank e'aminer deems too risk% onl% after a court order. D. can #e forced to sell assets that the #ank e'aminer deems too risk% onl% after #oth e'aminers from the &ed and from the &DI! agree. $. 8one of the a#ove. Ans-er.
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In the Dnited +tates, #anks A. ma% not #e forced #% #ank e'aminer to adGust their #alance sheets #% -riting off loans the e'aminer thinks -ill not #e repaid. . ma% #e forced #% the #ank e'aminer to adGust their #alance sheets #% -riting off loans the e'aminer thinks -ill not #e repaid. !. ma% #e forced #% the #ank e'aminer to adGust their #alance sheets #% -riting off loans the e'aminer thinks -ill not #e repaid onl% if the &ed and the &DI! e'aminers agree. D. ma% #e forced #% the #ank e'aminer to adGust their #alance sheets #% -riting off loans the e'aminer thinks -ill not #e repaid onl% if the &ed and the (ffice of the !omptroller of the !urrenc% e'aminers agree. $. oth ! and D. Ans-er.
1:/
Essay Questions 1. What are the three t%pes of transactions #et-een the residents of different countries? 1. /. 6. /. Trades of goods and services for goods or services. Trades of goods and services for assets. Trades of assets for assets.
Ans-er.
What are the three t%pes of gains from international transactions #et-een the residents of different countries? 1. /. 6. "ains due to comparative advantage and economies of scale. "ains due to inter)temporal trade, -hich is the e'change of goods and services for claims to future goods and services, -hich is for assets. "ains due to trades of assets for assets, such as the e'change of real estate located in London for D.+. Treasur% #onds.
Ans-er.
6.
No- can international trade in assets make #oth countries #etter off?
Ans-er. % allo-ing them to reduce the riskiness of the return on their -ealth and #% allo-ing the t-o parties to diversif% their portfolios, i.e., to divide their -ealth among a -ider spectrum of assets, and thus reduce the amount of mone% placed on one specific asset. ;. $'plain To#inIs idea of LDonIt put all %our eggs in one #asket.M
Ans-er. The idea of diversification advanced #% To#in in his Attitude To-ards *isk and Portfolio DiversificationIs paper. <. Wh% is it useful to make a distinction #et-een de#t and eAuit% instruments?
Ans-er. +ee page B;: and !hapter //. De#t instruments such as #onds and #ank deposits are repaid regardless of economic circumstances. $Auit% instruments, such as a share of stock, have a pa%off that is linked to economic performances. No-ever, remem#er the possi#ilit% of #ankruptc% and the real return, -hich is su#Gect to domestic currenc% fluctuations.
1:6
B.
Who are the main actors in the international capital market? !ommercial #anks. !orporations. 8on)#ank financial institutions, such as insurance companies, pension funds, and mutual funds. This includes investment #anks, -hich speciali7e in under-riting sales of stocks and #onds #% corporations and in some cases governments. !entral #anks and other government agencies.
Ans-er. 1. /. 6.
;. C.
Descri#e the role of offshore #anking and of offshore currenc% 2eurocurrencies4 trading.
Ans-er. +ee pages B;6)B;C. oth have mushroomed due to increased international trade, increased multinational corporations, and glo#ali7ation. +tudents should also emphasi7e #anksI desire to escape domestic government regulations and ta'es on financial activities and political concerns from holding deposits in the countr% that issued them, -hich increases default concerns on the part of the foreign investors, etc. =. What do %ou e'pect -ould #e the effects of 9511 on the si7e of the $urocurrenc% markets?
Ans-er. Will increase due to fear that foreign deposits in the Dnited +tates -ill #e fro7en unless coordinated efforts #% all countries. 9. $'plain -h% a London $uro#ank has a competitive advantage over a #ank in 8eHork in attracting dollar deposits.
Ans-er. It can pa% more #ecause the London #ank is not su#Gect to an% reserve reAuirements 2neither American nor ritish4, -hereas the 8e- Hork #ank is su#Gect to D.+. reserve reAuirements. 1:. ,an% o#servers #elieve that the largel% unregulated nature of glo#al #anking activit% leaves the -orld financial s%stem vulnera#le to #ank failure on a massive scale. Is this a real threat? If so, -hat measures have governments taken to reduce it?
1:;
11.
L ank failure ma% not #e limited to #anks that have mismanaged their assets.M $'plain -h%.
Ans-er. A sound #ank faced -ith the -holesale loss of deposits is likel% to close its door even if the asset side of its #alance sheet is fundamentall% sound #ecause man% #ank assets are illiAuid and cannot #e sold Auickl% to meet deposit o#ligations -ithout su#stantial loss to the #ank. +tudents should stress the atmosphere of financial panic, -hich -ill lead to self) fulfilling e'pectations. 1/. LIt is in the interest of each depositor to -ithdra- her mone% from a #ank if all other depositors are doing the same, even -hen the #ankIs assets are sound.M Discuss. As part of %our ans-er clearl% state -hether the statement is true or false.
Ans-er. True. +tudents should ela#orate on #ank run and stress the atmosphere of financial panic, -hich -ill lead to self)fulfilling e'pectations. 16. LThere is evidence that the string of D.+. #ank closings in the earl% 196:s helped start and -orsen the "reat Depression.M Discuss.
Ans-er. True. +ee the reference to ernanke in the te't#ook and earlier account #% Anna +ch-art7 and ,ilton &riedman. 1;. Descri#e the e'tensive Lsafet% netM that has #een set up in the Dnited +tates in order to reduce the risk of #ank failure. 1. /. 6. ;. <. Deposit insurance *eserve reAuirements !apital reAuirements and asset restrictions ank e'amination Lender of last resort facilities
Ans-er.
1<.
$'plain -h% the &DI! is follo-ing a Ltoo)#ig)to)failM polic% of full% protecting all depositors at the largest #anks.
Ans-er. A trick% Auestion. The &DI! does that although, officiall%, it still applies onl% to the >1::,::: limit. Pro#a#l%, the idea is that the cost to one depositor is un#eara#le relative to the small cost -e all need to pa% as a collective. Also, there are the issues of political pressure and avoiding #laming the government for mismanaging the safeguards. 1B. $'plain the issues involved -ith the &ed acting as a lender of Last *esort 2LL*4.
Ans-er. (n the one hand, LL* ena#les the &ed to avoid panic and distur#ance to proper functioning of financial markets. (n the other hand, using the polic% ma% cause pro#lems of moral ha7ard.
1:<
1C.
$'plain the causes of the D.+. +avings and Loans crisis of the earl% 19=:s.
Ans-er. (n the one hand, allo-ing +KL to make much riskier loans, for e'ample, loans on commercial real estate. (n the other hand, inadeAuate e'amination for the ne- situation and depositors, together -ith increase in interest rates due to increased inflation rate. 1=. $'plain the difficulties in regulating international #anking. 1. 8o deposit insurance, in particular, inter)#ank deposits are unprotected /. A#sence of reserve reAuirements 6. ank e'amination more difficult to enforce ;. 8ot clear -hich group of regulators has responsi#ilit% for monitoring a given #ankIs assets <. 8ot clear -hich central #ank, if an%, is responsi#le for providing Lender of Last *esort assistance
Ans-er.
19.
LThe internationali7ation of #anking has -eakened national safeguards against #anking collapse, #ut at the same time it has made the need for effective safeguards more urgent.M Discuss.
Ans-er. True. +tudents should ela#orate on. 1. 8o deposit insurance, in particular, inter)#ank deposits are unprotected /. A#sence of reserve reAuirements 6. ank e'amination more difficult to enforce ;. 8ot clear -hich group of regulators has responsi#ilit% for monitoring a given #ankIs assets <. 8ot clear -hich central #ank, if an%, is responsi#le for providing Lender of Last *esort assistance. /:. What is the connection #et-een the 1991 film The Godfather, Part III and international #anking?
Ans-er. +ee page B<1. /1. Wh% did the &ed step in to organi7e a rescue for Long Term !apital ,anagement 2LT!,4 in +eptem#er 199=, rather than simpl% letting the trou#le fund fail? Was the &edIs action necessar% or advisa#le?
Ans-er. +ee pages B<6)B<;. To avoid -hat the &ed perceived as a possi#le meltdo-n of international #anking caused #% the crisis in *ussia and -hen Asia and Latin American economies -ere alread% facing a steep economic slo-do-n. The pro#lem is moral ha7ard again.
1:B
//.
Ans-er. International portfolio diversification has increased. +ee also page B<<. /6. $'plain -h%, according to &eldstein and Norioka, one should e'pect that domestic investment rates diverge -idel% from saving rates.
Ans-er. The decisions of corporations to invest and for households to save are different. Thus glo#ali7ation means more and different -a%s to save and invest and increasing the differences #et-een the t-o ratios. /;. $'plain -h% large interest rate differences -ould #e strong evidence of unreali7ed gains from trade.
Ans-er. The difference #et-een onshore and offshore interest rates on similar assets denominated in the same currenc% should #e small if information a#out glo#al investment opportunities is transmitted efficientl%. Data sho- that this is the case for the Dnited +tates, "erman%, Oapan and the 8etherlands. /<. Discuss studies #ased on the interest parit% conditions.
Ans-er. pages B<9)BB:. In general, the formula does not hold and is not a good predictor of future devaluations. $ven -orse, it failed to predict correctl% even the direction in -hich the spot e'change rate -ould change. /B. What is securiti7ation?
Ans-er. The term refers to financial instruments in -hich #ank assets are repackaged in readil% marketa#le forms. These kind of Lderivatives,M although useful for the international investors and the #anks that under-rite them, causes huge pro#lems in government a#ilities to monitor #ank assets and independentl% assess their risk to the soundness of the international #anking s%stem.
1:C
Quantitative Graphin! Problems 1. +uppose %ou are offered a gam#le in -hich %ou -in >1,::: half the time #ut lose >1,::: half the time. If %ou are a risk averter, -ill %ou take the gam#le?
Ans-er. ecause %ou are as likel% to -in as to lose the >1,:::, the average pa%off on this gam#leF its e'pected value))is. :.<0>1,::: 3 :.<0 2)>1,:::4 1 :. If %ou are risk averse, %ou -ill not take the gam#le #ecause, for %ou, the possi#ilit% of losing >1::: out-eighs the possi#ilit% that %ou -ill -in, although #oth outcomes are eAuall% likel%. /. !alculate the e'pected pa%off for the follo-ing cases, -here A1 and A/ are the pro#a#ilities of state 1 and /, respectivel%.
q1 0.5 0.5 0.5 0.6 q2 0.5 0.5 0.5 0.4 payoff if state 1 Payoff if state 2 Expected payoff 1,000 -1000 200 -200 300 -100 1,000 -1000
Ans-er.
q1 0.5 0.5 0.5 0.6 q2 0.5 0.5 0.5 0.4 payoff if state 1 1,000 200 300 1,000 payoff if state 2 -1000 -200 -100 -1000 Expected payoff 0 0 100 200
1:=
6.
q1 0.5 0.5 0.5 0.6 0.7 0.3 0.4
0.9
Ans-er.
q1 0.5 0.5 0.5 0.6 0.7 0.3 0.1 0.4 q2 0.5 0.5 0.5 0.4 0.3 0.7 0.9 0.6 payoff if state 1 Payoff is state 2 Expected payoff 1,000 -1000 0 200 -200 0 300 -100 100 1,000 -1000 200 1100 1000 1070 1200 -100 290 1300 -100 40 1400 -100 500
1:9
;.
The follo-ing simple t-o)countr% Auestion illustrates ho- countries are made #etter off #% trade in assets. Imagine that there are t-o countries, Nome and &oreign, and that residents of each o-n onl% one asset, domestic land %ielding an annual harvest of ki-i fruit. Assume that the %ield on the land is uncertain. Nalf the time, NomeIs land %ields a harvest of 1:: tons of ki-i fruit at the same time that &oreignIs land %ields a harvest of <: tons. The other half of the time the outcomes are reversed. &oreignIs harvest is 1:: tons, #ut the Nome harvest is onl% <:. A. !alculate the average, for each countr%, of ki-i harvest.
Ans-er. The average for each countr% of ki-i harvest is. :.<01:: 3 :.<0<: 1 C< tons of ki-i fruit. No-ever, note that the inha#itants of the t-o countries never kno- in advance -hether the ne't %ear -ill #ring feast or famine. . 8o- suppose the t-o countries can trade shares in the o-nership of their prospective assets. &urther, assume that a Nome citi7en o-ns a 1: percent share in &oreign land. Ne -ill receive a 1: percent share in &oreign land, and thus receives 1: percent of the annual &oreign ki-i fruit harvest. &urther assume that a &oreign o-ner of a 1: percent share in Nome land is permitted. In this case, a &oreigner is entitled to 1: percent of the Nome harvest. !alculate the e'pected value of ki-i fruit for each investor. Is the investor #etter off?
Ans-er. "ood %ear at Nome. the farmer -ill get 9: toms of ki-i from home and < tons of ki-i from &oreign. ad %ears at home. he -ill get ;< tons of ki-i from his Nome and 1: tons from the &oreign countr%, namel% << tons. The pro#a#ilit% for a good or a #ad %ear is :.<. Thus the e'pected returns -ill no- #e. :.<09< 3 :.< 0 << 1 C< It is not clear -hether the investor is #etter off or not. If he likes to smooth his consumption, he ma% #e #etter off. (ther-ise, it is impossi#le to tell -ithout a particular utilit% function. !. 8o- suppose the t-o countries can trade shares in the o-nership of their prospective assets. &urther assume that a Nome citi7en o-ns a /< percent share in &oreign land. Ne -ill receive a /< percent share in &oreign land and thus receives /< percent of the annual &oreign ki-i fruit harvest. &urther assume that a &oreign o-nership of a /< percent share in Nome land is permitted also. In this case, a &oreigner is entitled to /< percent of the Nome harvest. !alculate the e'pected value of ki-i fruit for each investor.
"ood %ear at Nome. C< 3 1/.< 1 =C.< tons -ith pro#a#ilit% :.< ad %ear at Nome. 6C.< from Nome and /< from &oreign 1 B/.< -ith pro#a#ilit% :.<. The e'pected return is. :.<0=C.< 3 :.<0B/.< 1 C<. Again, this case sho-s smoother consumption relative to parts A or .
11:
D.
8o- suppose the t-o countries can trade shares in the o-nership of their prospective assets -ithout an% restrictions. Assume that the consumers in #oth countries -ould like to totall% smooth their consumption. Descri#e the outcomes.
Ans-er. In this case, Nome residents -ill #u% a <: percent share of the land in &oreign, and the% -ill pa% for it #% giving &oreign residents a <: percent share in Nome land. To understand -h%, think a#out the returns to the Nome and &oreign portfolios -hen #oth are eAuall% divided #et-een titles to Nome and &oreign land. When times are good at Nome 2and therefore #ad in &oreign4, each countr% earns the same return harvest, -hich is C< ever% %ear -ith certaint%. Nalf of the Nome harvest 21:: ton of ki-i fruit4 plus half of the &oreign harvest 2<: tons of ki-i fruit4 or C< tons of fruit. :.<01:: 3 :.<0<:: 1 C<. In the opposite case, #ad times in Nome, good time in &oreign, each countr% still earns C< tons of fruit. Thus, -e have sho-n that if the countries hold portfolios eAuall% divided #et-een the t-o assets, each countr% earns a certain return of C< tons of ki-i fruit. This certain return is e'actl% the same as the average harvest each faced #efore international asset trading -as allo-ed. This trade completel% eliminates the risk faced #% #oth countries -ithout changing average returns. Assuming risk)averse individuals in #oth countries, the t-o countries are #etter off as a result of asset trading. $. 8o- suppose that trade in assets is not allo-ed #ut the t-o countries sign a treat% that guarantee the sending of /< tons of ki-i in good time #% the high output countr% in that season. What -ill #e the outcome of such a treat%? $'plain -h%.
Ans-er. The outcomes -ill #e e'actl% the same as in !ase D a#ove. In other -ords, rather than signing a treat%, Gust leaving the financial markets to function -ill lead us to the desira#le results.
111
<.
Does the interest rate parit% hold in each of the follo-ing cases? In case it does not hold , calculate the risk premium. A. *t 1 <, *t0 1 6, $t 1 <, $t31e 1 C . *t 1 B, *t0 1 6, $t 1 <, $t31e 1 C !. *t 1 C, *t0 1 6, $t 1 <, $t31e 1 C D. *t 1 =, *t0 1 6, $t 1 <, $t31e 1 C $. *t 1 <, *t0 1 ;, $t 1 <, $t31e 1 C &. *t 1 <, *t0 1 <, $t 1 <, $t31e 1 C ". *t 1 <, *t0 1 B, $t 1 <, $t31e 1 C N. *t 1 <, *t0 1 6, $t 1 B, $t31e 1 C I. *t 1 <, *t0 1 6, $t 1 C, $t31e 1 C O. *t 1 <, *t0 1 6, $t 1 =, $t31e 1 C P. *t 1 <, *t0 1 6, $t 1 <, $t31e 1 = L. *t 1 <, *t0 1 6, $t 1 <, $t31e 1 9 ,. *t 1 <, *t0 1 6, $t 1 <, $t31e 1 1:
Ans-er.
Case % & C ' E ) * + , . / 0 Rt 5 6 7 ( 5 5 5 5 5 5 5 5 5 Rt* 3 3 3 3 4 5 6 3 3 3 3 3 3 Et 5 5 5 5 5 5 5 6 7 ( 5 5 5 Ee t 1 7 7 7 7 7 7 7 7 7 7 ( 9 10 Ris! P"e#i$# 1.6 2.6 3.6 4.6 0.6 -0.4 -1.4 1.(33333333 2 2.125 1.4 1.2 1
11/
B.
Assume interest parit% holds. !alculate $t31e for each of the follo-ing cases.
Case % & C ' E ) Rt 5 6 7 ( 5 5 Rt* 3 3 3 3 4 5 Et 5 5 5 5 5 5 Ee t
1
Ans-er.
Rt 5 6 7 ( 5 5
Rt* 3 3 3 3 4 5
Et 5 5 5 5 5 5
Et 1 15 20 25 30 10 5
116