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Final Exam
Instructions: Use complete sentences and label all diagrams carefully. You may use a calculator
but you may not use any other outside materials: smartphones, scratch paper, etc. There are 65
points possible.
1. Monetary aggregates I. Answer the following questions about monetary aggregates.
(a) (4 points) For each asset in the following list, place an X in the appropriate column(s)
to indicate that the asset is part of the M1 monetary aggregate, the M2 monetary
aggregate, or both.
M1
M2
Small-denomination time
deposits
Checkable deposits
Travelers checks
Money market mutual
fund shares (retail)
Other checkable deposits
Currency and coins held by
nonbank public
Savings deposits / money
market deposit accounts
(b) (3 points) List each of the three roles of money. You do not have to define them.
(c) (2 points) Provide at least one reason for why economists do not typically count the
funds that you hold on account with a stock market mutual fund as part of the money
supply.
2. Monetary aggregates II. For each of the following transactions identify by how much M1
and M2 change.
(a) (3 points) You receive a check for $2,500 from your employer. You deposit the check into
your checking account. You then withdraw $500 as cash and transfer $1,000 into your
savings account, and use the remainder to purchase shares of a stock market mutual
fund.
(b) (3 points) Umut has $4 million of funds in a savings account. He moves $2 million of
the funds from his savings account into a retail money market mutual fund (RMMMF)
account. He then moves $1 million from his savings account to his checking account.
(b) (3 points) A 10 year coupon bond with a 4% coupon rate and yield to maturity i = 0.05
sells for a price of $9,227.8245. What is the face value of the bond? Round your answer
to the nearest cent.
4. The Risk Premium. Answer the following questions about the risk premium.
(a) (3 points) Provide two reasons for why the yields to maturity on municipal bonds are
generally different from the yields on US Treasury bonds. Are the yields on municipal
bonds typically greater than or less than the yields on US Treasury bonds?
(b) (4 points) Construct a diagram that shows how the equilibrium yields to maturity on
US Treasury bonds and municipal bonds are jointly determined. Be sure to identify the
risk premium on municipal bonds on your diagram.
5. The Term Structure of Interest Rates. Answer the following questions about the term
structure.
(a) (3 points) Write down the equation that captures the liquidity premium theory of the
term structure. Which part of the equation directly reflects the liquidity premium? List
two reasons why there would be a liquidity premium on longer-term bonds.
(b) (5 points) You are given the current 1-year interest rate, a sequence of expected 1-year
interest rates, and a sequence of liquidity premiums:
it
= 0.07
l1t = 0
iet+1 = 0.05
l2t = 0.005
iet+2
l3t = 0.01
= 0.03
iet+3 = 0.01
l4t = 0.015
iet+4 = 0.04
l5t = 0.02
Find the yields on 1, 2, 3, 4, and 5-year bonds that are implied by the expectations
theory and the liquidity premium theory. Plot the yield curves implied by each theory.
You may also use the following page to write your answer.
6. A simple banking model.. A bank raises funds by accepting deposits D in order to make
loans L. The central bank requires that the bank hold a minimum quantity of reserves R in
proportion to its deposits:
R = D,
(1)
where is the required reserve ratio. You should assume that the bank does not hold excess
reserves. The bank is competitive and takes the lending rate rL and the deposit rate rD
as given. The supply of deposits is perfectly elastic at rD . The bank chooses a quantity of
deposits to accept, loans to make, and reserves to hold in order to maximize its profit.
(a) (3 points) Write down the banks balance sheet constraint.
(c) (3 points) Solve the banks profit-maximization problem to find the equilibrium relationship between the deposit rate rD , the lending rate rL , and the required reserve ratio ?
Show your work.
(d) (3 points) Suppose that a borrower uses borrowed funds from the bank to purchases an
investment good I so that I = L. With certainty, the investment good generates income
for the borrower according to the function:
f (I) = 10,000 I 0.25 .
(2)
If the deposit rate is rD = 0.081 and the required reserve ratio is = 0.1, then what
is the quantity of investment I that the borrower will choose to undertake? Show your
work.
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7. Capital management. Initially, Anteater National Bank has the following assets:
$200 million in loans
$28 million in securities
$22 million in reserves
and the following liabilities:
$200 million in deposits
$25 million in borrowed funds
Use this information to answer the following questions:
(a) (2 points) What is the initial amount of equity capital for Anteater National?
(b) (4 points) Prepare the balance sheet for Anteater National. Include all assets and liabilities listed above and the value for equity capital that you found for part (a).
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(c) (2 points) Holding everything else constant, what is the greatest loss that Anteater
National can endure on its loan portfolio before the bank becomes insolvent?
(d) (3 points) If Anteater Nationals net profit after taxes is $10 million, what is its return
on assets (ROA)? What is Anteater Nationals return on equity (ROE)?
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8. The Money Multiplier For this question c denotes the ratio of currency to deposits, denotes
the ratio of required reserves to deposits, and e denotes the ratio of excess reserves to deposits.
(a) (3 points) Express the money multiplier m in terms of c, , and e.
(3)
= 0.1
(4)
e = 0.02
(5)
Find the value of the money multiplier m. If the Feds objective were to have a money
supply equal to $1 trillion, then how large would the monetary base need to be?
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1
(1 + i)k
1
1
1
+ +
+
1 + i (1 + i)2
(1 + i)N
for various combinations of i and N . For example, when i = 0.07 and N = 10,
10
X
k=1
1
= 7.0236.
(1 + 0.07)k
Yield to Maturity (i )
N
0.01
0.02
0.03
0.04
0.05
0.06
0.07
0.990 10
0.980 39
0.970 87
0.961 54
0.952 38
0.943 40
0.934 58
1.970 40
1.941 56
1.913 47
1.886 09
1.859 41
1.833 39
1.808 02
2.940 99
2.883 88
2.828 61
2.775 09
2.723 25
2.673 01
2.624 32
3.901 97
3.807 73
3.717 10
3.629 90
3.545 95
3.465 11
3.387 21
4.853 43
4.713 46
4.579 71
4.451 82
4.329 48
4.212 36
4.100 20
5.795 48
5.601 43
5.417 19
5.242 14
5.075 69
4.917 32
4.766 54
6.728 19
6.471 99
6.230 28
6.002 05
5.786 37
5.582 38
5.389 29
7.651 68
7.325 48
7.019 69
6.732 74
6.463 21
6.209 79
5.971 30
8.566 02
8.162 24
7.786 11
7.435 33
7.107 82
6.801 69
6.515 23
10
9.471 30
8.982 59
8.530 20
8.110 90
7.721 73
7.360 09
7.023 58
11
10.367 63
9.786 85
9.252 62
8.760 48
8.306 41
7.886 87
7.498 67
12
11.255 08
10.575 34
9.954 00
9.385 07
8.863 25
8.383 84
7.942 69
13
12.133 74
11.348 37
10.634 96
9.985 65
9.393 57
8.852 68
8.357 65
14
13.003 70
12.106 25
11.296 07
10.563 12
9.898 64
9.294 98
8.745 47
15
13.865 05
12.849 26
11.937 94
11.118 39
10.379 66
9.712 25
9.107 91
20
18.045 55
16.351 43
14.877 47
13.590 33
12.462 21
11.469 92
10.594 01
25
22.023 16
19.523 46
17.413 15
15.622 08
14.093 94
12.783 36
11.653 58
30
25.807 71
22.396 46
19.600 44
17.292 03
15.372 45
13.764 83
12.409 04
40
32.834 69
27.355 48
23.114 77
19.792 77
17.159 09
15.046 30
13.331 71
50
39.196 12
31.423 61
25.729 76
21.482 18
18.255 93
15.761 86
13.800 75
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Yield to Maturity (i )
N
0.08
0.09
0.10
0.11
0.12
0.13
0.14
0.925 93
0.917 43
0.909 09
0.900 90
0.892 86
0.884 96
0.877 19
1.783 26
1.759 11
1.735 54
1.712 52
1.690 05
1.668 10
1.646 66
2.577 10
2.531 29
2.486 85
2.443 71
2.401 83
2.361 15
2.321 63
3.312 13
3.239 72
3.169 87
3.102 45
3.037 35
2.974 47
2.913 71
3.992 71
3.889 65
3.790 79
3.695 90
3.604 78
3.517 23
3.433 08
4.622 88
4.485 92
4.355 26
4.230 54
4.111 41
3.997 55
3.888 67
5.206 37
5.032 95
4.868 42
4.712 20
4.563 76
4.422 61
4.288 30
5.746 64
5.534 82
5.334 93
5.146 12
4.967 64
4.798 77
4.638 86
6.246 89
5.995 25
5.759 02
5.537 05
5.328 25
5.131 66
4.946 37
10
6.710 08
6.417 66
6.144 57
5.889 23
5.650 22
5.426 24
5.216 12
11
7.138 96
6.805 19
6.495 06
6.206 52
5.937 70
5.686 94
5.452 73
12
7.536 08
7.160 73
6.813 69
6.492 36
6.194 37
5.917 65
5.660 29
13
7.903 78
7.486 90
7.103 36
6.749 87
6.423 55
6.121 81
5.842 36
14
8.244 24
7.786 15
7.366 69
6.981 87
6.628 17
6.302 49
6.002 07
15
8.559 48
8.060 69
7.606 08
7.190 87
6.810 86
6.462 38
6.142 17
20
9.818 15
9.128 55
8.513 56
7.963 33
7.469 44
7.024 75
6.623 13
25
10.674 78
9.822 58
9.077 04
8.421 74
7.843 14
7.329 98
6.872 93
30
11.257 78
10.273 65
9.426 91
8.693 79
8.055 18
7.495 65
7.002 66
40
11.924 61
10.757 36
9.779 05
8.951 05
8.243 78
7.634 38
7.105 04
50
12.233 48
10.961 68
9.914 81
9.041 65
8.304 50
7.675 24
7.132 66
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Scratch paper
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