Questions for Exam 2 - Financial Markets and Economic Fluctuations | ECON 423, Exams of Financial Market

Download Questions for Exam 2 - Financial Markets and Economic Fluctuations | ECON 423 and more Exams Financial Market in PDF only on Docsity! 1 Econ 423: Essay Questions and Problems from Previous Versions of Exam 2 Spring 2006 1. Write an equation that solves for the most a risk-neutral individual would pay for insurance against loss from an event. Be sure to define your variables carefully, and explain VERY briefly. [20 points] 2. Print a capital letter from this figure to identify the behavior described by the A-F points if at these points, an individual is indifferent between a certain risky expected value and the associated less risky, more certain [surer] gains or losses. Then complete the sentence in #5. [25 points] ___ (1) Risk averse when faced with prospects for potential gains. ___ (2) Risk loving [loss-averse] when confronted with prospects for potential losses. ___ (3) Risk averse when faced with prospects for potential losses. ___ (4) Risk–loving when faced with prospects for potential gains. (5) A risk neutral individual would make choices that are: _____________________. 3. Write an equation that solves for the monthly payment for a family taking out a conventional mortgage. Be sure to define your variables carefully, and explain VERY briefly. [20 points] 4. Write equations that identify the relationships between the reserve requirement ratio[rr], the actual money supply [MSA = M1], the potential money multiplier [mP], the monetary base [MB], currency in circulation [CNBP], the actual money multiplier [mP], legal (total bank) reserves [LR], required bank reserves [RR], and demand deposits [DD]. [40 points] 5. Briefly explain why the Federal Reserve System seldom if ever changes the margin requirement. [20 points] 6. Briefly explain why lottery ticket buyers who select their “own numbers” for lottery tickets are making even worse decisions, probabilistically, than those who allow the system’s random number generator to select the numbers. [20 points] 2 7. Briefly describe the mechanisms through which the money supply and spending are affected by changes in the Federal Reserve System’s: (a) reserve requirement ratio. (b) open market operations. (c) discount rate. [Hints: Income velocity of money [V]? Required reserves [RR]? Potential money multiplier [mP]? Actual money multiplier [mA]? Monetary base [MB]? Currency in circulation [CNBP]? Total (legal) reserves in the banking system? [LR] Excess reserves [XR]? Excess reserves ratio [xr]?) [40 points] 8. Interpret Keynesian “spending multiplier” analysis as a mechanism for controlling aggregate spending within the framework of the tautological [“true” by definition] Fisher Equation of Exchange. [30 points] Fall 2005 1. Describe the process by which the U.S. Treasury sells Treasury bills. [15 points] 2. Evaluate inflation targeting as a strategy for central banks. [20 points] 3. Describe predictable changes in the global economic environment and some changes in Fed policy that financial market participants expect as Ben Bernanke takes over as Chairman of the Fed in early 2006.[30 points] 4. List and describe at least six money market instruments. [30 points]. Spring 2005 1. Allowing only those factors to vary that must, rank up to six capital market instruments by the expected interest rate or rate of return that investors will require before purchasing the instruments. [lowest interest rate or rate of return to highest.] [3 minimum, 5 points each.] 2. Identify at least three reasons why banks and thrift institutions have declined in relative importance as repositories of household wealth during the past half century. [30 points.] 3. Describe in reasonable detail the mechanisms by which an expansionary open market policy affects, for example, total bank reserves, required bank reserves, excess reserves, the monetary base, potential and real money multipliers, money supply, and nominal and/or real interest rates across time. [Note that some of the variables listed to help you think are red herrings, and are unaffected by open market operations as banks and borrowers attain equilibrium.] 60 points. 5 Spring 2002 Essay 1. Explain how the purchasing power parity theorem is a model of exchange rate determination. 2. Explain how adjustments to flexible exchange rates ensure that, after adjustments for risk, real interest rates will be identical between countries. Spring 2001 Essay 1. How did deregulation contribute to the collapse of many savings-and-loans during the 1980s? 2. What types of regulations limit the ability of financial institutions to deal with the problems of disintermediation? Fall 2000 Corporate Finance [Duke] Section B: A Hypothetical Case Study. 1. PsychoMystics Unlimited (PMU) is considering provision of interactive but fully-automated psychic readings from a web site. The PMU project, PsychoDrama, would require an initial investment of $300,000, but variable costs are expected to be trivial because the server contemplated is sufficiently powerful that all feasible customers would be served easily. However, PsychoDrama would entail fixed costs for web site maintenance and R&D in each period. Based on the success of its “Psychic HotLine”, PMU believes that annual revenues will be between $360,000 and $840,000 into perpetuity. You have been hired to do sensitivity analysis. PMU webmasters expect site maintenance costs to range from $96,000 to $144,000 annually, and PMU researchers assert that their efforts will cost between $192,000 and $288,000 annually. PMU’s cost of capital is 10%. PMU’s PsychoDrama subsidiary will locate in the Cayman Islands, and therefore, not be subject to taxes. PMU managers want you to assume that, (running from pessimistic to optimistic, revenue and) cost outcomes will be perfectly positively correlated. a) Fill in this table Pessimistic Most Likely Optimistic Total revenues Costs: Website Costs: Research b. .What does your sensitivity analysis of the NPV of PsychoDrama reveal? (Show your work.) An acceptable but overly simplified answer assuming perfect correlation between positive and negative outcomes, which I indicated in class would be acceptable to save time: Pessimistic 6 Most Likely Optimistic 2. Briefly explain why PMU’s assumptions about the relative cash flows and costs may be overly optimistic in the long run. 3. Briefly explain what is like to be true about abandonment and expansion values of PMU’s project. Section C: Problems. Print your answer in the blank to the left of each problem, but show your work, where appropriate, in the space provided. Answers 1. If the standard deviation is 34% and the number of observations is 72, what is the standard error? 2. The historical returns data for the past three years for Company A's stock is -6.0%, 15%, 15% and that of the market portfolio is 10%, 10% and 16%. Calculate the expected return for the stocks and the market portfolio. 3. The historical returns data for the past three years for PMU and the stock market portfolio are: PMU:- 24%, 0%, 24%, Market Portfolios:- 10%, 12%, 20%. Calculate the covariance of returns between PMU and the market portfolio. 4. The historical returns data for the past three years for PMU and the stock market portfolio are: PMU:- 24%, 0%, 24%, Market Portfolios:- 10%, 12%, 20%. If the risk- free rate is 4%, calculate the market risk premium. 5. The historical returns data for the past three years for PMU and the stock market portfolio are: PMU:- 24%, 0%, 24%, Market Portfolios:- 10%, 12%, 20%. Calculate the required rate of return (cost of equity) for PMU using CAPM. 7 6. Hammer Company proposes to invest $6 million in a new type of hammer-making equipment. The fixed costs are $0.5 million per year. The equipment is expected to last for 5 years. The manufacturing costs per hammer is $1. Calculate the break-even volume per year. (Ignore taxes.)