Money, Banking, and Financial Markets Midterm Exam III - July 25, 2005 (Econ 353), Exams of Economics

Download Money, Banking, and Financial Markets Midterm Exam III - July 25, 2005 (Econ 353) and more Exams Economics in PDF only on Docsity! Money, Banking, and Financial Markets (Econ 353) Midterm Examination III July 25, 2005 Name__________________________________ Univ. Id #______________________ Note: Each multiple-choice question is worth 4 points. Problems 21, 22, carry 10 points each. 1) Regular bank examinations and restrictions on asset holdings help to indirectly reduce the _____ problem because, given fewer opportunities to take on risk, risk-prone entrepreneurs will be discouraged from entering the banking industry. A) moral hazard B) post-contractual opportunism. C) ex post shirking D) adverse selection 2) Advocates of Fed independence fear that subjecting the Fed to direct presidential or congressional control would A) impart an inflationary bias to monetary policy. B) force monetary authorities to sacrifice the long-run objective of price stability. C) make the so-called political business cycle less pronounced. D) both A and B of the above. 3) The theory of bureaucratic behavior when applied to the Fed helps to explain why the Fed A) resists so vigorously congressional attempts to limit the central bank's autonomy. B) is so secretive about the conduct of future monetary policy. C) sought less control over banks in the 1980s. D) all of the above. E) only A and B of the above. 4) The rapid growth of the commercial paper market since 1970 is due to A) government regulation. B) the fact that commercial paper has no default risk. C) improved information technology making it easier to screen credit risks. D) FDIC insurance for commercial paper. E) all of the above. 5) When compared to banks with _____ net worth, banks with _____ net worth have fewer incentives to engage in activities that ensure profitability. A) high; low B) low; high C) low; low D) high; high 6) In figure above, with a expiration price of 120, the best return is obtained by A) selling futures. B) buying a put option. C) buying futures. D) buying a call option. E) none of the above. 18) Social Security is a A) federally insured private pension plan. B) government sponsored private pension plan. C) fully funded pension plan. D) "pay-as-you-go" system. 19) If a bank has $10 million of deposits, a required reserve ratio of 10 percent, and it holds $2 million in reserves, then it will not have enough reserves to support a deposit outflow of A) $1.1 million. B) $1 million. C) $1.2 million. D) either A or B of the above. 20) (Bonus Question) One of the crucial assumptions of the Herd Behavior Model is: A) signals coming from observing other individuals’ behavior always precedes the reception of own signal B) own signal and signals coming from observing other individuals’ behavior is of the same quality C) the quality of own signal is always higher than the quality of signals coming from observing other individuals’ behavior D) signals coming from observing other individuals’ behavior and the own signal are always received at the same time 21. Suppose that two types of firms, H-type and L-type, are issuing new stocks. You know that the stock of L-type firms is worth $50/stock whereas those of H-type firms are worth $120/stock. You have to invest your money in buying stocks. Unfortunately, you have no way to find out which one is L-type or H-type. However, you know that, overall, the proportion of L-type firms is 10% whereas that of H-type firms is 90%. a. (5 points) If both firms were selling their stocks in the market, what price you would be willing to pay for each share without knowing the quality of the firm? Now, if we know that the H-type firms would be willing to issue the stock for any price equal or above $100, which firms will be selling their stocks and at what price? (Show your work) b. (5 points) Now suppose that the proportions change to 90% of L-type firms and 10% of H-type firms. Which firms would be selling their stocks now and at what price? (Again, we assume that H-type firms require at least $100 for their stock) (Show your work) 22. Here are the summary balance sheets of two banks A and B. The required reserve ratio is 10%. A Assets Liabilities Reserves: $10 m Deposits: $95m Loans: $90m Bank’s Capital: $5m B Assets Liabilities Treasury Bills $5 m Discount Loans $10m Reserves: $15 m Deposits: $98m Loans: $90m Bank’s Capital: $2m a. (5 points) Suppose both banks have similar loans in regard to their expected returns and default risk. If, for each bank, $4 m loans become non-performing and the borrowers default, the banks will have to write them off. The depositors at which bank are facing high risk that the bank itself will default? Why? (Show your work using the T-accounts) b. (5 points) Suppose there is no default problem and both banks have equal net profits of $1 m from interest on their loans. Calculate ROE, ROA and EM for both banks and thoroughly EXPLAIN THE DIFFERENCES. (Show your work)