Why are deposit insurance and other types of government safety nets important to the health of

the economy?

"According to the expectations theory of the term structure, it is better to invest in one-year
bonds, reinvested over two years, than to invest in a two-year bond if interest rates on one-year
bonds are expected to be the same in both years." Is this statement true, false, or uncertain?

Go to the St. Louis Federal Reserve FRED database, and find daily yield data on the following
U.S. treasuries securities: one-month (DGS1MO), three-month (DGS3MO), six-month
(DGS6MO), one-year (DGS1), two-year (DGS2), three-year (DGS3), five-year (DGS5), seven-
year (DGS7), 10-year (DGS10), 20-year (DGS20), and 30-year

Describe how each of the following can affect the money supply: (a) The central bank; (b)
Banks; (c) Depositors.

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You wish to hire Ron to manage your Dallas operations. The profits from the operations depend
partially on how hard Ron works, as follows. If Ron is lazy, he will surf the Internet all day, and
he views this as a zero cost opportunity. However, Ron views working hard as a "personal cost"
valued at $1,000. What fixed

Go to the St. Louis Federal Reserve FRED database, and find data on the 30-year conventional
mortgage rate (WRMORTG) and the 5/1-year adjustable-rate mortgage (MORTGAGE5US). a.
What are the mortgage rates reported for the most recent week of data available? b. If the
principal payment for a given month were $2000, th

Which is more independent, the Federal Reserve or the European Central Bank? Why?

Go to the St. Louis Federal Reserve FRED database, and find data on net worth of households
(TNWBSHNO) and the net percentage of domestic banks tightening standards for prime
mortgage loans (DRTSPM). Adjust the units setting for the net worth indicator to "Percent
Change from Year Ago," and download the data into a spr

Go to the St. Louis Federal Reserve FRED database, and find data on the level of money market
mutual fund assets (MMMFFAQ027S). Download the data into a spreadsheet. a. When did
assets start entering money market mutual funds? What was the total worth of assets in money
market mutual funds at the end of 1970? b. For

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Go to the St. Louis Federal Reserve FRED database, and find data on the interest rate on a four-
year auto loan (TERMCBAUTO48NS). Assume that you borrow $20,000 to purchase a new
automobile and that you finance it with a four-year loan at the most recent interest rate given in
the database. If you make one payment per y
If a forecaster spends hours every day studying data to forecast interest rates, but his expectations
are not as accurate as predicting that tomorrow's interest rate will be identical to today's interest
rate, are his expectations rational?

If a bank depositor withdraws $1,000 of currency from an account, what happens to reserves,
checkable deposits, and the monetary base?

The U.S. Treasury offers some of its debt as Treasury Inflation Protected Securities, or TIPS, in
which the price of bonds is adjusted for inflation over the life of the debt instrument. TIPS bonds
are traded on a much smaller scale than nominal U.S. Treasury bonds of equivalent maturity.
What can you conclude about th

What are the two main sources of cash flows for a stockholder? How reliably can these cash
flows be estimated? Compare the problem of estimating stock cash flows to the problem of
estimating bond cash flows. Which security would you predict to be more volatile?

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Gustavo is a young doctor who lives in a country with a relatively inefficient legal and financial
system. When Gustavo applied for a mortgage, he found that banks usually required collateral
for up to 300% of the amount of the loan. Explain why banks might require that much collateral
in such a financial system. Comme

Classify each of these transactions as an asset, a liability, or neither for each of the "players" in
the money supply process-the federal reserve, banks, and depositors. a. You get a $10,000 loan
from the bank to buy an automobile. b. You deposit $400 into your checking account at the local
bank. c. The Fed provide

Go to the St. Louis Federal Reserve FRED database, and find data on Moody's Aaa corporate
bond yield (AAA) and Moody's Baa corporate bond yield (BAA). Download the data into a
spreadsheet. a. Calculate the spread (difference) between the Baa and Aaa corporate bond yields
for the most recent month of data available. W

In December 2001, Argentina announced it would not honor its sovereign (government-issued)
debt. Many investors were left holding Argentinean bonds priced at a fraction of their previous
value. A few years later, Argentina announced it would pay back 25% of the face value of its
debt. Comment on the effects of informat

What is a credit spread? Why do credit spreads rise significantly during a financial crisis?

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Go to the St. Louis Federal Reserve FRED database, and find data on the unemployment rate in
each of the twelve Federal Reserve districts. These are coded as (D1URN), (D2URN),
(D3URN), . . . , (D12URN). For the most recent month of data available, determine which
district had the highest, and which had the lowest, unem

At the height of the global financial crisis in October 2008, the U.S. Treasury forced nine of the
largest U.S. banks to accept capital injections in exchange for nonvoting ownership stock, even
though some of the banks did not need the capital and did not want to participate. What could be
the Treasury's rationale for

What causes bank panics to occur?

What are some of the limitations to the Basel and Basel 2 Accords? How does the Basel 3
Accord attempt to address these limitations?

Despite the important role played by the Board of Governors in setting monetary policy, seats to
serve on the Board of Governors can sometimes be empty for several years. How might this
happen?

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Why has the number of bank holding companies dramatically increased?

What are the advantages and disadvantages of interstate banking?

Why is it important for the regional Federal Reserve Bank presidents to attend the FOMC
meetings, even if they are nonvoting members?

Why is loophole mining so prevalent in the banking industry in the United States?

Go to the St. Louis Federal Reserve FRED database, and find data for all commercial banks on
total assets (TLAACBM027SBOG), U.S. government and agency securities held (USGSEC),
other securities held (OTHSEC), commercial and industrial loans (BUSLOANS), real estate
loans (REALLN), consumer loans (CONSUMER), interbank lo

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What are the three approaches to limiting the too-big-to-fail problem? Briefly describe the
advantages and disadvantages of each of the approaches.

What has been the likely effect of the Gramm-Leach-Bliley Act on financial consolidation?

Many policymakers in developing countries have proposed the implementation of a system of

deposit insurance similar to the system that exists in the United States. Explain why this might
create more problems than solutions in the financial system of a developing country.
Following a policy meeting on March 19, 2009, the Federal Reserve made an announcement that
it would purchase up to $300 billion of longer-term Treasury securities over the following six
months. What effect might this policy have on the yield curve?

Go to the St. Louis Federal Reserve FRED database, and find data on the M1 money supply
(M1SL) and the 10-year U.S. treasury bond rate. For the M1 money supply indicator, adjust the
units setting to "Percent Change from Year Ago," and for the 10-year treasury bond, adjust the
frequency setting to "Quarterly." Download

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Why might more competition in financial markets be a bad idea? Would restrictions on
competition be a better idea? Why or why not?

In what way does the Federal Reserve have a high degree of instrument independence? If it has a
specific mandate from Congress to achieve "maximum employment and low, stable prices," then
how does the Fed have goal independence?

During 2008, the difference in yield (the yield spread) between three-month AA-rated financial
commercial paper and three-month AA-rated nonfinancial commercial paper steadily increased
from its usual level of close to zero, spiking to over a full percentage point at its peak in October
2008. What explains this sudden

In the aftermath of the global economic crisis that started to take hold in 2008, U.S. government
budget deficits increased dramatically, yet interest rates on U.S. Treasury debt fell sharply and
stayed low for quite some time. Does this make sense? Why or why not?

Why does the United States operate under a dual banking system?

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Prior to 2008, mortgage lenders required a house inspection to assess a home's value, and often
used the same one or two inspection companies in the same geographical market. Following the
collapse of the housing market in 2008, mortgage lenders required a house inspection, but this
inspection was arranged through a th

If junk bonds are "junk," then why do investors buy them?

Early the next day, the bank invests $50 million of its excess reserves in commercial loans. Later
that day, terrible news hits the mortgage markets, and mortgage rates jump to 13%, implying a
present value of Oldhat's current mortgage holdings of $124,798 per mortgage. Bank regulators
force Oldhat to sell its mortgage

Why is the New York Federal Reserve always a voting member of the FOMC?
How does bank chartering reduce adverse selection problems? Does it always work?

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How does the concept of asymmetric information help to define a financial crisis?

Why is it important for the U.S. government to have resolution authority?

How do sweep accounts and money market mutual funds allow banks to avoid reserve
requirements?

Go to the St. Louis Federal Reserve FRED database, and find data on the federal funds rate
target (DFEDTAR, DFEDTARU, and DFEDTARL) and the discount, or primary credit rate
(DPCREDIT). When was the last time the federal funds rate target was changed? When was the
last time the primary credit rate was changed? Did the r

Why is there only one U.S. bank among the ten largest banks in the world?

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The U.S. Treasury issues some bonds as Treasury Inflation Indexed Securities, or TIIS, which
are bonds adjusted for inflation; hence the yields can be roughly interpreted as real interest rates.
Go to the St. Louis Federal Reserve FRED database, and find data on the following TIIS bonds
and their nominal counterparts.

Go to the St. Louis Federal Reserve FRED database, and find data on net worth of households
and non-profits (HNONWRQ027S) and the 10-year U.S. treasury bond (GS10). For the net
worth indicator, adjust the units setting to "Percent Change from Year Ago," and for the 10-year
bond, adjust the frequency setting to "Quarter

Go to the St. Louis Federal Reserve FRED database, and find data on corporate net worth of
nonfinancial businesses (TNWMVBSNNCB), private domestic investment (GPDIC1), and a
measure of financial frictions, the St. Louis Fed financial stress index (STLFSI). For all three
measures, be sure to convert the frequency settin

Why is it a good idea for macro prudential policies to require countercyclical capital
requirements?

Describe two similarities and two differences between the United States' experiences during the
Great Depression and the financial crisis of 2007-2009.

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Go to the St. Louis Federal Reserve FRED database, and find data on the residual of assets less
liabilities, or bank capital (RALACBM027SBOG), and total assets of commercial banks
(TLAACBM027SBOG). Download the data from January 1990 through the most recent month
available into a spreadsheet. For each monthly observati

Why is it unlikely that the policy recommendation put forth by the chair of the Board of
Governors would ever be voted down by the rest of the FOMC?

The presidents of each of the district Federal Reserve Banks (including the New York Federal
Reserve Bank) are currently not required to undergo a formal political appointment and approval
process. Do you think this is appropriate? Why or why not?

Go to the St. Louis Federal Reserve FRED database, and find data on net corporate dividend
payments (B056RC1A027NBEA). Adjust the units setting to "Percent Change from Year Ago,"
and download the data into a spreadsheet. a. Calculate the average annual growth rate of
dividends from 1960 to the most recent year of dat

Consider a failing bank. How much is a deposit of $350,000 worth if the FDIC uses the payoff
method? The purchase and assumption method? Which method is more costly to taxpayers?

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How can asymmetric information problems lead to a bank panic?

In 2010 and 2011, the government of Greece risked defaulting on its debt due to a severe budget
crisis. Using bond market graphs, compare the effects on the risk premium between U.S.
Treasury debt and comparable-maturity Greek debt.

Why might the efficient market hypothesis be less likely to hold when fundamentals suggest
stocks should be at a lower level?

M1 money growth in the U.S. was about 15% in 2011 and 2012, and 10% in 2013. Over the
same time period, the yield on 3-month Treasury bills was close to 0%. Given these high rates of
money growth, why did interest rates stay so low, rather than increase? What does this say about
the income, price-level, and expected-in

The money multiplier declined significantly during the period 1930-1933 and also during the
recent financial crisis of 2008-2010. Yet the M1 money supply decreased by 25% in the
Depression period but increased by more than 20% during the recent financial crisis. What
explains the difference in outcomes?

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How did competitive forces lead to the repeal of the Glass-Steagall Act's separation of the
banking and securities industries?
If bond investors decide that 30-year bonds are no longer as desirable an investment as they were
previously, predict what will happen to the yield curve, assuming (a) The expectations theory of
the term structure holds; (b) The segmented markets theory of the term structure holds.

How is the president of the United States able to exert influence over the Federal Reserve?

Find data on the percent of value of loans secured by collateral for all commercial and industrial
loans (ESANQ) and the net percentage of domestic banks tightening standards for commercial
and industrial loans to large and middle-market firms (DRTSCILM). Download the data into a
spreadsheet. a. Go to the St. Louis Fe

What factors led to decreases in both the unemployment and inflation rates in the 1990s?

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"If fÌ… increases, then the Fed can keep output constant by reducing the real interest rate by the
same amount as the increase in financial frictions." Is this statement true, false, or uncertain?
Explain your answer.

"When the stock market rises, investment spending is increasing." Is this statement true, false, or
uncertain? Explain your answer.

What were the motivations for the original Glass-Steagall Act of 1933?

Go to the St. Louis Federal Reserve FRED database, and find data on the Dow Jones Industrial
Average (DJIA). Assume the DJIA is a stock that pays no dividends. Apply the one-period
valuation model, using the data from one year prior up to the most current date available, to
determine the required return on equity inves

What happens to inflation and output in the short run and the long run when government
spending increases?

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If a bank sells $10 million of bonds to the Fed to pay back $10 million on the loan it owes, what
is the effect on the level of checkable deposits?

The Fed buys $100 million of bonds from the public and also lowers the required reserve ratio.
What will happen to the money supply?

How does inflation targeting help reduce the time-inconsistency problem of discretionary policy?

"The federal funds rate can never be above the discount rate." Is this statement true, false, or
uncertain? Explain your answer.
"The federal funds rate can never be below the interest rate paid on reserves." Is this statement
true, false, or uncertain? Explain your answer.

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"The Fed can perfectly control the amount of the monetary base, but has less control over the
composition of the monetary base." Is this statement true, false, or uncertain? Explain.

Why are repurchase agreements used to conduct most short-term monetary policy operations,
rather than the simple, outright purchase and sale of securities?

Internet sites that enable people to post their resumes online reduce the costs of job searches.
How do you think the Internet has affected the natural rate of unemployment?

"The Fed can perfectly control the amount of reserves in the system." Is this statement true, false,
or uncertain? Explain.

Assume that the monetary policy curve is given by r = 1.5 + 0.751Ï€. a. Calculate the real
interest rate when the inflation rate is 2%, 3%, and 4%. b. Draw a graph of the MP curve,
labeling the points from part (a). c. Assume now that the monetary policy curve is given by r =
2.5 + 0.751Ï€. Does the new monetary pol

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How would you expect velocity to typically behave over the course of the business cycle?

If the manager of the open market desk hears that a snowstorm is about to strike New York City,
making it difficult to present checks for payment there and so raising the float, what defensive
open market operations will the manager undertake?

Go to the St. Louis Federal Reserve FRED database, and find data on Personal Consumption
Expenditures (PCEC), Personal Consumption Expenditures: Durable Goods (PCDG), Personal
Consumption Expenditures: Nondurable Goods (PCND), and Personal Consumption
Expenditures: Services (PCESV). a. Using the most recent data: What

What would be the effect of an increase in U.S. net exports on the aggregate demand curve?
Would an increase in net exports affect the monetary policy curve? Explain.

In each of the cases below, what happens to equilibrium output? Briefly explain how it affects
the relevant component(s) of planned spending. a. The real interest rate rises. b. The marginal
propensity to consume falls. c. Financial frictions increase. d. Autonomous consumption
decreases. e. Both taxes and governm

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If you decide to hold $100 less cash than usual and therefore deposit $100 more cash in the bank,
what effect will this have on checkable deposits in the banking system if the rest of the public
keeps its holdings of currency constant?

Classify each of the following as either a policy instrument or an intermediate target, and explain
your choice. a. The ten-year Treasury bond rate b. The monetary base c. M1 d. The fed funds
rate

The Fed's maximum employment mandate is generally interpreted as an attempt to achieve an

unemployment rate that is as close as possible to the natural rate and inflation that is close to its
2% goal for personal consumption expenditure price inflation. Go to the St. Louis Federal
Reserve FRED database, and find data o

Suppose that a new Fed chair is appointed and that his or her approach to monetary policy can be
summarized by the following statement: "I care only about increasing employment. Inflation has
been at very low levels for quite some time; my priority is to ease monetary policy to promote
employment." How would you expect

Suppose a given country experienced low and stable inflation rates for quite some time, but then
inflation picked up and over the past decade has been relatively high and quite unpredictable.
Explain how this new inflationary environment would affect the demand for money according to
portfolio theories of money demand.

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What does the Taylor rule imply that policymakers should do to the fed funds rate under the
following scenarios? a. Unemployment rises due to a recession. b. An oil price shock causes the
inflation rate to rise by 1% and output to fall by 1%. c. The economy experiences prolonged
increases in productivity growth whil

In September 2012, the Federal Reserve announced a large-scale asset-purchase program (known
as QE3) designed to lower intermediate and longer-term interest rates. What effect should this
have had on the dollar/ euro exchange rate?

Why is it that a decrease in the discount rate does not normally lead to an increase in borrowed
reserves? Use the supply and demand analysis of the market for reserves to explain.

How is an autonomous tightening or easing of monetary policy different from a change in the
real interest rate caused by a change in the current inflation rate?

If the British central bank lowers interest rates to reduce unemployment, what will happen to the
value of the pound in the short run and in the long run?

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Why is paying interest on reserves an important tool for the Federal Reserve in managing crises?

What is the key assumption underlying the Fed's ability to control the real interest rate?

Compare the methods of controlling the money supply-open market operations, loans to financial
institutions, and changes in reserve requirements-on the basis of the following criteria:
flexibility, reversibility, effectiveness, and speed of implementation.

Why do increases in the real interest rate lead to decreases in net exports, and vice versa?

Open market operations are typically repurchase agreements. What does this tell you about the
likely volume of defensive open market operations relative to the volume of dynamic open
market operations?

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Both the portfolio choice and Keynes's theories of the demand for money suggest that as the
relative expected return on money falls, demand for it will fall. Why does the portfolio choice
approach predict that money demand is affected by changes in interest rates? Why did Keynes
think that money demand is affected by c

Why does equilibrium output increase as the marginal propensity to consume increases?

If credit cards were made illegal by congressional legislation, what would happen to velocity?
Explain your answer.

What are some of the disadvantages of China's pegging the yuan to the dollar?

"Persistent budget deficits always lead to higher inflation." Is this statement true, false, or
uncertain? Explain your answer.

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Go to the St. Louis Federal Reserve FRED database, and find data on the monthly U.S. dollar
exchange rate to the Chinese yuan (EXCHUS), the Canadian dollar (EXCAUS), and the South
Korean won (EXKOUS). Download the data into a spreadsheet. a. For the most recent five-year
period of data available, use the average, max,

"Since financial crises can impart severe damage to the economy, a central bank's primary goal
should be to ensure stability in financial markets." Is this statement true, false, or uncertain?
Explain.

Why does the aggregate demand curve shift when "animal spirits" change?
"The fiscal stimulus package of 2009 caused the IS curve to shift to the left, since output
decreased and unemployment increased after the policies were implemented." Is this statement
true, false, or uncertain? Explain your answer.

A measure of real interest rates can be approximated by the Treasury Inflation-Indexed Security,
or TIIS. Go to the St. Louis Federal Reserve FRED database, and find data on the five-year TIIS
(FII5) and the personal consumption expenditure price index (PCECTPI), a measure of the price
index. Choose "Quarterly" for the

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Why was the Term Auction Facility more widely used by financial institutions than the discount
window during the global financial crisis?

If households and firms believe the economy will be in a recession in the future, will this
necessarily cause a recession, or have any impact on output at all?

What is the main advantage and the main disadvantage of an unconditional policy commitment?

If λ = 0, what does this imply about the relationship between the nominal interest rate and the
inflation rate?

Why did the Federal Reserve pursue inherently recessionary policies in the early 1980s?

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What three motives for holding money did Keynes consider in his liquidity preference theory of
the demand for real money balances? On the basis of these motives, what variables did he think
determined the demand for money?

According to the Greenspan doctrine, under what conditions might a central bank respond to a
perceived stock market bubble?

How does an autonomous tightening or easing of monetary policy by the Fed affect the MP
curve?

Why aren't most central banks more proactive in trying to use monetary policy to eliminate asset-
price bubbles?

When the Federal Reserve reduces its policy interest rate, how, if at all, is the IS curve affected?
Briefly explain.

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Why does the MP curve necessarily have an upward slope?

"Autonomous monetary policy is more effective at changing output when λ is higher." Is this
statement true, false, or uncertain? Explain your answer.

Why is a public announcement of numerical inflation rate objectives important to the success of
an inflation-targeting central bank?

In what ways is the Volcker disinflation considered a success? In what ways is it considered a
failure?

Suppose the Mexican central bank chooses to peg the peso to the U.S. dollar and commits to a
fixed peso/dollar exchange rate. Use a graph of the market for peso assets (foreign exchange) to
show and explain how the peg must be maintained if a shock in the U.S. economy forces the Fed
to pursue contractionary monetary po

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If firms suddenly become more optimistic about the profitability of investment and planned
investment spending rises by $100 billion, while consumers become more pessimistic and
autonomous consumer spending falls by $100 billion, what happens to aggregate output?

Consider the portfolio choice theory of money demand. How do you think the demand for money
would be affected during a hyperinflation (i.e., monthly inflation rates in excess of 50%)?

When the Federal Reserve conducts an expansionary monetary policy, what happens to the
money supply? How does this affect the supply of dollar assets?

If government spending increases and taxes are raised to keep the budget balanced, what happens
to the aggregate demand curve?

What are the disadvantages of using loans to financial institutions to prevent bank panics?

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Go to the St. Louis Federal Reserve FRED database, and find data on the M1 Money Stock
(M1SL), M1 Money Velocity (M1V), and Real GDP (GDPC1). Convert the M1SL data series to
"quarterly" using the frequency setting, and for all three series, use the "Percent Change from
Year Ago" setting for units. a. Calculate the ave

Are there any "good" supply shocks?

Some payment technologies require infrastructure (e.g., merchants need to have access to credit
card swiping machines). In most developing countries, this infrastructure is either nonexistent or
very costly. Everything else being equal, would you expect the transaction component of the
demand for money to be greater or
If net exports were not sensitive to changes in the real interest rate, would monetary policy be
more or less effective in changing output?

Go to the St. Louis Federal Reserve FRED database, and find data on the exchange rate of U.S.
dollars per British pound (DEXUSUK). A Mini Cooper can be purchased in London, England,
for £17,865 or in Boston, United States, for $23,495. a. Use the most recent exchange rate
available to calculate the real exchange rate

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When the inflation rate increases, what happens to the federal funds rate? Operationally, how
does the Fed adjust the federal funds rate?

Why would a central bank be concerned about persistent, long-term budget deficits?

Why does the Keynesian view of the demand for money suggest that velocity is unpredictable?

Suppose you read that prospects for stronger future economic growth have led the dollar to
strengthen and stock prices to increase. a. What effect does the strengthened dollar have on the
IS curve? b. What effect does the increase in stock prices have on the IS curve? c. What is the
combined effect of these two even

Go to the St. Louis Federal Reserve FRED database, and find data on the capital account
(BOPCAT) and the current account (BOPBCA). Calculate the net change in government
international reserves for the most recent quarter of data available and for the same quarter five
years prior. What do the numbers imply about the ne

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Go to the St. Louis Federal Reserve FRED database, and find data on nonborrowed reserves
(NONBORRES) and the federal funds rate (FEDFUNDS). a. Calculate the percent change in
nonborrowed reserves and the percentage point change in the federal funds rate for the most
recent month of data available and for the same mon

Go to the St. Louis Federal Reserve FRED database, and find data on the personal consumption
expenditure price index (PCECTPI), real GDP (GDPC1), an estimate of potential GDP
(GDPPOT), and the federal funds rate (DFF). For the price index, adjust the units setting to
"Percent Change From Year Ago" to convert the data t

Why might it be better to lean against credit-driven bubbles rather than just clean up after other
types of asset bubbles burst?

Why is inventory investment counted as part of aggregate spending if it isn't actually sold to the
final end user?
"Discount loans are no longer needed because the presence of the FDIC eliminates the possibility
of bank panics." Is this statement true, false, or uncertain?

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When the U.S. dollar depreciates, what happens to exports and imports in the United States?

Go to the St. Louis Federal Reserve FRED database, and find data on the M1 Money Stock
(M1SL) and the Monetary Base (AMBSL). a. Calculate the value of the money multiplier using
the most recent data available and the data from five years prior. b. Based on your answer to part
(a), how much would a $100 million open m

Go to the St. Louis Federal Reserve FRED database, and find data on the daily dollar exchange
rates for the euro (DEXUSEU), British pound (DEXUSUK), and Japanese yen (DEXJPUS).
Also find data on the daily three-month London Interbank Offer Rate, or LIBOR, for the United
States dollar (USD3M-TD156N), euro (EUR3MTD156N),

A measure of real interest rates can be approximated by the Treasury Inflation-Indexed Security,
or TIIS. Go to the St. Louis Federal Reserve FRED database, and find data on the five-year TIIS
(FII5) and the personal consumption expenditure price index (PCECTPI), a measure of the price
index. Choose "Quarterly" for the

"The Fed decreased the fed funds rate in late 2007, even though inflation was increasing. This
action demonstrated a violation of the Taylor principle." Is this statement true, false, or
uncertain? Explain your answer.

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If higher inflation is bad, then why might it be advantageous to have a higher inflation target
rather than a lower target that is closer to zero?

Go to the St. Louis Federal Reserve FRED database, and find data on Real Private Domestic
Investment (GPDIC1), a measure of the real interest rate; the 10-year Treasury Inflation-Indexed
Security, TIIS (FII10); and the spread between Baa corporate bonds and the 10-year U.S.
treasury (BAA10YM), a measure of financial fr

Why would it be problematic for a central bank to have a primary goal of maximizing economic
growth?

Why is the composition of the Fed's balance sheet a potentially important aspect of monetary
policy during an economic crisis?

Go to the St. Louis Federal Reserve FRED database, and find the most current data available on
Currency (CURRNS), Total Checkable Deposits (TCDNS), Total Reserves (RESBALNS), and
Required Reserves (RESBALREQ). a. Calculate the value of the currency deposit ratio c. b. Use
RESBALNS and RESBALREQ to calculate the amoun

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Suppose that a plot of the values of M2 and nominal GDP for a given country over 40 years
shows that these two variables are very closely related. In particular, a plot of their ratio (nominal
GDP/M2) yields very stable and easy-to-predict values. On the basis of this evidence, would you
recommend that the monetary aut

Following the global financial crisis in 2008, assets on the Federal Reserve's balance sheet
increased dramatically, from approximately $800 billion at the end of 2007 to $3 trillion by
2011. Many of the assets held are longer-term securities acquired through various loan programs
instituted as a result of the crisis.

Suppose that government spending is increased at the same time that an autonomous monetary
policy tightening occurs. What will happen to the position of the aggregate demand curve?

If the unemployment rate is above the natural rate of unemployment, holding other factors
constant, what will happen to inflation and output?

What evidence is used to assess the stability of the money demand function? What does the
evidence suggest about the stability of money demand, and how has this conclusion affected
monetary policymaking?

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According to the portfolio theories of money demand, what are the four factors that determine
money demand? What changes in these factors can increase the demand for money?

"If nominal GDP rises, velocity must rise." Is this statement true, false, or uncertain? Explain
your answer.

"Since inventories can be costly to hold, firms' planned inventory investment should be zero, and
firms should acquire inventory only through unplanned inventory accumulation." Is this
statement true, false, or uncertain? Explain your answer.

What are the advantages and disadvantages of quantitative easing as an alternative to

conventional monetary policy when short-term interest rates are at the zero lower bound?

What determined the exchange rates among currencies under the gold standard? Why did the
gold standard collapse?

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Why would a government choose to issue a perpetuity, which requires payments forever, instead
of a terminal loan, such as a fixed-payment loan, discount bond, or coupon bond?

In January 2007, before the financial crisis, the exchange rate was $1.30 per euro. In July 2008,
during the financial crisis, the exchange rate was $1.58 per euro. Was this change in the dollar-
euro exchange rate good news or bad news for U.S. firms exporting goods and services to
Europe? Was it good news or bad news

Go to the St. Louis Federal Reserve FRED database, and find data on the budget deficit
(FYFSD), the amount of federal debt held by the public (FYGFDPUN), and the amount of
federal debt held by the Federal Reserve (FDHBFRBN). Convert the two "debt held" series to
"Annual" using the frequency setting. Download all three

In December 2008, the Fed switched from a point federal funds target to a range target (and it's
possible that it will switch back to a point target in the future). Go to the St. Louis Federal
Reserve FRED database, and find data on the federal funds targets/ ranges (DFEDTAR,
DFEDTARU, DFEDTARL) and the effective feder

An article in the Economist observed that there were "some perturbing parallels between the gold
standard and the euro." What parallels are there between the gold standard and the euro? What
would make these parallels perturbing?

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After World War II, why might countries have preferred the Bretton Woods system to
reestablishing the gold standard? In your answer, be sure to note the important ways in which the
Bretton Woods system differed from the gold standard.

Which European countries currently use the euro as their currency? Why did these countries
agree to replace their previous currencies with the euro?

The Economist observed, "In Argentina, many loans were taken out in dollars: this had
catastrophic consequences for borrowers once the peg collapsed." What does the article mean
when it says that Argentina's "peg collapsed"? Why was this collapse catastrophic for borrowers
in Argentina who had taken out dollar loans?

In April 2009, the growth rate of M1 fell to 6.1%, while the growth rate of M2 rose to 10.3%. In
September 2013, the year-over-year growth rate of the M1 money supply was 6.5%, while the
growth rate of the M2 money supply was about 8.3%. How should Federal Reserve policymakers
interpret these changes in the growth rate

Go to the Web site of the Federal Reserve Bank of St. Louis (FRED)
(research.stlouisfed.org/fred2/) and find the values for the China/U.S. Foreign Exchange Rate
(DEXCHUS) from 1981 to the most recent date available. a. Compared with its value in 1981,
has the yuan appreciated or depreciated against the U.S. dollar? Br

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What is destabilizing speculation? What role did it play in the collapse of the Bretton Woods
system?

Go to the St. Louis Federal Reserve FRED database, and find data on federal debt held by the
Federal Reserve (FDHBFRBN), by private investors (FDHBPIN), and by international and
foreign investors (FDHBFIN). Using these series, calculate the total amount held and the
percentage held in each of the three categories for t

Go to the St. Louis Federal Reserve FRED database, and find data on the total assets of all
commercial banks (TLAACBM027SBOG) and the total assets of money market mutual funds
(MMMFFAQ027S). Transform the commercial bank assets series to quarterly by adjusting the
Frequency setting to "Quarterly." Calculate the percent

A $1000-face-value bond has a 10% coupon rate, its current price is $960, and its price is
expected to increase to $980 next year. Calculate the current yield, the expected rate of capital
gain, and the expected rate of return.

A significant number of European banks held large amounts of assets as mortgage-backed

securities derived from the U.S. housing market, which crashed after 2006. How does this
demonstrate both a benefit and a cost to the internationalization of financial markets?

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One of the factors contributing to the financial crisis of 2007-2009 was the widespread issuance
of subprime mortgages. How does this demonstrate adverse selection?

Why is the United States sometimes called the "world's largest debtor"?

The table below shows hypothetical values, in billions of dollars, of different forms of money. a.
Use the table to calculate the M1 and M2 money supplies for each year, as well as the growth
rates of the M1 and M2 money supplies from the previous year. b. Why are the growth rates of
M1 and M2 so different? Explain.

What is the theory of purchasing power parity? Does the theory give a complete explanation for
movements in exchange rates in the long run? Briefly explain.

According to the theory of purchasing power parity, if the inflation rate in Australia is higher
than the inflation rate in New Zealand, what should happen to the exchange rate between the
Australian dollar and the New Zealand dollar? Briefly explain.
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What happens to national saving when the government runs a budget surplus? What is the twin
deficits idea? Did it hold for the United States in the 1990s? Briefly explain.

Why does monetary policy have a greater effect on aggregate demand in an open economy than
in a closed economy?

The global financial crisis of 2007-2009 led some economists and policymakers to suggest the
reinstitution of capital controls-or limits on the flow of foreign exchange and financial
investments across countries- which existed in many European countries prior to the 1960s. Why
would a financial crisis lead policymakers

Retired persons often have much of their wealth placed in savings accounts and other interest-
bearing investments, and complain whenever interest rates are low. Do they have a valid
complaint?

Does bondholders fare better when the yield to maturity increases or when it decreases? Why?

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Although it is a member of the European Community, Denmark is not part of the eurozone; it has
its own currency, the krone. Because the krone is pegged to the euro, Denmark's central bank is
obliged to maintain the value of the krone within 2.25 percent either above or below the value of
the euro. To maintain the peg w

Go to the Web site of the Federal Reserve Bank of St. Louis (FRED)
(research.stlouisfed.org/fred2/) and find the most recent values from FRED for the Japan/U.S.
Foreign Exchange Rate (DEXJPUS) and the U.S. Imports of Goods from Japan (IMPJP) and the
values for one year earlier. Given the change in the exchange rate bet

Why are foreign investors more likely to invest in U.S. government bonds than in U.S. corporate
stocks and bonds?

Look again at the table on page 1050 that shows the prices of Big Macs and the implied and
actual exchange rates. Indicate whether the U.S. dollar is overvalued or undervalued against each
currency.

Graph the demand and supply of Chinese yuan for U.S. dollars and label each axis. To maintain
a pegged exchange rate, the Chinese central bank can use yuan to buy U.S. dollars. Indicate
whether the Chinese central bank would typically be interested in pegging the exchange rate
above or below the market equilibrium exch

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Consider this statement: It takes more than 120 yen to buy 1 U.S. dollar and more than 1.5
dollars to buy 1 British pound. These values show that the United States must be a much
wealthier country than Japan and that the United Kingdom must be wealthier than the United
States. Do you agree with this reasoning? Briefl

Why does fiscal policy have a smaller effect on aggregate demand in an open economy than in a
closed economy?

An opinion column in the New York Times offers the view that "zealous money printing in the
1960s led to the inevitable collapse of the Bretton Woods system (and complete fiat money was
born)." a. What does the author mean by "zealous money printing"? b. Why would zealous
money printing have led to the collapse of th

Suppose that Federal Reserve policy leads to higher interest rates in the United States. a. How
will this policy affect real GDP in the short run if the United States is a closed economy? b. How
will this policy affect real GDP in the short run if the United States is an open economy? c. How
will your answer to part

If you were going to get a loan to purchase a new car, which financial intermediary would you
use: a credit union, a pension fund, or an investment bank?

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Much of the U.S. government debt is held by foreign investors as treasury bonds and bills. How
do fluctuations in the dollar exchange rate affect the value of that debt held by foreigners?

An article in the Atlantic referred to a poll of economists that found no support for the United
States to readopt the gold standard: It prevents the central bank from fighting recessions by
outsourcing monetary policy decisions to how much gold we have-which, in turn, depends on
our trade balance and on how much of t

What does it mean when one currency is "pegged" against another currency? Why do countries
peg their currencies? What problems can result from pegging?

Use the graph to answer the following questions. a. According to the graph, is there a surplus or
a shortage of baht in exchange for U.S. dollars? Briefly explain. b. To maintain the pegged
exchange rate, will the Thai central bank need to buy baht in exchange for dollars or sell baht in
exchange for dollars? How man

What was the main cause of the recession that began in 2007?

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Suppose that under the gold standard, there was 1/5 ounce of gold in a U.S. dollar and 1 ounce of
gold in a British pound. Demonstrate that if the exchange rate between the dollar and the pound
was $4 = £1 rather than $5 = £1, you could make unlimited profits by buying gold in one
country and selling it in the other.

Go to the St. Louis Federal Reserve FRED database and find data on the M1 money supply
(M1SL) and the 10-year treasury bond rate (GS10). Add the two series into a single graph by
using the "Add Data Series" feature. Transform the M1 money supply variable into the M1
growth rate by adjusting the units for the M1 money s

An article in GulfNews.com noted that in September 2012, the Indian government of Prime
Minister Manmohan Singh made "urgently needed reforms to reduce the fiscal deficit and attract
foreign investment to help the current account deficit and growth." a. Could there be a
connection between India's f iscal (budget) defi

Assume that you are interested in earning some return on the idle balances you usually keep in
your checking account and decide to buy some money market mutual funds shares by writing a
check. Comment on the effect of your action (with everything else the same) on M1 and M2.

How do conflicts of interest make the asymmetric information problem worse?

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Most of the time it is quite difficult to separate the three functions of money. Money performs its
three functions at all times, but sometimes we can stress one in particular. For each of the
following situations, identify which function of money is emphasized. a. Brooke accepts money
in exchange for performing her d

How were exchange rates determined under the gold standard? How did the Bretton Woods
system differ from the gold standard?

In 2008, as a financial crisis began to unfold in the United States, the FDIC raised the limit on
insured losses to bank depositors from $100,000 per account to $250,000 per account. How
would this help stabilize the financial system?

The German firm Bayer reported that its pharmaceutical group experienced a 21 percent increase
in profit for the second quarter of 2015. The firm stated that the increase was partly the result of
"favorable currency effects." a. Briefly explain what the firm means by "favorable currency
effects." b. How would favorab

The U.S. Treasury publishes data on capital flows. Treasury International Capital Flows can be
found at www.treasury.gov/resource-center/ data-chart-center/tic/Pages/index.aspx. Go to
"Monthly Transactions in Long-Term Securities." a. Look at recent net purchases of long-term
securities. How has the volume of purchase

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Economists Michael Bordo of Rutgers University and Angela Redish of the University of British
Columbia have argued that the "Bretton Woods system functioned for a number of years but
beginning in the late 1960s, in the face of inflationary US monetary policy it became a slow
moving train wreck." Why would inflationary

The text states that "the globalization of financial markets has helped increase growth and
efficiency in the world economy." Briefly explain which aspects of globalization help to increase
growth in the world economy.

Go to the St. Louis Federal Reserve FRED database and find data on the three-month treasury
bill rate (TB3MS), the three-month AA nonfinancial commercial paper rate (CPN3M), the 30-
year treasury bond rate (GS30), the 30-year conventional mortgage rate (MORTG), and the
NBER recession indicators (USREC). a. In general,

How does the current size of the U.S. budget deficit compare to the historical budget deficit or
surplus for the time period since 1950?

An article in the Economist discussed the situation facing the U.S. economy in mid-2015: "The
combination of weaker-than-expected CPI inflation and some dovish comments in the minutes of
the Federal Reserve's July meeting have caused the dollar ... to fall. Inflation continues to
languish close to zero due to cheap oil

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True or False: With a discount bond, the return on the bond is equal to the rate of capital gain.

Go to the Web site of the Federal Reserve Bank of St. Louis (FRED)
(research.stlouisfed.org/fred2/) and find the most recent values for the Japan/U.S. Foreign
Exchange Rate (DEXJPUS) and the U.S. Exports of Goods to Japan (EXPJP) and the values for
one year earlier. Given the change in the exchange rate between the two

What were the main factors behind the globalization of capital markets in the 1980s and 1990s?

What is meant by a policy channel?

Go to the St. Louis Federal Reserve FRED database, and find data on small-denomination time
deposits (STDSL), savings deposits and money market deposit accounts (SAVINGSL), and retail
money market funds (RMFSL). Calculate the percentage change of each of these three
components of M2 (not included in M1) from the most r

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How would an increase in the value of the pound sterling affect American businesses?

Briefly describe the pattern of foreign investments in U.S. securities between 1995 and 2014.
The following table lists foreign exchange rates between U.S. dollars and British pounds (GBP)
during April. Which day would have been the best for converting $200 into British pounds?
Which day would have been the worst? What would be the difference in pounds?

What is the difference between a mortgage and a mortgage-backed security?

Britain decided not to join other European Union countries in using the euro as its currency. One
British opponent of adopting the euro argued, "It comes down to economics. We just don't
believe that it's possible to manage the entire economy of Europe with just one interest rate
policy. How do you alleviate recession

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Go to the Web site of the Federal Reserve Bank of St. Louis (FRED)
(research.stlouisfed.org/fred2/) and download the most recent value and the value from the same
month one year earlier from FRED for the U.S./Euro Foreign Exchange Rate (EXUSEU). a.
Using these values, compute the percentage change in the euro's value.

Briefly describe how the Bretton Woods system operated.

One economist has argued that the East Asian exchange rate crisis of the late 1990s was due to
"the simple failure of governments to remember the lessons from the breakdown of the Bretton
Woods System." What are these lessons? In what sense did the East Asian governments fail to
learn these lessons?

Why is simply counting currency an inadequate measure of money?

If you use an online payment system such as PayPal to purchase goods or services on the
Internet, does this affect the M1 money supply, the M2 money supply, both, or neither? Explain.

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An article in the Economist observes, "When the Depression [of the 1930s] struck, this gold
standard became a noose around the necks of struggling economies." In what sense was the gold
standard a "noose around the necks of struggling economies" during the 1930s?

Briefly describe the four determinants of exchange rates in the long run.

An article in the New York Times states, "On Aug. 15, 1971, President Nixon unhitched the
value of the dollar from the gold standard." Is the author of this article correct that the United
States abandoned the gold standard in 1971? What led President Nixon to take the action
described in the article?

Go to the Web site of the Federal Reserve Bank of St. Louis Federal Reserve (FRED)
(research.stlouisfed.org/fred2/) and find the most recent values for the Japan/U.S. Foreign
Exchange Rate (DEXJPUS), China/U.S. Foreign Exchange Rate (DEXCHUS), and the
Mexico/U.S. Foreign Exchange Rate (DEXMXUS). a. Explain whether the

In prison, cigarettes are sometimes used among inmates as a form of payment. How is it possible
for cigarettes to solve the "double coincidence of wants" problem, even if a prisoner does not
smoke?

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Go to the St. Louis Federal Reserve FRED database, and find data on currency (CURRSL),
traveler's checks (TVCKSSL), demand deposits (DEMDEPSL), and other checkable deposits
(OCDSL). Calculate the M1 money supply, and calculate the percentage change in M1 and in
each of the four components of M1 from the most recent mon

In December 2014, you needed 30 percent more pesos to buy one U.S. dollar than you had
needed in December 2004. Over the same time period, the consumer price index in Mexico
increased 49.5 percent, and the consumer price index in the United States increased 23.3 percent.
Are these data consistent with the theory of pu

Section 29.4 states: "The budget surpluses of the late 1990s occurred at a time of then-record
current account deficits." Holding everything else constant, what would the likely effect have
been on domestic investment in the United States during those years if the current account had
been balanced instead of being in d

Use the saving and investment equation to explain why the United States experienced large
current account deficits in the late 1990s.

Suppose the federal government increases spending without also increasing taxes. In the short
run, how will this action affect real GDP and the price level in a closed economy? How will the
effects of this action differ in an open economy?

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An investment analyst recommended that investors "gravitate toward the stronger currencies and
countries that are running current-account and fiscal surpluses," such as South Korea and
Taiwan. a. Holding all other factors constant, would we expect a country that is running a
government budget surplus to have a currenc

Why would a life insurance company be concerned about the financial stability of major
corporations or the health of the housing market?

In August 2015, after the Chinese central bank moved to decrease the value of the yuan in
exchange for the dollar, a column in the Wall Street Journal offered this opinion: "China's
trading partners are right to suspect that the real purpose of the so-called reform is a competitive
devaluation that boosts exports and
An article in the Toronto Star discussed the Canadian teams that play in the National Hockey
League, the National Basketball Association, Major League Baseball, and Major League Soccer.
The article noted, "Under their collective agreements players get paid in U.S. dollars. The
majority of [team] revenue, however, is in

An article in the Economist quotes the finance minister of Peru as saying, "We are one of the
most open economies of Latin America." What did he mean by Peru being an "open economy"?
Is fiscal policy in Peru likely to be more or less effective than it would be in a less open
economy? Briefly explain.

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An article in USA Today argues, "Ironically, the euro's fall-and the benefit for German exports-is
largely the result of eurozone policies that Germany has taken the lead in opposing . . .
[including] easier money policies by the European Central Bank." a. How does the "euro's fall"
benefit German exports? b. How is

Go to the Web site of the Federal Reserve Bank of St. Louis (FRED) (research.
stlouisfed.org/fred2/) and find the Gold Fixing Price 10:30 a.m. (London time) in the London
Bullion Market in U.S. Dollars (GOLDAMGBD228NLBM) from 1968 to the most recent
available date. a. What explains the relative stability of the price

One way to gauge the general value of one currency relative to other currencies is to calculate
the trade-weighted exchange rate, which is an index number similar to the consumer price index.
The trade-weighted exchange rate for the U.S. dollar weights each individual exchange rate by
the share of that country's trade

Consider a bond with a 4% annual coupon and a face value of $1,000. Complete the following
table. What relationships do you observe between years to maturity, yield to maturity, and the
current price? Years to Maturity Yield to Maturity Current Price 2..........................................2%
2..................

Fill in the missing values in the following table. Assume that the Big Mac is selling for $4.79 in
the United States. Explain whether the U.S. dollar is overvalued or undervalued relative to each
of the other currencies and predict what will happen in the future to each exchange rate if the
actual exchange rate moves t

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Describe who issues each of the following money market instruments: a. Treasury bills b.
Certificates of deposit c. Commercial paper d. Repurchase agreement e. Fed funds

How can the provision of several types of financial services by one firm be both beneficial and
problematic?
Briefly explain whether you agree with the following statement: "The Federal Reserve is limited
in its ability to issue paper currency by the amount of gold the federal government has in Fort
Knox. To issue more paper currency, the government first has to buy more gold."

The United States and most other countries abandoned the gold standard during the 1930s. Why
would the 1930s have been a particularly diff icult time for countries to have remained on the
gold standard? (Hint: Think about the macroeconomic events of the 1930s and about the possible
problems with carrying out an expansi

Why did cavemen not need money?

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What role did the International Monetary Fund play in the Bretton Woods system?

Why might "the continued willingness of foreign investors to buy U.S. stocks and bonds and
foreign companies to build factories in the United States" result in the United States running a
current account deficit?

If a country is using the gold standard, what is likely to happen to its money supply if new gold
deposits are discovered in the country, as happened in the United States with the gold discoveries
in California in 1849? Is this change in the money supply desirable? Briefly explain.

An article in the Economist notes that after the end of the Bretton Woods system, "the Europeans
did not like leaving their currencies to the whims of the markets." What does it mean for a
country to leave its currency to the "whims of the markets"? What problems might a country
experience as a result? What exchange ra

Consider a game in which a coin will be flipped three times. For each heads you will be paid
$100. Assume that the coin comes up heads with probability â…”. a. Construct a table of the
possibilities and probabilities in this game. b. Compute the expected value of the game. c. How
much would you be willing to pay to p

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Assuming the chances of being paid back are the same, would a nominal interest rate of 10
percent always be more attractive to a lender than a nominal rate of 5 percent? Explain.

Compute the present value of a $100 investment made 6months, 5 years, and 10years from now
at 4 percent interest.

Go to the Web site of the Federal Reserve Bank of St. Louis (FRED)
(research.stlouisfed.org/fred2/) and download and plot the U.S. dollar-euro exchange rate
(EXUSEU), the U.S. dollar-yen exchange rate (EXJPUS), and the U.S. dollar-Canadian dollar
exchange rate (EXCAUS) for the period from 2001 to the present. Answer th
It is not unusual to find a business that displays a sign saying "no personal checks, please." On
the basis of this observation, comment on the relative degree of liquidity of a checking account
versus currency.

Explain how liquidity problems can be an important source of systemic risk in the financial
system.

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You have $1,000 to invest over an investment horizon of three years. The bond market offers
various options. You can buy (i) a sequence of three one-year bonds; (ii) a three-year bond; or
(iii) a two-year bond followed by a one-year bond. The current yield curve tells you that the one-
year, two-year, and three-year y

You are about to purchaseyour first home and receive an advertisement regarding adjustable-rate
mortgages (ARMs). The interest rate on the ARM is lower than that on a fixed rate mortgage.
The advertisement mentions that there would be a payment cap on your monthly payments and
you would have the option to convert to

Car insurance companies sell a large number of policies. Explain how this practice minimizes
their risk.

Plot the expected real interest rate since 1979 by subtracting the Michigan survey inflation
measure (FRED code: MICH) from the three-month Treasury bill rate (FRED code: TB3MS).
Plot as a second line the ex post or realized real interest rate by subtracting from the three-month
Treasury bill rate (FRED code: TB3MS) th

Use the model of supply and demand for bonds to determine the impact on bond prices and
yields of expectations that the real estate market is going to weaken. (LO3)

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For each of the following actions, identify whether the method of risk assessment motivating
your action is due to the value at risk or the standard deviation of an underlying probability
distribution. a. You buy life insurance. b. You hire an investment advisor who specializes in
international diversification in stoc

You are considering three investments, each with the same expected value and each with two
possible payoffs. The investments are sold only in increments of $500. You have $1,000 to
invest and so you have the option of either splitting your money equally between two of the
investments or placing all $1,000 in one of th

How does inflation affect nominal interest rates? a. Plot the three-month U.S. Treasury bill rate
(FRED code: TB3MS) from 1960 to the present. What long-run pattern do you observe? What
may have caused this pattern? b. Plot the inflation rate based on the percent change from a year
ago of the U.S. consumer price inde

Suppose you purchase a 3-year, 5-percent coupon bond at par and hold it for two years. During
that time, the interest rate falls to 4 percent. Calculate your annual holding period return.

Probably the most famous stock index in the financial markets is the Dow Jones Industrial
Average. Plot this index (FRED code: DJIA) over the period from 1960 to the present.

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Assuming that the current interest rate is 3 percent, compute the present value of a five-year, 5
percent coupon bond with a face value of $1,000. What happens when the interest rate goes to 4
percent? What happens when the interest rate goes to 2 percent?

Consider a one-year, 10-percent coupon bond with a face value of $1,000 issued by a private
corporation. The one-year risk-free rate is 10 percent. The corporation has hit on hard times, and
the consensus is that there is a 20 percent probability that it will default on its bonds. If an
investor were willing to pay

Suppose you need to take out a personal loan with a bank. Explain how you could be affected by
problems in the interbank lending market such as those seen during the 2007-2009 financial
crisis.

Give an example of systematic risk for the U.S. economy and how you might reduce your
exposure to such a risk.

Graph investors’ long-term expected inflation rate since 2003 by subtracting from the 10-
year U.S. Treasury bond yield (FRED code: GS10) the yield on 10-year Treasury Inflation
Protected Securities (FRED code: FII10). Do these market-based inflation expectations appear
stable? Did the financial crisis of 2007-2009 af

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Under what circumstances might you be willing to pay more than $1,000 for a coupon bond that
matures in three years, has a coupon rate of 10 percent, and a face value of $1,000?

As the manager of a financial institution, what steps could you take to reduce the risks referred to
in Problem 21?

You are planning for retirement and must decide whether to purchase only your employer’s
stock for your 401(k) or, instead, to buy a mutual fund that holds shares in the 500 largest
companies in the world. From the perspective of both idiosyncratic and systematic risk, explain
how you would make your decision.
If the current interest rate increases, what would you expect to happen to bond prices? Explain.

In a recent issue of the Wall Street Journal (or on www.wsj.com), locate the yields on
government bonds for various countries. Find a country whose 10-year government bond yield
was above that on the U.S. 10-year Treasury bondand one whose 10-year yield was below the
Treasury yield. What might account for these diff

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If higher leverage is associated with greater risk, explain why the process of deleveraging
(reducing leverage) can be destabilizing.

You wish to buy an annuity that makes monthly payments for as long as you live. Describe what
happens to the purchase price of the annuity as (a) Your age at the time of purchase goes up, (b)
The size of the monthly payment rises, (c) Your health improves.

Economists sometimes exclude food and energy prices from the “headline” consumer price
index and use the resulting “core” price measure to assess inflation prospects. For the
period since 1990, plot on one graph the percent change from a year ago of the consumer price
index (FRED code: CPIAUCSL) and the percent

You have the option to invest in either country A or country B but not both. You carry out some
research and conclude that the two countries are similar in every way except that the returns on
assets of different classes tend to move together much more in country A– that is, they are
more highly correlated in countr

Consider two possible investments whose payoffs are completely independent of one another.
Both investments have the same expected value and standard deviation. If you have $1,000 to
invest, could you benefit from dividing your funds between these investments? Explain your
answer.

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Suppose that theinterest rate on one-year bonds is currently 4 percent and is expected to be 5
percent in one year and 6 percent in two years. Using the Expectations Hypothesis, compute the
yield curve for the next three years.

For the period since 1986, plot on one graph the 30-year conventional mortgage rate (FRED
code: MORTG) and the one-year adjustable mortgage rate (FRED code: MORTGAGE1US).
Explain their systematic relationship using Core Principle 2.

Given the data in the accompanying table, would you say that this economy is heading for a
boom or for a recession? Explain yourchoice.
Recently, some lucky person won the lottery. The lottery winnings were reported to be $85.5
million. In reality, the winner got a choice of $2.85 million per year for 30 years or $46 million
today. a. Explain briefly why winning $2.85 million per year for 30 years is not equivalent to
winning $85.5 million. b. The ev

According to the liquidity premium theory, if the yield on both one-and two-year bonds are the
same, would you expect the one-year yield in one-year’s time to be higher, lower or the
same? Explain your answer.

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You are an officer of a commercial bank and wish to sell a car loan that the bank owns as an
asset to another bank. Using equation A5 in the Appendix to Chapter 4, compute the price you
expect to receive for the loan if the annual interest rate is 6 percent, the car payment is $430 per
month, and the loan term is five

The expected real interest rate is the rate which people use in making decisions about the future.
It is the difference between the nominal interest rate and the expected inflation rate, not the
actual inflation rate. How does expected inflation over the coming year compare with actual
inflation over the past year? Plo

Use Core Principle 3 from Chapter to suggest some ways in which the problems associated with
the shadow banking sector during the 2007-2009 financial crisis might be mitigated in the future.

Suppose that a sustainable peace is reached around the world, reducing military spending by the
U.S. Government. How would you expect this development to affect the U.S. bond market?

You and a friend are reading The Wall Street Journal and notice that the Treasury yield curve is
slightly upward sloping. Your friend comments that all looks well for the economy but you are
concerned that the economy is heading for trouble. Assuming you are both believers in the
liquidity premium theory, what might

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You are considering purchasing a consol that promises annual payments of $4. a. If the current
interest rate is 5 percent, what is the price of the consol? b. You are concerned that the interest
rate may rise to 6 percent. Compute the percentage change in the price of the consol and the
percentage change in the interes

Do changes in stock values affect the wealth of households? Beginning in 1960, plot on a
quarterly basis the percent change from a year ago of the Dow Jones Industrial Average (FRED
code: DJIA) and the percent change from a year ago of household net worth (FRED code:
TNWBSHNO). Compare the two lines.
Your firm has the opportunity to buy a perpetual motion machine to use in your business. The
machine costs $1,000,000 and will increase your profits by $75,000 per year. What is the internal
rate of return?

Consider an investment that pays off $800 or $1,400 per $1,000 invested with equal probability.
Suppose you have $1,000 but are willing to borrow to increase your expected return. What
would happen to the expected value and standard deviation of the investment if you borrowed an
additional $1,000 and invested a total

Mortgages increase the risk faced by homeowners. a. Explain how. b. What happens to the
homeowner’s risk as the down payment on the house rises from 10 percent to 50 percent.

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If inflation and interest rates become more volatile, what would you expect to see happen to the
slope of the yield curve?

Assume that the economy can experience high growth, normal growth, or recession. Under these
conditions, you expect the following stock market returns for the coming year: a. Compute the
expected value of a $1,000 investment over the coming year.If you invest $1,000 today, how
much money do you expect to have next

You are considering going to graduate school for a one-year master’s program. You have
done some research and believe that the master’s degree will add $5,000 per year to your
salary for the next 10 years of your working life, starting at the end of this year. From then on,
after the next 10 years, it makes no di

You are the founder of IGRO, an Internet firm that delivers groceries. a. Give an example of an
idiosyncratic risk and a systematic risk your company faces. b. As founder of the company, you
own a significant portion of the firm, and your personal wealth is highly concentrated in IGRO
shares. What are the risks that y

Suppose two parties agree that the expected inflation rate for the next year is 3 percent. Based on
this, they enter into a loan agreement where the nominal interest rate to be charged is 7 percent.
If inflation for the year turns out to be 2 percent, who gains and who loses?

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Which of these $100 face value one-year bonds will have the highest yield to maturity and why?
a. A 6 percent coupon bond selling for $85. b. A 7 percent coupon bond selling for $100. c. An 8
percent coupon bond selling for $115.

Consider two scenarios. In the first, the nominal interest rate is 6 percent and the expected rate of
inflation is 4 percent. In the second, the nominal interest rate is 5 percent and the expected rate of