Review for Final

The non comprehensive version of the final is over chapter 18 and class discussions on derivatives.

You can expect about 25 multiple choice problems and two short answers.

One of the short answer problems is:

1. How can a well-functioning financial system increase the level of savings and investment spending.

This is the question on homework #1. I will be looking to see how more sophisticated an answer you can come up with.

If you are taking the fully comprehensive version, you should consult your notes and relevant readings for all the material covered in the class. You can expect up to 60 multiple choice problems and 3 short answer problems. One of them is the one listed above. A second one is the same problem the others face on the non comprehensive test. A third one is likely drawn from the material covered on one of the first 4 quizzes.

The test will begin promptly at 1 p.m. as those taking the comprehensive version must be allocated the entire 2 hours. However, you are expected to arrive on time no matter which version you take. The instructor reserves the right to refuse an exam to anyone arriving late, especially after one person is finished, no one arriving late will be given an exam.

Good luck.

Alternate Assignment link

For the 60 Minutes interview with Fed Chair Ben Bernanke:

http://www.cbsnews.com/stories/2009/03/12/60minutes/main4862191.shtml

Answer questions on the handout received in class on July 23.

In defense of question 7 from quiz 1

The following is question 7 from the first test.

7. A financial asset is:
A) a tangible asset like a car
B) a claim that entitles the owner to future income from the seller
C) the value of accumulated savings
D) all of the above


The correct answer is (B).

The question is seeking a definition. (A) A car is not an asset. It is a good consumed over time. It may retain some value but it tends to depreciate. (Only in the very exceptional case that a car becomes "historical" will it appreciate. This is a grand exception and also merely a possible example.) (C) can reflect the value of the set of all financial assets (note how it is plural and it refers to the value, that is, dollar value, of the set of assets) but does nothing to define what an asset is. (B) defines what an asset is.

The following statement also appears on the test: On the answer sheet provided, fill in the space corresponding to the best answer.

Given the statement above, I have no recourse but to accept (B) as the only possible answer.

Material covering quiz 2

You should study your notes and the following parts of the text:

Chapter 4: up to page 77. (However, the part that follows on price ceilings may be of interest, it comes up in the next chapter on "usury laws".)

Chapter 5: pp. 96 to end (Demand and Supply in Financial Capital Markets; Don't Kill the Price Messengers). No questions will be asked about labor markets.

Welcome & Comment on Text

This is the class blog for Econ 281: Money and Capital Markets with Prof. Jack Julian for Summer Session II at IUP.

The text can be found at the following link: http://www.textbookmedia.com/

Please bookmark this page for announcements and updates.

Answer Key to Study Questions for the Final

Here is the answer key to the sample multiple choice problems. Please let me know if you think there are any errors. **Some of these have been corrected. Thanks M.D.**

1-C, 2-A, 3-C, 4-E, 5-C, 6-A, 7-C,
8-A, 9-B, 10-A, 11-C or E (essentially the same thing), 12-D, 13-D,
14-B, 15-A or C*, 16-D*, 17-C, 18-A, 19-C,
20-E, 21-A, 22-C, 23-A, 24-B, 25-B

* Sorry about the editing issues on 15 and 16. For 15, alternatives A and C are the same and are the correct choices. For 16, again, A and C are the same, but the correct answer is D.

Just so we're clear:

When bond prices and interest rates are negatively related.

When you write an option, you are under the obligation to deliver or accept delivery of the underlying security if the buyer of the option chooses to exercise that option.

Good luck!

Answer Key to Study Questions for Test #3

Here is the key to the sample multiple choice problems for the 3rd test.

1-B, 2-B, 3-D, 4-B, 5-D, 6-D,
7-D, 8-D, 9-A, 10-A, 11-A, 12-C,
13-D, 14-D, 15-D, 16-D, 17-D, 18-D, 19-D,
20-D, 21-D, 22-D, 23-D, 24-A, 25-B,
26-E, 27-A, 28-C*, 29-D, 30-A,
31-D, 32-A, 33-B, 34-C.

Let me know if you think there are any errors.

For problems 2 and 3: Full disclosure--I pulled many of these problems from a test bank. The test bank obviously plays fast and loose with the rounding.

#3: You should have calculated $95.23, rounding to $95.

#4: You should have calculated $1997.20, rounding to $2,000.

I agree it is inappropriate to round so much when dealing with problems like these. I'll be much more precise for the real test.

*#28 was originally listed as D. C is much better. But I think this is a lousily worded question and I'll be more conscientious for the real test. ;-)

You can consider the terms "liquidity preference" or "liquidity premium" theories of the term structure of interest rates as the same thing. Similarly, "expectations theory" or "expectations hypothesis" is the same a "unbiased expectations".

J

Some comments for homework due 4-10

For problem 1: see

For problem 2: see

For problems 3 and 4 use the following:

nominal interest rate = real interest rate + inflation premium + default risk premium + maturity risk premium + liquidity risk premium

all of those can be stated in percentage terms

For 5F:

Ok, this problem is a bit more convoluted than I intended. So I’ll just try to explain what it is asking and how to figure it out.

The key point to remember is that we’re trying to solve for expected inflation rates with a bit more precision.

So, if you do E, you should find expected inflations as 1.5%, 3%, 5%, and 5.5%.

Now, let’s interpret these.

Inflation is expected to be 1.5% over the next year.

Inflation is expected to average 3% over the next 5 years.

Inflation is expected to average 5% over the next 10 years.

Inflation is expected to average 5.5% over the next 20 years.

So, if inflation is expected to average 1.5% over year 1 and 3% over years 1 through 5, then what is the expected average for years 2 through 5?

3% average over 5 years would have a cumulative inflation of 15% (3% x 5). Since we expect inflation over year one to be 1.5%, then the cumulative inflation over the 4 year period (2 through 5) would be 15% - 1.5% = 13.5%. Divide 13.5% ÷ 4 = 3.375%. That’s expected inflation (3.375%) for each year 2 through 5, given year 1 is expected to be 1.5%

5% average over 10 years would have a cumulative inflation of 50% (5% x 10). To find expected inflation over years 6 through 10 we can subtract off the expected (cumulative) inflation over the first 5 years, 15% (= 3% x 5), to give us a cumulative inflation over the years 6 – 10 of 35%. Divide that by 5 years. 35% ÷ 5 = 7%. So expected inflation years 6 through 10 is 7% per year, given expected inflation is 3%* on average years 1 through 5. (*previously reported as 7%)

5.5% average over 20 years would have a cumulative inflation of 110% (5.5% x 20). To find expected inflation over years 11 through 20 we can subtract off the expected (cumulative) inflation over the first 10 years, 50% (= 5% x 10), to give us a cumulative inflation over the years 11 – 20 of ____%. Divide that by ____ years. ___% ÷ ___ = ____%. (Finish using the examples above.)

For problem 6, your calculation of the discounted value of the revenue stream results in your valuation. Given those other market determined prices you should decide if at those prices the bond is over valued or undervalued.

If the market price is greater than your valuation, you will find it overvalued in the market and you will expect the price to fall.

If the market price is less than your valuation you will believe it is undervalued in the market and you will expect its price to rise.

So explain if you'd want to buy it at those prices, given your calculated valuations.