Chapter 13.How can a change in interest rates affect the profitability of financial institutions?A change in interest rates affects the cost of acquiring funds for financial institution as well as changes the income on assets such as loans, both of which affect profits. In addition, changes in interest rates affect the price of assets such as stock and bonds that the financial institution owns which can lead to profits or losses.7.How does a decline in the value of the pound sterling affect British consumers? It makes foreign goods more expensive and so British consumers will buy less foreign goods and more domestic goods.1.The following table lists foreign exchange rates between US dollars and British pounds during April.Date US Dollars per GBP Date US Dollars per GBP4/1 1.9564 4/18 1.75044/4 1.9293 4/19 1.72554/5 1.914 4/20 1.69144/6 1.9374 4/21 1.6724/7 1.961 4/22 1.66844/8 1.8925 4/25 1.66744/11 1.8822 4/26 1.68574/12 1.8558 4/27 1.69254/13 1.796 4/28 1.72014/14 1.7902 4/29 1.75124/15 1.7785Which day would have been the best day to convert $200 into British pounds? Which day would have been the worst day? What would be the difference in pounds?Solution: The best day is 4/25. At a rate of $1.6674/pound, you would have £119.95.The worst day is 4/7. At $1.961/pound, you would have £101.99, or adifference of £17.96Chapter 22.If I can buy a car today for $5,000 and it is worth $10,000 in extra income next year to me because it enables me to get a job as a traveling anvil seller, should I take out a loan from Larry the Loan Shark at a 90% interest rate if no one else will give me a loan? Will I be better or worse off as a result of taking out this loan? Can you make a case for legalizing loan-sharking?Yes, I should take out the loan, because I will be better off as a result of doing so. My interest payment will be $4,500 (90% of $5,000), but as a result, I will earn an additional $10,000, so I will be ahead of the game by $5,500. Since Larry’sloan-sharking business can make some people better off, as in this example, loan sharking may have social benefits. (One argument against legalizing loan sharking, however, is that it is frequently a violent activity.)5.”Because corporations do not actually raise any funds in secondary markets, they are less important to the economy than primary markets. ” Comment.This statement is false. Prices in secondary markets determine the prices that firms issuing securities receive in primary markets. In addition, secondary markets make securities more liquid and thus easier to sell in the primary markets. Therefore, secondary markets are, if anything, more important than primary markets.6.If you suspect that a company will go bankrupt next year, which would you rather hold, bonds issued by the company or equities issued by the company? Why?You would rather hold bonds, because bondholders are paid off before equity holders, who are the residual claimants.13.Why might you be willing to make a loan to your neighbor by putting funds ina savings account earning a 5% interest rate at the bank and having the banklend her the funds at a 10% interest rate rather than lend her the fundsyourself?Because the costs of making the loan to your neighbor are high (legal fees, fees for a credit check, and so on), you will probably not be able to earn 5% on the loan after your expenses even though it has a 10% interest rate. You are better off depositing your savings with a financial intermediary and earning 5% interest. In addition, you are likely to bear less risk by depositing your savings at the bank rather than lending them to your neighbor.Chapter 32.If there is a decline in interest rates, which would you rather be holding,long-term bonds or short-tern bonds? Why? Which type of bond has the greater interest-rate risk?You would rather be holding long-term bonds because their price would increase more than the price of the short-term bonds, giving them a higher return4.If mortgage rates rise from 5% to 10%, but the expected rate of increase in housing prices rises from 2% to 9%, are people more or less likely to buy houses?People are more likely to buy houses because the real interest rate when purchasing a house has fallen ––9percent). The real cost of financing the house is thus lower, even though mortgage rates have risen. (If the tax deductibility of interest payments is allowed for, then it becomes even more likely that people will buy houses.)7.Property taxes in DeKalb County are roughly 2,66% of the purchase price every year. If you just bought a $100,000 home, what is the PV of all the future property tax payments? Assume that the house remains worth $100,000 forever, property tax rates never change, and that a 9% discount rate is used for discounting.Solution: The taxes on a $100,000 home are roughly 100,000 ⨯ 0.0266 = 2,660.The PV of all future payments = 2,660/0.09 = $29,555.55 (a perpetuity).Chapter 41.Explain why you would be more or less willing to buy a share of Polaroidstock in the follow situations:a.Your wealth fallsb.You expect it to appreciate in value.c.The bond market become more liquid.d.You expect gold to appreciate in value.e.Prices in the bond market become more volatilea. Less, because your wealth has declined;b. more, because its relative expected return has risen;c. less, because it has become less liquid relative to bonds;d. less, because its expected return has fallen relative to gold;e. more, because it has become less risky relative to bonds.4.I own a professional football team ,and I plan to diversify by purchasing shares in either a company that owns a Pro basketball team or a pharmaceuticalcompany. Which of these two investments is more likely to reduce the overall risk I face? Why?Purchasing shares in the pharmaceutical company is more likely to reduce my overall risk because the correlation of returns on my investment in a football team with the returns on the pharmaceutical company shares should be low. By contrast, the correlation of returns on an investment in a football team and an investment in a basketball team are probably pretty high, so in this case there would be little risk reduction if I invested in both.15.The chairman of the Fed announces that interest rate will rise sharply next year, and the market believes him. What will happen to today’s interest rate on AT&T bonds, such as the 188s of 2022 ?The interest rate on the AT&T bonds will rise. Because people now expect interest rates to rise, the expected return on long-term bonds such as the 188s of 2022 will fall, and the demand for these bonds will decline. The demand curve Bd will therefore shift to the left, and the equilibrium bond price falls and the interest rate will rise.Chapter 53.Risk premiums on corporate bonds are usually anticyclical; that is, they decrease during business cycle expansions and increase during recessions, Why is this so?During business cycle booms, fewer corporations go bankrupt and there is less default risk on corporate bonds, which lowers their risk premium. Similarly, during recessions, default risk on corporate bonds increases and their risk premium increases. The risk premium on corporate bonds is thus anticyclical, rising during recessions and falling during booms.4.Consider the decision to purchase either a 5-year corporate bond or a 5-year municipal bond. The corporate bond is a 12% annual coupon bond with a parvalue of $1,000. It is currently yielding 11.5%. The municipal bond has an 8.5% annual coupon and a par value of $1,000. It is currently yielding 7%. Which of the two bonds would be more beneficial to you? Assume that your marginal tax rate is 35%.Solution: Municipal BondPurchase Price= $1,061.50After-tax Coupon Payment= $85Par Value= $1,000Calculated YTM=7%Corporate BondPurchase Price= $1,018.25After-tax Coupon Payment= $78Par Value=$1,000Calculated YTM=7.35%The corporate bond offers a higher yield, and is the better buy.Chapter 61.Why was the Federal reserve System set up with twelve regional Federal Reserve banks rather than one central bank, as in other countries ?Because of traditional American hostility to a central bank and centralized authority, the system of 12 regional banks was set up to diffuse power along regional lines.2.What political realities might explain why the Federal Reserve Act of 1913 placed two Federal Reserve banks in Missouri?The placement of two banks in the Midwest farm belt might have been engineered to placate farmers, an important voting block in the early twentieth century.11.”The theory of bureaucratic behavior indicates that the Fed never operates inthe public interest” is this statement true ,false , or uncertain ? Explain your answer.False. Maximizing one’s welfare does not rule out altruism. Operating in the public interest is clearly one objective of the Fed. The theory of bureaucratic behavior only points out that other objectives, such as maximizing power, also influence Fed decision making.12.Why might eliminating the Fed’s independence lead to a more pronouncedpolitical business cycle ?Eliminating the Fed’s independence might make it more shortsighted and subject to political influence. Thus, when political gains could be achieved byexpansionary policy before an election, the Fed might be more likely to engage in this activity. As a result, more pronounced political business cycles might result.Chapter 73.”If the demand for reserves did not fluctuate, the Fed could purser both a nonborrowed reserves target and an interest-rate target at the same time. ” Is this statement true, false, or uncertain? Explain your answer.True: In such a world hitting a nonborrowed reserves target would mean that the Fed would also hit its interest rate target, or vice versa. Thus the Fed couldpursue both a nonborrowed reserves target and an interest rate target at thesame time.pare the monetary base to M2 on the grounds of controllability and measurability. Which do you prefer as an intermediate target? Why?The monetary base is more controllable than M2 because it is more directlyinfluenced by the tools of the Fed. It is measured more accurately and quicklythan M2 because the Fed can calculate the base from its own balance sheet data, while it constructs M2 numbers from surveys of banks, which takes some time to collect and are not always that accurate. Even though the base is a betterintermediate target on the grounds of measurability and controllability, it is not necessarily a better intermediate target because its link to economic activity may be weaker than that between M2 and economic activity.5.The short-term nominal interest rate is 5% with an expected inflation of 2%.Economists forecast that next year’s nominal rate will increase by 100 basis points, but inflation will fall to 1.5%. What is the expected change in real interest rates?Answer:Real rates have increased by 150 basis points.Chapter 85,What was the purpose motivating regulators to impose interest ceilings on bank savings accounts? What impact did this eventually have on the money markets?Following the Great Depression, regulators were primarily concerned with stopping banks from failing. By removing interest-rate competition, bank risk was substantially reduced. The problem with these regulations was that when market interest rates rose above the established interest-rate ceiling, investors withdrew their funds from banks.10.Which of the money market securities is the most liquid and considered the most risk-free? Why?Treasury bills are usually viewed as the most liquid and least risky of securities because they are backed by the strength of the U.S. government and trade in extremely large volumes.1. What would be your annualized discount rate % and our annualizedinvestment rate % on the purchase of a 182-day Treasury bill for $4,925 that pays $5,000 at maturity?Solution: Discount Rate$5,000$4,9253600.02967 2.967%$5,000182-⨯== Investment Rate$5,000$4,9253650.03054 3.054%$4,925182-⨯==6.How much would you pay for a Treasury bill that matures in 182 days and pays $10,000 if yourequire a 1.8% discount rate?Solution: Let C What you would pay[($10,000)/($10,000)](360/182)0.018[($10,000)/($10,000)] 1.9780.018[($10,000)]0.018$10,000 1.978$10,00091$9,909C C C C C -⨯=-⨯=-=⨯÷-==8.How much would you pay for a Treasury bill that matures in one year and pays $10,000 if you require a 3% discount rate?Solution: Let C What you would pay[$10,000)/($10,000)](360/182)0.03[($10,000)/($10,000)]0.03(182/360)$10,000151.67$9,848.33C C C C -⨯=-=⨯-==Chapter 93.Distinguish between the primary market and the secondary market for securities.The primary market is for securities being issued for the very first time, and the issuer receives the funds paid for the security. The secondary market is for securities that have been issued previously but are being traded among investors.7.In addition to Treasury securities, some agencies of the government issue bonds. List three such agencies, and state what the funds raised by the bond issues are used for.Agencies that issue securities include Ginnie Mae (formerly the Government National Mortgage Association), the Federal Housing Administration, the Veterans Administration, the Federal National Mortgage Association, and the Student Loan Marketing Association. The first four fund mortgage loans and the last funds college student loansChapter 103.Discuss the features that differentiate organized exchanges from the over-the- counter market.Organized exchanges have a physical building where business is conducted. They generally have a governing board that establishes rules for trading. The organized exchanges tend to have larger firms listed on them than trade over the counter.In the IPO, the Ebay issued 3,500,000 new shares. The initial price to the public was $18.00 per share.The final first-day closing price was $44.88.1.If the investment bankers retained $1.26 per share as fees, what was the netproceeds to Ebay? What was the market capitalization of new shares of Ebay?Solution: Net Proceeds to Ebay⨯2.Two common statistics in IPOs are underpricing and money left on the table.Underpricing is defined as percentage change between the offering price and the first day closing price. Money left on the table is the difference between the first day closing price and the offering price, multiplied by the number of shares offered. Calculated the underpricing and money left on the table for Ebay. What does this suggest about the efficiency of the IPO process?Solution:⨯5. Suppose Microsoft, Inc. was trading at $27.29 per share. At that time, Itpays an annual dividend of $0.32 per share, and analysts have set a 1-year target price around $33.30 per share. What is the expected return on thisstock?Solution:Chapter 112.Most Mortgage loans once had balloon payments; now most Currentmortgage loans fully amortize. What is the difference between a balloon loan and amortizing loan?Balloon loans require that a large final payment be made to pay off the remaining principal balance. Amortizing loans are structured so that equal monthly payments are made such that the total of all payments cover both interest and principal over the lifetime of the loan.4.What are discount points, and why do somw motrgage borrowers choose topay them?Discounts points paid when a loan is initiated result in a reduced interest rate. If the borrower plans to hold on to the loan long enough for the value of the reduced interest rate to exceed the up-front cost of the points, it is a good idea to elect to pay them.8.Lenders tend not to be as flexible about the quanlifications required of mortgage customers as they can be for other types of bank loans. Why is this so?Most mortgage loans are sold to government agencies. These agencies establish criteria for which loans they will accept. If the loans do not meet these criteria, the initiating bank cannot sell them.。