Reference no: EM133077427

1) Using the supply/demand for bonds model, answer the following with graphs/explanation:

a) The stock market crashes (people will seek safe investments).

b) Expected inflation increases due to oil shock.

c) The Federal Reserve announces they will continue to buy treasury bonds.

d) U.S. economic growth increases drastically.

e) The number of wealthy Chinese business people increase drastically.

2) Answer the following questions about the yield curve.

a) What does a normal yield curve look like? Label as much as possible.

b) How does the Liquidity Premium theory explain the shape of the normal yield curve?

c) What is the difference between Expectations Theory and Liquidity Premium theory?

d) How does the Segmented Market Hypothesis explain the shape of the yield curve?

3) Answer the following questions about a coupon bond and present value.

a) Why is there an inverse relationship between price and yield? Give an example.

b) What is present value? What do we mean when we say present value, and what does it mean that a bond price is in present value terms?

c) What is the bond price equation? What happens to the yield of a bond if the coupon payment increases?

4) Using the liquidity preference model, answer the following with graphs/explanation:

a) The United States decided to go cashless, using an electronic embedded chip as the form of electronic payment.

b) The stock market turns into a "bull market" (a good market).

c) The Federal Reserve buys short term debt from banks (open market operations).

d) The Federal Reserve sells short term debt to banks (open market operations).

5) Answer the following questions about the yield curve:

a) Compare with illustrates a normal yield curve, steep yield curve, flat yield curve, and inverted yield curve.

b) Explain what economic circumstances could lead to each type of yield curve, and explain what the type of yield curve signals about markets.

c) Illustrate a yield curve with CURRENT interest rates. What shape does the current yield curve have compared to previous times in history?

d) Explain the three theories of yield curve determination. Which theory makes most sense to you, and why?

6) Illustrates with balance sheets an example of a "high capital" bank and "low capital bank," then answers the following questions:

a) Suppose there was a drop in assets, either loans or securities, that made low capital bank insolvent, but not high capital bank. Illustrate on a balance sheet.

b) What are the solutions to this problem for low capital bank?

c) What are the disadvantages to having high capital for the high capital bank, and what are the solutions to make high capital bank more competitive?