Fe - Tutorial 1.docx

Financial Economics – Tutorial 1 - Introduction Tutorial Exercises 1. Why are financial markets important to the health of the economy?

You can back-up your answer using below link. (Abstract of the article) https://academic.oup.com/qje/article-abstract/111/3/639/1839927

2. If there is a decline in the rate of money growth, what might happen to a. real output? b. the inflation rate? c. interest rate?

With the help of macroeconomic knowledge, discuss in detail. You can refer to the lecture note uploaded in TIMeS. 3. What does below table present? April 2014

January 2000

M1 Money Growth

10.33%

2.19%

10-year Treasury rate

2.71%

6.66%

Would you be able to extract the same concept from below article? Bank Of Japan Announces More Quantitative Easing: The Next Chapter In Abenomics http://www.forbes.com/sites/jonhartley/2014/11/02/bank-of-japan-announces-more-quantitativeeasing-the-next-chapter-in-abenomics/

4. Define each of the following money market instruments and describe who issues each of the respective tools? a. Treasury bills b. Certificates of deposit c. Commercial paper d. Repurchase agreement e. Central Bank funds 5. How can the adverse selection problem explain why you are more likely to make a loan to a family member than a stranger? 6. What is the difference between a mortgage and a mortgage-backed security?

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7. 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?

8. Suppose you have just inherited $10,500 and are considering the following options for investing the money to maximize your return:

9. Option 1: Hold the money in cash and earn zero return. Option 2: Loan the money to one of your friend’s roommates, Mike, at an agreed-upon interest rate of 8%, even though you believe there is a 6% chance that Mike will leave town without repaying you. Option 3: Invest the money in a corporate bond with a stated return of 5%, although there is a 11% chance the company could go bankrupt. Option 4: Put the money in an interest-bearing checking account that earns 3%. The FDIC insures the account against bank failure. If you are risk-neutral (that is, neither seek out nor shy away from risk), which of the four options should you choose to maximize your expected return? (Hint: To calculate the expected return of an outcome, multiply the probability that an event will occur by the outcome of that event.)

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