Description / paper instructions
Answer the questions on the problem set that I uploaded. It requires lecture 1-3’s stuffs, so i uploaded the notes as well.
Lecture 1-3 STUDY GUIDE
Lecture 1
- Definition of GDP: meaning of key words. What goods are counted to GDP? What are not? Know how to calculate GDP deflator and inflation from the GDP deflator
- Definition of Business Cycle: expansion phase and contraction phase or recession
- Investment options: an MCQ question on which investment option is most profitable to you
Lecture 2
- Financial markets role and importance: channeling funds, increasing economic efficiency
- Interest rates are rental rates of funds: cost to borrowers but gain to lenders. Higher interest rate encourages agents to save and discourage agents to borrow.
- Interest rates influence GDP in two ways: capital investment of firms e.g. machinery, and spending on durable goods of households e.g. housing, car, etc.
- Direct/indirect finance: indirect finance involves financial intermediaries. Examples?
- Debt/equity markets: two ways a corporation can raise funds from financial markets. Debt instruments come in a variety of short to long-term, but equity is only long term
- Bonds/stocks differ by priority of claimant, periodic payment, maturity, and other benefits. When someone would prefer bonds to stocks? Stocks to bonds?
- Primary/secondary markets: investment banks underwrite newly issued securities in primary markets, brokers and dealers facilitate trading in secondary market. Firms only raise funds from primary market, but secondary market is no less important. Why?
- Money/capital markets: instruments in money market is short-term. Most liquid asset on money market: US T-bill, on capital market: US T-bond. Definition of federal funds.
- Information asymmetry: Moral hazard (occuring after transaction) and adverse selection (before transaction). How financial intermediaries reduce these problems?
- Assets and liabilities of depository institution, insurance companies, pension funds
- Main roles of the Federal Reserves, SEC, FDIC: Fed set reserve requirement and fed funds rate, SEC prevents insider trading, FDIC provides deposit insurance
Lecture 3
- Money: Three functions of money. Which one is unique to money? Which not? What is the disadvantage of money over other assets?
- Criteria for a commodity to function as money, two conditionsfor a fiat money to be accepted, definition of legal tender. Is check a legal tender?
- Liquidity concept definition. Rank asset by liquidity level “>>” denoting higher liquidity
- General rule: Money >> Financial assets >> Real or physical assets
- Money: M1 (currency, checking accounts) >> M2 (savings, time deposit)
- Financial assets: short-term >> long-term, safe >> risky
- Real or physical assets: movable >> immovable
- Measure of money stock: Venn diagram of M1 and M2, how M1 and M2 change (increase or decrease) following an action
EC 370 Money and Banking
MTWR 2:00-3:50 pm, MCK 240C
PROBLEM SET 1
Please not that you may work with other students on the homework, but you must turn in your own work. No late assignments will be accepted. Keep your answer within the space provided below the questions.
LECTURE 1
- In the country of Oz, there are two goods: Boeing Airplane and Voodoo Donuts. The table below lists the quantity and price of each good in 2005, 2015, and 2016.
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2005 |
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2015 |
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2016 |
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Goods |
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Quantity |
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Price ($/each) |
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Quantity |
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Price ($/each) |
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Quantity |
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Price ($/each) |
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Boeing |
5 |
$1000 |
8 |
$1020 |
10 |
$1050 |
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Donut |
10 |
$20 |
25 |
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25 |
$42 |
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Choose 2005 as the base year. Answer the following questions
- Find the Nominal GDP in 2015, given that the GDP deflator in 2015 is 1.06
- Find the price of a Voodoo Donut in 2015
- Find Real GDP in 2016 and then find the growth rate of real GDP in 2016
- Find the inflation rate in 2016 (you need to find the GDP deflator in 2016 first)
- What is the inflation rate in 2015?
- Based on the definition of CPI, which good do you think will be included in the calculation of CPI basket?
LECTURE 2
- Why are financial markets important to the health of the economy?
- 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?
- True or false? Explain. “Because corporations do not actually raise any funds in secondary markets, secondary markets are less important to the economy than primary markets are.”
- How can the adverse selection problem explain why you are more likely to make a loan to a family member than to a stranger?
- Suppose you have just inherited $10,000 and are considering the following options for investing the money to maximize your return:
Option 1: Put the money in an interest-bearing checking account, which earns 2%. The FDIC insures the account against bank failure.
Option 2: Invest the money in a corporate bond, with a stated return of 5%, but there is a 10% chance the company could go bankrupt.
Option 3: Loan the money to one of your friends’ roommates, Drizella, at an agreed-upon interest rate of 8%, but you believe there is a 7% chance that Drizella will leave town without repaying you.
Option 4: Hold the money in cash and earn zero return.
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?
LECTURE 3
- In ancient Greece, why was gold a more likely candidate for use as money than wine?
- Which of the Federal Reserve’s measures of the monetary aggregates—M1 or M2—is composed of the most liquid assets? Which is the larger measure?
- How do M1 and M2 change if
- An individual moves money from currency to a demand deposit account?
- An individual uses money from a demand deposit account to purchase a U.S. Treasury bond?
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