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Prince Mohammed Bin Fahd University
Money And Banking
FINA 3313
Section: 101
Abdulrahman Khalil
200801624
Assignment (Chapter 1-4)
CHAPTER 1
1. Has the inflation rate in China increased or decreased in the past few years?
What about interest rates?
Increased Inflation.
Increased Interest.
2. If history repeats itself and we see a decline in the rate of money growth,
what might you expect to happen to
a.real output
b.the inflation rate,and
c.interest rates?
a. real output: decrease
b. the inflation rate: decrease
C. interest rate: decrease
7.What is the basic activity of banks?
1. Collecting deposits from customers and giving them interest
2. Lending loans to customers
3. Safeguarding customers valuables by means of safe deposit vaults
4. Provide investment services like Mutual funds
5. Provide Depository services
10.What effect might a fall in stock prices have on business investment?
stock prices seem to have an impact on companies’ investment decisions. In other
words, when stock prices fall, companies’ investment spending seems to fall as well.
Foreign-made.
Strong
It will not be happy, because the demand will be less.
CHAPTER 2
2.If I can buy a car today for $5000and it is worth $10,OOO 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’s loan-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.)
3.Some economists suspect that one of the reasons that economies in developing
countries so slowly is that they do not have well-developed financial markets.
Does this argument make sense?
Yes, because the absence of financial markets means that funds cannot be channeled to
people who have the most productive use for them. Entrepreneurs then cannot acquire funds
to set up businesses that would help the economy grow rapidly.
5."Because corporations do not actually raise any funds in secondary markets,
they are less important than 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.
9.Why do loan sharks worry less about moral hazard in connection with their
borrowers than some other lenders do?
Loan sharks can threaten their borrowers with bodily harm if borrowers take
actions that might jeopardize their paying off the loan. Hence borrowers from
loan shark are less likely to increase moral hazard.
13.Why might you be willing to make a loan to your neighbor by putting funds in
a savings account earning a 5% interest rate at the bank and having the bank
lend her the funds at a 10% interest rate rather than lend her the funds yourself?
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 3
5.In ancient Greece, why was gold a more likely candidate for use as money
than wine was?
Wine is more difficult to transport than gold and is also more perishable. Gold is
thus a better store of value than wine and also leads to lower transaction costs. It is
therefore a better candidate for use as money.
7.Would you be willingto give up your checkbook and instead use an electronic
means of payment if it were made available? Why or why not?
Of course - in fact, we almost are there (1 to 3 checks a month only because the
car payment is at my credit union two floors down). Convenience, lack of paper,
no postage, and speed are 4 major factors - not to mention it makes it easier to
budget when you can lock in a payment date as opposed to guessing just when
the PO will deliver an envelope and the receivng bank will open it and credit it.
9.Why have some economists described money during a hyperinflation as a
"hot potato" that is quickly passed from one person to another?
Money loses its value at an extremely rapid rate in hyperinflation, so you want
to hold it for as short a time as possible. Thus money is like a hot potato that is
quickly passed from one person to another.
11.Suppose that a researcher discovers that a measure of the total amount of
debt in the U.S.economy over the past 2O years was a better predictor of inflation
and the business cycle than M1, M2, M3. Does this discovey mean that we should
define money as equal to the total amount of debt in the economy?
Not necessarily. Although the total amount of debt has predicted inflation and
the business cycle better than M1, M2, or M3, it may not be a better predictor in
the future. Without some theoretical reason for believing that the total amount of
debt will continue to predict well in the future, we may not want to define money
as the total amount of debt.
CHAPTER 4
2.You have just won $20 million in the state lottery, which promises to pay you
$1 million (taxe free) every year for the next 2O years. Have you really won $20
million?
No, because the present discounted value of these payments is necessarily less than
$10 million as long as the interest rate is greater than zero.
3. If the interest rate is 10%, what is the present value of a security that pays
you $1100 next year, $1210?the year after, and $1331 the year after that?
$1100/(1+0.10)+$1210/(1+0.10)2+ $1331/(1+ 0.10)3= $3000.
4. If the security in problem3sold for $4000, is the yield to maturity greater or
less than 10%? Why?
The yield to maturity would be less than 10 percent if the security sold for $3,500.
5. Write down the formula that is used to calculate the yield to maturity on a
20-year 10% coupon bond with $1000 face value that sells for $2000?
$2000=$100/(1+i)+$100/(1+i)2+……+$100/(1+i)20+$1000/(1+i)20.
6.What is the yield to maturity on a $1000-face-value discount bond
maturating in one year that sells for $800?
25 percent.
7.What is the yield to maturity on simple loan for $1 million that requires a
repayment of $2 million in five years’ time?
14.9%, derived as follows: the present value of the $2 million payment five years
from now is $2/(1+i)5 million, which equals the $1 million loan. Thus l=2/(1+i)5.
Solving for i,(1+i)5=2, so that i=0.149=149%.
8. To pay for college, you have just taken out a $1,000 government loan that
makes you pay $126 per year for 25 years. However, you don’t have to start
making these payments until you graduate from college two years from now.
Why is the yield to maturity necessarily less than 12%, the yield to maturity on a
normal $1,000 fixed payment loan in which you pay $126 per year for 25 years?
If the interest rate were 12 percent, the present discounted value of the payments
on the government loan are necessarily less than the $1,000 loan amount because
they do not start for two years. Thus the yield to maturity must be lower than 12
percent in order for the present discounted value of these payments to add up to
$1,000.
9.Which $1000 bond has the higher yield to maturity, a 20?year bond selling
for $800 with a current yield of 15% or a one-year bond selling for $800 with a
current yield of 5%?
The one-year bond has a higher yield to maturity.
12. If there is a decline in interest rates, which would you rather be holding,
long-term bonds or short-term bonds? Why? Which type of bond has the greater
interest-rate risk?
You would rather be holding short-term bonds because the decline in their price
following the decline in interest rates will not be as severe.
15. Interest rates were lower in the mid-1980s than they were in the late 1970s,
yet many economists have commented that real interest rates were actually
much higher in the mid-1980s than in the late 1970s. Does this make sense? Do
you think that these economists are right?
The economists are right. They reason that nomina1 interest rates were below
expected rates of inflation in the late 1970s, making real interest rates negative.
The expected inflation rate, however fell much faster than nominal interest rates
in the mid-1980s, so nominal interest rates were above the expected inflation
rate and real rates became positive.