Download Economics 303

ECO 212
Fall 2001
Comprehensive Final
Name:___________________
ID #:____________________
Instructions: Answer ALL questions for BOTH parts of the exam on the exam itself and
turn in the entire exam.
Helpful reminders: ER(X) =  pi · Xi
i
2 =  p ·[( X – ER(X) )2 ]
, X
i
i
i
cov(A,B) =  pi ·[ (Ai – ER(A)) · (Bi – ER(B)) ]
A =
i
, and
cov(iA ,im )
var(im )
Capital Asset Pricing Model: ER(i A ) = i rf + A·[ER(i m ) – i rf ]
Suppose you are considering buying an asset issued by Company Z. You investigation into this
company leads has given you the following information:
You believe that the return you will earn from the asset issued by Company Z will be either 18%
(0.16) or minus two percent (–.02). If the economy expands next year, you believe that there is
an 80% probability that you will enjoy the 18% return and a 20% probability that you will earn –
2%. If there is a recession, you believe that there is a 20% probability that you would earn the
18% return and an 80% probability that you would get –2%. The outcomes and probabilities are
summarized in the table below:
return on asset Z
If the economy expands:
(probability = 0.5)
return
0.18
–0.02
Probability
0.8
0.2
If there is a recession:
(probability = 0.5)
0.18
–0.02
0.2
0.8
Suppose a completely diversified portfolio of all available assets (the "market" asset) will have a
10% (0.10) return if the economy expands and a 2% (0.02) return if there is a recession.
1.
Fill in the missing values in the "tree" below:
Asset Z
Prob
Market Asset Z
return return
_____
_____ ______
_____
_____ ______
_____
_____ ______
Economic
recovery
Recession
_____
2.
3.
_____ ______
Fill in the missing values in the table below:
ER(i z ) = __________
2
z = 0 .01
ER(i m ) = __.06___
2
m = ___________
Calculate the covariance of asset Z with the market asset.
4.
What must the risk-free interest rate be if the current price of (and returns from) Asset Z
obey the capital asset pricing model?
5.
If asset Z had a ß = 1 instead of the value you calculated above, how would you make
money by giving valuable investment advice? (What advice would you give?)
Part II: Instructions: Select the best answer for each question and record your answer on the
exam itself.
1.
Bulgaria has a currency board system that fixes the value of the lev against the DM. The
adoption of the fixed exchange rate means that Bulgaria can no longer:
a.
b.
c.
d.
e.
set its level of tariffs on imported goods at the level it desires.
choose its monetary policy separately to meet the needs of the individual country.
have a balance of payments deficit.
have a government budget deficit.
increase government spending to try to reduce unemployment.
British Pound Market
Exchange
Rate
(A$/UK£)
S of £
2.5
2.0
1.5
D for £
10
20
30
Quantity of
British £
For the following five questions, suppose the picture above represents the supply and demand for
British pounds (UK£), in terms of its value relative to the Australian dollar (A$).
2.
Assume that Britain and Australia operate under the Bretton Woods system, in which the
par value of the British pound is US$ 2.00, and the par value of the Australian dollar is US$0.80.
If the government of Great Britain is believed to be about to change the par value of the British
pound rather than change its money supply, currency speculators will seek to make profits by:
a.
borrowing British pounds today and converting them into bank deposits denominated in
Australian dollars.
b.
borrowing Australian dollars today and converting them into British pound bank deposits.
c.
exchanging British pound bank deposits today and converting them into British assets
like bonds or land.
d.
taking their Australian dollars to the Australian treasury and converting them into gold
until the change in par value takes place.
e.
borrowing Australian dollars, converting them into U.S. dollars, and selling them in the
currency market for British pounds.
3.
If Britain and Australia are using the gold standard and the par values of a gram of gold
are A$15 and UK£10, then the Australian treasury must _______ gold, which will cause the
Australian money supply to _______.
a.
b.
c.
d.
e.
buy
fall.
buy
rise
sell
rise
sell
fall
none of the above.
4.
Suppose the British central bank intervenes in the currency markets to prevent the value
of the pound from falling. If the central bank does not want this to affect the domestic money
supply, it must make another transaction. The other transaction must involve:
a.
b.
c.
d.
e.
selling domestic assets.
buying foreign assets.
selling foreign assets.
buying domestic assets.
none of the above.
5.
Under the gold standard, if the official exchange rate (determined by the par values of
gold) between British pounds and Australian dollars is A$2.5/UK£, then in the short run British
imports of goods, services, and assets are equal to exports of goods, and assets because Britain
must _______.
a.
b.
c.
d.
e.
buy £20 worth of gold.
sell £20 worth of gold.
buy A$20.
sell A$20
import A$ 30 worth of Australian goods.
6.
Under the gold standard, if the official exchange rate (determined by the par values of
gold) between British pounds and Australian dollars is A$2.5/UK£, then in the long run British
imports of goods, services, and assets are equal to exports of goods, and assets because Britain
must _______.
a.
b.
c.
d.
e.
import more Australian goods.
reduce its money supply, causing British prices and incomes to fall.
increase its money supply, causing British prices and incomes to rise.
lower the par value of the British pound.
raise British interest rates.
7.
You repay your debt to me by giving me last week's Aspector. If I accept the newspaper
as payment even though it no longer has any value as a newspaper (if it ever did) because I
believe someone else will also accept it as payment, the category which best describes the
newspaper is:
a.
b.
c.
d.
e.
commodity money.
commodity-backed money.
fiat money.
unit of account.
instrument of barter.
8.
The Capital Asset Pricing Model says that if an asset pays three times the risk premium
as a completely diversified portfolio of assets, it should also:
a.
pay the holder three times the yield-to-maturity of a completely diversified portfolio of
assets.
b.
have risky returns with three times the variance that a completely diversified portfolio of
assets has.
c.
cost three times as much as a completely diversified portfolio of assets.
d.
have three times as much systematic risk as a completely diversified portfolio of assets.
e.
none of the above.
9.
The loanable fund supply curve would shift to the right if there was ________, but would
not shift to the right if there was _________.
a.
an increase in interest rates; an increase in expected future income
b.
an increase in current real incomes; an increase in expected future income
c.
an increase in expected future real income; an increase in profitability of firms'
investment projects
d.
a decrease in interest rates; a shift to the right of the bond demand curve
e.
an increase in the expected profitability of firms' investment projects; a shift to the left of
the bond supply curve
Bond Market
Price of
Bonds
F
G
(high)
H
I
W
J
K
L
(low)
M
Quantity of Bonds
The following two questions refer to the graph above. For EACH question, assume that the
initial condition before any events mentioned in the question is the intersection of the bold lines - at point I in the bond market.
10.
Suppose that something happens that convinces households that their future real income
will be lower than what they had previously planned. The new equilibrium point in the diagram
will be:
a.
b.
c.
d.
e.
point W in the bond market.
point H in the bond market.
point M in the bond market.
point L in the bond market.
point G in the bond market.
11.
Suppose something happens that convinces both firms and households that inflation in
the future will be lower than the level they had previously expected. The new equilibrium point
in the diagram will be:
a.
b.
c.
d.
e.
point J.
point H.
point M.
point F.
point W.
12.
If the Ricardian Doctrine is correct, then ___________ will not change when there is a
change in ___________.
a.
b.
c.
d.
e.
savings
consumption spending
current consumption spending
households' savings
none of the above
investment
investment
future expected income
taxes
RET d
Exchange
Rate
•N
H
•
I•
G•
•M
F•
• L
RET f
• K
J •
id
Expected Return
13.
In the figure above, RETd and RETf represent the expected returns on domestic and
foreign deposits, respectively, so the current exchange rate satisfies the interest rate parity
condition at point F. If domestic expected inflation decreases, then:
a.
b.
c.
d.
e.
the RETd line must shift to the right.
the RETf line must shift to the right.
the RETd line must shift to the left.
the RETf line must shift to the left.
none of the above.
14.
In the figure above, RETd and RETf represent the expected returns on domestic and
foreign deposits, respectively, so the current exchange rate satisfies the interest rate parity
condition at point F. If foreign interest rates rise, the interest rate parity condition would be met
after this change at point:
a.
b.
c.
d.
e.
I
N
G
M
K
Yield Curve
9%-8%-7%-6%-|
1
|
2
|
3
|
4
Term to Maturity
(years)
15.
According to the expectations theory of the term structure of interest rates, if the yields to
maturity on 1, 2, and 3 year bonds are as shown in the graph above, then bond buyers and sellers
expect the sequence of 1 year interest rates beginning this year to be approximately:
a.
b.
c.
d.
e.
6%
6%
6%
6%
6%
8%
8%
7%
7%
8%
8%
7%
7%
8%
10%
16.
In order to use the simple deposit multiplier to describe the creation of new money supply
from a given change in the monetary base, we need to assume:
a.
banks lend out all excess reserves, and the public deposits all its cash into banks.
b.
all required reserves are held as deposits at the central bank, and all excess reserves are
held as vault cash.
c.
banks use their excess reserves to make loans instead of buying bonds, and the public
maintains a constant proportion of their money as bank accounts.
d.
banks lend out all their deposits, and households hold all of the reserves.
e.
bank capital is kept to a minimum, and banks lend money at zero interest.
17.
The purchasing power parity condition states that exchange rates should equate the cost
of ___________ with the cost of the same thing purchased in another country.
a.
b.
c.
d.
e.
a typical basket of goods and services
any tradable, standard commodity
gold
a bank deposit
an ordinary worker's wage
18.
Duration analysis involves comparing the _____ of the bank's assets to that of its
liabilities.
a.
b.
c.
d.
e.
default risk
average term to maturity
liquidity
average yield to maturity
interest rate gap
19.
An increase in the interest rates paid on deposits can affect the money supply by:
a.
b.
c.
d.
e.
causing the monetary base to fall, which reduces the money multiplier.
causing the {C/D} ratio to rise, which reduces the money multiplier.
causing the {ER/D} ratio to rise, which reduces the money multiplier.
causing the {C/D} ratio to fall, which increases the money multiplier.
causing the rD ratio to rise, which reduces the money multiplier.
20.
A bank has the following balance sheet:
____________________________________
Reserves
$20
|
Deposits
$200
Securities
$50
|
Borrowings $100
Loans
$260 |
Bank Capital $30
Suppose that reserves earn no interest, securities and deposits are rate sensitive, and the loans
and borrowings are fixed rate. If interest rates fall by three percentage points (for instance, from
7% to 4%):
a.
b.
c.
d.
e.
bank capital falls by 4.5%.
bank profits fall by 4.5%.
bank profits rise by 4.5%.
bank profits rise by $4.5.
none of the above.