Essay Questions:
Lecture 1:
1. Discuss the purpose of the primary and secondary markets, and how each
functions. Explain how the secondary market supports the function of the
primary market, and how financial market turmoil (e.g. 2008-09) impedes this.
2. Discuss the differences between the Money and Capital Markets, and the types of
securities trade in those markets. Give examples.
3. Discuss what market whether you would go to the Money or Capital Markets to
raise funds for construction of a factory. Explain why. Discuss which market and
the sort of instruments you should use to manage corporate treasury funds.
Lecture 2:
4. Explain in words why a dollar has different values dependent on point in time
received, and how “present valuing” or “future valuing” cash-flows corrects for
these differences. Also, look at the mathematics of the “annuity” versus the
“annuity due”, and explain why the annuity is 1+r more valuable. Finally, create
an amortization table using your calculator (like in the notes) and explain why the
amount of interest paid is decreasing, and the principle paid is increasing.
5. Explain what makes bonds more sensitive to discount rate changes, and how
Duration measures bond sensitivity. Why does higher Duration mean greater
sensitivity, and lower Duration less (explain by using the equation, in terms of the
present value of the coupon and principle payments)?
6. Explain why the current yield does not correctly reflect the true yield (yield to
maturity) of a bond. Also discuss the effect of maturity on the error.
Lecture 3:
7. Discuss in words and graphs what will happen to bond prices, interest rates, and
the dollar volume of bonds issued, due to factors such as: rising inflationary
expectation, increased indebtedness, changes in taxation policies, etc. Think in
terms of both supply and demand.
8. Explain graphically, how increased government bond issuance can result in a
decrease of corporate bond issuance, and lower corporate bond prices.
9. Show how increased government spending crowds out investment using both
investment and money supply/demand curves. Also explain why investment may
not be crowed out during recession, and the long-run drawbacks to government
fiscal stimulus (spending) during a recession.
10. Explain graphically why monetary stimulus is transitory (temporary), and leads
only to higher prices (inflation) over the long run.
11. Explain the difference between the “expected inflation” and “income” effect.
12. Describe the difference between “default risk” and “liquidity risk”, and between
default and liquidity premia. Explain why it is hard to differentiate between types
of premia.
13. Explain how bonds get rated, and the difference between investment grade and
non-investment grade ratings.
14. Discuss the three theories explaining the shape of the yield curve (Expectations,
Segmented Markets, and Preferred Habitat). How is this indicated in the
equations?
Lecture 4:
15. Explain the difference between Rational Expectations and EMH (begin by
defining each). Explain the crucial assumptions of these theories, without which
they fail.
16. Discuss the theoretical implications of Rational Expectations and EMH (e.g. what
information is relevant, how investors should value securities, and how markets
should behave when prices are incorrect). Discuss the practical implications
regarding ability to forecast future prices and ability to beat the market or earn
excessive profits.
17. Discuss evidence from the current market that Rational Expectations and EMH
does not hold. Explain why the fundamental breakdown in these theories has
occurred (hint: identify the absent or incorrect assumptions).
18. Explain specific regulations you might use to correct these market problems, and
what specific problem these regulations would address.
19. Discuss the difference between moral hazard and adverse selection. Discuss
examples from ENRON, TYCO, WORLDCOM, MERRILL LYNCH.
20. Discuss ways of controlling moral hazard and adverse selection, and the role that
specific types of financial institutions play in reducing it (be specific: e.g.
commercial banks, venture capitalists, etc.)
21. Discuss how and why government has a role in controlling moral hazard, adverse
selection, and agency problems. How does the principal-agent problem (agency)
relate to moral hazard and adverse selection?
Midterm 
Lecture 5:
22. Explain the difference between commercial banks and investment banks. Discuss
their roles in our financial system, how each facilitates capital raising by firms,
and how each earns profits. Discuss the potential conflict of interest when these
two entities are housed under the same roof.
23. Explain how commercial banks ‘create money’ and what transactions lead to
money creation. Discuss the impact on our financial system of a new 100,000
deposit (assuming a 10% reserve requirement), and in theory, how much this
deposit will expand the total money supply. Discuss the ledger entries, and how
exactly money is created.
24. Discuss why a sale of treasuries by the FED will contract the money supply, and
why a purchase of treasuries will expand it. In doing so, first discuss the impact
on bank reserves. Also, discuss why buying or selling reserves would have a tenfold impact on the money supply with a 10% reserve requirement. Finally,
discuss whether a higher or lower reserve requirement would have a greater effect
on the money supply, and explain why. What is the impact of a zero-reserve
requirement?
25. Discuss the difference between capital and reserve requirements. Explain what
risks they are intended to control, and how they reduce these risks. Does either
control Moral Hazard? Can either reduce Adverse Selection? Explain.
26. Discuss the benefits and risks stemming from off-balance sheet income sources;
give examples that are commonly used by banks. Discuss why the specific
sources are risky. Also, discuss indicators of bank health, and signs to look for in
a failing bank.
27. Discuss the Federal Reserve Act of 1913; what exactly the act did, what the FED
was supposed to do, and why it was passed. Did the FED act as anticipated in the
stock market crash of 1929. If not, what did it not do that it should have?
28. What was the fundamental mission of the Glass-Steagall Act, and when and why
was it passed? What act repealed it and why was it repealed? Are there any
dangers to its repeal?
29. Discuss deposit insurance, and why it was put in place in 1934. What risks are
created by having deposit insurance, and to whom? How should we control these
risks?
30. What was FIRREA, and how did it resolve the S&L crisis? What were the costs?
31. Discuss Sarbanes-Oxley and Dodd-Frank, what each act supposed to do, why it
was passed, and the problems it has created. Discuss criticisms of each.
32. Discuss how banks are currently regulated, and identify the regulatory authorities.
If different banks are regulated by different authorities, summarize who regulates
what.
33. What is Universal Banking? What is the difference with our traditional banking
system in the US, and what are the risks that we have created by moving to a
universal banking system through Graham-Leach-Bliley? When did we do this?
34. Discuss the differences between Mutual Banks, Credit Unions, and Savings and
Loans, and how they differ from commercial banks. Discuss any special
protections they have, why they exist, and how their health is measured.
Lecture 6:
35. Discuss how investment banks operate, how they function in our financial system,
and how they earn money. Discuss I-banks add to the financial system in terms of
services that they uniquely provide, and the importance of bank’s reputation to its
survival.
36. Discuss the underwriting process, and the difference between negotiated and
competitive sales. Under which type of sale is a financial advisor mandatory, and
in that case, what is its role? Explain syndication, and why banks will form a
syndicate. Also explain why banks prefer underwriting to financial advisory.
37. Explain what a prospectus is, what an offering memorandum is, and the
information contained in the two documents. What is a red-herring?
38. Who are the major participants (players) in underwriting a financial issue, and
what are their roles? How are they paid?
39. Discuss the major components of an I-bank, what operations are conducted in
each, what services each component provides to our financial system, and how
each earns fees. Discuss who works in each of these components. Discuss the
difference between the underwriting and capital markets groups (both are crucial
to the underwriting process, and divide under-writer fees).
40. Discuss what a mutual fund is and how it is structured. Discuss its role in our
financial system, and who it primarily employs. Discuss what these people do.
41. Discuss what a hedge fund is, and how it earns profits. Explain what a marketneutral strategy is, and how it would be employed using two treasury bonds with a
120 month and 121 month maturities.
42. Explain how a venture capital firm operates, earns profits, and why an investment
bank cannot replace it in our financial system. Explain why it is able to control
Moral Hazard better than many other types of firms. How do these firms control
for Adverse Selection?
43. Explain how finance companies operate, and how investment banks can conduct
similar operations (structured product groups in I-banks effectively create the
same product, and in-fact, are responsible for many of the CMO’s that have
created problems).
44. Explain how insurance companies make money, why they are primary market
participants, and how they control Moral Hazard and Adverse Selection. Explain
what insurance is, the difference between “whole life” and “term”, and who
regulates them.
45. Explain what a pension fund is, how it is similar to a mutual fund, the advantages
it has over a mutual fund, and what an under-funded pension is. Explain the
differences of under-funding pensions. Discuss the difference between a defined
contribution and defined benefit. What will happen to pensions if GMAC and
Ford go bankrupt?
46. Discuss the problems with Social Security, and potential corrections?
Lecture 7:
47. Discuss the Great Depression, the causes, and why it led to a collapse of our
banking system. Explain what the FED did or did not do, and what it should have
done. Explain how it destroyed our economy, and what we did to ensure it never
would happen again.
48. What caused the S&L crisis in the 1980’s, and why were S&L’s going bankrupt?
What did congress do that increased the severity of the crisis, and what action
should congress have taken?
49. Discuss the Long Term Capital fiasco: how they were making money, what
changed that led to the failure, and why their strategy failed. Explain the systemic
risk created by LTC, why the FED intervened, and how the problem was solved.
Discuss the similarity to the Orange County Investment Pool bankruptcy, four
years earlier. Discuss what “Too Big to Fail” means.
50. Discuss the financial accounting scandals at ENRON, World Com, and Tyco.
How did they differ, and how were they similar. Fundamentally, what did each
scheme attempt to do (all had the same basic objectives)? How did we respond?
51. Discuss the financial crises of 2008-2009. Which crises is it most similar to?
What are the similarities and what are the differences? What are the chief factors
that created this crisis, and how these factors work together to magnify the crises?
52. Can we stimulate (or spend) our way out of the 2008-2012 recession? What is the
difference between this recession and our previous recession that might ultimately
limit the effectiveness of stimulus? What does the US fundamentally need to do
to get out of the recession?
Lecture 8:
53. Discuss the difference between forwards, futures, and options. Which contract(s)
fix the price of an asset in the future, and how is it done. Discuss exactly how
each of these contracts works. How are futures and forwards quite similar?
Which of these three contracts is most like an insurance policy, why?
54. Discuss the greatest danger to hedging with futures, and how firms have gone
bankrupt using futures hedges.
55. Discuss what causes option premia to increase or decrease? Discuss how the
strike affects the price of an option. If you’re hedging the value of your
retirement portfolio, when would you be most likely to use options vice futures?
56. Explain fundamentally what an interest rate swap is, and how one might do it.
Explain what swapping for comparative advantage is, and the chief goal.
Final 