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Name (.5 points) _____________________
Student ID _____________________
Final Exam
Economics 333
Money and Banking
Friday, December 14th 2007
Multiple Choice (2.5 Points Each)
1. The price (relative to face value) of a 1-year HK$ discount bond is greater than
the price (relative to face value) of a 2-year HK$ discount bond. The price
(relative to face value) of a 1-year HK$ discount bond is greater than the price
(relative to face value) of a 1-year bond denominated in yen. If uncovered interest
parity and the expectations theory of the term structure are true:
a. The markets expect the Hong Kong dollar will increase in value relative to the
Yen over the next year but we need more information to determine whether
the market expects that next year’s HK dollar interest rate will be higher or
lower than this year’s.
b. The markets expects the Hong Kong dollar will decrease in value relative to
the Yen over the next year but we need more information to determine
whether the market expects that next year’s HK dollar interest rate will be
higher or lower than this year’s.
c. The markets expect the Hong Kong dollar interest rate will be higher this year
than next year but we need more information to determine whether the
markets expect that the Hong Kong dollar will decrease in value relative to the
Yen.
d. The markets expect the Hong Kong dollar interest rate will be lower this year
than next year but we need more information to determine whether the
markets expect that the Hong Kong dollar will decrease in value relative to the
Yen.
_________________
2. Which of the following is not part of the CAMEL ratings?
a. Capital adequacy.
b. Asset quality.
c. Earnings quality.
d. Liabilities quality.
_________________
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3. Which of the following will increase the dividend yield, the ratio of dividends to
prices: of stocks:
a. An increase in market interest rates and an increase in the expected growth
rate of dividends
b. An increase in market interest rates and a decrease in the expected growth rate
of dividends
c. A decrease in market interest rates and an increase in the expected growth rate
of dividends
d. A decrease in market interest rates and a decrease in the expected growth rate
of dividends
_________________
4. Banking regulation in Hong Kong does not require that banks:
a. limit the amount of equity stakes that they own in non-financial
companies.
b. Keep a percentage of demand deposits on reserve at the central bank.
c. Keep a certain percentage of liquid or liquefiable assets relative to liquid
liabilities.
d. Maintain an 8% CAR.
___________
5. We can say that when comparing making a residential real estate loan and a
commercial loan to finance inventories:
a. residential lending has more credit risk and more liquidity risk.
b. residential lending has more credit risk but less liquidity risk
c. residential lending has less credit risk but more liquidity risk
d. residential lending has less credit risk and less liquidity risk.
___________
6. Gold would be a superior commodity money compared to wheat because:
a. Wheat has a high value relative to weight, which gold does not
b. It is easier to divide wheat into small units
c. Wheat has more practical uses than gold
d. Wheat is perishable
___________
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7. A monetary policy rule sets the real interest rate as a function of inflation. We can
say when comparing a rule that is sensitive to the inflation with one that is
relatively insensitive:
a. an inflation sensitive policy will generate more long-lived demand driven
business cycles and an insensitive policy will generate sharper supply-driven
cycles.
b. an inflation sensitive policy will generate less long-lived demand driven
business cycles and an insensitive policy will generate sharper supply-driven
cycles.
c. an inflation sensitive policy will generate more long-lived demand driven
business cycles and an insensitive policy will generate milder supply-driven
cycles.
d. an inflation sensitive policy will generate less long-lived demand driven
business cycles and an insensitive policy will generate milder supply-driven
cycles.
___________
8. Under the Hong Kong exchange rate peg
a. A decrease in the U.S. interest rate will lead to the automatic purchase of U.S.
dollars by the HKMA while an increase in demand for bank deposits in Hong
Kong will lead to the automatic purchase of U.S. dollars by the HKMA.
b. A decrease in the U.S. interest rate will lead to the automatic sale of U.S.
dollars by the HKMA while an increase in demand for bank deposits in Hong
Kong will lead to the automatic purchase of U.S. dollars by the HKMA.
c. A decrease in the U.S. interest rate will lead to the automatic purchase of U.S.
dollars by the HKMA while an increase in demand for bank deposits in Hong
Kong will lead to the automatic sale of U.S. dollars by the HKMA.
d. A decrease in the U.S. interest rate will lead to the automatic sale of U.S.
dollars by the HKMA while an increase in demand for bank deposits in Hong
Kong will lead to the automatic sale of U.S. dollars by the HKMA.
___________
9. Assume that people form their expectation of future inflation as equal to the
current rate of inflation so that  tE1   t . Also assume that the US central bank
behaves according to a Taylor rule. If US inflation rises by 1%, we should expect
to see:
a. US real interest rates to rise and US nominal interest rates to rise by more than
1%.
b. US real interest rates to rise and US nominal interest rates to rise by less than
1%..
c. US real interest rates to fall and US nominal interest rates to fall by less than
1%.
d. US real interest rates to fall and US nominal interest rates to fall by more than
1%.
___________
Calculations
10. [4 points] Currently, the yield on two year Exchange Fund bonds is 1.1%. The
yield on 3 year bonds is 1.8%. What is the market expectations of one year HK$
interest rates in 2 years.
11. [4 points] You buy a two year discount bond with an annual yield to maturity of
5%. When you sell the bond, one year later, the yield to maturity of the bond is
10%. What is your net return on your bond for the year?
12. [5 points] Attached at the back of the exam are the consolidated income and
balance sheets of DBS bank for 2006. Calculate the Net Interest Margin for 2005
and 2006. Given what we know about the maturity structure of bank balance
sheets would we guess that market interest rates were probably rising or falling
between the two years? Circle one
Interest Rates are:
RISING
FALLING
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13. [8 points] To raise funds, a bank manager issues a 5 year coupon bond with a 10%
coupon and a face value of 100 million. The manager uses this money plus his
own money to purchase a 5 year discount bond with a face value of 100 million
and a 10 year discount bond with a face value of 200 million.
a. If the yield to maturity for each bond is 10%, calculate the price that the
bank will be able to get for the coupon bond. This is the value of
liabilities.
L = _______________
b. If the yield to maturity is 10%, calculate the cost of the two discount
bonds. What is the sum of the present value of these assets?
A = __________ _
c. How much extra money (beyond the value raised by selling the coupon
bond), will the manager need to put in to acquire both discount bonds.
NW = _____________
d. Use your answer for a. as the liabilities of the bank, and your answer for b.
as the assets of the bank. What is the equity multiplier of the bank.
EM = ___________________
e. Calculate the duration of the assets of the bank.
dA = ________________
f. If the duration of the liabilities is 4.17, what is the duration gap? What is
the % effect of an increase in yields of maturity on the net worth of the
hedge fund.
D-GAP = ___________
NW
= __________
NW
14. [4 points] Some bonds have maturities with dates as long as 70 years. Calculate
the present value of a T = 70 year bond with a discount factor = 10% (i =.10), a
face value of 100 and a coupon rate of 8%. Compare this with the present value of
a consol that pays a coupon of 8 forever (T = ∞) assuming the same discount
factor.
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Short Answer
15 [4 points] The newspapers report that non-performing loans as a fraction of
banks’ assets in China have been reduced drastically. List 3 policies of the central
government that have helped lead to this outcome.
i.
ii.
iii.
16 [4 points] Economic forecasters predict that in the next year inflation will
decrease in the USA and increase in the UK. Given the monetary policies of these
two central banks, describe the likely effects on money market rates in the two
countries. How are these money market rate changes likely to affect the pounddollar exchange rate?
17 [2 points] Name two off-balance sheet activities that banks are increasingly doing
to increase fee income.
a.
b.
18 [5 points] Explain the advantages, from the standpoint of a bank, the advantages
and disadvantages of funding through core deposits relative to funding through
managed liabilities. In which case, would a bank want to fund through managed
liabilities?
a. Advantages
b. Disadvantages
c. When Would you Want to Use Managed Liabilities
19 [5 points] Singapore is thinking of revamping the organization of its central bank
system along the most modern line of thinking. Make three concrete suggestions
for Singapore to adopt for the organization of its central bank.
a.
b.
c.
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20 [6 points] The inverse of the Equity Multiplier (EM) and the Capital Adequacy
Ratio are both ratios. How are these ratios conceptually similar and what are the
advantages and disadvantages of having a high level for them? Name two ways
that they are different.
a. Conceptual Similarity
b. Advantages of a High Level
c. Disadvantages of a High Level
d. Two Ways they are Different
i.
ii.
21 [3 points] Explain in 3 sentences or less the difference between a Credit Swap and
an Interest Rate Swap.
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Graphical Questions & Economic Theory
22 [7 points] During the recovery from the emerging markets crisis of the late 20th
century, East Asian stock markets started to become attractive once again to
foreign investors. Assume that investors need the local currency to buy local
stocks. Draw two graphs showing 1) the impact on the exchange rate of Korea
(which pursues a domestically oriented monetary policy); 2) the impact on the
interbank interest rate market in Hong Kong.
Korea
S
Forex
Hong Kong
iHIBOR
Reserves
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23 [5 points] A bank can collect deposits at a 10% interest rate to make commercial
loans. The bank has the potential to make two possible loans of $10,000. One is
safe and can be made at a 20% interest rate and will be repaid with 100%
probability. The other is risky and will pay a 50% interest rate if the loan is repaid
which occurs with a 50% probability. If the borrower defaults, which also occurs
with a 50% probability, the banker will recover only $5,000. The bank’s owner
finances the loan with deposits of $8000 and promises to pay depositors $8800.
The banker puts in her own equity of $2000. If the bank does not have $8800 after
one year, they must turn over all of the banks income to the depositors and the
banker keeps nothing. In that case of default, the banker’s income will be 0.
Calculate the expected income of the banker under either project. Is the banks
capitalization sufficient to get them to pursue the safe project? Which project will
the banker pursue?
Banker will choose:
SAFE
RISKY
24 [4 points] U.S. real estate investment is perceived to drop in expected return.
Draw a picture showing the effect on the price of bonds in the USA.
P
Bonds
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25 [ 7 points] Assume there are two types of 1 year discount bond issuers, safe and
speculative. A fraction, f, of issuers are speculative and another fraction, 1-f, are
safe. Investors are willing to accept an interest rate of no less than 5% from safe
issuers and demand an interest rate of 10% from risky issuers. Investors are risk
neutral, so they are willing to pay the expected present value of a bond of
unknown type. Safe issuers are willing to pay an interest rate no more than 7%
while speculative issuers are willing to pay an interest of 15%.
a. What maximum price would investors pay for a bond they knew was
speculative? What price would they pay for a bond they knew was safe?
b. The maximum price that investors would pay for a bond of unknown type
would be a probability weighted average of the maximum they would pay
for each type of bond. What is the maximum they would pay for a bond if
f = .5. What is the interest rate associated with that price? Would there be
a market for safe bonds?
c. [Harder, 2points] What is the maximum fraction of speculative issuers that
could exist before adverse selection kicks in and pushes safe investors out
of the bond market?