Graphically illustrate a response to an increase in the default risk on corporate bonds (two graphs).

In terms of a more liquid corporate bond, having all the other aspects constant, or ceteris paribus. Here the corporate bond demand curve, observes a shift to the left, this decreases the quantity and the price of the corporate bonds.

1.      Compare and explain the following Graphically illustrate a response to an increase in the default risk on corporate bonds

a.      Expectations theory Graphically illustrate a response to an increase in the default risk on corporate bonds

This is the theory that focuses on the interest rates along with the time duration, this duration can vary and change with the requirements of the analysis. Here the there is a yield curve that indicates the expectations of the short-term future rate.

b.      Segmented markets theory Graphically illustrate a response to an increase in the default risk on corporate bonds

This is the theory that deals with the individual investors, there are maturity preferences that should be held, in terms of securities, there are recommendations in this theory that makes a preference for higher interest rates and this applies to foreign investors also.

c.       Liquidity premium and preferred habitat theory Graphically illustrate a response to an increase in the default risk on corporate bonds

The theory illustrates that the rate for long period is always equal to the potential reasoning in terms of the geometric average of the current along with the short-term rates, that are expected, adding the liquidity risk premium added to the securities

2.      Graphically illustrate and identify the four yield curves and explain each (Figure 6).

There are basic types of yield curves, all of these are discussed below:

Normal Yield Curve Graphically illustrate a response to an increase in the default risk on corporate bonds

The normal yield curve has an upward sloped curve, and it indicates that on the longer run it can be said that the bonds in a longer term, it may also get a rise, and there is an economic expansion, when there are investors, expect a longer maturity bonds, it also yields a higher longer term yield in an overall concept.

Inverted Yield Curve Graphically illustrate a response to an increase in the default risk on corporate bonds

Like its name an inverted curve has a negative or inverted slope. This suggests the yield curve to fall, and this would pool the investors, who want to take investment out of the assets. It can also be seen that in a longer term, negative yield curves would result in fall in prices, and the investors would be selling these securities, in order to minimize their losses.

Flat Yield Curve Graphically illustrate a response to an increase in the default risk on corporate bonds

Flat Yield Curve is a curve that yields no upward or downward curve and it also limits the potential to stay the same, these securities are normally risk free in terms of yield, and has both yield and price stable, this is normally used by the investors to diversify their risk and as the risk is diversified, the return of the portfolio is also reduced. Normally the flat curve retains growth probability more than the loss chance.

1.      Define and discuss the efficient market hypothesis and explain its implications.

EMH or Efficient Market Hypothesis illustrates that the information the investment securities in terms of stocks, the information is already factored, and it gives the investors a potential over others, while giving them the edge of information. This takes in the implication that a regular investor invests randomly, and is always positive in every sense. It is also said that the yield curve for the investor is normal that has an upward, or a positive slope. An example for this is the mutual funds that are managed and run by investors having edge over others.

Lesson 5

Management of Financial Institutions

Written Assignment

Essays (length varies, 10 points)

1.      Identify the balance sheet components of a commercial bank.

The balance sheet of a commercial bank is almost the same the elements that are different are as follows:

Assets > Cash with central bank

Assets > Cash with other banks

Assets > Money short

Assets > Bills discounted

Assets > Loans and Advances

Liabilities > Deposits

Equity > Reserve Fund

2.      Compare and contrast asset management with liability management.

Assets management and liabilities management is all about managing both these items, as these are of interest for the investors, so there are chances that the potential fluctuates in terms of liquidity and solvency, the assets and liabilities are both a part of these heads, liquidity is short term so it takes into account current accounts and current liabilities. Moreover, solvency takes into account in a longer perspective.

3.      What is credit rationing? Is it rational?

Credit rationing illustrates the limiting the lenders with credit, this is the case even if the interest rates are very high. This is rational as it reduces the default risk, of the company.

4.      Your bank has the following balance sheet:

Assets                                      Liabilities

Reserves $50 million              Checkable deposits $200 million

Securities $50 million

Loans $150 million                 Bank capital $50 million

If the required reserve ratio is 10%, what actions should the bank manager take if there is an unexpected deposit outflow of $50 million?

After the outflow of deposit, there is a deficit of $ 15 million, and the bank manager could initiate a discount loan of an amount, and the securities amount to $ 15 million. This would be costly, and the funds that would be according to the costing and regarded as the least costly.

Lesson 6

Structure and Competition of the Banking System

Written Assignment

Essays (length varies, 10 points)

1.      What financial innovations helped banks to get around the bank branching restrictions of the McFadden Act?

With the advent of ATM, the access of account holders of a bank, giving the access to funds from all over the country. There was a bank restriction, that moved beyond the branch restriction. The holding companies therefore controlled interest of several banks and other related companies

2.      Discuss three ways in which U.S. banks can become involved in international banking.

The three ways are as follows:

The US bank can open any foreign branch of the bank in other countries

US Bank can have controlling interest in a foreign country bank

US Banks can open deposit from foreigners within the country.

3.      Outline and discuss financial innovation in response to:

1) changes in demand conditions

Demand is altered as there would be an increase in volatility of interest rate, indicating the adjusted rate in terms of mortgage and financial derivatives, and it can be seen that the issued securities.

2) changes in supply conditions

In terms of supply, there would be more increase in technology and computers, it also lowered financial transactions costs, and the ease of information with respect to banking information for a variety of purposes.

4.      Discuss the Gramm-Leach-Bliley Financial Services Modernization Act of 1999, its provisions and implications.

The company repealed glass steagall, and it also removed the securities and banking industries in the nation.

Lesson 7

Economic Analysis of Banking Regulation

Written Assignment

Essays (length varies, 10 points)

1. The government safety net creates an adverse selection problem and moral hazard problem. Explain.

The adverse selection is a process of systematic information sharing between two parties. The main reason for the occurrence of adverse selection problem is that individuals particularly risk loving individuals consider the banking system as a fascinating system that provides wonderful opportunities to use the funds and to generate the money. While on the other hand, fund knowing people knows that these funds are often protected. The main issue and the hazard problem occurs due to deposits that are not imposed for the banks at some disciplines. In the banks the funds are protected and bank service providers are tempted to face more problems and risks as compared to the others.

2. How did the increase in the interest rates in the early 1980s contribute to the S&L crisis?

The risk problems associated with the interest rates are observed that causes S and L to suffer from certain issues. The interest rate of the economy increases to reach the specified issues. At the lower interest rate, the values of the fixed mortgage rate is lower. The increase in the interest rate becomes to climb and the S&L starts to loss the profitability. Due to financial innovation and the deregulations the undertaking of S & L becomes more risky ventures. The main issue is to regain the profitability. A number of them were not able to judge the credit risk specified in the new loan areas that results in the large losses.

3. Discuss the provisions and implications of the following banking legislation:

a. Depository Institutions Deregulation and Monetary Control Act of 1980

On 31 March 1980, the president Jimmy Carter passed a federal financial statute in the United States. The act was passed for non-member of the banks and forced the banks to reserve the Fed rules. The Depository Institutions Deregulation and Monetary Control Act allows the ways to merge the banks and provides demand deposit account for the nation.

b. Financial Institutions Reform, Recovery, and Enforcement Act of 1989

The federal law of United States was enacted to improve the savings and to reduce the loan crisis. The Financial Institutions Reform, Recovery, and Enforcement Act was designed for the dramatic changes in the loan industry and the savings as according to the federal regulations.

c. Federal Deposit Insurance Corporation Improvement Act of 1991

The FDIC improvement law was passed in 1991 for the federal savings and the loan insurance. The main purpose to introduce the act was to reduce the bank problems and for the thrift industries. The act was signed by the president George as a special piece of the federal legislations.  

Exame #2 >>  (you must uses the book to answer these questions)

1. Graphically illustrate a response to an increase in the default risk on corporate bonds (two graphs). Explain the graphs.

Consider if the probability of the default risk in the corporate bond increases then the corporation can be forced to suffer from the potential losses. The default risk is associated with the corporate bond that increases and in the return the decrease in the bond values is observed while the other parameters remains constant. The increase in the default risk decreases the corporate bond return. The treasury bond increases for relative rises for the bond return.    

2. The government safety net creates both an adverse selection problem and a moral hazard problem. Explain.

In the risk loving individuals the adverse selection problem occurs for the accurate process of banking. The wonderful opportunity provided by the banks is for the customers and people having information about the funds. These funds are protected by the bank. There is possibility for the occurrence of moral hazards that induces impact on the discipline of banks and funds that are protected by the banks. The tempted access is for the risk and funds are protected.

3. Outline and discuss financial innovation in response to:

            •           changes in demand conditions
The innovation demand can be described by the Modigliani Miller theorem and it is about the new product and the values. The unsatisfied demand is provided by the investors. The example of financial innovation is bank usage of the derivative for the hedge risk and the other example is adjustable rate for the mortgage. The derivatives for the response to the demand changes are contracts, options, swaps, forward conditions, and the future conditions for the pay and delivery of assets.

            •           changes in supply conditions.
The example for the financial innovations are related to the lower cost and includes commercial paper, securitization, and junk bonds. The response for the changes in the supply includes collateralized debt obligations (CDOs) and asset backed securities (ABSs). The packages of loans, CDSs and corporate bonds are risk that is smaller than ABSs, default risk that is insured, and the collateralized loan obligations.    

4. Why did the interest rate volatility of the 1970s spur financial innovation?

The banks are provided with the valuable and vulnerable interest rates, the risk is associated with the mortgage loans. The policies of the banks are designed to protect the issues related to the adjustable rate of the mortgage. The interest rate for the financial innovation increases along with the market interest rate. The additional derivatives for the financial consideration are developed for the process of hedge and it is against the risk of interest rate.   

5. Compare and explain the following:

            •           expectations theory
The expectation theory is related to the long term interest rate, compound bond, and geometric averages. The expectation theory provides information about the term structure of the interest rate. There are three different types of the expectation theory including preferred habitat theory, liquidity preference theory, and pure expectation theory.   

            •           segmented markets theory
The theory of segmented market defines that there is no relation between bonds of market and the bonds are referred to different maturity lengths and the interest rates. The bonds holds for the investors and the borrowers.  

            •           liquidity premium and preferred
The liquidity premium explains the difference between two different types of the financial securities. In case of liquidity the qualities are same and the segments of theory are divided in the three parts that gives information to explain yield curves and the interest rates.   

6.  Outline and summarize the assigned essay: Wheelock, David C., “Monetary Policy in the Great Depression: What the Fed Did, and Why.” Federal Reserve Bank of St. Louis Review (March/April 1992).

The author “Wheelock David” described about the monetary policies developed in the great depressions. The author measured the causes along with the receptive interests. The leadership challenges are related to the depression in the authority and the solution for the appropriate policies. The author determined the policies of the organization as effected by the little strains. The policies can be attributed to the standards that are designed by the proper methods.