Dennis notices that jackets are on sale for $99. in this case money is functioning as a

ECONOMICS 305 PAGE NUMBER 1

UNIVERSITY OF VICTORIA MIDTERM 1 V1

May 26th, 2017

Last Name: _____________________ First Name: _____________________ STUDENT NUMBER: V00______________

Course Name & No. Money and Banking, ECON 305 Section(s) A01 CRN: 31116 Instructor: Omar Saleh Duration: 75 minutes

This exam has a total of 10 pages including this cover page. Students must count the number of pages and report any discrepancy immediately to the Invigilator. This exam is to be answered:

X On the paper X NCS Answer sheet (using HB pencil or Pen)

Marking Scheme: The exam is out of 40 marks. There are 2 sections. Read the questions carefully and explain your answers fully. Good luck! Materials Allowed: Regular Calculator; 1/2 page handwritten (one-sided) crib sheet. Hand in: (i) Write your Name and Student ID number on ALL items, i.e. exam paper, crib sheet, and NCS sheet (omit V00 from ID on NCS). (ii) Please tuck your NCS sheet and crib sheet into this exam paper.

ECONOMICS 305 PAGE NUMBER 2

Section 1 (25 marks). Answer ALL 25 of the following multiple-choice questions. Answer on the N.C.S. answer sheet with an HB pencil or Pen. 1- A $1000 invested at an interest rate of 4% increases to $4000 in roughly A) 28-30 years B) 35-37 years. C) 38-40 years. D) 48-50 years. 2- In the liquidity preference framework, the liquidity effect A) is a short run effect whereby an increase (decrease) in the money supply reduces (increases) the interest rate. B) always dominates the long run effects from changes in the expected inflation, the price level and income. C) is always dominated by the long run effects from changes in the expected inflation, the price level and income. D) is greater with whiskey rather with beer. 3- You withdrawal $100 from your chequing account and deposit it in a money market mutual fund. A) M2+ will fall by $100. B) M1+ and M2+ will not change. C) M1+ will decrease by $100. D) M2+ will increase by $100. 4- Stock prices are ________. A) relatively stable trending upward at a steady pace B) relatively stable trending downward at a moderate rate C) extremely volatile D) unstable trending downward at a moderate rate 5- Evidence from Canada and other foreign countries indicates that ________. A) there is a strong positive association between inflation and growth rate of money supply over long periods of time B) there is little support for the assertion that "inflation is always and everywhere a monetary phenomenon" C) countries with low monetary growth rates tend to experience higher rates of inflation, all else being constant D) money growth is clearly unrelated to inflation 6- Eurodollars are A) foreign currencies deposited in banks outside Europe. B) the currency of the countries of the European Monetary Union. C) bonds issued by European countries promising to pay in U.S. dollars. D) U.S. dollar deposits in foreign banks outside the U.S.

ECONOMICS 305 PAGE NUMBER 3

6- ________ is used to make purchases while ________ is the total collection of pieces of property that serve to store value. A) Money; income B) Wealth; income C) Income; money D) Money; wealth 7- When compared to exchange systems that rely on money, disadvantages of the barter system include ________. A) the requirement of a double coincidence of wants B) lowering the cost of exchanging goods over time C) lowering the cost of exchange to those who would specialize D) encouraging specialization and the division of labor 8- In a barter economy the number of prices in an economy with N goods is ________. A) N(N/2) – 1 B) N(N/2) C) 2N D) [N(N - 1)]/2 9- Dennis notices that jackets are on sale for $99. In this case money is functioning as a ________. A) medium of exchange B) unit of account C) store of value D) payments-system ruler 10- Ranking assets from most liquid to least liquid, the correct order is ________. A) savings bonds; house; currency B) currency; savings bonds; house C) currency; house; savings bonds D) house; savings bonds; currency 11- The evolution of the payments system from barter to precious metals, then to fiat money, then to cheques can best be understood as a consequence of ________. A) government regulations designed to improve the efficiency of the payments system B) government regulations designed to promote the safety of the payments system C) innovations that reduced the costs of exchanging goods and services D) competition among firms to make it easier for customers to purchase their products 12- Well-functioning financial markets ________. A) cause inflation B) eliminate the need for indirect finance C) cause financial crises D) produce an efficient allocation of capital

ECONOMICS 305 PAGE NUMBER 4

13- Which of the following can be described as involving direct finance? A) A corporation issues new shares of stock. B) People buy shares in a mutual fund. C) A pension fund manager buys a short-term corporate security in the secondary market. D) An insurance company buys shares of common stock in the over-the-counter markets. 14- If the maturity of a debt instrument is less than one year, the debt is called ________. A) prima-term B) intermediate-term C) long-term D) short-term 15- A corporation acquires new funds only when its securities are sold in the ________. A) secondary market by a commercial bank B) primary market by a stock exchange broker C) secondary market by a securities dealer D) primary market by an investment bank 16- A debt instrument sold by a bank to its depositors that pays annual interest of a given amount and at maturity pays back the original purchase price is called ________. A) commercial paper B) a negotiable certificate of deposit C) a municipal bond D) federal funds 17- ________ are short-term loans in which Treasury bills serve as collateral. A) Government agency securities B) Negotiable certificates of deposit C) Overnight funds D) Repurchase agreements 18- From 1968-2014 the price level in Canada increased more than ________. A) twofold B) threefold C) sixfold D) ninefold 19- Countries that experience very high rates of inflation may also have ________. A) balanced budgets B) rapidly growing money supplies C) falling money supplies D) constant money supplies

ECONOMICS 305 PAGE NUMBER 5

20- With an interest rate of 6 percent, the present value of $100 next year is approximately ________. A) $106 B) $100 C) $94 D) $92 21- A credit market instrument that provides the borrower with an amount of funds that must be repaid at the maturity date along with an interest payment is known as a ________. A) simple loan B) fixed-payment loan C) coupon bond D) discount bond 22- If a $5000 coupon bond has a coupon rate of 13 percent, then the coupon payment every year is ________. A) $650 B) $1300 C) $130 D) $13 23- If the probability of a bond default increases because corporations begin to suffer large losses, then the default risk on corporate bonds will ________ and the expected return on these bonds will ________, everything else held constant. A) decrease; increase B) decrease; decrease C) increase; increase D) increase; decrease 24- Other things being equal, an increase in the default risk of corporate bonds shifts the demand curve for corporate bonds to the ________ and the demand curve for Canada bonds to the ________. A) right; right B) right; left C) left; right D) left; left 25- Bonds with relatively high risk of default are called ________. A) Brady bonds B) junk bonds C) zero coupon bonds D) investment grade bonds

ECONOMICS 305 PAGE NUMBER 6

Section 2 (15marks) Answer all parts of the following question. Answer BOTH of the following questions. 1. (7 Marks) The following are US government bond yields (from Bloomberg.com).

Yield Dec 10/14 Yield Dec 10/15 12-Month 0.21 0.69 2-Year 0.57 0.94 3-Year 0.91 1.14

a) (1 mark) Sketch the yield curve for Dec 10/14. What type of curve is this?

b) (2 marks) Under the Expectations Theory, what are the expected one-year rates for years starting Dec 2015 and Dec 2016 implied by the Dec 10/14 yield curve?

ECONOMICS 305 PAGE NUMBER 7

c) (2 marks) Under the Liquidity Preference Theory, what is the expected one-year rate in

Dec 10 2015 implied by the Dec 10/14 yield curve (i.e. derive/provide the relevant formula)? Now find the specific risk premium, l2,2014 >0, that reconciles the forecast with the actual (realized) rate?

d) (2 mark) Use the risk premium you found in part (c) to calculate the expected one-year rate in Dec 2016 implied by the Dec 10/15 yield curve. Use l2,2014 = l2,2015

ECONOMICS 305 PAGE NUMBER 8

2 (8Marks) Your daughter is currently eight years old. You anticipate that she will be going to college in 10 years. You would like to have $120,000 in a savings account to fund her education at that time. If the account promises to pay a fixed interest rate of 6% per year. Show all your calculations to get full credit.

a) (2marks) How much money do you need to put into the account today to ensure that you will have $120,000 in ten years?

b) (2marks) Instead of deposit the whole amount today, the bank adviser tells you that you can deposit each year a certain amount and by the time your daughter turns 18 years, you will have the $120,000 ready in your account. Calculate the yearly payment in your saving account?

ECONOMICS 305 PAGE NUMBER 9

c) (2marks) you find that a yearly payment is not efficient to you. You decided to contribute each month into your saving account. How much will be your monthly contribution? (Hint: Find the monthly interest rate and then proceed)

d) (2marks) which investment you prefer: a discount bond with current price $900 and a face value of $1,000. Or a coupon bond that pays you 10% coupon rate with face value $1,000. Both have a one year maturity.

ECONOMICS 305 PAGE NUMBER 10

END

a) (1 mark) Sketch the yield curve for Dec 10/14. What type of curve is this?

b) (2 marks) Under the Expectations Theory, what are the expected one-year rates for years starting Dec 2015 and Dec 2016 implied by the Dec 10/14 yield curve?

c) (2 marks) Under the Liquidity Preference Theory, what is the expected one-year rate in Dec 10 2015 implied by the Dec 10/14 yield curve (i.e. derive/provide the relevant formula)? Now find the specific risk premium, l2,2014 >0, that reconciles the...

d) (2 mark) Use the risk premium you found in part (c) to calculate the expected one-year rate in Dec 2016 implied by the Dec 10/15 yield curve. Use l2,2014 = l2,2015

END

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