ECS3701 EXAM PACK-1
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ECS3701 EXAM PACK
1
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Question 1
1.1 Bond attracts interest as return
stock attracts dividends as return.
1.2 They have expertise thus they can detect and prevent adverse selection.
-they have economies of scale
1.3 –to protect depositors
-to detect investors
-to prevent financial crisis.
1.4 money market is market for short-term funds eg TB
-capital market is a market for long term funds eg stock
1.5 M2 = -Is a broader definition of money
M1 plus deposits which are
-cash/currency
+cheque and transmission deposit near money
+demand deposit- consists of short-term and medium
+other short term deposits eg saving deposits, share investments
1.6 1/r = 1/0.05 = 20
1.7 5 advantages of inflation targeting
-Simple and easy
-does not rely on stable relationships between M and P;uses information inclusive
approach
-increased accountability of central bank; smaller likelihood to fall into time
inconsistency traps; less political pressure on central bank
-reduced effects of inflationary shocks; IT has good record to cut inflation.
1.8 store of value
-medium of exchange
-standard of differed payments
2
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1.9 Real interest has no inflation element
-nominal are not inflation adjusted
1.10 A financial crisis is a situation in which value of financial institutions or assets
drops rapidly due to worsened adverse selection and moral hazards.
1.11 Assets- bank loans
-Reserves
Liabilities- cheque and transmission deposits
-capital
1.12 Interest rate risk refers to the risk that is faced by bond owners from fluctuating
interest rates depending on the time to maturity and coupon rate.
1.13 Calculating return on a bond
Return on a bond is the total return on a bond by an investor over a specific time
period t to t+1.
R = C + Pt + 1-Pt
Pt
Where R = is return from holding a bond from t to time tt1
P =Price of a bond
C= Coupon payment
Question 2
2.1 Explain how lemons problem might arise
The presence of the lemons problem makes securities markets (debt and equity)
ineffective in channeling funds from savers to borrowers. Investors can not
distinguish between good firms (high profits and low risk), and bad firms (low profits
and high risk) due to lack of information. Owners of firms have better information
and are willing to sell securities for only an average price (or they require a higher
interest rate) because only bad firms investors will therefore be willing to sell
securities, investors will be unwilling to buy securities.
The lemons problem will disappear if the asymmetric information problem (adverse
selection) can be eliminated by the supply of accurate information. Private
companies can collect and produce information and sell it to investors. Firms like
Standard &Poor, Moodys etc sell information to subscribers.
This does not completely solve the problem due to the free rider problem (people
who do not pay, but take advantage of the information.
3
REED TUTORIALS (Pty) LTD
www.reedtutorials.co.za
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written by
mrsNURSE01
www.stuvia.com
Downloaded by: mrsNURSE01 |
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REED TUTORIALS (PTY) LTD
ECS3701 EXAM PACK
1
REED TUTORIALS (Pty) LTD
www.reedtutorials.co.za
Downloaded by: mrsNURSE01 |
Distribution of this document is illegal
, Stuvia.com - The Marketplace to Buy and Sell your Study Material
OCTOBER/NOVEMBER 2014
Question 1
1.1 Bond attracts interest as return
stock attracts dividends as return.
1.2 They have expertise thus they can detect and prevent adverse selection.
-they have economies of scale
1.3 –to protect depositors
-to detect investors
-to prevent financial crisis.
1.4 money market is market for short-term funds eg TB
-capital market is a market for long term funds eg stock
1.5 M2 = -Is a broader definition of money
M1 plus deposits which are
-cash/currency
+cheque and transmission deposit near money
+demand deposit- consists of short-term and medium
+other short term deposits eg saving deposits, share investments
1.6 1/r = 1/0.05 = 20
1.7 5 advantages of inflation targeting
-Simple and easy
-does not rely on stable relationships between M and P;uses information inclusive
approach
-increased accountability of central bank; smaller likelihood to fall into time
inconsistency traps; less political pressure on central bank
-reduced effects of inflationary shocks; IT has good record to cut inflation.
1.8 store of value
-medium of exchange
-standard of differed payments
2
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1.9 Real interest has no inflation element
-nominal are not inflation adjusted
1.10 A financial crisis is a situation in which value of financial institutions or assets
drops rapidly due to worsened adverse selection and moral hazards.
1.11 Assets- bank loans
-Reserves
Liabilities- cheque and transmission deposits
-capital
1.12 Interest rate risk refers to the risk that is faced by bond owners from fluctuating
interest rates depending on the time to maturity and coupon rate.
1.13 Calculating return on a bond
Return on a bond is the total return on a bond by an investor over a specific time
period t to t+1.
R = C + Pt + 1-Pt
Pt
Where R = is return from holding a bond from t to time tt1
P =Price of a bond
C= Coupon payment
Question 2
2.1 Explain how lemons problem might arise
The presence of the lemons problem makes securities markets (debt and equity)
ineffective in channeling funds from savers to borrowers. Investors can not
distinguish between good firms (high profits and low risk), and bad firms (low profits
and high risk) due to lack of information. Owners of firms have better information
and are willing to sell securities for only an average price (or they require a higher
interest rate) because only bad firms investors will therefore be willing to sell
securities, investors will be unwilling to buy securities.
The lemons problem will disappear if the asymmetric information problem (adverse
selection) can be eliminated by the supply of accurate information. Private
companies can collect and produce information and sell it to investors. Firms like
Standard &Poor, Moodys etc sell information to subscribers.
This does not completely solve the problem due to the free rider problem (people
who do not pay, but take advantage of the information.
3
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www.reedtutorials.co.za
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