Assignment:
1. A bank with a two-year investment horizon has issued a one-year certificate of deposit for $50 million at an interest rate of 2 percent. With the proceeds, the bank has purchased a two-year Treasury note that pays 4 percent interest. What risk does the bank face in entering into these transactions? What would happen if all interest rates were to rise by 1 percent?
2. Suppose you have a defined-contribution pension plan. As you go through your working life, in what order would you choose to have the following portfolio al- locations: (a) 100 percent bonds and money-market instruments, (b) 100 percent stocks, (c) 50 percent bonds and 50 percent stocks?
3. Suppose in an election year the economy started to slow down. At the same time, clear signs of inflationary pressures were apparent. How might the central bank with a primary goal of price stability react? How might members of the incumbent political party who are up for re-election react?
4. In which of the following cases will the size of the central bank's balance sheet change?
a. The Federal Reserve conducts an open market purchase of $100 million U.S. Treasury securities.
b. A commercial bank borrows $100 million from the Federal Reserve.