Assignment:
Money and Banking:
1. Use annual interest rates to define the meaning of the term compounding? Explain why compounding becomes more important as the time horizon increases.
2. Why can't you add $10 delivered today with $12 delivered one year from now and get a total of $22?
3. What is the intuitive meaning of present value? What are the three main "ingredients" in the present value formula? What is the yield to maturity on a coupon bond? Illustrate other ways in which this formula is use?
4. How do compare interest rates for, say, one month, and interest rates for, say, 9 months? Be sure to discuss the idea of compounding in your answer.
5. What are the three major debt instruments that the US Treasury uses to borrow? How are they different?
6. How is the yield to maturity on a bond related to the price of the bond, and the price of the bond relative to par? Are these relationships definitional or theoretical?
7. What is the difference between a bid price and an ask price on a Treasury security? What is the source of this spread?
8. What is meant by the term structure of interest rates? What is the yield curve? What are the guiding facts with respect to the term structure of interest rates?
9. In the pure expectations hypothesis, the long term rate is the average of the current and expected short term rates. Explain how this relationship arises and the key assumption(s) behind it?
10. What are the pitfalls of the pure expectations hypothesis as a theory of the term structure of interest rates? What is the liquidity premium hypothesis? How does it help us understand the guiding facts of the term structure?
11. What is the preferred habitat hypothesis? How does it help us understand the guiding facts of the term structure?
12. If the return on acme stock has a variance of 3 and the variance of the return on widget bonds has a variance of 5, does this mean that the return on widget bonds is riskier than the return on acme stock? Explain.
13. What is a portfolio? How is the riskiness of a portfolio typically measured? What are the assumptions of the capital asset pricing model? Define and construct the efficient frontier. What portfolios are rule out being on this frontier and why?
14. If there is a risk free asset, construct the "menu" of portfolio options available in capm model? What is the market portfolio and what determines the portfolio choice of a decision-maker? Explain.
15. What is the beta coefficient? What does a beta of less than one on asset mean? What is beta is greater than one? If beta is greater than one, will anyone hold that asset? Explain.
16. How do you arrive at the result that betai = Cov(Ri, Rm)/Var(Rm)? How is this value calculated in practice?
17. Sometimes a broad index of stocks is used as the market portfolio. Why might this market portfolio be of limited use? Explain.
18. Use marginal analysis to find the condition for the optimal portfolio. You need only consider two asset portfolios.
19. Assume that one of your assets is a risk free asset. Show that that the expected return on the risky asset can be written as the risk free rate plus a risk premium. Be sure to explain why the risk premium is positive (so explain why the covariance term is negative). Compare this expression for the expected return with the expression from the capital asset pricing model.
20. What is a corporation's market capitalization and what is its p-e ratio? What is the fundamental value theory of stock prices? Explain the rationale behind equation.
21. What is the Gordon Model and what are its assumptions? Use this model to discuss the determinants of the price-earnings ratio in the long run.
22. What is meant by the term rational agents or market efficiency in the context of asset markets? If all agents are rational, what does this imply about the shape of the demand curve for an asset?
23. What are "animal spirit agents"? How can their presence affect the behavior of markets?
24. How can rational agents take advantage of animal spirit agents if an asset is priced above its fundamental value? Is this strategy safe or risky?
25. What is the fixed or sunk cost fallacy? How might it affect an individual making a portfolio decision?