<p>Name:______</p><p>FNCE 4070 – Midterm 1 – October 3, 2012 Round all answers to 3 decimal places. 1. Mutual savings banks are financial intermediaries that take deposits and primarily use these to fund mortgages. a. (3 points) Give an example of a moral hazard that these institutions might solve.</p><p> b. (3 points) Give an example of adverse selection that these institutions might solve.</p><p>2. (5 points) What are the two primary drivers in cost-push inflation?</p><p>3. (3 points) What is the par value of a 95-day piece of commercial paper with an investment rate of 1.25% and a present value of $1000?</p><p>1 Name:______</p><p>4. The following chart shows the relationship between the British Pound (GBP) and the Euro (EUR). a. (1 point) If 1 Euro is worth less than one Pound then in what units is the following graph?</p><p> b. (2 points) In what month would an English family have preferred to travel to France (EUR is the currency used in France)? Why?</p><p> c. (2 points) Does an exchange rate of 1.34 represent a strengthening or a weakening of the EUR vs. the GBP relative to the exchange rate on September 18th, 2012 (the last date on this graph)? </p><p>2 Name:______</p><p>5. Assume the expectations theory of interest rates. a. (2 points) What is the present value of a 13W T-bill with a quote of 1.25%?</p><p> b. (2 points) From part (a) what is the discount factor between today and 13 weeks?</p><p> c. (2 points) What is the present value of a 26W T-bill with a quote of 2.25%?</p><p> d. (2 points) From part (c) what is the discount factor between today and 26 weeks?</p><p> e. (2 points) What is the expected discount factor between 13 weeks and 26 weeks?</p><p> f. (3 points) What is the expected quote for a 13W T-bill starting in 13 weeks time?</p><p>3 Name:______</p><p>6. The current 1-year interest rate is 2%. Economists forecast one-year interests of 2.5%, 3%, 4% and 5% for years 2, 3, 4 and 5. These are all annualized interest rates. Assume the liquidity premium theory for interest rates and that the liquidity premium for two years is 0.30% and the liquidity premium for 3 years is 0.40%. a. (8 points total) Complete the following table. Cashflow Maturity Present Value 750 2 1050 3</p><p> b. (2 points) Would you expect the present value of these cashflows to be larger or smaller under the expectations theory of interest rates? Explain your answer.</p><p>7. The following question refers to the Fed Funds rate a. (2 points) What does this rate refer to?</p><p> b. (2 points) Explain two ways in which the Federal Reserve can influence the Fed Funds rate.</p><p>4 Name:______</p><p>8. A bond has the following cashflows: Years Cashflow 1 $200 2 $240 3 $120</p><p> a. (4 points) If the yield to maturity on this bond is 5% then what is its duration?</p><p> b. (2 points) If its yield to maturity moved to 5.25% would you expect its duration to increase or to decrease? Why? </p><p> c. (6 points) I buy this bond today for $500. I hold the bond for two years. If the yield to maturity when I sell the bond is 5% and I assume that my reinvestment rate on any cash I receive is 5% then what will be my return on this investment?</p><p> d. (3 points) If the brokerage cost of buying this bond increases would you expect demand for it to increase or decrease? How would you expect this to affect its price? Why?</p><p>5 Name:______</p><p>9. Assume the Market Segmentation Theory of the term structure of interest rates. Assume that there are 4 investable markets for bonds – short-term corporates, short-term Treasuries, long-term corporates and long-term Treasuries. a. (4 points) Draw supply and demand curves for short and long-term treasuries according to this theory. Draw and label two separate graphs.</p><p> b. (4 points) The Federal Reserve has embarked on an open market operation (OMO) where they are buying long-term treasuries and selling short-term treasuries. Show on the graphs what you would expect the effect of this OMO to be. Clearly label the effect as (b). Explain. </p><p>6 Name:______</p><p> c. (6 points) Assume that the below graph represents the initial corporate yield curve. On this graph draw the expected corporate yield curve after the operation described in (b). Explain.</p><p>10. In the following question we are going to discuss LIBOR. a. (2 points) What does LIBOR stand for?</p><p> b. (2 points) What is the primary usage of LIBOR?</p><p> c. (1 point) Which bank paid record fines for attempting to manipulate LIBOR?</p><p>7</p>