Semester Two Final Examination, 2020 ECON7200 Economics of Financial Markets Page 1 of 9 Exam information Course code and title ECON7200 Economics of Financial Markets Semester Semester 2, 2020 Exam type Online, non-invigilated, open‐book, final examination Exam technology File upload to Blackboard (Parts A and B) and file upload to Turnitin (Part C) Exam date and time This examination is scheduled to commence at 8:00am AEST on 6 November 2020. The examination duration will be 12 hours. Exam window You have 12 hour window in which you must complete your exam. You can access and submit your exam at any time within the 12 hour window. Even though you have the entire 12 hours to complete and submit your exam, it is anticipated that it will take between 6-8 hours to complete the exam. Permitted materials This is an open book exam – all course materials are permitted. Recommended materials Ensure the following materials are available during the exam: Calculator; bilingual dictionary; phone/camera/scanner Instructions You will need to download the question paper included within the Blackboard Test. Answer ALL questions in parts A and B. In part C, answer only ONE question, either C1 or C2. You can handwrite or type the answers to parts A and B. However, you must type the answer to part C, as they will be checked for plagiarism. Scan your answers to Parts A and B and save them in a format that can be uploaded to Blackboard (e.g., .pdf or .jpg). If you do not have access to a flatbed scanner, you can use a phone app such as “Adobe Scan” or “Microsoft Office Lens”. Upload them to the Blackboard submission link for Parts A and B. Please submit well before the deadline, as traffic can be heavy closer to 8pm, making your submission unsuccessful. You can upload multiple times, and only the last attempt will be marked. Type your answer to Part C as a MSWord file and upload it to the Turnitin Assignment submission link for Part C. Please submit well before the deadline, as traffic can be heavy closer to 8pm, making your submission unsuccessful. You can upload multiple times, and only the last attempt will be marked. Total questions: 20 Total marks: 100 Who to contact Given the limited communications options, responding to student queries and/or relaying corrections to exam content during the exam will not be feasible. Semester Two Final Examination, 2020 ECON7200 Economics of Financial Markets Page 2 of 9 If you experience any interruptions to your examination, please collect evidence of the interruption (e.g. photographs, screenshots or emails). If you experience any technical difficulties during the examination, contact the Library AskUs service for advice as soon as practicable: Chat: support.my.uq.edu.au/app/chat/chat_launch_lib Phone: +61 7 3506 2615 Email: examsupport@library.uq.edu.au You should also ask for an email documenting the advice provided so you can provide this to the course coordinator immediately at: a.mclennan2@uq.edu.au Important exam condition information Academic integrity is a core value of the UQ community and as such high academic integrity expectations apply to all examinations, whether undertaken face-to-face or online. This means:  You are permitted to refer to the allowed resources for this open book exam, but you cannot cut‐and‐paste material other than your own work as answers.  You are not permitted to consult any other person – whether directly, online, or through any other means – about any aspect of this examination during the period that it is available.  If it is found that you have given or sought outside assistance with this examination, then that will be deemed to be cheating. Undertaking this online examination deems your commitment to UQ’s academic integrity pledge as summarised in the following declaration: “I certify that I have completed this examination in an honest, fair and trustworthy manner, that my submitted answers are entirely my own work, and that I have neither given nor received any unauthorised assistance on this examination”. Semester Two Final Examination, 2020 ECON7200 Economics of Financial Markets Page 3 of 9 PART A – Multiple Choice Questions (15 marks) Answer ALL Questions. Each Question is worth 1 mark 1. When you deposit $100 in your account at University Bank and a $80 check you have written on this account is cashed at College Bank, then A. the reserves at University Bank rise by $20. B. the assets of University Bank fall by $20. C. the assets of College Bank rise by $20. D. the liabilities at College Bank fall by $20. 2. Suppose there is an excess demand of reserves in the federal funds market. If the Federal Reserve wishes to keep the federal funds rate at its target level, then the appropriate action for the Federal Reserve to take is a ________ open market ________, everything else held constant. A. defensive; purchase B. dynamic; purchase C. defensive; sale D. dynamic; sale 3. Which of the following is NOT a component of microprudential supervision? A. Assessing the riskiness of an individual bank's activities. B. Focusing on financial system liquidity. C. Checking a bank's compliance with disclosure requirements. D. Checking capital ratios of a bank. 4. According to the efficient markets hypothesis, stock prices follow a "random walk." Therefore, the optimal strategy for investing in the stock market is ________. A. a "churning strategy" of buying and selling often to catch market swings. B. a "buy and hold strategy" of holding stocks to avoid brokerage commissions. C. following the advice of technical analysts. D. turning over your stock portfolio each month, selecting stocks that have performed well within the previous months. 5. How would the lending role of financial institutions such as commercial banks change as technology improves? A. It should increase somewhat. B. It should increase significantly. C. It should decrease. D. There is no change. 6. How does high net worth diminish the moral hazard problem? A. By making the debt contract incentive compatible. B. By giving the debt contract characteristics of equity contracts. C. By requiring the state to verify the debt contract. D. By collateralizing the debt contract. EXAMINATION CONTINUES ON NEXT PAGE Semester Two Final Examination, 2020 ECON7200 Economics of Financial Markets Page 4 of 9 7. According to the Taylor Rule, when the inflation rate ________, the nominal interest rate should be ________ by ________ than the change in inflation rate. A. decreases; increased; less B. increases; decreased; more C. increases; increased; more D. decreases; decreased; less 8. In Argentina, firms’ debts tend to be denominated in foreign currency such as U.S. dollars. A depreciation of the Argentine peso A. means that Argentine firms do not owe as much on their foreign debt. B. strengthens their balance sheet in terms of the peso. C. results in an increase in the value of the firm's assets, making them more able to secure more loans for investment. D. results in increases in the firm's indebtedness in peso, even though the value of their assets remains unchanged. 9. If there is an expected rise in interest rates, banks prefer to A. make long-term rather than short-term loans. B. buy long-term rather than short-term bonds. C. buy short-term rather than long-term bonds. D. make either short or long-term loans; expectations of future interest rates are irrelevant. 10. Assuming a mild value of the liquidity premium, if the yield curve slope is flat for short maturities and then slopes steeply upward for longer maturities, from the liquidity premium theory, the market is predicting short-term interest rates to be ________ in the near future and ________ further out in the future. A. rising; declining B. constant; declining C. constant; constant D. declining; rising 11. Factors that led to worsening financial market conditions in East Asia in 1997-1998 include A. increased uncertainty from political shocks. B. weak supervision by bank regulators. C. a rise in interest rates abroad. D. unanticipated increases in the price level. 12. Both the dual or hierarchical mandates can be used as long as in the ________, the primary goal of ________ can be achieved. A. long run; price stability B. short run; price stability C. short run; reducing business-cycle fluctuations D. long run; reducing business-cycle fluctuations EXAMINATION CONTINUES ON NEXT PAGE Semester Two Final Examination, 2020 ECON7200 Economics of Financial Markets Page 5 of 9 13. Regular bank examinations help reduce the ________ problem, while chartering helps reduce the ________ problem. A. moral hazard; moral hazard B. adverse selection; adverse selection C. moral hazard; adverse selection D. adverse selection; moral hazard 14. Inflation targeting has the following advantages EXCEPT FOR ________. A. reduction of the time-inconsistency problem B. immediate signal on the achievement of the target C. consistency with democratic principles D. increased monetary policy transparency 15. Why does holding a large amount of bank capital reduce the likelihood of bank failure? A. It increases banks’ income, making it safer as banks become larger. B. It makes it easier to sell loans when it needs liquidity. C. It makes it easier to call in loans. D. It can be used to absorb the losses from bad loans. EXAMINATION CONTINUES ON NEXT PAGE Semester Two Final Examination, 2020 ECON7200 Economics of Financial Markets Page 6 of 9 PART B: Short-Answer Question (35 marks) Answer ALL questions in Part B. Please show all workings. Round your answers to two decimal places. Questions in Part B carry marks as indicated. B1. (10 marks) Suppose that the required reserve ratio is 6%, currency in circulation is $1900 billion, the amount of checkable deposits is $1550 billion, and excess reserves are $250 billion. (a) Calculate the money supply, the currency deposit ratio, the excess reserve ratio, and the money multiplier. (5 marks) (b) Suppose the central bank conducts an unusually large open market sale of bonds to commercial banks of $ 1,000 billion to prick an ongoing housing bubble. Assuming the ratios you calculated in part (a) remain the same, predict the change of the money supply, and the resulting money supply in the market after the sale. (5 marks) B2. (15 marks) (a) Crisis-free Bank started its first day of operations with $200 million in capital. It received a total of $200 million in checkable deposits. The bank makes a $100 million commercial loan and invests $90 million in shares and $100 million in Treasury bonds. Assume required reserves are 8% of deposits and all remaining assets are kept as excess reserves, write the balance sheet of Crisis-free Bank. (5 marks) (b) Suppose that you are the manager of Unique National Bank, whose current balance sheet is as follows: Assets Liabilities Rate-sensitive $120 million $100 million Fixed-rate $30 million $20 million Bank Capital $30 million (i) Use the gap analysis to calculate the change in the bank’s profit if the interest rate decreases from 4% to 1%. (3 marks) (ii) Suppose that the average duration of its assets is four years, while the average duration of its liabilities is three years. Use the duration analysis to calculate the approximate change of the bank’s net worth as a percentage of the total original asset value if the interest rate decreases from 4% to 1%. (7 marks) EXAMINATION CONTINUES ON NEXT PAGE Semester Two Final Examination, 2020 ECON7200 Economics of Financial Markets Page 7 of 9 B3. (10 marks) Using graphs of the market for reserves, indicate what happens to the federal funds rate (the cash rate in Australia), borrowed reserves, and nonborrowed reserves in the following situations holding everything else constant. Note that different starting positions of the graph can result in different results; your answer must cover all potential scenarios. (a) The Fed (central bank) reduces the required reserve ratio (5 marks) (b) The Fed (central bank) reduces the target federal funds rate. (5 marks) EXAMINATION CONTINUES ON NEXT PAGE Semester Two Final Examination, 2020 ECON7200 Economics of Financial Markets Page 8 of 9 PART C: Essay (50 marks) Answer ONLY ONE question, either C1 or C2. Questions in Part C carry marks as indicated. C1. (50 marks) Read the following article: The Most Dovish Fed in History Is on a Mission to Spur Inflation – Bloomberg Businessweek by Peter Coy published on 8 October 2020. Write an essay, between 600 and 1200 words, that answers the following tasks: (a) Summarize the article. (10 marks) (b) Explain the main reasons behind the Fed’s recent announcement to increase the inflation target. (10 marks) (c) Discuss the effectiveness of the Fed’s dual mandate (price stability and full employment) versus the inflation targeting policy of other Central Banks (e.g. the European Central Bank, the RBA and the Bank of England), in light of the recent economic crisis resulting from the COVID-19 pandemic. (20 marks) Writing quality of your essay (including grammar, organization, clarity and references) will also be assessed. (10 marks). EXAMINATION CONTINUES ON NEXT PAGE Semester Two Final Examination, 2020 ECON7200 Economics of Financial Markets Page 9 of 9 C2. (50 marks) Read the following article: Banks lose out to capital markets when it comes to credit provision – The Economist published on 25 July 2020. Write an essay, between 600 and 1200 words, that answers the following tasks: (a) Summarize the article. (10 marks) (b) Explain how bank regulations have changed since the Global Financial Crisis of 2007-09. (10 marks) (c) Contrast and discuss the reasons behind the differences between the conclusion of this article and Fact #4 of the eight basic facts about the financial structure throughout the world that you learned in Lecture 6. This fact states that “Financial intermediaries, particularly banks, are the most important source of external funds used to finance businesses.” (20 marks) Writing quality of your essay (including grammar, organization, clarity and references) will also be assessed. (10 marks). Specify any assumptions you have made in completing the exam and to which questions those assumptions relate. You may also include queries you may have made with respect to a particular question, should you have been able to `raise your hand’ in an examination room. 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