Assignment 1b

Due: After Unit 3

Assignment 1 is worth 8% of your final course grade. Each question is worth 10 marks. Answer all parts of each question as completely as possible.

1. The Bank of Canada defines the Canadian money supply in terms of Ml+, M1++, M2, M2+, M2++, and M3 monetary aggregates.

What financial assets are included in each of these six aggregates?

How does each aggregate satisfy the functions generally attributed to money?

Are there any characteristics (other than those of money’s functions) that should be considered in the definition of money? (10 marks)

2. Suppose you just deposited $14,000 in your bank savings account. The current real interest rate is 3%, and inflation is expected to be 2.5% over the next year.

What nominal interest rate would you require from the bank over the next year?

How much money will you have at the end of one year?

If you are saving to buy a car that currently sells for $14,900, will you have enough to buy it? (10 marks)

3. A $1000 face-value coupon bond has a 10% coupon rate, a maturity of 4 years, and a price of $960.

a. Is the yield to maturity going to be above or below 10%, and why? (2.5 marks)

b. Calculate the present value of the bond when interest rate is 12%. Must the yield to maturity be above or below 12%, and why? (2.5 marks)

c. Calculate the present value of the bond when interest rate is 8%. Must the yield to maturity be above or below 8%, and why? (2.5 marks)

d. Calculate the yield to maturity for this bond at the current price. (2.5 marks)

4. State the expectations theory and explain its significance. (3 marks)

Using the generalized equation of the expectations theory of the term structure of interest rates, calculate today’s four-year rate, assuming that the current one-year, 6% rate is expected to rise by one percentage point in each of the next three years.

(7 marks)

5. A company has just announced a 3-for-1 stock split, effective immediately. Prior to the split, the company had a market value of $4 billion with $100 million shares outstanding. Suppose the split conveys no new information about the company, answer the following questions indicating how you arrived at your answer in each case.

a. What is the value of the company? (2.5 marks)

b. What is the number of shares outstanding? (2.5 marks)

c. What is the price per share after the split? (2.5 marks)

d. If the actual market price immediately following the split is $20 per share, what does this tell you about market efficiency? (2.5 marks)

6. Describe how, in recent years, banks have become multi-service institutions, and explain how there has been an erosion of the “four pillars” of finance. (10 marks)

7. Suppose Paul has the following deposits with ABC Bank, a member of CDIC.

Account type Funds

(in Canadian dollars except where noted)

Chequing account $10,000

Savings account $80,000

USD term deposit $50,000

3-year GIC $100,000

7-year GIC $80,000

a. In the event of bank failure, how much of Paul’s deposits is insured by the CDIC?

(3 marks)

b. If the CDIC decides ABC Bank is too big to fail, what will happen?

Of the payoff method and purchase-and-assumption method, which one will CDIC use? Why? (5 marks)

c. Why might the CDIC declare ABC bank too big to fail? (2 marks)

8. What is meant by the term virtual banking? Outline the advantages and disadvantages of virtual banking to the public. (10 marks)

9. Complete all three parts of this question.

a. Explain why shares in closed-end mutual funds typically sell for less than the market price of the stocks they hold. (4 marks)

b. For what reason(s) would you buy a no-load mutual fund instead of a load fund?

(3 marks)

c. Why can a money market mutual fund allow its shareholders to redeem shares at a fixed price but other mutual funds cannot? (3 marks)

10. Briefly describe each of the following terms:

a. asymmetric information problems (2 marks)

b. liquidity premium theory (2 marks)

c. asset-price bubble (2 marks)

d. Basel Accord (2 marks)

e. securitization (2 marks)

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