Economics 3215: Final Exam Information
When: Tuesday,April 18,9:00-12:00 noonWhere:Ryan Building RB1023
Coverage: Entire course but with more weight on post-midterm material.
Format: Part 1: 4-5 Definitions (a few will be from pre-midterm material)
Part 2: 5-6Shorter answer questions (a few will be on pre-midterm material)
Part 3: One longer answer question (pre-midterm material)
Part 4: Two longer answer questions on post-midterm material.
Example questions: (see also the midterm, the Midterm Format document and the assignments)
1. What is the Fisher effect? Use the supply-demand model of an asset market to explain why the effect might exist.
2. Say that a financial asset promises a stream of payments over the next N-years of: P1, P2, P3 … PN and currently costs C. (a) Show how you would calculate the yield on this asset. (b) Use the formula from (i) to explain the relationship between the yield and the price of an asset. (c) How would you calculate the real yield on the asset?
3. (a) What is a Treasury Bill? Whose debt is it? How would you calculate its yield? (b) What would be the price of a perpetuity (consol) that pays $1000 forever given that other long term assets currently pay a yield of 5%? Explain.
4. (a) What are the three roles that money plays in an economy? Explain their importance.
(b) What assets make up the Canadian money supply? What does most of the money supply consist of?
5. What is a risk premium? Use the supply-demand model of an asset market to explain why they arise. Provide an example where a risk premium might help explain the difference in yield between two assets.
6. A key function of financial markets is to match those who want to lend to those who want to borrow.
(a) What sector of the economy is the main source of funds? What sectors are the major borrowers?
(b) What markets and institutions have this matching function as their major role?
(c) Explain why the matching role of financial markets is so important to the economy.
7. (a) Economists sometimes argue that market outcomes are efficient. What does this mean? Why might this be so? Refer to the Supply-Demand model of an assets market when answering this question. (b) What problems may give rise to inefficient outcomes in financial markets? Explain each.
8. (a) Draw typical lender and borrower curves for bonds. Explain the economic reasoning behind their slopes.
(b) How would the diagram differ if you had the bond price rather than the bond yield on the vertical axis? Explain.
(c) Explain the likely effects of the following changes on the market for medium term bonds. Use a diagram to illustrate: (i) annual inflation is expected to be 2% higher during the term of the bond than previously thought. (ii) businesses expect a recession in the near future.
(iii) there is a reduction in household wealth.
(iv) lenders view corporate bonds as riskier than they had been in the past.
9. The quantity equation says: MV=PY. Define each of the terms. What two major assumptions are made to turn the equation into a theory? Explain the thinking behind each assumption.
10. Let go through the basic macroeconomic model discussed in class.
(a) Draw the IS curve (be sure to clearly label the axes). What do points in the IS curve show? Explain why the economic reason why IS curve has a downward slope.
(b) Draw the MP curve (clearly label both axes). Explain the behavior that underlies the MP curve.
(c) Draw the Aggregate Demand curve (inflation rate on the vertical axis). Explain how it is derived from the IS curve and MP curve.
(d) Draw the Short-run Aggregate Supply curve. Give the equation underlying the curve. Explain the economic reasons for its slope.
(e) Draw the Long-run Aggregate Supply curve. Explain why it is vertical.
(f) Say that the economy is in a short-run equilibrium with real GDP above its full employment (potential) level.
(i) If policymakers do not respond, what will happen to this economy in the long-run? Show this is
a diagram and explain why this happens.
(ii) If the central bank is targeting the inflation rate how might it respond to the situation? Explain
why and illustrate the effect of the central bank’s policy.
11. Our macroeconomic model suggests that a central bank that targets inflation can stabilize both real GDP and inflation if the economy typically changes over time due to shifts in Aggregate Demand but not if the economy changes mainly due to shifts in Short-run Aggregate Supply. Explain why this is true.
12. Say that the US economy slides into recession and that this recession both reduces Canadian exports to the US and undermines business confidence in Canada.
(a) Use the macroeconomic model discussed in class to make a prediction about how the Canadian inflation rate, interest rates and real GDP will change in the short-run as a result of the US recession. Be sure to provide a diagram.
(b) How will the variables in (a) change in the long-run? (i) if the economy is left to adjust on its own; (ii) if the central bank responds to the situation in (a) in an attempt to end the recession. Provide a diagram.
13. (a) Recent work on monetary policy often talks about the ‘zero lower bound’. What does this refer to?
(b) What are its consequences for the shape of the Aggregate Demand curve? Explain why and provide
diagrams.
(c) Explain why recessions may be a much greater problem for economies at the zero lower bound.
14.(a) Explain the adverse selection problem.
(b) What problems does the adverse selection problem pose for financial markets?
(c) What kinds of arrangements have arisen in borrower-lender relationships to deal with
adverse selection?
(d) What is the moral hazard problem? What are its likely consequences for financialmarkets?
15. (a) Outline the efficient markets hypothesis. What are its implications for stock prices?
(b) Outline the evidence for and against the hypothesis.
16. (a) What is a yield curve?
(b) Explain the Expectations theory of the yield curve. What does it imply about the equilibrium
relationship between the interest rate (yield) on a one-year and a two-year bond.
(c) Use the expectations theory and 1 other term structure theory to explain why a yield curve:
(i) can be upward sloping; (ii) can be u-shaped
17. (a) What are bank reserves? In Canada what assets are used as bank reserves?
(b) Explain why banks hold reserves.
(c) Explain in detail one way in that the central bank (Bank of Canada) could
increase reserve assets in the banking system by $100,000.
(d) (i) Describe the deposit expansion process which will be set of by the injection of $100,000 of
reserves (do this for the simplest case where there is only one type of deposit and the
public does not hold currency, assume a target reserve ratio of 0.05).
(ii) By how much will deposits increase as a result the deposit expansions process?
(e) Will the ultimate increase in the quantity of deposits be larger or smaller if the members of the
public desire to hold $1 of currency for every $2 dollars of deposits they have. Explain.
18. (a) Say that the Bank of Canada wants to reduce its target for the overnight rate from 3% to 2%.
(i) Would the policy require the Bank of Canada to increase or decrease the quantity of
reserves? Describe two ways in which the change in reserves could be achieved.
(ii) Use the model of the overnight market to illustrate the effect of the policy.
(b) Thoroughly explain how and why the change in the overnight rate in (a) will affect other
interest rates (e.g. deposit rates, loan rates, yields in securities markets etc.)
(c) What is the likely effect of the policy on the exchange rate? How will this change in the
exchange rate affect aggregate demand?
19. (a) What is the current policy goal of the Bank of Canada?
(b) Whymight this be a reasonable focus?
(c) Say that the inflation rate is expected to rise above its target value. Would you
suggest that the Bank of Canada buy or sell treasury bills? Explain.
20. Both the US Federal Reserve Bank and the Bank of Canada effectively place a ceiling on the level of the overnight rate (the Federal Funds rate in the US). How is this done? Show the effect on the supply curve for reserves.
21. (a) What is a deposit multiplier? On what variables does it depend?
(b) Explain the effect of the following on the size of the deposit multiplier:
(i) the Bank of Canada raises the rate it charges to banks who borrow from itto cover shortfalls.
(ii) Increasing use of bank cards decreases the amount of currency households wish to hold.
(iii) households increasingly hold their funds in low turnover types of deposits
22. (a) Thoroughly outline three channels through which monetary policy can affect Aggregate Demand for goods and services. (b) What is the overnight rate? Explain how a fall in reserves affects this rate (provide a diagram).
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