Review Sheet for the Second Exam

Review Sheet for the Second Exam

Dec8th2009—W-1-555:30 PM

1. What is a derivative?
2. Can you define the following instruments and explain how they work? (i) A future, (ii) A call option, (iii) A put option, (iv) A credit default swap, (v) An interest rate swap. Do you know under what circumstances you might obtain a future or a call option or a put option?
3. What are transactions costs? How does the financial system lower these?
4. What are informational asymmetries?
5. What is adverse selection? What is moral hazard? What is credit rationing?
6. Can you provide examples of adverse selection and moral hazard in financial markets?
7. What are principal-agent problems? Can you explain why these exist in financial markets? How have firms tried to mitigate these problems?
8. What are the five main types of financial institutions? Can you describe what their main functions are (underwriting, M & A, transferal of risk, etc)?
9. Do you know what Glass-Steagall refers to and what the Gramm-Leach-Bliley act refers to?
10. What are the three sorts of risks that banking institutions face? What avenues are open to them to mitigate each sort of risk? Can you explain how these work?
11. Can you explain the assets and liabilities of a commercial bank?
12. What does it mean to have a currency appreciate or depreciate?
13. What is the difference between real and nominal exchange rates? Can you express the relationship between these and the price levels in two different countries?
14. What is the relationship between changes in the nominal and real exchange and the rates of inflation in each country?
15. What is a spot transaction? What is a forward transaction? Why might we have forward markets?
16. What is purchasing power parity? What is the law of one price? What conditions are necessary the law of one price to hold? What is nominal interest parity?
17. What is the formula for nominal interest parity? Can you use this formula with actual numbers?
18. How does trade affect the exchange rate? How do capital flows? Can you show these effects in a diagram?
19. Can you draw and explain a diagram which shows the relationship between exchange rates and the expected return on bonds in different countries? Can you explain what shifts each graph?
20. What is the monetary base? How is it defined? Can you show the monetary base using the balance sheet of the fed? What are the elements of the monetary base?
21. What are the two major ways in which the fed can affect the monetary base? Can you explain in detail how each one of these works?
22. What is the simple deposit multiplier? Do you know the formula for it?
23. What are excess reserves? What are its determinants?
24. What is the currency-deposit ratio? What are its determinants?
25. What is the formula for the money multiplier when you take into account excess reserves and currency deposit ratios? Using the notion of the monetary base and the money multiplier can you tell what the money supply will be?
26. Can you explain how changing the money supply affects interest rates using a diagram for the market for money (which you learned in detail in 102)?