EXAM STRUCTURE

3 points: Multiple-choice questions based on the content outlined in the slides of the chapters
covered in the syllabus.
2 points: Calculation exercises similar to the ones in the attached file.
5 points: Essay questions, including 3 questions listed in the review file.

CALCULATIONS AND DECISION-MAKING:

1. Which share has higher current price, assuming you require a ke= 18% return for both:
Stock A: that pays a DA= $3 per year dividend and that you expect to be able to sell in one year
for PA= $25
P0A= DA/ (1+ ke) + PA / (1+ke)
Stock B: that a firm’s dividends should grow at g= 8%, on average, in the foreseeable future. The
firm’s last dividend was DB= $2.
P0B= DB *(1+g) / (ke - g)

Solve:

2. The current price of a stock is P 0= $99. If dividends are expected to be D=$1.5 per share
for the next five years, and the required return is k e= 15%, then what should the price of the stock
be in 6 years when you plan to sell it? If the dividend and required return remain the same, and
the stock price is expected to increase by $1 five years from now, does the current stock price
also increase by $0.5? Why or why not?
P0 = D1 / (1+ke)1 + D2 / (1+ke)2 + D3 / (1+ke)3+ D4 / (1+ke)4 + D5 / (1+ke)5 + (P6+D6) / (1+ke)6
 P6=?
* If the stock price is expected to increase by $1 five years from now
We have: 1/ (1+ke)6 =?

Solve:

3. Which F= $1,100 bond has the higher yield to maturity, a 20-year bond selling for P 1=
$900 with a current yield of g 1 = 15% or a one-year bond selling for P 2= $990 with a current
yield of g2 = 5%?
Current yield = C/P => C=?
P= C * (1- (1+r)-n)/ r + F/ (1+r) n => r =?
Solve:
CALCULATIONS AND DECISION-MAKING:
 1. Which share has higher current price, assuming you require a 18% return for both:
Stock A : that pays a $3 per year dividend and that you expect to be able to sell in one year
for $25
Stock B: that a firm’s dividends should grow at 8%, on average, in the foreseeable future.
The firm’s last dividend was $2.

2. The current price of a stock is $99. If dividends are expected to be $1.5 per share for the
next five years, and the required return is 15%, then what should the price of the stock be
in 6 years when you plan to sell it? If the dividend and required return remain the same,
and the stock price is expected to increase by $1 five years from now, does the current
stock price also increase by $0.5? Why or why not?

3. Which $1,100 bond has the higher yield to maturity, a 20-year bond selling for $900 with
a current yield of 15% or a one-year bond selling for $990 with a current yield of 5%?

PROBLEM SOLVING:

1. Using both the liquidity preference framework (khuôn khổ ưu tiên

thanh khoản) and the supply and demand for bonds framework, show why
interest rates are rising when the economy is expanding.
- When the economy is booming, people's wealth rises along with investment
opportunities, the bond's demand and supply curves both shift rightward as a result of this. But
the demand curve's movement is less than the supply curve's, it results in a drop in pricing and an
increase in interest rates. In the liquidity framework, during a boom era, both demand and supply
of money increase, but demand exceeds(vượt) supply, causing the interest rate to rise.

- Interest rates are thus pro-cyclical

2. Using both the liquidity preference framework and the supply and
demand for bonds framework, show why interest rates are falling during
recessions.
During a recession, people's wealth levels are reduced, and company investment opportunities
drop as well. Bond demand and supply both fall as a result of this, but supply falls faster than
demand, resulting in an increase in prices and a decrease in the interest rate. In the liquidity
framework, in a recessionary time, both demand and supply of money decline, but demand
decreases more than supply, lowering the interest rate.

3. How Financial Intermediaries Reduce Transaction Costs

-Financial intermediaries have evolved to reduce transaction costs.

+ Economies of scale: Financial intermediaries can also benefit from economies of scale to
engage in large transactions with a lower cost per dollar. By bringing together investors' funds so
that economies of scale can be realized, financial intermediaries reduce the cost of transactions.

+ Expertise: Financial intermediaries are also better able to develop expertise that can be used to
lower transaction costs. Low transaction costs enable financial intermediaries to provide their
customers with liquidity services, which are services that make it easier for customers to conduct
transactions.

4. Illustrate Tools to Help Solve Moral hazard in equity contracts

(Principal-Agent Problem)
Solutions to the principal-agent problem aim to align the interest of both parties. There are two
main areas of improvement to address the problem:

-Contract design

The creation of a contract framework between the principal and the agent to address issues of
information asymmetry, stimulate the agent’s incentives to act in the best interests of the
principal and to determine procedures for monitoring agents.

-Performance evaluation and compensation

The agent’s compensation is the primary method of aligning the interests of both parties. In
order to address the principal-agent problem, the compensation must be linked to the
performance of the agent.

The performance of the agent is usually measured by subjective evaluation because it is a more
flexible and balanced assessment method for complex jobs. Common methods of agent
compensation include stock options, profit-sharing, and deferred compensation. Tying the
agent’s compensation closely to the benefits obtained for the principal helps to eliminate
conflicts of interest.

5. Illustrate Tools to Help Solve Adverse Selection Problems in financial

market
 - Solve adverse selection by increasing access to information, thus minimizing asymmetries. For
consumers, the internet has greatly increased access while reducing costs.

- Warranties and guarantees offered by sellers can also help, allowing consumers to use a product
risk-free for a certain period to see if it has flaws or quality issues and the ability to return them
without consequence if there are issues.

- Insurers reduce adverse selection by requesting medical information from applicants in the
form of requiring paramedical examinations. This gives the insurance company more
information that an applicant may fail to disclose on their own.

6. Tools to Help Solve Moral Hazard (rủi ro đạo đức) in Debt Contracts in
financial
- Net Worth and Collateral: When borrowers have more at stake because their net worth (the
difference between their assets and their liabilities) is high or the collateral they have pledged to
the lender is valuable, the risk of moral hazard (the temptation to act in a manner that lenders
find objectionable) is greatly reduced because the borrowers themselves have a lot to lose.
- Monitoring and Enforcement of Restrictive Covenants:
+ discourage undesirable behavior. Covenants can be designed to lower moral hazard by
keeping the borrower from engaging in the undesirable behavior of undertaking risky investment
projects.

+ encourage desirable behavior. Restrictive covenants can encourage the borrower to engage in
desirable activities that make it more likely that the loan will be paid off. One such restrictive
covenant requires the breadwinner in a household to carry life insurance that will pay off the
mortgage upon that person’s death.
+ keep collateral valuable. Because collateral is an important protection for the lender,
restrictive covenants can encourage the borrower to keep the collateral in good condition and
make sure that it stays in the possession of the borrower.
+ provide information. Restrictive covenants also require a borrowing firm to provide
information about its activities periodically, in the form of quarterly accounting and income
reports, thereby making it easier for the lender to monitor the firm and reduce moral hazard.
- Financial Intermediation: Although restrictive covenants help reduce the moral hazard
problem, they do not eliminate it completely. It is almost impossible to write covenants that rule
out every risky activity. Furthermore, borrowers may be clever enough to find loopholes in
restrictive covenants that make them ineffective.

7. Illustrate three goals and four tools of Asset Management in relation to

banks
Three goals
+ Seek the highest possible returns on loans and securities.
+ Reduce risk.
+ Have adequate liquidity.
Four Tools
+ Find borrowers who will pay high-interest rates and have a low possibility of defaulting.
+ purchase securities with high returns and low risk.
+ lower risk by diversifying.
+ Balance need for liquidity against increased returns from less liquid assets.

11. Why might financial liberalization and globalization lead to financial

crises in emerging market economies?
Emerging economies are experiencing a financial crisis as a result of globalization and financial
liberalization. As a result, many countries will have rapid and low-risk expansion in a well-
known banking system over time, followed by a period of increased danger of a financial crisis.
The crisis was triggered by financial conditions as a result of financial globalization.
Emerging countries' financial and security markets are underdeveloped. It's true that there's a
problem with adverse selection and moral hazard. It is not their role to determine which
investments are good and which are bad, or to keep track of the projects to which money is
provided.
12.Why might severe fiscal imbalances lead to financial crises in emerging
market economies?
Banks in countries with fiscal policies where the government does not have a stable policy, force
these banks to buy their bonds with capital to cover business activities, then the Investors
consider this a bad practice in the financial markets and then they don't know if the government
is able to repay the debt. Especially, foreign investors who sell bonds massively will cause a
decrease in bond prices and then the balance sheet will be unstable and the affected capital will
decrease and they will not be able to lend much and could not get results to stimulate growth.
13.Why do currency crises make financial crises in emerging market
economies even more severe?
Because of increasing predicted and real inflation, the interest rate rises even more. Interest
payments rise, and because we rely on external funds for investment, investment falls, and
economic activity falls as well. As a result, the currency crisis worsens the economy.
Explanation: When the financial market is disrupted by financial friction, a financial crisis
arises. Credit increased dramatically, finance markets ceased to function, and economic activity
collapsed. This could be due to the credit and asset booms and busts, as well as an increase in
uncertainty. As a result of the adverse selection concerns, fewer banks have information
regarding the creditworthiness of borrowers, and banks fail. Then, due to the load of
indebtedness, the drop in price level further erodes the net value of banks and enterprises.

14. How Changes in Open Market Operations of Monetary Policy Affect the
Federal Funds Rate. Also provide related examples in reality.
As part of open market operations, when the Fed buys securities from banks, it increases the
money supply and the banks' reserves, which results in a reduction in the fed funds rate.
Conversely, when the Fed sells securities to banks, this reduces the money supply and the banks'
reserves, which increases the fed funds rate.

Example in reality
In 1979, To combat inflation, the Fed started selling securities in an attempt to reduce the money
supply. A year later, the federal funds rate as high as 20%. In 1981 and 1982 average 30-year
fixed mortgage rates rising above 16%.
Conversely, the Fed purchased over $1 trillion in securities in response to the 2008 recession.
This expansionary policy, called quantitative easing, increased the money supply and drove
down interest rates.
15. How Changes in Discount Lending of Monetary Policy Affect the Federal
Funds Rate.
The effect of a discount rate change depends on whether the demand curve intersects the supply
curve in its vertical section or its flat section. Since the Fed now usually keeps the discount rate
above its target for the federal funds rate—the discount rate have no effect on the federal funds
rate
Example: Since March 2020, the FOMC has kept the discount rate at .25% to encourage lending
and borrowing during (and following) the economic downturn caused by the coronavirus. This is
the lowest discount rate in the history of the FOMC; it is likely to continue to be renewed or
slightly adjusted up until the Committee sees its goal of an average of 2% inflation over the
coming
16. How Changes in Reserve Requirement and Interest on Excess Reserves of
Monetary Policy Affect the Federal Funds Rate
Reserve Requirements: When the required reserve ratio increases, required reserves increase
and hence the quantity of reserves demanded increases for any given interest rate. Similarly, a
decline in the required reserve ratio lowers the quantity of reserves demanded, shifts the demand
curve to the left, and causes the federal funds rate to fall. When the Fed decreases reserve
requirements, the federal funds rate falls.
Interest on Excess Reserves: The effect of a change in the interest rate paid by the Fed on
excess reserves depends on whether the supply curve intersects the demand curve in its
downward-sloping section or its flat section. When the federal funds rate is at the interest rate
paid on excess reserves, a rise in the interest rate on excess reserves raises the federal funds rate.
17. Summarize how conventional monetary policy tools are implemented
During normal times, the Federal Reserve uses three tools of monetary policy—open market
operations, discount lending, and reserve requirements—to control the money supply and interest
rates, and these three tools are referred to as conventional monetary policy tools. We will look at
each of them in turn, and then at the additional tool of paying interest on excess reserves, to see
how the Fed wields them in practice and how relatively useful each tool is.

Open Market Operations: Open market operations fall into two categories: Dynamic open
market operations and defensive open market operations
Discount Policy and the Lender of Last Resort:
+ Operation of the Discount Window:
+ Lender of Last Resort:
Reserve Requirements: A rise in reserve requirements reduces the amount of deposits and
leads to a contraction of the money supply. A rise in reserve requirements also increases the
demand for reserves and raises the federal funds rate. Conversely, a decline in reserve
requirements leads to an expansion of the money supply and a fall in the federal funds rate.
Interest on Excess Reserves: The Fed sets the discount rate above the federal funds target.
In the aftermath of the global financial crisis, banks accumulated huge quantities of reserves and,
in this situation, increasing the federal funds rate would require massive amounts of open market
operations to remove these reserves from the banking system.
19. What are the advantages and disadvantages of quantitative easing as an
alternative to conventional monetary policy when short-term interest rates are
at the effective lower bound?
Advantages: Quantitative easing (QE) can seem as though too promising to be true for the time
being. A higher supply of capital has for quite some time been associated with a decrease in
interest rates. This is the point at which the economy continues to stream surplus cash thus banks
should haggle with one another to loan the abundance of cash.
Disadvantages:
- The central banks plan to downplay inflation. All things considered, the quantitative
easing strategy does the specific opposite. It is inherently inflationary, as this approach creates
liquidity and utilizations this money to additionally intensify loaning by involving this money as
stores.
- Like inflation, central banks expect to hold financing costs at relatively consistent levels.
The more financing costs in the economy fluctuate, the less fortunate the effectiveness of the
central bank.
- The program of quantitative easing is contributing to a momentary decrease in financing
costs
20. Summarize three stages of Financial Crisis in Emerging Market
Economies
Stage one: Initial Phase
- Path A: Credit Boom and Bust
+ Weak supervision and lack of expertise lead to a lending boom.
+ Domestic banks borrow from foreign banks.
+ Fixed exchange rates give a sense of lower risk.
+ Banks play a more important role in emerging market economies since securities markets are
not well developed yet.
- Path B: Severe Fiscal Imbalances
+Governments in need of funds sometimes force banks to buy government debt.
+When government debt loses value, banks lose and their net worth decreases.
Additional factors:
+ Increase in interest rates (from abroad)
+ Asset price decrease
+ Uncertainty linked to unstable political systems
Stage two: Currency Crisis
- Deterioration of bank balance sheets triggers currency crises:
+ Government cannot raise interest rates (doing so forces banks into insolvency)…
+ … and speculators expect a devaluation.
- Severe fiscal imbalances trigger currency crises:
+ Foreign and domestic investors sell the domestic currency.
Stage three: Full-Fledged Financial Crisis
- The debt burden in ter ms of domestic currency increases (net worth decreases).
- Increase in expected and actual inflation reduces firms’ cash flow.
- Banks are more likely to fail:
+ Individuals are less able to pay off their debts (value of assets fall).
+ Debt denominated in foreign currency increases (value of liabilities increase).

21. What are the differences between bond and share? And give out some
examples.
Shares and bonds are both types of investment securities, but they have very different
characteristics and behave very differently. Simply put, when an investor buy shares they are
buying part of a company; when they buy bonds, they are lending money to a company.
Investing in bonds is generally less risky than investing in shares because bonds sit higher on the
capital hierarchy. This means that bond investors will get paid back before share investors, if a
company defaults.

22. What are the differences between unsecured loans and mortgages? And
provide some examples.
A mortgage is a type of loan used to purchase or maintain a home, land, or other types of real
estate. A borrower must apply for a mortgage through their preferred lender and ensure that they
meet several requirements, including minimum credit scores and down payments.

An unsecured loan is a loan that doesn't require any type of collateral. Instead of relying on a
borrower's assets as security, lenders approve unsecured loans based on a borrower's
creditworthiness. Examples of unsecured loans include personal loans, student loans, and credit
cards.

23.Describe why asymmetric information leads to adverse selection and moral

hazard
The presence of transaction costs in financial markets partly explains why financial
intermediaries and indirect finance play such an important role in financial markets.

- Asymmetric information—a situation that arises when one party’s insufficient knowledge
about the other party involved in a transaction makes it impossible for the first party to
make accurate decisions when conducting the transaction—is an important aspect of
financial markets.

- Adverse selection is an asymmetric information problem that occurs before a transaction

occurs. Adverse selection occurs when one party to a transaction has information about a
 hidden characteristic and takes economic advantage of this information by engaging in a
transaction with less informed parties.

- Moral hazard arises after the transaction occurs. Moral hazard occurs when an informed
party takes a hidden (unobserved) action that harms the less informed party

The analysis of how asymmetric information problems affect economic behavior is called
agency theory.

Describe determinants of Asset Demand, and how quantity of an asset

demanded responds to changes in those determinants.
-Wealth, the total resources owned by the individual, including all assets

-Expected return (the return expected over the next period) on one asset relative to alternative
assets

-Risk (the degree of uncertainty associated with the return) on one asset relative to alternative
assets

-Liquidity (the ease and speed with which an asset can be turned into cash) relative to alternative
assets

How quantity of an asset demanded responds to changes in those determinants:

-Wealth

+In a business cycle expansion with growing wealth, the demand for bonds rises and the demand
curve for bonds shifts to the right.

+ Applying the same reasoning, in a recession, when income and wealth are falling, the demand
for bonds falls, and the demand curve shifts to the left

-Expected returns on bonds relative to alternative assets

+Higher expected future interest rates lower the expected return for long-term bonds, decrease
the demand, and shift the demand curve to the left.

+Lower expected future interest rates increase the demand for long-term bonds and shift the
demand curve to the right

-Risk of bonds relative to alternative assets

+An increase in the riskiness of bonds causes the demand for bonds to fall and the demand curve
to shift to the left

24. Summarize changes in Bond Equilibrium interest rates ( including shifts

in demand and supply )
Shifts in the Demand for Bonds: These factors include changes in the following four
parameters: + Wealth

+ Expected returns on bonds relative to alternative assets

+ Risk of bonds relative to alternative assets

+ Liquidity of bonds relative to alternative assets

Shifts in the Supply of Bonds

Certain factors can cause the supply curve for bonds to shift. Among these factors are
the following:

+ Expected profitability of investment opportunities

+ Expected inflation

+ Government budget deficits