Homework 1 Essay

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EF3333 Financial Systems, Markets and Instruments Assignment 1 (due date 27 February 2013) 1. How does an increase in the value of the pound sterling affect American businesses? 2. Why do managers of financial institutions care so much about the activities of the Federal Reserve System? 3. Some economists suspect that one of the reasons that economies in developing countries grow so slowly is that they do not have well-developed financial markets. Does this argument make sense? 4. Why do loan sharks worry less about moral hazard in connection with their borrowers than some other lenders do? 5. Assume you just deposited $1000 into a bank account. The current real interest rate is 2%, and inflation is expected to be 6% over the next year. What nominal 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 stereo that currently sells for $1050, will you have enough to buy it? 6. The duration of a $100 million portfolio is 10 years. $40 million in new securities are added to the portfolio, increasing the duration of the portfolio to 12.5 years. What is the duration of the $40 million in new securities? 7. Predict what will happen to interest rates if prices in the bond market become more volatile. 8. Yow own a $1000-par zero coupon bond that has five years of remaining maturity. You plan on selling the bond in one year, and believe that the required yield next year will have the following probability distribution: Probability | Required Yield % | 0.1 | 6.60% | 0.2 | 6,75% | 0.4 | 7.00% | 0.2 | 7.20% | 0.1 | 7.45% | a. What is your expected price when you sell the bond? b. What is the standard deviation of the bond price? 9. What effect would reducing income tax rates have on the interest rates of municipal bonds?

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