1. Suppose there are two investors. One has a project to build a factory; the other has a project to visit casinos and play roulette. Which investor has a greater incentive to issue bonds? Why? Which investor's bonds are a better deal for savers? Why?
2. Using the example from #1, above - suppose you were required to put all of your retirement savings in the securities of one of these companies. Which company would you choose, and why?
3. In the 1964 movie Goldfinger the title character schemes to increase the price of gold. He plans to drop an atomic bomb on Fort Knox, making the gold there radioactive. His operation is financed by North Korea, which hopes to make the dollar worthless, disrupting the US economy. If 007 hadn't thwarted Goldfinger's plan, what effects might it have had on the monetary system in 1964? In 2014? In 1904?
4. Describe how each of the following events impact stock AND bond prices (separately)
a. The economy enters a recession
b. A genius invents a new technology that makes factories more productive
c. The Federal Reserve raises its target for interest rates
d. People learn that major news about the economy will be announced in a few days, but they don't know whether it is good news or bad news.
5. "I just bought my first house. I got a 30 year fixed rate mortgage at a great, low rate! Economists are predicting low inflation in the future, but I sure hope they are wrong!" Why might it make sense for someone to say this?
6. Suppose that a discount investment bank make bonds cheaper to issue. It becomes quick and inexpensive for companies to issue bonds. Discount brokers make it easy and inexpensive to sell bonds in the secondary market. Using the liquidity preference theory, how does this development affect money demand and the interest rate?
7. Using the same facts as in #6, above - what should the Federal Reserve do if it doesn't want the interest rate to change? Explain your answer.
8. Research around 1980 showed that stocks of small firms had higher average returns than stocks of large firms. The finding gained much attention, as it seemed to contradict the efficient market hypothesis. It suggested a simple way to beat the market: purchase only small-cap stocks.
a. Can you explain this deviation from market efficiency from a behavioral perspective?
b. Can you explain this deviation from a CAPM perspective?
c. Would you guess that small stocks have done better than large stocks since 1980? Why or why not?
1. Suppose you buy call options on Paccar stock. Each option costs $3, has a strike price of $40 and an expiration date of July 1. Would you exercise the option in each of the following situations? (Answer yes or no and why, and give the expected profit or loss assuming you did exercise)
a. It is March 1 and Paccar is trading at $30
b. It is March 1 and Paccar is trading at $41
c. It is March 1 and Paccar is trading at $65
d. It is June 30 and Paccar is trading at $55
e. It is June 30 and Paccar is trading at $41
f. It is June 30 and Paccar is trading at $30
2. When a bank makes a loan, it sometimes requires borrowers to maintain a checking account or savings account at the bank until the loan is paid off. What are the reasons behind this requirement?