1. Under what circumstances might you expect barter to reemerge in an economy that has fiat money as a means of payment?

A. If there are periods of high inflation and the public loses confidence or trust in fiat money, barter may reemerge.

B. If inflation is low and stable and people do not believe that fiat money has much value, barter may reemerge.

2. What factors should you take into account when considering using the following assets as stores of value?

a. Gold

b. Real estate

c. Stocks

d. Government Bonds

3. Under what circumstances might money in the form of currency be the best option as a store of value?

4. Suppose a significant fall in the price of certain stocks caused the market makers in those stocks to experience difficulties with their funding liquidity. Under what circumstances might that development lead to liquidity problems in markets for other assets?

5. Life insurance companies tend to invest in long-term assets such as loans to manufacturing firms to build factories or to real estate developers to build shopping malls and skyscrapers. Auto insurers tend to invest in short-term assets such as Treasury bills. What accounts for these differences?

6. Why do you think the financial system has become more globally integrated over time? Can you think of any downside to this increased integration?

7. Consider an investment that pays off $800 or $1,400 per $1,000 invested with equal probability. Suppose you have $1,000 but are willing to borrow to increase your expected return. What would happen to the expected value and standard deviation of the investment if you borrowed an additional $1,000 and invested a total of $2,000? What if you borrowed $2,000 to invest a total of $3,000? Assume that the borrowing rate is 0%.

Instructions: Fill in the table below to answer the questions above. Enter your answers as whole numbers.

8. You have the option to invest in either Country A or Country B but not both. You carry out some research and conclude that the two countries are similar in every way except that the returns on assets of different classes tend to move together much more in Country A-that is, they are more highly correlated in Country A than in Country B. Which country would you choose to invest in and why?

9. In a recent issue of The Wall Street Journal (or on www.wsj.com), locate the yields on government bonds for various countries. Find a country whose 10-year government bond yield was above that on the U.S. 10-year Treasury bond and one whose 10-year was below the Treasury yield. What might account for these differences in yields?

10. As you read the business news, you come across an advertisement for a bond mutual fund - a fund that pools the investments from a larger number of people and then purchases bonds, giving the individuals "shares" in the fund. The company claims their fund has had a return of 13½ percent over the last year. But you remember that interest rates have been pretty low - 5 percent at most. A quick check of the numbers in the business section you're holding tells you that your recollection is correct. Explain the logic behind the mutual fund's claim in the advertisement.

11. Consider two scenarios. In the first, the nominal interest rate is 6 percent and the expected rate of inflation is 4 percent. In the second, the nominal interest rate is 5 percent and the expected rate of inflation is 2 percent. In which situation would you rather be a lender? In which would you rather be a borrower?

12. Under what circumstances might you be willing to pay more than $1,000 for a coupon bond that matures in 3 years, has a coupon rate of 10%, and a face value of $1,000?

13. If inflation and interest rates become more volatile, what would you expect to see happen to the slope of the yield curve?

14. As economic conditions improve in countries with emerging markets, the cost of borrowing funds there tends to fall. Explain why.

15. Suppose a country with a struggling economy suddenly discovered vast quantities of valuable minerals under government-owned land. How might the government's bond rating be affected? Using the model of demand and supply for bonds, what would you expect to happen to the bond yields of that country's government bonds?

16. Given the data in the accompanying table, would you say that this economy is heading for a boom or for a recession?

17. The purpose of derivatives is to:
A. increase the risk so the return is larger.
B. eliminate risk for both parties in the transaction.
C. postpone the risk for both parties in the transaction.
D. transfer the risk from one person to another.

18. The value of a derivative is determined by:
A. the Federal Reserve.
B. SEC regulation.
C. the value of the underlying asset.
D. the risk-free rate.

For the following questions, just show the calculation and the equation, the answers are highlighted,

19. Using the equation of exchange, if real GDP increases by 3.0%, the velocity of money grows by 1.0% and the growth rate of money is 3.0%; what is the rate of inflation?
A +1.0%
B. It is constant or a 0% change
C. It is the same as the growth rate of money, or 3.0%
D. -1.0%

20. Using the equation of exchange, if inflation is 1%, the velocity of money grows by 1.0% and the growth rate of money is 3.0%; what is real growth?
A. +3.0%
B. 1%
C. 4.0%
D. -1.0%

21. If money growth and real output growth are both zero, the change in the price level will:
A. also be zero.
B. equal the percentage change in velocity.
C. be indeterminate.
D. be the inverse of the percentage change in velocity.

22. According to the equation of exchange, if real output and the money supply stay the same and the price level increases:

A. the velocity of money has to increase.
B. the velocity of money has to decrease.
C. the real GDP had to rise.
D. nominal GDP remains constant.

23. Using the equation of exchange, if inflation is 1.5%, real output grows by 3.0%, and the growth rate of money is 5.0%, the change in the velocity of money is:
A. Zero; velocity is constant.
B. -0.5%.
C. +4.5%.
D. +0.5%.

24. Using the equation of exchange, if real GDP increases by 3.0%, the velocity of money grows by 1.0% and the growth rate of money is 3.0%; what is the rate of inflation?

A. +1.0%
B. It is constant or a 0% change
C. It is the same as the growth rate of money, or 3.0%
D. -1.0%