a) Outline two important functions that the financial system performs in the economy. Why is the smooth functioning of the financial system important to the economy?

b) What are some of the dangers and incentive problems of the financial sector getting "too big"?

3. The Commonwealth Bank issues bonds on the capital market to raise financing for its loans.

a) How much financing will the Commonwealth Bank raise if it issues 500 5-year bonds today that pay an annual coupon of 6% and have a face value of $1000 if yields on bonds of similar risk and maturity are 4%? (6 marks)

b) What will happen to the price of the bonds in a) if 1 year from now the credit rating of the Commonwealth Bank is increased from AA to AAA? Why?

c) How much would an investor pay for the the bond from a) 1 year after it was issued if yields on bonds of similar risk and maturity had gone down to 3% by that time?

4. Apple Inc. (APPL share code) issues bank bills on the money market to raise short-term financing for its operations. How much financing would Apple raise if it issued a bank bill that has a maturity of 180 days, a face value of $50 million and was issued at a rate of 5%? The acceptance fee is 50 basis points.

5. The ANZ Bank (Share code: ANZ.AX) expects to pay a dividend of $0.91 today and dividends are expected to grow at 6% forever. The required return on ANZ shares is 9%. Based on this information would you buy the share today? (Base your answer on current market data for ANZ shares)

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