eco349 midterm winter2012 long sol
PART 2. Long Answer. Total 40 marks (10 marks each).
1. Demonstrate graphically and explain how increased profitability of investments and increased government deficits happening simultaneously affect bond prices and interest rates. (10 marks).
(6 for graph)
As increased deficits and increased profitability of investment both increase the supply of bonds, one graph showing this shift and the resulting fall in prices and increase in interest rates is appropriate; but it has to be stated that the Bs curve shifts out twice.
Bond prices decline, meaning interest rates rise.
(4 explanation)
2. When interest rates on 1 2 3 4 5 year bonds are 2.0, 2.1, 2.3, 2.4, and 2.5% respectively, what information do we derive on future economic growth and real output? (10 marks)
According to these interest rates, the yield curve is gently upward sloping, indicating that short-term interest rates are not expected to change significantly in the next 5 years. (4 marks; can include a graph but not necessary)
We do know that periods of economic growth and output booms are associated with rising interest rates, and recessions are associated with low interest rates. (3 marks)
As the yield curve is found to be an accurate predictor of the business cycle, we would expect no significant changes in real output over the next 5 years (3 marks)
3. What are conflicts of interest for financial intermediaries? When are they likely to occur? (10 marks) Conflicts of interest are a type of moral hazard problem that occur when a person or institution has multiple objectives (interests) and as a result has conflicts between them. (5 marks)
Conflicts of interest are especially likely to occur when a financial institution provides multiple services. the potentially competing interests of those services may lead an individual or firm to conceal information or disseminate misleading information (5 marks)
4. Financial markets suffered from a high degree of asymmetric information (both in the forms
1. Demonstrate graphically and explain how increased profitability of investments and increased government deficits happening simultaneously affect bond prices and interest rates. (10 marks).
(6 for graph)
As increased deficits and increased profitability of investment both increase the supply of bonds, one graph showing this shift and the resulting fall in prices and increase in interest rates is appropriate; but it has to be stated that the Bs curve shifts out twice.
Bond prices decline, meaning interest rates rise.
(4 explanation)
2. When interest rates on 1 2 3 4 5 year bonds are 2.0, 2.1, 2.3, 2.4, and 2.5% respectively, what information do we derive on future economic growth and real output? (10 marks)
According to these interest rates, the yield curve is gently upward sloping, indicating that short-term interest rates are not expected to change significantly in the next 5 years. (4 marks; can include a graph but not necessary)
We do know that periods of economic growth and output booms are associated with rising interest rates, and recessions are associated with low interest rates. (3 marks)
As the yield curve is found to be an accurate predictor of the business cycle, we would expect no significant changes in real output over the next 5 years (3 marks)
3. What are conflicts of interest for financial intermediaries? When are they likely to occur? (10 marks) Conflicts of interest are a type of moral hazard problem that occur when a person or institution has multiple objectives (interests) and as a result has conflicts between them. (5 marks)
Conflicts of interest are especially likely to occur when a financial institution provides multiple services. the potentially competing interests of those services may lead an individual or firm to conceal information or disseminate misleading information (5 marks)
4. Financial markets suffered from a high degree of asymmetric information (both in the forms