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Exam (elaborations) ECS3701 - Monetary Economics EXAM QUESTION PAPERS AND SOLUTIONS FROM JUN2018 TO JAN2021
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Exam (elaborations) ECS3701 - Monetary Economics Exam
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,ECS3701: MONETARY ECONOMICS
JAN 2021 SUPPLEMENTARY EXAM MEMO
Question 1
1.1 Risk structure of interest rates: the relationship between interest rates on bonds
with the same maturity. Factors such as risk, liquidity and income tax rules play a
role in determining the risk structure of different bonds.
Term structure of interest rates: bonds with identical risk, liquidity and tax
characteristics may have different interest rates because of different times remaining
to maturity.
1.2 a) liquidity, income tax consideration, default risk`
b) liquidity- lower interest rate
Income tax- increase in interest rate
Default risk- increase in interest rate
Question 2
2.1
1. Expectations theory
2. The segmented theory
3. The liquidity premium theory – better explains most facts and hence, most widely
used.
2.2 The liquidity premium and preferred habitat theories are the most widely accepted
theories of the term of structure as they explain all three empirical facts about the term
structure. They combine both expectations theory and the segmented markets theory by
asserting that a long-term interest rate will be the sum of a liquidity premium and the
average of the short-term interest rates that are expected to occur over the life of the
bond.
The theories also help us predict the movement of short-term interest rates in the future.
A steep upward slope of the yield curve means that short-term rates are expected to
remain the same. A flat slope means that short-term rates are expected to fall
moderately and an inverted yield curve means that short-term interest rates are
expected to fall sharply.
2.3 a) moral hazard and adverse selection
,b) Adverse selection – is an asymmetric information problem that occurs before that
transaction. Potential bad credit risks are the ones who most actively seek out loans
thus produce an undesirable outcome.
Moral hazard – arises after the transaction occurs. The lender runs the ik that the
borrower will engage in undesirable activities. Moral hazard reduces the probability the
loan will be paid, lenders may decide not to make a loan.
Question 3
3.1 False
3.2 A loan commitment is a bank’s commitment to provide a firm with loans up to a
given amount at an interest rate tied to some market rate. The advantage for the firm is
that it has credit available if needed. The advantage for the bank is the long-term
relationship make collection customer information and screening easier and cheaper.
3.3 bond supply and demand framework and the liquidity preference framework
3.4 bond supply and demand framework
Question 4
4.1 a flow has a time dimension, that is measured over a given period while a stock has
no time dimension which means it is measured at any point in time. Flows affect stocks
since they represent the rate of movement in and out of stocks.
4.2 hierarchical mandate and dual mandate
4.3
It can help focus the political debate on what a central bank can do in the long
run, i.e. control inflation, rather than what it cannot do, increase economic growth
and employment. It has the potential to reduce political pressures on central
banks.
It is readily understood by the public and is highly transparent due to regular
communication with the public.
There is the tendency towards increased accountability.
Often, once inflation has been reduced, it has stayed down even during
subsequent cyclical expansions.
PLEASE CHOOSE ANY TWO FROM THE FOUR
ABOVE!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!
Question 5
, 5.1 Money in the form of currency or checks is a medium of exchange; it is used to pay
for goods and services. It promotes economic efficiency by minimizing time spent
exchanging goods and services.
In a barter economy, time spent trying to exchange goods and services are called
transaction costs. In a barter economy these are high as one has to satisfy ‘a double
coincidence of wants’. This is avoided with money.
Money promotes efficiency by eliminating time spent exchanging goods and services
and allowing people to specialization and the division of labor.
5.2 a) false
b)
1. There is a net increase in the loans the banks grant to the nonbank public.
2. There is a net increase in assets (mostly securities) that banks buy from the nonbank
public.
3. There is a net increase in the payments the central bank makes to the nonbank
public via the latter's accounts with commercial banks. This figure roughly corresponds
with the net amount of open-market purchases by the central bank from the nonbank
public.
4. There is a net increase in the payments the government makes to the nonbank public.
This figure roughly corresponds with the size of the government budget deficit
(government spending minus tax income minus net borrowing from the nonbank public).
5. There is a net increase in the amount of foreign exchange the nonbank public sells to
the banks.
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