1. Give an example when the financial system does not work efficiently. What negative consequences arise from the failure of the financial system?
2. By using money, a society reduces transaction costs and encourages specialization. Explain.
3. According to Cecchetti, the financial system provides key services to savers and borrowers. Discuss each of these services briefly.
4. Suppose that Congress imposes a fixed tax on each purchase and sale of registered securities. That is, no matter how much is sold, the same tax is paid on ever transaction, large and small. What implication(s) would this action have?
5. Bond prices and market interest rates are inversely related. Explain.
6. Gibson Fender is contemplating dividing his portfolio between two assets, a risky asset that has an expected return of 10% and a standard deviation of 5%, and a T-bond that has a return of 6%
   a) If G. Fender is willing to accept a standard deviation of 3%, how should he divide is wealth between the two assets?
   b) What is his expected return?
   c) What is the price of risk?
7.  Suppose you are considering the purchase of a coupon bond that has the following future payments: $500 in one year, $500 in two years, $500 + $10,000 in three years.
   a) What is the bond worth today if the market interest rate is 8%?
   b) Suppose that you have just purchased the bond and suddenly the market interest rate falls to 5%. What is the bond worth now?
8. The "fiscal cliff" may increase the marginal tax rate. How should this affect the spread between municipal and Treasury securities?
9. The large government deficits of the recent past have increased substantially. How should overall bond prices and interest rates be affected?
10. The economic news indicates the economy is currently is starting to expand. What affect should this have on the spread between AAA and B rated bonds? Why? Illustrate your answer.
11. How would the follow affect bond prices and interest rates? Illustrate your answers.
1. An increase in the inflation rate.
2. The economy enters a recession.
3. We drill for oil in Alaska and find reserves 10 times larger than expected.
4. A earthquake destroy bridges and roads in California, leading to increased investment spending to rebuild.
5. And others like these….
12. When the dollar appreciates, US net exports decline. Why?
13. The theory of purchasing power parity of the exchange rates states that changes in the nominal exchange rate arise from differences in inflation among countries.
1. Use economic analysis and the scientific method to evaluate the theory.
2. How might purchasing power parity theory be modified so that it better explains exchange rate changes?
14. Suppose that you are the vice-president of a bank. You have just agreed to lend $1 million at an interest rate of 6.75% in three months. However, the bank’s board worries that interest rate fluctuations between now and the effective date of the loan will expose the bank to risk. How can you use the derivative market to hedge against the risk?
15. Briefly discuss adverse selection in bank loans.
16. The saving and loan crisis in the 1980s was in part due to the principal-agent problem. Explain.
17. The primary reason for regulating banks is federal deposit insurance. Comment.
18. The Federal Reserve did all it could in the early 1930s to try to prevent the Great Depression. Comment.
19. What are the general functions of the Fed?
20. What tools can the Fed use to increase the money supply?
21. Open market operation is the best tool for controlling the money supply. Comment.