Exam (elaborations)
ECO 4223 MONEY & BANKING EXAM 2 QUESTIONS AND ANSWERS WITH SOLUTIONS 2024
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ECO 4223 MONEY & BANKING EXAM 2 QUESTIONS AND ANSWERS WITH SOLUTIONS 2024
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ECO 4223 MONEY & BANKING EXAM 2QUESTIONS AND ANSWERS WITH
SOLUTIONS 2024
Risk Structure of Interest rate - ANSWER The relationship among the various interest rates on bonds with
the same term to maturity.
e.g: A 10yr bond from Coca Cola vs. a 10yr bond from ABC Inc.
Factors include: Default Risk; Liquidity; Taxes
Default Risk - ANSWER The risk that the issuer may not be able to honor a bond. The issuer can not make
interest payments or pay face value at maturity
Risk Premium - ANSWER The difference between investmenting in a risky asset and a risk-free
investment.
Liquidity is also a factor. The less liquid assets have a higher premium.
Example of Risk Premium - ANSWER T-Bill = 3% Coke = 5%
There is a 2% Risk Premium on the Coke bond because it has more risk than the T-Bill.
5yr bond = 5% 1yr bond = 2%
There is a 3% Risk Premium on the 5yr Bond
Sovereign Debt - ANSWER Bonds issued by a National Gov.
Bond Rating Agency - ANSWER Agencies that assess the "credit worthiness" of an organization (Default
Risk). The two major rating agencies are Moody's and Standard & Poor.
, Junk Bonds - ANSWER Bonds with a BB rating or below. They are considered to be too risky to be
considered investment grade.
Liquidity (Bonds) pg115 - ANSWER Liquid bonds are more easily sold so they are more desirable. It also
affects the Risk Premium. Less liquid means more premium.
Taxes (Bonds) - ANSWER Taxation affects interest rates. Most relevant on Municipal Bond.
Municipal Bond - ANSWER a bond issued by a state or local government or municipality to finance such
improvements as highways, state buildings, libraries, parks and schools (They are tax-free)
Term Structure of Interest Rate - ANSWER The pattern of rates of return for debt securities that differ
only in the length of time maturity
Yield Curve (pg 108) - ANSWER Graph comparing interest rates on bonds of various maturities at a given
point in time (The relationship between interest rates and time)
Normal Yield Curve - ANSWER An upward-sloping yield curve indicates that long-term interest rates are
generally higher than short-term interest rates
Inverted Yield Curve - ANSWER Unusual situation where short-term interest rates are higher than long-
term rates. (Down ward sloping)
Flat Yield Curve - ANSWER An environment where long and short term interest rates are the same.
3 imperial fact of Yield Curve - ANSWER 1) Interest rate on Bond move together. (If one is going up, they
are all going up)
2) If Short-Term Interest rate are low (Normal Yield Curve).
If Short-Term Interest rate are High (Inverted Yield Curve)
3) Yield Curve slope upward 90% of the time (Normal Yield Curve)
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