Case 1

Question:1 why Americans tend to have positively biased self-perceptions of their financial
knowledge?
Answer: In this case we found that American people think that they have very high knowledge
about finance. But in reality, they have relatively low level of financial literacy. For this
positively biased self-perception they are putting millions of people life at risk. After 2009
meltdown the people of Americans thought that they have higher level of financial knowledge
and they can oppose if any financial breakdown occurs. But after taking a financial quiz the
result was disaster. Less than 40% people actually had basic financial knowledge. For this
particular reason I think Americans have positively biased self-perception of their financial
knowledge.

Question: 2 Why financial literacy is an important factor to make people more aware about
their future? Bond basics are important factors to make aware about bond markets. Do
you agree with it? Why and why not?
Answer: Financial literacy is an important factor in all aspects to prosper and lead life. Financial
literacy means understanding how money works how to earn and invest money and also how to
expend money. If people don’t have any knowledge about finance, they will find it difficult to
make decision where they will invest money and how much they will earn from that invest.
Though a person cannot guarantee earnings from an investment but a literate person can invest
where the possibilities are higher. If a person does not have financial literacy that person will
face financial crisis in some part of his life and there is high possibility that he can be under debt.
Because those who doesn’t know how to manage and expense their money they might be out of
money in life and turns out to take loans. So, it is very much important for a person to have
financial literacy to aware themselves about their future. On the other hand, bond basics are also
important factors to make aware about bond markets. Many companies and govt. sell bonds in
the market to borrow money from people. So, we have to know about the bond basics so that we
have proper knowledge about which bonds we need to buy.

Question:3 Americans have grown more confident about their financial acumen since the
market meltdown that ended in 2009. Justify it.
Answer: Americans became confident about their financial knowledge since the market
meltdown that ended in 2009. In 2009, the market faced a huge crash which affected their market
but after sometimes they managed to overcome that crash and stabilized the market. After this
event they became confident about financial market and stating to think that they know a lot
about the market and if anything happens thy can stand for it and overcome any kind of disaster.
They did not think that it is necessary to look at the financial matters and learn about it and that’s
why they just ignored these. And in the end, they are now mostly financial illiterate. If anything,
major occurs in their market they will not be able to handle the situation which will cause a great
loss for them and for the country.

Question: 4 People are still facing difficulties specially minority population. How will you
justify it?
Answer: In these recent years, world economy has seen tremendous progress. Though some
people of Americans are still facing financial difficulties and specially those who are from
minority population. In this case we can see that there was a quiz taken in which most of the
people failed to passed it because they lack of knowledge of finance. As of minority people most
of them they do no get chance to study a lot. So, it is obvious that they will not gain knowledge
about financial condition and relative matters. When a people do not have knowledge, they will
face difficulties to take decisions in their life. The authority or the Govt. have to take a step to
give college education to these minority people so that they can progress in their life which will
benefit the Govt. eventually.

Question: 5 Which major participant in financial markets is in good shape? Justify it.
Answer: there are some major participant in financial market such as Banks, financial
institutions, stock exchange, brokers, depositories. Among all of these, banks are doing really
good in financial market. Banks play major role in an economy to do well. Bank assures
depositors by using their money properly and they also monitor the problems between investors
and borrowers. If a market falls down all the other participant may fall but banks always do good
and that’s they are reliable and they contribute a lot to the economy so that the economy can
prosper properly. There are different types of bank in market. Some provide benefits to farmers
or some may become beneficial for the corporate or individual person. But all of them play a
vital role to perform well in the market. That’s why I think banks are in good shape in the
financial market.
 case 2

1) Answer:
A) pure expectations theory: The theory contends that long term rates are an average of the
expected short-term rates in the future. It means the forward rates are estimated for future. the
yield curve is shaped by the expectations of the investors. the key fact about this theory is the
investors will not choose one maturity bonds with another.
B) The market segmentation theory: This theory suggests complete segmentation of the market
for specific maturity bonds. In this theory the interest rate curve may always slope upward
because longer bonds yield will generally be higher here. This theory differs interest rate of each
bond by the maturity and there will be no effect from expected returns for different maturities
bonds.
C) The liquidity premium theory: Liquidity means how quick an asset can be sold without
lowering price. The liquidity premium theory means that the bond holders favor extremely
volatile, short-dated assets that can easily be priced over long-dated ones. The curve of liquidity
premium of normally is upward slope but sometimes it may be downward slope or flat.
D) In the passage we can see that the curve in rising which means investors are getting paid
handsomely by the governments. We know that if the demand curve is rising that it indicates
liquidity premium theory. If the demand curve of the slope is in upward than there is high
demand because of that the price will be higher and they will earn more from government. That
is why I think the curve indicates the liquidity premium theory.

2) Answer:
A) Assume,
i =5%
t 1

t+1 1 r =5%

t+2 1 r =5%
For two-year bond interest rate,
(1+ti2)2= (1+ti1) (1+t+1r1)
(1+ti2)2= (1+5%) (1+5%)
(1+ti2)2= 1.1025
(1+ti2)2*1/2=1.10251/2
i = 1.10251/2-1
t 2

i = 5% (ans)
t 2

B) For three-year bond one year from now interest rate,

(1+ti3)3= (1+ti1) (1+t+1r1) (1+t+2r1)
(1+ti3)3= (1+5%) (1+5%) (1+5%)
(1+ti3)3= 1.1576
(1+ti3)3*1/3= 1.15761/3
i = 1.15761/3-1
t 3

i = 5% (ans)
t 3

3) Answer:
A) Bonds maturity means when a bond takes months or years to mature. Maturity affects another
aspect that is interest risk. The further the maturity of the bond, the higher the possibility that the
valuation of the bond may be influenced by increases in interest rate which may affect the price
of the bond.

B) (i) Here,
LP2= 0.0075
i = 5%
t 1

t+1 1 r = 5%
So,
(1+ti2)2= (1+ti2) (1+t+1r1) + LP2
(1+ti2)2= (1+5%) (1+5%) + 0.0075
(1+ti2)2= 1.11
(1+ti2)2*1/2= 1.111/2
i = 1.111/2-1
t 2

i = 5.35% (ans)
t 2
(ii) Here,
LP3= 0.0085
i = 5%
t 1

t+1 1 r = 5%

t+2 1 r = 5%
So,
(1+ti3)3= (1+ti1) (1+t+1r1) (1+t+2r1) + LP3
(1+ti3)3= (1+5%) (1+5%) (1+5%) + 0.0085
(1+ti3)3= 1.166125
(1+ti3)3*1/3= 1.1661251/3
i = 1.1661251/3-1
t 3

i = 5.26% (ans)
t 3

(iii) Here,
i = 5%
t 1

i = 5.35%
t 2

expected rate for one-year treasury bonds one year from now,
(1+ti2)2= (1+ti1) (1+t+1r1)
1+t+1r1= (1+ti2)2
(1+ti1)

t+1 1 r = (1+5.35%)2
-1
(1+5%)

t+1 1 r = 5.70% (ans)