TUTORIAL 1

OVERVIEW OF FINANCIAL SYSTEM

Part 1. Questions for review
1. What is the main function of financial markets?
 Performs the essential function of channeling funds from economic players
that have saved surplus funds to those that have a shortage of funds.
 Direct finance: borrowers borrow funds directly from lenders in financial
markets by selling them securities.
 Promotes economic efficiency by producing an efficient allocation of capital,
which increases production.
 Directly improve the well-being of consumers by allowing them to time
purchases better.

2. Classify financial markets

 Debt and Equity Markets
- Debt instruments (contractual agreement)
Maturity: the remaining time until the expiration date
- Equities (residual claims to net income and assets)
Dividends: periodic payment to shareholders
Residual claimant
 Primary and Secondary Markets
- The primary markets are not well known to the public.
 Investment banks underwrite securities in primary markets.
- The previously issued securities will be sold in the secondary market
 Brokers and dealers work in secondary markets.
 Exchanges and Over-the-Counter (OTC) Markets:
- Exchanges: NYSE, Chicago Board of Trade
- OTC markets: Foreign exchange, Federal funds
 Money and Capital Markets:
- Money markets deal in short-term debt instruments
 Short terms to maturity, least price fluctuations and least risky investment
- Capital markets deal in longer-term debt and equity instruments
 With maturities more than one year
 3. List and distinguish the differences among financial instruments
 U.S. Treasury Bills
- No interest payments but they are sold at a discounted price
- The most liquid instruments
 Negotiable Bank Certificates of Deposits
 Commercial Papers
 Repurchase Agreements
- With very short maturities
- Treasury bills serve as collateral (an asset that the lender will receive if the borrower
defaults)
 Fed Funds

4. Identify the differences among types of financial intermediaries (in terms of

primary liabilities and assets) using Table 3, page 40
Type of Intermediary Primary Liabilities Primary Assets (Uses of Funds)
(Sources of Funds)
Depository institutions (banks)
Commercial banks Deposits Business and consumer loans, mortgages, U.S.
government securities, and municipal bonds
Savings and loan associations Deposits Mortgages
Mutual savings banks Deposits Mortgages
Credit unions Deposits Consumer loans

Contractual savings institutions

Life insurance companies
Fire and casualty insurance
companies
Pension funds, government
retirement funds
Investment intermediaries
Finance companies
Mutual funds
Money market mutual funds
Hedge funds
Premiums from policies Corporate bonds and mortgages
Premiums from policies Municipal bonds, corporate bonds and stock,
and U.S. government securities
Employer and employee Corporate bonds and stock
contributions
Commercial paper, Consumer and business loans
stocks, bonds
Shares Stocks, bonds
Shares Money market instruments
Partnership participation Stocks, bonds, loans, foreign currencies, and
many other assets
Part 1. Multiple-choice questions
1. Evidence from the United States and other foreign countries indicates that
A. Money growth is clearly unrelated to inflation
B. There is a strong positive association between inflation and growth rate of
money over long periods of times
C. Countries with low monetary growth rate tend to experience higher rates of
inflation, all else being constant
D. There is a little support for the assertion that “inflation is always and
everywhere a monetary phenomenon”

2. Economists group commercial banks, saving and loans associations, credit

unions, mutual funds, mutual savings banks, insurance companies, pension funds
and finance companies under the heading financial intermediaries. Financial
intermediaries:
A. produce nothing of value and therefore a drain on society’s resources
B. provide a channel for linking between those who want to save and those who
want to spend
C. can hurt the performance of the economy
D. have been a source of slow and resistant financial innovation

3. What is the basic activity of banks?

A. To sell shares of corporations to the general public
B. To facilitate the transfer of money from savers to borrowers
C. To represent the interest of insurance companies
D. To ensure everyone who wants a loan gets one
E. To equate future consumption with current consumption

4. Banks, savings and loans associations, mutual savings banks and credit unions
A. are no longer important players in financial intermediation
B. have been adept at innovating in response to changes in regulatory
environment
C. produce nothing of value and therefore a drain on society’s resources
D. since deregulation now provide services only to small depositors
5. Why are financial markets important to the health of the economy?
A. They channel funds from investors to savers
B. They identify and shut down inefficient firms
C. They eliminate the needs for financial intermediaries
D. They allow consumers to time their purchase better

6. These financial institutions are very small cooperative lending institutions

organized around a particular group: union members, employees of a firm and so
forth. They acquire funds from deposits called shares and primarily make
consumer loans. They are
A. Credit unions
B. Commercial banks
C. Savings and loan associations
D. Mutual fund

7. These financial intermediaries raise funds primarily by issuing checkable

deposits, savings deposits and time deposits. They then use these funds to make
commercial, consumer and mortgage loans, and to buy US government securities
and municipal bonds. They are
A. Credit union
B. Commercial bank
C. Savings and loan
D. Mutual fund

8. These instruments are typically overnight loans between banks of their deposits
at Federal Reserve.
A. Commercial paper
B. Treasury bills
C. Repurchase agreement
D. Federal Funds
E. Banker’s acceptances

9. Short-term debt instruments issued by large banks and well-known corporations

 A. Commercial paper
B. Treasury bills
C. Repurchase agreement
D. Federal Funds
E. Banker’s acceptances

10. These instruments are effectively short-term loans (usually with maturity of less
than two weeks) for which Treasury bills serve as collateral, which the lender
receives if the borrower does not pay back the loan.
A. Commercial paper
B. Treasury bills
C. Repurchase agreement
D. Federal Funds
E. Banker’s acceptances

11. A share of Microsoft common stock is:

A. a liability to the shareholder because it must be sold to realize a capital gain
B. an asset of Microsoft because it allows Microsoft to invest in capital
equipment or other companies
C. identical to a bond issued by Microsoft
D. an asset for its owner and a liability for Microsoft.

12. A share of  common stock is a claim on a corporation’s

A) debt.
B) liabilities.
C) expenses.
D) earnings and assets.
Being called the residual claimant.
Shareholders/ equity holder:
- Ownership
- Cash: dividends and capital gains.
NI earnings -> pay for the dividends, and the rest reinvest into assets of the firms
to get higher share price in the market -> raise the capital gains.
13. The price  paid  for the rental  of borrowed funds (usually expressed as a perce
ntage of the rental of $100  per year) is commonly referred to as the
A) inflation rate.
B) exchange rate.
C) interest rate.
D) aggregate price level.

14. ___________ occurs when the potential borrowers who are the most likely to
produce an undesirable (adverse) outcome – the bad credit risks – are the ones who
most actively seek out a loan and are thus most likely to be selected.
A. Adverse selection
B. Asymmetric information
C. Moral hazard
D. Credit ratings
Before the transaction: Asymmetic information- inefficient market
- Adverse selection: happen before the transaction
 Information discloser (transparency of the information market.
- Moral hazard: happen after the transaction
 Put some of the covernant on the borrowing contract.

15. A situation where one party often does not know enough about the other party
to make accurate decisions
A. Adverse selection
B. Asymmetric information
C. Moral hazard
D. Credit ratings

16. A situation where the borrower might engage in activities that are undesirable
from the lender’s point of view because they make it less likely that the loan will be
paid back.
A. Adverse selection
B. Asymmetric information
C. Moral hazard
 D. Credit ratings

17. Which of the following is a true statement?
A. Money or the money supply is defined as Federal Reserve notes.
B. The average price of goods and services in an economy is called the aggregate
price level
C. The inflation rate is measured as the rate of change in the federal government
budget deficit.
D. The aggregate price level is measured as the rate of change in the inflation rate
.
18. Equity  holders are a  corporationʹs ________.  That means the corporation m
ust pay all  of its debt holders before it pays its equity holders.
A. debtors
B. brokers
C. residual claimants
D. underwriters

19. A corporation  acquires new funds only when  its  securities are sold in the

A. secondary market by an investment bank.
B. primary market by an investment bank.
C. secondary market by a stock exchange broker.
D. secondary market by a commercial bank.

20. Which of the following statements about financial markets and securities is tr
ue?
A. Many common stocks are traded over-the-counter, although the largest
corporations usually have their shares traded at organized stock exchanges
such as such as the New York Stock Exchange.
B. As a corporation gets a share of the brokerʹs commission, a corporation
acquires new funds whenever its securities are sold.
C. Capital market securities are usually more widely traded than shorter-term
securities and so tend to be more liquid.
D. Because of their short term to maturity, the prices of money market
instruments tend to fluctuate widely.
Part 2: Questions and applications
Question 3: Give at least three examples of a situation in which financial markets
allow consumers to better time their purchases.
 The purchase of a durable good, like a car or furniture.
 Paying for tuition.
 Paying the cost of repairing a flooded basement.
In all three cases, consumers were able to pay for a good or service (education or the
reparation of a flooded basement) without having to wait to save enough and only
then being able to afford such goods and services.

Question 4: If you suspect that a company will go bankrupt next year, which would
you rather hold, bonds issued by the company or equities issued by the company?
Why?
You would rather hold bonds, because bondholders are paid off before equity holders,
who are the residual claimants.

Question 6: Describe who issues each of the following money market

instruments:--> short term
a. Treasury bills--> govt securities issued by treasury--> depend on govt spending
b. Certificates of deposit--> issued by banks
c. Commercial paper--> issued by bank, well known corporation
d. Repurchase agreement--> Repo
e. Fed funds-> Fed fund rate

Question 10: How does risk sharing benefit both financial intermediaries and
private investors?
 Financial intermediaries benefit by carrying risk at relatively low transaction
costs. Since higher risk assets on average earn a higher return, financial
intermediaries can earn a profit on a diversified portfolio of risky assets.
 Individual investors benefit by earning returns on a pooled collection of assets
issued by financial intermediaries at lower risk. Risk to individual investors is
lowered through the pooling of assets by the financial intermediary.
 TUTORIAL 2
MONEY AND INTEREST RATES

Part 1: Review questions

1. Definition of money, measuring money
Money – payment for goods and services or repayment of debts – a board
definition
Money (a stock concept) is different from:
– Wealth: the total collection of pieces of property that
serve to store value
– Income: flow of earnings per unit of time
(a flow concept)
Measuring money: Monetary aggregates using the concept of
liquidity:
- M1 (most liquid assets) = currency + traveler’s checks + demand deposits +
other checkable deposits
- M2 (adds to M1 other assets that are not so liquid) = M1 + small denomination
time deposits + savings deposits and money market deposit accounts + money
market mutual fund shares
2. Distinguish major credit types, provide examples
Checks: an instruction to your bank to transfer money
from your account
• Electronic Payment (e.g. online bill pay)
• E-Money (electronic money):
– Debit card
– Stored-value card (smart card)
– E-cash
3. Relationship between YTM and bond prices
Yield to maturity has negative rela. with current bond price
4. Yield and returns
The return equals the yield to maturity only if the holding period equals the
time to maturity.

Part 1: Revision:
1. Definition of money, measuring money.
Money – money supply (not cash)
- Commodity money.
- Fiat money
- Checks.
- Electronic payment.
- E- money.
Measure money by liquidity.
- M1: most liquid assets: currency + traveler’s checks + demand deposits +
other checkable deposits.
 - M2: M1 + small denomination time deposit + saving deposits and money
market deposit account + money market mutual funds shares.
2. Distinguish major credit types, provide examples:
Loans:
- Simple loan: pay interest and principal at the maturity of the loan
- Fixed payment loan: pay same amount of cash periodically eg:
amortization
- Coupon bond: pay coupon periodically and principal at the maturity.’=
- Discounted bond: pay only principal at the maturity.( chỉ áp dụng cho
short-term bonds vì long term mang đến nhiều rủi ro may be bankrupt).

Part 2: Multiple choice questions

1. Fiat money is:

A. credit card charges
B. not convertible into precious metals.
C. coins
D. checks

2. Which of these is not a function of money in an economy?

A. Unit of account
B. Source of income
C. Store of value
D. Medium of exchange

3. Which of the following is not part of M1?

A. traveler's checks
B. savings accounts
C. checking accounts
D. currency

4. If Mary deposits $100 of her currency in her checking account, then:

A. M2 will fall by $100.
B. M1 will increase by $100.
C. M1 and M2 will not change.
D. M2 will increase by $100.

5. If Mary moves $100 from her savings account (decrease 100 in M2) to her
checking account ( increase 100 in M1), then:
A. M2 will not change.
B. M2 will fall by $100.
C. M1 will not change.
D. M1 will fall by $100

6. Inefficiencies that are created when using checks as money include:

A. Checks can transfer funds slowly and require paper shuffling.
B. Checks can be written for any amount.
C. Checkbooks can be stolen.
D. There are too many bad checks written
7. The liquidity of an asset is:
A. the amount of an asset sold at discount or premium.
B. the ability of an asset to earn interest income.
C. the relative ease with which an asset can be converted into a medium of
exchange.
D. the relative ease with which an asset can be converted into a common
stock.

8. Which of the following is true regarding money's store of value function?

A. money is superior to all other stores of value during periods of inflation.
B. money is the most liquid store of value available.
C. money is the only store of value available.
D. money does not allow a person to hold purchasing power from the time
income is earned until it is spent.

9. Which of the following is not a disadvantage of electronic money?

A. The cost of setting up a system for processing e-money payments is high.
B. People are concerned about the privacy and security of e-money
transactions.
C. E-money does not allow people to take advantage of float.
D. E-money transactions cost more than paper check transactions.

10. You receive a check for $100 two years from today. The discounted present
value of this $100 is:
A. $100*(1+i)
B. $100/(1+i)2
C. $100*(1+i)2
D. $100/(1+i)

11. Why do current prices on previously issued bonds offered for resale change
when the market interest rate changes?
A. Because old bonds cannot sell at face value today.
B. Because no buyer of bonds today will accept a lower yield to maturity
than the market rate, and no buyer will be able to get a higher yield.
C. Because the marketplace does not provide enough information to price
bonds accurately.
D. Because new bonds are always preferred to old bonds.

12. If a bond sells at a premium, where price exceeds face value, then we would
expect to see:
A. market interest rates could be the same, higher, or lower than the coupon
rate.
B. market interest rate the same as the coupon rate.
C. market interest rates below the coupon rate.
D. market interest rates above the coupon rate.
YTM >C -> P <FV -> selling at discount
YTM = C -> P=FV -> selling at par.
YTM < C -> P > FV -> selling at premium
13. As bond prices increase:
A. yields to maturity decrease.
B. yields to maturity increase.
C. yields to maturity can rise, fall, or not change.
D. yields to maturity do not change.

14. For a $1000 one year discount bond with a price of $975, the yield to maturity
is
A. ($1000 – $975)/($1000)
B. $975/$1000
C. ($1000 – $975)/$975
D. $1000/$975

15. The return on a bond is

A. current yield + rate of capital gain.
B. coupon rate – rate of capital gain.
C. coupon rate + rate of capital gain.
D. current yield – rate of capital gain
interest rate risk: worry that interest rate will go up -> affect more on the long term
bond.
Rollover risk: worry that interest rate will go down

16. Interest rate risk is:

A. the risk the coupon rate on the bond will fall.
B. the risk the government or firm will not make interest payments.
C. the risk associated with change in return with changes in interest rates.
D. the risk the coupon payment will rise.

17. The real interest rate is:

A. the nominal rate plus the expected inflation rate.
B. the nominal interest rate/the CPI.
C. the product of the nominal rate and the CPI.
D. the nominal rate minus the expected inflation rate

18. For a coupon bond, the yield to maturity is the:

A. difference between the bond's price and its face value.
B. annual interest payment divided by the bond's face value.
C. interest rate that equates the bond's present value with its price.
D. interest rate that equates the bond's present value with its face value.

19. When interest rates fluctuate, which bonds will experience the least price
volatility?
A. 20-year bonds
B. 1-year bonds
C. 5-year bonds
D. 10-year bonds
20. Why is the Rate of Return often the most relevant measure of a bond's
benefit to the buyer?
A. Because the Rate of Return uses the current yield.
B. Because the Rate of Return includes the return of the face value at
maturity.
C. Because the Rate of Return uses the difference between the face value
and the purchase price to compute a capital gain on the bond.
D. Because the Rate of Return recognizes that many bond buyers do not
plan to hold to maturity, but will sell the bond before maturity.

21. If a $5,000 coupon bond has a coupon rate of 13 percent, then the coupon
payment every year is
A) $650. ($5000x13%)
B) $1,300.
C) $130.
D) $13.

22. Examples of discount bonds include
A) U.S. Treasury bills.
B) corporate bonds.
C) U.S. Treasury notes.
D) municipal bonds.

23.Economists consider the ________ to be the most accurate measure of interest
rates
A) simple interest rate.
B) current yield.
C) yield to maturity.
D) real interest rate.

24.If the amount payable in two years is $2420 for a simple loan at 10 percent
interest, the loan amount is
A) $1000.
B) $1210.
C) $2000.(2420/ (1+10%)^2)
D) $2200.

25.If $22,050 is the amount payable in two years for a $20,000 simple loan made t
oday, the interest rate is
A) 5 percent. (20000=22050/(1+X%)^2) => X=5
B) 10 percent.
C) 22 percent.
D) 25 percent

26.If a security pays $110 next year and $121 the year after that, what is its yield 
to maturity if it sells for $200?
A) 9 percent
B) 10 percent (110/(1+X) = 121/(1+X)^2 => X=0.1)
C) 11 percent
D) 12 percent
27.The price of a coupon bond and the yield to maturity are ________ related; th
at is, as the yield to maturity ________, the price of the bond ________.
A) positively; rises; rises
B) negatively; falls; falls
C) positively; rises; falls
D) negatively; rises; falls
.
28. Which of the following $5,000 face-value securities has the highest
yield to maturity?
A) A 6 percent coupon bond selling for $5,000
B) A 6 percent coupon bond selling for $5,500
C) A 10 percent coupon bond selling for $5,000
D) A 12 percent coupon bond selling for $4,500

29. In which of the following situations would you prefer to be the lender?
(Fisher effect)
A) The interest rate is 9 percent and the expected inflation rate is 7 percent.
B) The interest rate is 4 percent and the expected inflation rate is 1 percent.
C) The interest rate is 13 percent and the expected inflation rate is 15 percent.
D) The interest rate is 25 percent and the expected inflation rate is 50 percent.

30. In which of the following situations would you prefer to be the borrower?
A) The interest rate is 9 percent and the expected inflation rate is 7 percent.
B) The interest rate is 4 percent and the expected inflation rate is 1 percent.
C) The interest rate is 13 percent and the expected inflation rate is 15 percent.
D) The interest rate is 25 percent and the expected inflation rate is 50 percent.

Part 3: End-of-chapter questions

Chapter 3: Questions 12, 13, 15
Question 12: Explain the concept of liquidity. Rank the following assets from most
liquid to least liquid:
a. Land 5
b. The inventory of a merchandiser 6
c. Cash in hand 1
d. A savings account at a local bank 3
e. A one-year bond 2
f. Ordinary shares 4

Question 13: Which of the Federal Reserve’s measures of the monetary aggregates—
M1 or M2—is composed of the most liquid assets? Which is the larger measure?
M1 – the most liquid assets
M2 – the larger measure

Question 15: For each of the following assets, indicate which of the monetary
aggregates (M1 and M2) includes them:
a. Currency M1&M2
b. Money market mutual funds M2
c. Small-denomination time deposits M2
d. Checkable deposits M1&M2
Chapter 4: Questions 2, 6, 7, 10, 11
Question 2: What is the formula used to calculate the yield to maturity on a 20-year
coupon bond with a current yield of 12% and $1,000 face value that sells for $2,500.
$2,500 = $120/(1 + i) + 120/(1 + i)^2 + . . . + 120/(1 + i)^20 + $1,000/(1 + i)^20.
Solving for i gives the yield to maturity.

Question 6: If mortgage rates rise from 5% to 10% but the expected rate of increase
in housing prices rises from 2% to 9%, are people more or less likely to buy houses?
People are more likely to buy houses because the real interest rate when purchasing a
house has fallen from 3% (5-2%) to 1% (10-9%) and is thus lower, even though
nominal mortgage rates have risen. (If the tax deductibility of interest payments is
allowed for, then it becomes even more likely that people will buy houses.)
Question 7: When is the current yield a good approximation of the yield to maturity?
The current yield will be a good approximation to the yield to maturity whenever the
bond price is very close to par or when the maturity of the bond is over about ten
years. This is because cash flows farther in the future have such small present
discounted values that the value of a long-term coupon bond is close to a perpetuity
with the same coupon rate.
Question 10: True or False: With a discount bond, the return on the bond is equal to
the rate of capital gain.
True. The return on a bond is the current yield iC plus the rate of capital gain, g. A
discount bond, by definition, has no coupon payments, thus the current yield is always
zero (the coupon payment of zero divided by current price) for a discount bond.
Question 11: If interest rates decline, which would you rather be holding, long-term
bonds or short-term bonds? Why? Which type of bond has the greater interest-rate
risk?
You would rather be holding long-term bonds because their price would increase
more than the price of the short-term bonds, giving them a higher return. Longer-term
bonds are more susceptible to higher price fluctuations than shorter-term bonds, and
hence have greater interest-rate risk.

Part 4: Additional problems

1. You have just purchased a 10-year, $1,000 par value bond. The coupon rate on
this bond is 8 percent annually, with interest being paid each 6 months. If you
expect to earn a 10 percent yield on this bond, how much did you pay for it?

FV

2. Callaghan Motors ‘bonds have 10 years remaining to maturity. Interest is paid

annually, they have a $1,000 par value, the coupon interest rate is 8%, and the
yield to maturity is 9%. What is the bond’s current market price?

PV factor of sum = (1+i)^-n = (1+9%)^-10 =1.09^-10 = 0.4224

 PV factor of annuity = 1 - (1+i)^-n / i = 1 - (1+9%)^-10 / 9% = 1 - 0.4224 / 9%
= 0.5775 / 9% = 6.417

= PV factor of Sum * Par Value + PV factor of annuity * coupon payment

= 0.4224 * 1,000 + 6.417 * 80 = 422.4 + 513.3 = 935.76

3. 3. A bond has a $1,000 par value, 10 years to maturity, and a 7% annual

coupon and sells for $985.
a. What is its yield to maturity (YTM)?
The YTM is the discounting rate that will make the Present Value of
interest and principal equal to the price today.
b. Assume that the yield to maturity remains constant for the next 3 years.
What will the price be 3 years from today?
N=10, PV= -$985, FV=$1,000, PMT=$70
Par value= bond price => YTM = coupon rate
 P=