Test 2: SET A (20 marks)

1.)

2.)a.) Suppose investors prefer one year bonds to two year bonds and will purchase a two year bond
only if they expect to receive an additional 2 percent over the return from holding one year bonds.
Currently one year bonds yield 6 percent, but investors expect the yield to fall to 2 percent next year.
(i) Which of the three models of term structure is relevant in this case? (2 marks)
(ii) What is the yield on a two year bond? (2 marks)
(iii) Is the yield curve upward sloping, flat or downward sloping? (1 mark)
OR
2 b.) Discuss the causes and consequences of financial crisis (5 marks)

Test 2: SET B (20 marks)

1.) Why was there a need to move from base rate lending system to MCLR system? Discuss in this
context the effectiveness of MCLR system in improving the transmission effects of monetary
policy. (10 marks=5+5)
2.) Banks that issue car loans require a much larger down payment on a used car than on a new one.
Furthermore, interest rates on used car loans are higher than rates on new cars. Why? (explain also with
figure) (5 marks)
3.) A.) State how the expectation hypothesis and segmented market hypothesis are extreme versions of
the preferred habitat hypothesis. How do all these hypotheses explain the shape of the yield curves?
(5 marks)
OR
B.) Explain the risk/ return profile of counterparties in an interest rate swap transaction (5 marks).
 Answers: Set A

1. Unit 2 Baye and Jansen chapter 5 (slide set 2)

2.

2 b.) Unit 2 slide set 1 (plus additional notes provided on sept. 26 on classroom group).

Answers: Set B

1.) Unit 3 slide set 2

2.)
3.) Unit 3 (slide set 1)
OR
4.) Unit 2 slides of chapter 30 Fabozzi (8-11) or directly textbook example.