Question 1 : 8 points
Suppose the Bank of Canada made an announcement that it would purchase up to $500 billion of long term Canada bonds over the following six month. What effect might this policy has on the yield curve? Explain in detail.
During the current economic crisis caused by the Coronavirus, what would you expect the yiedd curve to look like? Upward sloping, flat, or inverted.Explain in detail.
Question 2 : 10 points
Assume Bank One has the following balance sheet items in millions of dollars:
Rate sensitive Asset $20m
Rate sensitive Liabilities $50m
Fixed Rate Assets $80m
Fixed Rate Liablities $40m
Capital$10m
Also assume the duration of the assets is 2 years and that of its liabilities is 3 years.
Assume that interest rates are initially 3%.
List the above information in a T account.
What is the income gap for the bank?
What will happen to the income of the bank if interest decreases by 1%? Explain using gap analysis
If the bank sells $10m of its fixed rate assets and replaces them with rate sensitive assets. What is the income gap for the bank?
After event (d) above, what will happen to the income of the bank if interest increases by 1%? Explain using gap analysis
If interest increases from 3% to4%calculate the change in the market value of the net worth as a percentage of total assets.
Question 3: 8 points
Bank A has the following balance sheet as December 31 2019:
Reserves $5m
loans $40m
Deposits $35m
Capital $10m
Net profit of the bank is $1.5m
List the above information in a T account.
Calculate the return on assets, the return on equity, and the equity multiplier.
Additional deposits of 5m were added and 3m of loans were offered to new clients. Reflect that in the T account and recalculate thereturn on assets, the return on equity, and the equity multiplier.
After actions “b” above, would you be willing to invest in this bank? Explain in detail.
Question 4: 8 points
Analyze each of the following statements and determine whether it is True, False, or Uncertain. Marking will be based entirely on the supporting arguments. Therefore, try to be thorough in your answers and base your discussion on the theories that have been reviewed in this course.
If the overnight rate is above its target for the day, the Bank of Canada will enter into Special Purchase and Resale Agreements (SPRAs) of sufficient volume to drive it down to its target.
Eurodollars are U.S. dollars issued by a European bank
A bank with a positive duration gap would experience a decrease in the market value of networth with rising interest rates.
For a given maturity, high coupon bonds have higher price volatility than low coupon bonds.
If you deposit a $50 cheque in the bank, before the cheque has cleared, the change in your bank’s balance sheet will be a $50 increase in cash items in the process of collection and a $50 increase in chequable deposits.
Last resort lending is no longer needed because the presence of Canadian Depository Insurance Corporation (CDIC) eliminates the presence of bank panics.
The supply curve for bonds has the usual upward slope, indicating that as the price increases, other things equal, quantity supplied increases.
If a corporate bond becomes less liquid, the interest on the bond will fall. As result of that interest rate of Government of Canada bond will rise.
Question 5: 8 points
The currency/deposit ratio (c) is 25% and the desired reserve ratio (r) is 15%. Bank of Canada moves $200m dollars worth of government deposits out of its books and into commercial banks.
Show the relevant accounting entries and indicate the size of the effect on the money supply.
Assume that the monetary base is $20m. Calculate the money supply. Calculate the effect on the money supply of a decrease in (c)to 10%
What is the appropriate response on the part of the central bank in order to offset the effects of the decrease in the currency/deposit ratio?
Question 6 : 10 points
Bank A has the following balance sheet as at December 31 2019:
Reserves $20m
Securities $40m
Loans $140m
Deposits $150m
Capital $50m.
List the above in a T account
If the required reserve is 10% calculate the excess reserve, if any
A client withdrew $10m. reflect this transation in the balance sheet. Calculate the new reserve. How much is the excess reserve if any?
If there is a reserve deficiency show the possible actions of the bank and wich one is most likely to take effect?
Assume that one of the clients of bank declared bankruptcy and $60m of loans were wiped out. Show the change in the balance sheet. Comment generally on the overall bank health.
Question 7: 8 points
Assume that no banks hold excess reserves, and the public holds no currency. If bank A sells a $100,000 security to the Bank of Canada, explain what happens to this bank and two additional steps in the deposit expansion process, assuming a 10 percent reserve requirement. How much do deposits and loans increase for the banking system when the process is completed?
Question 8: 8 points
You heard in the news that Bank of Canada has just lowered the policy overnight rate to 0.25% due to the economic catastrophy of Corornavirus.
Does this signal the Bank is moving to to more expansionary or contractionary monetary policy? Explain in detail.
In your opinion why did the bank lowered the policy overnight rate?
Question 9: 8 points
The Bank of Canada targests the value of overnight interest rate within it operating band. Explain, in detail, the actions of the Bank of Canada within the below two senarios:
If the overnight rate is trading above the target.
If the overnight rate is trading below the target.
Question 10: 8 points
Due to the current economic ciris caused by Corornvirus Bank of Canada lowered the reference overnight rate to 0.25%. What is the bank rate and what is the lending rate?
In normal times, the bank of Canada relies mainly on conventional monetary policy tool. But in times of crises, like the one in scenario in (a) above, convenestion monetary polic is not effective. In this case the Bank will adhere to the tools of non-convestion monetary policy. Explain in detail one of these tools.
Question 11: 8 points
The following is an extract of bonds from the Globe-investor website. The extraction didn’t go very well because there are some pricing errors. Without calculating the price of each bond, indicate which prices seem to be reported incorrectly, and explain why? All bonds have a face value of 100.
Bond
Price
CPN (%)
Yield (%)
A
96.7
3.00
1.04
B
102.3
4.00
0.9
C
106.12
2.00
2.62
D
102.5
2.5
1.40
E
110.15
2.5
3.06
F
118.67
8.4
3.53
Question 12: 8 points
The presence of asymmetric information in the financial system leads to adverse selection and moral hazard. Eexplain in detailwhat do we mean by asymmetric information, adverse selection and moral hazard?
How do you relate the government safety net “too big to fail” to asymmetric information? Explain in detail.
Sample Solution
