EXAMINATION II for MONEY & BANKING  FALL 2000
Hints for full credit: Write legibly, in full sentences.  Answer essay questions with a minimum of one full paragraph.  For problems, show all work, and label all numbers with appropriate units.

ESSAYS (10 points each) :
1.  “Exchange rates are always and everywhere a monetary phenomenon.”  Assuming this statement is true, explain what it means in a short essay.
2.  Explain the role that banking regulations played in a) bank failures of the early 1930s and b) bank failures during the S&L crisis of the 1980s and 1990s.
3.  Explain the concept of financial disintermediation, and give two or three examples of the financial distermediation that occured in the 1970s and 1980s because of advances in information technology.
Be specific.

PROBLEMS:
1. (15 points total) 1 year zero coupon treasury securities are selling for \$947.87 in the U.S. and for £934.58 in the U.K. (assume 1000 face value in both dollars and pounds, and round interest rates to two decimal places).  The current ex-rate is \$1.58/£.
a.  calculate the one year returns (YTM) in the U.S. and in the U.K. for T-bills.
b. If interest rate parity holds, should the pound be selling at a forward discount or premium?  Why?
c. based on your answer in part b, and using the current spot rate, calculate the expected one year forward ex-rate (quote forward rates to four decimal places) if interest rate parity holds.
d. If interest rate parity does not hold and the actual one year forward rate is \$1.5642/£, calculate the actual forward discount or premium.  Using that forward discount or premium and the one year yields from part a, compare an American investor’s rate of return in the U.S. versus the U.K. (For the U.K. investment , assume the investor would use a forward contract to cover ex-rate risk.)
e.  Based on your answer to part d, explain what would happen to bond prices and interest rates in both the U.S. and U.K. to restore interest rate parity.

2.  (12 points total) You are given the following information on prices for zero coupon Treasury securities:
Maturity                      Price                Face Value
1 year                    \$947.87                  \$1000
2 years                   \$890.00                  \$1000
3 years                   \$827.85                  \$1000

a.  (4) Solve for the yields (spot rates) on these securities: R1, R2, R3.  Round to two decimal places (e.g. 4.00%, 4.50%, etc.)
b.  (4) Solve for the forward rates: f2 and f3.
c.  (4) Explain what the above yield curve and forward rates imply about the direction of future interest rates.

3.  (13 points total) You are given the following information on a typical S&L in the late1970s.
Assets:           Average Duration = 7.5 years               PV of Assets   =      \$500m
Liabililities:     Average Duration = 1.6 years               PV of Liabilities =  \$460m

a.  (7) Scenario 1: Using the above information, assume that interest rates rise by 4%.  What will happen to the bank’s value?

b.  (6) Scenario 2: Using the above information, assume there is a downward sloping yield curve, and the bank pays out an average of 15% on its deposits (liabilities) during a one year period and earns an average of 12% on its loan portfolio(assets) during that year.  What would be the bank’s annual net income in this situation?