What are the four main areas of finance? Give a brief definition of each.

1 INCT571 FinanceforInternationalTradeFall2020HW1

1.(10 points) What are the four main areas of finance? Give a brief definition of each. 2.(10 points) Define “money market” and “capital market” and give an example of a security that trades in each. 3.(10 points) Provide definitions for capital budgeting, capital structure, and working capital management. 4.(10 points) Define the term “limited liability” and state why you think it is an important feature of the corporate form of organization. 5.(10 points) Describe the principal-agent relationship. In your answer, give an example of how a principal-agent problem arises in the corporate world. Can such a problem become costly? Explain. 6.(5 points) How do regulators help to ensure the soundness of financial intermediaries? 7.(10 points) Explain the three main areas of the balance sheet of a company. 8.(5 points) Your favorite uncle advises you to purchase long-term bonds because their interest rate is higher than that of short-term bonds. Should you follow his advice? 9.(5 points) Would it make sense to buy a house when mortgage rates are 14% and expected inflation is 15%? Explain your answer. 10.(5 points) What is the impact on interest rates when the central bank decreases the money supply by selling bonds to the public?

2 11.(5 points) Use demand and supply analysis to explain why an expectation of an increase in central bank’s policy rate would cause the bond prices to fall. 12.(5 points) Which economic variable measures the opportunity cost of holding money? 13.(5 points) What is the national income identity for a closed and an open economy? Discuss the values of private saving in closed and open economies. 14.(5 points) What are the three types of transactions between the residents of different countries? 15.(5 points) Why is it useful to make a distinction between debt and equity instruments? 16.(5 points) Who are the main actors in the international capital market? 17.(10 points) Describe the role of offshore banking and of offshore currency (eurocurrencies) trading. 18.(5 points) Explain what Eurocurrencies are and why they are significant. 19.(10 points) “It is in the interest of each depositor to withdraw her money from a bank if all other depositors are doing the same, even when the bank’s assets are sound.” Discuss. As part of your answer clearly state whether the statement is true or false. 20.(10 points) Does the interest rate parity hold in each of the following cases? In case it does not hold, calculate the risk premium. A. Rt = 5, Rt* = 3, Et = 5, Eet+1 = 7 B. Rt = 6, Rt* = 3, Et = 5, Eet+1 = 7 C. Rt = 7, Rt* = 3, Et = 5, Eet+1 = 7 D. Rt = 8, Rt* = 3, Et = 5, Eet+1 = 7 E. Rt = 5, Rt* = 4, Et = 5, Eet+1 = 7 F. Rt = 5, Rt* = 5, Et = 5, Eet+1 = 7 G. Rt = 5, Rt* = 6, Et = 5, Eet+1 = 7 H. Rt = 5, Rt* = 3, Et = 6, Eet+1 = 7 I. Rt = 5, Rt* = 3, Et = 7, Eet+1 = 7 J. Rt = 5, Rt* = 3, Et = 8, Eet+1 = 7 K. Rt = 5, Rt* = 3, Et = 5, Eet+1 = 8 L. Rt = 5, Rt* = 3, Et = 5, Eet+1 = 9 M. Rt = 5, Rt* = 3, Et = 5, Eet+1 = 10

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