Money and Banking Chapter 2

Tutorial Answers: Chapter 2 3. Yes, because the absence of financial markets means that funds cannot be channeled to people who have the most productive use for them. Entrepreneurs then cannot acquire funds to set up businesses that would help the economy grow rapidly. 5. This statement is false. Prices in secondary markets determine the prices that firms issuing securities receive in primary markets. In addition, secondary markets make securities more liquid and thus easier to sell in the primary markets. Therefore, secondary markets are, if anything, more important than primary markets. 11. Yes, because even if you know that a borrower is taking actions that might jeopardize paying off the loan, you must still stop the borrower from doing so. Because that may be costly, you may not spend the time and effort to reduce moral hazard, and so the problem of moral hazard still exists.

Tutorial Answers: Chapter 4 2. No, because the present discounted value of these payments is necessarily less than $10 million as long as the interest rate is greater than zero. 5. $2,000  $100/(1  i)  $100/(1  i)2  . . .  $100/(1  i)20  $1,000/(1  i)20. 6. 25%  ($1,000 – $800)/$800  $200/$800  0.25. 15. The economists are right. They reason that nominal interest rates were below expected rates of inflation in the late 1970s, making real interest rates negative. The expected inflation rate, however, fell much faster than nominal interest rates in the mid-1980s, so nominal interest rates were above the expected inflation rate and real rates became positive.