•  This examination requires the use of a combination of discursive material, diagrams, and/or mathematical expressions.

•  You must type your solutions in Word adding hand-written diagrams or equations by photographing and embedding such material in your document. Diagrams may be placed at the end of the document, but must be properly labelled and clearly referenced in the    text. Word documents can then be saved in pdf format for submission if preferred.

•  Only one document may be submitted. This can be in Word or pdf format.

•  You are advised that your final script should not exceed 4,000 words in length. It is expected to be shorter than this allowing for other types of material (diagrams, equations). In writing your answers, bear in mind you can provide a good answer by being succinct and using fewer words. Long answers are unlikely to be good answers in this context.

•  You are advised that this examination is designed to take no longer than 4 (four) hours to complete. Part A consists of 4 Questions, and it is in the format of your final examination. It is designed to take no longer than 3 (three) hours to complete and the word limit should be 3,000 words. Part B should take you no more than 1 (one) hour to   complete and the word limit is set at 1,000 words.

•  Normal University rules on academic misconduct apply. Academic misconduct includes, but is not restricted to the presentation of the work of others as though it is your own, and making your own work available to others.

•  The grade of your mid-term assessment will be calculated as: (grade in Part A)*0.75 + (grade in Part B)*0.25.

•  Submission deadline: Wednesday, March 22, 2023, 12:00pm; submission point in the Assignment Submission section in your module’s Blackboard page (Turnitin).

PART A

QUESTIONS

1.   a) Using the demand/supply framework for bonds and the market for gold framework, describe the implications of an increase in expected inflation on interest rates on bonds and the price of gold. Draw the necessary graph(s). (17 marks)

b) Assume that consumers’ marginal propensity to consume decreases. Explain the impact to the interest rates on bonds, using the market for bonds framework, and draw the necessary graph(s). (8 marks)

2.   a) Describe the implications of an increase in the money supply on interest rates through the income effect introduced by Friedman. Draw the necessary graph(s). (18 marks)

b) Consider the Friedman’s modifications to the liquidity preference framework. Assuming that the liquidity effect is smaller than the other effects and that the adjustment of expected inflation is quite slow, should short-sighted policy-makers increase or decrease the money supply growth rate if they want to decrease interest rates? Explain your answer. (7 marks)

3.   a)  Assume a simultaneous open market purchase of E100 million from the Bank of England and a repayment of a discount loan of E5 million from Bank A to the Bank of England. Show the overall change in their balance sheets and discuss the implications for the monetary base. If the currency ratio is 0.6, the excess reserves ratio is 0.3, and the required reserve ratio is 0. 1, compute the change in the money supply and comment on your result. If the Bank of England would prefer the money supply to change by the amount it would have if it was not for the repayment of the discount loan, how much the Bank of England needs to change the required reserve ratio? (18 marks)

b) Assume a reduction in the supply of thirty-year UK government bonds. Explain whether this will affect their yields, assuming that (i) the expectations theory of the term structure is valid; and (ii) the liquidity premium theory of the term structure is valid. (7 marks)

4.   a) Explain how the free-rider problem emerges in both asymmetric information problems in financial markets and how financial intermediaries can deal with this problem. (18 marks)

b) Suppose a common share pays a dividend of E2 which the investor is expected to receive immediately. The dividend is expected to grow by 5% per year and the investor has a required rate of return of 8%. What should be the price of the stock according to the Gordon Growth model? If the market price at the moment is E65, will you buy this share? If you do buy the share at the market price, what is your expected return? Is it lower or greater than your required return? (7 marks)