ECO00076M Money and Banking 2021–22
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ECO00076M
MSc Degree Examinations 2021–22
Money and Banking
Question 1:
[20 Marks]
(a) Explain the major reasons for the existence of banks. [10 marks]
(b) The 1988 Basel Capital Accord (Basel I) requires that banks hold as capital at least 8% of their risk-weighted assets. Discuss how these assets are classified and what is the rationale behind these classifications. [10 marks]
Question 2:
[20 marks]
(a) Explain how the Bretton Woods System worked and what were its major problems. [10 marks]
(b) Discuss all possible causes and reasons for why the Federal Reserve System as the
US central bank is radically different from other central banks. [10 marks]
Question 3:
[30 marks]
A bank principal (she) wants to hire a bank manager (he) to manage an investment project. The manager can shirk or work diligently. He can exert two levels of unobservable effort, high and low, with costs ch = 100 and cl = 60. The output that can be observed is positively associated with effort and the high output is xh = 1, 000, 000 and the low output is xl = 100, 000. The probability of generating different outputs is also positively associated with effort and has the relation ph = 0.8 > pl = 0.4. The principal cannot observe the manager’s effort but can verify the output and decide that the salary depends on the output. Assume that the principal is risk-neutral. The manager has the utility function of u(x) = ^x for any payment x ≥ 0 with a dis-utility of zero for not working. Let sh be the salary associated with the high output and sl the salary associated with the low output.
(a) Formulate the problem as a constrained maximisation problem and explain the objec- tive function and the incentive-compatible constraints in detail. [15 marks]
(b) Derive the relationship between the two salaries sh and sl and calculate the two optimal salaries. [15 marks]
Question 4: [30 marks]
Consider a model of bank run. There are three periods (T = 0, 1, 2) and a single perfectly
divisible good. There is a unit mass of agents [0, 1]. Every agent is endowed with one unit
of the good at T = 0. If the good is invested in a bank at T = 0, it yields a return of 2 units
of the good if it is held until T = 2, but only 1 unit if the project is stopped in T = 1. Agents
can privately store their good at no cost. Ex ante, all agents are the same. Only at T = 1,
every agent learns his type. Type 1 is impatient and cares only about consumption at T = 1,
while type 2 is patient and wants to consume only at T = 2. Types are private information.
Every agent has the same utility function u(x) = 1 − 2北(1) for all x > 0. With probability 0.6
factor ρ = 0.6. Let c1 and c2 denote the consumption that an agent can possibly obtain at time T = 1 or 2, respectively.
Calculate the optimal allocation c1 and c2 that a competitive bank can offer to agents who deposit at T = 0 but consume at T = 1 or T = 2. Prove that 1 < c1 < c2 < 2.
The bank can make the following deposit scheme to all agents: If an agent deposits her initial endowment at the bank at T = 0, she can receive c1 when withdrawing at T = 1, and she can receive c2 when withdrawing at T = 2. Explain when and why a good equilibrium may occur and support the optimal allocation. Furthermore, explain when and why a bad equilibrium-a bank run-may happen. Finally, discuss how and why a bank run can be prevented when depositors are the shareholders of the bank.
2022-08-09