Midterm2Solutions_mb_sp09 - Money and Banking(Spring 2009...

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1 Money and Banking (Spring 2009) Midterm Exam #2 April 13, 2009 Aditi Thapar Name _______________________________________ NetID _________________________ Do not open exam until you have been given permission to do so. Please Note: 1. There are two parts to the exam. Part 1: short answer 4 questions Part 2: fill-in-blank 4 questions 2. Answer all of the questions. In some cases partial answers may receive some credit. Blank answers will not. 3. The explanation is a very important part of the short answer questions. Better explanations will re- ceive more points. 5. NO credit will be given for just stating the correct answer. A correct answer accompanied by a completely wrong explanation will not get any credit either. 6. The academic conduct code of the College of Arts and Sciences will be strictly enforced. 7. Grades will be posted on Course Compass. 8. Graphing calculators are not allowed. NO RECITATION THIS WEEK
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2 PART 1: SHORT ANSWERS 1. Explain in one or two sentences how money serves as a medium of exchange. Briefly explain what happens to this function of money during a hyperinflation and why? ANSWER a. (5 points) A medium of exchange is an accepted means of payment for trade of goods and services. So, sellers have to be willing to accept the money from the buyers in return for giving up the item. This requires trust on the part of the sellers that later, other also will be willing to ac- cept the money in exchange for goods. b. (5 points) (3 points) Hyperinflation occurs when the inflation rate exceeds 50% per month. So, in these situations, sellers do not want to accept money in return for goods, because the money loses its value very quickly. (2 points) Thus, money ceases to be a viable medium of exchange for the economy. The monetary system is replaced by the barter system or another foreign currency. Goods are not bought and sold due to problems related to the requirement of a double coincidence of wants. Output falls. 2. Suppose markets were expecting the Fed to cut interest rates by 50 basis points (0.5%). After the FOMC meeting it is announced that the Fed cut rates by 25 basis points. Holding everything else constant and assuming markets are efficient, how do you think this action affected stock prices? Explain briefly. ANSWER (3 points) Since markets are efficient, the original expected interest rate cut was already factored into stock prices. Thus, when the Fed cuts interest rates less than expected, we have an effective increase in the interest rate. Thus, the required return to equity ݇ increases. (2 points)
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This note was uploaded on 11/14/2011 for the course ECON V31.0231â taught by Professor Aditi during the Fall '11 term at NYU.

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Midterm2Solutions_mb_sp09 - Money and Banking(Spring 2009...

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