PART THREEAnswers to End-of-Chapter Problems Not Answered in Textbook57Chapter 1 Why Study Money, Banking, and Financial Markets?7.The basic activity of banks is to accept deposits and make loans.9.The interest rate on three-month Treasury bills fluctuates more than the other interest rates and is lower on average. The interest rate on Baa corporate bonds is higher on average than the other interest rates.11.Higher stock prices means that consumers wealth is higher and so they will be more likely to increase their spending.13.It makes British goods more expensive relative to American goods. Thus American businesses will find it easier to sell their goods in the United States and abroad and the demand for their products will rise.15.When the dollar increases in value, foreign goods become less expensive relative to American goods; thus you are more likely to buy French-made jeans than American-made jeans. The resulting drop in demand for American-made jeans because of the strong dollar hurts American jeans manufacturers. On the other hand, the American company that imports jeans into the United States now finds that the demand for its product has risen, so it is better off when the dollar is strong.58 Mishkin The Economics of Money, Banking, and Financial Markets, Eighth Edition Chapter 2 An Overview of the Financial System2.Yes, I should take out the loan, because I will be better off as a result of doing so. My interest payment will be $4,500 (90% of $5,000), but as a result, I will earn an additional $10,000, so I will be ahead of the game by $5,500. Since Larrys loan-sharking business can make some people better off, as in this example, loan sharking may have social benefits. (One argument against legalizing loan sharking, however, is that it is frequently a violent activity.)4.The principal debt instruments used were foreign bonds which were sold in Britain and denominated in pounds. The British gained because they were able to earn higher interest rates as a result of lending to Americans, while the Americans gained because they now had access to capital to start up profitable businesses such as railroads.6.You would rather hold bonds, because bondholders are paid off before equity holders, who are the residual claimants.10.They might not work hard enough while you are not looking or may steal or commit fraud.12.True. If there are no information or transactions costs, people could make loans to each other at no cost and would thus have no need for financial intermediaries.14.A ranking from most liquid to least liquid is (a), (b), (c), and (d). The ranking is similar for the most safe to the least safe.Part Three: Answers to End-of-Chapter Problems Not Answered in Textbook 59Chapter 3 What is Money?1.(b)3.Cavemen did not need money. In their primitive economy, they did not specialize in producing one type of good and they had little need to trade with other cavemen.5.Wine is more difficult to transport than gold and is also more perishable. Gold is thus a better store of value than wine and also leads to lower transactions cost. It is therefore a better candidate for use as money.7.Not necessarily. Checks have the advantage in that they provide you with receipts, are easier to keep track of, and may make it harder for someone to steal money out of your account. These advantages of checks may explain why the movement toward a checkless society has been very gradual.8.The ranking from most liquid to least liquid is: (a), (c), (e), (f), (b), and (d).10.Because of the rapid inflation in Brazil, the domestic currency, the real, is a poor store of value. Thus many people would rather hold dollars, which are a better store of value, and use them in their daily shopping.14.(a) M1 and M2, (b) M2, (c) M2, (d) M1 and M2.60 Mishkin The Economics of Money, Banking, and Financial Markets, Eighth Edition Chapter 4 Understanding Interest Rates2.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.4.The yield to maturity is less than 10 percent. Only if the interest rate was less than 10 percent would the present value of the payments add up to $4,000, which is more than the $3,000 present value in the previous problem.6.25% ($1,000 $800)/$800 $200/$800 0.25.8.If the interest rate were 12 percent, the present discounted value of the payments on the government loan are necessarily less than the $1,000 loan amount because they do not start for two years. Thus the yield to maturity must be lower than 12 percent in order for the present discounted value of these payments to add up to $1,000.10.The current yield will be a good approximation to the yield to maturity whenever the bond price is very close to par or when the maturity of the bond is over ten years.12.You would rather be holding long-term bonds because their price would increase more than the price of the short-term bo