# What are the three causes for the emergence of the shadow banking system?

## ECON 2411: Principles of Money and Banking

ECON 2411: Principles of Money and Banking

Question
ECON 2411: Principles of Money and Banking

Instructor: Hoonsik Yang

Problem Set 2 – Fall 2015Instructions

• Partial credit will be given provided you show intermediate steps and are solving parts of the problem

correctly
.

• Due: 10/30 Friday at 3:30PM; Please refer to the syllabus for the late penalty
.

• Double check if you have written your name
.

Questions

1
. (10 points)

(a) The current price of a stock is \$70
. If dividends are expected to be \$1 per share for the next four

years, and the required return is 20%, then what should be the price of the stock be in 4 years

when you plan to sell it?

(b) Next day, you heard a commentary from ECONOMICS channel saying that due to the unexpected

success of the ﬁrm’s investment, the dividends are expected to be \$2 per share for the next four

years (and it did not change the expected dividends after that four years)
. What will be the price

of this stock now if rational expectation theory is right?

2
. (10 points) What speciﬁc procedures do ﬁnancial intermediaries use to reduce asymmetric information

problems in lending? Explain three of them
.

3
. (10 points) The proﬁts from your asset portfolio depends on how your fund manager works
.

Lazy

Hard working

Proﬁt Probabilities

Proﬁt = \$20,000

80%

40%

Proﬁt = \$70,000

20%

60%

Your manager views being lazy as a &quot;leisure&quot; valued at \$5000
. If you oﬀer 10% of the proﬁt from your

portfolio to the manager, will he/she work hard? What if it is 50% of the proﬁt?

4
. (15 points) Bank of Storrs has the following balance sheet
.

Assets

Reserves \$ 50 mil
.

Loans \$ 450 mil
.

Liabilities

Deposits \$ 300 mil
.

Bank Capital \$ ? mil
.

(a) How much bank capital does Bank of Storrs have?

(b) Suppose that a required reserve ratio is 10%
. How much excess reserves does the bank have?

(c) How much reserves Bank of Storrs will have if the bank suﬀers a deposit outﬂow of \$30 million?

Will it be more or less than what is required? If less, what should they do to have enough reserves?

List four options
.

5
. (10 points) Using the t-accounts of Bank of Storrs and Columbia bank, describe what happens when

Hoonsik writes a \$100 check on his account at Bank of Storrs to pay his friend Frederic, who in turn

deposits the check in his account at Columbia bank
.

1

6
. (10 points) Bank of Storrs has the following balance sheet
.

Assets

Reserves \$ 50 mil
.

Loans \$ 450 mil
.

Liabilities

Deposits \$ 400 mil
.

Bank Capital \$ 100 mil
.

Suppose that the bankers in Bank of Storrs ﬁnd that \$50 million of their loans have become worthless
.

How the bank balance sheet will look like as a result?

7
. (10 points) How can a bursting of an asset-price bubble in the stock market help trigger a ﬁnancial

crisis?

8
. (10 points) What is debt-deﬂation? Why the net worth of borrowers decline? (Use the deﬁnition in

the textbook
. It can mean slightly diﬀerent things depending on the context
.)

9
. (15 points) Read &quot;The run on shadow banking and a framework for reform&quot; in HuskyCT (reading

materials) and answer the following questions
.

(a) What are the three causes for the emergence of the shadow banking system?

(b) Suppose that I lend you \$200 for a day, and you give me a set of bonds with a market value of

\$202 as collateral
. How much is the haircut in this case? If I ﬁnd out that you are more likely to

default than I originally expected, will the haircut increase or decrease?

2

ECON 2411: Principles of Money and Banking

Place New Order
It's Free, Fast & Safe

Feeling Lucky?