C.U.H.K.

ECON1420B/UGEC1560QB Basic Banking and Finance (Spring 2015 Midterm Test)

NAME: __________________________________(______________________) Student I.D.: __________________

Part I: M.C. Select the best answer and write the letter into corresponding box provided (@ 2 points)
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1. Which of the following could be a saver(s)?

A) The Chinese University of Hong Kong.
C) HKSAR Government.

15. Risk-free investments have rates of return __.

A) equal to zero
C) with a standard deviation equal to zero

B) rate of return equal to market portfolio

D) equal to any freely chosen number

16. Which of the following are true concerning the distinction between interest rates and return?
A) The rate of return on a bond is expected but the interest rate is unexpected.
B) The return can be expressed as the sum of the current yield and the rate of capital gains.
C) The rate of return will be greater than the interest rate when the bond price falls between time t and t+1.
D) All of the above.
17. A plot of the yields on bonds with different terms to __ but the same risk, liquidity, and tax considerations is
called yield curve.
A) interest
B) maturity
C) return
D) yield
18. When the coupon bond is priced at its par value, the yield to maturity __ the coupon rate.
A) equals
B) is greater than
C) is less than
D) is not related to

B) Foreign government.
D) All of the above.

2. Bond is traded in the bond market in which __ rates are determined.

A) interest
B) inflation
C) exchange

C.U.H.K. ECON1420B/UGEC1560QB Basic Banking and Finance (Spring 2015 Midterm Test)

D) bond

3. __ instrument is a contractual agreement by the borrower to pay the holder of the instrument fixed dollar
amounts at regular intervals until a specified date.
A) Debt
B) Equity
C) Financial
D) Global
4. What do you think about the wealth elasticity of demand for a luxury car parked at CUHK?
A) Negative number.
B) 0
C) Between 0 and 1.
D) Greater than 1.
5. A credit market instrument that pays the owner a __ coupon payment every year until the maturity date and
then repays the face value is called a coupon bond.
A) loan
B) food
C) shopping
D) fixed
6. Negotiable Bank Certificates of Deposits is a debt instrument sold by a __ to depositors that pays annual
interest of a given amount and at maturity pays back the original purchase price.
A) bank
B) consumer
C) government
D) household
7. If stock prices become __ volatile and unstable, the demand curve for bonds shifts to the __, the interest rate
__.
A) more; right; falls
B) more; left; falls
C) less; left; falls
D) less; right; rises
8. Factor(s) which cause(s) the supply curve for bonds to shift to the right include
A) a decrease in the expected inflation.
B) an increase in profitable opportunity.
C) a decrease in the volatility of stock prices.
D) all of the above.
9. The rate that equates present value of __ payments received from a debt instrument with its value today is yield
to maturity.
A) simple
B) future
C) face
D) real interest
10. The money market is for the trading of short-term instruments those with maturities of __.
A) more than ten years
B) one to ten years
C) exactly one year
D) less than a year
11. Financial intermediaries and indirect finance in financial markets reduce __ in provision of safekeeping,
accounting and payments mechanisms for funds.
A) yield return
B) uncertainty
C) transaction costs
D) symmetric information
12. The risk premium on corporate bonds increases if the __ of corporate bonds __.
A) return; decreases
B) return; is constant C) liquidity; increases
D) liquidity; decreases
13. The probability of a corporate bond default __ as the corporation is found of losing many businesses.
A) is zero
B) increases
C) decreases
D) will not change
14. A __ bond is bought at a price below its face value, and the __ value is repaid at the maturity date.
A) coupon; discount
B) coupon; face
C) discount; face
D) discount; discount

19. EBITDA is Earning Before Interest, Taxes, Depreciation, __.

A) Accumulation
B) Amortization
C) Appreciation

D) Association

20. __ is (are) the legal tender in Hong Kong.

A) Silver
B) Renminbi

D) Gold

C) Hong Kog dollar

21. Capital market lines starting point is the __ rate in the capital market pricing model.
A) interest
B) risk-free
C) exchange
D) inflation
22. P/E ratio is defined as the market __ of a share divided by the most recent earnings per share
A) expectation
B) price
C) return
D) risk
23. The risk of a well-diversified portfolio depends only on the __ risk of the assets in the portfolio.
A) investment
B) portfolio
C) nonsystematic
D) systematic
24. A well-defined enforceable corporate governance provides a structure working for the benefit of everyone
concerned by ensuring that the enterprise adheres to accepted ethical standards and best practices as well as to
A) loyalty.
B) patriotism.
C) formal laws.
D) democracy.

Part II: Compulsory Short Questions Detailed answers are preferable. (@ 7 points)
1. What is your understanding of three definitions of money supply in Hong Kong?
2. What do you expect for the demand of money during a period of economic expansion?
3. (a) What is the name of a bond without a maturity date? Can we trade it in the money market? (2)
(b) Please describe any three money market instruments. (3)
(c) Is bond issuance a good way of financing the third runway in Hong Kong? Why? (2)
4. What are the characteristics of a commodity being good money?
5. What is your understanding of balance sheet?
6. Dont put all your eggs in one basket! Please comment.

Fools Day Test

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C.U.H.K. ECON1420B/UGEC1560QB Basic Banking and Finance (Spring 2015 Midterm Test)
Guide (Not Perfect Answer. Score will also depend on the presentation an relative performance.)
S1. M1 = Currency in circulation (0.5)+ demand deposits (0.5)
M2 refers to the sum of M1 (1) + customers savings (0.5) and time deposits (0.5) with licensed banks (0.5) +
negotiable certificates of deposits (NCDs) issued by licensed banks (0.5) held by non-authorized institutions. (0.5)
M3 refers the sum of M2 (1) + customer deposits with restricted license banks (RLBs) (0.5) and deposit-taking
companies (DTCs) (0.5) + negotiable certificates of deposits issued by RLBs and DTCs held by non-authorized
institutions. (0.5)
(0.5 points deducted for each incorrect spelling.)
M1 exhibits a significant seasonal pattern, whereas there is no strong evidence of seasonality in M2 & M3. (Bonus
0.5) M1 stresses on the medium of exchange function, but M2 & M3 will consider the store of value function.
(Bonus 0.5) If money is defined in terms of liquidity, currency (M1) is the most liquid among all assets.

An economy expands (1.5)

(income and wealth )
people will hold money as a store of value.

An economy expands (1.5)

income
transaction
more money will be held by people.

2.

Hence, Md shifts to the right.

Interbank Loans are loans between banks and "Interest Rate = Interbank rate"
The London Interbank Offered Rate (LIBOR) is a daily reference rate based on the interest rates at which banks
borrow unsecured funds from banks in the London wholesale money market (or interbank market).
Federal Fund Rate is the interest rate at which private depository institutions (mostly banks) lend balances
(federal funds) at the Federal Reserve to other depository institutions, usually overnight in the United States. It
is the interest rate banks charge each other for loans.
Hong Kong Interbank Offered Rate ( HIBOR) is the rate of interest offered on Hong Kong dollar loans by
banks in the interbank market for a specified period ranging from overnight to one year.

Repurchase Agreements (Repos) are effectively short-term loans (usually with a maturity of less than two
weeks) in which treasury bonds serve as collateral, an asset that the lender receives if the borrower does not pay
back the loan.

Income

Any ONE (each 0.75 with explanation 0.25)

(c) Yes. (1) Long-term project could be financed by long-term bond. (1)
Other opinion with appropriate argument is acceptable.

quantity of money in real terms

S4. Being accepted as a medium of exchange, money should have some properties in order to reduce the cost of
transaction.

To restore holdings of money in real terms to its former level,

people will want to hold a greater nominal quantity of money
Hence, a rise in the price level causes the demand for money to
increase and the demand curve to shift to the right.
Hence, Md shifts to the right.

Price
s

Shifts in the Supply of Money (M ) (2)

Liquidity effect:

(b) Treasury (T) Bills is a short-term financial instrument issued by the government.
Exchange Fund Bills and Notes, debt instruments issued by the HKMA for the account of the Exchange Fund
It was introduced in March 1990in Hong Kong. The benchmarks for fixings are 1-week, 1-month, 3-month, 6month, 9-month and 12-month.

Commercial Paper is a short-term instrument issued by large banks and well-known corporation (good credit
rating). e.g, the first issue of commercial paper in H.K was in 1977 by the MTRC.
Banker's Acceptance is a bank draft issued by a firm, payable at some future date, and guaranteed for a fee by
the bank that stamps it "accepted" (stamp fee).

Price-level Effect (2)

Price-level

S3. (a) Consol or Perpetuity (1); No, it is capital market tool (0.5) as its maturity date is more than 1 year. (0.5)

Negotiable Bank Certificates of Deposits (NCDs) is a debt instrument sold by a bank to depositors that pays
annual interest of a given amount and at maturity pays back the original purchase price.

S2. Income Effect

1.

C.U.H.K. ECON1420B/UGEC1560QB Basic Banking and Finance (Spring 2015 Midterm Test)

MS i

An increase in the money supply will shift the supply curve for
money to the right. Opportunity cost (interest rate) of holding
money decreases and quantity demanded of money increases.
MS

1. Stability: The value of money must be relatively stable. The frequent change in exchange ratio will bring as
higher information cost.
2. Scarcity: Relative scarcity and limited supply of money prevents the money from losing its value easily. The
stability of money can be maintained.
3. Homogeneity / Uniformity: Money must be uniform in physical quality and appearance. All version of the
same denomination of currency must have the same purchasing power so that very denomination must be in
uniform. Money should be easy to recognize. Otherwise, the investigation cost is very high.
4. Durability: Money has to be passed from one man to another many times in a long period.
5. Portability / Transportability: It can be easily moved from one location to another if such movement is needed
to complete exchanges. Reducing the transportation cost of carrying large amounts of money in transaction, the
size and weight of money cannot be too large.
6. Divisibility: It can facilitate transaction in small quantities.
7. Genuineness with malleability: This characteristic means that money cannot be easily duplicated but money
should be malleable so that it could be made into new money.
8. Acceptability: It is the necessary condition. Everyone must accept it to purchase goods and services.
Any ONE above (each 0.75 with explanation 0.25) Max. is 7.
If only the functions of money are just mentioned, only (0.5) granted for each.

C.U.H.K. ECON1420B/UGEC1560QB Basic Banking and Finance (Spring 2015 Midterm Test)
S5. What the company owns and owes? (1)
Balance Sheet or Statement of Financial Position (1) states the companys position at the end of the
accounting year. (1) It provides a snapshot of the financial condition of the firm at a particular point of time.
(1)
It balances the three accounts, reconciling the Accounting Equation:
Assets = Liabilities + Owners Equity. (2)
We have to check or derive the followings( @0.5) from the Balance Sheet:

Debt: The debt to equity ratio (long term debt divided by stockholder's equity) is the measure typically used.
Lower is better, and zero is ideal.
Cash (relative to annual sales). Cash is always a good thing, but it's especially important to companies that
sometimes want or need to temporarily go cash flow negative. Remember that when new shares are issued,
proceeds from the sale also appear here.
Return on equity: This is a measure of net income relative to stockholder's equity. Higher is better.
Receivables and inventory: They should not be rising much faster than sales are.
Current ratio: This is the ratio of current assets (cash, receivables and inventory) to short-term liabilities. The
higher is usually the better.
Asset should outweigh liabilities by a comfortable margin to avoid possible cash-flow problems.

Differences with other reports. (1)

Max. is 7.
S6. If you put all your eggs in one basket, you risk everything on a single opportunity which, like eggs breaking, could
go wrong. (1) Generally speaking, adding more assets to a portfolio for diversification tends to reduce its risk (1)
if the risks of assets are not correlated. (1). Indeed, profit or return is also limited. (1)
However, if an investor starts with little money, it is impossible to have diversification because the stocks is not
unlimited divisible. (1) It is also not easy to get as many as assets for diversification (1) in the market because of
significant transaction and information cost. (1) He may not have time to manage or remember a big
portfolio. (1)
Even though the market portfolio is diversified, there is still systematic risk. (1)
(Max. is 7.)