vu cs001 Mid Term Subjective Solved Past Paper No.1
vu cs001 Computer Proficiency License Solved Past Papers
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Default Risk
It is define as that "there is no guarantee that a bond issuer will make the payment which he promised.
When there is higher default risk the higher the probability that those who have the bond will not receive the promised payments and thus higher the yield.
The investor which are risk averse require some compensation for risk, more compensation is require for higher risk.
For exampleSuppose risk free rate is 10%
ABC corp. issue one year bond at 10%
Price without risk= (100 +10)/1.1= Rs.100
Suppose, there is probability that ABC corp. goes bankrupt, get nothing than two possible payoffs: Rs.110 and Rs.0
- Life insurance
- Property and casualty insurance
Which makes a payment to the insured's beneficiaries upon the death of the policy holder.
Company can get group insurance for their employees.
Whole life insurance
It is combination of life insurance and fix saving account.
We pay fix amount for a fixed period of time and in case of death of policy holder his/her beneficiary gets the money.
If the policy holder decides to discontinue the policy
Property and casualty Insurance
The policyholder pays fixed amount in exchange for protection to its property or assets. For example. Insuring the building against the fire.Insurance of house for theft.
auto insurance.
Transaction Demand for money: The quantity of money people hold for transaction purposes is called transaction demand for money. It depend on following factors
Nominal income of people: As the nominal income increases spending increases which causes
an increase in the demand for money holding.
Cost of holding money: The cost of money holding is the interest foregone in holding the money in hand. So if the nominal interest rate is higher people will prefer keeping money in banks etc so demand for money holding decreases.
Availability of substitutes: If people have cheaper alternative means of payment they will hold less money.
Portfolio Demand for Money: Money is one instrument that people can hold in their investment portfolio. The demand for holding money in portfolio is dependent on following factors:
Wealth: An increase in wealth increases the demand for money Return on alternative investments: As the return on alternative investments fall people hold more money.
Expected future interest rate: An increase in expected future interest rate increases holding demand for money
Riskiness of alternatives: Riskier the alternative investments greater the demand for money.
Liquidity: If alternative investments become more liquid demand for money decreases
Inflation shock is a change in the cost of producing output which causes the the short run aggregate supply curve to shift.
It can be the result of change in the cost of raw materials or change in price of energy.
A positive inflation shock causes the short run aggregate supply curve to shift upward, and cause the inflation to rise
Insolvent mean bankrupt or someone who has insufficient assets to cover their debts. Insolvent is not in position to pay its due bills
Illiquidity
In such a position where assets are not immediately or easily be converted into cash. Illiquid assets can be converted into cash, but usually only after a time or at lower value.
Insolvent is in hard time or not an position to revive its working condition compared to insolvency illiquidity is position where business has enough assets only thing is not immediately available. Lender of last resort can take those assets as security to provide the funds.
A government is considering changing its deposit insurance system from one in which deposits are implicitly guaranteed (that is, if a bank fails, people trust the government to put enough resources into the bank so that depositors will lose nothing) to one with an explicit ceiling. What would be the impact of such a change on depositors on bankers?
Bank will be having less money to business as they have to keep money as deposit. Due to keeping more money as required reserve banks will not be in position to lend more loans. It will reduce their business activity. Same time it will increase the liquidity of bank. People will trust then banks more, due to guaranty form Govt.Due to shortage of lending more money to public bank might charge more keeping demand and supply rule in mind. Cost of borrow from bank can increase.
It is helpful to think of aggregate demand as having two parts, one that is sensitive to real interest rate changes and one that is not Investment is the most important of the components of aggregate demand that are sensitive to changes in the real interest rate.
Output (Y)Inflation (?)
An investment can be profitable only if its internal rate of return exceeds the cost of borrowing Consumption and net exports also respond to the real interest rate;
Consumption decisions often rely on borrowing, and the alternative to consumption is saving (higher rates mean more saving).
As for net exports, when the real interest rate in a country rises, her financial assets become attractive to foreigners, causing local currency to appreciate, which in turn means more imports and fewer exports (lower net exports)
While changes in real interest rate may have an impact on the government's budget by raising the cost of borrowing, the effect is likely to be small and ignorable.
