Part 1.

  1. Show graphically what happens to the risk premium when municipal bonds gain tax-exemption. Why might aAaa/AA Municipal Bond pay less yield than comparable Treasury that is rated Aaa/AAA? Comparable meaning they have the same liquidity and years to maturity. But, they do have different risk—they are rated differently.








  1. Suppose that investors treat all bond maturities as perfect substitutes. What is this called and what would the yield curve look like if there is no future change in expected change in interest rates? Also, show graphically what would happen to the relative yields in short-term maturities and long-term maturities when the Fed engages in quantitative easing.








  1. Suppose that the constant news releases in 2009 showing the fall of very large financial institutions started to scare many Americans about the safety of their money in banks. Using the market for reserves show graphically what this would do to the equilibrium Fed Funds rate in all cases. If the Fed is interest rate targeting how would they respond?









  1. Suppose you purchase 400 shares of Company XYZ at $566 per share, but you are worried that it may fall in price so you wish to hedge part of your position by writing 2 call options. The option has a strike price of $245 and a premium of $320. If at that the time of expiration, the stock is selling at the following prices ($200, $500, $750) what will be your overall gain or loss?











  1. Meredith Whitney came out during the Great Recession and stated that there would be billions of dollars in municipalities defaulting on their debt from a lack of tax revenues and too much of a debt burden. Graphically show using the bond market what would happen to the premium between Munis and Treasuries following this announcement.




  1. True/False and why: you would never buy a stock if you expect prices to fall from this year to next year.






Part 2

  1. Using the IS/LM model, AD/AS, the Asset Market, the Taylor Rule, and Okun’s Law:

Goods Market: C=225 + 1/2(Y-T) I=240-400r G=125

Money Market:
Money Supply=490 L(r,y)=(1/2)Y-100r
Long-Term Inflation: 2%
Natural Rate of Unemployment: 5%


  1. What are the IS and LM equations?
  2. Calculate and show the equilibrium output and interest rates?
  3. Considering a Keynesian Model, show graphically what happens to P, Y, and r in the SR when

the there is an increased risk of the stock market changing the Money Demand by 25 regardless of Y or r.

  1. What is the short run Y and r?
  2. What is unemployment and Taylor Fed Funds Target in the SR?
  3. Suppose that the Fed would like to stabilize the economy. Show how large of a policy they 
would conduct.
  4. Compare the magnitudes of the Governments policies if they use only a change in expenditure, 
only a change in taxes, or only a balanced budget policy.

Extra Credit: Prior to the Great Recession, which famous economist infamously claimed that the Federal Reserve understood monetary policy so much there would never be another phenomenon such as the Great Depression. Provide documentation—website etc.—of this.


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