Question 1 (Total of 50 points)
One of the reasons why financial intermediaries emerge as one of the key institutions
in an economy is the high possibility of more prevalent moral hazard problems in equity
finance.
a. Explain what is meant by the moral hazard problem in finance. (10 points)
b. Explain how moral hazard emerges in equity finance.(15 points)
c. Do you think financial intermediaries can fully mitigate the moral hazard
problem? Why or why not? (15 points).
d. Discuss two policies that can be used by governments to limit the extent of the
moral hazard problem in equity finance. Explain how these policies can address
this problem. (10 points)

Question 2 (Total of 50 points)
The term structure of interest rates gives us the relationship between interest rates
and different maturities. It can provide us important information about the current state
of the economy and the expectations about the near future.
a. Using theoretical frameworks and examples from data, explain whether the
yield on bonds with differing terms to maturity but the same risk, liquidity, and
tax considerations should be same or not. (20 points)
b. Explain what a yield curve is and discuss how it is linked to the concept of term
structure of interest rates. (15 points)
c. Suppose you are an economist working in a central bank. You observe that
yield curves for the government securities in your country have a negative
slope. Why and how would you use this observation to make a policy proposal
to the decision making bodies, such as the monetary policy committee, at the
central bank? (15 points)

Section B
You must answer 1 question, using a separate document for each question (all
questions of equal weighting/the weighting is noted against the question/sub
question).
Word limit: 1000
Question 3 (Total of 50 points)
Banks are often asked to increase their capital requirements, such as their tier-one
ratio, following stress tests, or in times of distress.
a. Explain what is meant by a bank’s tier-one capital ratio. (10 points)
b. Explain how banks can respond to increased capital requirements and increase
their tier one ratio. (15 points)
c. Discuss empirical evidence which examines how increasing banks’ capital
requirements may or may not be detrimental to the real economy (25 points)

Question 4 (Total of 50 points)
Banks have long been involved in the process of securitization of financial products.
a. Explain the process of securitization (12.5 Points)
b. Explain what is meant by a collateralized debt obligation (CDO) (12.5 Points)
c. Are markets for securitized products safer today than they were pre-global
financial crisis? (25 Points)

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