June 15 questions:

Here is an amusing tax story I forgot was on the server.

Define adaptive and rational expectations. In a market in which investors and traders have rational expectations, what should the price of an asset equal?

Is a liquid market an efficient market? Why or why not?

Give a concise definition of the efficient markets hypothesis. What assumptions does it require about liquidity and information?

If you believe that the stock market is an efficient market, why would an investment strategy of "buy and hold" be a good idea?

Why are fads inconsistent with the predictions of the efficient market hypothesis?

What is program trading? Does it play a significant role in increasing market volatility? What are some of the other problems with EMH discussed in class today? Why would Warren buffet likely not embrace this hypothesis?

What are transaction costs and how can they be reduced by exploiting economies of scale?

Why do higher interest rates increase adverse selection in the loan market?

Distinguish symmetric information with asymmetric information, and state why the distinction is important for the financial system.

What is the difference between moral hazard and adverse selection? How does each contribute to making information asymmetric?

How is information collection in financial markets is subject to the free rider problem? How do banks overcome the free rider problem?

Explain, verbally and graphically, what the "lemons problem" is. How does the lemons problem lead many firms to borrow from banks rather than from individual investors?

Why might the number of loans that aren't repaid to banks rise as interest rates rise? What might be a better strategy for banks than raising interest rates?

Suppose that a bank makes a loan to a business and that the loan contract specifies that the business is not to engage in certain lines of business. What is this type of provision called? Why would the bank make such a provision?

What is the name of the main problem associated with the separation of ownership and management? What do managers do that owners don't like? What types of solutions are available?

Is a large firm with thousands of shareholders more or less likely to suffer a principal-agent problem than a small firm with just a few shareholders? Explain.

Why don't insurance companies sell income insurance? That is, if a person loses his or her job or doesn't get as big of a raise as anticipated, that person would be compensated under his or her insurance coverage.

Differentiate between investment bankers and securities brokers.

Define contractual saving. How do insurance companies know how high their premiums should be for life and accident insurance? What kinds of problems do they face in assessing risk?

Finally, regarding the points made today about insider trading, I just remembered that Henry Manne had an article last week in the Wall Street Journal callaing for the abolishment of insuder trading laws. Here's a link to the article (it might require registration). Here's an excerpt:

The implications of what we already know of this “wisdom of crowds” approach to price formation, as against the traditional marginal pricing/arbitrage approach, are apt to be startling. We should rethink any current policies based on a view of pricing in which we exclude the best-informed traders and discard the wisdom of the many. For instance, we now have a new and more powerful argument than we had in the past for legalizing most insider or informed trading.

Since such trading clearly makes the market process work more efficiently, it aids capital allocation decisions and informs business executives through market-price feedback of the best predictions about the value of new plans. Furthermore, the Supreme Court’s “fraud on the market” theory of civil liability under the federal securities laws and Congress’s ideas of correct civil damage claims for insider trading no longer have any intellectual merit. The same is true of any other part of our securities laws implicitly based on the notion of the marginal trader as a rational arbitrageur of price.

The new approach would suggest that it is undesirable to have laws discouraging stock trading by anyone who has any knowledge relevant to the valuation of a security.

Questions for June 14:

Countries with lower real interest rates have more development in those things that require long-term commitments. Would Bohm-Bawerk agree? Explain.

Define time preference, high time preference, low time preference, and time preference rate.

What are the two conditions necessary for capital formation to set in and continue?

What are the external and biological time preference factors? Why does it matter for these factors to be expected? What role is played by nutrition and health care?

Are members of the military more likely or less likely to have high time preferences? Explain.

Why are property rights violations harmful to capital formation? What were the examples given in class? Can you think of others?

How did credit cards come about? How did they become a mass consumption good? What is a signature loan?

Explain the relationship between the credit card rate and the federal funds rate.

Why do banks offer credit cards with no fees? What are "deadbeats"?

who are the three defects of debit cards relative to credit cards, as discussed in class?