Answer the following questions, each part. Be sure to define key terms and, where appropriate, show your calculations.
Indicate whether each of the following regulations and restrictions im- posed on banks can be seen as a response to the adverse selection prob- lem (AS), the moral hazard problem (MH), both (B) or neither (N), and give a brief explanation of their rationale.
(a) Restrictions on bank branching.
(b) Minimum capital requirements.
Suppose that a bank has $300 million in assets with an average duration of 8 years and $250 million in liabilities with an average duration of 6 years. Calculate the change in the market value of this bank’s (a) assets, (b) liabilities, and (c) bank capital resulting from a one percentage point increase in interest rates.
Discuss the validity and, where appropriate, the invalidity of the following statements. [20 points]
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- “Since federal deposit insurance induces banks to take on excessive risks, there is no doubt that it should be abolished.”
- “There is no meaningful distinction between the problems of adverse selection and moral hazard, and solutions to each of them are roughly the same.
