WSJ Example

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Economics

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Feb 20, 2024

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AN EXAMPLE OF USING WSJ ARTICLES IN THE EXAMS Fall 2023

• This exam has 15 questions. Abstract • All the questions are inspired by the WSJ articles. The full articles are provided at the end of this document. • Except for question 11, which has 2 points, all other questions have 7 points each. • To get the full mark, for ALL the questions, you have to show your full work , which means you should clearly: 1. mention the theory you are using, (1 point) 2. explain the theory, (2 point) 3. draw the diagrams and equations when applicable, (2 point) 4. and conduct your final analysis. (2 point) • The best way to manage your time would be 1. to read the questions for each article first, 2. then skim the articles and look for the information that is directly asked in the questions, 3. highlight that information, 4. and then mix that information with the theories learned in the class 5. and write down your work fully, ensuring all the criteria mentioned above are met to get the full mark.

1 WSJ I- Yield Curve Inversion Reaches New Extremes By Sam Goldfarb — November 29, 2022 Summary: Yields on longer-term U.S. Treasuries have fallen further below those on short-term bonds than at any time in decades, a sign that investors think the Federal Reserve is close to winning its inflation battle regardless of the cost to economic activity. 1. What is an inverted yield curve? (7 Points) Grading tips: answers should include the definition of yield curve, (i.e,the liquidity premium theory of term structcure) (4point),and drawing the diagram (3 points) 2. What does an inverted yield curve ”say” about the market’s expectations for short-term interest rates in the future and why? (7 Points) Grading tips: students should extensively interprete the inversion pointing to the business cycle prediction, expectations about the Fed’s policies in the future, why short term interest rates are typically lower than long term rates and why in the inversion, short term interest rates are higher than long term (7 points). 3. Does the current shape of the yield curve indicate an impending recession or that the Fed is winning the war against inflation and the economic outlook is stabilizing? (7 Points) In this case, students should directly refer to the article. If they have not done so, we will lose at least 4 points. 4. What are the arguments supporting or rebutting these positions? (7 Points) Grading Tips: In this case, similar to the previous case, students should directly refer to the article. If they have not done so, we will lose at least 4 points. Also, students should write argumenets in favor (4 points) and against this prediction (3 points). WSJ II- Tech Selloff Catches Up With Private Startups By Julie Steinberg Ben Dummett — November 29, 2022 Summary: Tech startups are plunging in value in private trades, mirror- ing the big markdowns of their publicly listed brethren over the past year. Before companies go public, their shares are often traded by employees, founders, and institutions in secondary deals. The trades allow existing holders to cash out before a startup goes public, and buyers to make new investments or add to existing holdings.

2 5. Using the Supply-Demamd framework, explain how can secondary trading of private company shares be used to measure investors appetite for these startups? (7 Points) Grading Tips: Students should explain porfolio choice theory (2 points), draw the diagram (2 points) and fully analyze the situation in this case (3 points). Specifically, they should “clearly” connect secondary market arguement with liquidity and explain the shift in the diagram when the liquidity situation changes. 6. Use the Treynor Model and show the impact of investors’ appetite for startups on the private dealing system. Show your work fully. (7 Points) Grading Tips:Students should explain the Treynor model, especially they should talk about inventories, dealer spread, finance need or finance limits, and the pricing dynam (i.,e dealers lower the price as their inventories deplete and vice versa)(2 points), draw the diagram (1 points) and conduct an analysis based on the model (4 points). There are different ways of responding to this, but the most robust and straightforward is that private investors are selling their shares in these startups. Therefore, there are more sellers than buyers, which means the dealers absorb these imbalances. In the Treynor model, the private dealing system is adding these imbalances to its inventories and needs to finance them. In response, they are reducing their prices to discourage poten- tial sellers from selling additional shares to them and encourage potential buyers to buy these assets off their balance sheets. 7. Let’s assume you are working for a dealer in this market. Based on the existing dealer’s position in this market, what would be the most signifi- cant risk that your company is facing? What is your hedging strategy for your company? (7 Points) Grading Tips: Students should briefly describe the problem again (no worries if they have not, as they have already written about it in the pre- vious questions. Absorbing inventories mean dealers are exposed to price risk, and funding/liquidity risk, and the risks of trading with value- based dealer: Price risk means that the value of these assets changes. As these inventories, in most cases, are used as collateral, lower collateral value reduces their ability to secure funding. Students then have to elaborate on these points. (2 points) Funding risk means that the dealers might need help to raise short-term, cheap funding to purchase these unwanted assets. This is called liquidity risk (2 points) If these risks materialize, the risk of reaching the finance limit, in this case, the max long position, will materialize. This is a risk that the dealer will trade with the value-based dealer and have to face negative spread (3 points) 8. What types of companies are seeing the largest discounts on secondary exchanges and why? (7 Points)

3 The answer to this question is clearly mentioned in the article. Please read the article. Per Grading distribution, what type.. part has (3 points) and why part has (4 points). 9. What are the arguments referenced in the article in support of and against the current levels of discounts being an attractive buying opportunity? (7 Points) The answer to this question is clearly mentioned in the article. Please read the article. Per Grading distribution, mentioning supporting arguements has (3 points) and against arguements has (4 points). 10. How has the Fed’s interest rate increase impacted the relative performance of these shares and why? (7 Points) Grading Tips: This is a standard textbook question where students should use their knowledge of stock pricing. To answer the questions, students should name and write the Dividiend-Discount equation, also referred to as the Gordon-Growth Model ( 1 point). Next, they should use the model to show that when Fed increases the rates, the risk-free rate increases; hence, the required return on equity will also increase. In this case, the stock prices fall (2 points). However, at the same time, when Fed increases the rates, the bond prices will fall as the existing fixed-income assets were issued when rates were low, and investors should accept lower prices if they want to sell their bond holdings (2 points). In this environment, the stocks become more attractive in terms of relative expected return, and investors increase their demand for stocks. This means that according to this channel, share prices should increase. In theory, after the Fed increases the rate, this impact dominates the former, and stocks gain value. (2 points) WSJ III- Rocky Treasury-Market Trading Rattles Wall Street By Matt Grossman Sam Goldfarb — October 30, 2022 Summary: Rising friction in the trading of U.S. government debt has investors worried about the health of a $ 24 trillion market that is critical to the functioning of the broader financial system. 11. What is Treasury Buyback? (2 Points) Treasury buyback is a new proposal by US Treasury that involves swap- ping long-term bonds with short-term bills. The idea is that long- term US Treasuries are losing their attractiveness for investors as they yield very low rates during the high-interest rate period. Therefore, they are becoming illiquid and causing issues. US Treasury is fighting this liquidity problem by buying long-term US T-Bonds and paying for these purchases by issuing higher-yielding short-term US Treasury bills.

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