Chapter1
WhyStudyFinancialMarketsandInstitutions?
Multiple Choice Questions

1.
Financialmarketsandinstitutions
(a) involvethemovementofhugequantitiesofmoney.
(b) affecttheprofitsofbusinesses.
(c) affectthetypesofgoodsandservicesproducedinaneconomy.
(d) doalloftheabove.
(e) doonly(a)and(b)oftheabove.
Answer:D
2.
Financialmarketactivitiesaffect
(a) personalwealth.
(b) spendingdecisionsbyindividualsandbusinessfirms.
(c) theeconomyslocationinthebusinesscycle.
(d) alloftheabove.
Answer: D
3. Marketsinwhichfundsaretransferredfromthosewhohaveexcessfundsavailableto
thosewhohaveashortageofavailablefundsarecalled
(a) commoditymarkets.
(b) fundsmarkets.
(c) derivativeexchangemarkets.
(d) financialmarkets.
Answer: D
4. Thepricepaidfortherentalofborrowedfunds(usuallyexpressedasapercentageofthe
rentalof$100peryear)iscommonlyreferredtoasthe
(a) inflationrate.
(b) exchangerate.
(c) interestrate.
(d) aggregatepricelevel.
Answer: C
5.
Thebondmarketsareimportantbecause
(a) theyareeasilythemostwidelyfollowedfinancialmarketsintheUnitedStates.
(b) theyarethemarketswhereinterestratesaredetermined.
(c) theyarethemarketswhereforeignexchangeratesaredetermined.
(d) alloftheabove.
Answer: B
6. Interestratesareimportanttofinancialinstitutionssinceaninterestrateincrease
_________thecostofacquiringfundsand_________theincomefromassets.
(a) decreases;decreases
(b) increases;increases
(c) decreases;increases
(d) increases;decreases
Answer: B
7.
Typically,increasinginterestrates
(a) discourageindividualsfromsaving.
(b) discouragecorporateinvestments.
(c) encouragecorporateexpansion.
(d) encouragecorporateborrowing.
(e) noneoftheabove.
Answer: B
8. ComparedtointerestratesonlongtermU.S.governmentbonds,interestrateson
_________fluctuatemoreandareloweronaverage.
(a) mediumqualitycorporatebonds
(b) lowqualitycorporatebonds
(c) highqualitycorporatebonds
(d) threemonthTreasurybills
(e) noneoftheabove
Answer: D
9. ComparedtointerestratesonlongtermU.S.governmentbonds,interestratesonthree
monthTreasurybillsfluctuate_________andare_________onaverage.
(a) more;lower
(b) less;lower
(c) more;higher
(d) less;higher
Answer: A
10. Thestockmarketisimportantbecause
(a) itiswhereinterestratesaredetermined.
(b) itisthemostwidelyfollowedfinancialmarketintheUnitedStates.
(c) itiswhereforeignexchangeratesaredetermined.
(d) alloftheabove.
Answer: B
Chapter2
OverviewoftheFinancialSystem

1.
Everyfinancialmarketperformsthefollowingfunction:
(a) Itdeterminesthelevelofinterestrates.
(b) Itallowscommonstocktobetraded.
(c) Itallowsloanstobemade.
(d) Itchannelsfundsfromlenderssaverstoborrowersspenders.
Answer: D
2.
Financialmarketshavethebasicfunctionof
(a) bringingtogetherpeoplewithfundstolendandpeoplewhowanttoborrowfunds.
(b) assuringthattheswingsinthebusinesscyclearelesspronounced.
(c) assuringthatgovernmentsneedneverresorttoprintingmoney.
(d) both(a)and(b)oftheabove.
(e) both(b)and(c)oftheabove.
Answer: A
3.
Whichofthefollowingcanbedescribedasinvolvingdirectfinance?
(a) Acorporationsstockistradedinanoverthecountermarket.
(b) Peoplebuysharesinamutualfund.
(c) Apensionfundmanagerbuyscommercialpaperinthesecondarymarket.
(d) Aninsurancecompanybuyssharesofcommonstockintheoverthecounter
markets.
(e) Noneoftheabove.
Answer: E
4.
Whichofthefollowingcanbedescribedasinvolvingdirectfinance?
(a) Acorporationsstockistradedinanoverthecountermarket.
(b) Acorporationbuyscommercialpaperissuedbyanothercorporation.
(c) Apensionfundmanagerbuyscommercialpaperfromtheissuingcorporation.
(d) Both(a)and(b)oftheabove.
(e) Both(b)and(c)oftheabove.
Answer: B
5.
Whichofthefollowingcanbedescribedasinvolvingindirectfinance?
(a) Acorporationtakesoutloansfromabank.
(b) Peoplebuysharesinamutualfund.
(c) Acorporationbuyscommercialpaperinasecondarymarket.
(d) Alloftheabove.
(e) Only(a)and(b)oftheabove.
Answer: E
6.
Whichofthefollowingcanbedescribedasinvolvingindirectfinance?
(a) AbankbuysaU.S.Treasurybillfromoneofitsdepositors.
(b) Acorporationbuyscommercialpaperissuedbyanothercorporation.
(c) Apensionfundmanagerbuyscommercialpaperintheprimarymarket.
(d) Both(a)and(c)oftheabove.
Answer: D
7.
Financialmarketsimproveeconomicwelfarebecause
(a) theyallowfundstomovefromthosewithoutproductiveinvestmentopportunitiesto
thosewhohavesuchopportunities.
(b) theyallowconsumerstotimetheirpurchasesbetter.
(c) theyweedoutinefficientfirms.
(d) theydoalloftheabove.
(e) theydo(a)and(b)oftheabove.
Answer: E
8.
Acountrywhosefinancialmarketsfunctionpoorlyislikelyto
(a) efficientlyallocateitscapitalresources.
(b) enjoyhighproductivity.
(c) experienceeconomichardshipandfinancialcrises.
(d) increaseitsstandardofliving.
Answer: C
9.
Whichofthefollowingaresecurities?
(a) Acertificateofdeposit
(b) AshareofTexacocommonstock
(c) ATreasurybill
(d) Alloftheabove
(e) Only(a)and(b)oftheabove
Answer: D
10. Whichofthefollowingstatementsaboutthecharacteristicsofdebtandequityaretrue?
(a) Theybothcanbelongtermfinancialinstruments.
(b) Theybothinvolveaclaimontheissuersincome.
(c) Theybothenableacorporationtoraisefunds.
(d) Alloftheabove.
Answer: D
11. Themoneymarketisthemarketinwhich_________aretraded.
(a) newissuesofsecurities
(b) previouslyissuedsecurities
(c) shorttermdebtinstruments
(d) longtermdebtandequityinstruments
Answer: C
12. Longtermdebtandequityinstrumentsaretradedinthe_________market.
(a) primary
(b) secondary
(c) capital
(d) money
Answer: C
13. Whichofthefollowingareprimarymarkets?
(a) TheNewYorkStockExchange
(b) TheU.S.governmentbondmarket
(c) Theoverthecounterstockmarket
(d) Theoptionsmarkets
(e) Noneoftheabove
Answer: E
14. Whichofthefollowingaresecondarymarkets?
(a) TheNewYorkStockExchange
(b) TheU.S.governmentbondmarket
(c) Theoverthecounterstockmarket
(d) Theoptionsmarkets
(e) Alloftheabove
Answer: E
15. Acorporationacquiresnewfundsonlywhenitssecuritiesaresoldinthe
(a) secondarymarketbyaninvestmentbank.
(b) primarymarketbyaninvestmentbank.
(c) secondarymarketbyastockexchangebroker.
(d) secondarymarketbyacommercialbank.
Answer: B
16. Intermediarieswhoareagentsofinvestorsandmatchbuyerswithsellersofsecuritiesare
called
(a) investmentbankers.
(b) traders.
(c) brokers.
(d) dealers.
(e) noneoftheabove.
Answer: C
17. Intermediarieswholinkbuyersandsellersbybuyingandsellingsecuritiesatstated
pricesarecalled
(a) investmentbankers.
(b) traders.
(c) brokers.
(d) dealers.
(e) noneoftheabove.
Answer: D
18. Animportantfinancialinstitutionthatassistsintheinitialsaleofsecuritiesintheprimary
marketisthe
(a) investmentbank.
(b) commercialbank.
(c) stockexchange.
(d) brokeragehouse.
Answer: A
19. Whichofthefollowingstatementsaboutfinancialmarketsandsecuritiesaretrue?
(a) Mostcommonstocksaretradedoverthecounter,althoughthelargestcorporations
havetheirsharestradedatorganizedstockexchangessuchastheNewYorkStock
Exchange.
(b) Acorporationacquiresnewfundsonlywhenitssecuritiesaresoldintheprimary
market.
(c) Moneymarketsecuritiesareusuallymorewidelytradedthanlongertermsecurities
andsotendtobemoreliquid.
(d) Alloftheabovearetrue.
(e) Only(a)and(b)oftheabovearetrue.
Answer: D
(a) Abondisalongtermsecuritythatpromisestomakeperiodicpaymentscalled
dividendstothefirmsresidualclaimants.
(b) Adebtinstrumentisintermediatetermifitsmaturityislessthanoneyear.
(c) Adebtinstrumentislongtermifitsmaturityistenyearsorlonger.
(d) Thematurityofadebtinstrumentisthetime(term)thathaselapsedsinceitwas
issued.
Answer: C
(a) Fewcommonstocksaretradedoverthecounter,althoughtheoverthecounter
marketshavegrowninrecentyears.
(b) Acorporationacquiresnewfundsonlywhenitssecuritiesaresoldintheprimary
market.
(c) Capitalmarketsecuritiesareusuallymorewidelytradedthanlongertermsecurities
andsotendtobemoreliquid.
Answer: B
22. Whichofthefollowingmarketsissometimesorganizedasanoverthecountermarket?
(a) Thestockmarket
(b) Thebondmarket
(c) Theforeignexchangemarket
(d) Thefederalfundsmarket
(e) alloftheabove
Answer: E
23. Bondsthataresoldinaforeigncountryandaredenominatedinthatcountryscurrencyare
knownas
(a) foreignbonds.
(b) Eurobonds.
(c) Eurocurrencies.
(d) Eurodollars.
Answer: A
24. Bondsthataresoldinaforeigncountryandaredenominatedinacurrencyotherthan
thatofthecountryinwhichtheyaresoldareknownas
(a) foreignbonds.
(b) Eurobonds.
(c) Eurocurrencies.
(d) Eurodollars.
Answer: B
25. Financialintermediaries
(a) existbecausetherearesubstantialinformationandtransactioncostsintheeconomy.
(b) improvethelotofthesmallsaver.
(c) areinvolvedintheprocessofindirectfinance.
Answer: D
26. Themainsourcesoffinancingforbusinesses,inorderofimportance,are
(a) financialintermediaries,issuingbonds,issuingstocks.
(b) issuingbonds,issuingstocks,financialintermediaries.
(c) issuingstocks,issuingbonds,financialintermediaries.
(d) issuingstocks,financialintermediaries,issuingbonds.
Answer: A
27. Thepresenceoftransactioncostsinfinancialmarketsexplains,inpart,why
(a) financialintermediariesandindirectfinanceplaysuchanimportantroleinfinancial
markets.
(b) equityandbondfinancingplaysuchanimportantroleinfinancialmarkets.
(c) corporationsgetmorefundsthroughequityfinancingthantheygetfromfinancial
intermediaries.
(d) directfinancingismoreimportantthanindirectfinancingasasourceoffunds.
Answer: A
28. Financialintermediariescansubstantiallyreducetransactioncostsperdollarof
transactionsbecausetheirlargesizeallowsthemtotakeadvantageof
(a) poorlyinformedconsumers.
(b) standardization.
(c) economiesofscale.
(d) theirmarketpower.
Answer: C
29. Thepurposeofdiversificationisto
(a) reducethevolatilityofaportfoliosreturn.
(b) raisethevolatilityofaportfoliosreturn.
(c) reducetheaveragereturnonaportfolio.
(d) raisetheaveragereturnonaportfolio.
Answer: A
30. Aninvestorwhoputsallherfundsintooneasset_________herportfolios_________.
(a) increases;diversification
(b) decreases;diversification
(c) increases;averagereturn
(d) decreases;averagereturn
Answer: B
31. Throughrisksharingactivities,afinancialintermediary_________itsownriskand
_________therisksofitscustomers.
(a) reduces;increases
(b) increases;reduces
(c) reduces;reduces
(d) increases;increases
Answer: B
32. Thepresenceof_________infinancialmarketsleadstoadverseselectionandmoral
hazardproblemsthatinterferewiththeefficientfunctioningoffinancialmarkets.
(a) noncollateralizedrisk
(b) freeriding
(c) asymmetricinformation
(d) costlystateverification
Answer: C
33. Whenthelenderandtheborrowerhavedifferentamountsofinformationregardinga
transaction,_________issaidtoexist.
(a) asymmetricinformation
(b) adverseselection
(c) moralhazard
(d) fraud
Answer: A
34. Whenthepotentialborrowerswhoarethemostlikelytodefaultaretheonesmost
activelyseekingaloan,_________issaidtoexist.
(c) moralhazard
(d) fraud
Answer: B
35. Whentheborrowerengagesinactivitiesthatmakeitlesslikelythattheloanwillbe
repaid,_________issaidtoexist.
(c) moralhazard
(d) fraud
Answer: C
36. Theconceptofadverseselectionhelpstoexplain
(a) whichfirmsaremorelikelytoobtainfundsfrombanksandotherfinancial
intermediaries,ratherthanfromthesecuritiesmarkets.
(b) whyindirectfinanceismoreimportantthandirectfinanceasasourceofbusiness
finance.
(c) whydirectfinanceismoreimportantthanindirectfinanceasasourceofbusiness
finance.
(d) only(a)and(b)oftheabove.
(e) only(a)and(c)oftheabove.
Answer: D
37. Adverseselectionisaproblemassociatedwithequityanddebtcontractsarisingfrom
(a) thelendersrelativelackofinformationabouttheborrowerspotentialreturnsand
risksofhisinvestmentactivities.
(b) thelendersinabilitytolegallyrequiresufficientcollateraltocovera100percent
lossiftheborrowerdefaults.
(c) theborrowerslackofincentivetoseekaloanforhighlyriskyinvestments.
(d) noneoftheabove.
Answer: A
38. Whentheleastdesirablecreditrisksaretheonesmostlikelytoseekloans,lendersare
subjecttothe
(a) moralhazardproblem.
(b) adverseselectionproblem.
(c) shirkingproblem.
(d) freeriderproblem.
(e) principalagentproblem.
Answer: B
39. Financialinstitutionsexpectthat
(a) moralhazardwilloccur,astheleastdesirablecreditriskswillbetheonesmost
likelytoseekoutloans.
(b) opportunisticbehaviorwilloccur,astheleastdesirablecreditriskswillbetheones
mostlikelytoseekoutloans.
(c) borrowerswillcommitmoralhazardbytakingontoomuchrisk,andthisiswhat
drivesfinancialinstitutionstotakestepstolimitmoralhazard.
(d) noneoftheabovewilloccur.
Answer: C
40. Successfulfinancialintermediarieshavehigherearningsontheirinvestmentsbecause
theyarebetterequippedthanindividualstoscreenoutgoodfrombadrisks,therebyreducing
lossesdueto
(a) moralhazard.
(b) adverseselection.
(c) badluck.
(d) financialpanics.
Answer: B
41. Infinancialmarkets,lenderstypicallyhaveinferiorinformationaboutpotentialreturns
andrisksassociatedwithanyinvestmentproject.Thisdifferenceininformationiscalled
(a) comparativeinformationaldisadvantage.
(b) asymmetricinformation.
(c) variantinformation.
(d) caveatvenditor.
Answer: B
42. Thelargestdepositoryinstitutionattheendof2004was
(a) lifeinsurancecompanies.
(b) pensionfunds.
(c) stateretirementfunds.
(d) noneoftheabove.
Answer: D
43. Whichofthefollowingfinancialintermediariesaredepositoryinstitutions?
(a) Asavingsandloanassociation
(b) Acommercialbank
(c) Acreditunion
(d) Alloftheabove
(e) Only(a)and(c)oftheabove
Answer: D
44. Whichofthefollowingisacontractualsavingsinstitution?
(a) Alifeinsurancecompany
(b) Acreditunion
(c) Asavingsandloanassociation
(d) Amutualfund
Answer: A
Chapter3
WhatDoInterestRatesMeanandWhatIsTheir
RoleinValuation?
.1
1.
Aloanthatrequirestheborrowertomakethesamepaymenteveryperioduntilthe
maturitydateiscalleda
(a) simpleloan.
(b) fixedpaymentloan.
(c) discountloan.
(d) samepaymentloan.
(e) noneoftheabove.
Answer: B
2.
Acouponbondpaystheownerofthebond
(a) thesameamounteverymonthuntilmaturitydate.
(b) afixedinterestpaymenteveryperiodandrepaysthefacevalueatthematuritydate.
(c) thefacevalueofthebondplusaninterestpaymentoncethematuritydatehasbeen
reached.
(d) thefacevalueatthematuritydate.
(e) noneoftheabove.
Answer: B
3.
Abondsfuturepaymentsarecalledits
(a) cashflows.
(b) maturityvalues.
(c) discountedpresentvalues.
(d) yieldstomaturity.
Answer: A
4.
Acreditmarketinstrumentthatpaystheownerthefacevalueofthesecurityatthe
maturitydate
andnothingpriortotheniscalleda
(a) simpleloan.
(b) fixedpaymentloan.
(c) couponbond.
(d) discountbond.
Answer: D
5. (I)Asimpleloanrequirestheborrowertorepaytheprincipalatthematuritydatealong
withaninterestpayment.(II)Adiscountbondisboughtatapricebelowitsfacevalue,and
thefacevalueisrepaidatthematuritydate.
(a) (I)istrue,(II)false.
(b) (I)isfalse,(II)true.
(c) Botharetrue.
(d) Botharefalse.
Answer: C
6.
Whichofthefollowingaretrueofcouponbonds?
(a) Theownerofacouponbondreceivesafixedinterestpaymenteveryyearuntilthe
maturitydate,whenthefaceorparvalueisrepaid.
(b) U.S.Treasurybondsandnotesareexamplesofcouponbonds.
(c) Corporatebondsareexamplesofcouponbonds.
(d) Alloftheabove.
Answer: D
7.
Whichofthefollowingaregenerallytrueofallbonds?
(a) Thelongerabondsmaturity,theloweristherateofreturnthatoccursasaresult
oftheincreaseinaninterestrate.
(b) Eventhoughabondhasasubstantialinitialinterestrate,itsreturncanturnoutto
benegativeifinterestratesrise.
(c) Pricesandreturnsforlongtermbondsaremorevolatilethanthoseforshorterterm
bonds.
Answer: D
8.
(I)Adiscountbondrequirestheborrowertorepaytheprincipalatthematuritydate
plusaninterestpayment.(II)Acouponbondpaysthelenderafixedinterestpayment
everyyearuntilthematuritydate,whenaspecifiedfinalamount(faceorparvalue)is
repaid.
(c) Botharetrue.
(d) Botharefalse.
Answer: B
9.
Ifa$5,000couponbondhasacouponrateof13percent,thenthecouponpayment
everyyearis
(a) $650.
(b) $1,300.
(c) $130.
(d) $13.
(e) Noneoftheabove.
Answer: A
10. An$8,000couponbondwitha$400annualcouponpaymenthasacouponrateof
(a) 5percent.
(b) 8percent.
(c) 10percent.
(d) 40percent.
Answer: A
11.
Theconceptof_________isbasedonthecommonsensenotionthatadollarpaidto
youinthefutureislessvaluabletoyouthanadollartoday.
(a) presentvalue
(b) futurevalue
(c) interest
(d) deflation
Answer: A
12.
Dollarsreceivedinthefutureareworth_________thandollarsreceivedtoday.The
processofcalculatingwhatdollarsreceivedinthefutureareworthtodayiscalled
_________
(a) more;discounting.
(b) less;discounting.
(c) more;inflating.
(d) less;inflating.
Answer: B
13.
Theprocessofcalculatingwhatdollarsreceivedinthefutureareworthtodayiscalled
(a) calculatingtheyieldtomaturity.
(b) discountingthefuture.
(c) compoundingthefuture.
(d) compoundingthepresent.
Answer: B
14.
Withaninterestrateof5percent,thepresentvalueof$100receivedoneyearfromnow
isapproximately
(a) $100.
(b) $105.
(c) $95.
(d) $90.
Answer: C
15.
Withaninterestrateof10percent,thepresentvalueofasecuritythatpays$1,100next
yearand$1,460fouryearsfromnowisapproximately
(a) $1,000.
(b) $2,000
(c) $2,560.
(d) $3,000.
Answer: B
16. Withaninterestrateof8percent,thepresentvalueof$100receivedoneyearfromnow
isapproximately
(a) $93.
(b) $96.
(c) $100.
(d) $108.
Answer: A
17.
Withaninterestrateof6percent,thepresentvalueof$100receivedoneyearfromnow
isapproximately
(a) $106.
(b) $100.
(c) $94.
(d) $92.
Answer: C
18.
Theinterestratethatequatesthepresentvalueofthecashflowreceivedfromadebt
instrumentwithitsmarketpricetodayisthe
(a) simpleinterestrate.
(b) discountrate.
(c) yieldtomaturity.
(d) realinterestrate.
Answer: C
19.
Theinterestratethatfinancialeconomistsconsidertobethemostaccuratemeasureis
the
(a) currentyield.
(b) yieldtomaturity.
(c) yieldonadiscountbasis.
(d) couponrate.
Answer: B
20.
Financialeconomistsconsiderthe_________tobethemostaccuratemeasureof
interestrates.
(a) simpleinterestrate
(b) discountrate
(c) yieldtomaturity
(d) realinterestrate
Answer: C
21.
Forasimpleloan,thesimpleinterestrateequalsthe
(a) realinterestrate.
(b) nominalinterestrate.
(c) currentyield.
(d) yieldtomaturity.
Answer: D
22. Forsimpleloans,thesimpleinterestrateis_________theyieldtomaturity.
(a) greaterthan
(b) lessthan
(c) equalto
(d) notcomparableto
Answer: C
23.
Theyieldtomaturityofaoneyear,simpleloanof$500thatrequiresaninterest
paymentof$40is
(a) 5percent.
(b) 8percent.
(c) 12percent.
(d) 12.5percent.
Answer: B
24.
Theyieldtomaturityofaoneyear,simpleloanof$400thatrequiresaninterest
paymentof$50is
(a) 5percent.
(b) 8percent.
(c) 12percent.
(d) 12.5percent.
Answer: D
25.
A$10,000,8percentcouponbondthatsellsfor$10,000hasayieldtomaturityof
(a) 8percent.
(b) 10percent.
(c) 12percent.
(d) 14percent.
Answer: A
26.
Whichofthefollowing$1,000facevaluesecuritieshasthehighestyieldtomaturity?
(a) A5percentcouponbondsellingfor$1,000
(b) A10percentcouponbondsellingfor$1,000
(c) A12percentcouponbondsellingfor$1,000
(d) A12percentcouponbondsellingfor$1,100
Answer: C
27.
Whichofthefollowing$1,000facevaluesecuritieshasthehighestyieldtomaturity?
(a) A5percentcouponbondsellingfor$1,000
(b) A10percentcouponbondsellingfor$1,000
(c) A15percentcouponbondsellingfor$1,000
(d) A15percentcouponbondsellingfor$900
Answer: D
28. Whichofthefollowingaretrueforacouponbond?
(a) Whenthecouponbondispricedatitsfacevalue,theyieldtomaturityequalsthe
couponrate.
(b) Thepriceofacouponbondandtheyieldtomaturityarenegativelyrelated.
(c) Theyieldtomaturityisgreaterthanthecouponratewhenthebondpriceisbelow
theparvalue.
Answer: D
29.
Whichofthefollowingaretrueforacouponbond?
couponrate.
(b) Thepriceofacouponbondandtheyieldtomaturityarenegativelyrelated.
(c) Theyieldtomaturityisgreaterthanthecouponratewhenthebondpriceisabove
theparvalue.
Answer: E
30.
Whichofthefollowingaretrueforacouponbond?
couponrate.
(b) Thepriceofacouponbondandtheyieldtomaturityarepositivelyrelated.
(c) Theyieldtomaturityisgreaterthanthecouponratewhenthebondpriceisabove
theparvalue.
Answer: A
31.
Aconsolbondisabondthat
(a) paysinterestannuallyanditsfacevalueatmaturity.
(b) paysinterestinperpetuityandnevermatures.
(c) paysnointerestbutpaysfacevalueatmaturity.
(d) risesinvalueasitsyieldtomaturityrises.
Answer: B
32.
Theyieldtomaturityonaconsolbondthatpays$100yearlyandsellsfor$500is
(a) 5percent.
(b) 10percent.
(c) 12.5percent.
(d) 20percent.
(e) 25percent.
Answer: D
33.
Theyieldtomaturityonaconsolbondthatpays$200yearlyandsellsfor$1000is
(a) 5percent.
(b) 10percent.
(c) 20percent.
(d) 25percent.
Answer: C
34. Afrequentlyusedapproximationfortheyieldtomaturityonalongtermbondisthe
(a) couponrate.
(b) currentyield.
(c) cashflowinterestrate.
(d) realinterestrate.
Answer: B
35.
Thecurrentyieldonacouponbondisthebonds_________dividedbyits_________.
(a) annualcouponpayment;price
(b) annualcouponpayment;facevalue
(c) annualreturn;price
(d) annualreturn;facevalue
Answer: A
36.
Whenabondspricefalls,itsyieldtomaturity_________anditscurrentyield
_________.
(a) falls;falls
(b) rises;rises
(c) falls;rises
(d) rises;falls
Answer: B
37.
Theyieldtomaturityforaoneyeardiscountbondequals
(a) theincreaseinpriceovertheyear,dividedbytheinitialprice.
(b) theincreaseinpriceovertheyear,dividedbythefacevalue.
(c) theincreaseinpriceovertheyear,dividedbytheinterestrate.
(d) noneoftheabove.
Answer: A
38.
Ifa$10,000facevaluediscountbondmaturinginoneyearissellingfor$8,000,then
itsyieldtomaturityis
(a) 10percent.
(b) 20percent.
(c) 25percent.
(d) 40percent.
Answer: C
39.
Ifa$10,000facevaluediscountbondmaturinginoneyearissellingfor$9,000,then
itsyieldtomaturityis
(a) 9percent.
(b) 10percent.
(c) 11percent.
(d) 12percent.
Answer: C
40. Ifa$10,000facevaluediscountbondmaturinginoneyearissellingfor$5,000,thenits
yieldtomaturityis
(a) 5percent.
(b) 10percent.
(c) 50percent.
(d) 100percent.
Answer: D
41.
Ifa$5,000facevaluediscountbondmaturinginoneyearissellingfor$5,000,thenits
yieldtomaturityis
(a) 0percent.
(b) 5percent.
(c) 10percent.
(d) 20percent.
Answer: A
42.
TheFisherequationstatesthat
(a) thenominalinterestrateequalstherealinterestrateplustheexpectedrateof
inflation.
(b) therealinterestrateequalsthenominalinterestratelesstheexpectedrateof
inflation.
(c) thenominalinterestrateequalstherealinterestratelesstheexpectedrateof
inflation.
(d) both(a)and(b)oftheabovearetrue.
(e) both(a)and(c)oftheabovearetrue.
Answer: D
43.
Ifyouexpecttheinflationratetobe15percentnextyearandaoneyearbondhasa
yieldtomaturityof7percent,thentherealinterestrateonthisbondis
(a) 7percent.
(b) 22percent.
(c) 15percent.
(d) 8percent.
(e) noneoftheabove.
Answer: D
44.
Ifyouexpecttheinflationratetobe5percentnextyearandaoneyearbondhasayield
tomaturityof7percent,thentherealinterestrateonthisbondis
(a) 12percent.
(b) 2percent.
(c) 2percent.
(d) 12percent.
Answer: C
45. Thenominalinterestrateminustheexpectedrateofinflation
(a) definestherealinterestrate.
(b) isabettermeasureoftheincentivestoborrowandlendthanisthenominalinterest
rate.
(c) isamoreaccurateindicatorofthetightnessofcreditmarketconditionsthanisthe
nominalinterestrate.
(d) alloftheabove.
(e) only(a)and(b)oftheabove.
Answer: D
46.
Thenominalinterestrateminustheexpectedrateofinflation
(a) definestherealinterestrate.
(b) isalessaccuratemeasureoftheincentivestoborrowandlendthanisthenominal
interestrate.
(c) isalessaccurateindicatorofthetightnessofcreditmarketconditionsthanisthe
nominalinterestrate.
(d) definesthediscountrate.
Answer: A
47.
Inwhichofthefollowingsituationswouldyouprefertobemakingaloan?
(a) Theinterestrateis9percentandtheexpectedinflationrateis7percent.
(b) Theinterestrateis4percentandtheexpectedinflationrateis1percent.
(c) Theinterestrateis13percentandtheexpectedinflationrateis15percent.
(d) Theinterestrateis25percentandtheexpectedinflationrateis50percent.
Answer: B
48.
Inwhichofthefollowingsituationswouldyouprefertobeborrowing?
(a) Theinterestrateis9percentandtheexpectedinflationrateis7percent.
(b) Theinterestrateis4percentandtheexpectedinflationrateis1percent.
(c) Theinterestrateis13percentandtheexpectedinflationrateis15percent.
(d) Theinterestrateis25percentandtheexpectedinflationrateis50percent.
Answer: D
49.
Whatisthereturnona5percentcouponbondthatinitiallysellsfor$1,000andsellsfor
$1,200oneyearlater?
(a) 5percent
(b) 10percent
(c) 5percent
(d) 25percent
(e) Noneoftheabove
Answer: D
50. Whatisthereturnona5percentcouponbondthatinitiallysellsfor$1,000andsellsfor
$900oneyearlater?
(a) 5percent
(b) 10percent
(c) 5percent
(d) 10percent
(e) Noneoftheabove
Answer: C
51.
Thereturnona5percentcouponbondthatinitiallysellsfor$1,000andsellsfor$1,100
oneyearlateris
(a) 5percent.
(b) 10percent.
(c) 14percent.
(d) 15percent.
Answer: D
52.
Thereturnona10percentcouponbondthatinitiallysellsfor$1,000andsellsfor$900
oneyearlateris
(a) 10percent.
(b) 5percent.
(c) 0percent.
(d) 5percent.
Answer: C
53.
Whichofthefollowingaregenerallytrueofallbonds?
(a) Theonlybondwhosereturnequalstheinitialyieldtomaturityisonewhosetimeto
maturityisthesameastheholdingperiod.
(b) Ariseininterestratesisassociatedwithafallinbondprices,resultingincapital
lossesonbondswhosetermtomaturitiesarelongerthantheholdingperiod.
(c) Thelongerabondsmaturity,thegreateristhepricechangeassociatedwitha
giveninterestratechange.
Answer: D
54.
Whichofthefollowingaretrueconcerningthedistinctionbetweeninterestratesand
return?
(a) Therateofreturnonabondwillnotnecessarilyequaltheinterestrateonthat
bond.
(b) Thereturncanbeexpressedasthesumofthecurrentyieldandtherateofcapital
gains.
(c) Therateofreturnwillbegreaterthantheinterestratewhenthepriceofthebond
fallsbetweentimetandtimet+1.
Answer: E
55. Iftheinterestratesonallbondsrisefrom5to6percentoverthecourseoftheyear,
whichbondwouldyouprefertohavebeenholding?
(a) Abondwithoneyeartomaturity
(b) Abondwithfiveyearstomaturity
(c) Abondwithtenyearstomaturity
(d) Abondwithtwentyyearstomaturity
Answer: A
56.
Supposeyouareholdinga5percentcouponbondmaturinginoneyearwithayieldto
maturityof15percent.Iftheinterestrateononeyearbondsrisesfrom15percentto20
percentoverthecourseoftheyear,whatistheyearlyreturnonthebondyouare
holding?
(a) 5percent
(b) 10percent
(c) 15percent
(d) 20percent
Answer: C
57.
(I)Pricesoflongermaturitybondsrespondmoredramaticallytochangesininterest
rates.(II)Pricesandreturnsforlongtermbondsarelessvolatilethanthoseforshort
termbonds.
(c) Botharetrue.
(d) Botharefalse.
Answer: A
58.
(I)Pricesoflongermaturitybondsrespondlessdramaticallytochangesininterest
rates.(II)Pricesandreturnsforlongtermbondsarelessvolatilethanthoseforshorter
termbonds.
(c) Botharetrue.
(d) Botharefalse.
Answer: D
59.
Theriskinessofanassetsreturnthatresultsfrominterestratechangesiscalled
(a) interestraterisk.
(b) couponraterisk.
(c) reinvestmentrisk.
(d) yieldtomaturityrisk.
Answer: A
60.
Ifaninvestorsholdingperiodislongerthanthetermtomaturityofabond,heorsheis
exposedto
(a) interestraterisk.
(b) reinvestmentrisk.
(c) bondmarketrisk.
(d) yieldtomaturityrisk.
Answer: B
61. Reinvestmentriskistheriskthat
(a) abondsvaluemayfallinthefuture.
(b) abondsfuturecouponpaymentsmayhavetobeinvestedataratelowerthanthe
bondsyieldtomaturity.
(c) aninvestorsholdingperiodwillbeshortandequalinlengthtothematurityofthe
bondsheorsheholds.
(d) abondsissuermayfailtomakethefuturecouponpaymentsandaninvestorwill
havenocashtoreinvest.
Answer:
62.
(I)Theaveragelifetimeofadebtsecuritysstreamofpaymentsiscalledduration.(II)
Thedurationofaportfolioistheweightedaverageofthedurationsoftheindividual
securities,withtheweightsreflectingtheproportionoftheportfolioinvestedineach.
(c) Botharetrue.
(d) Botharefalse.
Answer: C
63.
Thedurationofatenyear,10percentcouponbondwhentheinterestrateis10percent
is6.76years.Whathappenstothepriceofthebondiftheinterestratefallsto8
percent?
(a) itrises20percent
(b) itrises12.3percent
(c) itfalls20percent
(d) itfalls12.3percent
Answer: B
True/False
1.
Abondscurrentmarketvalueisequaltothepresentvalueofthecouponpayments
plusthepresentvalueofthefaceamount.
Answer:
2.
Discountingthefutureistheprocedureusedtofindthefuturevalueofadollarreceived
today.
Answer:
3.
FALSE
Therealinterestrateisequaltothenominalrateminusinflation.
Answer:
12.
FALSE
Interestrateriskistheuncertaintythataninvestorfacesbecausetheinterestrateat
whichabondsfuturecouponpaymentscanbeinvestedisunknown.
Answer:
11.
TRUE
Allelsebeingequal,thegreatertheinterestratethegreateristheduration.
Answer:
10.
FALSE
Increasingdurationimpliesthatinterestrateriskhasincreased.
Answer:
9.
TRUE
Alongtermbondspriceislessaffectedbyinterestratemovementsthanisashort
termbondsprice.
Answer:
8.
TRUE
Pricesforlongtermbondsaremorevolatilethanforshortertermbonds.
Answer:
7.
FALSE
Thecurrentyieldistheyearlycouponpaymentdividedbythecurrentmarketprice.
Answer:
6.
FALSE
Unlessabonddefaults,aninvestorcannotlosemoneyinvestinginbonds.
Answer:
5.
FALSE
Thecurrentyieldisthebestmeasureofaninvestorsreturnfromholdingabond.
Answer:
4.
TRUE
TRUE
Thecurrentyieldgoesupasthepriceofabondfalls.
Answer:
TRUE
Essay
1.
Distinguishbetweencouponrate,yieldtomaturity,andcurrentyield.
2.
Describethecashflowsreceivedfromowningacouponbond.
3.
Whatconceptisusedtovalueabond?
4.
Howisabondscurrentyieldcalculated?Whyiscurrentyieldamoreaccurate
approximationofyieldtomaturityforalongtermbondthanforashorttermbond?
5.
Whyarelongtermbondsmoreriskythanshorttermbonds?
6.
Whatisinterestrateriskandhowisitmeasured?
7.
Whymayabondsrateofreturndifferfromitsyieldtomaturity?
8.
Howdoesreinvestmentriskdifferfrominterestraterisk?
9.
Whatisthedistinctionbetweenthenominalinterestrateandtherealinterestrate?
Whichisabetterindicatorofincentivestoborrowandlend?Why?
10.
DescribehowTreasuryInflationProtectionSecurities(TIPS)workandhowtheyhelp
policymakersestimateexpectedinflation.
Chapter4
WhyDoInterestRatesChange?
.2
1.
Asthepriceofabond_________andtheexpectedreturn_________,bondsbecome
moreattractivetoinvestorsandthequantitydemandedrises.
(a) falls;rises
(b) falls;falls
(c) rises;rises
(d) rises;falls
Answer: A
2.
Thesupplycurveforbondshastheusualupwardslope,indicatingthatastheprice
_________,ceterisparibus,the_________increases.
(a) falls;supply
(b) falls;quantitysupplied
(c) rises;supply
(d) rises;quantitysupplied
Answer: D
3.
Whenthepriceofabondisabovetheequilibriumprice,thereisexcess_________in
thebondmarketandthepricewill_________.
(a) demand;rise
(b) demand;fall
(c) supply;fall
(d) supply;rise
Answer: C
4.
Whenthepriceofabondisbelowtheequilibriumprice,thereisexcess_________in
thebondmarketandthepricewill_________.
(a) demand;rise
(b) demand;fall
(c) supply;fall
(d) supply;rise
Answer: A
5.
Whenthepriceofabondis_________theequilibriumprice,thereisanexcesssupply
ofbondsandthepricewill_________.
(a) above;rise
(b) above;fall
(c) below;fall
(d) below;rise
Answer: B
6.
Whenthepriceofabondis_________theequilibriumprice,thereisanexcess
demandforbondsandthepricewill_________.
(a) above;rise
(b) above;fall
(c) below;fall
(d) below;rise
Answer: D
7.
Whentheinterestrateonabondisabovetheequilibriuminterestrate,thereisexcess
_________inthebondmarketandtheinterestratewill_________.
(a) demand;rise
(b) demand;fall
(c) supply;fall
(d) supply;rise
Answer: B
8.
Whentheinterestrateonabondisbelowtheequilibriuminterestrate,thereisexcess
_________inthebondmarketandtheinterestratewill_________.
(a) demand;rise
(b) demand;fall
(c) supply;fall
(d) supply;rise
Answer: D
9.
Whentheinterestrateonabondis_________theequilibriuminterestrate,thereis
excess_________inthebondmarketandtheinterestratewill_________.
(a) above;demand;fall
(b) above;demand;rise
(c) below;supply;fall
(d) above;supply;rise
Answer: A
10.
Whentheinterestrateonabondis_________theequilibriuminterestrate,thereis
excess_________inthebondmarketandtheinterestratewill_________.
(a) below;demand;rise
(b) below;demand;fall
(c) below;supply;rise
(d) above;supply;fall
Answer: C
11. Whenthedemandforbonds_________orthesupplyofbonds_________,interestrate
rise.
(a) increases;increases
(b) increases;decreases
(c) decreases;decreases
(d) decreases;increases
Answer: D
12.
Whenthedemandforbonds_________orthesupplyofbonds_________,interest
ratesfall.
Answer: B
13.
Whenthedemandforbonds_________orthesupplyofbonds_________,bondprices
rise.
(a) increases;decreases
(b) decreases;increases
(d) increases;increases
Answer: A
14.
Whenthedemandforbonds_________orthesupplyofbonds_________,bondprices
fall.
Answer: D
15.
Factorsthatdeterminethedemandforanassetincludechangesinthe
(a) wealthofinvestors.
(b) liquidityofbondsrelativetoalternativeassets.
(c) expectedreturnsonbondsrelativetoalternativeassets.
(d) riskofbondsrelativetoalternativeassets.
(e) alloftheabove.
Answer: E
16.
Thedemandforanassetrisesif_________falls.
(a) riskrelativetootherassets
(b) expectedreturnrelativetootherassets
(c) liquidityrelativetootherassets
(d) wealth
Answer: A
17. Thehigherthestandarddeviationofreturnsonanasset,the_________istheassets
_________.
(a) greater;risk
(b) smaller;risk
(c) greater;expectedreturn
(d) smaller;expectedreturn
Answer: A
18.
Diversificationbenefitsaninvestorby
(a) increasingwealth.
(b) increasingexpectedreturn.
(c) reducingrisk.
(d) increasingliquidity.
Answer: C
19.
Inarecessionwhenincomeandwealtharefalling,thedemandforbonds_________
andthedemandcurveshiftstothe_________.
(a) falls;right
(b) falls;left
(c) rises;right
(d) rises;left
Answer: B
20.
Duringbusinesscycleexpansionswhenincomeandwealtharerising,thedemandfor
bonds_________andthedemandcurveshiftstothe_________.
(a) falls;right
(b) falls;left
(c) rises;right
(d) rises;left
Answer: C
21.
Foraholdingperiodofoneyear,theexpectedreturnonaconsolis_________the
higheristhepriceoftheconsoltoday,and_________thehigheristhepriceofthe
consolnextyear.
(a) higher;higher
(b) higher;lower
(c) lower;higher
(d) lower;lower
Answer: C
22.
Higherexpectedinterestratesinthefuture_________thedemandforlongtermbonds
andshiftthedemandcurvetothe_________.
(a) increase;left
(b) increase;right
(c) decrease;left
(d) decrease;right
Answer: C
23. Lowerexpectedinterestratesinthefuture_________thedemandforlongtermbonds
andshiftthedemandcurvetothe_________
(a) increase;left.
(b) increase;right.
(c) decrease;left.
(d) decrease;right.
Answer: B
24.
Whenpeoplebegintoexpectalargestockmarketdecline,thedemandcurveforbonds
shiftstothe_________andtheinterestrate_________.
(a) right;falls
(b) right;rises
(c) left;falls
(d) left;rises
Answer: A
25.
Whenpeoplebegintoexpectalargerunupinstockprices,thedemandcurveforbonds
(a) right;rises
(b) right;falls
(c) left;falls
(d) left;rises
Answer: D
26.
Anincreaseintheexpectedrateofinflationwill_________theexpectedreturnon
bondsrelativetothaton_________assets,andshiftthe_________curvetotheleft.
(a) reduce;financial;demand
(b) reduce;real;demand
(c) raise;financial;supply
(d) raise;real;supply
Answer: B
27.
Adecreaseintheexpectedrateofinflationwill_________theexpectedreturnon
bondsrelativetothaton_________assets.
(a) reduce;financial
(b) reduce;real
(c) raise;financial
(d) raise;real
Answer: D
28.
Whentheexpectedinflationrateincreases,thedemandforbonds_________,the
supplyofbonds_________,andtheinterestrate_________.
(a) increases;increases;rises
(b) decreases;decreases;falls
(c) increases;decreases;falls
(d) decreases;increases;rises
Answer: D
29. Whentheexpectedinflationratedecreases,thedemandforbonds_________,thesupply
ofbonds_________,andtheinterestrate__________.
Answer: C
30.
Whenbondinterestratesbecomemorevolatile,thedemandforbonds_________and
theinterestrate_________.
(a) increases;rises
(b) increases;falls
(c) decreases;falls
(d) decreases;rises
Answer: D
31.
Whenbondinterestratesbecomelessvolatile,thedemandforbonds_________and
theinterestrate_________.
(a) increases;rises
(b) increases;falls
(c) decreases;falls
(d) decreases;rises
Answer: B
32.
Whenpricesinthestockmarketbecomemoreuncertain,thedemandcurveforbonds
(a) right;rises
(b) right;falls
(c) left;falls
(d) left;rises
Answer: B
33.
Whenstockpricesbecomelessvolatile,thedemandcurveforbondsshiftstothe
_________andtheinterestrate_________.
(a) right;rises
(b) right;falls
(c) left;falls
(d) left;rises
Answer: D
34.
Whenbondsbecomemorewidelytraded,andasaconsequencethemarketbecomes
moreliquid,thedemandcurveforbondsshiftstothe_________andtheinterestrate
_________.
(a) right;rises
(b) right;falls
(c) left;falls
(d) left;rises
Answer: B
35. Whenbondsbecomelesswidelytraded,andasaconsequencethemarketbecomesless
liquid,thedemandcurveforbondsshiftstothe_________andtheinterestrate_________.
(a) right;rises
(b) right;falls
(c) left;falls
(d) left;rises
Answer: D
36.
Factorsthatcausethedemandcurveforbondstoshifttotheleftinclude
(a) anincreaseintheinflationrate.
(b) anincreaseintheliquidityofstocks.
(c) adecreaseinthevolatilityofstockprices.
(d) alloftheabove.
(e) noneoftheabove.
Answer: D
37.
Factorsthatcausethedemandcurveforbondstoshifttotheleftinclude
(a) adecreaseintheinflationrate.
(b) anincreaseinthevolatilityofstockprices.
(c) anincreaseintheliquidityofstocks.
(d) alloftheabove.
Answer: C
38.
Duringaneconomicexpansion,thesupplyofbonds_________andthesupplycurve
shiftstothe_________.
(a) increases,left
(b) increases,right
(c) decreases,left
(d) decreases,right
Answer: B
39.
Duringarecession,thesupplyofbonds_________andthesupplycurveshiftstothe
_________.
(a) increases,left
(b) increases,right
(c) decreases,left
(d) decreases,right
Answer: C
40. Anincreaseinexpectedinflationcausesthesupplyofbondsto_________andthe
supplycurvetoshifttothe_________.
(a) increase,left
(b) increase,right
(c) decrease,left
(d) decrease,right
Answer: B
41.
Whenthefederalgovernmentsbudgetdeficitincreases,the_________curvefor
bondsshiftstothe_________.
(a) demand;right
(b) demand;left
(c) supply;left
(d) supply;right
Answer: D
42.
Whenthefederalgovernmentsbudgetdeficitdecreases,the_________curvefor
(a) demand;right
(b) demand;left
(c) supply;left
(d) supply;right
Answer: C
43.
Whentheinflationrateisexpectedtoincrease,theexpectedreturnonbondsrelativeto
realassetsfallsforanygiveninterestrate;asaresult,the_________bondsfallsand
the_________curveshiftstotheleft.
(a) demandfor;demand
(b) demandfor;supply
(c) supplyof;demand
(d) supplyof;supply
Answer: A
44.
Whentheinflationrateisexpectedtoincrease,therealcostofborrowingdeclinesat
anygiveninterestrate;asaresult,the_________bondsincreasesandthe_________
curveshiftstotheright.
(a) demandfor;demand
(b) demandfor;supply
(c) supplyof;demand
(d) supplyof;supply
Answer: D
Figure4.1
45.
InFigure4.1,themostlikelycauseoftheincreaseintheequilibriuminterestratefrom
i1toi2is
(a) anincreaseinthepriceofbonds.
(b) abusinesscycleboom.
(c) anincreaseintheexpectedinflationrate.
(d) adecreaseintheexpectedinflationrate.
Answer: C
46.
InFigure4.1,themostlikelycauseoftheincreaseintheequilibriuminterestratefrom
i1toi2isa(n)_________inthe_________.
(a) increase;expectedinflationrate
(b) decrease;expectedinflationrate.
(c) increase;governmentbudgetdeficit
(d) decrease;governmentbudgetdeficit
Answer: A
47.
InFigure4.1,themostlikelycauseofadecreaseintheequilibriuminterestratefromi 2
toi1is
(a) anincreaseintheexpectedinflationrate.
(b) adecreaseintheexpectedinflationrate.
(c) abusinesscycleexpansion.
(d) acombinationofboth(a)and(c)oftheabove.
Answer: B
48.
Factorsthatcancausethesupplycurveforbondstoshifttotherightinclude
(a) anexpansioninoveralleconomicactivity.
(b) adecreaseinexpectedinflation.
(c) adecreaseingovernmentdeficits.
(d) alloftheabove.
Answer: A
49.
Factorsthatcancausethesupplycurveforbondstoshifttotheleftinclude
(a) anexpansioninoveralleconomicactivity.
(b) adecreaseinexpectedinflation.
(c) anincreaseingovernmentdeficits.
(d) only(a)and(c)oftheabove.
Answer: B
50.
TheeconomistIrvingFisher,afterwhomtheFishereffectisnamed,explainedwhy
interestrates_________astheexpectedrateofinflation_________.
(a) rise;increases
(b) rise;stabilizes
(c) rise;decreases
(d) fall;increases
(e) fall;stabilizes
Answer: A
51.
Anincreaseintheexpectedrateofinflationcausesthedemandforbondsto_________
andthesupplyforbondsto_________.
(a) fall;fall
(b) fall;rise
(c) rise;fall
(d) rise;rise
Answer: B
52.
Adecreaseintheexpectedrateofinflationcausesthedemandforbondsto_________
andthesupplyofbondsto_________.
(a) fall;fall
(b) fall;rise
(c) rise;fall
(d) rise;rise
Answer: C
53.
Whentheeconomyslipsintoarecession,normallythedemandforbonds_________,
thesupplyofbonds_________,andtheinterestrate_________.
Answer: B
54.
Whentheeconomyentersintoaboom,normallythedemandforbonds_________,
thesupplyofbonds_________,andtheinterestrate_________.
(c) increases;decreases;rises
Answer: A
Figure4.2
55.
InFigure4.2,onepossibleexplanationfortheincreaseintheinterestratefromi 1toi2is
a(n)_________in_________.
(a) increase;theexpectedinflationrate
(b) decrease;theexpectedinflationrate
(c) increase;economicgrowth
(d) decrease;economicgrowth
Answer: C
56.
InFigure4.2,onepossibleexplanationfortheincreaseintheinterestratefromi 1toi2is
(a) anincreaseineconomicgrowth.
(b) anincreaseingovernmentbudgetdeficits.
(c) adecreaseingovernmentbudgetdeficits.
(d) adecreaseineconomicgrowth.
(e) adecreaseintheriskinessofbondsrelativetootherinvestments.
Answer: A
57.
InFigure4.2,onepossibleexplanationforadecreaseintheinterestratefromi 2toi1is
(a) anincreaseingovernmentbudgetdeficits.
(b) anincreaseinexpectedinflation.
(c) adecreaseineconomicgrowth.
(d) adecreaseintheriskinessofbondsrelativetootherinvestments.
Answer: C
QuestionsforChapter4,WebAppendix2:SupplyandDemandintheMarketforMoney:
TheLiquidityPreferenceFramework
58.
InKeynessliquiditypreferenceframework,individualsareassumedtoholdtheir
wealthintwoforms:
(a) realassetsandfinancialassets.
(b) stocksandbonds.
(c) moneyandbonds.
(d) moneyandgold.
Answer: C
59. Inhisliquiditypreferenceframework,Keynesassumedthatmoneyhasazerorateof
return;thus,wheninterestrates_________theexpectedreturnonmoneyfallsrelativetothe
expectedreturnonbonds,causingthedemandformoneyto_________.
(a) rise;fall
(b) rise;rise
(c) fall;fall
(d) fall;rise
Answer: A
60.
Theloanablefundsframeworkiseasiertousewhenanalyzingtheeffectsofchangesin
_________,whiletheliquiditypreferenceframeworkprovidesasimpleranalysisofthe
effectsfromchangesinincome,thepricelevel,andthesupplyof_________
(a) expectedinflation;bonds.
(b) expectedinflation;money.
(c) governmentbudgetdeficits;bonds.
(d) thesupplyofmoney;bonds.
Answer: B
61.
Whencomparingtheloanablefundsandliquiditypreferenceframeworksofinterest
ratedetermination,whichofthefollowingistrue?
(a) Theliquiditypreferenceframeworkiseasiertousewhenanalyzingtheeffectsof
changesinexpectedinflation.
(b) Theloanablefundsframeworkprovidesasimpleranalysisoftheeffectsofchanges
inincome,thepricelevel,andthesupplyofmoney.
(c) Inmostinstances,thetwoapproachestointerestratedeterminationyieldthesame
predictions.
Answer: C
62.
Ahigherlevelofincomecausesthedemandformoneyto_________andtheinterest
rateto_________
(a) decrease;decrease.
(b) decrease;increase.
(c) increase;decrease.
(d) increase;increase.
Answer: D
63.
Alowerlevelofincomecausesthedemandformoneyto_________andtheinterest
rateto_________
(a) decrease;decrease.
(b) decrease;increase.
(c) increase;decrease.
(d) increase;increase.
Answer: A
64. Ariseinthepricelevelcausesthedemandformoneyto_________andthedemand
curvetoshifttothe_________
(a) decrease;right.
(b) decrease;left.
(c) increase;right.
(d) increase;left.
Answer: C
65.
Adeclineinthepricelevelcausesthedemandformoneyto_________andthe
demandcurvetoshifttothe_________
(a) decrease;right.
(b) decrease;left.
(c) increase;right.
(d) increase;left.
Answer: B
66.
Adeclineintheexpectedinflationratecausesthedemandformoneyto_________and
thedemandcurvetoshifttothe_________
(a) decrease;right.
(b) decrease;left.
(c) increase;right.
(d) increase;left.
Answer: B
67.
Holdingeverythingelseconstant,anincreaseinthemoneysupplycauses
(a) interestratestodeclineinitially.
(b) interestratestoincreaseinitially.
(c) bondpricestodeclineinitially.
(d) both(a)and(c)oftheabove.
Answer: A
68.
Holdingeverythingelseconstant,adecreaseinthemoneysupplycauses
(a) interestratestodeclineinitially.
(b) interestratestoincreaseinitially.
(c) bondpricestoincreaseinitially.
Answer: B
Figure4.3
69.
InFigure4.3,thefactorresponsibleforthedeclineintheinterestrateis
(a) adeclineinthepricelevel.
(b) adeclineinincome.
(c) anincreaseinthemoneysupply.
(d) adeclineintheexpectedinflationrate.
Answer: C
70.
InFigure4.3,thedecreaseintheinterestratefromi 1toi2canbeexplainedby
(a) adecreaseinmoneygrowth.
(b) anincreaseinmoneygrowth.
(c) adeclineintheexpectedpricelevel.
Answer: B
71.
InFigure4.3,anincreaseintheinterestratefromi2toi1canbeexplainedby
(a) adecreaseinmoneygrowth.
(b) anincreaseinmoneygrowth.
(c) adeclineinthepricelevel.
(d) anincreaseintheexpectedpricelevel.
Answer: A
72.
Ofthefoureffectsoninterestratesfromanincreaseinthemoneysupply,theonethat
worksintheoppositedirectionoftheotherthreeisthe
(a) liquidityeffect.
(b) incomeeffect.
(c) priceleveleffect.
(d) expectedinflationeffect.
Answer: A
73.
Ofthefoureffectsoninterestratesfromanincreaseinthemoneysupply,theinitial
effectis,generally,the
(a) incomeeffect.
(b) liquidityeffect.
(c) priceleveleffect.
(d) expectedinflationeffect.
Answer: B
74. Iftheliquidityeffectissmallerthantheothereffects,andtheadjustmentofexpected
inflationisslow,thenthe
(a) interestratewillfall.
(b) interestratewillrise.
(c) interestratewillinitiallyfallbuteventuallyclimbabovetheinitiallevelin
responsetoanincreaseinmoneygrowth.
(d) interestratewillinitiallyrisebuteventuallyfallbelowtheinitiallevelinresponse
toanincreaseinmoneygrowth.
Answer: C
75.
Whenthegrowthrateofthemoneysupplyincreases,interestratesendupbeing
permanentlylowerif
(a) theliquidityeffectislargerthantheothereffects.
(b) thereisfastadjustmentofexpectedinflation.
(c) thereisslowadjustmentofexpectedinflation.
(d) theexpectedinflationeffectislargerthantheliquidityeffect.
Answer: A
76.
Whenthegrowthrateofthemoneysupplydecreases,interestratesendupbeing
permanently
lowerif
(a) theliquidityeffectislargerthantheothereffects.
(b) thereisfastadjustmentofexpectedinflation.
(c) thereisslowadjustmentofexpectedinflation.
(d) theexpectedinflationeffectislargerthantheliquidityeffect.
Answer: D
77.
Whenthegrowthrateofthemoneysupplyisdecreased,interestrateswillrise
immediatelyiftheliquidityeffectis_________thantheothereffectsandifthereis
_________adjustmentofexpectedinflation.
(a) larger;rapid
(b) larger;slow
(c) smaller;slow
(d) smaller;rapid
Answer: B
78.
Whenthegrowthrateofthemoneysupplyisincreased,interestrateswillrise
immediatelyiftheliquidityeffectis_________thantheothereffectsandifthereis
_________adjustmentofexpectedinflation.
(a) larger;rapid
(b) larger;slow
(c) smaller;slow
(d) smaller;rapid
Answer: D
79. IftheFedwantstopermanentlylowerinterestrates,thenitshouldlowertherateof
moneygrowthif
(a) thereisfastadjustmentofexpectedinflation.
(b) thereisslowadjustmentofexpectedinflation.
(c) theliquidityeffectissmallerthantheexpectedinflationeffect.
(d) theliquidityeffectislargerthantheothereffects.
Answer: C
80.
IftheFedwantstopermanentlylowerinterestrates,thenitshouldraisetherateof
moneygrowthif
(a) thereisfastadjustmentofexpectedinflation.
(b) thereisslowadjustmentofexpectedinflation.
(c) theliquidityeffectissmallerthantheexpectedinflationeffect.
(d) theliquidityeffectislargerthantheothereffects.
Answer: D
81.
MiltonFriedmancontendsthatitisentirelypossiblethatwhenthemoneysupplyrises,
interestratesmay_________ifthe_________effectismorethanoffsetbychangesin
income,thepricelevel,andexpectedinflation.
(a) fall;liquidity
(b) fall;risk
(c) rise;liquidity
(d) rise;risk
Answer: C
Figure4.4
82.
Figure4.4illustratestheeffectofanincreasedrateofmoneysupplygrowth.Fromthe
figure,onecanconcludethattheliquidityeffectis_________thantheexpected
inflationeffectandinterestratesadjust_________tochangesinexpectedinflation.
(a) smaller;quickly
(b) larger;quickly
(c) larger;slowly
(d) smaller;slowly
Answer: A
83. Figure4.4illustratestheeffectofanincreasedrateofmoneysupplygrowth.Fromthe
figure,onecanconcludethatthe
(a) Fishereffectisdominatedbytheliquidityeffectandinterestratesadjustslowlyto
(b) liquidityeffectisdominatedbytheFishereffectandinterestratesadjustslowlyto
(c) liquidityeffectisdominatedbytheFishereffectandinterestratesadjustquicklyto
(d) Fishereffectissmallerthantheexpectedinflationeffectandinterestratesadjust
quicklytochangesinexpectedinflation.
Answer: C
Figure4.5
84.
figure,onecanconcludethattheliquidityeffectis_________thantheexpected
inflationeffectandinterestratesadjust_________tochangesinexpectedinflation.
(a) smaller;quickly
(b) larger;quickly
(c) larger;slowly
(d) smaller;slowly
Answer: C
85.
figure,onecanconcludethatthe
(a) Fishereffectisdominatedbytheliquidityeffectandinterestratesadjustslowlyto
(b) liquidityeffectisdominatedbytheFishereffectandinterestratesadjustslowlyto
(c) liquidityeffectisdominatedbytheFishereffectandinterestratesadjustquicklyto
(d) Fishereffectissmallerthantheexpectedinflationeffectandinterestratesadjust
quicklytochangesinexpectedinflation.
Answer: A
True/False
1.
Wheninterestratesdecrease,thedemandcurveforbondsshiftstotheleft.
Answer:
2.
FALSE
Whenaneconomygrowsoutofarecession,normallythedemandforbondsincreases
andthesupplyofbondsincreases.
Answer:
TRUE
3.
Whenthefederalgovernmentsbudgetdeficitdecreases,thedemandcurveforbonds
shiftstotheright.
Answer:
4.
Investorsmaketheirchoicesofwhichassetstoholdbycomparingtheexpectedreturn,
liquidity,andriskofalternativeassets.
Answer:
5.
FALSE
TheFisherEffectpredictsthataninceaseinexpectedinflationwilllowertheinterest
rateonbonds.
Answer:
10.
TRUE
Anincreaseintheinflationratewillcausethedemandcurveforbondstoshifttothe
right.
Answer:
9.
TRUE
Whenincomeandwealtharerising,thedemandforbondsrisesandthedemandcurve
shiftstotheright.
Answer:
8.
FALSE
Interestratesareprocyclicalinthattheytendtoriseduringbusinesscycleexpansions
andfallduringrecessions.
Answer:
7.
TRUE
Apersonwhoisriskaversepreferstoholdassetsthataremore,notless,risky.
Answer:
6.
FALSE
FALSE
Anincreaseinthefederalgovernmentbudgetdeficitwillraisetheinterestrateon
bonds.
Answer:
TRUE
Essay
1.
Identifyandexplainthefourfactorsthatinfluenceassetdemand.Whichofthese
factorsaffecttotalassetdemandandwhichinfluenceinvestorstodemandoneasset
overanother?
2.
Howistheequilibriuminterestratedeterminedinthebondmarket?Explainwhythe
interestratewillmovetowardequilibriumifitistemporarilyaboveorbelowthe
equilibriumrate.
3.
UsethebonddemandandsupplyframeworktoexplaintheFishereffectandwhyit
occurs.
4.
Ifinvestorsperceivegreaterinterestraterisk,whatwillhappentotheequilibrium
interestrateinthebondmarket?Explainusingthebonddemandandsupply
framework.
5.
Howwilladecreaseinthefederalgovernmentsbudgetdeficitaffecttheequilibrium
interestrateinthebondmaket?Explainusingthebonddemandandsupplyframework.
6.
Whatistheexpectedreturnonabondifthereturnis9%twothirdsofthetimeand3%
onethirdofthetime?Whatisthestandarddeviationofthereturnsonthisbond?
Wouldyoupreferthisbondoronewithanidenticalexpectedreturnandastandard
deviationof4.5?Why?
Chapter5
HowDoRiskandTermStructureAffectInterest
Rates?
.3
1.
Thetermstructureofinterestratesis
(a) therelationshipamonginterestratesofdifferentbondswiththesamematurity.
(b) thestructureofhowinterestratesmoveovertime.
(c) therelationshipamongthetermstomaturityofdifferentbonds.
(d) therelationshipamonginterestratesonbondswithdifferentmaturities.
Answer: D
2.
Theriskstructureofinterestratesis
(a) thestructureofhowinterestratesmoveovertime.
(b) therelationshipamonginterestratesofdifferentbondswiththesamematurity.
(c) therelationshipamongthetermstomaturityofdifferentbonds.
(d) therelationshipamonginterestratesonbondswithdifferentmaturities.
Answer: B
3.
Whichofthefollowinglongtermbondsshouldhavethelowestinterestrate?
(a) CorporateBaabonds
(b) U.S.Treasurybonds
(c) CorporateAaabonds
(d) Municipalbonds
Answer: D
4.
Whichofthefollowinglongtermbondsshouldhavethehighestinterestrate?
(a) CorporateBaabonds
(b) U.S.Treasurybonds
(c) CorporateAaabonds
(d) Municipalbonds
Answer: A
5.
Theriskpremiumoncorporatebondsbecomessmallerif
(a) theriskinessofcorporatebondsincreases.
(b) theliquidityofcorporatebondsincreases.
(c) theliquidityofcorporatebondsdecreases.
(d) theriskinessofcorporatebondsdecreases.
(e) either(b)or(d)occur.
Answer: E
6.
Bondswithrelativelylowriskofdefaultarecalled
(a) zerocouponbonds.
(b) junkbonds.
(c) investmentgradebonds.
(d) noneoftheabove.
Answer: C
7.
Bondswithrelativelyhighriskofdefaultarecalled
(a) Bradybonds.
(b) junkbonds.
(c) zerocouponbonds.
(d) investmentgradebonds.
Answer: B
8.
Acorporationsufferingbiglossesmightbemorelikelytosuspendinterestpaymentson
itsbonds,thereby
(a) raisingthedefaultriskandcausingthedemandforitsbondstorise.
(b) raisingthedefaultriskandcausingthedemandforitsbondstofall.
(c) loweringthedefaultriskandcausingthedemandforitsbondstorise.
(d) loweringthedefaultriskandcausingthedemandforitsbondstofall.
Answer: B
9.
(I)Ifacorporationsuffersbiglosses,thedemandforitsbondswillrisebecauseofthe
higherinterestratesthefirmmustpay.(II)Thespreadbetweentheinterestrateson
bondswithdefaultriskanddefaultfreebondsiscalledtheriskpremium.
(c) Botharetrue.
(d) Botharefalse.
Answer: B
10.
Holdingeverythingelseconstant,ifacorporationbeginstosufferlargelosses,thenthe
defaultriskonitsbondswill_________andtheexpectedreturnonthosebondswill
_________.
(a) increase:increase
(b) decrease;increase
(c) increase;decrease
(d) decrease;decrease
Answer: C
11.
Holdingeverythingelsethesame,ifacorporationsearningsrise,thenthedefaultrisk
onitsbondswill_________andtheexpectedreturnonthosebondswill_________.
(a) increase;decrease
(b) decrease;decrease
(c) increase;increase
(d) decrease;increase
Answer: D
12. Ifacorporationbeginstosufferlargelosses,thenthedefaultriskonitsbondswill
_________andtheequilibriuminterestrateonthesebondswill_________.
(b) decrease;increase
(d) decrease;decrease
Answer: C
13.
Ifacorporationsearningsrise,thenthedefaultriskonitsbondswill_________and
theequilibriuminterestrateonthesebondswill_________.
(b) decrease;decrease
(d) decrease;increase
Answer: B
14.
Whenthedefaultriskoncorporatebondsdecreases,otherthingsequal,thedemand
curveforcorporatebondsshiftstothe_________andthedemandcurveforTreasury
(a) right;right
(b) right;left
(c) left;left
(d) left;right
Answer: B
15.
(I)Anincreaseindefaultriskoncorporatebondsshiftsthedemandcurveforcorporate
bondstotheright.(II)Anincreaseindefaultriskoncorporatebondsshiftsthedemand
curveforTreasurybondstotheleft.
(c) Botharetrue.
(d) Botharefalse.
Answer: D
16.
(I)Anincreaseindefaultriskoncorporatebondsshiftsthedemandcurveforcorporate
bondstotheleft.(II)Anincreaseindefaultriskoncorporatebondsshiftsthedemand
curveforTreasurybondstotheright.
(c) Botharetrue.
(d) Botharefalse.
Answer: C
17. WhenbudgettalksbetweencongressionalRepublicansandPresidentClintonoccurredin
late1995,fearofagovernmentdefault_________,Treasurybondvalues_________,and
interestratesonTreasurybonds_________.
(a) rose;fell;rose
(b) rose;rose;rose
(c) fell;rose;fell
(d) fell;fell;fell
Answer: A
18.
ThespreadbetweeninterestratesonlowqualitycorporatebondsandU.S.government
bonds_________duringtheGreatDepression.
(a) wasreversed
(b) narrowedsignificantly
(c) widenedsignificantly
(d) didnotchange
Answer: C
19.
AsaresultoftheEnroncollapseandbankruptcy,thedemandforlowqualitycorporate
bonds_________,thedemandforhighqualitycorporatebonds_________,andthe
riskspread_________.
(a) increased;decreased;wasunchanged
(b) decreased;increased;increased
(c) increased;decreased;decreased
(d) decreased;increased;wasunchanged
Answer: B
20.
MoodysandStandardandPoorsareagenciesthat
(a) helpinvestorscollectwhencorporationsdefaultontheirbonds.
(b) advisemunicipalbondissuersonthetaxexemptstatusoftheirbonds.
(c) produceinformationabouttheprobabilityofdefaultoncorporatebonds.
(d) maintainliquidmarketsforcorporatebonds.
Answer: C
21.
IfMoodysorStandardandPoorsdowngradesitsratingonacorporatebond,the
demandforthebond_________anditsyield_________.
(a) increases;decreases
(b) decreases;increases
(c) increases;increases
(d) decreases;decreases
Answer: B
22.
Corporatebondsarenotasliquidasgovernmentbondsbecause
(a) fewerbondsforanyonecorporationaretraded,makingthemmorecostlytosell.
(b) thecorporatebondratingmustbecalculatedeachtimetheyaretraded.
(c) corporatebondsarenotcallable.
(d) alloftheabove.
Answer: A
23. (I)Theriskpremiumwidensasthedefaultriskoncorporatebondsincreases.(II)The
riskpremiumwidensascorporatebondsbecomelessliquid.
(c) Botharetrue.
(d) Botharefalse.
Answer: C
24.
Whenthecorporatebondmarketbecomeslessliquid,otherthingsequal,thedemand
(a) right;right
(b) right;left
(c) left;left
(d) left;right.
Answer: D
25.
Whenthecorporatebondmarketbecomesmoreliquid,otherthingsequal,thedemand
(a) right;right
(b) right;left
(c) left;left
(d) left;right
AnswerB
26.
(I)Ifacorporatebondbecomeslessliquid,thedemandforthebondwillfall,causing
theinterestratetorise.(II)Ifacorporatebondbecomeslessliquid,thedemandfor
Treasurybondsdoesnotchange.
(c) Botharetrue.
(d) Botharefalse.
Answer: A
27.
(I)Ifacorporatebondbecomeslessliquid,theinterestrateonthebondwillfall.(II)If
acorporatebondbecomeslessliquid,theinterestrateonTreasurybondswillfall.
(c) Botharetrue.
(d) Botharefalse.
Answer: B
28. Whichofthefollowingbondsgenerallyhasthelowestinterestrate?
(a) Treasurybonds
(b) CorporateBaabonds
(c) Municipalbonds
(d) CorporateAaabonds
Answer: C
29.
Ifincometaxrateswerelowered,then
(a) theinterestrateonmunicipalbondswouldfall.
(b) theinterestrateonTreasurybondswouldrise.
(c) theinterestrateonmunicipalbondswouldrise.
(d) thepriceofTreasurybondswouldfall.
Answer: C
30.
Ifincometaxratesrise,then
(a) thepricesofmunicipalbondswillfall.
(b) thepricesofTreasurybondswillrise.
(c) theinterestrateonTreasurybondswillrise.
(d) theinterestrateonmunicipalbondswillrise.
Answer: C
31.
Anincreaseinmarginaltaxrateswouldlikelyhavetheeffectof_________the
demandformunicipalbondsand_________thedemandforU.S.governmentbonds.
(a) increasing;increasing
(b) increasing;decreasing
(c) decreasing;increasing
(d) decreasing;decreasing
Answer: B
32.
Adecreaseinmarginaltaxrateswouldlikelyhavetheeffectof_________thedemand
formunicipalbondsand_________thedemandforU.S.governmentbonds.
(a) increasing;increasing
(b) increasing;decreasing
(c) decreasing;increasing
(d) decreasing;decreasing
Answer: C
33.
Whichofthefollowingstatementsaretrue?
(a) Becausecouponpaymentsonmunicipalbondsareexemptfromfederalincometax,
theexpectedaftertaxreturnonthemwillbehigherforindividualsinhigher
incometaxbrackets.
(b) Anincreaseintaxrateswillincreasethedemandformunicipalbonds,lowering
theirinterestrates.
(c) Interestratesonmunicipalbondswillbelowerthanoncomparablebondswithout
thetaxexemption.
(d) Alloftheabovearetruestatements.
(e) Only(a)and(b)aretruestatements.
Answer: D
34.
Whichofthefollowingstatementsaretrue?
(a) Becausecouponpaymentsonmunicipalbondsareexemptfromfederalincometax,
theexpectedaftertaxreturnonthemwillbehigherforindividualsinhigher
incometaxbrackets.
(b) AnincreaseintaxrateswillincreasethedemandforTreasurybonds,lowering
theirinterestrates.
(c) Interestratesonmunicipalbondswillbehigherthanoncomparablebondswithout
thetaxexemption.
(d) Only(a)and(b)aretruestatements.
Answer: A
35.
Whenamunicipalbondisgiventaxfreestatus,thedemandformunicipalbondsshifts
_________,causingtheinterestrateonthebondto_________
(a) leftward;rise.
(b) leftward;fall.
(c) rightward;rise.
(d) rightward;fall.
Answer: D
36.
Whenamunicipalbondisgiventaxfreestatus,thedemandforTreasurybondsshifts
_________,andtheinterestrateonTreasurybonds_________
(a) leftward;rises.
(b) leftward;falls.
(c) rightward;rises.
(d) rightward;falls.
Answer: A
37.
Ifmunicipalbondsweretolosetheirtaxfreestatus,thenthedemandforTreasury
bondswouldshift_________,andtheinterestrateonTreasurybondswould
_________
(a) rightward;fall.
(b) rightward;rise.
(c) leftward;fall.
(d) leftward;rise.
Answer: A
38.
TheBushtaxcutpassedin2001reducesthetopincometaxbracketfrom39percentto
35percentoverthenexttenyears.Asaresultofthistaxcut,thedemandformunicipal
bondsshouldshifttothe_________andtheinterestrateonmunicipalbondsshould
_________.
(a) right;decline
(b) right;increase
(c) left;decline
(d) left;increase
Answer: D
39. Therelationshipamonginterestratesonbondswithidenticaldefaultrisk,butdifferent
maturities,iscalledthe
(a) timeriskstructureofinterestrates.
(b) liquiditystructureofinterestrates.
(c) yieldcurve.
(d) bonddemandcurve.
Answer: C
40.
Yieldcurvescanbeclassifiedas
(a) upwardsloping.
(b) downwardsloping.
(c) flat.
(d) alloftheabove.
Answer: D
41.
Typically,yieldcurvesare
(a) gentlyupwardsloping.
(b) gentlydownwardsloping.
(c) flat.
(d) bowlshaped.
(e) moundshaped.
Answer: A
42.
Whenyieldcurvesaresteeplyupwardsloping,
(a) longterminterestratesareaboveshortterminterestrates.
(b) shortterminterestratesareabovelongterminterestrates.
(c) shortterminterestratesareaboutthesameaslongterminterestrates.
(d) mediumterminterestratesareabovebothshorttermandlongterminterestrates.
(e) mediumterminterestratesarebelowbothshorttermandlongterminterestrates.
Answer: A
43.
Economistsattemptstoexplainthetermstructureofinterestrates
(a) illustratehoweconomistsmodifytheoriestoimprovethemwhentheyare
inconsistentwiththeempiricalevidence.
(b) illustratehoweconomistscontinuetoaccepttheoriesthatfailtoexplainobserved
behaviorofinterestratemovements.
(c) provethattherealworldisaspecialcasethattendstogetshortshriftintheoretical
models.
(d) haveprovedentirelyunsatisfactorytodate.
Answer: A
44. Accordingtothepureexpectationstheoryofthetermstructure,
(a) theinterestrateonlongtermbondswillexceedtheaverageofexpectedfuture
shortterminterestrates.
(b) interestratesonbondsofdifferentmaturitiesmovetogetherovertime.
(c) buyersofbondsprefershorttermtolongtermbonds.
(d) alloftheabove.
Answer: B
45.
Accordingtothepureexpectationstheoryofthetermstructure,
(a) whentheyieldcurveissteeplyupwardsloping,shortterminterestratesare
expectedtoriseinthefuture.
(b) whentheyieldcurveisdownwardsloping,shortterminterestratesareexpectedto
declineinthefuture.
(c) buyersofbondsprefershorttermtolongtermbonds.
(d) alloftheabove.
Answer: E
46.
(a) whentheyieldcurveissteeplyupwardsloping,shortterminterestratesare
(b) whentheyieldcurveisdownwardsloping,shortterminterestratesareexpectedto
remainrelativelystableinthefuture.
(c) investorshavestrongpreferencesforshorttermrelativetolongtermbonds,
explainingwhyyieldcurvestypicallyslopeupward.
(d) alloftheabove.
Answer: A
47.
(a) yieldcurvesshouldbeequallylikelytoslopedownwardastoslopeupward.
(b) whentheyieldcurveissteeplyupwardsloping,shortterminterestratesare
(c) whentheyieldcurveisdownwardsloping,shortterminterestratesareexpectedto
remainrelativelystableinthefuture.
(d) alloftheabove.
Answer: E
48.
Iftheexpectedpathofoneyearinterestratesoverthenextfouryearsis5percent,4
percent,
2percent,and1percent,thenthepureexpectationstheorypredictsthattodaysinterest
rateonthefouryearbondis
(a) 1percent.
(b) 2percent.
(c) 4percent.
(d) noneoftheabove.
Answer: D
49. Iftheexpectedpathofoneyearinterestratesoverthenextfiveyearsis1percent,2
percent,
3percent,4percent,and5percent,thepureexpectationstheorypredictsthatthebondwith
thehighestinterestratetodayistheonewithamaturityof
(a) oneyear.
(b) twoyears.
(c) threeyears.
(d) fouryears.
(e) fiveyears.
Answer: E
50.
Iftheexpectedpathofoneyearinterestratesoverthenextfiveyearsis2percent,4
percent,
1percent,4percent,and3percent,thepureexpectationstheorypredictsthatthebond
withthelowestinterestratetodayistheonewithamaturityof
(a) oneyear.
(b) twoyears.
(c) threeyears.
(d) fouryears.
Answer: A
51.
Accordingtothemarketsegmentationtheoryofthetermstructure,
(a) theinterestrateforbondsofonematurityisdeterminedbysupplyanddemandfor
bondsofthatmaturity.
(b) bondsofonematurityarenotsubstitutesforbondsofothermaturities;therefore,
interestratesonbondsofdifferentmaturitiesdonotmovetogetherovertime.
(c) investorsstrongpreferenceforshorttermrelativetolongtermbondsexplains
whyyieldcurvestypicallyslopeupward.
(d) alloftheabove.
(e) noneoftheabove.
Answer: D
52.
Accordingtothemarketsegmentationtheoryofthetermstructure,
(a) theinterestrateforbondsofonematurityisdeterminedbysupplyanddemandfor
bondsofthatmaturity.
(b) bondsofonematurityarenotsubstitutesforbondsofothermaturities;therefore,
interestratesonbondsofdifferentmaturitiesdonotmovetogetherovertime.
(c) investorsstrongpreferenceforshorttermrelativetolongtermbondsexplains
whyyieldcurvestypicallyslopedownward.
Answer: D
53.
Theliquiditypremiumtheoryofthetermstructure
(a) indicatesthattodayslongterminterestrateequalstheaverageofshortterm
interestratesthatpeopleexpecttooccuroverthelifeofthelongtermbond.
(b) assumesthatbondsofdifferentmaturitiesareperfectsubstitutes.
(c) suggeststhatmarketsforbondsofdifferentmaturitiesarecompletelyseparate
becausepeoplehavepreferredhabitats.
(d) doesnoneoftheabove.
Answer: D
54. Theliquiditypremiumtheoryofthetermstructure
(a) assumesinvestorstendtoprefershorttermbondsbecausetheyhavelessinterest
raterisk.
(b) assumesthatinterestratesonthelongtermbondrespondtodemandandsupply
conditionsforthatbond.
(c) assumesthatanaverageofexpectedshorttermratesisanimportantcomponentof
interestratesonlongtermbonds.
(d) assumesalloftheabove.
(e) assumesnoneoftheabove.
Answer: D
55.
Accordingtotheliquiditypremiumtheoryofthetermstructure,
(a) theinterestrateonlongtermbondswillequalanaverageofshortterminterest
ratesthatpeopleexpecttooccuroverthelifeofthelongtermbondsplusa
liquiditypremium.
(b) buyersofbondsmaypreferbondsofonematurityoveranother,yetinterestrates
onbondsofdifferentmaturitiesmovetogetherovertime.
(c) evenwithapositiveliquiditypremium,iffutureshortterminterestratesare
expectedtofallsignificantly,thentheyieldcurvewillbedownwardsloping.
(d) alloftheabove.
Answer: D
56.
Accordingtotheliquiditypremiumtheoryofthetermstructure,
(a) becausebuyersofbondsmaypreferbondsofonematurityoveranother,interest
ratesonbondsofdifferentmaturitiesdonotmovetogetherovertime.
(b) theinterestrateonlongtermbondswillequalanaverageofshortterminterest
ratesthatpeopleexpecttooccuroverthelifeofthelongtermbondsplusaterm
premium.
(c) becauseofthepositivetermpremium,theyieldcurvecannotbedownward
sloping.
(d) alloftheabove.
Answer: B
57.
Iftheyieldcurveslopeisflat,theliquiditypremiumtheoryindicatesthatthemarketis
predicting
(a) amildriseinshortterminterestratesinthenearfutureandamilddeclinefurther
outinthefuture.
(b) constantshortterminterestratesinthenearfutureandfurtheroutinthefuture.
(c) amilddeclineinshortterminterestratesinthenearfutureandacontinuingmild
declinefurtheroutinthefuture.
(d) constantshortterminterestratesinthenearfutureandamilddeclinefurtheroutin
thefuture.
Answer: C
58. Iftheyieldcurvehasamildupwardslope,theliquiditypremiumtheoryindicatesthat
themarketispredicting
(a) ariseinshortterminterestratesinthenearfutureandadeclinefurtheroutinthe
future.
(b) constantshortterminterestratesinthenearfutureandfurtheroutinthefuture.
(c) adeclineinshortterminterestratesinthenearfutureandarisefurtheroutinthe
future.
(d) adeclineinshortterminterestratesinthenearfutureandanevensteeperdecline
furtheroutinthefuture.
Answer: B
59.
Accordingtotheliquiditypremiumtheoryofthetermstructure,adownwardsloping
yieldcurveindicatesthatshortterminterestratesareexpectedto
(a) riseinthefuture.
(b) remainunchangedinthefuture.
(c) declinemoderatelyinthefuture.
(d) declinesharplyinthefuture.
Answer: D
60.
Accordingtotheliquiditypremiumtheoryofthetermstructure,whentheyieldcurve
hasitsusualslope,themarketexpects
(a) shortterminterestratestorisesharply.
(b) shortterminterestratestodropsharply.
(c) shortterminterestratestostayneartheircurrentlevels.
(d) noneoftheabove.
Answer: C
61.
Inactualpractice,shortterminterestratesarejustaslikelytofallastorise;thisisthe
majorshortcomingofthe
(a) marketsegmentationtheory.
(b) pureexpectationstheory.
(c) liquiditypremiumtheory.
(d) separablemarketstheory.
Answer: B
62.
Whichtheoryofthetermstructureproposesthatbondsofdifferentmaturitiesarenot
substitutesforoneanother?
(a) marketsegmentationtheory
(b) pureexpectationstheory
(c) liquiditypremiumtheory
(d) separablemarketstheory
Answer: A
63. Sinceyieldcurvesareusuallyupwardsloping,the_________indicatesthat,onaverage,
peopletendtopreferholdingshorttermbondstolongtermbonds.
(a) marketsegmentationtheory
(b) pureexpectationstheory
(c) liquiditypremiumtheory
(d) both(a)and(b)oftheabove
(e) both(a)and(c)oftheabove
Answer: E
64.
_________cannotexplaintheempiricalfactthatinterestratesonbondsofdifferent
maturitiestendtomovetogether.
(a) Themarketsegmentationtheory
(b) Thepureexpectationstheory
(c) Theliquiditypremiumtheory
(d) Both(a)and(b)oftheabove
(e) Both(a)and(c)oftheabove
Answer: A
65.
Whichofthefollowingtheoriesofthetermstructureis(are)abletoexplainthefact
thatinterestratesonbondsofdifferentmaturitiestendtomovetogetherovertime?
(a) Theexpectationshypothesis
(b) Thesegmentedmarketstheory
(c) Thepreferredhabitattheory
(d) Both(a)and(b)oftheabove
(e) Both(a)and(c)oftheabove
Answer: E
66.
Ofthefourtheoriesthatexplainhowinterestratesonbondswithdifferenttermsto
maturityarerelated,theonethatviewslongterminterestratesasequalingtheaverage
offutureshorttermratesexpectedtooccuroverthelifeofthebondisthe
(a) pureexpectationstheory.
(b) preferredhabitattheory.
(d) segmentedmarketstheory.
Answer: A
67.
Ofthefourtheoriesthatexplainhowinterestratesonbondswithdifferenttermsto
maturityarerelated,theonethatassumesthatbondsofdifferentmaturitiesarenot
substitutesforoneanother
isthe
(a) pureexpectationstheory.
(b) segmentedmarketstheory.
(d) preferredhabitattheory.
Answer: B
68. Amoderatelyupwardslopingyieldcurveindicatesthatshortterminterestratesare
expectedto
(a) neitherrisenorfallinthenearfuture.
(b) remainrelativelyunchanged,butthatlongtermratesareexpectedtofall.
(c) neitherrisenorfall,butthatlongtermratesareexpectedtorisemoderately.
(d) risemoderatelyinthenearfuture.
Answer: A
69.
Asteepupwardslopingyieldcurveindicatesthatshortterminterestratesareexpected
to
(a) neitherrisenorfallinthenearfuture.
(b) remainrelativelyunchanged,butthatlongtermratesareexpectedtofall.
(c) neitherrisenorfall,butthatlongtermratesareexpectedtorisemoderately.
(d) risemoderatelyinthenearfuture.
Answer: D
True/False
1.
Thetermstructureofinterestratesdescribeshowinterestratesmoveovertime.
Answer:
2.
Theriskstructureofinterestratesdescribestherelationshipbetweentheinterestrates
ofdifferentbondswiththesamematurity.
Answer:
3.
TRUE
Theinterestratesonbondsofdifferentmaturitiestendtomovetogetherovertime.
Answer:
7.
FALSE
Anincreaseinincometaxrateswillcausetheinterestratesontaxexemptmunicipal
bondstofallrelativetotheinterestrateontaxablecorporatesecurities.
Answer:
6.
TRUE
Theriskpremiumoncorporatebondsbecomessmallerastheliquidityofthebonds
falls.
Answer:
5.
TRUE
FollowingtheEnronbankruptcy,thespreadbetweentheinterestratesonBaabonds
andAaabondswidened.
Answer:
4.
FALSE
TRUE
Thepureexpectationstheoryisabletoexplainwhyyieldcurvesareusuallyupward
sloping.
Answer:
8.
Accordingtothepureexpectationstheory,theinterestrateonalongtermbondisthe
averageoftheshortterminterestratesexpectedoverthelifeofthelongtermbond.
Answer:
9.
TRUE
Anincreaseinthemarginaltaxratewouldlikelyincreasethedemandformunicipal
bonds,anddecreasethedemandforU.S.governmentbonds.
Answer:
14.
FALSE
Amildlyupwardslopingyieldcurvesuggeststhatthemarketispredictingconstant
shortterminterestrates.
Answer:
13.
FALSE
Apositiveliquiditypremiumindicatesthatinvestorspreferlongtermbondsovershort
termbonds.
Answer:
12.
FALSE
Bondswiththelowestriskofdefaultareoftenreferredtoasjunkbonds.
Answer:
11.
TRUE
Themarketsegmentationtheoryisabletoexplainwhyinterestratesonbondsof
differentmaturitiesmovetogetherovertime.
Answer:
10.
FALSE
TRUE
Whenyieldcurvesaredownwardsloping,longterminterestratesareaboveshortterm
interestrates.
Answer:
FALSE
Essay
1.
Contrasttheliquiditypremiumtheorytothemarketsegmentationtheoryoftheterm
structureofinterestrates.
2.
Whywouldanincreaseintheincometaxratereduceborrowingcoststo
municipalities?
3.
Discusswhatisshownbyayieldcurve.
4.
Whyisitunlikelythatthepureexpectationstheoryaloneisthecorrecttheoryfor
explainingtheyieldcurve?
5.
Whatismeantbytheriskstructureofinterestrates?
6.
Howwouldasevererecessionaffecttheriskpremiumoncorporatebonds?
7.
ExplainwhyaflighttoqualityoccurredfollowingtheEnronbankruptcyandhowthis
affectedtheinterestratesonlowerqualityandhigherqualitycorporatebonds.
8.
Whatdocreditratingagenciesdoandwhyisthisworkimportant?
Chapter6
TheMoneyMarkets
.4
1.
Activityinmoneymarketsincreasedsignificantlyinthelate1970sandearly1980s
becauseof
(a) risingshortterminterestrates.
(b) regulationsthatlimitedwhatbankscouldpayfordeposits.
(c) both(a)and(b).
(d) neither(a)nor(b).
Answer: C
2.
Moneymarketsecuritieshaveallthefollowingcharacteristicsexcepttheyarenot
(a) shortterm.
(b) money.
(c) lowrisk.
(d) veryliquid.
Answer: B
3.
Moneymarketinstruments
(a) areusuallysoldinlargedenominations.
(b) havelowdefaultrisk.
(c) matureinoneyearorless.
(d) arecharacterizedbyalloftheabove.
(e) arecharacterizedbyonly(a)and(b)oftheabove.
Answer: D
4.
Thebankingindustry
(a) shouldhaveanefficiencyadvantageingatheringinformationthatwouldeliminate
theneedforthemoneymarkets.
(b) existsprimarilytomediatetheasymmetricinformationproblembetweensaver
lendersandborrowerspenders.
(c) issubjecttomoreregulationsandgovernmentalcoststhanarethemoneymarkets.
(d) alloftheabovearetrue.
(e) only(a)and(b)oftheabovearetrue.
Answer: D
5.
Insituationswhereasymmetricinformationproblemsarenotsevere,
(a) themoneymarketshaveadistinctcostadvantageoverbanksinprovidingshort
termfunds.
(b) themoneymarketshaveadistinctcostadvantageoverbanksinprovidinglong
termfunds.
(c) bankshaveadistinctcostadvantageoverthemoneymarketsinprovidingshort
termfunds.
(d) themoneymarketscannotallocateshorttermfundsasefficientlyasbankscan.
Answer: A
6.
Brokeragefirmsthatofferedmoneymarketsecurityaccountsinthe1970shadacost
advantageoverbanksinattractingfundsbecausethebrokeragefirms
(a) werenotsubjecttodepositreserverequirements.
(b) werenotsubjecttothedepositinterestrateceilings.
(c) werenotlimitedinhowmuchtheycouldborrowfromdepositors.
(d) hadtheadvantageofalltheabove.
(e) hadtheadvantageofonly(a)and(b)oftheabove.
Answer: E
7.
Whichofthefollowingstatementsaboutthemoneymarketaretrue?
(a) Notallcommercialbanksdealfortheircustomersinthesecondarymarket.
(b) Moneymarketsareusedextensivelybybusinessesbothtowarehousesurplusfunds
andtoraiseshorttermfunds.
(c) ThesinglemostinfluentialparticipantintheU.S.moneymarketistheU.S.
TreasuryDepartment.
Answer: E
8.
Whichofthefollowingstatementsaboutthemoneymarketsaretrue?
(a) Mostmoneymarketsecuritiesdonotpayinterest.Insteadtheinvestorpayslessfor
thesecuritythanitwillbeworthwhenitmatures.
(b) Pensionfundsinvestaportionoftheirassetsinthemoneymarkettohavesufficient
liquiditytomeettheirobligations.
(c) Unlikemostparticipantsinthemoneymarket,theU.S.TreasuryDepartmentis
alwaysademanderofmoneymarketfundsandneverasupplier.
Answer: D
9.
Whichofthefollowingaretruestatementsaboutparticipantsinthemoneymarkets?
(a) LargebanksparticipateinthemoneymarketsbysellinglargenegotiableCDs.
(b) TheU.S.governmentandcorporationsborrowinthemoneymarketsbecausecash
inflowsandoutflowsarerarelysynchronized.
(c) TheFederalReserveisthesinglemostinfluentialparticipantintheU.S.money
market.
Answer: D
10. Themostinfluentialparticipant(s)intheU.S.moneymarket
(a) istheFederalReserve.
(b) istheU.S.TreasuryDepartment.
(c) arethelargemoneycenterbanks.
(d) aretheinvestmentbanksthatunderwritesecurities.
Answer: A
11.
TheFedisanactiveparticipantinmoneymarketsmainlybecauseofitsresponsibility
to
(a) lowerborrowingcoststoencouragecapitalinvestment.
(b) controlthemoneysupply.
(c) increasetheinterestincomeofretireesholdingmoneymarketinstruments.
(d) assisttheSecuritiesandExchangeCommissioninregulatingthebehaviorother
moneymarketparticipants.
Answer: B
12.
Commercialbanksarelargeholdersof_________andarethemajorissuerof
_________.
(a) negotiablecertificatesofdeposit;U.S.governmentsecurities
(b) U.S.governmentsecurities;negotiablecertificatesofdeposit
(c) commercialpaper;Eurodollars
(d) Eurodollars;commercialpaper
Answer: B
13.
Theprimaryfunctionoflargediversifiedbrokeragefirmsinthemoneymarketisto
(a) sellmoneymarketsecuritiestotheFederalReserveforitsopenmarketoperations.
(b) makeamarketformoneymarketsecuritiesbymaintaininganinventoryfrom
whichtobuy
orsell.
(c) buymoneymarketsecuritiesfromcorporationsthatneedliquidity.
(d) buyTbillsfromtheU.S.TreasuryDepartment.
Answer: B
14.
Financecompaniesraisefundsinthemoneymarketbyselling
(a) commercialpaper.
(b) federalfunds.
(c) negotiablecertificatesofdeposit.
(d) Eurodollars.
Answer: A
15.
Financecompaniesplayauniqueroleinmoneymarketsby
(a) givingconsumersindirectaccesstomoneymarkets.
(b) combiningconsumersinvestmentstopurchasemoneymarketsecuritiesontheir
behalf.
(c) borrowingincapitalmarketstofinancepurchasesofmoneymarketsecurities.
(d) assistingthegovernmentinitssalesofU.S.Treasurysecurities.
Answer: A
16. Wheninflationroseinthelate1970s,
(a) consumersmovedmoneyoutofmoneymarketmutualfundsbecausetheirreturns
didnotkeeppacewithinflation.
(b) bankssolidifiedtheiradvantageovermoneymarketsbyofferinghigherdeposit
rates.
(c) brokeragehousesintroducedhighlypopularmoneymarketmutualfunds,which
drewsignificantamountsofmoneyoutofbankdeposits.
(d) consumerswereunabletotakeadvantageofhigherratesinmoneymarketsbecause
oftherequirementoflargetransactionsizes.
Answer: C
17.
Whichofthefollowingisthelargestborrowerinthemoneymarkets?
(a) commercialbanks
(b) largecorporations
(c) theU.S.Treasury
(d) U.S.firmsengagedinforeigntrade
Answer: C
18.
MoneymarketinstrumentsissuedbytheU.S.Treasuryarecalled
(a) Treasurybills.
(b) Treasurynotes.
(c) Treasurybonds.
(d) Treasurystrips.
Answer: A
19.
TheTreasuryauctions91dayand182dayTreasurybillsonceaweek.Itauctions52
weekbills
(a) onceamonth.
(b) onceevery13weeks.
(c) onceayear.
(d) everytwoweeks.
Answer: A
20.
WhichofthefollowingstatementsaretrueofTreasurybills?
(a) ThemarketforTreasurybillsisextremelydeepandliquid.
(b) Occasionally,investorsfindthatearningsonTbillsdonotcompensatethemfor
changesinpurchasingpowerduetoinflation.
(c) Byvolume,mostTreasurybillsaresoldtoindividualswhosubmitnoncompetitive
bids.
Answer: E
21.
Supposethatyoupurchasea91dayTreasurybillfor$9,850thatisworth$10,000
whenitmatures.Thesecuritysannualizedyieldifheldtomaturityisabout
(a) 4percent.
(b) 5percent.
(c) 6percent.
(d) 7percent.
Answer: C
22. Supposethatyoupurchasea182dayTreasurybillfor$9,850thatisworth$10,000
whenitmatures.Thesecuritysannualizedyieldifheldtomaturityisabout
(a) 1.5%
(b) 2%
(c) 3%
(d) 6%
Answer: C
23.
Treasurybillsdonot
(a) payinterest.
(b) haveamaturitydate.
(c) haveafaceamount.
(d) haveanactivesecondarymarket.
Answer: A
24.
IfyourcompetitivebidforaTreasurybillissuccessful,thenyouwill
(a) certainlypaylessthanifyouhadsubmittedanoncompetitivebid.
(b) probablypaymorethanifyouhadsubmittedanoncompetitivebid.
(c) paytheaverageofpricesofferedinothersuccessfulcompetitivebids.
(d) paythesameasothersuccessfulcompetitivebidders.
Answer: B
25.
IfyournoncompetitivebidforaTreasurybillissuccessful,thenyouwill
(a) certainlypaylessthanifyouhadsubmittedacompetitivebid.
(b) certainlypaymorethanifyouhadsubmittedacompetitivebid.
(c) paytheaverageofpricesofferedinothernoncompetitivebids.
(d) paythesameasothersuccessfulnoncompetitivebidders.
Answer: D
26.
Federalfunds
(a) areshorttermfundstransferredbetweenfinancialinstitutions,usuallyforaperiod
ofoneday.
(b) actuallyhavenothingtodowiththefederalgovernment.
(c) providebankswithanimmediateinfusionofreserves.
(d) arealloftheabove.
(e) areonly(a)and(b)oftheabove.
Answer: D
27.
Federalfundsare
(a) usuallyovernightinvestments.
(b) borrowedbybanksthathaveadeficitofreserves.
(c) lentbybanksthathaveanexcessofreserves.
(d) alloftheabove.
Answer: D
28. TheFedcaninfluencethefederalfundsinterestratebyadjustingthelevelofreserves
availabletobanks.TheFedcan
(a) lowerthefederalfundsinterestratebyaddingreserves.
(b) raisethefederalfundsinterestratebyremovingreserves.
(c) removereservesbysellingsecurities.
Answer: D
29.
TheFederalReservecaninfluencethefederalfundsinterestratebybuyingsecurities,
which_________reserves,thereby_________thefederalfundsrate.
(a) adds;raising
(b) removes;lowering
(c) adds;lowering
(d) removes;raising
Answer: C
30.
TheFedcanlowerthefederalfundsinterestrateby_________securities,thereby
_________reserves.
(a) selling;adding
(b) selling;lowering
(c) buying;adding
(d) buying;lowering
Answer: C
31.
IftheFedwantstolowerthefederalfundsinterestrate,itwill_________thebanking
systemby_________securities.
(a) addreservesto;selling
(b) addreservesto;buying
(c) removereservesfrom;selling
(d) removereservesfrom;buying
Answer: B
32.
IftheFedwantstoraisethefederalfundsinterestrate,itwill_________securitiesto
_________thebankingsystem.
(a) sell;addreservesto
(b) sell;removereservesfrom
(c) buy;addreservesto
(d) buy;removereservesfrom
Answer: B
33.
Governmentsecuritiesdealersfrequentlyengageinreposto
(a) manageliquidity.
(b) takeadvantageofanticipatedchangesininterestrates.
(c) lendorborrowforadayortwowithwhatisessentiallyacollateralizedloan.
Answer: D
34.
Reposare
(a) usuallylowriskloans.
(b) usuallycollateralizedwithTreasurysecurities.
(c) lowinterestrateloans.
(d) alloftheabove.
Answer: D
35.
Anegotiablecertificateofdeposit
(a) isatermsecuritybecauseithasaspecifiedmaturitydate.
(b) isabearerinstrument,meaningwhoeverholdsthecertificateatmaturityreceives
theprincipalandinterest.
(c) canbeboughtandsolduntilmaturity.
(d) alloftheabove.
Answer: D
36.
Negotiablecertificatesofdeposit
(a) arebearerinstrumentsbecausetheirholdersearntheinterestandprincipalat
maturity.
(b) typicallyhaveamaturityofonetofourmonths.
(c) areusuallydenominatedat$100,000.
Answer: E
37.
Commercialpapersecurities
(a) areissuedonlybythelargestandmostcreditworthycorporations,astheyare
unsecured.
(b) carryaninterestratethatvariesaccordingtothefirmslevelofrisk.
(c) neverhaveatermtomaturitythatexceeds270days.
(d) alloftheabove.
Answer: D
38.
Unlikemostmoneymarketsecurities,commercialpaper
(a) isnotgenerallytradedinasecondarymarket.
(b) usuallyhasatermtomaturitythatislongerthanayear.
(c) isnotpopularwithmostmoneymarketinvestorsbecauseofthehighdefaultrisk.
(d) alloftheabove.
Answer: A
39. Abankersacceptanceis
(a) usedtofinancegoodsthathavenotyetbeentransferredfromthesellertothe
buyer.
(b) anordertopayaspecifiedamountofmoneytothebeareronagivendate.
(c) arelativelynewmoneymarketsecuritythataroseinthe1960sasinternational
tradeexpanded.
(d) alloftheabove.
Answer: E
40.
Bankersacceptances
(a) canbeboughtandsolduntiltheymature.
(b) areissuedonlybylargemoneycenterbanks.
(c) carrylowinterestratesbecauseoftheverylowdefaultrisk.
Answer: D
41.
Eurodollars
(a) aretimedepositswithfixedmaturitiesandare,therefore,somewhatilliquid.
(b) mayoffertheborroweralowerinterestratethancanbereceivedinthedomestic
market.
(c) arelimitedtoLondonbanks.
Answer: E
42.
Whichofthefollowingstatementsaboutmoneymarketsecuritiesaretrue?
(a) Theinterestratesonallmoneymarketinstrumentsmoveverycloselytogetherover
time.
(b) ThesecondarymarketforTreasurybillsisextensiveandwelldeveloped.
(c) Thereisnowelldevelopedsecondarymarketforcommercialpaper.
Answer: D
.5
True/False
1.
Moneymarketsecuritiesareshortterminstrumentswithanoriginalmaturityofless
thanoneyear.
Answer:
2.
MoneymarketsecuritiesincludeTreasurybills,commercialpaper,federalfunds,
repurchaseagreements,negotiablecertificatesofdeposit,bankersacceptances,and
Eurodollars.
Answer:
3.
FALSE
TheTbillisnotaninvestmenttobeusedforanythingbuttemporarystorageofexcess
fundsbecauseitbarelykeepsupwithinflation.
Answer:
11.
TRUE
ThemarketforU.S.Treasurybillsisashallowmarketbecausesofewindividual
investorsbuy
Tbills.
Answer:
10.
FALSE
Moneymarketsareusedextensivelybybusinessesbothtowarehousesurplusfundsand
toraiseshorttermfunds.
Answer:
9.
TRUE
Banksareunusualparticipantsinthemoneymarketbecausetheybuy,butdonotsell,
moneymarketinstruments.
Answer:
8.
FALSE
TheU.S.TreasuryDepartmentisthesinglelargestborrowerintheU.S.moneymarket.
Answer:
7.
FALSE
TheU.S.TreasuryDepartmentisthesinglemostinfluentialparticipantintheU.S.
moneymarket.
Answer:
6.
TRUE
Moneymarketsarereferredtoasretailmarketsbecausesmallindividualinvestorsare
theprimarybuyersofmoneymarketsecurities.
Answer:
5.
TRUE
Thetermmoneymarketisactuallyamisnomer,becauseliquidsecuritiesaretradedin
thesemarketsratherthanmoney.
Answer:
4.
TRUE
TRUE
Themainpurposeforfederalfundsistoprovidebankswithanimmediateinfusionof
reservesshouldtheybeshort.
Answer:
TRUE
12. TheFedcaninfluencethefederalfundsratebyadjustingthelevelofreservesinthe
bankingsystem.
Answer:
13.
Commercialpapersecuritiesareunsecuredpromissorynotes,issuedbycorporations,
thatmatureinnomorethan270days.
Answer:
14.
TRUE
Interestratesonbankersacceptancesarelowbecausetheriskofdefaultisverylow.
Answer:
16.
TRUE
Abankersacceptanceisanordertopayaspecifiedamountofmoneytothebeareron
agivendate.Bankersacceptanceshavebeenusedsincethetwelfthcentury.
Answer:
15.
TRUE
TRUE
Ingeneral,moneymarketinstrumentsarelowrisk,highyieldsecurities.
Answer:
FALSE
.6
Essay
1.
Explainwhybanks,whichwouldseemtohaveacomparativeadvantageingathering
information,havenoteliminatedtheneedforthemoneymarkets.
2.
ExplainhowtheFederalReservecaninfluencethefederalfundsinterestrate.
3.
Explainwhythemoneymarketsarereferredtoaswholesalemarkets.
4.
Explainwhymoneymarketinterestratesmovesocloselytogetherovertime.
5.
HowareTreasurybillssold?Howdocompetitiveandnoncompetitivebidsdiffer?
6.
Whatarethemaincharacteristicsofmoneymarketsecurities?
7. Whatarethemajortypesofsecuritiesandwhoarethemajorparticipantsinthemoney
markets?
Chapter7
TheBondMarket
.7
1.
Comparedtomoneymarketsecurities,capitalmarketsecuritieshave
(a) moreliquidity.
(b) longermaturities.
(c) loweryields.
(d) lessrisk.
Answer: B
2.
(I)Securitiesthathaveanoriginalmaturitygreaterthanoneyeararetradedincapital
markets.
(II)Thebestknowncapitalmarketsecuritiesarestocksandbonds.
(c) Botharetrue.
(d) Botharefalse.
Answer: C
3.
(I)Securitiesthathaveanoriginalmaturitygreaterthanoneyeararetradedinmoney
markets.
(II)Thebestknownmoneymarketsecuritiesarestocksandbonds.
(c) Botharetrue.
(d) Botharefalse.
Answer: D
4.
(I)Firmsandindividualsusethecapitalmarketsforlongterminvestments.(II)The
capitalmarketsprovideanalternativetoinvestmentinassetssuchasrealestateand
gold.
(c) Botharetrue.
(d) Botharefalse.
Answer: C
5. Theprimaryreasonthatindividualsandfirmschoosetoborrowlongtermistoreduce
theriskthatinterestrateswill_________beforetheypayofftheirdebt.
(a) rise
(b) fall
(c) becomemorevolatile
(d) becomemorestable
Answer: A
6.
Afirmthatchoosestofinanceanewplantbyissuingmoneymarketsecurities
(a) mustincurthecostofissuingnewsecuritiestorolloveritsdebt.
(b) runstheriskofhavingtopayhigherinterestrateswhenitrollsoveritsdebt.
(c) incursboththecostofreissuingsecuritiesandtheriskofhavingtopayhigher
interestratesonthenewdebt.
(d) ismorelikelytoprofitifinterestratesrisewhiletheplantisbeingconstructed.
Answer: C
7.
Theprimaryreasonthatindividualsandfirmschoosetoborrowlongtermisto
(a) reducetheriskthatinterestrateswillfallbeforetheypayofftheirdebt.
(b) reducetheriskthatinterestrateswillrisebeforetheypayofftheirdebt.
(c) reducemonthlyinterestpayments,asinterestratestendtobehigheronshortterm
than
longtermdebtinstruments.
(d) reducetotalinterestpaymentsoverthelifeofthedebt.
Answer: B
8.
Afirmwillborrowlongterm
(a) iftheextrainterestcostofborrowinglongtermislessthantheexpectedcostof
risinginterestratesbeforeitretiresitsdebt.
(b) iftheextrainterestcostofborrowingshorttermduetorisinginterestratesdoesnot
exceedtheexpectedpremiumthatispaidforborrowinglongterm.
(c) ifshortterminterestratesareexpectedtodeclineduringthetermofthedebt.
(d) iflongterminterestratesareexpectedtodeclineduringthetermofthedebt.
Answer: A
9.
Theprimaryissuersofcapitalmarketsecuritiesinclude
(a) thefederalandlocalgovernments.
(b) thefederalandlocalgovernments,andcorporations.
(c) thefederalandlocalgovernments,corporations,andfinancialinstitutions.
(d) localgovernmentsandcorporations.
Answer: B
10.
Governmentsneverissuestockbecause
(a) theycannotsellownershipclaims.
(b) theConstitutionexpresslyforbidsit.
(c) both(a)and(b)oftheabove.
(d) neither(a)nor(b)oftheabove.
Answer: A
11. (I)Theprimaryissuersofcapitalmarketsecuritiesarefederalandlocalgovernments,
andcorporations.(II)Governmentsneverissuestockbecausetheycannotsellownership
claims.
(c) Botharetrue.
(d) Botharefalse.
Answer: C
12.
(I)Theprimaryissuersofcapitalmarketsecuritiesarefinancialinstitutions.
(II)Thelargestpurchasersofcapitalmarketsecuritiesarecorporations.
(c) Botharetrue.
(d) Botharefalse.
Answer: D
13.
Thedistributionofafirmscapitalbetweendebtandequityisits
(a) leverageratio.
(b) liabilitystructure
(c) acidratio.
(d) capitalstructure.
Answer: D
14.
Thelargestpurchasersofcapitalmarketsecuritiesare
(a) households.
(b) corporations
(c) governments.
(d) centralbanks.
Answer: A
15.
Individualsandhouseholdsfrequentlypurchasecapitalmarketsecuritiesthrough
financialinstitutionssuchas
(a) mutualfunds.
(b) pensionfunds.
(c) moneymarketmutualfunds.
(d) alloftheabove.
Answer: E
16.
(I)Therearetwotypesofexchangesinthesecondarymarketforcapitalsecurities:
organizedexchangesandoverthecounterexchanges.(II)Whenfirmssellsecurities
fortheveryfirsttime,theissueisaninitialpublicoffering.
(c) Botharetrue.
(d) Botharefalse.
Answer: C
17. (I)Capitalmarketsecuritiesfallintotwocategories:bondsandstocks.(II)Longterm
bondsincludegovernmentbondsandlongtermnotes,municipalbonds,andcorporatebonds.
(c) Botharetrue.
(d) Botharefalse.
Answer: B
18.
The_________valueofabondistheamountthattheissuermustpayatmaturity.
(a) market
(b) present
(c) discounted
(d) face
Answer: D
19.
The_________rateistherateofinterestthattheissuermustpay.
(a) market
(b) coupon
(c) discount
(d) funds
Answer: B
20.
(I)Thecouponrateistherateofinterestthattheissuerofthebondmustpay.
(II)Thecouponrateisusuallyfixedforthedurationofthebondanddoesnotfluctuate
withmarketinterestrates.
(c) Botharetrue.
(d) Botharefalse.
Answer: C
21.
(I)Thecouponrateistherateofinterestthattheissuerofthebondmustpay.(II)The
couponrateonoldbondsfluctuateswithmarketinterestratessotheywillremain
attractivetoinvestors.
(c) Botharetrue.
(d) Botharefalse.
Answer: A
22.
Treasurybondsaresubjectto_________riskbutarefreeof_________risk.
(a) default;interestrate
(b) default;underwriting
(c) interestrate;default
(d) interestrate;underwriting
Answer: C
23. ThepricesofTreasurynotes,bonds,andbillsarequoted
(a) asapercentageofthecouponrate.
(b) asapercentageofthepreviousdaysclosingvalue.
(c) asapercentageof$100facevalue.
(d) asamultipleoftheannualinterestpaid.
Answer: C
24.
ThesecuritywiththelongestmaturityisaTreasury
(a) note.
(b) bond.
(c) acceptance.
(d) bill.
Answer: B
25.
(I)Tosellanoldbondwheninterestrateshaverisen,theholderwillhavetodiscount
thebonduntiltheyieldtothebuyeristhesameasthemarketrate.(II)Theriskthatthe
valueofabondwillfallwhenmarketinterestratesriseiscalledinterestraterisk.
(c) Botharetrue.
(d) Botharefalse.
Answer: C
26.
Tosellanoldbondwheninterestrateshave_________,theholderwillhaveto
_________thepriceofthebonduntiltheyieldtothebuyeristhesameasthemarket
rate.
(a) risen;lower
(b) risen;raise
(c) fallen;lower
(d) risen;inflate
Answer: A
27.
Mostofthetime,theinterestrateonTreasurynotesandbondsis_________thaton
moneymarketsecuritiesbecauseof_________risk.
(a) above;interestrate
(b) above;default
(c) below;interestrate
(d) below;default
Answer: A
28.
(I)InmostyearstherateofreturnonshorttermTreasurybillsisbelowthatonthe20
year
Treasurybond.(II)InterestratesonTreasurybillsaremorevolatilethanratesonlong
termTreasurysecurities.
(c) Botharetrue.
(d) Botharefalse.
Answer: C
29. (I)BecauseinterestratesonTreasurybillsaremorevolatilethanratesonlongterm
securities,thereturnonshorttermTreasurysecuritiesisusuallyabovethatonlongerterm
Treasurysecurities.
(II)ATreasurySTRIPseparatestheperiodicinterestpaymentsfromthefinalprincipal
repayment.
(c) Botharetrue.
(d) Botharefalse.
Answer: B
30.
WhichofthefollowingstatementsaboutTreasuryinflationindexedbondsisnottrue?
(a) Theprincipalamountusedtocomputetheinterestpaymentvarieswiththe
consumer
priceindex.
(b) Theinterestpaymentriseswheninflationoccurs.
(c) Theinterestrateriseswheninflationoccurs.
(d) Atmaturitythesecuritiespaythegreateroffacevalueorinflationadjusted
principal.
Answer: C
31.
Theinterestratesongovernmentagencybondsare
(a) almostidenticaltothoseavailableonTreasurysecuritiessinceitisunlikelythatthe
federalgovernmentwouldpermititsagenciestodefaultontheirobligations.
(b) significantlyhigherthanthoseavailableonTreasurysecuritiesduetotheirlow
liquidity.
(c) significantlylowerthanthoseavailableonTreasurysecuritiesbecauseagency
interestpaymentsaretaxexempt.
(d) significantlylowerthanthoseavailableonTreasurysecuritiesbecausetheinterest
rateriskonagencysecuritiesislowerthanthatonTreasurysecurities.
Answer: B
32.
(I)Municipalbondsthatareissuedtopayforessentialpublicprojectsareexemptfrom
federaltaxation.(II)Generalobligationbondsdonothavespecificassetspledgedas
securityoraspecificsourceofrevenueallocatedfortheirrepayment.
(c) Botharetrue.
(d) Botharefalse.
Answer: C
33.
(I)Mostcorporatebondshaveafacevalueof$1000,payinterestsemiannually,and
canberedeemedanytimetheissuerwishes.(II)Registeredbondshavenowbeen
largelyreplacedbybearerbonds,whichdonothavecoupons.
(c) Botharetrue.
(d) Botharefalse.
Answer: A
34. Thebondcontractthatstatesthelendersrightsandprivilegesandtheborrowers
obligationsiscalledthe
(a) bondsyndicate.
(b) restrictivecovenant.
(c) bondcovenant.
(d) bondindenture.
Answer: D
35.
Policiesthatlimitthediscretionofmanagersasawayofprotectingbondholders
interestsarecalled
(a) restrictivecovenants.
(b) debentures.
(c) sinkingfunds.
(d) bondindentures.
Answer: A
36.
Typically,theinterestrateoncorporatebondswillbe_________themorerestrictions
areplacedonmanagementthroughrestrictivecovenants,because_________.
(a) higher;corporateearningswillbelimitedbytherestrictions
(b) higher;thebondswillbeconsideredsaferbybondholders
(c) lower;thebondswillbeconsideredsaferbybuyers
(d) lower;corporateearningswillbehigherwithmorerestrictionsinplace
Answer: C
37.
Restrictivecovenantscan
(a) limittheamountofdividendsthefirmcanpay.
(b) limittheabilityofthefirmtoissueadditionaldebt.
(c) restricttheabilityofthefirmtoenterintoamergeragreement.
Answer: D
38.
(I)Restrictivecovenantsoftenlimittheamountofdividendsthatfirmscanpaythe
stockholders.
(II)Mostcorporateindenturesincludeacallprovision,whichstatesthattheissuerhas
therighttoforcetheholdertosellthebondback.
(c) Botharetrue.
(d) Botharefalse.
Answer: C
39.
Callprovisionswillbeexercisedwheninterestrates_________andbondvalues
_________.
(a) rise;rise
(b) fall;rise
(c) rise;fall
(d) fall;fall
Answer: B
40. Arequirementinthebondindenturethatthefirmpayoffaportionofthebondissue
eachyear
iscalled
(a) asinkingfund.
(b) acallprovision.
(c) arestrictivecovenant.
(d) ashelfregistration.
Answer: A
41.
(I)Callablebondsmusthaveahigheryieldthancomparablenoncallablebonds.(II)
Convertiblebondsareattractivetobondholdersandsellforahigherpricethan
comparablenonconvertiblebonds.
(c) Botharetrue.
(d) Botharefalse.
Answer: C
42.
Longtermunsecuredbondsthatarebackedonlybythegeneralcreditworthinessofthe
issuer
arecalled
(a) junkbonds.
(b) callablebonds.
(c) convertiblebonds.
(d) debentures.
Answer: D
43.
Asecuredbondisbackedby
(a) thegeneralcreditworthinessoftheborrower.
(b) aninsurancecompanysfinancialguarantee.
(c) theexpectedfutureearningsoftheborrower.
(d) specificcollateral.
Answer: D
44.
Financialguarantees
(a) areinsurancepoliciestobackbondissues.
(b) arepurchasedbyfinanciallyweakersecurityissuers.
(c) lowertheriskofthebondscoveredbytheguarantee.
Answer: D
45.
Corporatebondsarelessriskyiftheyare_________bondsandmunicipalbondsare
lessriskyiftheyare_________bonds.
(a) secured;revenue
(b) secured;generalobligation
(c) unsecured;revenue
(d) unsecured;generalobligation
Answer: B
46. Whichofthefollowingaretrueforthecurrentyield?
(a) Thecurrentyieldisdefinedastheyearlycouponpaymentdividedbythepriceof
thesecurity.
(b) Theformulaforthecurrentyieldisidenticaltotheformuladescribingtheyieldto
maturityforadiscountbond.
(c) Thecurrentyieldisalwaysapoorapproximationfortheyieldtomaturity.
Answer: A
47.
Thenearerabondspriceistoitsparvalueandthelongerthematurityofthebondthe
moreclosely_________approximates_________
(a) currentyield;yieldtomaturity.
(b) currentyield;couponrate.
(c) yieldtomaturity;currentyield.
(d) yieldtomaturity;couponrate.
Answer: A
48.
Whichofthefollowingaretrueforthecurrentyield?
(a) Thecurrentyieldisdefinedastheyearlycouponpaymentdividedbythepriceof
thesecurity.
(b) Thecurrentyieldandtheyieldtomaturityalwaysmovetogether.
(c) Theformulaforthecurrentyieldisidenticaltotheformuladescribingtheyieldto
maturityforadiscountbond.
Answer: E
49.
Thecurrentyieldisalessaccurateapproximationoftheyieldtomaturitythe
_________thetimetomaturityofthebondandthe_________thepriceisfrom/tothe
parvalue.
(a) shorter;closer
(b) shorter;farther
(c) longer;closer
(d) longer;farther
Answer: B
50.
Thecurrentyieldona$6,000,10percentcouponbondsellingfor$5,000is
(a) 5percent.
(b) 10percent.
(c) 12percent.
(d) 15percent.
Answer: C
51. Thecurrentyieldona$5,000,8percentcouponbondsellingfor$4,000is
(a) 5percent.
(b) 8percent.
(c) 10percent.
(d) 20percent.
(e) noneoftheabove.
Answer: C
52.
Foraconsol,thecurrentyieldisan_________oftheyieldtomaturity.
(a) underestimate
(b) overestimate
(c) approximatemeasure
(d) exactmeasure
Answer: D
53.
Whichofthefollowingaretrueoftheyieldonadiscountbasisasameasureofthe
interestrate?
(a) Itusesthepercentagegainonthefacevalueofthesecurity,ratherthanthe
percentagegainonthepurchasepriceofthesecurity.
(b) Itputstheyieldontheannualbasisofa360dayyear.
(c) Itignoresthetimetomaturity.
Answer: E
54.
Theformulaforthemeasureoftheinterestratecalledtheyieldonadiscountbasisis
peculiarbecause
(a) itputstheyieldontheannualbasisofa360dayyear.
(b) itusesthepercentagegainonthepurchasepriceofthebill.
(c) itignoresthetimetomaturity.
(e) both(a)and(c)oftheabove.
Answer: A
55.
Theyieldonadiscountbasisofa180day$1,000Treasurybillsellingfor$950is
(a) 10percent.
(b) 20percent.
(c) 25percent.
(d) 40percent.
Answer: A
56. Theyieldonadiscountbasisofa90day$1,000Treasurybillsellingfor$950is
(a) 5percent.
(b) 10percent.
(c) 15percent.
(d) 20percent.
(e) noneoftheabove.
Answer: D
57.
(a) 10percent.
(b) 20percent.
(c) 25percent.
(d) 40percent.
Answer: D
58.
(a) 10percent.
(b) 20percent.
(c) 25percent.
(d) 40percent.
Answer: B
59.
Whenanoldbondsmarketvalueisaboveitsparvaluethebondissellingata
_________.Thisoccursbecausetheoldbondscouponrateis_________thecoupon
ratesofnewbondswith
similarrisk.
(a) premium;below
(b) premium;above
(c) discount;below
(d) discount;above
Answer: B
True/False
1.
Theprimaryissuersofcapitalmarketsecuritiesarelocalgovernmentsand
corporations.
Answer:
2.
Capitalmarketsecurutiesarelessliquidandhavelongermaturitiesthanmoneymarket
securities.
Answer:
3.
TRUE
Mostofthetime,theinterestrateonTreasurynotesisbelowthatonmoneymarket
securitiesbecauseoftheirlowdefaultrisk.
Answer:
6.
TRUE
Tosellanoldbondwhenrateshaverisen,theholderwillhavetodiscountthebond
untiltheyieldtothebuyeristhesameasthemarketrate.
Answer:
5.
TRUE
Governmentsneverissuestockbecausetheycannotsellownershipclaims.
Answer:
4.
FALSE
FALSE
Municipalbondsthatareissuedtopayforessentialpublicprojectsareexemptfrom
federaltaxation.
Answer:
TRUE
7.
Mostmunicipalbondsarerevenuebondsratherthangeneralobligationbonds.
Answer:
8.
Mostcorporatebondshaveafacevalueof$1000,aresoldatadiscount,andcanonly
beredeemedatthematuritydate.
Answer:
9.
TRUE
Afinancialguaranteeensuresthatthelender(bondpurchaser)willbepaidboth
principalandinterestintheeventtheissuerdefaults.
Answer:
14.
TRUE
Inaleveragedbuyout,afirmgreatlyincreasesitsdebtlevelbyissuingjunkbondsto
financethepurchaseofanotherfirmsstock.
Answer:
13.
TRUE
Debenturesarelongtermunsecuredbondsthatarebackedonlybythegeneral
creditworthinessoftheissuer.
Answer:
12.
FALSE
Asinkingfundisarequirementinthebondindenturethatthefirmpayoffaportionof
thebondissueeachyear.
Answer:
11.
FALSE
Registeredbondshavenowbeenlargelyreplacedbybearerbonds,whichdonothave
coupons.
Answer:
10.
FALSE
TRUE
Thecurrentyieldonabondisagoodapproximationofthebondsyieldtomaturity
whenthebondmaturesinfiveyearsorlessanditspricediffersfromitsparvaluebya
largeamount.
Answer:
FALSE
Essay
1.
Whatisthepurposeofthecapitalmarket?Howdocpaitalmarketsecuritiesdifferfrom
moneymarketsecuritiesintheirgeneralcharacteristics?
2.
Whatisabondindenture?
3.
Whatroledorestrictivecovenantsplayinbondmarkets?
4.
Whatisthedifferencebetweenageneralobligationandarevenuebond?
5.
WhatareTreasurySTRIPS?
6.
Whatisaconvertiblebond?Howdoestheconvertibilityfeatureaffectthebondsprice
and
interestrate?
7.
Whatisabondscurrentyield?Howdoescurrentyielddifferfromyieldtomaturity
andwhatdetermineshowclosethetwovaluesare?
8.
Distinguishbetweengeneralobligationandrevenuemunicipalbonds.
9.
Whatisacallablebond?Howdoesthecallabilityfeatureaffectthebondspriceand
interestrate?.
10.
Whattypesofrisksshouldbondholdersbeawareofandhowdotheseaffectbond
pricesandyields?
Chapter8
TheStockMarket
.8
1.
(I)Ashareofcommonstockinafirmrepresentsanownershipinterestinthatfirm.(II)
Ashareofpreferredstockisasmuchlikeabondasitislikecommonstock.
(c) Botharetrue.
(d) Botharefalse.
Answer: C
2.
Preferredstockholdersholdaclaimonassetsthathaspriorityovertheclaimsof
(a) bothcommonstockholdersandbondholders.
(b) neithercommonstockholdersnorbondholders.
(c) commonstockholders,butafterthatofbondholders.
(d) bondholders,butafterthatofcommonstockholders.
Answer: C
3.
(I)Preferredstockholdersholdaclaimonassetsthathaspriorityovertheclaimsof
commonstockholders,butafterthatofbondholders.(II)Firmsissuepreferredstockin
fargreateramountsthancommonstock.
(c) Botharetrue.
(d) Botharefalse.
Answer: A
4.
(I)Preferredstockholdersholdaclaimonassetsthathaspriorityovertheclaimsof
commonstockholders.(II)Bondholdersholdaclaimonassetsthathaspriorityoverthe
claimsofpreferredstockholders.
(c) Botharetrue.
(d) Botharefalse.
Answer: C
5. (I)Firmsissuecommonstockinfargreateramountsthanpreferredstock.(II)Thetotal
volumeofstockissuedismuchlessthanthevolumeofbondsissued.
(c) Botharetrue.
(d) Botharefalse.
Answer: C
6.
Theriskiestcapitalmarketsecurityis
(a) preferredstock.
(b) commonstock.
(c) corporatebonds.
(d) Treasurybonds.
Answer: B
7.
Organizedexchangesaccountforabout_________percentofthetotaldollarvolume
ofdomesticstocksharestraded.
(a) 30
(b) 45
(c) 60
(d) 70
Answer: D
8.
Organizedexchangesaccountforabout_________percentofthetotaldollarvolume
ofdomesticstockstraded.
(a) 60
(b) 70
(c) 80
(d) 90
Answer: B
9.
(I)ThelargestoftheorganizedstockexchangesintheUnitedStatesistheNewYork
StockExchange.(II)TobelistedontheNYSE,afirmmusthaveaminimumof$100
milliondollarsinmarketvalueor$10millioninrevenues.
(c) Botharetrue.
(d) Botharefalse.
Answer: A
10.
TolistontheNYSE,afirmmust
(a) haveearningsofatleast$100millionforeachofthelastthreeyears.
(b) haveatleast$500millionofmarketvalueand$100millionofrevenue.
(c) haveatotalof$100millioninmarketvalueofpubliclytradedshares.
(d) meetalloftheaboverequirements.
(e) meet(a)and(b)oftheaboverequirements.
Answer: E
11. Securitiesnotlistedononeoftheexchangestradeintheoverthecountermarket.Inthis
exchange,dealersmakeamarketby
(a) buyingstocksforinventorywheninvestorswanttosell.
(b) sellingstocksfrominventorywheninvestorswanttobuy.
(c) doingbothoftheabove.
(d) doingneitheroftheabove.
Answer: C
12.
Themostactivestockexchangeintheworldisthe
(a) NikkeiStockExchange.
(b) LondonStockExchange.
(c) ShanghaiStockExchange.
(d) NewYorkStockExchange.
Answer: A
13.
Whichofthefollowingstatementsabouttradingoperationsinanorganizedexchange
arecorrect?
(a) Floortradersalldealinawidevarietyofstocks.
(b) Inmosttrades,specialistsmatchbuyandsellorders.
(c) Inmosttrades,specialistsbuyfororsellfromtheirowninventories.
(d) TheSuperDOTsystemisusedtoexpeditelargetradesofover100,000shares.
Answer: B
14.
WhichofthefollowingisnotanadvantageofElectronicCommunicationsNetworks
(ECNs)?
(a) AllunfilledordersareavailableforreviewbyECNtraders.
(b) TransactionscostsarelowerforECNtrades.
(c) Tradesaremadeandconfirmedfaster.
(d) ECNsworkwellforthinlytradedstocks.
Answer: D
15.
WhichofthefollowingstatementsisfalseregardingElectronicCommunications
Networks(ECNs)?
(a) ArchipelagoandInstinetaretwoexamplesofECNs.
(b) CompetitionfromECNshasforcedNASDAQtocutitsfees.
(c) Tradersbenefitfromlowertradingcostsandfasterservice.
(d) ECNsallowinstitutionalinvestors,butnotindividuals,totradeafterhours.
Answer: D
16.
Abasicprincipleoffinanceisthatthevalueofanyinvestmentis
(a) thepresentvalueofallfuturenetcashflowsgeneratedbytheinvestment.
(b) theundiscountedsumofallfuturenetcashflowsgeneratedbytheinvestment.
(c) unrelatedtothefuturenetcashflowsgeneratedbytheinvestment.
(d) unrelatedtothedegreeofriskassociatedwiththefuturenetcashflowsgenerated
bytheinvestment.
Answer: A
17. Astockcurrentlysellsfor$25pershareandpays$0.24peryearindividends.Whatisan
investorsvaluationofthisstockifsheexpectsittobesellingfor$30inoneyearandrequires
15percentreturnonequityinvestments?
(a) $30.24
(b) $26.30
(c) $26.09
(d) $27.74
Answer: B
18.
Astockcurrentlysellsfor$30pershareandpays$1.00peryearindividends.Whatis
aninvestorsvaluationofthisstockifheexpectsittobesellingfor$37inoneyearand
requires12percentreturnonequityinvestments?
(a) $38
(b) $33.50
(c) $34.50
(d) $33.93
Answer: D
19.
Intheoneperiodvaluationmodel,astocksvaluewillbehigher
(a) thehigherisitsexpectedfutureprice.
(b) thelowerisitsdividend.
(c) thehigheristherequiredreturnoninvestmentsinequity.
(d) alloftheabove.
Answer: A
20.
Intheoneperiodvaluationmodel,astocksvaluefallsifthe_________rises.
(a) dividend
(b) expectedfutureprice
(c) requiredreturnonequity
(d) currentprice
Answer: C
21.
Inthegeneralizeddividendvaluationmodelastocksvaluedependonlyon
(a) itsfuturedividendpaymentsanditsfutureprice.
(b) itsfuturedividendpaymentsandtherequiredreturnonequity.
(c) itsfuturepriceandtherequiredreturnoninvestmentsonequity.
(d) itsfuturedividendpayments.
Answer: B
22.
WhichofthefollowingisnotanelementoftheGordongrowthmodelofstock
valuation?
(a) thestocksmostrecentdividendpaid.
(b) theexpectedconstantgrowthrateofdividends.
(c) therequiredreturnoninvestmentsinequity.
(d) thestocksexpectedfutureprice.
Answer: D
23. AccordingtotheGordongrowthmodel,whatisaninvestorsvaluationofastockwhose
currentdividendis$1.00peryearifdividendsareexpectedtogrowataconstantrateof10
percentoveralongperiodoftimeandtheinvestorsrequiredreturnis11percent?
(a) $110
(b) $100
(c) $11
(d) $10
(e) $5.24
Answer: A
24.
AccordingtotheGordongrowthmodel,whatisaninvestorsvaluationofastock
whosecurrentdividendis$1.00peryearifdividendsareexpectedtogrowataconstant
rateof10percentoveralongperiodoftimeandtheinvestorsrequiredreturnis15
percent?
(a) $20
(b) $11
(c) $22
(d) $7.33
(e) $4.40
Answer: C
25.
Holdingotherthingsconstant,astocksvaluewillbehighestifitsdividendgrowthrate
is
(a) 15percent
(b) 10percent
(c) 5percent
(d) 2percent
Answer: A
26.
Holdingotherthingsconstant,astocksvaluewillbehighestifitsmostrecentdividend
is
(a) $2.00
(b) $5.00
(c) $0.50
(d) $1.00
Answer: B
27.
Holdingotherthingsconstant,astocksvaluewillbehighestiftheinvestorsrequired
returnoninvestmentsinequityis
(a) 20percent
(b) 15percent
(c) 10percent
(d) 5percent
Answer: D
28. SupposetheaverageindustryPEratioforautopartsretailersis20.Whatisthecurrent
priceofAutoZonestockiftheretailersearningspershareareprojectedtobe$1.85?
(a) $21.85
(b) $37
(c) $10.81
(d) $9.25
Answer: B
29.
WhichofthefollowingistrueregardingtheGordongrowthmodel?
(a) Dividendsareassumedtogrowataconstantrateforever.
(b) Thedividendgrowthrateisassumedtobegreaterthantherequiredreturnon
equity.
(c) Both(a)and(b).
(d) Neither(a)nor(b).
Answer: A
30.
ThePEratioapproachtovaluingstockisespeciallyusefulforvaluing
(a) privatelyheldfirms.
(b) firmsthatdontpaydividends.
(c) both(a)and(b).
Answer: C
31.
ThePEratioapproachtovaluingstockisespeciallyusefulforvaluing
(a) publiclyheldcorporations.
(b) firmsthatregularlypaydividends.
(c) both(a)and(b).
Answer: D
32.
AweaknessofthePEapproachtovaluingstockisthatitis
(a) difficulttoestimatetheconstantgrowthrateofafirmsdividends.
(b) difficulttoestimatetherequiredreturnonequity.
(c) difficulttopredicthowmuchafirmwillpayindividends.
(d) basedonindustryaveragesratherthanfirmspecificfactors.
Answer: D
33.
Afirmisexpectedtopayadividendof$1.00nextyearandthedividendisexpectedto
growataconstantrateof4percentovertime.Someinvestorshaverequiredreturnson
investmentsinequityof12percent,some10percent,andsome8percent.Themarket
priceofthisfirmsstockwillbeslightlyabove
(a) $25
(b) $18
(c) $16.67
(d) $12.50
Answer: C
34. (I)Themarketpriceofasecurityatagiventimeisthehighestvalueanyinvestorputson
thesecurity.(II)Superiorinformationaboutasecurityincreasesitsvaluebyreducingitsrisk.
(a) (I)istrue,(II)isfalse.
(b) (I)isfalse,(II)istrue.
(c) Botharetrue.
(d) Botharefalse.
Answer: B
35.
Themaincauseoffluctuationsinstockpricesischangesin
(a) taxlaws.
(b) errorsintechnicalstockanalysis.
(c) dailytradingvolumeinstockmarkets.
(d) informationavailabletoinvestors.
(e) totalhouseholdwealthintheeconomy.
Answer: D
36.
Stockvaluescomputedbyvaluationmodelsmaydifferfromactualmarketprices
becauseitisdifficultto
(a) estimatefuturedividendgrowthrates.
(b) estimatetheriskofastock.
(c) forecastastocksfuturedividends.
(d) alloftheabovearetrue.
Answer: D
37.
The2001terroristattacksandtheEnronfinancialscandalcausedanticipateddividend
growthto_________,investorsrequiredreturnonequityto_________,andstock
pricesto_________.
(a) decreases;increase;decrease
(b) decrease;increase;increase
(c) increase;decrease;decrease
(d) increase;decrease;increase
Answer: A
38.
WhichofthefollowingisnotanobjectiveoftheSecuritiesandExchange
Commission?
(a) maintainintegrityofthesecuritiesmarkets
(b) adviseinvestorsaboutwhichparticularstocksaregoodbuys
(c) requirefirmstoprovidespecificinformationtoinvestors
(d) regulatemajorparticipantsinsecuritiesmarkets
Answer: B
.9
True/False
1.
MorestocktradingintheU.S.occursinoverthecountermarketsratherthanon
organizedexchanges.
Answer:
2.
Inoverthecountermarkets,dealersincreasestheliquidityofthinlytradedsecurities.
Answer:
3.
FALSE
Astocksmarketvaluewillbehigherthehigherisitsexpecteddividendstream.
Answer:
11.
TRUE
Abouthalfofnewequityissuesarepreferredstock.
Answer:
10.
FALSE
TheSecuritiesandExchangeCommissionrequiresfirmstosubmitvariousdocuments
toincreasetheflowofinformationtoinvestorsbutdoesnotverifytheaccuracyofthat
information.
Answer:
9.
TRUE
TheDowJonesIndustrialAverageisthebroadestandbestindicatorofthestock
markets
daytodayperformance.
Answer:
8.
TRUE
TheEnronfinancialscandalincreaseduncertaintyaboutthequalityofaccounting
informationandasaresultincreasedrequiredreturnoninvestmentinstocks.
Answer:
7.
FALSE
Commonstockistheriskiestcorporatesecurity,followedbypreferredstockandthen
bonds.
Answer:
6.
FALSE
Allstockspaydividends,asthatistheonlywayaninvestorcanprofitfromholding
stock.
Answer:
5.
TRUE
ElectronicCommunicationsNetworksapplytechnologytomakeorganizedexchanges
moreefficientandspeedy.
Answer:
4.
FALSE
TRUE
TheGordongrowthmodelassumesthatastocksdividendgrowsataconstantrate
forever.
Answer:
TRUE
12.
Astocksmarketvaluewillbehigherthehigheristheinvestorsrequiredrateofreturn.
Answer:
FALSE
Essay
1.
Howdocorporatestocksdifferfrombonds?
2.
Howdocommonstocksdifferfrompreferredstock?
3.
Howdooverthecountermarketsdifferfromorganizedexchanges?
4.
Whatistheroleofspecialistsonastockexchange?
5.
WhataretheadvantagesanddisadvantagesofElectronicCommunicationsNetworks
(ECNs)fortradingstocks?
6.
Whatistheroleoftherequiredreturnonequityinvestmentsinstockvaluationmodels?
7.
UsingtheGordongrowthmodel,explainwhythe2001teroristattacksandtheEnron
financialscandalcausedstockpricestodecline.
8.
WhatareAmericanDepositoryReceipts(ADRs)?
9.
WhataretheobjectivesoftheSecuritiesandExchangeCommission?
Chapter9
TheMortgageMarket
.10 Multiple Choice Questions

1.
Whichofthefollowingareimportantwaysinwhichmortgagemarketsdifferfromthe
stockandbondmarkets?
(a) Theusualborrowersinthecapitalmarketsaregovernmententitiesandbusinesses,
whereastheusualborrowersinthemortgagemarketsareindividuals.
(b) Mostmortgagesaresecuredbyrealestate,whereasthemajorityofcapitalmarket
borrowingisunsecured.
(c) Becausemortgagesaremadefordifferentamountsanddifferentmaturities,
developingasecondarymarkethasbeenmoredifficult.
(d) Alloftheaboveareimportantdifferences.
(e) Only(a)and(b)oftheaboveareimportantdifferences.
Answer: D
2.
Whichofthefollowingareimportantwaysinwhichmortgagemarketsdifferfrom
stockandbondmarkets?
(a) Theusualborrowersincapitalmarketsaregovernmententities,whereastheusual
borrowersinmortgagemarketsaresmallbusinesses.
(b) Theusualborrowersincapitalmarketsaregovernmententitiesandlarge
businesses,whereastheusualborrowersinmortgagemarketsaresmallbusinesses.
(c) Theusualborrowersincapitalmarketsaregovernmententitiesandlarge
businesses,whereastheusualborrowersinmortgagemarketsaresmallbusinesses
andindividuals.
(d) Theusualborrowersincapitalmarketsarebusinessesandgovernmententities,
whereastheusualborrowersinmortgagemarketsareindividuals.
Answer: D
3.
Whichofthefollowingaretrueofmortgages?
(a) Amortgageisalongtermloansecuredbyrealestate.
(b) Aborrowerpaysoffamortgageinacombinationofprincipalandinterest
paymentsthatresultinfullpaymentofthedebtbymaturity.
(c) Over80percentofmortgageloansfinanceresidentialhomepurchases.
(d) Alloftheabovearetrueofmortgages.
(e) Only(a)and(b)oftheabovearetrueofmortgages.
Answer: D
4.
(a) Amortgageisalongtermloansecuredbyrealestate.
(b) Borrowerspayoffmortgagesovertimeinsomecombinationofprincipaland
interestpaymentsthatresultinfullpaymentofthedebtbymaturity.
(c) Lessthan65percentofmortgageloansfinanceresidentialhomepurchases.
(d) Alloftheabovearetrueofmortgages.
(e) Only(a)and(b)oftheabovearetrueofmortgages.
Answer: E
5.
(a) Priortothe1920s,U.S.bankinglegislationdiscouragedmortgagelendingby
banks.
(b) Inthe1920s,mostmortgageswereballoonloans,whichrequiredtheborrowerto
paytheentireloanamountafterthreetofiveyears.
(c) Becausemortgagesarelongtermloanssecuredbyrealestate,mortgagelenders
tendedtofailwhenlandpricesdeclined,aswasoftenthecaseduringeconomic
recessions.
Answer: D
6.
Whichofthefollowingistrueofmortgageinterestrates?
(a) Interestratesonmortgageloansaredeterminedbythreefactors:currentlongterm
marketrates,thetermofthemortgage,andthenumberofdiscountpointspaid.
(b) MortgageinterestratestendtotrackalongwithTreasurybondrates.
(c) Theinterestrateon15yearmortgagesislowerthantherateon30yearmortgages,
allelse
thesame.
Answer: D
7.
(a) Morethan80percentofmortgageloansfinanceresidentialhomepurchases.
(b) TheNationalBankingActof1863rewardedbanksthatincreasedmortgage
lending.
(c) Mostmortgagesduringthe1920sand1930swereballoonloans.
(e) Only(a)and(c)oftheabovearetrue.
Answer: E
8.
(a) Longertermmortgageshavelowerinterestratesthanshortertermmortgages.
(b) MortgageratesarelowerthanTreasurybondrates,becauseofthetaxdeductibility
ofmortgageinterestrates.
(c) Inexchangeforpoints,lendersreduceinterestratesonmortgageloans.
Answer: C
9. Typically,discountpointsshouldnotbepaidiftheborrowerwillpayofftheloanin
_________yearsorless.
(a) 5
(b) 10
(c) 15
(d) 20
Answer: A
10.
(a) Longertermmortgageshavehigherinterestratesthanshortertermmortgages.
(b) Inexchangeforpoints,lendersreduceinterestratesonmortgageloans.
(c) MortgageratesarelowerthanTreasurybondratesbecauseofthetaxdeductibility
ofmortgageinterestpayments.
Answer: E
11.
Whichofthefollowingreducesmoralhazardforthemortgageborrower?
(a) Collateral
(b) Downpayments
(c) Privatemortgageinsurance
(d) Borrowerqualifications
Answer: B
12.
Whichofthefollowingprotectsthemortgagelendersrighttosellpropertyifthe
underlyingloandefaults?
(a) Alien
(b) Adownpayment
(c) Privatemortgageinsurance
(d) Borrowerqualification
(e) Amortization
Answer: A
13.
(a) MortgageratesarecloselytiedtoTreasurybondrates,butmortgageratestendto
staybelowTreasuryratesbecausemortgagesaresecuredwithcollateral.
(b) Longertermmortgageshavehigherinterestratesthanshortertermmortgages.
(c) Interestratesarehigheronmortgageloansonwhichlenderschargepoints.
Answer: B
14. Duringtheearlyyearsofanamortizingmortgageloan,thelenderapplies
(a) mostofthemonthlypaymenttotheoutstandingprincipalbalance.
(b) allofthemonthlypaymenttotheoutstandingprincipalbalance.
(c) mostofthemonthlypaymenttointerestontheloan.
(d) allofthemonthlypaymenttointerestontheloan.
(e) themonthlypaymentequallytointerestontheloanandtheoutstandingprincipal
balance.
Answer: C
15.
Duringthelastyearsofanamortizingmortgageloan,thelenderapplies
balance.
Answer: A
16.
Duringthelastyearsofaballoonmortgageloan,thelenderapplies
balance.
Answer: D
17.
Duringtheearlyyearsofaballoonmortgageloan,thelenderapplies
balance.
Answer: D
18.
AborrowerwhoqualifiesforanFHAorVAloanenjoystheadvantagethat
(a) themortgagepaymentismuchlower.
(b) onlyaveryloworzerodownpaymentisrequired.
(c) thecostofprivatemortgageinsuranceislower.
(d) thegovernmentholdsthelienontheproperty.
Answer: B
19.
(I)Conventionalmortgagesareoriginatedbyprivatelendinginstitutions,andFHAor
VAloansareoriginatedbythegovernment.(II)Conventionalmortgagesareinsuredby
privatecompanies,andFHAorVAloansareinsuredbythegovernment.
(c) Botharetrue.
(d) Botharefalse.
Answer: B
20. Borrowerstendtoprefer_________to_________,whereaslendersprefer_________
(a) fixedrateloans;ARMs;fixedrateloans.
(b) ARMs;fixedrateloans;fixedrateloans.
(c) fixedrateloans;ARMs;ARMs.
(d) ARMs;fixedrateloans;ARMs.
Answer: C
21.
(I)ARMsofferlowerinitialratesandtheratemayfallduringthelifeoftheloan.(II)
Conventionalmortgagesdonotallowaborrowertotakeadvantageoffallinginterest
rates.
(c) Botharetrue.
(d) Botharefalse.
Answer: A
22.
Growingequitymortgages(GEMs)
(a) helptheborrowerpayofftheloaninashortertime.
(b) havesuchlowpaymentsinthefirstfewyearsthattheprincipalbalanceincreases.
(c) offerborrowerspaymentsthatareinitiallylowerthanthepaymentsona
conventionalmortgage.
Answer: A
23.
Aborrowerwitha30yearloancancreateaGEMby
(a) simplyincreasingthemonthlypaymentsbeyondwhatisrequiredanddesignating
thattheexcessbeappliedentirelytotheprincipal.
(b) convertinghisARMintoaconventionalmortgage.
(c) convertinghisconventionalmortgageintoanARM.
(d) convertinghisconventionalmortgageintoaGPM.
Answer: A
24.
Whichofthefollowingareusefulforhomebuyerswhoexpecttheirincometorisein
thefuture?
(a) GPMs
(b) RAMs
(c) GEMs
(d) (a)and(b)
(e) (a)and(c)
Answer: E
25.
Whichofthefollowingareusefulforhomebuyerswhoexpecttheirincometofallin
thefuture?
(a) GPMs
(b) RAMs
(c) GEMs
(d) (a)and(b)
(e) (a)and(c)
Answer: B
26. Retiredpeoplecanliveontheequitytheyhaveintheirhomesbyusinga
(a) GEM.
(b) GPM.
(c) SAM.
(d) RAM.
Answer: D
27.
Secondmortgagesservethefollowingpurposes:
(a) theygiveborrowersawaytousetheequitytheyhaveintheirhomesassecurityfor
anotherloan.
(b) theyallowborrowerstogetataxdeductiononloanssecuredbytheirprimary
residenceorvacationhome.
(c) theyallowborrowerstoconverttheirconventionalmortgagesintoGEMs.
(d) alloftheabove.
Answer: E
28.
Whichofthefollowingisadisadvantageofasecondmortgagecomparedtocreditcard
debt?
(a) Theloansaresecuredbytheborrowershome.
(b) Theborrowergivesupthetaxdeductionontheprimarymortgage.
(c) Theborrowermustpaypointstogetasecondmortgageloan.
(d) Theborrowerwillfinditmoredifficulttoqualifyforasecondmortgageloan.
Answer: A
29.
Theshareofthemortgagemarketheldbysavingsandloansisapproximately
(a) 50percent.
(b) 40percent.
(c) 20percent.
(d) 10percent.
Answer: D
30.
Theshareofthemortgagemarketheldbycommercialbanksisapproximately
(a) 50percent.
(b) 25percent.
(c) 15percent.
(d) 5percent.
Answer: B
31.
Whichofthefollowinghasnotbeenareasonforthedevelopmentandgrowthofon
linemortgagelending?
(a) Mortgagelendingisaninformationbasedserviceandnoproductshavetobe
inventoriedorshipped.
(b) Theproduct(amortgageloan)ishomogeneous.
(c) Ithasledtosimplificationofloanalternativesandmadecomparisonshopping
easier.
(d) Onlinelendershaveloweroverheadandcanofferloansatlowercosts.
Answer: C
True/False
1.
Downpaymentsaredesignedtoreducethelikelihoodofdefaultonmortgageloans.
Answer:
2.
Discountpoints(orsimplypoints)areinterestpaymentsmadeatthebeginningofa
loan.
Answer:
3.
TRUE
Apointonamortgageloanreferstoonemonthlypaymentofprincipalandinterest.
Answer:
4.
TRUE
FALSE
Closingforamortgageloanreferstothemomenttheloanispaidoff.
Answer:
5.
Privatemortgageinsuranceisapolicythatguaranteestomakeupanydiscrepancy
betweenthevalueofthepropertyandtheloanamount,shouldadefaultoccur.
Answer:
6.
TRUE
Manyinstitutionsthatmakemortgageloansdonotwanttoholdlargeportfoliosof
longtermsecurities,becauseitwouldsubjectthemtounacceptablyhighinterestrate
risk.
Answer:
13.
TRUE
Nearlyhalfthefundsformortgagelendingcomefrommortgagepoolsandtrusts.
Answer:
12.
FALSE
Anadvantageofagraduatedpaymentmortgageisthatborrowerswillqualifyfora
largerloanthaniftheyrequestedaconventionalmortgage.
Answer:
11.
TRUE
MortgageinterestrateslooselytrackinterestratesonthreemonthTreasurybills.
Answer:
10.
FALSE
Adjustableratemortgagesgenerallyhavelowerinitialinterestratesthandofixedrate
mortgages.
Answer:
9.
FALSE
OneimportantadvantagetoaborrowerwhoqualifiesforanFHAorVAloanisthe
verylowinterestrateonthemortgage.
Answer:
8.
TRUE
Duringtheearlyyearsoftheloan,thelenderappliesmostofthepaymenttothe
principalon
theloan.
Answer:
7.
FALSE
TRUE
Aproblemthatinitiallyhinderedthemarketabilityofmortgagesinasecondarymarket
wasthattheywerenotstandardized.
Answer:
TRUE
14. Mortgagebackedsecuritieshavedeclinedinpopularityinrecentyearsasinstitutional
investorshavesoughthigherreturnsinothermarkets.
Answer:
15.
FALSE
Mortgagebackedsecuritiesaremarketablesecuritiescollateralizedbyapoolof
mortgages.
Answer:
TRUE
16.
FannieMaeandFreddieMactogethereitherownorinsuretheriskonnearlyone
fourthofAmericasresidentialmortgages.
Answer:
FALSE
Essay
1.
Howhasthemodernmortgagemarketchangedoverrecentyears?
2.
Explainthefeaturesofmortgageloansthataredesignedtoreducethelikelihoodof
default.
3.
Whatarepoints?Whatistheirpurpose?
4.
Howdoesanamortizingmortgageloandifferfromaballoonmortgageloan?
5.
Evaluatetheadvantagesanddisadvantages,fromboththelendersandtheborrowers
perspectives,offixedrateandadjustableratemortgages.
6.
Whyhastheonlinelendingmarketdevelopedinrecentyearsandwhatarethe
advantagesanddisadvantagesofthisdevelopment?
7.
WhymayFannieMaeandFreddieMacposeathreattothehealthofthefinancial
system?
8.
Whataremortgagebackedsecurities,whyweretheydeveloped,whattypesof
mortgagebackedsecuritiesarethere,andhowdotheywork?
Chapter10
TheForeignExchangeMarket

1.
Americanfirmsbecamelesscompetitivecomparedtoforeignfirmsduringthe1980s
because
(a) thequalityandproductivityofAmericanworkersdeclined.
(b) foreignfirmswereyoungerthanAmericanfirmsandasaresulthadmoremodern
facilitiesthatmadeuseofthelatesttechnology.
(c) theU.S.dollarbecameworthmoreintermsofforeigncurrencies.
(d) theU.S.dollarbecameworthlessintermsofforeigncurrencies.
Answer: C
2.
Aspottransactionintheforeignexchangemarketinvolvesthe
(a) exchangeofexportsandimportsataspecifiedfuturedate.
(b) exchangeofbankdepositsataspecifiedfuturedate.
(c) immediate(withintwodays)exchangeofexportsandimports.
(d) immediate(withintwodays)exchangeofbankdeposits.
Answer: D
3.
WhenthevalueoftheBritishpoundchangesfrom$1.50to$1.25,thenthepoundhas
_________andthedollarhas_________.
(a) appreciated;appreciated
(b) depreciated;appreciated
(c) appreciated;depreciated
(d) depreciated;depreciated
Answer: B
4.
Whenthevalueofthedollarchangesfrom0.5to0.75,thenthepoundhas
_________andthedollarhas_________.
Answer: B
5.
Whentheexchangeratechangesfrom1.0eurostothedollarto1.2eurostothedollar,
thentheeurohas_________andthedollarhas_________.
Answer: B
6.
Whentheexchangeratechangesfrom1.0eurostothedollarto0.8eurostothedollar,
thentheeurohas_________andthedollarhas_________.
Answer: C
7.
Ifthedollar_________from1.2eurosperdollarto0.8eurosperdollar,theeuro
_________from0.83dollarsto1.25dollarspereuro.
(a) appreciates;appreciates
(b) appreciates;depreciates
(c) depreciates;depreciates
(d) depreciates;appreciates
Answer: D
8.
Ifthedollarappreciatesfrom0.8eurosperdollarto1.2eurosperdollar,theeuro
depreciatesfrom_________dollarsto_________dollarspereuro.
(a) 1.25;0.83
(b) 0.83;1.25
(c) 0.67;1.50
(d) 1.50;0.67
Answer: A
9.
IfthedollardepreciatesrelativetotheSwissfranc,
(a) SwisschocolatewillbecomemoreexpensiveintheUnitedStates.
(b) AmericancomputerswillbecomelessexpensiveinSwitzerland.
(c) SwisschocolatewillbecomecheaperintheUnitedStates.
Answer: D
10.
IfthedollarappreciatesrelativetotheSwissfranc,
(a) SwisschocolatewillbecomemoreexpensiveintheUnitedStates.
(b) AmericancomputerswillbecomelessexpensiveinSwitzerland.
(c) SwisschocolatewillbecomecheaperintheUnitedStates.
Answer: C
11. Whentheexchangeratefortheeurochangesfrom$1.00to$1.20then,holding
everythingelseconstant,theeurohas
(a) appreciatedandGermancarssoldintheUnitedStatesbecomemoreexpensive.
(b) appreciatedandGermancarssoldintheUnitedStatesbecomelessexpensive.
(c) depreciatedandAmericanwheatsoldinGermanybecomesmoreexpensive.
(d) depreciatedandAmericanwheatsoldinGermanybecomeslessexpensive.
Answer: A
12.
Whentheexchangeratefortheeurochangesfrom$1.20to$1.00,then,holding
everythingelseconstant,theeurohas
(a) appreciatedandGermancarssoldintheUnitedStatesbecomemoreexpensive.
(b) appreciatedandGermancarssoldintheUnitedStatesbecomelessexpensive.
(c) depreciatedandAmericanwheatsoldinGermanybecomesmoreexpensive.
(d) depreciatedandAmericanwheatsoldinGermanybecomeslessexpensive.
Answer: C
13.
Thestartingpointforunderstandinghowexchangeratesaredeterminedisasimpleidea
called_________,whichstatesthatiftwocountriesproduceanidenticalgood,the
priceofthegoodshouldbethesamethroughouttheworldnomatterwhichcountry
producesit.
(a) Greshamslaw
(b) thelawofoneprice
(c) purchasingpowerparity
(d) arbitrage
Answer: B
14.
Thetheoryofpurchasingpowerparityisatheoryofhowexchangeratearedetermined
in
(a) thelongrun.
(b) theshortrun.
(c) both(a)and(b).
(d) noneoftheabove.
Answer: A
15.
The_________statesthatexchangeratesbetweenanytwocurrencieswilladjustto
reflectchangesinthepricelevelsofthetwocountries.
(a) theoryofpurchasingpowerparity
(b) lawofoneprice
(c) theoryofmoneyneutrality
(d) quantitytheoryofmoney
Answer: A
16.
Thetheoryofpurchasingpowerparitystatesthatexchangeratesbetweenanytwo
currencieswilladjusttoreflectchangesin
(a) thetradebalancesofthetwocountries.
(b) thecurrentaccountbalancesofthetwocountries.
(c) fiscalpoliciesofthetwocountries.
(d) thepricelevelsofthetwocountries.
Answer: D
17.
Inthelongrun,ariseinacountryspricelevel(relativetotheforeignpricelevel)
causesitscurrencyto_________,whileariseinthecountrysrelativeproductivity
causesitscurrencyto_________
(a) appreciate;appreciate.
(b) appreciate;depreciate.
(c) depreciate;appreciate.
(d) depreciate;depreciate.
Answer: C
18.
Ifthe2005inflationrateinBritainis6percent,andtheinflationrateintheU.S.is4
percent,thenthetheoryofpurchasingpowerparitypredictsthat,during2005,thevalue
oftheBritishpoundintermsofU.S.dollarswill
(a) riseby10percent.
(b) riseby2percent.
(c) fallby10percent.
(d) fallby2percent.
(e) dononeoftheabove.
Answer: D
19.
Thetheoryofpurchasingpowerparitycannotfullyexplainexchangeratemovements
because
(a) notallgoodsareidenticalindifferentcountries.
(b) monetarypolicydiffersacrosscountries.
(c) somegoodsarenottradedbetweencountries.
Answer: D
20.
because
(a) allgoodsareidenticalevenifproducedindifferentcountries.
(b) monetarypolicydiffersacrosscountries.
(c) somegoodsarenottradedbetweencountries.
(d) fiscalpolicydiffersacrosscountries.
Answer: C
21.
Increaseddemandforacountrys_________causesitscurrencytoappreciateinthe
longrun,whileincreaseddemandfor_________causesitscurrencytodepreciate.
(a) imports;imports
(b) imports;exports
(c) exports;imports
(d) exports;exports
Answer: C
22.
Ifthedemandfor_________goodsdecreasesrelativeto_________goods,the
domesticcurrencywilldepreciate.
(a) foreign;domestic
(b) foreign;foreign
(c) domestic;domestic
(d) domestic;foreign
Answer: D
23.
Highertariffsandquotascauseacountryscurrencyto_________inthe_________
run.
(a) depreciate;short
(b) appreciate;short
(c) depreciate;long
(d) appreciate;long
Answer: D
24.
Lowertariffsandquotascauseacountryscurrencyto_________inthe_________
run.
(a) depreciate;short
(b) appreciate;short
(c) depreciate;long
(d) appreciate;long
Answer: C
25.
IftheinflationrateintheUnitedStatesishigherthanthatinGermanyandproductivity
isgrowingataslowerrateintheUnitedStatesthanitisinGermany,inthelongrun,
(a) theeuroshouldappreciaterelativetothedollar.
(b) theeuroshoulddepreciaterelativetothedollar.
(c) thereshouldbenochangeintheeuropriceofdollars.
(d) itisnotclearwhatwillhappentotheeuropriceofdollars.
Answer: A
26.
IftheFrenchdemandforAmericanexportsrisesatthesametimethatU.S.productivity
risesrelativetoFrenchproductivity,then,inthelongrun,
(a) theeuroshouldappreciaterelativetothedollar.
(b) thedollarshoulddepreciaterelativetotheeuro.
(c) thedollarshouldappreciaterelativetotheeuro.
(d) itisnotclearwhethertheeuroshouldappreciateordepreciaterelative
tothedollar.
Answer: C
27.
Thetheoryofassetdemandsuggeststhatthemostimportantfactoraffectingthe
demandfordomesticandforeigndepositsis
(a) theleveloftradeandcapitalflows.
(b) theexpectedreturnontheseassetsrelativetooneanother.
(c) theliquidityoftheseassetsrelativetooneanother.
(d) theriskinessoftheseassetsrelativetooneanother.
Answer: B
28.
WhenFranoistheForeignerconsiderstheexpectedreturnondollardepositsinterms
offoreigncurrency,theexpectedreturnmustbeadjustedfor
(a) anyexpectedappreciationordepreciationofthedollar.
(b) theinterestratesonforeigndeposits.
(c) both(a)and(b)oftheabove.
(d) neither(a)nor(b)oftheabove.
Answer: A
29.
Theexpectedreturnondollardepositsintermsofforeigncurrencyisthe_________
theinterestrateondollardepositsandtheexpectedappreciationofthedollar.
(a) productof
(b) ratioof
(c) sumof
(d) differencein
Answer: C
30.
Iftheinterestrateonforeigndeposits(iF)increases,holdingeverythingelseconstant,
(a) theexpectedreturnonthesedepositsmustalsoincrease.
(b) theexpectedreturnondomesticdepositsmustdecrease.
(c) theexpectedreturnondomesticdepositsmustincrease.
Answer: A
31.
Iftheinterestrateondollardepositsis10percent,andthedollarisexpectedto
appreciateby
7percentoverthecomingyear,theexpectedreturnondollardepositsintermsofthe
foreigncurrencyis
(a) 3percent.
(b) 10percent.
(c) 13.5percent.
(d) 17percent.
(e) 24percent.
Answer: D
True/False
1.
Theforeignexchangemarketisorganizedasanoverthecountermarketinwhich
depositsdenominatedinforeigncurrenciesareboughtandsold.
Answer:
2.
Whenthevalueofthedollarchangesfrom0.5poundsto0.75pounds,thenthepound
hasappreciatedandthedollarhasdepreciated.
Answer:
3.
TRUE
becausefiscalpolicydiffersacrosscountries.
Answer:
5.
FALSE
Whentheexchangeratefortheeurochangesfrom$0.90to$0.85,thenholding
everythingelseconstant,theeurohasdepreciatedandAmericanwheatsoldin
Germanybecomesmoreexpensive.
Answer:
4.
TRUE
FALSE
IfthedollardepreciatesrelativetotheBritishpound,Britishsweaterswillbecome
moreexpensiveintheUnitedStates.
Answer:
TRUE
6.
IfthedollarappreciatesrelativetotheSwissfranc,Swisschocolatewillbecome
cheaperintheUnitedStates.
Answer:
7.
IftheexchangeratebetweenthedollarandtheSwissfrancchangesfrom1.8to1.5
francsperdollar,thefrancdepreciatesandthedollarappreciates.
Answer:
8.
FALSE
Accordingtotheinterestrateparitycondition,ifthedomesticinterestrateis12percent
andtheforeigninterestrateis10percent,thentheexpectedappreciationoftheforeign
currencymustbe
2percent.
Answer:
12.
FALSE
Astherelativeexpectedreturnondollardepositsincreases,Americanswillwantto
holdfewerdollardepositsandmoreforeigndeposits.
Answer:
11.
TRUE
Increaseddemandforacountrysexportscausesitscurrencytodepreciate.
Answer:
10.
FALSE
Anincreaseintariffsandquotasonimportscausesacountryscurrencytoappreciate.
Answer:
9.
TRUE
TRUE
Afallintheexpectedfutureexchangerateshiftstheexpectedreturnschedulefor
domesticdepositstotherightandcausesthedomesticcurrencytodepreciate.
Answer:
FALSE
Essay
1.
Explainthelogicunderlyingthelawofonepriceandthetheoryofpurchasingpower
parity.
2.
Explaingraphicallyhowachangeinthedomesticpricelevelwillaffectexchangerates,
holdingeverythingelseconstant.
3.
Explainthetheoryofinterestrateparity.
4.
Explaingraphicallyhowachangeintheforeigninterestratewillaffectexchangerates.
5.
Discusstherelationshipbetweenchangesindomesticrealandnominalinterestrates
andexchangerates.
6.
Explaingraphicallyhowanincreaseinacountrysmoneysupplywillaffectthe
exchangerateforitscurrency.
Chapter11
CommercialBankingIndustry:Structureand
Competition

1.
ThemoderncommercialbankingsystembeganinAmericawhenthe
(a) BankoftheUnitedStateswascharteredinNewYorkin1801.
(b) BankofNorthAmericawascharteredinPhiladelphiain1782.
(c) BankoftheUnitedStateswascharteredinPhiladelphiain1801.
(d) BankofNorthAmericawascharteredinNewYorkin1782.
Answer: B
2.
AmajorcontroversyinvolvingtheU.S.bankingindustryinitsearlyyearswas
(a) whetherbanksshouldbothacceptdepositsandmakeloansorwhetherthese
functionsshouldbeseparatedintodifferentinstitutions.
(b) whetherthefederalgovernmentorthestatesshouldcharterbanks.
(c) whatpercentofdepositsbanksshouldholdasfractionalreserves.
(d) whetherbanksshouldbeallowedtoissuetheirownbanknotes.
Answer: B
3.
Thegovernmentinstitutionthathasresponsibilityfortheamountofmoneyandcredit
suppliedintheeconomyasawholeisthe
(a) centralBank.
(b) commercialBank.
(c) bankofsettlement.
(d) TreasuryDepartment.
Answer: A
4.
Becauseoftheabusesbystatebanksandtheclearneedforacentralbanktohelpthe
federalgovernmentraisefundsduringtheWarof1812,Congresscreatedthe
(a) FirstBankoftheUnitedStatesin1812.
(b) BankofNorthAmericain1814.
(c) SecondBankoftheUnitedStatesin1816.
(d) FederalReserveSystemin1813.
Answer: C
5.
TheSecondBankoftheUnitedStateswasdeniedanewcharterby
(a) PresidentAndrewJackson.
(b) VicePresidentJohnCalhoun.
(c) PresidentBenjaminHarrison.
(d) PresidentJohnQ.Adams.
Answer: A
6.
Before1863,
(a) federallycharteredbankshadregulatoryadvantagesnotgrantedtostatechartered
banks.
(b) thenumberoffederallycharteredbanksgrewatamuchfasterratethanatany
othertimesincetheendoftheCivilWar.
(c) banksacquiredfundsbyissuingbanknotes.
(d) theFederalReserveSystemregulatedonlyfederallycharteredbanks.
(e) theComptrolleroftheCurrencyregulatedbothstateandfederallychartered
banks.
Answer: C
7.
Before1863,
(a) theFederalReserveSystemregulatedonlyfederallycharteredbanks.
(b) theComptrolleroftheCurrencyregulatedbothstateandfederallychartered
banks.
(c) thenumberoffederallycharteredbanksgrewatamuchfasterratethanatany
othertimesincetheendoftheCivilWar.
(d) noneoftheabove.
Answer: D
8.
Althoughfederalbankinglegislationinthe1860sattemptedtoeliminatestatechartered
banksbyimposingaprohibitivetaxonbanknotes,thesebankshavebeenabletostayin
businessby
(a) issuingcreditcards.
(b) ignoringtheregulations.
(c) issuingdeposits.
(d) branchingintootherstates.
Answer: C
9.
Thebeliefthatbankfailureswereregularlycausedbyfraudorthelackofsufficient
bankcapitalexplains,inpart,thepassageof
(a) theNationalBankCharterAmendmentsof1918.
(b) theGlassSt.GermainActof1982.
(c) theNationalBankActof1863.
(d) noneoftheabove.
Answer: C
10.
Toeliminatetheabusesofthestatecharteredbanks,the_________createdanew
bankingsystemoffederallycharteredbanks,supervisedbythe_________
(a) NationalBankingActof1863;OfficeoftheComptrolleroftheCurrency.
(b) FederalReserveActof1863;OfficeoftheComptrolleroftheCurrency.
(c) NationalBankingActof1863;OfficeofThriftSupervision.
(d) FederalReserveActof1863;OfficeofThriftSupervision.
Answer: A
11. TheNationalBankingActof1863,andsubsequentamendmentstoit,
(a) createdabankingsystemoffederallycharteredbanks.
(b) establishedtheOfficeoftheComptrolleroftheCurrency.
(c) broadenedtheregulatorypowersoftheFederalReserve.
(d) didalloftheabove.
(e) didonly(a)and(b)oftheabove.
Answer: E
12.
TheregulatorysystemthathasevolvedintheUnitedStateswherebybanksare
regulatedatthestatelevel,thenationallevel,orboth,isknownasa
(a) bilateralregulatorysystem.
(b) tieredregulatorysystem.
(c) twotieredregulatorysystem.
(d) dualbankingsystem.
Answer: D
13.
TodaytheUnitedStateshasadualbankingsysteminwhichbankssupervisedbythe
_________andbythe_________operatesidebyside.
(a) federalgovernment;municipalities
(b) stategovernments;municipalities
(c) federalgovernment;states
(d) municipalities;states
Answer: C
14.
TheFederalReserveActof1913requiredthat
(a) statebanksbesubjecttothesameregulationsasnationalbanks.
(b) nationalbanksestablishbranchesinthecitiescontainingFederalReservebanks.
(c) nationalbanksjointheFederalReserveSystem.
(d) alloftheabovebedone.
Answer: C
15.
TheFederalReserveActrequiredall_________bankstobecomemembersofthe
FederalReserveSystem,while_________bankscouldchoosetobecomemembersof
thesystem.
(a) state;national
(b) state;municipal
(c) national;state
(d) national;municipal
Answer: C
16.
WiththecreationoftheFederalDepositInsuranceCorporation,memberbanksofthe
FederalReserveSystem_________topurchaseFDICinsurancefortheirdepositors,
whilenonmembercommercialbanks_________tobuydepositinsurance.
(a) couldchoose;wererequired
(b) couldchoose;weregiventheoption
(c) wererequired,couldchoose
(d) wererequired;wererequired
Answer: C
17. WiththecreationoftheFederalDepositInsuranceCorporation,
(a) memberbanksoftheFederalReserveSystemweregiventheoptiontopurchase
FDICinsurancefortheirdepositors,whilenonmembercommercialbankswere
requiredtobuydepositinsurance.
(b) memberbanksoftheFederalReserveSystemwererequiredtopurchaseFDIC
insurancefortheirdepositors,whilenonmembercommercialbankscouldchoose
tobuydepositinsurance.
(c) bothmemberandnonmemberbanksoftheFederalReserveSystemwererequired
topurchaseFDICinsurancefortheirdepositors.
(d) bothmemberandnonmemberbanksoftheFederalReserveSystemcouldchoose,
butwerenotrequired,topurchaseFDICinsurancefortheirdepositors.
Answer: B
18.
Probablythemostsignificantfactorexplainingthedrasticdropinthenumberofbank
failuressincetheGreatDepressionhasbeen
(a) thecreationoftheFDIC.
(b) rapideconomicgrowthsince1941.
(c) theemploymentofnewproceduresbytheFederalReserve.
(d) betterbankmanagement.
Answer: A
19.
Investmentbankingactivitiesofthecommercialbankswereblamedformanybank
failures.
Thisledto
(a) thepassageoftheNationalBankCharterAmendmentsActof1918.
(b) thepassageoftheGarnSt.GermainActof1982.
(c) thepassageoftheNationalBankActof1863.
(d) thepassageoftheGlassSteagallActof1933.
(e) theestablishmentoftheFederalDepositInsuranceCorporationin1933.
Answer: D
20.
TheGlassSteagallActprohibitedcommercialbanksfrom
(a) issuingequitytofinancebankexpansion.
(b) engaginginunderwritingofanddealingincorporatesecurities.
(c) sellingnewissuesofgovernmentsecurities.
(d) purchasinganydebtsecurities.
Answer: B
21.
Whichbankregulatoryagencyhasthesoleregulatoryauthorityoverbankholding
companies?
(a) TheFederalDepositInsuranceCorporation
(b) TheComptrolleroftheCurrency
(c) TheFederalBankHoldingCompanyAgency
(d) TheFederalReserveSystem
Answer: D
22. StatebanksthatarenotmembersoftheFederalReserveSystemaremostlikelytobe
examinedbythe
(a) FederalReserveSystem.
(b) FederalDepositInsuranceCorporation.
(c) FederalHomeLoanBankSystem.
(d) ComptrolleroftheCurrency.
Answer: B
23.
Whichregulatorybodychartersnationalbanks?
(a) TheFederalReserve
(b) TheFederalDepositInsuranceCorporation
(c) TheComptrolleroftheCurrency
(d) Noneoftheabove
Answer: C
24.
WhichofthefollowingstatementsconcerningbankregulationintheUnitedStatesare
true?
(a) TheOfficeoftheComptrolleroftheCurrencyhastheprimaryresponsibilityfor
nationalbanks.
(b) TheFederalReserveandthestatebankingauthoritiesjointlyhaveresponsibility
forstatebanksthataremembersoftheFederalReserveSystem.
(c) TheFedhassoleregulatoryresponsibilityoverbankholdingcompanies.
Answer: D
25.
WhichofthefollowingstatementsconcerningbankregulationintheUnitedStatesare
true?
(a) TheOfficeoftheComptrolleroftheCurrencyhastheprimaryresponsibilityfor
statebanksthataremembersoftheFederalReserveSystem.
(b) TheFederalReserveandthestatebankingauthoritiesjointlyhaveresponsibility
forstatebanksthataremembersoftheFederalReserveSystem.
(c) TheOfficeoftheComptrolleroftheCurrencyhassoleregulatoryresponsibility
overbankholdingcompanies.
Answer: B
26.
Whichofthefollowingareimportantfactorsindeterminingthedegreeandtimingof
financialinnovation?
(a) Changesintechnology
(b) Changesinfinancialmarketconditions
(c) Changesinregulation
(d) Alloftheabove
(e) Only(a)and(b)oftheabove
Answer: D
27. Newcomputertechnologyhas
(a) increasedthecostoffinancialinnovation.
(b) increasedthedemandforfinancialinnovation.
(c) reducedthecostoffinancialinnovation.
(d) reducedthedemandforfinancialinnovation.
Answer: C
28.
Risinginterestraterisk_________the_________financialinnovation.
(a) increased;costof
(b) increased;demandfor
(c) reduced;costof
(d) reduced;demandfor
Answer: B
29.
Largefluctuationsininterestratesleadto
(a) substantialcapitalgainsandlossestoownersofsecurities.
(b) greateruncertaintyaboutreturnsoninvestments.
(c) greaterinterestraterisk.
(d) alloftheabove.
Answer: D
30.
Inthe1950stheinterestrateonthreemonthTreasurybillsfluctuatedbetween1.0%
and3.5%.Inthe1980s,thethreemonthTreasurybillraterangedfrom5%toover
15%.Fromthisonecouldpredictthatinthe1980sinterestrateriskwas_________
andthedemandforfinancialinnovationwas_________.
(a) greater;lower
(b) greater;greater
(c) lower;lower
(d) lower;greater
Answer: B
31.
Themostsignificantchangeintheeconomicenvironmentthatchangedthedemandfor
financialproductssince1970hasbeen
(a) theagingofthebabyboomergeneration.
(b) thedramaticincreaseinthevolatilityofinterestrates.
(c) thedramaticincreaseincompetitionfromforeignbanks.
(d) thederegulationoffinancialinstitutions.
Answer: B
32.
Adjustableratemortgages
(a) protecthouseholdsagainsthighermortgagepaymentswheninterestratesrise.
(b) keepfinancialinstitutionsearningshighevenwheninterestratesarefalling.
(c) havemanyattractiveattributes,explainingwhysofewhouseholdsnowseekfixed
ratemortgages.
(d) doonly(a)and(b)oftheabove.
(e) noneoftheabove.
Answer: E
33. Adjustableratemortgages
(a) benefithomeownerswheninterestratesarefalling.
(b) reducefinancialinstitutionsinterestraterisk.
(c) reducehouseholdsriskofhavingtopayhighermortgagepaymentswheninterest
ratesrise.
(d) doonly(a)and(b)oftheabove.
Answer: D
34.
Themostimportantsourceofthechangesinsupplyconditionsthatstimulatefinancial
innovationhasbeenthe
(a) agingofthebabyboomergeneration.
(b) dramaticincreaseinthevolatilityofinterestrates.
(c) improvementininformationtechnology.
(d) dramaticincreaseincompetitionfromforeignbanks.
(e) deregulationoffinancialinstitutions.
Answer: C
35.
Examplesoffinancialservicesthatbecamepracticalrealitiesastheresultofnew
computertechnologyinclude
(a) creditcards.
(b) electronicbankingfacilities.
(c) checkingaccounts.
(d) alloftheabove.
Answer: E
36.
Creditcardsdatebackto
(a) priortoWorldWarII.
(b) justafterWorldWarII.
(c) theearly1950s.
(d) thelate1950s.
Answer: A
37.
Afirmissuingcreditcardsearnsincomefrom
(a) loansitmakestocreditcardholders.
(b) paymentsmadetoitbystoresoncreditcardpurchases.
(c) paymentsmadetoitbymanufacturersoftheproductssoldinstoresoncreditcard
purchases.
(d) alloftheabove.
Answer: E
38.
TheentryofSears,AT&TandGMintothecreditcardbusinessisanindicationof
(a) governmentseffortstoderegulatetheprovisionoffinancialservices.
(b) therisingprofitabilityofcreditcardoperations.
(c) thereductionincostsofcreditcardoperationssince1990.
(d) thesaleofunprofitableoperationsbyBankofAmericaandCiticorp.
Answer: B
39.
Asmartcardisaformof
(a) storedvaluecard.
(b) creditcard.
(c) debitcard.
(d) ecashcard.
Answer: A
40.
Whichofthefollowingisnotafinancialinnovationstimulatedbyinformation
technology?
(a) Creditcard
(b) Debitcard
(c) Adjustableratemortgage
(d) Electronicbanking
Answer: C
41.
Whichofthefollowingisanexampleofafinancialinnovationintroducedtoavoid
regulations?
(a) Securitization
(b) Junkbond
(c) Debitcard
(d) Sweepaccount
Answer: D
42.
StrippingaTreasurybond
(a) meanssellingeachofitsfuturepaymentsasaseparatezerocouponbond.
(b) decreasesthetotalpresentdiscountedvalueoffuturepayments.
(c) both(a)and(b).
(d) noneoftheabove.
Answer: A
43.
Socalledfallenangelsdifferfromjunkbondsinthat
(a) junkbondsrefertopreviouslyissuedbondswhichhavehadtheircreditratingsfall
belowBaa.
(b) fallenangelsrefertonewlyissuedbondswithlowcreditratings.
(c) junkbondsrefertonewlyissuedbondswithlowcreditratings.
Answer: C
44.
Socalledfallenangelsdifferfromjunkbondsinthat
(a) junkbondsrefertonewlyissuedbondswithlowcreditratings,whereasfallen
angelsrefertopreviouslyissuedbondswhichhavehadtheircreditratingsfall
belowBaa.
(b) junkbondsrefertopreviouslyissuedbondswhichhavehadtheircreditratingsfall
belowBaa,whereasfallenangelsrefertonewlyissuedbondswithlowcredit
ratings.
(c) junkbondshaveratingsbelowBaa,whereasfallenangelshaveratingsbelowC.
(d) fallenangelshaveratingsbelowBaa,whereasjunkbondshaveratingsbelowC.
Answer: A
True/False
1.
TodaytheUnitedStateshasadualbankingsysteminwhichbankssupervisedbythe
federalgovernmentandbankssupervisedbythestatesoperatesidebyside.
Answer: TRUE
2.
BankholdingcompaniesareregulatedbytheFDIC.
Answer: FALSE
3.
TheexistenceoflargenumbersofbanksintheUnitedStatesindicatesthepresenceof
vigorouscompetition.
Answer:FALSE
4.
EvenwhenanATMisownedbyabank,statestypicallyhavespecialprovisionsthat
allowwiderestablishmentofATMsthanispermissiblefortraditionalbrickand
mortarbranches.
Answer: TRUE
5.
Bankholdingcompaniesthathavebeguntorivalthemoneycenterbanksinsizebut
whoseheadquartersarenotbasedinoneofthemoneycentercitiesarecalled
superregionalbanks.
Answer: TRUE
6.
ThefuturestructureoftheU.S.bankingindustryislikelytobecharacterizedbymany
moresmallerbanks,ascustomersdemandneighborhoodbanksoperatedbypeoplethey
knowpersonally.
Answer: FALSE
7.
RestrictionsoncommercialbankssecuritiesandinsuranceactivitiesputAmerican
banksat
acompetitivedisadvantagerelativetoforeignbanks.
Answer: TRUE
8.
EurodollarsarecreatedwhendepositsinaccountsintheUnitedStatesaretransferredto
abankoutsidethecountryandarekeptintheformofdollars.
Answer: TRUE
9.
Financialinnovationhaswidenedthecostadvantagesthatbankshaveinacquiring
funds,helpingtoexplainwhybankprofitabilityhassoaredinrecentyears.
Answer: FALSE
10.
Americansarethebiggestusersofchecksintheworldbutnonethelessareaheadof
Europeansintheproportionofnoncashpaymentsthataremadebyelectronicmeans.
Answer: FALSE
11.
Securitizationistheprocessoftransformingilliquidfinancialassetssuchasresidential
mortgagesintomarketablesecurities.
Answer: TRUE
12.
Disintermediationoccurswhenfundsaredepositedintobanksandlenttoborrowers.
Answer: FALSE
13.
TheprincipleunderlyingTreasurySTRIPSisthataninvestorwillearnahigherinterest
ratewhenreinvestmentriskiseliminated.
Answer: TRUE
14.
Economiesofscopecomefromincreasingthesizeofagivenfinancialactivityand
economiesofscalecomefromcombiningdifferentactivitiestolowertheircosts.
Answer: FALSE
15.
Checkabledeposits,atraditionalsourceoflowcostfundsforbanks,havedeclined
dramaticallyinimportance,fallingfromover60percentofbankliabilitiesto10
percenttoday.
Answer: TRUE
Essay
1.
Whatfinancialinnovationsarebestexplainedasattemptstoavoidregulations?
2.
Whatnewformsofbankinghavebeenspawnedbytheadvancesininformation
technologyofthepasttwodecades?Isitlikelythattraditionalbankswilldisappearasa
resultoftheseinnovations?Why?
3.
Whatnewformsofmakingpaymentshavebeenspawnedbytheadvancesin
informationtechnologyofthepasttwodecades?Isitlikelythatourswillbecomea
cashlesssocietyanytimesoonasaresultoftheseinnovations?Why?
4.
WhatareTreasurySTRIPS?Whatroleshavereinvestmentriskandinformation
technologyplayedinthedevelopmentofthisfinancialproduct?
5.
Whatarethereasonsforthedeclineoftraditionalbanking?
6.
IsthelargenumberofbankingfirmsintheUnitedStatesanindicationofacompetitive
bankingindustry?Explainwhyorwhynot.
7.
Arebankconsolidationandnationwidebankinggoodthings?Why?
8.
WhenandwhywastheGlassSteagallActpassed?Whenandwhywasitrepealed?
9.
DescribeEdgeActcorporations,internationalbankingfacilities,andthestructureof
foreignbanksintheUnitedStates.
Chapter12
SavingsAssociationsandCreditUnions

1.
Savingsbanks
(a) werefirstestablishedinScotlandandEngland.
(b) wereestablishedtoencouragesavingbythepoor.
(c) wereveryconservativewiththeirfunds,placingmostofthemincommercial
banks.
(d) alloftheabove.
Answer: D
2.
Whichofthefollowingstatementsaboutmutualsavingsbanksaretrue?
(a) Therearecurrentlyunder200mutualsavingsbanksintheUnitedStates.
(b) Mostmutualsavingsbanksarefederallychartered.
(c) Both(a)and(b).
(d) Noneoftheabove.
Answer: D
3.
Whichofthefollowingstatementsconcerningthemutualformofownershipofsavings
banks
aretrue?
(a) Themutualformofownershipaccentuatestheprincipalagentproblemthatexists
incorporations.
(b) Morecapitalisavailable,contributingtothesafetyofmutualsavingsbanks
comparedtootherbankingorganizations.
(c) Managersofmutualsavingsbanksaremoreriskaversethaninthecorporateform,
becausethevalueoftheirownershipdoesnotincreaseifthefirmdoeswell.
Answer: D
4.
Savingsandloanassociations
(a) wereestablishedbyCongresstoencouragehomeownership.
(b) initiallywerenotpermittedtoacceptdemanddeposits.
(c) heldabout85percentoftheirassetsintheformofmortgagespriortotheGreat
Depression.
(d) alloftheabove.
Answer: D
5.
Savingsandloansassociations
(a) initiallywereallowedtoattractfundsbyofferingsavingsaccountsthatpaida
slightlyhigherinterestratethanthatofferedbycommercialbanks.
(b) heldabout85percentoftheirtotalassetsasmortgagespriortotheGreat
Depression.
(c) didnotweathertheGreatDepressionwell,asthousandsofS&Lsfailedinthe
1930s.
(d) alloftheabove.
Answer: D
6.
Thrifts
(a) fueledthehomebuildingboomfrom19341978.
(b) sufferedinthe1970sasinflationroseabovedepositinterestrateceilings.
(c) havegrowninimportanceinattractingdepositsrelativetocommercialbankssince
1980.
(d) alloftheabove.
Answer: E
7.
Thriftssufferedproblemsinthe1970sas
(a) marketinterestratesroseabovetheratesthriftscouldpayondepositsandsavings
accounts.
(b) thriftcustomersmovedtheirfundsfromthriftstomoneymarketmutualfunds.
(c) governmentregulatorsseverelylimitedthescopeofactivitiesthatthriftscould
undertaketogrowtheirwayoutoftrouble.
(d) alloftheaboveoccurred.
(e) only(a)and(b)oftheaboveoccurred.
Answer: E
8.
Intheearlystagesofthe1980sbankingcrisis,financialinstitutionswereespecially
hurtby
(a) thesharpincreasesininterestratesfromlate1979until1981.
(b) thesevererecessionin198182.
(c) thesharpdeclineinthepricelevelfrommid1980toearly1983.
(d) alloftheabove.
Answer: E
9.
Intheearlystagesofthe1980sbankingcrisis,financialinstitutionswereespecially
harmedby
(a) declininginterestratesfromlate1979until1981.
(b) thesevererecessionin198182.
(c) thedisinflationfrommid1980toearly1983.
(d) alloftheabove.
Answer: B
10.
Savingsandloanslostatotalof$10billionin19811982duetoacombinationof
risinginterestratesin19791981and
(a) therecessionof19811982thatreducedrealestatepricesenoughtocause
significantloandefaults.
(b) theregulatoryrestrictionsenactedbyCongressin1981and1982.
(c) thelossofmarketsharetocommercialbanksthatwereallowedtocompetedirectly
withthriftsintherealestatemarket.
(d) theaccelerationofinflationin19811982thatcausedthriftstoloseadditional
fundstomoneymarketmutualfunds.
Answer: A
11.
Inthe1980s,thriftinstitutions,whichhadbeenalmostentirelyrestrictedtomaking
loansforhomemortgagesonly,wereallowedbyregulatorsto
(a) financeacquisitionsincommercialrealestate.
(b) extendconsumerloans.
(c) purchasejunkbonds.
Answer: D
12.
Thegovernmentgrantedthriftsgreaterpowersintheearly1980sinhopesofturning
theindustrysproblemsaround.Thesepowers
(a) requiredgreaterexpertiseinmanagingriskthanmanythriftmanagerspossessed.
(b) encouragedthriftstoexpandlendingrapidlyinrealestate,increasingtheir
exposuretorisk.
(c) expandedthescopeandcomplexityofthriftlendingactivitiesthatwentbeyond
whatregulatorscouldeffectivelymonitor,giventheirlimitedresources.
Answer: D
13.
WhennearlyhalfoftheS&LsintheUnitedStateshadanegativenetworthandwere
thusinsolventbytheendof1982,regulatorsadoptedapolicyof_________,which
amountedto_________capitalrequirements.
(a) regulatoryforbearance;raising
(b) regulatoryforbearance;lowering
(c) regulatorystringency;raising
(d) regulatorystringency;lowering
Answer: B
14.
Thepolicyof_________exacerbated_________problemsassavingsandloanstook
onincreasinglyhugelevelsofriskontheslimchanceofreturningtosolvency.
(a) regulatoryforbearance;moralhazard
(b) regulatoryforbearance;adverseselection
(c) regulatorystringency;moralhazard
(d) regulatorystringency;adverseselection
Answer: A
15.
Whichofthefollowingreasonsexplainwhyfederalregulatorsadoptedapolicyof
regulatoryforbearancetowardinsolventfinancialinstitutionsintheearly1980s?
(a) TheFSLIClackedsufficientfundstocoverinsureddepositsintheinsolventS&Ls.
(b) Theregulatorswerereluctanttoclosethefirmsthatjustifiedtheirregulatory
existence.
(c) TheFederalHomeLoanBankBoardandtheFSLICwerereluctanttoadmitthat
theywereinovertheirheadswithproblems.
(d) Alloftheabove.
Answer: D
16.
Thepolicyofregulatoryforbearance
(a) meantdelayingtheclosingofzombieS&Lsastheirlossesmountedduringthe
1980s.
(b) benefitedzombieS&LsattheexpenseofhealthyS&Ls,ashealthyinstitutions
lostdepositstoinsolventinstitutions.
(c) contributedtodecliningprofitabilityintheS&Lindustryandanincreaseinthe
numberofzombieS&Ls.
(d) alloftheabove.
Answer: D
17.
Thepolicyofregulatoryforbearance
(a) meantdelayingtheclosingofzombieS&Lsastheirlossesmountedduringthe
1980s.
(b) benefitedzombieS&LsattheexpenseofhealthyS&Ls,ashealthyinstitutions
lostdepositstoinsolventinstitutions.
(c) hadtheadvantageofbenefitinghealthyS&Lsbygivingthemtheopportunityto
attractdepositsthatbegantoleavethezombieS&Ls.
Answer: D
18.
Whichofthefollowingarereasonsthatexplainwhyregulatorspursuedapolicyof
regulatoryforbearancetowardthriftsintheearly1980s?
(a) RegulatorsknewthattheFSLICdidnothavesufficientfundstocloseinsolvent
S&Lsandpayofftheirdepositors.
(b) Regulatorswereprobablytooclosetothepeopletheyweresupposedtobe
regulatingtoclosedownthriftsandputthemoutofbusiness.
(c) Regulatorspreferredtosweeptheproblemsthatthriftsweresufferingundertherug
inthehopethattheywouldgoawayastheeconomyimproved.
(d) Alloftheaboveexplainregulatoryforbearance.
(e) Only(a)and(b)oftheaboveexplainregulatoryforbearance.
Answer: D
19. ExamplesofthehugerisksthatzombieS&Lsundertookinclude
(a) buildingshoppingcentersinthedesert.
(b) buyingmanufacturingplantstoconvertmanuretomethane.
(c) purchasingbillionsofdollarsofjunkbonds.
(d) alloftheabove.
Answer: D
20.
ZombieS&Ls
(a) paidabovemarketinterestratestoattractdepositstofueltheirlendingboom.
(b) offeredloansatbelowmarketinterestratestoexpandtheirlending.
(c) drovedowntheprofitabilityofsolventS&Ls,threateningtoturntheminto
zombiestoo.
Answer: D
21.
Accordingtothetext,theCompetitiveEqualityinBankingActof1987
(a) turnedthethriftindustryaroundbyprovidingthenecessaryfundstoclosethe
zombieS&Ls.
(b) loweredthecostofbailingouttheS&LsbyquicklyclosingzombieS&Lsbefore
theycouldcauseotherthriftstofail.
(c) failedtoprovidethefundsnecessarytocloseailingS&Ls,andactuallyencouraged
regulatorstocontinuetopursueregulatoryforbearance.
(d) didboth(a)and(b)oftheabove.
Answer: C
22.
TheCompetitiveEqualityinBankingActof1987
(a) discouragedregulatorsfrompursuingregulatoryforbearance.
(b) directedregulatorstoclosezombieS&Lsasquicklyasadministrativelypossible.
(c) encouragedregulatorstocontinuetheirpolicyofregulatoryforbearance.
(d) didboth(a)and(b)oftheabove.
Answer: C
23.
TheCompetitiveEqualityinBankingActof1987
(a) providedinsufficientfundstotheFSLICtoclosedowninsolventS&Ls.
(b) actuallydirectedS&Lregulatorstocontinuetopursueregulatoryforbearance,
furtherdelayingtheclosingofinsolventS&Ls.
(c) createdanewagency,theResolutionTrustCorporation,tomanageinsolvent
thrifts.
Answer: E
24.
ThemajorprovisionsoftheCompetitiveEqualityinBankingActof1987included
(a) expandingtheresponsibilitiesoftheFDIC,whichisnowthesoleadministratorof
thefederaldepositinsurancesystem.
(b) establishingtheResolutionTrustCorporationtomanageandresolveinsolvent
thriftsplacedinconservatorshiporreceivership.
(c) directingtheFederalHomeLoanBankBoardtocontinuetopursueregulatory
forbearance.
(d) alloftheabove.
Answer: C
25.
ThemajorprovisionsoftheCompetitiveEqualityinBankingActof1987included
(a) abolishingtheFederalHomeLoanBankBoardandtheFSLIC.
(b) transferringtheregulatoryroleoftheFederalHomeLoanBankBoardtotheOffice
ofThriftSupervision,abureauwithintheU.S.TreasuryDepartment.
(c) establishingtheResolutionTrustCorporationtomanageandresolveinsolvent
thriftsplacedinconservatorshiporreceivership.
(d) alloftheabove.
(e) noneoftheabove.
Answer: E
26.
Ananalysisofthepoliticaleconomyofthesavingsandloancrisishelpsoneto
understand
(a) whypoliticianshamperedtheeffortsofthriftregulators,cuttingregulatory
appropriationsandencouragingregulatoryforbearance.
(b) whythriftregulatorswerereluctanttoadmitthatanyproblemevenexistedinthe
thriftindustry.
(c) whythriftregulatorswillinglyaccededtopressuresplaceduponthembymembers
ofCongress.
(d) alloftheabove.
Answer: D
27.
Ananalysisofthepoliticaleconomyofthesavingsandloancrisishelpsoneto
understand
(a) whypoliticiansaidedtheeffortsofthriftregulators,raisingregulatory
appropriationsandencouragingclosingofinsolventthrifts.
(b) whythriftregulatorswerequicktoinformCongressoftheproblemsthatexistedin
thethriftindustry.
(c) whythriftregulatorswillinglyaccededtopressuresplaceduponthembymembers
ofCongress.
(d) alloftheabove.
Answer: C
28.
ThepoliticaleconomyoftheS&Lcrisisshowsthattheprincipalagentproblemoccurs
inpolitics.Inthisinstance,theagentregulatorsdidnotacttoprotecttheprincipal
taxpayersbecause
(a) regulatorswantedtoescapeblame,hopingthesituationwouldimprovebefore
othersdiscoveredtheproblem.
(b) regulatorsrespondedtopressuretopursueregulatoryforbearancefrompoliticians
whohadacceptedcampaigndonationsfromownersofS&Ls.
(c) Congresswasunwillingtoallocatethenecessaryfundsregulatorsneededtoclose
insolventS&Ls.
(d) alloftheabove.
Answer: D
29.
Thattaxpayerswerepoorlyservedbythriftregulatorsinthe1980sisnowquiteclear.
Thispoorperformanceisexplainedby
(a) regulatorsdesiretoescapeblameforpoorperformance,leadingtoaperverse
strategyofregulatorygambling.
(b) regulatorsincentivestoaccedetopressuresimposedbypoliticians,whosoughtto
keepregulatorsfromimposingtoughregulationsoninstitutionsthatweremajor
campaigncontributors.
(c) Congresssunwillingnesstoappropriatesufficientfundstopermitregulatorsto
examinethemanythriftinstitutionsthatneededmonitoring.
(d) alloftheabove.
Answer: D
30.
Thattaxpayerswerepoorlyservedbythriftregulatorsinthe1980sisnowquiteclear.
Thispoorperformancecannotbeexplainedby
(a) regulatorsdesiretoescapeblameforpoorperformance,leadingtoaperverse
strategyofregulatorygambling.
(b) regulatorsincentivestoaccedetopressuresimposedbypoliticians,whosoughtto
keepregulatorsfromimposingtoughregulationsoninstitutionsthatweremajor
campaigncontributors.
(c) Congresssdoggeddeterminationtoprotecttaxpayersfromtheunsoundbanking
practicesofmanagersatmanyofthenationssavingsandloans.
(d) anyoftheabove.
Answer: C
31.
ThatseveralhundredS&LswerenotevenexaminedonceintheperiodJanuary1984
throughJune1986canbeexplainedby
(a) Congresssunwillingnesstoallocatethenecessaryfundstothriftregulators.
(b) regulatorsreluctancetofindthespecificproblemthriftsthattheyknewexisted.
(c) prohibitionsagainstonerousregulatoryrestrictionsagainstS&Lsasmandatedin
theCompetitiveEqualityinBankingAct.
(d) alloftheabove.
Answer: A
32. Bureaucraticgamblingrefersto
(a) thebeliefofthriftmanagersthattheywouldnotbeauditedbythriftregulatorsin
the1980sduetotherelativelyweakbureaucraticpoweroftheregulators.
(b) theriskthatthriftregulatorstookinpublicizingtheplightoftheS&Lindustryin
theearly1980s.
(c) thestrategyadoptedbythriftregulatorsofloweringcapitalrequirementsand
pursuingregulatoryforbearanceinthe1980sinthehopethatconditionsintheS&L
industrywouldimprove.
(d) noneoftheabove.
Answer: C
33.
CharlesKeating
(a) wasallowedtoacquireLincolnSavingsandLoanofIrvine,California,even
thoughhehadbeenaccusedoffraudbytheSEConlyfourandahalfyearsearlier.
(b) firedLincolnsconservativelendingofficersandinternalauditors,eventhoughhe
hadpromisedregulatorshewouldkeepthem.
(c) enlistedthehelpoffivesenatorstodelaytheseizureofLincolnsassets.
Answer: D
34.
ExaminersfromtheFederalHomeLoanBankBoardofSanFranciscorecommended
thatLincolnSavingsandLoanbeseizedwhentheydiscoveredthat
(a) officialsatthethrifthadattemptedtomisleadthem.
(b) ithadexceededthe10percentlimitonequityinvestmentsby$600million.
(c) itsowner,CharlesKeating,hadbeenconvictedofembezzlementtenyearsbefore
hepurchasedthethrift.
(d) alloftheabove.
(e) both(a)and(b)oftheabove.
Answer: E
35.
Thebailoutofthesavingsandloanindustrywasmuchdelayedand,therefore,much
morecostlytotaxpayersbecause
(a) ofregulatorsinitialattemptstodownplaytheseriousnessofproblemswithinthe
thriftindustry.
(b) politicianswhoreceivedgenerouscampaigncontributionsfromthesavingsand
loanindustry,likeregulators,hopedthattheproblemsintheindustrywouldease
overtime.
(c) Congressencouraged,andthriftregulatorsaccededto,apolicyofregulatory
forbearance.
(d) alloftheabove.
Answer: D
True/False
1.
Themutualformofownershipaccentuatestheprincipalagentproblemthatexistsin
corporations.
Answer: TRUE
2.
Savingsandloansarenotasheavilyconcentratedinmortgagesandhavehadmore
flexibilityintheirinvestingpracticesthanmutualsavingsbanks.
Answer: FALSE
3.
ThecongressionallyimposedcapontheinterestratethatS&Lscouldpayonsavings
accountsbecameaseriousproblemfortheminthe1970swheninflationrose.
Answer: TRUE
4.
RegulatoryforbearancereducesmoralhazardbecauseanoperatingbutinsolventS&L
willtakefewerrisksthanhealthyS&Lsthatcantakerisksandstillremainsolvent.
Answer: FALSE
5.
TheCompetitiveEqualityinBankingActof1987allowedtheFSLICtoborrowallthe
fundsitneededtocloseinsolventS&Lsandpayoffdepositors.
Answer: FALSE
6.
Inthe1980s,regulatorsengagedinbureaucraticgamblingwhentheyallowedinsolvent
S&Lstocontinueoperating.
Answer: TRUE
7.
FIRREAimposednewrestrictionsonthriftactivitiesthat,inessence,reregulatedthe
S&Lindustrytotheassetchoicesithadbefore1982.
Answer: TRUE
8.
Mostcreditunionstodayhavefederalcharters.
Answer: TRUE
9.
Creditunionsareownedbystockholders.
Answer: FALSE
10.
Federallegislationallowscreditunionsrepresentinggroupswithdifferentcommon
bondstomergeintoasinglecreditunion.
Answer: TRUE
11.
Creditunionsviewcommercialbanksasgovernmentsupportedandhenceunfair
competitorsduetotheirtaxadvantages.
Answer: FALSE
12.
Mutualsavingsbanksaretheonlyfinancialinstitutionsthataretaxexempt.
Answer: FALSE
Essay
1.
Whatfactorscontributedtocreatingthethriftcrisis?
2.
Explainwhythriftregulatorsengagedinregulatoryforbearanceinthe1980s.
3.
ExplainhowtheLincolnSavingsandLoanscandalisanapplicationoftheprincipal
agentproblem.
4.
WhydidtheCompetitiveEqualityinBankingActof1987failtosolvetheproblemsin
thethriftindustry?
5.
HowhasthethriftindustrybeentransformedsinceFIRREA?
6.
Whyhavecommercialbanksgonetocourtinanefforttolimittheactivitiesofcredit
unions?
Chapter13TheMutualFundIndustry
1.
Mutualfundsholdabout_________offinancialintermediariestotalassets.
(a) onesixth
(b) onefourth
(c) onehalf
(d) twothirds
Answer: A
2.
_________intermediationmeansthatsmallinvestorscanpooltheirfundswithother
investorstopurchasehighfacevaluesecurities.
(a) liquidity
(b) financial
(c) denomination
(d) share
Answer: C
3.
Mutualfundsofferinvestorsallofthefollowingexcept
(a) greaterthanaveragereturns.
(b) diversifiedportfolios.
(c) lowertransactioncosts.
(d) professionalinvestmentmanagement.
Answer: A
4.
Mutualfunds
(a) pooltheresourcesofmanysmallinvestorsbysellingtheseinvestorssharesand
usingtheproceedstobuysecurities.
(b) allowsmallinvestorstoobtainthebenefitsoflowertransactioncostsinpurchasing
securities.
(c) providesmallinvestorsadiversifiedportfoliothatreducesrisk.
Answer: D
5. _________enablesmutualfundstoconsistentlyoutperformarandomlyselectedgroup
ofstocks.
(a) Managerialexpertise
(b) Diversification
(c) Denominationintermediation
(d) Noneoftheabove
Answer: D
6.
Attheendof2003thereover_________separatemutualfundswithtotalassetsover
_________.
(a) 800;$10trillion
(b) 8,000;$7trillion
(c) 10,000;$10trillion
(d) 1,000;$7trillion
Answer: B
7.
Mostmutualfundsarestructuredintwoways.Themostcommonstructureisa(n)
_________fund,fromwhichsharescanberedeemedatanytimeatapricethatistied
totheassetvalueofthefund.A(n)_________fundhasafixednumberof
nonredeemablesharesthataretradedintheoverthecountermarket.
(a) closedend;openend
(b) openend;closedend
(c) noload;closedend
(d) noload;load
(e) load;noload
Answer: B
8.
Whichofthefollowingisanadvantagetoinvestorsofanopenendmutualfund?
(a) Oncealltheshareshavebeensold,theinvestordoesnothavetoputinmore
money.
(b) Theinvestorscanselltheirsharesintheoverthecountermarketwithlow
transactionfees.
(c) Thefundagreestoredeemsharesatanytime.
(d) Themarketvalueofthefundssharesmaybehigherthanthevalueoftheassets
heldby
thefund.
Answer: C
9.
Thenetassetvalueofamutualfundis
(a) determinedbysubtractingthefundsliabilitiesfromitsassetsanddividingbythe
numberofsharesoutstanding.
(b) determinedbycalculatingthenetpriceoftheassetsownedbythefund.
(c) calculatedevery15minutesandusedfortransactionsoccurringduringthenext15
minuteinterval.
(d) calculatedasthedifferencebetweenthefundsassetsanditsliabilities.
Answer: A
10. _________fundsarethesimplesttypeofinvestmentfundstomanage.
(a) Balanced
(b) Globalequity
(c) Growth
(d) Index
Answer: D
11.
Themajorityofmutualfundassetsarenowownedby
(a) individualinvestors.
(b) institutionalinvestors.
(c) fiduciaries.
(d) businessorganizations.
(e) retirees.
Answer: A
12.
Capitalappreciationfundsselectstocksof_________andtendtobe_________risky
thantotalreturnfunds.
(a) largeestablishedcompaniesthatpaydividendsregularly;more
(b) largeestablishedcompaniesthatpaydividendsregularly;less
(c) companiesexpectedtogrowrapidly;more
(d) companiesexpectedtogrowrapidly;less
Answer: C
13.
Fromlargesttosmallest,thefourclassesofmutualfundsare
(a) equityfunds,bondfunds,hybridfunds,moneymarketfunds
(b) equityfunds,moneymarketfunds,bondfunds,hybridfunds
(c) moneymarketfunds,equityfunds,hybridfunds,bondfunds
(d) bondfunds,moneymarketfunds,equityfunds,hybridfunds
Answer: B
14.
Measuredbyassets,themostpopulartypeofbondfundisthe_________bondfund.
(a) statemunicipal
(b) strategicincome
(c) government
(d) highyield
Answer: B
15.
Inrecentyearstotalassetsinmoneymarketmutualfundshavedecreased.Themost
likelyreasonforthisisthat
(a) shortterminterestrateshavebeenquitelow.
(b) shortterminterestrateshavebeenquitehigh.
(c) longterminterestrateshavebeenquitelow.
(d) theriskofinvestinginmoneymarketfundshasrisen.
Answer: A
16. Peoplewhotaketheirmoneyoutofinsuredbankdepositstoinvestinuninsuredmoney
marketmutualfundshave_________riskbecausemoneymarketfundsinvestin_________
assets.
(a) high;longterm
(b) low;shortterm
(c) high;shortterm
(d) low;longterm
Answer: B
17.
Thelargestshareofassetsheldbymoneymarketmutualfundsis
(a) Treasurybills.
(b) certificatesofdeposit.
(c) commercialpaper.
(d) repurchaseagreements.
Answer: C
18.
Whichofthefollowingisafeatureofindexfunds?
(a) Theyhavelowerfees.
(b) Theyselectandholdstockstomatchtheperformanceofastockindex.
(c) Theydonotrequiremanagerstoselectstocksanddecidewhentobuyandsell.
(d) Alloftheabove.
Answer: D
19.
Anoloadmutualfundchargesacommission
(a) whensharesarepurchased.
(b) whensharesaresold.
(c) bothwhensharesarepurchasedandwhentheyaresold.
(d) whensharesareredeemed.
Answer: D
20.
Overthepasttwentyyearsmutualfundfeeshave_________,largelybecause
_________.
(a) fallen;SECfeedisclosureruleshaveledtogreatercompetition
(b) risen;investorshavelearnedthatfundswithhighfeesprovidebetterperformance
(c) risen;therehasbeencollusionbetweenlargemutualfundcompanies
(d) fallen;advancesininformationtechnologyhaveloweredtransactioncosts
Answer: A
21.
Whichofthefollowingismostlikelytobeanoloadfund?
(a) Valuefunds
(b) Hedgefunds
(c) Growthfunds
(d) Indexfunds
Answer: D
22. Wheninvestorsswitchbetweenfundsindifferentfamilies,mutualfundsmaycharge
(a) acontingentdeferredsalescharge.
(b) aredemptionfee.
(c) anexchangefee.
(d) 12b1fees.
(e) anaccountmaintenancefee.
Answer: C
23.
TheSecuritiesActsof1933and1934didnot
(a) regulatetheactivitiesofinvestmentfunds.
(b) requirefundstoregisterwiththeSEC.
(c) includeantifraudrulescoveringthepurchaseandsaleoffundshares.
(d) applytoinvestmentfunds.
Answer: B
24.
Thelargestshareoftotalinvestmentinmutualfundsisin
(a) stockfunds.
(b) hybridfunds
(c) bondfunds.
(d) moneymarketfunds.
Answer: A
25.
Hedgefundsare
(a) lowriskbecausetheyaremarketneutral.
(b) lowriskiftheybuyTreasurybonds.
(c) lowriskbecausetheyhedgetheirinvestments.
(d) highriskbecausetheyaremarketneutral.
(e) highrisk,eventhoughtheymaybemarketneutral.
Answer: E
26.
ThenearcollapseofLongTermCapitalManagementwascausedby
(a) thehighmanagementfeeschargedbythefundstwoNobelPrizewinners.
(b) thefundshighleverageratioof20to1.
(c) asharpdecreaseinthespreadbetweencorporatebondsandTreasurybonds.
(d) asharpincreaseinthespreadbetweencorporatebondsandTreasurybonds.
(e) thefundsshiftawayfromamarketneutralinvestmentstrategy.
Answer: D
27. Conflictsariseinthemutualfundsindustrybecause_________cannoteffectively
monitor_________.
(a) investmentadvisors;directors
(b) directors;shareholders
(c) shareholders;investmentadvisors
(d) investmentadvisors;stocksthatwilloutperformtheoverallmarket
Answer: C
28.
Latetradingisthepracticeofallowingordersreceived_________totradeatthe
_________netassetvalue.
(a) before4:00pm;4:00pm
(b) after4:00pm;4:00pm
(c) after4:00pm;nextdays
(d) before4:00pm;previousdays
Answer: B
29.
Markettiming
(a) takesadvantageoftimedifferencesbetweentheeastandwestcoastsoftheU.S.
(b) takesadvantageofarbitrageopportunitiesinforeignstocks.
(c) takesadvantageofthetimelagbetweenthereceiptandexecutionoforders.
(d) isdiscouragedbythestifffeesmutualfundschargeeveryinvestorforbuyingand
thensellingsharesonthesameday.
Answer: B
30.
Latetradingandmarkettiming
(a) allowlarge,favoredinvestorsinamutualfundtoprofitattheexpenseofother
investorsin
thefund.
(b) hurtordinaryinvestorsbyincreasingthenumberoffundsharesanddilutingthe
fundsnetassetvalue.
(c) both(a)and(b).
(d) noneoftheabove.
Answer: C
31.
Whichofthefollowingisnotaproposaltodealwithabusesinthemutualfund
industry?
(a) Strictlyenforcethe4:00pmnetassetvaluerule
(b) Makeredemptionfeesmandatory
(c) Disclosecompensationarrangementsforinvestmentadvisors
(d) Increasethenumberofdependentdirectors
Answer: D
True/False
1.
Thelargerthenumberofsharestradedinastocktransaction,thelowerthetransaction
costspershare.
Answer:
2.
Theincreaseinthenumberofdefinedcontributionpensionfundshasslowedthe
growthof
mutualfunds.
Answer:
3.
TRUE
Adeferredloadisafeechargedwhensharesinamutualfundareredeemed.
Answer:
10.
FALSE
MoneymarketmutualfundsoriginatedwhenthebrokeragefirmMerrillLynchoffered
itscustomersanaccountfromwhichfundscouldbetakentopurchasesecuritiesand
intowhichfundscouldbedepositedwhensecuritiesweresold.
Answer:
9.
FALSE
Amutualfundsboardofdirectorspicksthesecuritiesthatwillbeheldandmakesbuy
andselldecisions.
Answer:
8.
TRUE
Thenetassetvalueofamutualfundistheaveragemarketpriceofthestocks,bonds,
andotherassetsthefundowns.
Answer:
7.
FALSE
Openendmutualfundsaremorecommonthanclosedendfunds.
Answer:
6.
TRUE
Retirementfundsaccountfortwothirdsofallmutualfundassets.
Answer:
5.
FALSE
Thedollaramountinvestedinmutualfundsisaboutthesameasthetotalassetsofall
commercialbanksatthebeginningof2004.
Answer:
4.
TRUE
TRUE
SECresearchsuggeststhataboutthreefourthsofmutualfundsletprivileged
shareholdersengageinmarkettiming.
Answer:
TRUE
11.
Onefactorexplainingtherapidgrowthinmutualfundsisthattheyarefinancial
intermediariesthatarenotregulatedbythefederalgovernment.
Answer:
FALSE
Essay
1.
Whatbenefitsdomutualfundsofferinvestors?
2.
Howisamutualfundsnetassetvaluecalculated?
3.
Howdidmoneymarketmutualfundsoriginateandwhydidtheybecomeespecially
popularinthelate1970sandearly1980s?
4.
Howdoesthegovernancestructureofmutualfundsleadtoasymmetricinformationand
conflictsofinterest?
5.
Describethepracticesoflatetradingandmarkettimingandexplainhowthesepractices
harmamutualfundsshareholders.
6.
Discusstheproposalsthathavebeenmadetoreducetheconflictofinterestabusesin
themutualfundsindustry.

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Chapter1

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