ECON330 HW1-4 Exam 1

3.7) Monetary policy affects stock prices through the following except A.) the changes in the return on bonds. B.) the changes in the growth rate of the dividends. C.) the changes in the price level. D.) the changes in the required rate of return. Suppose that the Fed engages in an contractionary monetary​ policy, which raises interest rates. Which of the following statements best describes the impact of this event on the stock​ market?

the changes in the price level. There will be an increase in the required rate of return on equities, a decrease in the growth rate on dividends, and stock prices will fall.

4.16) For a given return on​ assets, the lower is bank​ capital,

the higher is the return for the owners of the bank.

2.12) The opportunity cost of holding money is

the interest rate.

3.6) In the generalized dividend​ model, the current stock price is the sum of

the present value of the future dividend stream.

4.12) When you deposit​ $50 in your account at First National Bank and a​ $100 check you have written on this account is cashed at Chemical​ Bank, then

the reserves at First National fall by​ $50.

1.14) A discount bond is also called a​ ________ because the owner does not receive periodic payments.

zero-coupon bond

2.9) Everything else held​ constant, an increase in the riskiness of bonds relative to alternative assets causes the demand for bonds to​ ________ and the demand curve to shift to the​ ________.

​fall; left

2.6) Everything else held​ constant, when bonds become less widely​ traded, and as a consequence the market becomes less​ liquid, the demand curve for bonds shifts to the​ ________ and the interest rate​ ________.

​left; rises

2.8) During business cycle expansions when income and wealth are​ rising, the demand for bonds​ ________ and the demand curve shifts to the​ ________, everything else held constant.

​rises; right

3.1) Using the one−period valuation​ model, assuming a year−end dividend of​ $0.11, an expected sales price of​ $110, and a required rate of return of​ 10%, the current price of the stock would be

$100.10

1.4) Calculate the present value of a ​$1,200 discount bond with 6 years to maturity if the yield to maturity is 3​%. The present value is ​$________

$1004.98

1.16) Consider a bond with a 6​% annual coupon and a face value of ​$1,100. Complete the following table. ​(Enter your responses rounded to two decimal​ places.) Years to Maturity | Yield to Maturity | Current Price 3 | 4​% | ​$______ 3 | 6​% | ​$______ 4 | 6​% | $______ 6 | 4​% | $______ 6 | 8​% | $______ Part 2 When the yield to maturity is ______ the coupon​ rate, the​ bond's current price is below its face value. For a given​ maturity, the​ bond's current price ______ as the yield to maturity rises. For a given yield to​ maturity, a​ bond's value ______ as its maturity increases. When the yield to maturity is ______ the coupon​ rate, a​ bond's current price equals its face value regardless of the number of years to maturity.

$1161.05 $1100 $1100 $1215.33 $998.30 greater than falls rises equal to

3.2) Suppose that the price a stock is bought for is ​$125. Based on the​ one-period valuation model of stock​ prices, if the stock is sold a year later at the price ​$131 and the required rate of return on the equity investments is 15​%, then the dividend paid out for the stock is ​$______. ​(Round your response to the nearest​ penny.) Suppose that the price a stock was bought for was higher than the one above. Holding every other variable the​ same, this implies that the dividend paid out for the stock is ______.

$12.75 also higher

3.4) The current price of a stock is ​$102.16. If dividends are expected to be ​$1.20 per share for the next five ​years, and the required return is 9​%, then what should the price of the stock be in 5 years when you plan to sell​ it? The price 5 years from now will be ​$______. ​(Round your response to the nearest​ dollar.) If the dividend and required return remain the​ same, and the stock price is expected to increase by ​$1 five years from​ now, does the current stock price also increase by ​$1​?

$150 ​No, the current stock price will not increase by $1 because the future stock price is discounted by the required return.

4.9) If a bank has​ $100,000 of checkable​ deposits, a required reserve ratio of 20​ percent, and it holds​ $40,000 in​ reserves, then the maximum deposit outflow it can sustain without altering its balance sheet is

$25,000.

4.17) Angus Bank holds no excess reserves but complies with the reserve requirement. The required reserves ratio is 8​%, and reserves are currently ​$25 million. The amount of deposits is ​$______ million. ​(Round your response to one decimal​ place.) The reserve shortage created by a deposit outflow of ​$4 million is ​$______ million. ​(Round your response to two decimal​ places.) The cost of the reserve shortage if Angus Bank borrows in the federal funds market​ (assume the federal funds rate is 0.30​%) is ​$______.

$312.5 million $-3.68 million $11,040

1.12) If the nominal rate of interest is 2​ percent, and the expected inflation rate is −10 percent, the real rate of interest is

12 percent.

1.15) What is the yield to maturity on a bond that has a price of ​$4,000 and pays ​$500 of interest annually​ forever? Yield to maturity​ = _____ percent

12.5

4.18) Suppose that a bank finances itself purely with deposits. Its bank capital is 50 USD. The reserve requirement is​ 10%. The bank holds 20 USD in​ reserves, out of which 10 USD are excess reserves. The bank has lend 85 USD to its customers. It also holds some financial securities and owns a building. We know that the financial securities are worth double value of the building. How much is the​ bank's building​ worth?

15 USD

Rank the following bank assets from most liquid ​(1) to least liquid​ (4). ​(Enter a numerical value between 1 and​ 4.) Asset | Rank Commercial loans | ____ Securities | ____ Reserves | ____ Physical capital | ____

3 2 1 4

2.17) The demand curve and supply curve for​ one-year discount bonds with a face value of ​$1,030 are represented by the following​ equations: Bd​: Price = −0.6Quantity+1,160 Bs​: Price = Quantity+680 The expected equilibrium quantity of bonds is _____. ​(Round your response to the nearest whole​ number.) The expected equilibrium price of bonds is ​$_____. ​(Round your response to the nearest whole​ number.) The expected interest rate in this market is _____%. ​(Round your response to two decimal​ places.)

300 $980 5.1%

2.2) Using the numbers ​1, 2,​ 3, and ​4, rank the following four assets from most liquid ​(1​) to least liquid ​(4​). A​ 10,000-square-foot office building ​$2,000 in cash A​ $10,000 Treasury bill 100 shares of Google stock

4 1 2 3

1.10) I purchase a 10 percent coupon bond. Based on my​ purchase, I calculate a yield to maturity of 8 percent. If I hold this bond to​ maturity, then my return on this asset is

8 percent.

3.8) A share of stock in Bodah Corporation pays an annual dividend of ​$5. The current market price is ​$50. From the list of individuals​ below, identify who is likely to be a buyer or a seller of this stock. ​(Each person currently owns 100​ shares.) Individual | Required Return | Expected Growth in Dividends | Buy or Sell? Kate | ​5% | 0% | ____ Keith | ​8% | 0% | ____ Kyle | 15% | 0% | ____

Buy Buy Sell

3.9) For​ bonds, the current price depends on the discounted stream of coupon payments​ (C) and the face value​ (F). For​ stocks, the current price depends on the discounted stream of dividends​ (D). Which of the following statements is​ true:

C and F are known​ today, D is not.

1.9) Which of the following are generally true of​ bonds? A.) The longer a​ bond's maturity, the smaller is the size of the price change associated with an interest rate change. B.) Prices and returns for short-term bonds are more volatile than those for longer-term bonds. C.) A​ bond's return equals the yield to maturity when the time to maturity is the same as the holding period. D.) A rise in interest rates is associated with a fall in bond​ prices, resulting in capital gains on bonds whose terms to maturity are longer than the holding periods.

C.) A​ bond's return equals the yield to maturity when the time to maturity is the same as the holding period.

4.11) TerpBank holds 9 mio USD in reserves. The reserve requirement is​ 10%. Which of the following statements is​ false? A.) None of these statements is false. B.) If TerpBank has 90 mio USD of its liabilities in deposits it fulfills the reserve requirement. C.) If TerpBank holds 90 mio USD in loans it fulfills the reserve requirement. D.) If TerpBank has 9 mio USD of its liabilities in deposits its excess reserves amount to 8.1 mio USD. E.) If TerpBank has 999 mio USD of its liabilities in deposits it does not fulfill the reserve requirement. F.) If TerpBank has 99 mio USD of its liabilities in deposits it does not fulfill the reserve requirement.

C.) If TerpBank holds 90 mio USD in loans it fulfills the reserve requirement.

4.3) Which of the following is not an asset on a​ bank's balance​ sheet?

Checkable deposits.

1.6) Which of the following are true of fixed payment​ loans? A.) The borrower repays both the principal and interest at the maturity date. B.) The borrower pays interest periodically and the principal at the maturity date. C.) Commercial loans to businesses are often of this type. D.) Installment loans and mortgages are frequently of the fixed payment type.

D.) Installment loans and mortgages are frequently of the fixed payment type.

1.8) The yield to maturity on a​ 10-year Treasury note​ (with face value​ = $100 and annual coupon rate​ = 2.625%) is​ 3.37%. If the price of this Treasury note goes​ up, its: I. coupon rate drops below​ 2.625%. II. coupon rate rises above​ 2.625%. III. yield to maturity drops below​ 3.37%. IV. yield to maturity rises above​ 3.37%.

III.

2.7) Given the business cycle contraction has resulted in a lack of profitable investment opportunities in the private​ sector, which of the following would potentially be a stimulus to the Japanese economy and would raise interest​ rates?

If the government runs large deficits to fund new infrastructure​ projects, it would issue debt to finance these deficits. This would increase the supply of​ bonds, which would raise interest rates.

2.11) What will happen in the bond market if the government imposes a limit on the amount of daily​ transactions? Which characteristic of an asset would be​ affected?

Liquidity of bonds relative to other assets will​ decrease, increasing the interest rate and lowering​ bond's prices.

2.15) For every​ $1,000 of annual​ income, households maintain average cash balances ​(their demand for money​) of​ $200. How will growth in GDP affect interest​ rates, holding the money supply​ constant? Use the liquidity preference framework ​1.) Using the line drawing​ tool, show the effect of growth in GDP using the liquidity preference framework. Properly label your line. ​2.) Using the point drawing tool​, indicate the new equilibrium interest rate and quantity of money. Label the point​ '2'.

Md shifts to the right The new equilibrium interest rate and quantity of money is where Md2 intersects Ms

2.13) Suppose you are in charge of the financial department of your company and you have to decide whether to borrow short or long term. Checking the​ news, you realize that the government is about to engage in a major infrastructure plan in the near future. Predict what will happen to interest rates. Will you advise borrowing short or long​ term?

Since the government is a major player in the market for​ bonds, this will most likely result in a shift to the right in the supply​ curve, lowering the price of bonds and increasing interest rates. You would recommend locking in a​ long-term loan at the current interest rate.

4.14) It is important for banks to manage interest rate risk​ because:

Some assets are sensitive to interest rate​ changes, and some liabilities are.

3.10) Suppose that you are asked to forecast future stock prices of ABC​ Corporation, so you proceed to collect all available information. The day you announce your​ forecast, competitors of ABC Corporation announce a brand new plan to merge and reshape the structure of the industry. Would your forecast still be considered​ optimal? ​(Select all that​ apply.)

Your forecast is considered​ optimal, but for a short period of time. Your answer is correct. Your forecast is still considered to be​ optimal, since it was made with all available information at the time.

4.7) A deposit outflow results in equal reductions in

assets and liabilities.

3.11) If the public expects a corporation to lose​ $5 per share this quarter and it actually loses​ $4, which is still the largest loss in the history of the​ company, what does the efficient market hypothesis say will happen to the price of the stock when the​ $4 loss is​ announced? The stock price will ______

be revised upward

3.12) If the public expects a corporation to lose​ $5 per share this quarter and it actually loses​ $4, which is still the largest loss in the history of the​ company, what does the efficient market hypothesis say will happen to the price of the stock when the​ $4 loss is​ announced? The stock price will ______

be revised upward

3.14) Sometimes one observes that the price of a​ company's stock falls after the announcement of favorable earnings. This phenomenon is

consistent with the efficient markets hypothesis if the earnings were not as high as anticipated.

1.5) A credit market instrument that pays the owner a fixed coupon payment every year until the maturity date and then repays the face value is called a

coupon bond.

1.1) The dollar amount of the yearly coupon payment expressed as a percentage of the face value of the bond is called the​ bond's

coupon rate.

1.2) An increase in the time to the promised future payment​ ________ the present value of the payment.

decreases

2.4) Along the supply curve for​ bonds, an increase in the price of bonds If the price of bonds is below the equilibrium​ price, there occurs an excess

decreases the interest rate and increases the quantity of bonds supplied. demand for bonds, the price will rise, and the interest rate will fall.

1.13) Since the early​ 1950s, nominal interest rates and real interest rates in the United States

do not always move in the same direction.

2.5) When the price of a bond​ decreases, all else​ equal, the bond demand curve​ ________.

does not shift

2.16) The president of the United States announces in a press conference that he will fight the higher inflation rate with a new​ anti-inflation program. Predict what will happen to interest rates if the public believes him. As a result of the​ president's announcement,​ people's expectations of inflation will _____​, which causes the demand for bonds to shift to the _____. ​However, the lower expected inflation rate causes the cost of borrowing to _____​, so the supply of bonds will _____​, which causes the supply curve for bonds to shift to the _____. The impact of this change in bond demand and supply will cause equilibrium interest rates to _____.

fall right rise decrease left decrease

1.3) A credit market instrument that requires the borrower to make the same payment every period until the maturity date is known as a

fixed − payment loan.

2.14) graph Using the diagram to the​ right, representative of a primary bond​ market, show the effects of an increase in household wealth and an increase in expected profitability of investments. Given how interests typically behave during a business cycle​ expansion, the effect of this shock is likely to

increase bond yields

4.6) When a new depositor opens a checking account at the First National​ Bank, the​ bank's assets​ ________ and its liabilities​ ________.

increase; increase

2.1) If wealth​ increases, the demand for stocks​ ________ and that of long−term bonds​ ________, everything else held constant.

increases; increases

4.15) Holding large amounts of bank capital helps prevent bank failures because

it can be used to absorb the losses resulting from bad loans.

3.15) The efficient markets hypothesis suggests that if an unexploited profit opportunity arises in an efficient​ market,

it will be quickly eliminated.

4.2) The most important category of assets on a​ bank's balance sheet is

loans.

3.13) If you read in the Wall Street Journal that the​ "smart money" on Wall Street expects stock prices to​ fall, you​ should:

not sell all of your stocks because this is publicly available information and is already reflected in stock prices.

4.13) A​ $5 million deposit outflow from a bank has the immediate effect of

reducing deposits and reserves by​ $5 million.

4.8) A​ $100 deposit into my checking account at My Bank increases my checkable deposits by​ $100, and the​ bank's ________ by​ $100.

reserves

4.4) The sum of a​ bank's vault cash plus its deposits at the Fed is the​ bank's Required reserves are a fixed percentage of a​ bank' If a bank has $1000 in deposits and the required reserve ratio is 10​%, then the amount required as the​ bank's reserves is $_____.

reserves. checkable deposits. $100

3.3) According to the Gordon Growth​ Model, the price of stocks depend on the following except A.) the most recent dividend paid B.) required return on investments C.) return on Treasure bills D.) expected constant growth rate in dividends When your required return on an equity investment increases​, then according to the Gordon Growth Model you will be willing to pay ______ for the investment. Suppose that a stock is expected to pay a ​$1 dividend next​ year, that the dividend is expected to grow at 5​% per​ year, and that your required return on this equity investment is 6​%. Using the Gordon growth​ model, the price you would be willing to pay for the stock is ​$______. ​(Round your response to the nearest two decimal​ place.)

return on Treasure bills less $100

2.10) In a business cycle​ expansion, the​ ________ of bonds increases and the​ ________ curve shifts to the​ ________ as business investments are expected to be more​ profitable, everything else held constant.

supply; supply; right

4.1) Which of the following are reported as assets on a​ bank's balance​ sheet?

Reserves

3.5) Suppose that a stock paid a dividend of ​$2 this year and that your required return on equity investments is 11​%. Using the Gordon growth​ model, if you expect the dividends to grow at 5​%, you will be willing to pay for the stock the amount ​$_____. ​(Round your response to the nearest two decimal​ places.) Using the Gordon growth model of stock price​ determination, if a share of stock will pay a ​$1 dividend next year​, dividends are expected to grow 2​%, and people require an 11​% return on equity​ investments, then the price of the stock is ​$_____. ​(Round your response to the nearest two decimal​ places.) According to the Gordon growth model of stock price​ determination, at what price should a stock sell for if the required return on equity investments is​ 12%, the stock will pay a dividend of​ $1.80 next​ year, and dividends are expected to grow at a constant rate of​ 3%?

$35 $11.11 $20

4.10) Suppose ​$50,000 is deposited at the Bank Of UMD. The required reserve ratio is 10 ​percent, and the Bank Of UMD chooses not to hold any excess reserves but makes loans instead. What are the Bank Of UMD​'s total​ loans? Total loans are equal to ​$______.

$45,000

1.11) A​ three-year bond with​ $1,000 face value and​ 10% coupon rate is sold for​ $1,000 today. If one year later the market interest rate increases to​ 15%, then this bond will have a market price of​ _______ next year.

$918.71

1.7) If a​ $5,000 face−value discount bond maturing in one year is selling for​ $5,000, then its yield to maturity is

0 percent.

3.16) Consider each of the following situations and answer the questions that follow. Situation One​: Many of your fellow investors are shocked when great news for TerpCorp—strong sales and large profits for the quarter—are met with a decrease in the price of TerpCorp stock. Does this indicate a failure of the efficient market​ hypothesis? Why or why​ not? Situation Two​: ​"I'm going to put all my savings into​ EconMart," a classmate tells you. ​ "I subscribe to a​ 'hot tips' investment newsletter that says​ they're about to put a product on the market that nearly everyone needs. The price of their stock is sure to​ skyrocket!" Do you agree with your​ classmate? Why or why​ not? Situation Three​: ​"I'm so​ confused," your brother tells you. ​ "I want to maximize the money available to me after​ retirement, but I just have no clue what to do with my small savings. ​ I'm thinking about buying shares in a mutual fund. ​ You've taken some economics and finance classes—what do you suggest I​ do?" ​ What's your advice for your​ brother?

No, the most likely explanation is that investors had expected TerpCorp sales and profits to be even higher than those reported. No, because information from an investment newsletter is already public and is therefore already reflected in stock prices. Buy shares in a​ no-load mutual fund and make sure that management fees are low.

3.17) Which of the following is an argument in favor of the efficient market hypothesis?

Over the long​ term, stock prices follow a random walk and do resemble their underlying fundamental value.

2.3) Raphael observes that at the current level of interest rates there is an excess supply of​ bonds, and therefore he anticipates an increase in the price of bonds. Is Raphael​ correct?

Raphael is incorrect. The supply and demand analysis tells us that interest rates will​ increase, creating a movement along both the demand curve​ (in the southeast​ direction) and the supply curve​ (in the southwest​ direction) in order to reach the equilibrium interest rate​ (and price). The​ bond's price will therefore fall.