final exam
Will a U.S. Treasury bill have a risk premium that is higher than, lower than, or the same as that of a similar security (in terms of maturity and liquidity) issued by the government of Colombia?
A U.S. Treasury bill will have a lower risk premium since U.S. government issued securities are usually considered to be default free.
Which of the following does not describe an off-balance-sheet activity? A. A bank writes a mortgage and sells it to a life insurance company. B. A bank exchanges dollars for euros for a large corporate customer. C. A bank makes a loan to a large corporate customer. D. A bank guarantees a firm's debt by signing a banker's acceptance.
A bank makes a loan to a large corporate customer.
A bank almost always insists that the firms it lends to keep compensating balancesLOADING... at the bank. Why? (Check all that apply.)
A. Compensating balances help establish long-term customer relationships, which make it easier for the bank to collect information about prospective borrowers, thus reducing the adverse selection problem C. Compensating balances can act as collateral D. Compensating balances help the bank monitor the activities of a borrowing firm, which reduces the moral hazard problem
If a bank is falling short of meeting its capital requirements by $1 million, what three things can it do to rectify the situation? (Check all that apply.)
Call in existing loans in an attempt to decrease its asset holdings. Issue stock. Decrease dividend payments to increase retained earnings.
To pay for college, you have just taken out a $1,000 government loan that makes you pay $126 per year for 25 years. However, you don't have to start making these payments until you graduate from college two years from now. Why is the yield to maturity necessarily less than 12% (this is the yield to maturity on a normal $1,000 fixed-payment loan in which you pay $126 per year for 25 years)?
D. This is the case because the first payment due begins at a future date.
The president of the United States can exert influence over the Federal Reserve in all of the following ways except: A. influencing congressional decisions that might reduce the independence of the Fed. B. appointing new members to the Board of Governors. C. appointing a new chairman to the Board of Governors. D. reducing the Fed's net earnings.
D. reducing the Fed's net earnings.
Why are deposit insurance and other types of government safety nets important to the health of the economy?
Deposit insurance and other government safety nets help to eliminate a contagion effect.
When depositors withdraw funds from commercial banks to seek other more attractive assets, deposit losses in the banking system may restrict the amount of funds that banks can lend. Which of the following identifies this process?
Disintermediation
"Bank managers should always seek the highest return possible on their assets." Is this statement true, false, or uncertain?
False. A bank must also consider an asset's risk and liquidity when deciding which assets to hold.
"According to the expectations theory of the term structure, it is better to invest in one-year bonds, reinvested over two years, than to invest in a two-year bond, if interest rates on one-year bonds are expected to be the same in both years." Is this statement true, false, or uncertain
False: These investments are almost of the same profitability.
The bank panic of 1907 led to the passage of the:
Federal Reserve Act of 1913
Which of the following is not a difficulty in the regulation and supervision of banks?
Financial institutions are not required to follow the rules
People in the United States in the nineteenth century were sometimes willing to be paid by cheque rather than with gold, even though they knew that there was a possibility that the cheque might bounce. Which of the following would represent an advantage of gold over cheques as a form of money?
Gold has intrinsic value when compared to cheques
Why does the existence of deposit insurance increase the likelihood that depositors will need deposit protection?
Insured banks tend to pursue greater risks than they otherwise would
How might a sudden increase in people's expectations of future real estate prices affect interest rates?
Interest rates would increase because real estate would have a relatively higher rate of return compared to bonds, which would cause the demand for bonds to decrease.
If junk bonds are "junk," then why would investors buy them?
Junk bonds can provide high yields.
Why might the efficient market hypothesis be less likely to hold when fundamentals suggest stocks should be at a lower level?
Most investors are subject to loss aversion, so not enough short selling takes place in the market.
Which of the following is an argument in favor of the efficient market hypothesisLOADING...?
Over the long term, stock prices follow a random walk and do resemble their underlying fundamental value.
Which of the following actions will reduce interest-rate risk faced by banks?
Purchase a financial future, option, or swap B. Shorten the duration of bank's assets C. Lengthen the duration of bank's liabilities D. All of the above
Short-term U.S. government securities are called secondary reserves because of their high liquidity.
Short-term U.S. government securities are called secondary reserves because of their high liquidity.
What are the costs and benefits of a too-big-to-fail policy?
The benefit is that it makes bank panics less likely; however, the cost is that it increases the incentive for moral hazard by big banks
Why might you be willing to make a loan to your neighbor by putting funds in a savings account earning a 5% interest rate at the bank and having the bank lend her the funds at a 10% interest rate rather than lend her the funds yourself?
The costs of writing up the loan contract might exceed the 5% difference between your deposit rate and the bank lending rate.
Again, consider the effect of tight money policy on stock prices. Which of the following accurately describes the effects of tight money policy on stock prices, according to this model?
The economy would slow down, causing an increase in the denominator of the simplified Gordon growth model and a decrease in the price of stock (Upper P 0P0).
Suppose after a few mergers and acquisitions, a single bank holds 70% of all the deposits in the United States. Which of the following statements is likely to be true in the event of the failure of the bank?
The failure of the bank will likely cause a financial catastrophe, prompting the FDIC to do everything to prevent the institution from going bankrupt.
Suppose that many big corporations decide not to issue bonds, since it is now too costly to comply with new financial market regulations. Can you describe the expected effect on interest rates?
The impact will translate into a shift to the left in the supply curve, increasing bond's prices (lowering interest rates) and lowering the quantity of bonds bought and sold in the market.
During 2008, the difference in yield (the yield spread) between 3-month AA-rated financial commercial paper and 3-month AA-rated nonfinancial commercial paper steadily increased from its usual level of close to zero, spiking to over a full percentage point at its peak in October 2008. Which of the following explains this sudden increase?
The increase in the yield spread was a result of the decrease in demand for financial commercial paper due to the uncertainty and soundness of financial companies and banks.
The U.S. Treasury offers some of its debt as Treasury Inflation Protected Securities, or TIPS, in which the price of bonds is adjusted for inflation over the life of the debt instrument. TIPS bonds are traded on a much smaller scale than nominal U.S. Treasury bonds of equivalent maturity. What can you conclude about the liquidity premium between TIPS and nominal U.S. bonds?
The liquidity premium for a TIPS bond is usually smaller than inflation compensation in nominal U.S. bond yields of equal maturity.
During 2008, the difference in yield (the yield spread) between 3-month AA-rated financial commercial paper and 3-month AA-rated nonfinancial commercial paper steadily increased from its usual level of close to zero, spiking to over a full percentage point at its peak in October 2008. Which of the following explains this sudden increase?
The liquidity premium for a TIPS bond is high, so it is more profitable than a nominal U.S. bond of equal maturity.
Consider tight money policy and its effects on stock prices via the simplified Gordon growth model equation (Equation 5LOADING...). Which of the following accurately describes the effects of tight money policy on stock prices, according to this model?
The return on bonds and the required return on an equity investment (k Subscript eke) would rise, while the price of stock (Upper P 0P0) would fall.
Why is simply counting currency an inadequate measure of money?
There are other liquid assets similar to currency that can be used as money to purchase goods and services.
What is the main disadvantage of moving to e-money or moving to a cashless society?
There are problems with security and privacy
Why does the United States operate under a dual banking system? (Check all that apply.)
There is skepticism of centralized power in the U.S. banking system. Federally chartered banks help to stabilize the banking system and are less prone to failure.
If stock prices did not follow a random walkLOADING..., which of the following statements would be true?
There would be unexploited profit opportunities in the market and expectations would not be rational
How dofinancial intermediariesLOADING... benefit by providing risk-sharing services?
They are able to earn a profit on the spread between the returns they earn on risky assets and the payments they make on the assets they have sold
Which of the following statements regarding Federal Reserve independence is incorrect? A. In order to gain additional power to regulate the financial system, the governors need the support of Congress and the president to pass favourable legislation B. The Board of Governors knows that their bureaucratic power can be reined in by congressional legislation and so must still curry favour with both Congress and the president C. The Fed may feel pressure to support the president's policies since the president can veto legislation that might limit the Fed's discretionary power and authority D. The 14-year non-renewable terms for governors effectively insulate the Board of Governors from political pressure
The 14-year non-renewable terms for governors effectively insulate the Board of Governors from political pressure
M1 money growth in the U.S. was about 16% in 2008, 7% in 2009, and 9% in 2010. Over the same time period, the yield on 3-month Treasury bills fell from almost 3% to close to 0%. Given these high rates of money growth, why did interest rates fall, rather than increase?
The income, price-level, and expected-inflation effects were small relative to the liquidity effect.
the Federal Reserve System. resembles the U.S. Constitution in that it was designed with many checks and balances." Is this statement true, false, or uncertain? Explain your answer.
True. Because of public hostility and the centralization of power, the Federal Reserve System was created with many checks and balances to diffuse power.
Can a person with rational expectationsLOADING..., given new information about the search technology industry, expect the price of a share of Google to rise by 10% in the next month?
Yes, if this information is such that expectations of growth prospects or desired yields justify such a change.
If no decent lending opportunity arises in the economy, and the central bank pays an interest rate on reserves that is similar to other low-risk investments, do you think banks will be willing to hold large amounts of excess reserves?
Yes. Banks will be willing to hold large amounts of excess reserves since these are safe investments.
The bank you own has the following balance sheetLOADING...: Assets Liabilities Reserves $ 75 million Deposits $500 million Loans $525 million Bank capital $100 million If the bank suffers a deposit outflow of $50 million with a required reserve ratio on deposits of 10%, what actions can you take to keep your bank from failing?
You can borrow reserves in the federal funds market. B. You can call in or sell off loans. C. You can go to the discount window. D. Any of the above are appropriate actions to take.
The many regional Federal Reserve banksLOADING... resulted from a compromise between parties favoring:
a private central bank and those favoring a government institution.
If borrowers with the most risky investment projects are more likely to seek bank loans as compared to those borrowers with the safest investment projects, banks are said to face the problem of:
adverse selection
Transformation of assetsLOADING... can be accomplishedby
borrowing short and lending long
An asset with great liquidity is one that
can be converted into a medium of exchange with relative ease and speed.
Reserves, cash items in process of collection, and deposits at other banks are collectively called
cash items
Which of the following is not an asset on a bank's balance sheet? A. Reserves. B. Government securities. C. Loans. D. Checkable deposits
checkable deposit
Assets of value promised to the lender as compensation if the borrower defaults are called:
collateral
The volume of checkable deposits relative to total bank liabilitiesLOADING... has:
declined over time.
Identify the cash flowsLOADING... available to an investor in stock.
dividends and capital gains
Currency in circulation that cannot be redeemed for gold is called
fiat money
Regulators impose capital requirements on banks because a low capital-to-asset ratio dramatically
increases a bank's moral hazard.
Financial intermediariesLOADING... have a role to play in matching savers and borrowers for all of the following reasons except:
information symmetries
A bank with excess reserves can economize on these reserves by:
lending reserves in the federal funds market.
A bank's capital-to-asset ratio is also known as its
leverage ratio .
We know that money is the most liquid store of value due to many reasons except that
money is exposed to the risks associated with hyperinflation.
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.
Suppose the interest rates on one-, five-, and ten-year U.S. Treasury bonds are currently 3%, 6%, and 6%, respectively. Investor A chooses to hold only one-year bonds, and Investor B is indifferent with regard to holding five- and ten-year bonds. Which theories best explain the behavior of Investors A and B?
nvestor A's preferences are best explained by the segmented markets theory, while Investor B's preferences are more consistent with the expectations theory
Currency includes:
paper money and coins
What basic principle of finance can be applied to the valuation of any investment asset?
present value
The efficient market hypothesis implies that:
prices in markets like the stock market are unpredictable.
Increasing the independence of a central bankLOADING... would probably:
reduce pressures to pursue inflationary policies B. hinder the coordination of monetary and fiscal policy C. allow the central bank to more easily pursue monetary policies that directly oppose the government's fiscal policies D. All of the above are correct
The portion of checkable deposits that banks are required to hold is called:
required reserves.
Bank chartering reduces adverse selectionLOADING... problems by:
screening proposals for new institutions to prevent undesirable people from running the institution
Examples of off-balance-sheet activitiesLOADING... include:
selling loan portfolios
When an individual or institution buys a corporate bond in the primary market:
she is making a loan to the corporation issuing the bond.
Stock market analysts might prepare a forecast of the next-period stock price Upper P Subscript t plus 1Pt+1 as follows: Upper P Subscript t plus 1Pt+1 = StartFraction Upper P Subscript t plus Upper P Subscript t minus 1 Baseline plus Upper P Subscript t minus 2 Baseline plus Upper P Subscript t minus 3 Over 4 EndFractionPt + Pt−1 + Pt−2 + Pt−34, a process known as a moving average. This technique is part of what is called:
technical analysis
The current yield is a good approximation to the yield to maturity when: (Check all that apply.)
the maturity of the bond occurs over a ten-year period. the bond price is very close to par.
Money may serve as an instrument that allows for comparison of the relative worth of various goods and services. What function of money does this describe?
unit of account
Interest rates were lower in the mid-1980s than in the late 1970s, yet many economists have commented that real interest rates were actually much higher in the mid- 1980s than in the late 1970s. Consider the diagram to the right that shows the nominal interest rateLOADING... and the inflation rate. The real interest rateLOADING...:
was higher in 1985 than 2005, when the real interest rate was zero.
If your broker has been right in her five previous buy and sell recommendations, you should continue to listen to her advice. Is this statement true or false?
False, although your broker has done well in the past, efficient market theory suggests that she has probably been lucky
If interest rates decline, which would you rather be holding, long-term bonds or short-term bonds?
Long-term bonds because their price would increase more than the price of short-term bonds
Would fiscal policy makers ever have reason to worry about potentially inflationary conditions?
Yes, higher inflation leads to a higher debt service burden and increases the costs of financing deficit spending.
In the aftermath of the global economic crisis that started to take hold in 2008, U.S. government budget deficits increased dramatically, yet interest rates on U.S. Treasury debt fell sharply and stayed low for quite some time. Does this make sense?
Yes, the decrease in investment opportunities and known risk factors significantly offset the wealth effect on demand and the deficit effect on supply.
Is it better for bondholders when the yield to maturity increases or decreases? Bondholders are better off when the yield to maturity:
decreases, since this represents an increase in the price of the bond and a decrease in potential capital losses
Risk that is related to the uncertainty about future interest-rate movements is called:
interest-rate risk
