Financial Markets and Institutions Exam 2

What is a municipal bond?

A bond issued by a state, city, county, or other local government.

What are repos?

A short term collateralized loan

Which of the following is NOT a potential error when using the Gordon Growth model?

Forecasting the wrong number of shares outstanding

Which of the following is NOT a characteristic of money market instruments?

High default Risk

What is another name for junk bonds?

High yield bonds

What are the steps for finding the price of a coupon bond?

Identify the cash flows, find the present value of the cash flows, sum the present values

Which of the following statements best describes what Federal Funds are?

Short term loans between two financial institutions, generally for only one day.

Which of the following is true about U.S. government debt?

The U.S government has never defaulted in its debt

How often has the U.S. government defaulted on their debt?

The US has never defaulted on its debt.

Suppose there are bonds that have a coupon rate of 8%. Market interest rates increase to 20%. The bonds have different years to maturity. Which of the following will have the lowest value or price?

The bond with 20 years until it matures

What do we call the payments that you receive if you provide the loan or the payments you make if you borrow the loan?

The cash flows

If the inputs into the Gordon Growth model are wrong, the resulting stock price will be incorrect.

True

If you are concerned about interest rate risk, you are worried that interest rates will increase.

True

If you are concerned with reinvestment risk, you should obtain long term bonds.

True

In a fixed payment loan, the monthly payment includes both principal repayment and interest payments.

True

Many discount bonds have a maturity of 1 year or less.

True

Most corporate bonds are unsecured bonds.

True

Municipal bonds are often used for public interest projects.

True

Non-banks can participate in the repo market.

True

One does not have to pay Federal income tax on gains from municipal bonds

True

Regardless of their bid, all participants in the T -bill auction pay the same price.

True

Reserve requirements create additional expense for banks that money markets do not have.

True

Some major companies have shares of stock that cost less than $10.

True

Stock prices are set by the market, in other words a stock is priced at what someone is willing to buy it for.

True

The Gordon Growth model requires that dividends grow at a constant rate.

True

The bond market is larger than the stock market in the U.S.

True

There is a secondary market for bonds.

True

WWW.Finance.yahoo.com is an excellent website for finding information about stock prices

True

We evaluate debt instruments by the amount and timing of the cash flows.

True

When inflation increases, your money loses buying power.

True

When market interest rates decrease, the value of a coupon bond increases

True

When you buy a Treasury bill, to whom are you loaning money?

US Government

Stock market volatility increases when investors have confidence in the market.

False

T-bills are auctioned to dealers every Tuesday.

False

The yield to maturity will always be represented as a dollar amount.

False

There is not a secondary market for negotiable CD's.

False

When interest rates increase the value of a coupon bond increases.

False

When market interest rates increase, the value of a bond increases.

False

Which of these money market instruments works like a pawn shop works?

Repo

What is the regulatory agency that oversees the stock market?

SEC

What are bonds?

securities that represent debt owed by the issuer to the investor

When you buy a share of stock, you are guaranteed to make a profit as long as you hold it for a year or more.

False

When you lend money, you have to pay interest.

False

With a banker's acceptance , it is normally the exporters bank that guarantees payment

False

You must be rich in order to invest in the stock market.

False

Which of the following money market instruments is the least liquid?

Federal Funds

Which of the following is the formula for finding Present Value?

PV= FV/ (1 +i)n

Which of the following is NOT a typical face value of a corporate bond?

$100

With simple interest , if I invest $100 for 3 years at 6% interest per year, how much will I have after 3 years?

$118

With compound interest , if I invest $100 for 3 years at 6% interest per year, how much will I have after 3 years?

$119.10

Suppose you borrow $15,000 to buy a car. Your loan is for 10 years. It has an interest rate of 7.5%. Your monthly payments are $200. What is LV in this example?

$15,000

Suppose Target stock pays a dividend of $2.71 and has a growth rate of 2.3%. What is the dividend one year in the future?

$2.77

Suppose you borrow $15,000 to buy a car. Your loan is for 10 years. It has an interest rate of 7.5%. Your monthly payments are $200. What is FP in this example?

$200

If the industry PE ratio for a firm is 55, what is the current stock price for a firm with earnings for $4.55 / share?

$250.25

If the industry PE ratio for a firm is 27, what is the current stock price for a firm with earnings for $2.25 / share?

$60.75

Suppose we have a bond portfolio with a duration of 5.23. The portfolio earns interest of 4.3%. Interest rates increase by 1/2%. What will the approximate change in my portfolio be?

-2.51%

Suppose you borrow $15,000 to buy a car. Your loan is for 10 years. It has an interest rate of 7.5%. Your monthly payments are $200. What is n in this example?

10

What is the maturity for a T-bill?

28 days to one year

Suppose we have a 4 year coupon bond with a face value of $1000 and a coupon rate of 4%. What are the cash flows?

4 payments of $40 and one final payment of $1,000

Suppose Clorox stock pays a dividend of 43 cents and has a growth rate of 3.7%. What is the dividend one year in the future?

45 cents

What is the yield to maturity on a coupon bond that is bought for $1,000 and has a coupon rate of 5%? The market interest rates are 6% and the bond is for 10 years. The bond has a par value of $1,000.

5%

What is the current yield of a bond with a price of $980 and a face value of $1,000. The bond is for 10 year sand has a coupon rate of 5%?

5.1%

What is the current yield for a bond with a face value of $1,000, a current price of $950, and a coupon rate of 7%?

7.37%

Suppose Sammy borrows $200 from you. He pays you back $215 in one year. What is the yield to maturity of this loan?

7.5%

Suppose you borrow $15,000 to buy a car. Your loan is for 10 years. It has an interest rate of 7.5%. Your monthly payments are $200. What is i in this example?

7.5%

What is the YTM on a discount bond that cost $920 and has a face value of $1,000?

8.7%

You pay $992.65 for a 28-day T-bill. It is worth $1,000 at maturity. What is its discount rate?

9.45%

You pay $992.65 for a 28-day T-bill. It is worth $1,000 at maturity. What is its annualized yield?

9.65%

What does a call provision on a bond do?

Allows the issuer to retire the debt early

Which of the following is the safest bond?

Amazon Bond

What do we call the investment that allows foreign firms to trade on U.S. exchanges by U.S. banks buying foreign shares and issuing receipts against the shares in U.S. markets?

American depository receipts

Which of the following best describes what a banker's acceptance is?

An order to pay a specified amount to the bearer on a given date if specified conditions have been met, usually delivery of promised goods.

When the mortgages that "backed" the Asset Backed Commercial Paper began to have massive defaults and everyone wanted to sell their paper, what was this similar to?

Bank Runs

When you buy a share of stock, what are you doing?

Buying an ownership share in the business

Real interest rates cannot go below 0%.

False

What do we call the market that contains investments with a maturity of 1 year or longer?

Capitol Market

Which of the following are often structured as fixed payment loans?

Car Loans, Home Loans, Student Loans

What do we call debt issued by businesses?

Corporate bonds

What do we call the amount of interest that a coupon bond pays?

Coupon Rate

What can we use to estimate the yield to maturity of a coupon bond that has a long maturity and is sold at price near par?

Current Yield

What are agency bonds?

Debt issued by U.S. government sponsored entities.

What type of debt instrument is a Treasury bill?

Discount Bond

How does one make money investing in stocks?

Dividends and/or capital gains

Eurodollars represent what?

Dollar denominated deposits held in foreign banks

When we have a bond that makes semi-annual payments and we wish to calculate the price, which of the following are the steps we need to take?

Double the number of periods, halve the coupon payment, halve the market interest rate

What is a tool that we have, that measures the impact of interest rate movements on a bond or a portfolio of bonds?

Duration

What do we call an investment that acts like a single stock, but actually represents a basket of stocks usually that follow a specific index?

ETF: exchange traded fund

Which of the following is the formula for finding Future Value?

FV = PV * ( 1 + i)n

$1,000 given to you next year is more valuable than $1,000 given to you today

False

A Treasury bill has only one coupon payment.

False

A discount bond has only one coupon payment.

False

A repo is a bearer insturment.

False

Agency debt has an explicit guarantee from the U.S. government that it will not let the debt default.

False

BBB rated bonds pay a lower coupon rate than AAA rated bonds.

False

Banker's acceptances have no secondary market.

False

Bond rating agencies use only quantitative measures when evaluating a bond's risk.

False

Bonds are more risky than stock.

False

Commercial paper is always collateralized

False

ECN's work best for small, not often traded stocks.

False

Everyone is guaranteed to get their orders filled in the T-bill auction process.

False

Home Depot bonds have a duration of 5.6. Lowe's bonds have a duration of 7.8. Lowe's bonds have less interest rate risk than home Depot bonds

False

If a business has better than expected profits their stock price will automatically increase.

False

If a company sees a large decrease in sales, their stock price will automatically decrease.

False

If you are concerned about reinvestment risk, you are worried that interest rates will increase.

False

If you are concerned with interest rate risk, you should obtain long term bonds

False

If you buy a bond at one price and sell it at a lower price, this is considered a capital gain.

False

If you invest in a stock that has always paid dividends, you are guaranteed to receive a dividend payment in the future.

False

In a fixed payment loan the payment is different every month.

False

Money is traded in the money market

False

Most corporate bonds pay interest quarterly.

False

No U.S. county has ever defaulted on a municipal bond.

False

Non- banks can participate in the Federal funds market

False

One does not have to pay Federal income tax on gains from corporate bonds.

False

What do we use to monitor the behavior of a group of stocks?

Indexes

Why is it important that the stock market has strict regulation?

Investors have to feel confident or else they would not invest in the market and the market would not exist.

What is a credit default swap?

It is a financial instrument that allows one to buy insurance on bonds

Which of the following is true about the money market ?

It provides borrowers a low cost source of temporary funds.

What do we call the amount of funds that the lender lends to the borrower?

Loan Principal

Commercial paper can be described as....................

Loans from one company to another company

What rate do we have in London that is very similar to the Federal Funds rte in the U.S.?

London Interbank Offer Rate

Which of the following assets invested heavily in Asset Backed Commercial Paper?

Money Market Mutual Funds

What do we call debt issued by state or local governments?

Municipal Bonds

What makes a stock price increase or decrease?

Prices are set by the market, basically the price for which someone is willing to sell and the price for which what someone is willing to buy.

If you wanted to buy some stock, which of the following would be a way to accomplish this?

Open an account with: TD Ameritrade, RobinHood, or e-Trade

Suppose we have a 4 year coupon bond with a face value of $1000 and a coupon rate of 4%. How would we find the present value of the final cash flow if market interest rates are 5%?

PV = $,1000/(1+ .05)4

Suppose we have a 4 year coupon bond with a face value of $1000 and a coupon rate of 4%. How would we find the present value of the first cash flow if market interest rates are 5%?

PV = $40/(1+ .05)

Which of the following best describes how a coupon bond works?

The investor lends money to an entity and the borrower pays a fixed amount of interest each year then at maturity returns the face value to the lender

Which of the following best describes how a discount bond works?

The lender buys the bond at a price less than the face value. At maturity the face value is returned to the lender.

In both of our formulas, FV and PV, what does n stand for?

The number of periods

Which of the following is the most basic assumption of the Gordon Growth model for valuing a stock?

The stock pays a dividend

Which of the following best describes asset backed commercial paper?

These are loans from one business to another business but they are collateralized by an asset often mortgage backed securities.

Which of the following statements best describes a Treasury Inflation-Indexed Security?

This is a Treasury bond that changes the interest rate paid as inflation changes.

Which of the following money market instruments is the most liquid?

Treasury Bills

What do we call debt issued by the U.S. government?

Treasury Bonds

A Treasury bill has a maturity of less than 1 year.

True

A negotiable CD is a bearer insturment.

True

A secured bond is one that has collateral.

True

Another term for face value is par value

True

Banker's acceptances are often used when buyers and sellers are from different countries.

True

Bonds are a popular investment for retirement funds.

True

Commercial paper is not protected by the FDIC.

True

Current yield is based on the perpetuity formula.

True

Current yield is calculated by taking one coupon payment and dividing it by the price paid for the bond

True

Events that worry people, for example President Trump contracting Covid 19 can increase market volatility.

True

Federal funds rates are very similar to the rates on short term Treasury bills.

True

If a money market mutual fund returns less than $1 for a dollar invested, it is referred to as, "Breaking the buck"

True

Which of the following describes what commercial paper is?

Unsecured promissory notes, issued by corporations, that mature in no more than 270 days.

Stock prices constantly move up and down. Some times the amount of up and down movement is more than other times. What is our measure of this movement?

Volatility

Which of the following statements best describes how we value (price) a bond?

We determine the cash flows and find the sum of the present value of the cash flows.

Which of the following statements describes the Gordon Growth model for pricing stocks?

We divide the dividend payment one period in the future by the required rate of return minus the growth rate

Which of the following best explains how a corporate bonds works?

When you buy a corporate bond, you loan money to a business. In return they pay you interest payments. At maturity, they pay you the face value of the bond.

The interest rate that makes today's value equal to the present value of all future cash flows is called what?

Yield to Maturity

Why do we say that money has a time value?

You can invest money that you have today and the longer you have it invested, the more it will be worth.

What do we call a bond where the payment go on forever?

a perpetuity

What do we call a software tool that allows one to enter desired characteristics of a stock and it provides a list of all stocks with those characteristics?

a stock screener

What is another name for a discount bond?

a zero coupon bond

Which of the following entities participate in the money market?

all of the above: US Treasury Department, Individuals, Pension funds, Businesses

Another name for an unsecured bond is..............

debenture

"Real" interest rates refers to what?

inflation adjusted interest rates

What is included when we calculate the rate of return on a bond?

interest payments received and the difference between the buy price and the sell price

In a fixed payment loan, how many cash flows are there?

it depends on the length of the loan.