Money and Banking Exam 2 Review

Consider a game with two possible outcomes: $2,000 of $0. The two outcomes are equally likely. A risk neutral individual would be willing to pay ____________ to play this game; a risk averse individual would be willing to pay _______________ to play it

$1,000; less than $1,000

Consider an uncertain situation in which there are three possible outcomes, described by the following table, which is the expected value? [Outcome][Payoff][Probability] A $1,200 0.6 B $1,600 0.3 C $2,000 0.1

$1,400

Which of the following is the future value of a $1,000 bond at 6% interest that matures in eight years, rounded to the nearest dollar

$1,594

If a firm's stock is priced at $50 per share and it has 2 million shares outstanding, then its market capitalization is equal to _______________

$100,000,000

Consider a consol (perpetuity) that promises to pay $2 per year forever at an interest rate of 10%. What would the price of the consol be?

$20

You are reliably told that in ten years that you'll receive $5,000. If the interest rate over that ten-year period is 2%, which of the following is the amount that sum is worth in today's dollars, rounded to the nearest dollar?

$4,102

A one-year Treasury bill with a face value of $100 sells for $95.24. The interest paid in this case is equal to $ _____________ and the rate of interest in percentage terms is equal to ___________

$4.76; 5%

Consider a six-month Treasury bill that pays $500 at maturity and pays interest in the amount of 4%. What it its price?

$490.29

A borrower who needs $5,000 issues a coupon bond for that amount, with an annual coupon rate of 10%, that will mature in 10 years. The yearly coupon payment for this bond would be _________________

$500

A bond dealer is concerned that his inventory of bonds will lose value. He could hedge risk by....

Engaging in a futures contract with a buyer concerned about increases in bond prices

As the default risk of a bond rises, we expect the price of the bond to ______________ and its yield to ________________

-Fall -Rise

An inverted yield curve signals that expected future short-term yields will __________________ and that economic policy is __________________

-Fall -Tight

When the price of a bond rises, its yield ________________. Therefore, when a bond's price is lower than its face value, its yield to maturity must be ______________ its coupon rate

-Falls -Above

Describe the two types of idiosyncratic risk

-One type affects some firms one way and some another -One type affects only one type of firm and not others

The most useful measure of the return on holding a bond is _________, which can be defined as the interest rate that _________________

-Yield to maturity -Bondholders receive if they hold the bond until the final principal payment is made

According to the dividend-discount model, the "fundamental" price of a stock equals its current dividend ___________________ the interest rate, ____________________ the dividend growth rate

-divided by -plus

All else equal, the longer the time to expiration, the ________________ the value of a call option, due to ________________________

-higher -increased time value

All else equal, the price of a one-year treasury bill will be ___________ than that of a six-month Treasury bill; in other words, the ________________ the time to maturity the more we are willing to pay

-lower -shorter

Consider a one-year 10% coupon bond with a face value of $100 that sells for $95. Rounded to four decimal places, the bond's current yield equals ____________

0.1053

Rank the following U.S. stock market indexes from the least broad index to the most broad index:

1. Dow Jones Industrial Average 2. S&P 500 3. NASDAQ Composite Index 4. Wilshire 5000

Consider two bonds that are completely identical, except interest income on Bond A is federally taxed while interest income on Bond B is not. If Bond A pays an 8% yield and the investor has a 30% tax rate, what will the yield be on Bond B, rounded to one decimal place

5.6% Tax-Exempt Bond Yield: (Taxable Bond Yield) x (1-Tax Rate) 8% x (1 - 0.3) = 5.6%

In your car loan contract, the interest rate is listed as 7%. Inflation is expected to be 3% throughout the duration of the loan. What is the nominal interest rate?

7%

The real exchange rate tells us....

The cost of a basket of goods and services in one country in terms of the same basket in another country

A promise to make a series of payments on specific dates in the future is called ______________

A bond

The expected value of a $2,000 investment is $2,160. This would most commonly be described as.....

A gain of 8%

Which of the following is true about forwards and futures? A. a forward is an agreement to exchange something for cash on some future date B. in a futures contract, the buyer has the short position and the seller has the long position C. a future is difficult to resell to someone else D. a forward is sold through an organized exchange

A. a forward is an agreement to exchange something for cash on some future date

Which of the following would we calculate future value to determine? A. how much a financial investment made today will be worth later B. how much our expected yearly income after college is worth today C. how much an expected future payment is worth today D. how much a given amount of money today can buy in the future, given inflation

A. how much a financial investment made today will be worth later

The value of a coupon falls as the value of its yearly coupon payment falls. Which of the following does NOT explain why this is so? A. the lower the interest rate, the lower the present value of future payments B. the smaller the payment, the smaller its present value C. the lower the coupon rate, the smaller the yearly coupon payments made

A. the lower the interest rate, the lower the present value of future payments

Which of the following is true about the simplest form of interest-rate swaps? A. they can turn a fixed-rate payment into a floating-rate payment B. all payment is made up front C. the fixed-rate payer will pay only the benchmark rate D. the bank is the floating-rate payer

A. they can turn a fixed-rate payment into a floating-rate payment

Which of the following is NOT true about zero-coupon bonds? A. they pay regular interest payments B. they are also called pure discount bonds C. they are redeemed for a face value higher than the price originally paid D. one example of a zero-coupon bond is a US Treasury bill

A. they pay regular interest payments

Which of the following is true about credit-default swaps? A. they provide insurance against borrower default B. they are generally very short-term C. they require no collateral D. the buyer pays the seller if default occurs

A. they provide insurance against borrower default

What is true about an option holder?

An option holder is a buyer, who obtains rights by buying the option

A derivative gets its value from.....

An underlying financial instrument

George wants to take advantage of temporary price differences in financial instruments - so he buys them where they are cheaper and resells them when they're more expensive. George is engaging in _____________________

Arbitrage

Which of the following is NOT true about forwards (forward contracts)? A. they represent an agreement to exchange something for cash in the future B. they are easy to resell to someone else C. they are customized agreements D. a yearlong apartment lease is a sequence of twelve forward contracts (one per month)

B. they are easy to resell to someone else

What is true about the law of one price?

Based on concept of arbitrage

Holding period return is calculated when a bond is sold ___________________ maturity

Before

Leverage refers to.....

Borrowing to pay for part of an investment

Bonds are issued by...

Businesses and the government

John wants his investments to do well no matter whether people tend to drive their own vehicles or ride public transportation, so he buys securities from both car manufacturers and bus companies. John is engaging in _____________ which is used to manage ____________ risk

Hedging, idiosyncratic

If over some time period a U.S. Treasury bond pays 2%, a bond from Company A pays 8.5%, and a bond from Company B pays 6%, which of the following is most likely true?

Company A's bond carries the most risk of the given three bonds

Which of the following is true about credit-default swaps and interest-rate swaps?

Credit-default swaps are a form of insurance

Short-term fluctuations in exchange rates happen because of changes in the demand for and supply of

Currencies

What is the role of the American dollar in foreign exchange markets today?

Currencies are often converted to dollars before the desired target currency

What is true about fixed-payment loans?

Each payment on a fixed-payment loan pays off some principal and some interest

Which of the following is not a way securitization uses the efficiency of markets to lower the cost of borrowing? A. allowing for risk diversification B. making markets broader C. increasing liquidity of assets D. removing systematic risk

D. Removing systematic risk

"Marking to market" is done on a _______________ basis

Daily

In the market for bonds, when the price of bonds is below the equilibrium price

Demand>Supply

If purchasing power parity holds, the one trading partner nation that experiences significant inflation, while its partner does not, will also experience......

Depreciation of its currency

The value of a coupon bond varies ________________ with the value of its yearly coupon payments and ____________________ with the interest paid on it

Directly, inversely

According to the dividend-discount model, stock prices should be high when.....

Dividend growth is rapid

What is true about a risk-free asset?

Its return is the risk-free rate of return

Futures can be used....

For both hedging risk and speculation

The Fisher equation implies that, all else equal, higher expected inflation is

Generally associated with higher nominal interest rates

All else equal, investors prefer __________________ expected values and _____________________ standard deviations

Higher; lower

Stock market indexes provide information on....

How much total wealth has risen or fallen

In the dollar-yen market, a perceived decrease in the riskiness of American bonds would tend to....

Increase the demand for dollars and raise their value

In the dollar-yen market, an increase in American wealth would tend to....

Increase the supply of dollars and lower their value

Consider a $400,000 investment for which the investor borrow $100,000. As a result the leverage ratio for the investment would ________________ its standard deviation by _______________

Increase; 1.33

Even if bond payments are made, increases in overall prices may reduce those payments real value. This is referred to as......

Inflation Risk

Which is true about compound interest?

Interest earned on interest

If you pay $180 for a coupon bond with a $200 face value, you will receive......

Interest payments and a capital gain of $20

All else equal, we expect present value to be higher when.....

Interest rate is lower

___________________ swaps are used to synchronize receipts and purchases

Interest-rate

In general, an investment should be made if its internal rate of return......

Is greater than the cost of borrowing to make the investment

What role does a clearing corporation play in a futures contract?

It guarantees buyer and seller will go through with an agreement

What does a margin account do?

It holds deposits from the buyer and seller in a futures contract

To modify the dividend-discount model to include risk, what change needs to be made to the interest rate when calculating present value?

It must include the risk-free return and a risk premium

Before expiration, the price of an option equals....

Its intrinsic value plus its time value

Before expiration, the price of an option equals.....

Its intrinsic value plus its time value

What is true about government intervention in foreign exchange markets?

Japan is the nation that most frequently intervenes in foreign exchange markets

In the equation for the price of a coupon bond, to the right of the equals sign, there are two parts. The part on the left represents ____________________, while the part on the right represents ____________________

Left: the interest Right: the value of the promise to repay the principal at maturity

When daily gains and losses related to a futures contract are posted to a margin account, this is called......

Marking to market

Which of the following is true about coupon bonds?

Most common type of bond

Which is true about the definition of risk?

Must be measured against a benchmark

Which of the U.S. stock market indexes are value-weighted?

NASDAQ, S&P 500, Wilshire 5000

The nominal interest rate is generally _________________________; the real interest rate is generally ____________________________

Observed, estimated

When the dollar appreciates relative to the Chinese yuan,

One dollar can now buy more yuan

An idiosyncratic risk affects ___________________; economic recession is an example of __________________

Only a small number of firms; a systematic risk

What is true about options?

Options transfer risk from the buyer to the seller

Speculative-grade commercial paper.......

Originally issues as prime-grade

If we are promised a sum at some point in the future and want to know how much it is worth today, we should calculate the _____________________

Present Value

After figuring the amount of money you'll need to retire comfortably, you calculate the amount you'll need to invest now to have that amount when you retire in twenty years. To do so, you should calculate __________________

Present value

When general business conditions decline, what happens to bond prices and yields?

Price increases and yield falls

When the government wants to spend more relative to the taxes it brings in, what happens to bond prices and their yields?

Price of bonds falls and yields rise

All else equal, when the demand for a bond increases....

Price rises and yield falls

If interest rates are expected to be higher in the future than they are today, what would happen to bond prices and yields?

Price to fall, yields to rise

As a bond is perceived to provide a higher return, or to be more liquid or less risky than other bonds,

Price will rise and yield will fall

The idea that exchange rates should adjust until a given basket of goods costs the same in both trading partner nations is called _______________

Purchasing power parity

The future value of a financial investment _______________________ as its time to maturity increases due to __________________

Rises, compound interest

When financial institutions pool assets that generate payment streams and turn them into tradeable bonds, this is called _________________

Securitization

What is true about speculators in futures markets?

Sellers of futures are betting that prices will fall

According to the expectations hypothesis of the term structure of interest rates, an upward sloping yield curve indicates that investors expect.......

Short term yields to rise

The expectations hypothesis of the term structure of interest rates assumes perfect certainty about present and future yields. This certainty implies that....

Short-term and long-term bonds will be perfect substitutes for each other

Someone who believes that the price of the underlying asset will decrease will.....

Speculate by taking the short position

Instead of purchasing bonds from only one firm, Jane buys bonds from three firms in different industries. Jane is engaging in _________________________, the foundation of the _______________________ industry

Spreading risk; insurance

Between standard deviation and variance, __________________ is considered more useful in investment analysis because _______________

Standard deviation; measured in dollars like payoffs

Stocks are risky because....

Stockholders are residual claimants

What describes stockholders liability for issuing firm's debts?

Stockholders were initially liable for the issuing firm's debts, but today limited liability means they are responsible only for the amount invested

The stock market has a reputation for being very risky, yet many investors hold a substantial portion of their wealth in stocks. Which of the following mist likely explains this?

Stocks are not risky if part of a long term investment horizon

Real-world evidence related to the Fisher equation is generally

Supportive of its claim that higher inflation rates are related to higher nominal interest rates

The law of one price generally does not hold because......

Tastes differ in different places

The yield curve graphically depicts the _______________ structure of interest rates and has _________________________ on its horizontal axis

Term; time to maturity

What is true about consols (perpetuities)?

The borrower only pays interest, not the principal

If American goods become more popular in foreign countries, including Japan, which of the following effects would likely be seen in the dollar-yen market?

The demand curve for dollars would shift rightward

When the euro appreciates against the dollar.....

The dollar must depreciate against the Euro

On the maturity date of a coupon bond, the bond issuer will pay....

The face value of the bond

The fundamental value of a stock is based on....

The firm's current assets and estimates of its future probability

The more diversified a portfolio of investments is, all else equal,

The less risky it is

The internal rate of return can be defined as the interest rate that equates

The present value of an investment with its cost

What amount should a bond buyer be willing to pay for a coupon bond?

The present value of its payments

The price of a stock is equal to....

The present value of the sum of its dividends plus the present value of its future price

Which is true about the relationship between the real interest rate and the nominal interest rate?

The real interest rate is adjusted for inflation, while the nominal interest rate is not

What happens to the bond market when inflation is expected to increase?

The supply curve for bonds shifts rightward and the price of bonds fall

An increase in the real interest rate in Japan would have which of the following effects on the dollar-yen market?

The supply curve for dollars would shift rightward

Swap spread equals _______________________________________ and is often studied as a measure of _______________________ risk

The swap rate minus the benchmark rate; systematic

What is true about derivatives?

They can be used to speculate

Interest-rate risk increases as the bond's __________________________ increases

Time to maturity

What is the purpose of derivatives?

Transferring risk from one person to another

Data on the risk structure of interest rates in the US indicates that the majority of fluctuations in yields over time come from fluctuations in.......................

Treasury yields

If you know that the Dow Jones Industrial Average ha gone from 12,000 to 15,000, that tells you that by this measure stock prices went.......

Up 25%

The two methods for measuring the risk of an investment are _______________

Variance & value at risk

An arbitrageur.....

Wants to buy at a low price and resell at a high price

Dividends are paid....

When firm makes a profit

Value at risk (VaR) would be most commonly calculated in which of the following situations

When we want to know the value of the worst possible outcome

A given type of sausage costs $6 in the United States and 5 euros in Germany. If the current nominal exchange rate is $1.25/1 euro.....

You can exchange one American sausage for 0.96 German sausages

In the short run, if we see a 2% increase in the nominal dollar-yen exchange rate when inflation is approximately 3%, we can estimate that the real dollar-yen exchange rate is experiencing approximately

a 2% increase

There is some evidence that increased inflation is associated with __________________ nominal interest rates, particularly in nations where inflation is especially ________________

higher; unstable

Current yield has ____________________ relationship with bond price; when the bond price rises, current yield ________________

inverse; falls

In a futures contract, the buyer has the ____________ position and benefits from ________________ in the price of the underlying asset

long; increases

All else equal, the fewer yen needed to buy one dollar, the ____________ dollars will be demanded; this is why the demand curve for dollars in foreign markets slopes __________________

more; downward

To reduce its risk, a clearing corporation requires the parties in a futures contract to place a deposit with them; this practice is called........

posting margin in a margin account

An increase in wealth shifts the demand curve for bonds ____________, causing the price of bonds to _______________________

rightward; increase

According to the theory of efficient markets....

stock price movements are unpredictable

The supply curve for dollars in foreign exchange markets slopes __________________, and those dollars are supplied by __________________ of non-US goods and financial assets

upward; buyers

An asset buyer who wants to insure against increases in prices.....

will hedge by taking the long position