Econ 3303

theory of portfolio choice

a theory that outlines how much of an asset people will want to hold in their portfolios, as determined by wealth, expected returns, risk, and liquidity

Suppose you have $1500 and plan to purchase a 5-year certificate of deposit (CD) that pays 3.5% interest, compounded annually. How much will you have when the CD matures?

$1781.53 1500(1.035)^5

Assume that a 1- year bond (issued by Municipality of Arlington) with a face value of $1,000 is currently trading at PV = $980.39, and another 2-year bond (also issued by Municipality of Arlington) with identical face value is currently trading at $907.03.According to the Expectations Theory of the Term Structure, anticipated price on identical 1-yr bond which is expected to be re-issued by the Municipality of Arlington next year should be:Standard rounding applies.

$925.93

If you expect annual inflation rate to be 12 percent next year and a one-year T-Note has an expected annual yield of 7 percent, then real annual rate of interest on the T-Note is _______.

-4.46%

Which of the following statements is true? None OF the Above

-A banks asset are its sources of funds -the banks liabilities are related to the costs of business -bank capital is recorded as an asset on the bank balance sheet -securities are banks main assets as they are highly liquid -none of the above

There are 3 functions of money?

1) medium of exchange 2)store of value 3) unit of account

Assume that an alien aircraft just landed next to UTA. A little green guy(Alien) found $20. JPM Chase offered him a time deposit with annual rate of 2.5% How long would it take for Alien to increase the value of his deposit by 40%?(note standard rounding applies)

13.63 YEARS NOT MONTHS.

Daniella is considering the purchase of a 7-yr, $1,000 bond being issued by Exxon Mobile, Inc. The bond offers an interest rate of 5.50%. The rate on identical maturity US T-Bond is 2.50%. All else equal, Daniella will be getting a default premium of _____, if she purchases the Disreputable, Inc. bond.

3%

Please estimate promised YTM on a 1-yr T-Note under assumption that 1-yr TIPS promises to pay 2.0% and investors anticipate 3.0% rate of inflation over the same time period.

5.06%

In context of financial investment, Adverse selecting is seen as__________? None of the above

A)Risk of selecting bad creditors B) Risk of unevenly distribution knowledge regarding a potential investment C) none of the above

An applicant applying for a loan has better information about the potential returns and risk on the investment projects he/ she plans to undertake relative to a lender. In economics, this inequality of information is called

Asymmetric information

Inflation is a benefit to _________.

Borrowers

In a business cycle expansion , both supply of bonds and demands for bonds will shift. If the shift in the demand curve DOMINATES IN MAGNITUDE such that it is twice as big as the shift in the supply curve, investors should expect a(an)_____ in equilibrium quantity of BONDS, a(an) _____pressue on the equilibrium price of bonds, and a(an)_____ pressure on the equilibrium interest rates, ceteris paribus.

Increase: Upward: Downward

When compared to an exchange system relying on money, the main disadvantage of the barter system is________?

The requirement to satisfy double coincidence of wants.

When money prices are used to facilitate comparison of value, money is said to function as

Unit of account

Economists consider ____ to be the most accurate measure of interest rates.

Yield of Maturity

Which of the following can be described as direct finance?

You borrow $2500 to a nun or borrow $100 from a drug dealer.

The best way to measure the default risk premium (DRP) is to _________.

compare the interest rate the borrower is paying vs. the risk-free rate, usually represented by the rate on US Treasury

An inverted yield curve likely means that the ________.

economy is probably headed for recession

The three theories that economists have developed to explain the shape of the yield curve are ___.

expectations theory, term premium theory, and segmented market theory.

An increase in the price of bonds will cause a decrease in the demand for bonds.

false

income

flow of earnings

As the federal marginal tax rate rises, the advantage of municipal bonds over corporate bonds __

increases;

An inverted yield occurs when ______.

long-term interest rates are lower than short-term interest rates.

During a business cycle expansion when income and wealth are raising, the demand for bond_____ and the demand curve Shifts to the____, assume everything else held constant. In the case you would expect a(an) pressure on the equilibrium price of the bonds, a(an)____in equilibrium quantity of bonds, and a(n)____ pressure on the equilibrium interest rate.

rise, right. upward, increase and downward

A yield curve illustrates the relationship between the ___________.

term to maturity of bonds and the interest rate (YTM) they pay, at a particular point of time;

A major advantage that municipal bonds have over corporate bonds for investors is that _____.

the income earned on municipal bonds is not subject to federal income tax;

No commodity can function as money unless authorized by the government

False

In our lecture discussion we concluded that________?

In macroeconomics we referred to a difference between goods produced and goods sold as an inventory investment.

You just read in WSJ that US Government decided to establish a permanent settlement on plant of Mars. According to Associated Press US congress just passed a bill to appropriate funds for that purpose by issuing $500 billion 20 yr bond package. Based on the our lectures discussions, ceteris paribus IF POTUS sings this bill into law, you would expect: ____ in_____ of debt securities, and as a result of that you'd expect ____pressure on the equilibrium price of those instruments, and what follows ____ pressure on the equilibrium interest rates.

Increase, Supply, Downward and Upward

store of value

Money is used to save purchasing power over time. Value storing refers to the time period from when we received money in exchange for goods(service) to the time period we want to use it to pay for other good or service

The expectations theory shows that the rates will tend?

Move together overtime

The yield to maturity (YTM) for a discount bond is ________ related to the current bond price.

Negatively

Ceteris paribus, assume that you have two separate opportunities to save(invest); 1st- by acquisition of a $1,000 certificate of deposit for a period of one year. according tot he agreement you are certain to withdraw $1,050, which means that effectively you will collect $50 in interest. 2nd- by buying a one year $1,000 face value discount bond issued by US Treasury at a current market price of $950, which means that effectively you will collect $50 in interest. Which of the above mention arrangements offers you better rate of return?

Option 2

Assume that you are acquired a previously issued debt instrument.According to its specifications, it promised to pay $1,000 precisely in two years from the day of its original issue. At the time it was issued, investors anticipated 8% in interest on instruments with similar characteristics and risk level. What price did you have to pay for this security under the assumption that you acquired it in a secondary market precisely THREE MONTHS BEFORE the MATURITY, and taking into account that at the time of your acquisition investors anticipated to earn 10% in interest on securities with similar features and risk characteristics?

PV=FV/(1+i)^n 1000/(1+.1)^.25 = 976.45

Conditions of Yield to Maturity

Purchase at FaceValue hold until the maturity date Rcv full payments as promise on time if payments are recv prior to maturity needs to reinvest

Value of all the goods and services in the economy is expressed in terms of single and widely accepted measurement system.

Quantity of money

In a business cycle contraction, both supply of bonds and demand for bonds will shift. If the shift in the demand curve dominates in magnitude such that it is twice as big as the shift in the supply curve, investors should expect a(an) _______ in equilibrium quantity of bonds, a(an) ______ pressure on the equilibrium price of bonds, and a(an) ______ pressure on the equilibrium interest rates, ceteris paribus.Decrease; upward; downwardCorrect! Decrease; downward; upwardIncrease; downward; upwardIncrease; upward; downwardIncrease; upward; upward

Decrease, Downward and Upward

Three risk factors

Default Risk Premium or DRP Liquidity Risk Premium or LPP Income Tax Premium or Tips

The supply of bonds is best described as a(an) __________ relationship between the price of bonds and the quantity of bonds supplied, all else equal.

Direct

When the price of a bond decreases, all else equal, the bond demand curve ______shifts rightshifts left

Does Not Shift

The reduction in transactions costs per dollar of investment as the number of transactions(or volume of activity)increases is known

Economic of Scale

An increase in the price of bonds will cause a decrease in the demand for bonds.

False

Ceteris Paribus,in TVM valuation techniques under assumption of: -positive future anticipated cash flows and -non negative interest rates The longer maturity of a bet instrument the ____________present value of that cash flow?

Lower

From perspective of an investor, interest represents compensation for

Time of investment , loss of real purchasing power(inflation) over period of investment

The spread in yield rates representing compensation for taking on greater credit risk is known asa(an) _____________ risk

dafault