Fin 326 Exam 1

A rise in the riskiness of bonds will cause the interest rate in the liquidity preference framework to 1. ____________ and cause the interest rate in the bond market to 2. _____________

1. Increase 2. Increase

A more independent Federal Reserve is ________ prone to political business cycles and is ____________ likely to produce higher inflation. Options: More or less

1. Less 2.Less A more independent Federal Reserve is less prone to political business cycles and is less likely to produce higher inflation.

Who benefits and who is hurt when interest rates rise? 1. Corporations with immediate capital construction needs are 2. Households with little debt, saving a significant fraction of annual income for retirement, are 3. The federal government running persistent budget deficits is 4. Black-market entrepreneurs operating on a 'cash-only' basis are

1. Worse off 2. Better off 3. Worse off 4. Worse off

Which of the following effects of the Sarbanes-Oxley Act discourages the foreign firms to list their companies in U.S. capital markets? A. An increase in severity of legal actions B. The separation in audit and non-audit services C. A rise in compliance cost D. Improved accounting standards

A rise in compliance cost

What effect would reducing income tax rates have on the interest rates of municipal bonds? A. Interest rates would rise because the reduction in income tax rates would make the tax-exempt privilege for municipal bonds less valuable and reduce the demand for municipal bonds. B. Interest rates would rise because Treasury securities are now less valuable and more people will want to hold municipal bonds. C. Interest rates would fall because the reduction in income tax rates would make the tax-exempt privilege for municipal bonds less valuable and reduce the demand for municipal bonds. D. Interest rates would fall because Treasury securities are now less valuable and more people will want to hold municipal bonds.

A. Interest rates would rise because the reduction in income tax rates would make the tax-exempt privilege for municipal bonds less valuable and reduce the demand for municipal bonds.

Consider a firm's financial statements for a given period. The difference between net incomeand dividends paid is best described as what? a. Addition to retained earnings b. Ending balance in retained earnings c. Total stockholders' equity d. Gross profit e. None of the other choices is correctc. Total stockholders' equity

A. Addition to retained earnings

Which of the following is not an effect of imposing higher capital requirements? A. An increase in moral hazard. B. Less incentive to take on risk. C. A larger buffer to withstand losses. D. Helps restrain unsustainable booms.

A. An increase in moral hazard.

Which of the following instruments uses Treasury bills as collateral? A. Repos B. Federal Funds C.Commercial papers D. Negotiable certificates of deposit

A. Repos

Required reserves are a fixed percentage of a bank's A. checkable deposits. B. capital. C. liabilities. D. assets. E. loans.

A. checkable deposits.

Suppose there is a/an decrease in the growth rate of the money supply. If the liquidity effect is smaller than the output, price-level, and expected inflation effects, then in the long run, interest rates A. fall compared to their initial value. B. rise when compared to their initial value.rise when compared to their initial value. C. remain unchanged when compared to their initial value. D. become unpredictable.

A. fall compared to their initial value. In the long-run, when the liquidity effect is smaller than the total of the other effects, then the change in the interest rate is positively related to the change in the growth rate of the money supply.

In the presence of a credit-driven asset price bubble, the appropriate policy is A. macroprudential regulation. B. monetary policy easing. C. monetary policy tightening. D. nothing; it is best to let the bubble run its course.

A. macroprudential regulation.

When the dollar is worth less in relation to currencies of other countries, are you more likely to buy American-made or foreign-made electronics? You are more likely to purchase

American-made products

Managerial perspective

Applied managerial perspective introduces and answers the real-world problems that managers of financial institutions commonly face and need to solve in their day to-day jobs.

Why do equity holders care more about ROE than about ROA? A. A change in ROE indicates a change in the safety of the investment, while a change in ROA does not. B. ROE measures how much equity holders are earning, while ROA measures how efficiently the bank is being run. C. A higher ROE indicates a higher level of liquidity for the investment, while a higher ROA does not. D. ROE measures how efficiently the bank is being run, while ROA measures how much equity holders are earning.

B. ROE measures how much equity holders are earning, while ROA measures how efficiently the bank is being run.

Which of the following money market securities offers the highest liquidity through a secondary market? A. Federal funds B. Treasury bills C. Commercial paper D. Eurodollar deposits

B. Treasury bills

Does the government borrow from money markets? Why? A. No, because money markets cannot cater short-term fund needs. B. Yes, because government revenues and government expenses occur at different times. C. Yes, because money markets provide funds for longer terms. D. No, because money market securities are a high cost source of funds.

B. Yes, because government revenues and government expenses occur at different times.

Reserves, cash items in process of collection, and deposits at other banks are collectively called A. bank capital B. cash items C. secondary reserves D. discount loans

B. cash items

When depositors fail to deposit funds in banks or withdraw existing deposits because they have found more profitable alternatives, we have observed A. securitization. B. disintermediation. C.the effects of economies of scope. D.financial innovation.

B. disintermediation.

The largest source of external finance for U.S. businesses is

Bank and Nonbank loans

Would interest rates of Treasury securities be affected by the tax rate change? A. No, there would be no impact on the market for Treasury securities. B. Yes, because municipal bonds are less risky than Treasury securities, the demand for Treasury securities will decrease. C. Yes, because the reduction in the tax-exempt privilege in municipal bonds would raise the relative value of Treasury securities, making Treasury securities more desirable. D. Yes, because the increase in interest rates would increase the desire to hold more municipal bonds and less Treasury securities.

C. Yes, because the reduction in the tax-exempt privilege in municipal bonds would raise the relative value of Treasury securities, making Treasury securities more desirable.

Why do credit spreads rise during financial crises? A. Credit spreads rise because the government becomes the only institution that is able to lend money to borrowers. B. Credit spreads rise because depositors with productive investment opportunities withdraw their funds from banks, which creates an incentive to lend to borrowers with riskier investment opportunities. C. Credit spreads rise because asymmetric information problems increase, making it more difficult to judge the risk of potential borrowers. D. None of the above are correct.

C. Credit spreads rise because asymmetric information problems increase, making it more difficult to judge the risk of potential borrowers.

Which of the following statements regarding direct finance is not true A. Securities are liabilities for the firm that issues them and assets for the individual that buys them. B. In the United States, less funds flow through direct financial channels than through indirect financial channels. C. Direct finance occurs when borrowers sell securities directly to lenders.

C. Direct finance requires the use of financial intermediaries. In direct​ finance, borrowers borrow funds directly from lenders in financial markets by selling them securities.

Which of the following statements about central bank structure and independence is true? A. In recent years, greater independence has been granted to many central banks with the exception of the Bank of England and the Bank of Japan, which are still subject to strict governmental control. B. In theory, central banks subject to government control produce better monetary policy, but experience suggests that more independent central banks have produced superior monetary policy results. C. In recent years, there has been a remarkable trend toward increasing independence. D. Only A and C are correct. E. All of the above are correct.

C. In recent years, there has been a remarkable trend toward increasing independence.

Which of the following is the difference between interest income and interest expenses as a percentage of total assets? A. Operating income. B. Return on equity. C. Net interest margin. D. Return on assets.

C. Net interest margin.

Greater central bank independence is associated with A. no change in either unemployment or inflation. B. lower inflation and lower unemployment. C. lower inflation and no change in unemployment. D. higher inflation and no change in unemployment.

C. lower inflation and no change in unemployment.

If the FDIC considers an insolvent bank to be "too big to fail", it will resolve the insolvency through the A. payoff method, which guarantees all deposits. B. payoff method, which guarantees only deposits that do not exceed $250,000. C. purchase and assumption method, which guarantees all deposits. D. purchase and assumption method, which guarantees only deposits that do not exceed $250,000.

C. purchase and assumption method, which guarantees all deposits.

Which of the following effects of the Sarbanes-Oxley Act discourages the foreign firms to list their companies in U.S. capital markets? A.The separation in audit and​ non-audit services B.An increase in severity of legal actions C.A rise in compliance cost D.Improved accounting standards

C.A rise in compliance cost

In which of the following situations would you choose to hold the corporate bond over the municipal bond, assuming that corporate and municipal bonds have the same maturity, liquidity, and default risk? A. The corporate bond pays 10%, the municipal bond pays 9%, and your marginal income tax rate is 20%. B. The corporate bond pays 10%, the municipal bond pays 7%, and your marginal income tax rate is 35%. C. The corporate bond pays 10%, the municipal bond pays 8%, and your marginal income tax rate is 25%. D. The corporate bond pays 10%, the municipal bond pays 7%, and your marginal income tax rate is 25%.

D. The corporate bond pays 10%, the municipal bond pays 7%, and your marginal income tax rate is 25%.

What is a credit spread? A.The difference between a borrower's credit score and the score of the most credit-worthy borrower. B. The difference between the interest rate on corporate bonds with different maturities. C. The difference between the net worth of a borrower and the amount of the loan the borrower would like to secure. D. The difference between interest rates on loans to households and businesses and interest rates on completely safe assets such as U.S. Treasury bonds.

D. The difference between interest rates on loans to households and businesses and interest rates on completely safe assets such as U.S. Treasury bonds.

In the long run, if the output, price-level, and expected inflation effects outweigh the liquidity effect, to raise interest rates the Federal Reserve should A. decrease the growth rate of the money supply. B. become unpredictable by varying the growth rate of the money supply without releasing the information to the public. C. maintain the growth rate of the money supply. D. increase the growth rate of the money supply

D. increase the growth rate of the money supply When the other effects outweigh the liquidity effect, the Fed should reduce the growth rate of the money supply to lower the interest rates in the long-run. To increase the interest rates, the Fed can simply do the reverse.

In what ways can the regional Federal Reserve Banks influence the conduct of monetary policy? A. By having members serve on the Federal Advisory Council. B.By having five of their presidents sit on the FOMC. C.Through their administration of the discount facilities at each bank. D.All of the above are correct.

D.All of the above are correct.

The sum of a bank's vault cash plus its deposits at the Fed is the bank's A. federal funds. B. capital. C. excess reserves. D. cash items in the process of collection. E. reserves.

E. reserves.

All the bonds denominated in euros are called Eurobonds ... T/F

False

Eurodollars are US dollars deposited in US banks ... T/F

False

T/F Simple models are constructed in which the variables held constant are omitted.

False

T/F The models are then used to explain various phenomena by focusing on changes in all variables at once.

False

t/f The duration of a multi-year bond, that pays an annual coupon,will never equal its maturity.

False The only case that this happens is with a zero coupon bond.

In which country among the United States, Germany, Japan, and Canada do firms use bonds to the least degree when compared to the firms of the other countries?

Germany Firms in the United States utilize bonds to the greatest degree compared to their counterparts in other countries. On the other hand, firms in Germany utilize bonds to the lowest degree.

You are in the mortgage business and you have a client that can afford to make monthly payments of$2,000 on a 30-year loan. Current rates are 6% APR. Given these inputs, how much can your client borrow?

N=12*30 = 360 PMT = 2,000 Monthly Rate or r = APR/12 = 6%/12% = 0.5% = .005 FV = $0 PV = ? PV = PV = (PMT/r)(1 - 1/(1+r)^N) PV = (2000/0.005)(1-1/1.005^360) = $333,583

Since the customer will be paying more than you are receiving, would it make sense for you to offer a loan to that individual at a higher rate than you will receive on your certificate of funds (but still competitively lower than the rate currently offered to the car loan borrower)? A. Yes, you are better able to monitor the borrower's activities than the bank. B.No, the bank is more efficient than you at dealing with asymmetric information problems. C.Yes, you will make more money and the borrower will pay less. D.No, the law restricts such lending activities to licensed financial intermediaries.

No, the bank is more efficient than you at dealing with asymmetric information problems.

Short-term U.S. government securities are called __________ because of their high liquidity.

Secondary Reserves

Other things being the same, the financial instrument that is the least risky to own is the

Short term bond

What about an American company that is in the business of importing electronic consumer goods into the United States? Importers of electronic goods into the United States are happier when the dollar is

Stronger

You own a $1,000 bond that pays a 6.0% annual coupon and also has a yield to maturity of 6.0%.You just received an annual coupon. The bond will mature exactly two years from now. What is the duration of this bond? a. 1.90 years b. 1.92 years c. 1.94 years d. 1.96 years e. 1.98 years

The PV of the bond equals its face value since the yield to maturity equals its coupon rate. Thus the PV = $1000. There are two payments, $60 and $1,060. The PVs of these two payments are: 1) 60/1.06 = 56.602) 1060/1.06^2 = 943.40 Duration = (1*56.60 + 2*943.40)/1000 = 1.94 years

Suppose that your marginal tax rate is 40%. Your after-tax return from holding (to maturity) a one-year corporate bond with a yield to maturity of 15% is

The after-tax return is (1minus−((40)/100))times×(15) = 9

What could be the fundamental reason for the downgrade of the reputation of the credit rating agencies in the 2007-2009 financial crisis? A. The products rated least risky by the credit rating agencies defaulted. B.The credit rating agencies were providing consultancy services and rating services to the same client. C.The issuers of bonds were paying fees to the credit rating agencies to rate their products. D.There were higher consultancy fees compared to rating fees.

The products rated least risky by the credit rating agencies defaulted.

Expectations theory

The proposition that the interest rate on a long-term bond will equal the average of the short-term interest rates that people expect to occur over the life of the long-term bond.

How would your yield curve change if people preferred shorter-term bonds over longer-term bonds?

The yield curve would become Steeper

Economists group commercial banks, savings and loan associations, credit unions, mutual funds, mutual savings banks, insurance companies, pension funds, and finance companies together under the heading financial intermediaries. What function do financial intermediaries perform?

They provide a channel for linking those who want to save with those who want to invest.

There are no restrictions on commercial banks' holding of 1.____________ 1. Treasury securities or Corporate Bonds 2. _______________ commercial banks deal in the secondary money market for their customers. 2. Not all or All

Treasury securities Not all

Eurocurrencies are similar to short-term Eurobonds ... T/F

True

T/F Each step in the derivation of the model is clearly and carefully laid out.

True

t/f During the financial crisis, Citigroup stopped paying its dividend. This action--all else equal--decreased its financial leverage.

True

t/f In the United States, bonds are a more important source of external funds than stocks.

True

Are US companies that manufacture semi-conductors happier when the dollar is strong or when it is weak? Semi-conductor manufacturers are happier when the dollar is

Weaker

Do we need money markets in the presence of the banking industry? A. Yes, because short-term securities offered by money markets are more liquid and safer than the bank securities are. B. No, because the money markets are subject to more governmental costs than the banks are. C. No, because money markets never have a cost advantage over banks in providing short-term funds. D. Yes, because the banking industry is subject to more regulations than the money markets are.

Yes, because the banking industry is subject to more regulations than the money markets are.

Consider the supply and demand for bonds in the market for U.S. Treasury bonds. Suppose that theU.S. government runs a much greater deficit than expected. How does that impact the market forbonds? (Choose best response, as always.) Hint: what happens to bond prices? a. The supply of bonds increases, and the interest rate increases. b. The supply of bonds decreases, and the interest rate increases. c. The supply of bonds decreases, and the interest rate decreases. d. The supply of bonds increases, and the interest rate decreases

a. The supply of bonds increases, and the interest rate increases.

BM creates and sells additional stock to the investment banker Morgan Stanley. Morgan Stanley then resells the issue to the U.S. public through its mutual funds.This transaction is an example of a(n): a. primary market transaction. b. money market transaction c. asset transformation by Morgan Stanley. d. maturity disintermediation. e. forward transaction.

a. primary market transaction.

Establishing a divide in research and underwriting services for investment banks and a separation of audit and non-audit services for the public accounting firm are measures to

directly reduce conflicts of interest If an accounting firm does not provide audit and non-audit services to the same client together and separate their services, it will help to directly reduce the conflicts of interest. This is because the accounting firm will have no incentive to make a favorable audit report for the client as they revenue only through auditing services and not any other services provided by them. Similarly, dividing the research and underwriting services in case of investment banks will help to directly reduce conflicts of interest.

Results because it takes time for workers and firms to find suitable matchups: natural rate of unemployment frictional unemployment structural unemployment potential output natural rate of output

frictional unemployment

Restrictive covenants A. reduce adverse selection. B.are most common in equity contracts. C.make debt contracts more incentive compatible. D.solve the lemons problem.

make debt contracts more incentive compatible.

Level of output produced at the natural rate of unemployment, at which there is no tendency for prices or wages to change: natural rate of unemployment frictional unemployment structural unemployment potential output natural rate of output

natural rate of output

The rate of unemployment consistent with full employment at which the demand for labor equals the supply of labor: natural rate of unemployment frictional unemployment structural unemployment potential output natural rate of output

natural rate of unemployment

Level of output synonymous with the natural rate of output: natural rate of unemployment frictional unemployment structural unemployment potential output natural rate of output

potential output

Which of the following reduces both adverse selection and moral hazard in a loan arrangement?

requiring that the borrower have high net worth

Results because of mismatch between job requirements and the skills or availability of local workers: natural rate of unemployment frictional unemployment structural unemployment potential output natural rate of output

structural unemployment

An institution in our financial structure that helps reduce the moral hazard arising from the principal-agent problem is the:

venture capital firm