351 final review
Suppose you are currently in the long position of a long−term bond. In this case, to hedge against a capital loss, you would enter into a ________ contract to ________ a long−term bond in the future.
interest−rate forward; sell
An important financial institution that assists in the initial sale of securities in the primary market is the
investment bank
With ________ finance, borrowers obtain funds from lenders by selling them securities in the financial markets.
direct
The current supervisory practice toward risk management
evaluates the soundness of a bank's risk−management process.
I purchase a 10 percent coupon bond. Based on my purchase, I calculate a yield to maturity of 8 percent. If I hold this bond to maturity, then my return on this asset is
8%
Asymmetric information
A situation where one party often does not know enough about the other party to make accurate decisions.
moral hazard
A situation where the borrower might engage in activities that are undesirable from the lender's point of view, because they make it less likely that the loan will be paid back
Which of the following are generally true of bonds?
A bond's return equals the yield to maturity when the time to maturity is the same as the holding period.
A share of common stock is a claim on a corporation's
earnings and assets
Competition between banks
encourages greater risk taking.
Other things being the same, the financial instrument that is the most risky to own is the
equity
The agency that was created to protect depositors after the banking failures of 1930−1933 is the
Federal Deposit Insurance Corporation
The __________ ____________ is the central bank responsible for monetary policy in the United States.
Federal Reserve
When expected inflation rises, causing interest rates to rise, we have seen a demonstration of the
Fisher Effect
If an individual moves money from a money market deposit account to currency,
M1 increases and M2 stays the same.
Adverse Selection
Occurs when the potential borrowers who are the most likely to produce an undesirable (adverse) outcome—the bad credit risks—are the ones who most actively seek out a loan and are thus most likely to be selected.
Which of the following is not true regarding primary and secondary markets?
Primary and secondary markets both sell assets directly from the institution that offers the bonds
A pension fund manager is expecting to receive $10 million in one year to invest. The fund manager is concerned about falling yields. Futures contracts are available in $100,000 lots. In order to lock in today's rate, the manager could:
Take a long position with 100 364 day T-bills
Which of the following statements about the liquidity of the assets in the monetary aggregates is true
The assets in M1 are more liquid than the assets in M2
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?
The corporate bond pays 10%, the municipal bond pays 7%, and your marginal income tax rate is 25%.
Why does a financial crisis ultimately cause a substantial reduction in economic activity?
The resulting credit crash severely reduces investment for productive activities.
Suppose you purchase $100,000 face value long-term U.S. Treasury bonds at 110 and you wish to hedge your interest-rate risk over the next year. You sell a futures contract for $100,000 face value U.S. Treasury bonds for delivery in one year for 110. When one year has passed, interest rates have risen so that the price of $100,000 face value Treasury bond is 105. Which of the following statements is true?
You successfully hedged your interest-rate risk.
As the payments system evolves from barter to a monetary system,
commodity money is likely to precede the use of paper currency
Regular bank examinations and restrictions on asset holdings help to indirectly reduce the ________ problem because, given fewer opportunities to take on risk, risk−prone entrepreneurs will be discouraged from entering the banking industry.
adverse selection
The chartering process is especially designed to deal with the ________ problem, and regular bank examinations help to reduce the ________ problem.
adverse selection; moral hazard
The problem created by asymmetric information before the transaction occurs is called ________, while the problem created after the transaction occurs is called ________.
adverse selection; moral hazard
An option that can be exercised at any time up to maturity is called ________.
an American option
One of the basic principles of hedging is that financial market participants can reduce risk by offsetting a short position by taking
an additional long position
Regardless of the original source of the financial crisis, all credit booms end in a credit crash because of
an increase in adverse selection and moral hazard in the loan market.
The following are associated with an increase in the required rate of return on the equity investment except
an increase in the current price of the stock
A swap that involves the exchange of one set of interest payments for another set of interest payments is called ________.
an interest rate swap
_________ occurs when market participants observe returns on a security that is larger than what is justified by the characteristics of that security and take action to quickly eliminate the unexploited profit opportunity.
arbitrage
The advantage of forward contracts over future contracts is that they
are more flexible
The presence of deposit insurance increases the adverse selection problem in banking by
attracting risk-loving people into bank ownership.
All of the following statements regarding bitcoin transactions are true EXCEPT
bitcoin transactions are now more prevalent than cash transactions
A/an decrease in expected inflation causes
bond demand to shift right, bond supply to shift left
Regulations that reduced competition between banks included
branching restrictions
If a firm must pay for goods it has ordered with foreign currency, it can hedge its foreign exchange−rate risk by ________ foreign exchange futures ________.
buying; long
Banks are required to file ________ usually quarterly that list information on the bank's assets and liabilities, income and dividends, and so forth.
call reports
If you buy a call option on Treasury futures at 110, and at expiration the market price is 115, the ________ will ________ exercised.
call; be
An advantage of an interest-rate forward contract is that it
can be tailored to the precise needs of the parties so that interest-rate risk can be completely eliminated.
All of the following are problems associated with commodity money EXCEPT
commodities tend to have little value in and of themselves
Because of asymmetric information, the failure of one bank can lead to runs on other banks. This is the
contagion effect
Which of the following instruments pays the holder of the instrument a fixed interest payment every year until maturity, and then at maturity pays the holder the face value (principle) of the instrument?
coupon bond
A increase in the tax rate causes a _________ in the interest rate on tax exempt bonds, such as municipal bonds.
decrease
If the dividend of a stock decreases, then according to the Gordon Growth Model, holding everything else constant, the price of the stock will
decrease
Because a firm making an interest forward contract is matched up with another firm, both parties run the risk that the other may:
default or go bankrupt
If the price of bonds is below the equilibrium price, there occurs an excess
demand for bonds, the price of bonds will rise, and the interest rate will fall
In the figure above, a factor that could cause the demand for bonds to shift to the right is:
expectations of lower interest rates in the future
Markets in which funds are transferred from those who have excess funds available to those who have a shortage of available funds are called
financial markets
A credit market instrument that requires the borrower to make the same payment every period until the maturity date is known as a
fixed payment loan
According to the efficient markets hypothesis, the current price of a financial security
fully reflects all available relevant information
According to the liquidity premium and preferred habitat theories of the term structure of interest rates, a flat yield curve indicates that
future short-term interest rates are expected to fall.
Off−balance−sheet activities
generate fee income but increase a bank's risk.
The Dodd-Frank Act required the Federal Reserve to
get approval from the U.S. Treasury Department to make use of its emergency lending authority.
In the United States during the late 1970s, the nominal interest rates were quite high, but the real interest rates were negative. From the Fisher equation, we can conclude that expected inflation in the United States during this period was
high
An increase in the liquidity of corporate bonds will ________ the price of corporate bonds and ________ the yield of Treasury bonds, everything else held constant.
increase; increase
An increase in the riskiness of corporate bonds will ________ the yield on corporate bonds and ________ the yield on Treasury securities, everything else held constant.
increase; reduce
An increase in the expected inflation rate causes the supply of bonds to ________ and the supply curve to shift to the ________, everything else held constant.
increase; right
Regulators impose capital requirements on banks because a low capital-to-asset ratio dramatically
increases a bank's moral hazard.
Along the supply curve for bonds, a decrease in the price of bonds
increases the interest rate and decreases the quantity of bonds supplied
Municipal bonds tend to pay lower interest rates than U.S. Treasury bonds because
interest payments received from holding municipal bonds are exempt from federal income tax.
An individual may find making a loan to another individual unprofitable due to the fact that
it is concentrating the loan risks
If a financial institution finds it difficult to execute a transaction in the interest-rate forward market at an acceptable price this is likely due to:
lack of liquidity
With deposit insurance, _______ information regarding banks will be collected by the depositors.
less
A bank's capital-to-asset ratio is also known as its
leverage ratio
we find that low growth rates in the money supply are most likely associated with a:
low rate of inflation and low long term bond rates
Of money's three functions, the one that distinguishes money from other assets is its function as a
medium of exchange
Monetary policy is the management of______ and _____.
money and interest rates
When your required return on an equity investment decreases, then according to the Gordon Growth Model, you will be willing to pay _______ for the investment.
more
A well−capitalized financial institution has ________ to lose if it fails and thus is ________ likely to pursue risky activities.
more; less
The yield to maturity for a discount bond is ________ related to the current bond price.
negatively
If you buy a call option for $100,000 face value long-term Treasury bonds for a 2-point premium and a strike price of 115 that expires at the end of June, and at the end of June the price of the bond is 113, then you will
not exercise the option and lose $2,000
The seller of an option has the ________ to buy or sell the underlying asset while the purchaser of an option has the ________ to buy or sell the asset.
obligation; right
If Second National Bank has more rate−sensitive liabilities than rate−sensitive assets, it can reduce interest rate risk with a swap that requires Second National to
pay fixed rate while receiving floating rate
The efficient market hypothesis implies that:
prices in markets like the stock market are unpredictable
Banks
provide a channel for linking those who want to save with those who want to invest
Evidence from business cycle fluctuations in the United States indicates that.
recessions are usually preceded by a decline in the growth rate of money.
Consumer protection legislation includes legislation to
reduce discrimination in credit markets
financial intermediaries
reduce transactions costs for lender-savers and borrower-spenders
According to the Gordon Growth Model, the price of stocks depend on the following except
return on Treasure bills
A put option gives the owner the
right to sell the underlying security
If a financial institution purchases $10 million of long-term Treasury bonds at par value and interest rates rise in the future, the value of the Treasury bonds will _______ prior to maturity
rise
If you sold a short contract on financial futures you hope interest rates
rise
If you take a short position in financial futures, you will profit if interest rates
rise
If you wish to hedge the interest-rate risk on $4 million worth of long-term Treasury bonds over the next year, and if the contract size is $100,000 per contract, which of the following transactions should you undertake?
sell 40 T-bond futures contracts with a delivery date in one year
Parties who have sold a futures contract and thereby agreed to ________ (deliver) the bonds are said to have taken a ________ position.
sell; short
If the interest rate on a bond is below the equilibrium interest rate, there is an excess ________ of bonds and the bond price will ________.
supply; fall
When the government has a surplus, as occurred in the late 1990s, the ________ curve of bonds shifts to the ________, everything else held constant.
supply; left
if inflation is lower in Canada than in the United States, it is likely that:
the Canadian money supply is growing slower than the U.S. money supply
Which of the following is NOT a problem with barter?
the commodity money having value for other uses besides money
Arbitrage is best described as
the elimination of riskless profit opportunities in a market
currency swaps involve
the exchange of a set of payments in once currency for a set of payments
M1 and M2 growth rates
the growth rates of these monetary aggregates do tend to move together
Everything else held constant, if the tax−exempt status of municipal bonds were eliminated, then
the interest rate on municipal bonds would exceed the rate on Treasury bonds
The most common type of interest-rate swap specifies:
the type of interest payments
One of the major disadvantages of forward contracts is
they are subject to default risk
All other things held constant, premiums on options will increase when the
volatility of the underlying asset increases
Which of the following statements about the monetary aggregates is false
when the growth rate of M2 increases, the growth rate of M1 must decrease
Does the efficient markets hypothesis imply that the average investor will not earn anything by purchasing stock?
No, the efficient market hypothesis implies that the average investor should not expect to receive abnormally high returns on a consistent basis