Econ 310 Exam 1

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short sale

option price declines buy the option sell the stock at a high price buy the stock back when it declines

listed options

options traded on exchanges (like the NYSE or the CBOE)

moral hazard

outcome of asymmetric info problem of verifying that borrowers are using funds as intended

foreign exchange market

over the counter market where international currencies are traded

noise trading

over-reacting to good and bad news

noisetrading

overreacting to good or bad news. -consequence of investors' overconfidence -Noise trading can also lead to herd behavior - investors imitating the behavior of other investors rather than attempting to trade on the basis of fundamental values.

dividend

payment that a corporation makes to stockholders, typically on quarterly basis

perpetuity

pays a fixed coupon, but does not mature

The majority of wealth held by households is in... One reason for this might be that such accounts offer ....

pension and retirement accounts tax advantages

The majority of wealth held by households is in ____ one reason for this might be that such accounts offer

pension and retirement accounts; tax advantages

adaptive expectations

people make forecasts of future values of a variable using only PAST values of the variable

adaptive expectations

people make forecasts of future values of a variable using only past values of the variable -most economists are critical b/c assumes people ignore info that would be useful in making forecasts

rational expectations

people make forecasts of future values using ALL available info

quants

people who evaluate and price new securities

momentum investing

persistence occurs in stock movements so that a stock that is increasing in price is more likely to continue to rise, and vice versa (the opposite of mean reversion)

stock exchange

physical location where stocks are bought and sold face to face on a trading floor ex NYSE

speculate

place financial bets, as in buying or selling futures or option contracts, in an attempt to profit from movements in asset prices

speculate

placing financial bets, as in buying or selling futures or options contracts, in an attempt to profit from movements in asset prices.

liquidity risk

possibility a bank may not be able to meet cash needs

risk loving

prefer to hold riskier assets with possibility of maximizing returns

risk loving investors

prefer to hold risky assets with the possibility of maximizing returns.

present discounted value

present value is sometimes called _______ ________ ______

spot price

price an asset can be sold at today

strike price

price at which the buyer has a riht to buy or sell an option

bear market

price decline of at least 20% from a previous high

adverse selection

problem in distinguishing between high and low risk investors associated with the lemon problem

financial arbitrage

process of buying and selling securities to profit from price change over a brief period of time

financial arbitrage

process of buying and selling securities to profit from price changes over a brief period of time

compounding

process of earning interest on interest as savings accumulate over time

market for corporate control

provides a means to remove top management this is failing to carry out wishes of shareholders

small open economy

quantity of loanable funds supplied or demanded is too small to affect the world real interest rate

preferred stockholders

receive a fixed dividend that is set when the corporation issues the stock

dividends on common stock

receive divided that fluctuates as the profitability of the corporation varies over time

dividends on preferred stock

receive fixed dividend that is set when corporation issues the stock

common stockholder

receives a dividend that fluctuates with the profitability of the corporation

preferred stockholder

receives a fixed dividend

stock prices are a leading indicator of

recessions

The purpose of diversification is to

reduce risk

When expected inflation increases, investors ________ their demand for bonds because, for each nominal interest rate, the higher the inflation rate, the ________ the real interest rate investors will receive.

reduce; lower

Suppose that there is concern about the stability of the global financial system causing a flight to the safety of U.S. government bonds. Which of the following is NOT a likely consequence?

reduced supply of U.S. government bonds

spending time and money acquiring info on bond _____ bond's expected return

reduces

double taxation of dividends

reduces investors' incentive to buy stocks and gives firms an incentive to retain profits, which may be inefficient

For any given nominal interest rate, an increase in the expected rate of inflation

reduces the expected real interest rate.

hedge

reducing risk by purchasing a derivative contract that will increase in value when another asset in an investor's portfolio decreases in value.

January effect

refers to the fact that during some years, rates of return on stocks have been abnormally high during january

The futures price

reflects traders' expectations of the spot price on the day of delivery.

risk structure of interest rates

relationship among interest rates on bonds that have different characteristics but same maturity

credit rationing

restriction of credit by lender so borrowers cannot obtain the funds they desire at a given interest rate

capital controls

restrictions on the ability of investors or financial firms to freely trade currencies

Rate of return (R) formula

return as a % + coupon payment / divided by initial price R = coupon/initial price + change in price / initial price

expected return

return expected on an asset during a future period. -Expected return = [(Probability of event 1 occurring) X (Value of event 1)]+ [(Probability of event 2 occurring) X (Value of event 2)].

rate of return (R)

return on a security as a % of the initial price. •For a bond, R equals the coupon payment plus the change in the price of a bond divided by the initial price. -the longer the maturity of your bond, the lower (more negative) your return after one year of holding the bond.

after-tax return

return the investors have left after paying their taxes

exchange rate risk

risk that an investor will suffer losses because of fluctuations in exchange rates

default risk

risk that bond issuer will fail to make payments of interest or principal

Interest-rate risk

risk that the price of a financial asset will fluctuate in response to changes in market interest rates -Bonds with fewer years to maturity will be less affected by a change in market interest rates.

return

security's total earnings. •For a bond, its return is the coupon payment plus the change in its price.

If you were convinced that the spot price of wheat was going to be lower in August than the current futures price, you could _____

sell wheat futures with the intention of buying them back at the lower price on or before the settlement date.

In a call options contract, the

seller has the obligation to deliver the instrument at a specified time.

stockholder

shareholder - has a legal claim on the firm's profits and on its equity (assets minus liabilities).

decrease in wealth and bond demand curve

shift the demand curve for bonds to the left. As a result, both the equilibrium price and the equilibrium quantity of bonds decrease.

increase in wealth and bond demand curve

shift the demand curve for bonds to the right. As a result, both the equilibrium price of bonds and the equilibrium quantity of bonds increase. because more funds are allocated to bonds

forms of bank borrowings

short term loans in federal funds market (from other banks) loans from foreign branches repurchase agreements discount loans from the Fed

repurchase agreements

short term loans where you sell Treasury securities and agree to buy them back later

downward sloping yield curve

short term rates are higher than long term

upward sloping yield curve

short term rates are lower than long term

Monetary policy has traditionally focused on the

short-term nominal interest rate

When the yield curve is downward-sloping,

short-term yields are higher than long-term yields.

treasury yield curve

shows relationship among i on treasury bonds with diff maturities

bubble

situation in which the price of an asset rises well above the asset's fundamental value

bubble

situation in which the price of an asset rises well above the asset's fundamental value -Investors imitating each other can fuel a speculative bubble.

Under the expectations theory, if market participants expect that future short-term rates will be higher than current short-term rates, the yield curve will

slope upward.

Under the liquidity premium theory, the expectation that future short-term rates will be constant results in a yield curve that

slopes upward.

Which of the following financial assets has both the highest risk and highest return for the period of 1926-2015?

small company stocks

sole proprietors

sole owners of a firm

sole proprietors

sole owners of a firm -unlimited liability for firm's debts

short position

someone has a ___ ____ if he or she has promised to sell or deliver the underlying asset.

medium of exchange

something accepted as payment for goods and services

liability

something an individual or firm owes

asset

something of value that an individual or firm owns

medium of exchange

something that is generally accepted as payment for goods and services.

Businesses typically issue bonds to finance

spending on new plant and equipment

futures contracts

standardized contract to buy or sell a specified amount of a commodity or financial asset on a specific future date -lack some flexibility of forward contracts -have greater liquidity and less counterparty risk and info costs --> increases willingness of investors to buy and sell future contracts. -large number of buyers and sellers in the market -symmetric rights and obligations - seller must deliver the underlying asset and teh buyer must take delivery at the futures price on the delivery date

types of off balance sheet activities

standby letters of credit loan commitments loan sales trading activities

leading indicator of recessions

stock prices

wealth

sum of value of persons assets minus the value of the persons liabilities

if government runs large deficit,

supply shifts right, EQ interest rate on bonds will increase, EQ quantity of bonds will increase

mean reversion

tendency for stocks that have recently been earning high returns to experience low returns to earn high returns in teh future

The idea that nominal interest rates rise or fall one-for-one with expected inflation is known as

the Fisher effect

higher, smaller

the ______ the interest rate we use to discount future payments, the _____ the present value of the payments.

term premium

the additional interest investors require in order to be willing to buy a long-term bond rather than a comparable sequence of short-term bonds

Many savers are willing to accept a lower interest rate on municipal bonds than on comparable instruments because

the after-tax yield on municipal bonds is greater.

Face value (or par value):

the amount to be repaid by the bond issuer (the borrower) at maturity

face value

the amount to be repaid by the bond issuer (the borrower) at maturity

face value of coupon bond

the amount to be repaid by the bond issuer (the borrower) at maturity

Coupon:

the annual fixed dollar amount of interest paid by the issuer of the bond to the buyer

coupon

the annual fixed dollar amount of interest paid by the issuer of the bond to the buyer

coupon of coupon bond

the annual fixed dollar amount of interest paid by the issuer of the bond to the buyer

behavioral finance

the application of concepts from behavioral economics to understand how people make choices in financial markets

fisher effect

the assertion by Irving Fisher that the nominal interest rises or falls point-for-point with changes in the expected inflation rate

required return on equities

the expected return necessary to compensate for the risk of investing in stocks -rate of return firms need to pay to attract investors - equity cost of capital -how much firms need to pay investors to attract them - compensates for risk investors are taking

future, smaller

the further in the _____ a payment is to be received, the ______ its present value.

the longer the maturity of a bond,

the lower (more negative) your return

The average investor must weigh the benefits of liquidity against

the lower returns on liquid assets

A call (put) option is in the money if

the market price above (below) the strike price.

mean reversion

the tendency for stocks that have recently been earning high returns to experience low returns in the future and for stocks that have recently been earning low returns to earn high returns in the future.

random walk

the unpredictable movements in the price of a security

random walk

the unpredictable movements in the price of a security -on any given day, prices will rise and fall

random walk

the unpredictable movements in the price of a security -stock prices follow random walk

future value

the value at some future tie of an investment made today

future value

the value at some future time of an investment made today -the future value of an investment (principal) in one year (FV1) with an interest rate i --> principal x (1+i) = FV1

Current yield:

the value of the coupon expressed as a percentage of the current price

current yield of coupon bond

the value of the coupon expressed as a percentage of the current price

current yield

the value of the coupon expressed as a percentage of the current price of the bond.

Coupon rate:

the value of the coupon expressed as a percentage of the par value of the bond

coupon rate of coupon bond

the value of the coupon expressed as a percentage of the par value of the bond coupon rate = C/F

coupon rate

the value of the coupon expressed as a percentage of the par value of the bond.

opportunity cost

the value of what you have to give up to engage in an activity

present value

the value today of funds that will be received in the future

time value of money

the way that the value of a payment changes depending on when the payment is received

If investors expect inflation to be higher:

the yields on bonds will rise because investors will need a higher rate of return on the bonds they are purchasing.

expectations theory

theory of term structure of interest rates which holds that the interest rate on a long-term bond is an average of the interest rate investors expect on short-term bonds over the lifetime of the long-term bond

segmented markets theory

theory of the term structure of interest rate -interest rate on a bond of a particular maturity is determined only by the demand and supply for bonds of that maturity

time value

there will be a greater premium if the expiration is farther

Given that most investors tend to be risk averse

there's a trade-off between risk and return.

People value something as money only if

they believe others will accept it from them as payment.

Forward contracts are often illiquid because

they generally contain terms specific to the particular buyer and seller.

In 2012 investors were willing to accept a negative real yield on 10-year Treasury notes because:

they were looking for a safe asset with any kind of nominal interest rate to purchase.

Which of the following types of mortgage loans became more common during the housing boom of the early-to-mid 2000s?

those with flawed credit history

categories of bank loans

to businesses to consumers real estate

churn a portfolio

to move funds repeatedly between stocks

hedge

to take action to reduce risk

hedge

to take action to reduce risk by, for example, purchasing a derivative contract that will increase in value when another asset in an investor's portfolio decreases in value

When the Fed increases the money supply, the money supply curve shifts

to the right, and the equilibrium nominal interest rate falls.

market capitalization

total market value of a firm's common and preferred stock

market capitalization

total market value of firm's common and preferred stock

money supply

total quantity of money in the economy

wealth

total value of assets a person owns, minus the total value of any liabilities that a person owes.

functions of speculators

transfer risks away from hedgers provide essential liquidity

credit default swap

type of insurance - requires seller to make payment to the buyer if the price of the security declines if you sell a credit default swap and you default, you have to pay the buyer (but they pay you a small amount per year if you don't default) popular with mortgage-backed securities and CDOs

Table 5.1 shows the interest rates for Treasury securities of different maturities. Assume that the liquidity premium theory is correct. Table 5.1 1 year 2 years 3 years 1.50% 2.25% 3.25% Refer to Table 5.1 On this day, what did investors expect the interest rate to be on the one-year Treasury bill in two years if the term premium on a two-year Treasury note is 0.25% and the term premium on a three-year Treasury note is 0.75%? A. 2.375% B. 3.25% C. 3.50% D. 4.75%

unknown

Which of the following best describes a "bubble"? A. when the price of an asset reaches a new high B. an unsustainable increase in the price of a class of assets C. when bond prices rise more quickly than stock prices D. rapid increases in inflation

unknown

random walk

unpredictable movement of the price of security

commercial paper

unsecured promissory notes of $100,000 and up that mature in 270 days or less

bubble

unsustainable increase in the price of a class of assets. -Overly optimistic expectations made it easier for families to borrow money to buy houses.

segmented markets theory offers plausible explanation of why the yield curve is ___ sloping:

upward -there are more investors who are in the market for short term bonds, causing their prices to be higher and their interest rates lower, and fewer investors who are in the market for long term bonds, causing their prices to be lower and interest rates higher -investors who buy long term bonds require a higher interest rate to compensate them for additional interest rate risk and lower liquidity of long term bonds

market for loanable funds approach

useful when considering how changes in demand and supply affect interest rates

bond market approach

useful when considering how the factors affecting supply and demand for bonds affect the interest rate

value-at-risk approach

uses statistical models to estimate the maximum losses a portfolios value is likely to sustain over a period of time

A decrease in expected inflation

usually leads to falling nominal interest rates

future value

value at some future time of an investment made today

Time value of money

value of a payment changes depending on when the payment is received.

present value

value today of funds that will be received in the future. -aka present discounted value -The present value of a series of future payment is simply the sum of the discounted value of each individual payment.

leverage ratio

value/assets INVERSE OF LEVERAGE

reserves

vault cash + bank deposits with the Fed

unit of account

way of measuring value in an economy in terms of money.

what happens to bond market when price changes

we move along the demand (supply) curve, so we have a change in quantity demanded (supplied).

money vs wealth vs income

wealth - bigger than income; money is a part of it, but its the sum of the value of a person's assets minus the value of the person's liabilities income - bigger than money holdings; persons earnings over period of time money - asset serves as a medium of exchange person has less money than income or wealth

direct finance

when borrowers go directly to savers for funds, if this replaced financial intermediaries, prices would increase and loans would decrease

specialization

when individuals produce the goods or services for which they have relatively the best ability

when is an investment bank subject to a run?

when investors do not renew their repurchase agreements

bank panic

when the bank is unable to return deposits

important distinction b/w futures and options contracts

when you purchase a futures contract, funds change hands daily as the contract is marked to market. with options contract, once you have purchased the option, funds change hands only when the option is exercised

OTC market

where financial securities are exchanged by dealers linked by computers

The further away the expiration date, the greater the chance that the intrinsic value of the option

will increase

When a mortgage is renegotiated, lenders ____ and borrowers ___

win, win

bank run

withdrawing deposits quickly from a bank

opposite

yields to maturity and bond prices move in ______ directions

the buy and hold strategy of expectations theory

you buy a two year (discount) bond and hold it until maturity -avoid having to deal with coupon payments

To fulfill the futures market obligation

you can engage in either settlement by delivery or settlement by offset

uncertainty in picking portfolio of assets

you can make a decision and select portfolio but the result in the end/future is unknown uncertainties are physical or human behavior

If you wish to speculate that future interest rates will be lower (or higher) than expected,

you could buy (or sell) Treasury futures contracts.

How many prices would there be in a barter economy with 100 goods?

4,950

Suppose there's an 80% chance of a stock rising by 20% and a 20% chance of it falling by 40%. What is the expected rate of return on the stock?

Why might the demand for U.S. $100 bills in emerging markets be greater than the demand for lower-denomination U.S. bills?

Large-denomination bills allow substantial transactions to be carried out in cash.

Is the United States likely to become a "cashless society"?

No, because many people worry about protecting their privacy in an electronic system. No, because the infrastructure for an e-payments system is expensive to build.

If preferred stocks are initially purchased at above face value a buyback might cause _______ for investors since the buyback price is _______.

losses: below the initial purchase price resulting in a capital loss

An asset is suitable to use as a medium of exchange if it is:

•Acceptable to most people •Standardized in terms of quality •Durable •Valuable relative to its weight •Divisible

What Happens to Bond Prices When Interest Rates Change?

•If new bonds are issued at a higher interest rate, holders of existing bonds would have to adjust their bond prices. •As the bond yield is higher, the bond's market price will fall below its face value. •So, when interest rates rise, bond prices fall. A capital gain occurs when the market price of an asset increases. A capital loss occurs when the market price of an asset declines.

Should Central Banks Be Independent?

•The more independent a central bank is, the more it can resist political pressures to increase the money supply, and so the lower the country's inflation rate is. •Critics of the Fed's independence argue that it violates democratic principles and that its actions exceed the authority granted under federal law. -Most economists believe that an independent central bank provides a check on inflation.

key features of small open economy

•The real interest rate in a small open economy is the same as the interest rate in the international capital market. •If the quantity of loanable funds supplied domestically exceeds the quantity of funds demanded domestically, the country invests some of its loanable funds abroad. •If the quantity of loanable funds demanded domestically exceeds the quantity of funds supplied domestically, the country finances some of its domestic borrowing needs with funds from abroad.

"Tips" published in leading commercial or financial publications are unlikely to lead to profitable trades because A) only wealthy individuals can buy stocks in the volume necessary to take advantage of tips. B) whatever is gained by trading on the basis of tips will be taxed away by the government. C) the news will already be reflected in the market prices of the assets. D) the news contained in the tips is usually inaccurate.

Suppose Matt's New Cars issues a discount bond with a face value of $10,000 payable in one year with an interest rate of 4%. How much will they receive for the bond?

$10,000 - ($10,000 & 4%) = $9615

At an interest rate of 6%, how much will need to be invested today to have $10,000 in 5 years?

$10,000/(1 + .06)^5 = $7473 OR -N = 5 years -I = 6% -FV = $10,000 -PMT = $7473

If the annual interest rate is 8%, what would you expect to pay for a bond paying a lump sum of $10,000 in ten years?

$10,000/(1 + .08)^10 = $4632 OR -N = 10 years -I = 8% -FV = $10,000 -PMT = $4632

Which of the following represents the equation that would be used to determine the yield to maturity of a three-year fixed payment loan of $1400 which has payments of $500 per year?

$1400 = $500/(1+i) + $500/(1+i)2 + $500/(1+i)3

Suppose you plan to hold a stock for one year. You expect that, in one year, it will sell for $30 and pay a dividend of $3 per share. If your required return on equity is 10%, what is the most you should be willing to pay for the share today?

$30

If you deposit $500 in a savings account at an annual interest rate of 5%, how much will you have in the account at the end of five years?

$500 * (1 + .05)^5 = $638 OR -N = 5 years -I = 5% -PV = $500 -FV = $638

A one-year discount bond with a face value of $1,000 has an interest rate of 4%. What is its price?

$961.54

What is the price of a coupon bond that has annual coupon payments of $85, a par value of $1000, a yield to maturity of 10%, and a maturity of three years?

$962.70

nominal exchange rate equation (assuming PPP holds)

%change nominal = inflationForeign - inflationDomestic

A one−year discount bond with a par value of $5000 sold today, at issuance, for $4750 has a yield to maturity of

($5,000 - $4750)/$5000 = 5.26%

What is the rate of return on a bond with a coupon of $38 payable in one year that was purchased for $950 and sold one year later for $931?

($950-$931)/$950 = 2%

calculating sellers profits

(futures price @ purchase) - (spot price @ settlement)

What are the three most important stock market indexes?

- Dow Jones Industrial Average. - NASDAQ Composite. - S&P 500

Origins of financial crisis

-The Federal National Mortgage Association ("Fannie Mae") and the Federal Home Loan Mortgage Corporation ("Freddie Mac") also helped homeowners borrow by selling bonds to investors and used the funds to purchase mortgages from banks. -Investment banks also participated in the mortgage market by bundling and selling mortgage-backed securities -Standards for obtaining loans were greatly loosened, so that many mortgages were being issued to subprime borrowers with flawed credit histories. -Adjustable-rate mortgages allowed borrowers to pay a very low interest rate. -In 2006, housing prices began to decline, leading to rising defaults and a sharp decline in the value of many mortgage-backed securities.

efficient markets hypothesis

-The application of rational expectations to financial markets -Implies that the equilibrium price of a security is equal to its fundamental value -When investors and traders use all available info in forming expectations of future dividend payments, the equilibrium price of a stock equals the market's optimal forecast -stock prices are not predictable. The price today reflects all available information.

what causes hyperinflation

-The quantity theory indicates that hyperinflation is caused by the money supply (M) rising more rapidly than real output (Y). -Hyperinflation occurs usually when governments spend more than they collect in taxes. -A country can monetize the government's debt by forcing its central bank to print money. -If central banks misbehave with the MS --> inflation. Governments have incentive to print money, but sometimes too much, which leads to hyperinflation but it does always end.

treasury bonds

-Treasury bonds have little default risk as the U.S. government is almost certain to make payments on its bonds. -In 2016, many financial advisors warned investors not to buy Treasury bonds due to the risk related to higher interest rates. -The Fed had responded to the weak U.S. economy by increasing the money supply that would lead to high inflation in the long run. -The expectation of high future inflation would lower the prices of bonds as a result of higher interest rates on those bonds.

supply for USD increases when...

-US demand for foreign goods increases -foreign interest rates rise relative to US interest rates

countries standard of living is based on:

-ability to accumulate physical capital -ability to adopt latest tech -ability of govt to provide legal framework to protect property rights

money

-anything that is generally accepted as payment for goods and services or to pay off debts -liquid asset; can always hold in your pocket -allows people to specialize, so they become more productive, and earn higher incomes.

expected real interest rate

-because lenders and borrowers don't know what the actual real interest rate will be during the period of a loan, they must estimate an EXPECTED real interest rate -r = i - pi(e) --> real int rate = nominal interest rate - expected rate of inflation i = r + expected rate of inflation

rollover strategy of expectations theory

-buy a one year bond today and hold it until it matures in one year. at that time, you buy a second one year bond and hold it until it matures at the end of the second year. -you cannot be sure what interest rate you will receive on the one year bond one year from now. instead, you must rely on all the info you have about the bond market to form an expectation of what the interest rate on the one year bond will be one year from now.

noise trading

-consequence of over confidence -involves investors overreacting to good or bad news

Pricing anomalies are inconsistent with the efficient markets hypothesis for several reasons:

-data mining -Risk, liquidity, and information costs -trading costs and taxes

gordon growth model

-dividend-discount model -uses the current dividend paid, the expected growth rate of dividends, and the required return on equities to calculate the price of a stock.

flight to quantity

-during recessions, the default risk on corporate bonds typically increases. -involves investors decreasing their demand for higher-risk bonds and increasing their demand for lower-risk bonds

common stockholders

-elect members of the board of directors -receive dividend that fluctuates as profitability of the corporation varies over time

stocks

-financial securities that represent partial ownership of a firm; also called equities -profit split by shareholders - if you buy stock, you're entitled to fraction of this profit

bonds

-financial security issued by a corporation or a government that represents a promise to repay a fixed amount of money -promise to pay in the future - the time is the maturity. -are predefined; typically promise dollar payments; relatively safe; some are very liquid (you can buy today and sell tomorrow).

changes in cost of equity funding for firms

-financing spending through stock sales is equity funding -higher stock prices make it easier for firms to fund spending on real physical investments by issuing new stock -lower stock prices make it more difficult for firms to finance this type of spending

seller of a futures contract

-has the obligation to deliver the underlying financial instrument at the specified date. -can use selling a futures contract to hedge if the seller is the owner of the underlying asset and wants to insure against the price faling -can use selling a futures contract to speculate if the seller believes that the price of the underlying asset will fall

buyer of futures contract

-has the obligation to receive the underlying financial instrument at the specified future date. -can use buying a futures contract to hedge if the buyer is someone who intends to buy the underlying asset and wants to insure against the price rising -can use buying a futures contract to speculate if the buyer believes that the price of the underlying asset will rise

changes in cost of equity funding for firms

-higher stock prices make it easier for firms to fund spending on real physical investments such as factories and machinery/research and development by issuing new stock -lower stock prices make it more difficult for firms to finance this type of spending

graphs of housing bubble

-housing bubble resulted in rapid increases in sales of new houses between 2000 and 2005, followed by a sharp decrease in sales beginning in July 2005 -home prices followed a similar pattern to home sales

Forward contracts are specific in terms, so they are:

-illiquid -subject to one specific type of default risk—counter party risk

importance of interest rate

-most financial transactions involve payments in the future. -The interest rate provides a link between the financial present and the financial future.

preferred stockholders

-not eligible to vote in electing board of directors -receive fixed that is set when the corporation issues the stock

dividends

-payments that a corporation makes to its shareholders after keeping some of its profits. -not fixed/known values up front - can fluctuate and are random. risk involved because dividends could be low.

liquidity premium theory

-preferred habitat theory) -the interest rate on a long term bond is an average of the interest rates investors expect on short term bonds over the lifetime of the long term bond plus a term premium that increases in value the longer the maturity of the bond

price of a stock held for two years should be equal to the sum of

-present values of the dividend payments the investor expects to receive during the two years -present value of the expected price of the stock at the end of two years

foreign exchange

-refers to units of foreign currency. -To buy foreign goods and services or foreign assets, a domestic business or a domestic investor must first exchange domestic currency for foreign currency. -Banks are the largest buyers and sellers of foreign exchange. -Banks engage in foreign currency transactions on behalf of investors and business firms.

changes in expectations of households and firms

-significant declines in stock prices are typically followed by economic recessions --> consumers aware of this pattern may become more uncertain about their future incomes and jobs when they see a fall in stock prices --> postpone spending on houses and consumer durables

changes in household wealth and stocks

-stocks make up significant portion of household wealth -when stock prices rise, so does household wealth; when stock prices fall, so does household wealth -households spend more when their wealth increases and less when their health decreases

financial arbitrage

-the process of buying and selling securities to profit from price changes over a brief period of time -profits made = arbitrage profits

changes in household wealth

-when stock prices rise, so does household wealth and when stock prices fall, so does household wealth

Suppose there's a 50% chance of a stock rising by 20% and a 50% chance of it falling by 20%. What is the expected rate of return on the stock?

would you rather have 1 dollar today or 1 dollar tomorrow

1 today so you can save/retain the $1 tomorrow. Whatever is possible with option 2, is possible with option 1 (getting the dollar today), but you will get it sooner. -funds in the future are worth less than funds in the present, so they have to be discounted to find present value

determinants of asset demand

1) The saver's "wealth", total amount of savings to be allocated among investments 2) The "Expected Rate of Return" from an investment compared with the expected rates of return on other investments 3) The degree of "risk" in an investment compared wit he degree of risk in other investments 4) The "Liquidity" of an investment compared with the liquidity of other investments 5) The "cost of acquiring information" about an investment compared with the cost of acquiring information about other investments.

Explain whether securitized loans provide risk sharing, liquidity, and information.

1) When a mortgage is securitized, the buyers jointly share the risk of a default. 2)A securitized loan can be resold and so has a secondary market, which makes it liquid. 3)When loans are securitized, investors rely on the bank to have gathered the necessary information.

effect of changes in stock prices on spending occurs in 3 channels:

1) changes in the cost of equity funding for firms 2) changes in household wealth 3) changes in expectations of households and firms

effect of changes in stock prices on spending occurs through 3 channels:

1) changes in the cost of equity funding for firms 2) changes in household wealth 3) changes in expectations of households and firms

2 ways to reduce savers risk

1) diversification 2)risk sharing

speculators help derivative markets operate by serving two purposes:

1) hedgers able to transfer risk to speculators 2) speculators provide essential liquidity. otherwise, there would not be a sufficient number of buyers and sellers for the market to operate efficiently.

investors can receive 2 types of income from owning bonds:

1) interest income from coupons 2) capital gains (or losses) from price changes on the

two parts of option premium

1) intrinsic value 2) time value

2 key assumptions of the expectations theory

1) investors have the same investment objectives 2) for a given holding period, investors view bonds of different maturities as being perfect substitutes for one another. Holding a 10 year bond for 10 years is the same to investors as holding a 5 year bond for 5 year and another 5 year bond for a second 5 years

segmented markets theory addresses shortcomings of expectations theory by making 2 related observations:

1) investors in the bond market do not all have the same objectives 2) investors do not see bonds of different maturities as being perfect substitutes for each other

points to notice about gordon growth model

1) model assumes that the growth rate of dividends is constant - may be an unrealistic assumption b/c investors might believe that dividends will grow in an uneven pattern 2) to use the model, required rate of return on the stock must be greater than the dividend growth rate 3) investors' expectations of the future profitability of firms and, therefore, their future dividends, are crucial in determining the price of stocks

how futures contracts differ from forward

1) traded on exchanges 2) specify quantity of underlying asset to be delivered but don't fix price on the settlement date when the asset is delivered. instead, the price changes continually as contracts are bought and sold on the exchange. 3) futures contracts are standardized in terms of the quantity of underlying asset to be delivered and the settlement dates for available contracts

four sources of inefficiency in barter system

1)A double coincidence of wants increases the transactions costs. 2)Each good has many prices. 3)A lack of standardization exists for goods and services. 4)It is difficult to accumulate wealth.

Why Are Bond Interest Rates So Low?

1)Between 2007 and 2016, the increase in government deficits in the United States shifted the supply curve for bonds to the right. 2)However, the demand curve for bonds also shifts to the right, which was even greater than the shifts in the supply curve. 3)The large increase in the demand for bonds was due to (1) investors' flight to quality by buying government bonds, and (2) a the quantitative easing monetary policy (purchases of long-term securities) by the Fed and other central banks. 4) As a result, bond prices increased and interest rates decreased.

financial system matches savers and borrowers through two channels

1)banks and other financial intermediaries 2)financial markets

financial markets facilitate 2 types of flow of funds

1)indirect finance - Funds flow from lenders to borrowers indirectly through financial intermediaries, such as banks. 2) direct finance - Funds flow directly from savers to borrowers ex. buy shares of apple, buy IBM bonds

points to notice about gordon growth model

1)the growth rate of dividends is constant - may be unrealistic 2) required rate of return on the stock must be greater than the dividend growth rate 3) investors' expectations of the future profitability of firms and, therefore their future dividends, are crucial in determining prices of stocks

interest rate parity condition does not always hold because

1. differences in default risks and liquidity 2. transaction costs 3. exchange rate costs

factors to shift supply curve of bonds

1. expected pretax profitability of physical capital investment 2. business taxes 3. expected inflation 4. government borrowing

important poins about discounting

1. further into future payment is received, the smaller the present value 2.higher interest rate used to discount future payments, the smaller PV of payments 3. PV of a series of FP is the sum of discounted value of each individual payment

fischer effect implies:

1. higher inflation leads to higher i 2. changes in expected inflation can lead to changes in i before a change in actual inflation occurs

two types of income from owning bonds

1. interest income from coupons- taxed at the same rates as wage and salary income 2. capital gains/losses from price changes on the bond

determinants of portfolio choice

1. investors wealth 2. expected rates of return 3. degrees of risk 4. liquidity of different investments 5. costs of acquiring information about dif investments

four functions of money

1. medium of exchange 2. unit of account 3. store of value 4. offers standard of deferred payment

complications of PPP

1. not all products can be traded internationally 2. products are differentiated 3. govts can impose barriers to trade

shifts in money demand curve

1. real GDP 2. price level

four types of debt payments

1. simple loans 2. discount bonds 3. coupon bonds 4. fixed payment loans

key features of US Financial System

1. small firms most important source of funds are from financial intermediaries 2. stock market is less important for raising funds than the bond market 3. debt contracts require collateral/restrictive covenants

desirable outcomes for a payment system

1. speed 2. security 3. efficiency 4. smooth international transactions 5. effective collaboration among participants in the system

4 main sources of inefficiency in barter economy

1. transaction costs 2. each good has many prices 3. a lack of standardization exists for goods and services 4. difficult to accumulate wealth

benefits of swaps

1. transfer interest rate risk to parties willing to bear it 2. more flexible than futures or options 3. offer long term hedging 4. little govt regulation

five factors that shift demand curve for bonds

1. wealth 2. expected return on bonds 3. risk 4. liquidity 5.info costs

Why Do Interest Rates Fall During Recessions?

1.An economic downturn reduces household wealth and thus decreases the demand for bonds. 2.The fall in expected profitability reduces lenders' supply of bonds. 3.In the new equilibrium, the bond price rises.

Expected Inflation and Interest Rates

1.An increase in expected inflation reduces investors' expected real return, thus the demand curve for bonds shifts to the left. 2.The increase in expected inflation increases firms' willingness to issue bonds, thus the supply curve for bonds shifts to the right. 3.In the new equilibrium, the bond price falls.

Warren Buffett identified three problems with derivatives particularly not traded on exchanges:

1.Derivatives are thinly traded, and dealers use prices predicted by models that may be inaccurate. 2.Many derivatives are not regulated and firms may not set aside sufficient reserves to offset potential losses. 3.Because derivatives are not traded in exchanges, they involve substantial counterparty risk.

Important factors for explaining shifts in the supply curve for bonds:

1.Expected pretax profitability of physical capital investment 2.Business taxes 3.Expected inflation 4.Government borrowing

Differences from forward contracts from future:

1.Futures contracts are traded on exchanges, e.g., the Chicago Board of Trade (CBOT) and the New York Mercantile Exchange (NYMEX). 2.Futures contracts typically specify a quantity of the underlying asset to be delivered but do not fix the price. 3.The prices of futures contract can change continually as contracts are traded on the exchange (or clearinghouse).

4 key functions of money

1.It acts as a medium of exchange. 2.It is a unit of account. 3.It is a store of value. 4.It offers a standard of deferred payment.

Variables that cause the money demand curve to shift:

1.Real GDP 2.The price level

our basic categories of debt instruments:

1.Simple loans 2.Discount bonds 3.Coupon bonds 4.Fixed-payment loans

The Fed believes that the most desirable outcomes for a payments system are:

1.Speed 2.Security 3.Efficiency 4.Smooth international transactions 5.Effective collaboration among participants in the system

The equity premium for an individual stock has two components:

1.Systematic risk - price fluctuations in the stock market that affect all stocks 2.Unsystematic (idiosyncratic) risk - movements in the price of that particular stock.

Determinants of portfolio choice (asset demand) are:

1.The investor's wealth 2.The expected rates of return from different investments 3.The degrees of risk in different investments 4.The liquidity of different investments 5.The costs of acquiring information about different investments

Five factors cause the demand curve for bonds to shift:

1.Wealth 2.Expected return on bonds 3.Risk 4.Liquidity 5.Information costs

pricing anamolies

1.small firm effect 2. january effect

A one-year discount bond with a face value of $1,000 that is currently selling for $900 has an interest rate of

11.1%.

Federal Reserve Act

1913 - created the Fed

If a bank has a leverage ratio of 0.1 and a return on assets of 2%, what is its return on equity?

20%

If a British automobile sells for pound 20,000 and the British pound is worth $1.50, then the dollar price of the automobile is

20,000 x 1.50 = 30,000

Which interest rate is typically the lowest?

3-month Treasury bills

If the real interest rate is 2% and expected inflation is 2%, the nominal interest rate is:

How many prices would there be in a barter economy with 100 goods?

4,950 E= N(N-1)/2 E = # of price ratios N = # of goods in the economy

According to the quantity theory of money, if the long - run economic growth rate is 2.5%, by how much should the Fed increase the money supply if it wants inflation to be 2%?

4.5%

Quantity theory of money - if the long run economic growth is 2.5%, by how much should the Fed increase the money supply if it wants 2% inflation

4.5% pi + delta Y = MS (2%) + (2.5%) = MS MS = 4.5%

Currently, a threeminus−year Treasury note pays 4.75%. Assuming that your tax rate is 20%, what is the minimum interest rate that you would you need to earn on a taxminus−free municipal bond in order to buy it instead?

4.75% * (1 - 20%) = 4.75% * (0.8) = 3.82%

A one-year bond currently pays 5% interest. It's expected that it will pay 4.5% next year and 4% the following year. The two-year term premium is 0.2% while the three-year term premium is 0.35%. What is the interest rate on a two-year bond according to the liquidity premium theory?

4.95%

If oranges sell for $100 per crate in the United States and 4,000 pesos per crate in Mexico, the law of one price indicates that you should be able to exchange $1 for

40 pesos

Suppose you have a fixed−rate mortgage with a nominal interest rate of 6% and the expected annual inflation rate over the life of the mortgage is 2%. What is the expected real interest rate?

6% - 2% = 4%

A one-year discount bond with a face value of $10,000 that is currently selling for $9,400 has an interest rate of

6.38%.

Suppose there's an 80% chance of a stock rising by 20% and a 20% chance of it falling by 40%. What is the expected rate of return on the stock?

Commodity money can best be described as A. a good used as money that also has value independent of its use as money. B. standardized goods like gold that trade in a financial market. C. the form of money used in a barter system. D. money used to purchase agricultural products.

During an economic expansion, A) the demand and supply curves for loanable funds both shift to the right and the equilibrium interest rate usually rises B) the demand and supply curves for loanable funds both shift to the left and the equilibrium interest rate usually falls C) the demand curve for loanable funds shifts to the right, the supply curve for loanable funds shifts to the left, and the equilibrium interest rate usually falls D) the demand curve for loanable funds shifts to the left, the supply curve for loanable funds shifts to the right, and the equilibrium interest rate usually rises

For a specific change in the yield to maturity A. the longer the time until a bond matures, the greater will be the change in its price. B. the longer the time until a bond matures, the greater will be the change in its par value. C. the shorter the time until a bond matures, the greater will be the change in its coupon rate. D. the shorter the time until a bond matures, the greater will be the change in its price.

How many prices would there be in a barter economy with 100 goods? A. 4,950 B. 10,000 C. 1,000 D. 100

If interest rates unexpectedly rise sharply, which would you prefer to be holding-- a 30 year deep discount bond or a treasury bill A) treasury bill B) 30 year bond C) you should be indifferent between the two D) cannot determine the answer without knowing their relative yields

If the expected gains on stocks rise, while the expected returns on bonds do not change, then A) the equilibrium interest rate will rise B) the demand curve for bonds will shift to the right C) the supply curve for bonds will shift to the right D) the equilibrium interest rate will fall

If the government increases taxes while holding expenditures constant, A) the bond supply curve will shift to the left and the equilibrium interest rate will fall B) the bond supply curve will shift to the right and the equilibrium interest rate will fall C) government borrowing will be increases D) the government's deficit will increase

If the government were to simultaneously cut the personal income tax and the corporate profits tax, the equilibrium interest rate A. might either rise or fall. B. would be unaffected. C. would rise. D. would fall.

If the real interest rate is 2% and expected inflation is 2%, the nominal interest rate is: A. 4% B. 0% C. 2% D. 1%

If, while you are holding a coupon bond, the interest rates on other similar bonds fall, you can be sure that A. the market price of your bond will rise. B. the coupon payments on your bond will fall. C. the par value of your bond will rise. D. the market price of your bond will fall

In the market for loanable funds, the seller is considered to be A) the lender B) the borrower C) the lender or the borrower depending on the use to which the funds are put D) the lender or the borrower depending upon whether interest rates are rising or falling

The Federal Reserve issues a report indicating that future inflation will increase from 3% to 4%. As a result A) the demand for loanable funds shifts to the right B) the supply curve for bonds shifts left C) the equilibrium interest rate falls D) the equilibrium price of bonds rises

The Federal Reserve issues a report indicating that future inflation will increase from 3% to 4%. As a result A) the supply of bonds shifts right B) the demand curve for bonds shifts right C) the equilibrium interest rate falls D) the equilibrium price of bonds rises

The current yield is equal to A. the coupon divided by the market price of the bond. B. the yield to maturity, if the bond is a coupon bond. C. the market price of the bond divided by its par value. D. the coupon divided by the par value of the bond.

The demand curve for bonds would be shifted to the left by A) an increase in expected returns on other assets B) a decrease in the information costs of bonds relative to other assets C) a decrease in expected inflation D) an increase in the liquidity of bonds relative to other assets

The existence of rating agencies has A. lowered returns on corporate bonds. B. left returns on corporate bonds largely unaffected. C. raised returns on corporate bonds. D. raised returns on both corporate bonds and Treasury securities.

The expectations theory A. has difficulty explaining why yield curves usually slope upward. B. has difficulty explaining why U.S. Treasury securities have lower yields than corporate bonds. C. accounts well for the fact that yield curves usually slope upward. D. has difficulty explaining why yields on bonds of different maturities move together.

The segmented markets theory A. explains upward-sloping yield curves as resulting from the demand for long-term bonds being low relative to the demand for short-term bonds. B. is unable to account for upward-sloping yield curves. C. explains upward-sloping yield curves as resulting from the favorable tax treatment of long-term bonds. D. explains upward-sloping yield curves as resulting from the demand for long-term bonds being high relative to the demand for short-term bonds.

The term structure of interest rates A. represents the relationship among the interest rates on bonds that are otherwise similar but that have different maturities. B. usually results in a downwardminussloping yield curve. C. always results in an upwardminussloping yield curve. D. reflects differing tax treatment received by different instruments

The two most important factors that cause the money demand curve to shift are A. real GDP and the price level. B. nominal GDP and the Fed. C. the nominal interest rate and the money supply. D. the price level and the nominal interest rate.

What is a primary reason for the yield on 3-month Treasury bills being low during recessions? A. the Fed pushing short-term interest rates down B. rising inflation C. low risk premium D. the inversion of the yield curve

What is the rate of return on a bond with a coupon of $55 that was purchased for $900 and sold one year later for $950? A. 11.67% B. 6.11% C. 12.43% D. 5.56%

When an economy grows out of a recession, normally the demand for bonds ___ and the supply of bonds _____, certeris paribus A) increases; increases B) increases; decreases C) decreases; decreases D) decreases; increases

When the economy grows out of a recession, normally the demand for bonds ______, and the supply for bonds ____, certeris paribus A) increases; increases B) increases; decreases C) decreases; decreases D) decreases; increases

When the price of a coupon bond increases, A. the current yield declines B. the coupon rate declines C. the coupon rate increases D. the current yield increases

Which of the following is NOT a key financial service provided by the financial system? A. profitability B. information C. risk sharing D. liquidity

Which of the following types of mortgage loans became more common during the housing boom of the early-to-mid 2000s? A. those with flawed credit histories B. those with down payments of at least 20% C. prime Mortgages D. thirty-year, fixed-rate mortgages

Which of the following will cause equilibrium interest rate to rise A) the savings rate decreases B) Business borrowing decreases C) the federal deficit increases D) National wealth increases

Which of these will cause the equilibrium interest rate to rise? A) A decrease in the supply of loanable funds B) A decrease in the demand for loanable funds C) An increase in the supply of loanable funds D) A decrease in the quantity of loanable funds demanded

If, while you are holding a coupon bond, its market price falls, you can be sure that A. the interest rate on other similar bonds must have risen. B. the par value of the bond must have declined. C. the interest rate on other similar bonds must have fallen. D. the coupon payment you are receiving must have been reduced.

A "primary market" is a market A) for government securities. B) in which newly issued claims are sold to buyers by borrowers. C) in which newly issued claims are sold by savers to borrowers. D) for debt by large or "primary" corporations

A bank lending depositors' money to a local business and a pension fund investing contributions in shares of a company are similar financial activities in that A) both involve the use of financial markets. B) both involve funds being channeled from savers to borrowers through financial intermediaries. C) both involve a reduction in the overall level of liquidity in the financial system. D) both involve in an increase in the overall level of risk in the financial system

A bond's price and its yield to maturity are inversely related because A) discounting future payments at a higher rate reduces the present value of the payments. B) discounting future payments at a higher rate increases the present value of the payments. C) an increase in the yield to maturity will lower a bond's coupon rate and hence its price. D) a fall in a bond's price will lower its par value and hence its yield to maturity

A borrower and a lender agree on a mortgage interest rate. If inflation turns out to be less than expected A) the actual real interest rate will exceed the expected real interest rate. B) the actual real interest rate will be less than the expected real interest rate. C) the actual nominal interest rate will be higher than expected. D) the actual nominal interest rate will be less than expected

A bubble occurs when A) the price of a stock is above its fundamental value. B) inside information is used to make profits from trading a company's stock. C) a company reports profits that are significantly above or below the expectations of financial analysts. D) the futures price is greater than the price of the underlying asset.

A call option is said to be in the money" if A) it is written on a Treasury bill or other money-market asset. B) it has increased in price since it was first written. C) the price of the underlying asset is currently greater than the strike price. D) the price of the underlying asset is currently greater than the strike price plus the option premium.

A capital gain occurs when the A) coupon rate increases. B) current yield increases. C) price of an asset increases. D) yield to maturity increases

What causes the demand curve for bonds to shift?

A change in wealth, a change in the liquidity of bonds, a change in expected inflation

Since the price of the bond equals its present value, the price is $50/1.04 + $50/(1.04)^2+ $1050/(1.04)^3 = $1029

A corporation issues a three year bond with a coupon of $50 and a face value of $1000. Immediately after being issued, market interest rates decline to 4%. What is the price of the bond? Report your answer to the nearest dollar

Since the price of the bond equals its present value, the price is $50/1.04 + $1050/(1.04)^2 = $1019.

A corporation issues a three-year bond with a coupon of $50 and a face value of $1000. A year later, market interest rates have declined to 4%. What is the price of the bond a year after it was issued? Report your answer to the nearest dollar.

A corporation's market capitalization is best described as A) the total value of its stocks and bonds. B) the total value of its common and preferred stock. C) its total profit for a particular year. D) its average profit over a period of years

Which of the following is NOT an implication of the theory of purchasing power parity?

A country with a higher inflation rate should experience an appreciation of its currency.

A coupon bond has an annual coupon of $75, a par value of $1000, and a market price of $900. Its current yield equals A) 7.50%. B) 8.33%. C) its yield to maturity. D) Not enough information has been provided to calculate the current yield for this bond

A coupon bond involves A) interest payments from the borrower to the lender periodically during the life of the loan and payment by the borrower to the lender of the face value of the loan at maturity. B) interest and principal payments from the borrower to the lender periodically during the life of the loan. C) periodic payments by the borrower to the lender that include both principal and interest. D) periodic payments by the borrower to the lender that include principal, but not interest

A debt instrument represents A) an ownership claim by the purchaser on the issuer. B) a promise by a borrower to repay principal plus interest to a lender. C) an attempt by a borrower in default to restore his or her credit. D) a nontaxable asset, owned primarily by large corporations.

A decline in bank lending has the most significant effect on A) small businesses. B) large businesses. C) state governments. D) federal government

A discount bond involves A) interest payments from the borrower to the lender periodically during the life of the loan. B) payment by the borrower to the lender of the face value of the loan at maturity. C) no payment of principal by the borrower to the lender. D) payment of interest by the borrower to the lender every six months during the life of the loan

A discount bond resembles a simple loan in that A) the interest on neither is taxable. B) the borrower repays in a single payment. C) both represent assets to the borrowers who issue them. D) both have par values greater than their face values

A futures contract is A) an agreement that specifies the delivery of a commodity or financial instrument at an agreed-upon future date at a currently agreed-upon price. B) an agreement that specifies the delivery of a commodity or financial instrument at an agreed-upon future date, with the price to be negotiated at the time of delivery. C) an agreement that specifies the delivery of a commodity or financial instrument at a currently agreed-upon price, with date of delivery to be negotiated subsequently. D) an agreement that specifies the delivery of a commodity or financial instrument, with the price and date of delivery to be negotiated subsequently

If an investor is certain that market interest rates will decline in the future, which of the following will she be most likely to purchase?

A gift-year government bond

Which best describes the relationship between the cost of acquiring information and return?

A high return must compensate for a high cost of acquiring information.

A key point made by the Gordon-Growth model is that the A) value of a stock depends on investor's expectations about the future profitability of a firm. B) past trends in a stock's behavior indicate future price trends. C) dividends have little to do with a stock's value. D) risk has little effect on a stock's value

A key reason that firms and financial institutions might participate in an interest rate swap is A) to transfer interest rate risk to parties that are more willing to bear it. B) the low information costs of swaps compared with other derivative contracts. C) the greater liquidity of swaps compared with other derivative contracts. D) the favorable tax implications of swaps compared with other derivative contracts

A lender who is worried that its cost of funds might rise during the term of a loan it has made can hedge against this rise by A) buying futures contracts on Treasury bills. B) selling futures contracts on Treasury bills. C) buying call options on Treasury bills. D) increasing the amount of money which it lends

A lender who is worried that its cost of funds might rise during the term of a loan it has made can hedge against this rise without eliminating the chance to profit from a decline in the cost of funds by A) buying futures contracts on Treasury bills. B) selling futures contracts on Treasury bills. C) buying put options on Treasury bills. D) buying call options on Treasury bills

mutual funds

A mutual fund obtains money by selling shares to investors and invests the money in a portfolio of financial assets. -allows someone else to solve problem of picking business/bonds/socks/shares - someone else builds portfolio and channels funds to businesses

The yield to maturity is ($1000-$880)/$880 = 13.64%

A one-year discount bond has a face value of $1000 and price of $880. What is the yield to maturity on the bond? Report using percentages with two decimal places

A one-year discount bond with a par value of $1000 sold today, at issuance, for $943 has a yield to maturity of A) 4.30%. B) 5.70%. C) 6.04%. D) 9.43%.

A one-year discount bond with a par value of $5000 sold today, at issuance, for $4750 has a yield to maturity of A) 5.00%. B) 5.26%. C) 2.50%. D) 9.75%.

capital gain

A profit from the sale of an investment. -Capital gains are taxed at a lower rate than salary and wage income.

A put option is said to be "in the money" if A) it is written on a Treasury bill or other money-market asset. B) it has increased in price since it was first written. C) the price of the underlying asset is currently less than the strike price. D) the price of the underlying asset is currently less than the strike price plus the option premium.

A shortcoming of swaps that has led to the participation of large firms and financial institutions is A) the lack of privacy. B) need to assess creditworthiness. C) desire for more flexibility. D) limited size of the market.

A stock option is said to be "out of the money" if: A) the strike price equals the exercise price. B) stock price equals the strike price. C) strike price exceeds the stock price. D) stock price exceeds the strike price

Typically, you will receive a very low interest rate on money you deposit in a bank. Interest rates on car loans and business loans are much higher. Which of the following is not a reason why most people prefer putting their money in a bank to lending it directly to individuals or businesses?

A. A saver would have difficulties or require substantial costs to acquire the necessary information to make a solid direct loan to other individuals or businesses. B. There is less risk of default or losing money if an individual were to make a deposit in a bank. C. CORRECT ANSWER Direct lending would allow a saver the opportunity to participate in spreading out the risk of lending. .D. Deposits in a bank offer individuals more liquidity than making a direct loan.

According to the article, all of the following are reasons why central banks might consider eliminating high-denomination notes, except:

A. to curb illicit activities. B. to reduce tax evasion. C. to curtail terrorism financing. D. CORRECT decreasing demand for high-denomination notes.

All of the following are reasons why investors might be concerned about Moody's rating of these bonds, except:

A. CORRECT Rating agencies charge investors for their services. B. Moody's may have an incentive to give higher ratings than might be justified. C. SoFi chose the agency that rated its bonds. D. Rating agencies charge issuers for their services.

A business might consider all of the following costs and benefits in making a decision as to whether to go cashless, except:

A. CORRECT The cost of printing paper currency. Your answer is correct. B. Potential cash losses from theft. C. Expenses associated with maintaining cash drawers. D. Credit card processing fees.

A. Deposits in a bank offer individuals more liquidity than making a direct loan. B. A saver would have difficulties or require substantial costs to acquire the necessary information to make a solid direct loan to other individuals or businesses. C. There is less risk of default or losing money if an individual were to make a deposit in a bank. D. CORRECT Direct lending would allow a saver the opportunity to participate in spreading out the risk of lending.

Which of the following is NOT a benefit to a bank that no longer makes cash available and does not accept cash deposits?

A.CORRECT Increased privacy for bank customers. B. Reduction in staffing levels. Your answer is not correct. C. Decreased likelihood of bank robbery. D. Cost savings.

Above-normal returns on stock investments can be expected by investors who A) possess insider information. B) are wealthy enough to hold the stock of many different companies in their portfolios. C) are risk seeking. D) concentrate their investments in one or two stocks

According to the Gordon-Growth model, if the stock price is $21, required return on equity is 10% and the current dividend is $1, what is the expected growth rate of dividends? A) 2% B) 5% C) 10% D) 15%

According to the Gordon-Growth model, what is the value of a stock with a dividend of $1, required return on equity of 10% and expected growth rate of dividends of 5%? A) $2 B) $10 C) $20 D) $21

According to the Gordon-Growth model, what is the value of a stock with a dividend of $2, required return on equity of 8% and expected growth rate of dividends of 4%? A) $25 B) $26 C) $50 D) $52

According to the Gordon-Growth model, what will be the percentage change in the value of a stock of a company whose current dividend is $10.00 and whose dividends had been expected to grow by 3% but now are expected to grow by 4% per year? A) 4.0% B) 17.8% C) 25.0% D) 33.3%

According to the Gordon-Growth model, what will be the percentage change in the value of the stock of a company whose current dividend is $10.00 and whose dividends had been expected to grow by 3% per year but now are expected to grow by 1% per year? A) -4.0% B) -23.7% C) -31.1% D) -66.0%

According to the Gordon-Growth model, which of the following can cause the value of a stock to decline? A) higher expected growth rate of dividends B) increase in the current dividend C) increased systemic risk D) decreased required return on equity

According to the efficient markets hypothesis, A) the equilibrium price of an asset equals the optimal forecast of fundamental value based on available information. B) the actual and expected prices of an asset will be equal. C) the actual price of an asset reflects only information on past returns on the asset. D) the expected price of an asset incorporates only information on past returns on the asset.

According to the efficient markets hypothesis, who is most likely to benefit from frequently moving funds from one asset to another? A) your broker B) small investors C) big investors D) only those who consistently beat the market

According to the efficient markets hypothesis, who should earn the highest risk-adjusted return on stocks? A) a financial expert who can devote considerable time to research B) the average investor who doesn't do too much research C) someone throwing darts at possible stock picks D) all of the above should earn the same average return

cost of acquiring info

All else being equal, investors will accept a lower return on an asset that has lower costs of acquiring information. -Desirable characteristics of a financial asset cause the quantity of the asset demanded by investors to increase, and vice versa.

All of the following are examples of risky mortgages that became more common in the 2000s EXCEPT A) alt-A mortgages. B) adjustable-rate mortgages with low rates for a few years and then higher rates in later years. C) mortgages requiring down payments of at least 20%. D) subprime mortgages.

As of 2009, which of the following was the largest stock exchange in terms of total value traded? A) the New York Stock Exchange B) London Stock Exchange C) Shanghai Stock Exchange D) Tokyo Stock Exchange

As the time of delivery in a futures contract gets closer A) the futures price gets closer to the spot price. B) the futures price generally rises further above the spot price. C) the futures price generally falls further below the spot price. D) the futures and spot prices remain the same as they were when the contract was first created

During an economic recession A) the demand and supply curves for loanable funds both shift to the right and the equilibrium interest rate usually rises B) the demand and supply curves for loanable funds both shift to the left and the equilibrium interest rate usually falls C) the demand curve for loanable funds shifts to the right, the supply curve for loanable funds shifts to the left, and the equilibrium interest rate usually falls D) the demand curve for loanable funds shifts to the left, the supply curve for loanable funds shifts to the right, and the equilibrium interest rate usually rises

Everything else held constant, if the expected return on RST stock falls from 10% to 9% and the expected return on XYZ stock falls from 8% to 7%, then the expected return of holding RST stock _____ relative to XYZ stock and demand for XYZ stock _____. A) rises; rises B) rises; falls C) falls; rises D) falls; falls

How are TIPS adjusted for inflation? A. the principal is adjusted once the bond reaches maturity B. the principal is adjusted for inflation each period C. the interest rate is adjusted once the bond reaches maturity D. the interest rate is adjusted for inflation during each period

If fluctuations in interest rates become larger, then, other things equal, the demand for stocks _______ and the demand for long-term bonds ________. A) increases; increases B) increases; decreases C) decreases; decreases D) decreases; increases

If stock market prices become less volatile, then, other things equal, the demand for stocks ____ and the demand for long-term bonds _____. A) increases; increases B) increases; decreases C) decreases; decreases D) decreases increases

If the federal government decreases its purchases and doesn't decrease taxes, the bond supply shifts to the A) left and the equilibrium interest rate rises B) left and the equilibrium interest rate falls C) right and the equilibrium interest rate rises D) right and the equilibrium interest rate falls

If there is an excess supply of loanable funds at a given interest rate, then A) the price of bonds will fall B) the price of bonds will rise C) the interest rate will rise D) the price of bonds may rise or fall depending upon the reasons for the excess supply of loanable funds

If you deposit $500 in a savings account at an annual interest rate of 5%, how much will you have in the account at the end of five years? A. $392 B. $638 C. $625 D. $550

Issuers of coupon bonds A. make a single payment of interest and principal. B. make a single payment of principal when the bonds matures, but multiple payments of interest over the life of the bond. C. make multiple payments of principal, but a single payment of interest. D. make a single payment of principal at the time the bond is issued and multiple payments of interest over the life of the bond.

Nominal interest rates are higher than real interest rates as long as A. the government taxes interest income. B. expected inflation is positive. C. inflation is expected to decline in the future. D. long−term interest rates are higher than short-term interest rates.

Securitization is the process of A. issuing bonds to finance purchases of equipment and structures. B. converting loans into securities. C. issuing stocks to finance capital spending. D. reducing risk by decreasing corporate debt loads.

Suppose that a small economy that had previously been closed becomes open. If its real interest rate had previously been below the world real interest rate, we would expect that A. the country would become a new borrower abroad. B. the country would become a net lender abroad. C. the amount of loanable funds supplied in the country would decline. D. the country's real interest rate would remain below the world level.

The attribute that distinguishes money from other assets is that only money A. is counted in determining the size of an individual's wealth. B. serves as a medium of exchange. C. retains its value during times of inflation. D. may be used as collateral for a bank loan.

The demand for bonds is A) equivalent to the demand for loanable funds B) equivalent to the supply of loanable funds C) represented by an upward-sloping line when the price of bonds is on the vertical axis and the quantity of bonds demanded is on the horizontal axis D) represented by a downward-sloping line when the interest rate is on the vertical axis and the quantity of bonds demanded is on the horizontal axis

The expected real interest rate approximately equals A. the nominal interest rate minus the tax rate. B. the nominal interest rate minus the expected rate of inflation. C. the nominal interest rate plus the expected rate of inflation. D. the yield to maturity on a coupon bond held to maturity.

The financial system is primarily a means by which A. the government puts into operation its plans for the economy. B. funds are transferred from savers to borrowers. C. money is put into circulation. D. business firms distribute their goods.

The supply curve for bonds would be shifted to the right by A) a decrease in government borrowing B) a decrease in the corporate tax on profits C) an increase in tax subsidies for investment D) a decrease in expected inflation

Though Treasury bonds may have little default risk, what type of risk exists when current interest rates are low? A. refinancing risk B. interest-rate risk C. price risk D. present value risk

What is the rate of return on a bond with a coupon of $38 payable in one year that was purchased for $950 and sold one year later for $931? A. 19% B. 2% C. 6% D. 4%

What is the yield to maturity on a simple loan that requires payment of $500 plus $30 in interest one year from now? A. 5.3% B. 6% C. 6.38% D. Not enough information has been provided to determine the answer.

Which of the following is a consequence of extending the payback period of a student loan from 10 to 30 years? A. higher monthly payments B. more interest paid over the life of the loan C. faster payoff of principal D. lower monthly payments initially, but higher monthly payments in the future

Which of the following will result in a decrease in the price of an existing corporate bond? A. lower expectations of inflation B. increased default risk C. new bonds issued at a lower interest rate D. all of the above

Which of the following would NOT cause a change in the desire to borrow at every interest rate A) a decrease in the US government deficit level B) a change in the price of bonds C) the economy enters an expansionary phase of the business cycle D) a decrease in the corporate profits tax

Which of the following would NOT increase the supply curve of loanable funds? A) A Federal Reserve purchase of US Government securities from commercial banks B) A higher interest rate C) An increase in the nation's real income D) All of the above shift supply

Which of the following would not increase the supply curve of loanable funds? A) A Federal Reserve purchases does of U.S. Government securities from commercial banks B) A higher interest rate C) An increase in the nation's real income D) All of the above shift the supply

in the bond market the issuer(seller) is considered the A) lender B) borrower C) the lender or the borrower depending on use to which the funds are put D) the lender or the borrower depending on whether interest rates are rising or falling

A "primary market" is a market A. for debt by large or "primary" corporations. B. in which newly issued claims are sold to buyers by borrowers. C. for government securities. D. in which newly issued claims are sold by savers to borrowers.

If the expected returns on commodities falls, while the expected returns on bonds does not change, then A) the demand curve for bonds will shift to the left B) the supply curve for loanable funds will shift to the right C) the equilibrium interest rate will rise D) the equilibrium price will fall

B/D

According to an article on the junk bond market in Europe published in the Economist in 2016, "The spread (the interest premium over government borrowing rates) paid by junk-bond issuers has risen by nearly three-and-a-half percentage points since March last year" What of the following ratings would you expect a junk bond to have?

As the housing bubble began to burst in 2006-2008, investors would only buy mortgage-backed securities at high yields to compensate for higher perceived default risk. As a result:

Banks suffered significant capital losses as the value of their holdings of mortgage-backed securities declined

Banks who held mortgage-backed securities "took a bath" during the financial crisis of 2007-2009 due to: A) rising yields in secondary markets which led to a decline in the price of mortgage-backed securities. B) falling yields in secondary markets which led to a decline in the price of mortgage-backed securities. C) their inability to issue new mortgages. D) more rapid pre-payment of mortgages.

Why is a bubble more likely to occur in the housing market rather than in the market for automobiles or the market for refrigerators?

Because a house is likely to increase in price while automobiles and refrigerators are less likely to gain in value.

Why did interest rates on bonds remain at historically low levels years after the end of the financial crisis of 2007−2009?

Because the actual and expected inflation rates were very low during this period, the Fisher effect would lead us to expect that the nominal interest rate on bonds would also be low.

Why might a carry trade end badly?

Because the average of expected short-term interest rates should be almost equal to the interest rate of the long-term investment, thus wiping out potential profits from the carry trade. Because if interest rates rise more rapidly than expected, the price of the long-term investment will decrease and create a capital loss for the investor.

How does securitization result in mortgages being "sliced into numerous pieces"?

Because the loans have been bundled with other loans and resold to other investors.

Behavioral economics can best be described as A) the study of situations in which people's choices do not appear to be economically rational. B) the study of human economic behavior. C) the basis for efficient markets. D) the study of how the economy affects human behavior

When Interest Rates Rise

Bond prices fall (inverse relationship)

The federal government imposes a tax of $10 per bond on bond sales and bond purchases.

Both the demand and supply curves shift to the left.

The mortgage lender sells the loan to a government-sponsored enterprise or financial firm that bundle the mortgage with mortgages from other lenders, providing the basis for a mortgage-backed security

Briefly explain the process of securitizing mortgages

How does the creation of a secondary market in mortgages help to promote home ownership?

By allowing banks to offer a lower interest rate than if they held the loan themselves. By allowing banks to transfer the risk of holding a loan to firms that have economies of scale in risk assessment.

How does the creation of a secondary market in mortgages help to promote home ownership?

By allowing banks to transfer the risk of holding a loan to firms that have economies of scale in risk assessment. By allowing banks to offer a lower interest rate than if they held the loan themselves.

By providing and communicating information, the financial system A) reduces the difference between the return on three- month U.S. Treasury bills and the return on thirty-year U.S. Treasury bonds. B) relieves individual savers from the necessity of searching out individual borrowers. C) eliminates the risk in investing in the stock market. D) guarantees investors a reasonable return on their money

A discount bond involves A. interest payments from the borrower to the lender periodically during the life of the loan. B. no payment of principal by the borrower to the lender. C. payment by the borrower to the lender of the face value of the loan at maturity. D. payment of interest by the borrower to the lender every six months during the life of the loan.

As the housing bubble began to burst in 2006dash-2008, investors would only buy mortgage-backed securities at high yields to compensate for higher perceived default risk. As a result: A. bank profits rose as they earned higher interest on mortgages B. funds available for mortgages increased C. banks suffered significant capital losses as the value of their holdings of mortgage-backed securities declined D. the price of mortgage-backed securities tended to rise due to the higher yields

As wealth increases in the economy, savers are willing to A. buy fewer bonds at any given price. B. hold more cash relative to their holdings of bonds. C. buy more bonds at any given price. D. lend less at any given interest rate.

Checks are A. not acceptable for settling transactions in most industrialized countries. B. promises to pay, on demand, coins minted from precious metals. C. promises to pay, on demand, money deposited with a financial institution. D. less important than currency as a means of settling transactions.

Currently, a three year Treasury note pays 4.75%. Assuming that your tax rate is 20%, what is the minimum interest rate that you would you need to earn on a tax free municipal bond in order to buy it instead? A. 15.25% B. 5.7% C. 3.8% D. 0.95%

Everything else held constant, if the expected return on RST stock rises from 7 to 9 percent and the expected return on XYZ stock rises from 11 to 12 percent, then the expected return of holding RST stock _____ relative to XYZ stock and demand for XYZ stock _______. A) rises; rises B) rises; falls C) falls; rises D) falls; falls

If an investor is certain that market interest rates will decline in the future, which of the following will she be most likely to purchase? A. a six−month government bill B. a ten−year government bond C. a fifty-year government bond D. a twominus−year government note

If the expected gains on stocks rise, while the expected returns on bonds do not change, then A. the supply curve for loanable funds will shift to the right. B. the equilibrium interest rate will fall. C. the equilibrium interest rate will rise. D. the demand curve for bonds will shift to the right.

If the federal government decreases its spending and doesn't decrease taxes, the bond supply shifts to the A. right and the equilibrium interest rate falls. B. right and the equilibrium interest rate rises. C. left and the equilibrium interest rate falls. D. left and the equilibrium interest rate rises.

If the federal government increases its purchases and doesn't change tax rates, the bond supply should shift to the A) left and the equilibrium interest rate rises B) left and the equilibrium interest rate falls C) right and the equilibrium interest rate rises D) right and the equilibrium interest rate falls

If the federal government were to offer larger tax breaks on the purchase of new equipment for businesses, all other factors constant A) the bond demand curve shift right B) the bond supply curve shift left C) the bond supply curve shift right D) the bond demand curve shift left

If there is an excess demand for bonds at a given price, then A) the price of bonds will fall B) the interest rate will rise C) the interest rate will fall D) the interest rate may rise or fall depending upon the reasons for the excess demand for bonds

If there is an excess demand for loanable funds at a given interest rate, then A) the supply of loanable funds will increase B) the price of bonds will rise C) the interest rate will rise D) the price of bonds may rise or fall depending upon the reasons for the excess demand for loanable funds

If there is an excess supply of money A) individuals sell bonds, causing the interest rate to rise B) individuals sell bonds, causing the interest rate to fall C) individuals buy bonds, causing the interest rate to fall D) individuals buy bonds, causing the interest rate to rise

The demand curve for bonds would be increased by A) an increase in the expected returns on other assets B) an increase in the information costs of bonds relative to other assets C) a decrease in the marginal income tax D) a decrease in the liquidity of bonds relative to other assets

The key to present value calculations is that they A. provide accurate answers only in a high-inflation environment. B. are appropriate only for funds in the same time period. C. provide a common unit for measuring funds at different times. D. provide accurate answers only in a low-inflation environment.

The yield on a thirty year Treasury bond is 8% at the same time as the yield on two year Treasury note is 5%. This occurrence A. indicates that the bond market is anticipating that inflation will fall. B. is largely explained by the favorable tax treatment of Treasury notes. C. is well explained by the segmented markets theory. D. indicates that the yield curve is downward sloping.

If fluctuations in stock prices become more volatile, then, other things equal, the demand for stocks _____ and the demand for long-term bonds _______. A) increase; decrease B) increase; increase C) decrease; decrease D) decrease; increase

If the US government's borrowing needs decrease, all other factors constant, A) the supply of bonds will increase B) the demand for bonds will increase C) the price of bonds will decrease D) the price of bonds will increase

If the liquidity effect is smaller than the other effects, and the adjustment to expected inflation is immediate, then the A) interest rate will fall B) interest rate will rise C) interest rate will fall immediately below the initial level when the money supply grows D) interest rate will rise immediately above the initial level when the money supply grows

If there is an excess supply of money A) individuals sell bonds, causing the interest rate to rise B) individuals sell bonds, causing the interest rate to fall C) individuals buy bonds, causing interest rates to fall D) individuals buy bonds, causing interest rates to rise

Suppose a coupon bond with a par value of $1,000 is currently priced at $950 and has a coupon of $40. Which of the following is TRUE? A. Coupon rate has declined. B. current yield < coupon rate C. Coupon rate has risen. D. current yield > coupon rate

Suppose a coupon bond with a par value of $1000 is currently priced at $950 and has a coupon of $40. Which of the following is true? A. coupon rate has declined B. current yield < coupon rate C. coupon rate has risen D. current yield > coupon rate

Suppose there's an 80% chance of a stock rising by 20% and a 20% chance of it falling by 40%. What is the expected rate of return on the stock? A. − 20% B. 16% C. − 40% D. 8%

The Troubled Asset Relief Program (TARP) allowed A. the Fed to make loans to banks as the lender of last resort. B. the Treasury to insure bank deposits at major U.S. banks. C. the Fed to provide funds to commercial banks in return for stock. D. the Treasury to inject funds into commercial banks in return for stock in the banks.

The most important economic benefit from specialization is that it A. makes it possible for an economy to begin using money. B. makes barter possible. C. eliminates the need for financial markets. D. leads to an increase in the standard of living in an economy.

The purchasing power of money A. is constant. B. is set by the Fed in January of each year. C. rises when prices rise. D. rises when prices fall.

The supply curve for bonds has the usual upward slope, indicating that as the price ______, ceteris paribus, the ______ increases. A) falls; supply B) falls; quantity supplied C) rises; supply D) rises; quantity supplied

The supply curve for bonds has the usual upward slope, indicating that as the price _______, ceteris paribus, the _______ increases. A) falls; supply B) falls; quantity supplied C) rises; supply D) rises; quantity supplied

The total payment to a lender for a one-period simple loan is A. P + i. B. (P + i)^n C. i(1 + i). D. P(1 + i).

Though Treasury bonds may have little default risk, what type of risk exists when current interest rates are low? A. refinancing risk B. price risk C. present value risk D. interest-rate risk

Diversification refers to the A) splitting of wealth into many assets. B) difference between the liquidity of an asset and its risk. C) difficulty of converting investments in common stocks into investments in bonds. D) difficulty of selling common stocks in a weak market

Dividends are A) payments made to stock holders. B) payments made to bond holders. C) the total profit earned by a corporation. D) payments to holders of common stock, not preferred stock

Making the Connection:The Rise of Peer-to-Peer Lending and Fintech

During the financial crisis of 2007−2009, many borrowers defaulted on their loans. •In response, federal government regulators began pushing banks to tighten their loan guidelines, making it more difficult for businesses and households to qualify for loans. •Peer-to-peer lenders, such as LendingClub, Prosper, and SoFi, began filling the demand for loans with funds from individuals, businesses and financial firms. •Those lenders are examples of financial technology, or fintech, because they relay heavily on smartphone technology in the loan application process.

Economists define liquidity as A) the difference between the return on the asset an d the return on a long-term U.S. Treasury bond. B) the fraction the asset makes up of an investor's port folio. C) the ease with which an asset can be exchanged for money. D) the difference between the total demand for an asset and the total supply of the asset.

Economists define money as A) cash in circulation. B) deposits in commercial banks. C) anything that people are willing to accept in payment for goods and services or to pay off debts. D) bonds issued by large corporations

Economists define risk as A) the difference between the interest rate borrower s pay and the interest rate lenders receive. B) the chance that the value of financial assets will change from what you expect. C) the ease with which an asset can be exchanged for other assets or for goods and services. D) the difference between the return on common stock and the return on corporate bonds.

Excess volatility refers to A) the unwillingness of financial analysts to consistently recommend the same stocks. B) the greater volatility of futures prices compared to the volatility of prices of the underlying assets. C) the tendency for stocks with high rates of returns also to have quite variable returns. D) the larger movements in market prices of stock than in their fundamental values

Corporate profits are subject to the corporate profits tax, which companies pay before they distribute dividends to their stockholders. Individuals must pay individual incomes taxes on the dividends they receive

Explain what is meant by the "double taxation of dividends

Financial markets A) channel funds indirectly between borrowers and lenders. B) channel funds directly from lenders to borrowers. C) act as go-betweens by holding a portfolio of assets and issuing claims based on that portfolio to savers. D) generally provide lenders with lower returns than do financial intermediaries

Financial securities are exchanged by dealers linked by computers in a A) stock exchange. B) public exchange. C) financial exchange. D) over the counter market

Financial securities that represent partial ownership of a corporation are known as A) bonds. B) stocks. C) coupons. D) dividends

For a specific change in the yield to maturity A) the shorter the time until a bond matures, the greater will be the change in its price. B) the longer the time until a bond matures, the greater will be the change in its price. C) the longer the time until a bond matures, the greater will be the change in its par value. D) the shorter the time until a bond matures, the greater will be the change in its coupon rate.

For bonds issued at the same point in time, which of the following is likely to have the highest coupon? A) Treasury bond B) high-grade corporate bond C) medium-grade corporate bond D) "junk" bond

For simple loans, the yield to maturity A) is always less than the specified simple interest rate. B) is always greater than the specified simple interest rate. C) is always equal to the specified simple interest rate. D) may be less than, greater than, or equal to the specified simple interest rate, depending on the maturity of the loan.

Suppose that you own $10,000 worth of stock in General Motors. Adding stock in which of the following companies would be least likely to reduce the risk in your portfolio?

Ford

Forward contracts A) are highly liquid. B) entail small information costs. C) provide little risk sharing. D) are subject to default risk

Forward contracts are often illiquid because A) any capital gains on them are heavily taxed, making investors reluctant to sell them. B) government regulation has not provided for a secondary market in them. C) they generally contain terms specific to the particular buyer and seller. D) the brokerage fees involved in buying and selling them are very high.

Forward transactions A) allow savers and borrowers to conduct a transaction now and settle in the future. B) allow savers and borrowers to postpone a transaction from now to the future. C) always involve increased risk compared with spot transactions. D) may not be conducted on organized exchanges

Forward transactions A) provide little risk sharing. B) are very liquid. C) have information problems. D) are widely used by sellers of commodities, but rarely used by buyers of commodities

The Transition from Commodity Money to Fiat Money

Gold and silver coins are cumbersome. •So, early banks began to store gold coins in safe places and issue paper certificates (paper currency). •Today, the central bank issues paper currency but does not exchange it for gold or anything else.

hedge funds

Hedge funds are similar to mutual funds but typically have very few wealthy investors and make riskier investments. -funds will be frozen for some time - give up liquidity (unlike mutual funds) and lock yourself in. But have extra expertise and generate higher return.

Hedgers are primarily interested in A) betting on anticipated changes in prices. B) reducing their exposure to the risk of price fluctuations. C) increasing market liquidity. D) reducing the spread between bid and ask prices on bonds

Herd behavior can best be described as A) the large number of investors involved in the stock market. B) how large participation in financial markets increase market efficiency. C) informed investors can outperform relatively uninformed investors. D) relatively uninformed investors follow the behavior of other investors instead of consider fundamentals.

Risk, liquidity, and information costs and inconsistencies with efficient markets hypothesis

Higher returns on investments are just compensation for investors accepting higher risk, lower liquidity, and higher information costs.

How are TIPS adjusted for inflation? A) the interest rate is adjusted for inflation during each period B) the principal is adjusted once the bond reaches maturity C) the principal is adjusted for inflation each period D) the interest rate is adjusted once the bond reaches maturity

The banks that grants, or originates, the original mortgages will still collect the interest paid by the borrowers and send those interest payments on to the government agency or financial firm to distribute to the investors who have bought the mortgage-backed security

How are interest payments on mortgages distributed to investors who own mortgage-backed securities?

How can the Gordon Growth model help explain the major decline in stock indexes during 2007-2009? A) There was an increase in the required return on equities and a decrease in the expected growth rate of dividends. B) There was a decrease in the required return on equities and a decrease in the expected growth rate of dividends. C) There was an increase in the required return on equities and an increase in the expected growth rate of dividends. D) There was a decrease in the required return on equities and a decrease in the expected growth rate of dividends.

Many investment banks and other investors purchased mortgage-backed securities because they paid higher interest rates than securities of comparable default risk. When the housing bubble burst, the value of the mortgage-backed securities declined significantly, resulting in massive losses for those who owned them, including many investment banks

How did securitization and the bursting of the housing bubble contribute to the Financial Crisis of 2007-2009?

The borrower provides collateral in the form of an easy-to-sell good in return for a short-term loan with a high interest rate. In the event that the borrower defaults on the loan, the pawn shop sells the good

How do pawn shops provide financing?

Borrowers that use a coupon bond make interest payments at regular intervals and repay the face value when the bond reaches maturity. Those that borrow using a fixed-payment loan makes periodic payments that are equal and include both interest and principal.

How do payments on a fixed-payment loan differ from a coupon bond

How does hedging affect the flow of funds in the financial system? A) It reduces it since it is a sign that investors do not like risk. B) It reduces it because it increases risk by encouraging speculation. C) It increases it because it reduces risk thus encouraging more people to make financial investments. D) It increases it by encouraging more speculation

Graduates had a very difficult time finding jobs. Many accepted less desirable positions at lower salaries. Studies have shown that those entering the job market during a recession earn less for a decade or more

How is the high unemployment rate that resulted from the Financial Crisis of 2007-2009 likely to affect those who graduated from college during the recession?

The decline in stock prices, though, may have been consistent with substantial changes in the expectations of investors with respect to both the future growth rate of dividends and the degree of risk involved in investing in stocks. The Gordon growth model indicates that an increase in rE and a decrease in g will cause a decline in stock prices

How would proponents of the efficient markets hypothesis use the Gordon-Growth model to explain the movement of stock prices during the Financial Crisis of 2007-2009?

If i is the yield to maturity of a fixed-payment loan, A) the value of the loan today equals i times the sum of the values of all the loan payments. B) i equals the present value of the loan payments. C) the value of the loan today equals the sum of the values of the loan payments. D) the value of the loan today equals the present value of the loan payments discounted at rate i.

If major traders believe the price of a stock should be higher than its current market price, A) they have an incentive to sell the stock. B) their actions will result in the information they possess being incorporated into the price of the stock. C) there is little they can do because government regulation precludes their acting on what they know. D) they should petition the Securities and Exchange Commission to authorize an adjustment in the price of the stock.

If market participants believe that the wheat crop is likely to be unusually small, A) the spot price of wheat is likely to be above the futures price of wheat. B) the spot price of wheat is likely to be below the futures price of wheat. C) it will not be possible to find a seller of a futures contract in wheat. D) it will not be possible to find a buyer of a futures contract in wheat

If market participants have rational expectations, then the best forecast of the price of a stock in the next period is A) equal to an average of the prices of the stock in previous periods. B) equal to the price of the stock in the current period. C) dependent upon all information available in the current period, including, but not limited to, the price of the stock in the current period. D) dependent on information available in the previous period

If market participants rely only past stock prices to forecast future stock prices, A) they will be better able to forecast future price increases than future price decreases. B) they will be better able to forecast future price decreases than future price increases. C) they have adaptive expectations. D) they have rational expectations

If the annual interest rate is 8%, what would you expect to pay for a discount bond paying $10,000 in ten years? A) $4,632 B) $9,259 C) $10,000 D) $21,589

If the annual interest rate is 9%, what would you expect to pay for a discount bond paying $10,000 in two years? A) $8,417 B) $8,200 C) $10,000 D) $11,881

If the current price of a bond is equal to its face value, A) there is no capital gain or loss from holding the bond until maturity. B) the yield to maturity must be greater than the current yield. C) the current yield must be greater than the coupon rate. D) the coupon rate must be greater than the yield to maturity

If the current price of a bond is greater than its face value A) an investor will receive a capital gain by holding the bond until maturity. B) the yield to maturity must be less than the coupon rate. C) the coupon rate must be less than the current yield. D) the coupon rate must be equal to the current yield.

If the current price of a bond is less than its face value, A) an investor will receive a capital gain by holding the bond until maturity. B) the yield to maturity must be less than the current yield. C) the coupon rate must be greater than the current yield. D) the coupon rate must be equal to the current yield.

If the price of a futures contract increases, then A) the exchange will collect the amount of the increase from the seller of the contract and transfer it to the account of the buyer of the contract. B) the exchange will collect the amount of the increase from the buyer of the contract and transfer it to the account of the seller of the contract. C) the exchange will collect the amount of the increase from both the buyer and the seller and place it in escrow until the delivery date. D) the additional funds will be required from either the buyer or the seller until the delivery date

If the prices of financial assets follow a random walk, then A) they should be easy to forecast, provided market participants have rational expectations. B) they should be easy to forecast, provided market participants have adaptive expectations. C) the change in price from one trading period to the next is not predictable. D) major traders in the market must not be making use of all available information about the assets.

If traders in a market have rational expectations, then A) the price of an asset equals its fundamental value. B) prices of riskier assets are higher than prices of less risky assets. C) past prices of assets do not affect market participants' expectations of future asset prices. D) they make use of less information than they would if they had adaptive expectations

$2.10/$86 + ($99 - $86)/$86 = 17.6%.

If you buy 100 shares of 3M at $86 a share and sell all shares one year later for $99 a share. During the year, you earned a dividend of $2.10 a share. What was your rate of return? Report your answer in percentages with one decimal point

If you buy a bond issued by Intel, the bond is a(n): A) liability to Intel and an asset to you. B) liability to you and an asset to Intel. C) liability to both you and Intel. D) asset to both you and Intel.

If you buy a futures contract for U.S. Treasury bills and on the delivery date the interest rate on T-bills is lower than you expected, you will have A) lost money on your long position. B) gained money on your long position. C) lost money on your short position. D) gained money on your short position

If you deposit $10,000 in a savings account at an annual interest rate of 6%, how much will you have in the account at the end of three years? A) $8,396 B) $11,800 C) $11,910 D) $10,600

If you deposit $500 in a savings account at an annual interest rate of 5%, how much will you have in the account at the end of five years? A) $625 B) $392 C) $638 D) $550

If you look at the financial page listings for futures contracts and find that futures prices on Treasury bonds are falling over a particular time period, futures market investors must expect that A) Treasury bond prices will be higher in the future. B) Treasury bond yields will be higher in the future. C) Treasury bond yields will be lower in the future. D) futures prices will rise again at the end of the period

If you purchase a Treasury bond, the Treasury bond is A) an asset to you as well as an asset to the U.S. government. B) an asset to you, but a liability to the U.S. government. C) a liability to you, but an asset to the U.S. government. D) a liability to you as well as a liability to the U.S. government

If you sell a futures contract for U.S. Treasury bills and on the delivery date the interest rate of T-bills is higher than you expected, you will have A) lost money on your long position. B) gained money on your long position. C) lost money on your short position. D) gained money on your short position

If, while you are holding a coupon bond, its market price falls, you can be sure that A) the coupon payment you are receiving must have been reduced. B) the interest rate on other similar bonds must have fallen. C) the interest rate on other similar bonds must have risen. D) the par value of the bond must have declined

In Wall Street Jargon, a "Bear Market" typically means A) stock prices have declined by at least 20%. B) stock prices have declined by at least 50%. C) stock prices have risen by at least 20%. D) stock prices have risen by at least 50%.

In a call options contract, the A) seller has the obligation to deliver the instrument at a specified time. B) buyer has the obligation to receive the instrument at a specified time. C) seller may choose whether or not to deliver the instrument at a specified time. D) buyer will choose to exercise his option only if the value of the underlying security falls

In a put options contract, the A) seller has the obligation to receive the instrument at a specified time. B) buyer has the obligation to deliver the instrument at a specified time. C) buyer has the obligation to receive the instrument at a specified time. D) seller has the obligation to deliver the instrument at a specified time

How do the Fed's current responsibilities compare with its responsibilities when it was first created by Congress?

In addition to its original role as a lender of last resort, the modern Fed is now responsible for monetary policy.

In an efficient market with rational expectations, the actual price of an asset A) will equal its expected price. B) will often be below its expected price. C) will often be above its expected price. D) equals its expected price plus a random error term

In an options contract, another name for the strike price is the A) market price. B) exercise price. C) equilibrium price. D) fixed price

In comparing actively managed mutual funds with those funds that simply buy and hold a large market portfolio (index funds), we would expect that A) the actively managed funds provide a higher return than the index funds. B) the index funds provide a higher return after expenses than the actively managed funds. C) actively managed funds and index funds provide the same returns. D) index funds provide a lower return than actively managed funds only if taxes are taken into consideration.

In comparing futures contracts with options contracts, we can say that A) in a futures contract, the buyer and seller have symmetric rights, whereas in an options contract, the buyer and seller have asymmetric rights. B) in a futures contract, the buyer and seller have asymmetric rights, whereas in an options contract,the buyer and seller have symmetric rights. C) in both futures and options contracts, the buyer and seller have symmetric rights. D) in both futures and options contracts, the buyer and seller have asymmetric rights

In comparing the yield to maturity on a Treasury bill with the yield on a discount basis on the same bill, we can say that the yield to maturity A) will always be greater than the yield on a discount basis. B) will always be less than the yield on a discount basis. C) will always be equal to the yield on a discount basis, provided the holding period is the same as the number of years to maturity. D) rises whenever the yield on a discount basis falls

In derivative markets, trade takes place in A) assets such as bonds or common stock that derive their value from the value of the companies which issue them. B) assets whose rates of returns must be derived from information published in financial tables. C) assets that derive their value from underlying assets. D) assets which are not allowed to be traded on organized exchanges

benefits of short and long position

In general, the holder of a short position benefits from a fall in the price of the underlying asset, and the holder of a long position benefits from a rise in the price of the underlying asset.

In recent decades, A) trading in financial futures declined in importance relative to trading in agricultural and mineral commodities futures. B) trading in financial futures increased in importance relative to trading in agricultural and mineral commodities futures. C) trading in agricultural and commodities futures was discontinued. D) trading in financial futures was discontinued

In the United States, monetary policy is carried out by A) the Federal Reserve System. B) Congress. C) the President. D) Congress and the President acting together

In the United States, the lender of last resort is A) Fannie Mae. B) the Federal Reserve. C) the Federal Deposit Insurance Corporation. D) Securities and Exchange Commission

In the context of the evaluation of the efficient markets hypothesis, pricing anomalies refer to A) the existence of trading strategies that appear to have offered above-normal returns. B) the gap between actual and expected prices. C) the spread between the price at which a broker will purchase stock from an investor and the price at which the broker will sell stock to an investor. D) the difficulty in practice of computing stock prices on the basis of expectations of future dividends.

In what way can the stock market affect the overall economy? A) It's an important source of funds for corporations. B) It can affect consumer and business sentiment. C) It is an important factor affecting consumer wealth and thus consumer spending. D) All of the above

Limited liability is the legal provision that shields owners of a corporation from losing more than they have invested in the firm

In what way do owners of stocks have limited liability

What would result in a decrease in the price of an existing corporate bond?

Increased default risk

Increased liquidity in recent decades has reduced interest rates on which of the following assets (holding constant all other things that affect interest rates)? A) U.S. government bonds B) bonds issued by large corporations C) business loans D) bonds issued by state governments

What does the statistical evidence show about the link between the growth rate of the money supply and the inflation rate in the long run?

Inflation will occur when the quantity of money increases faster than real GDP.

insurance companies

Insurance companies collect premiums from customers and then invest the premiums to obtain the funds necessary to pay claims and other costs.

What are the two types of income an investor can earn on a bond?

Interest income from coupon payments and capital gains from price changes.

Which of the following accurately describes the tax treatment of municipal bonds?

Interest is tax free, but realized capital gains are taxable.

Expectations Theory

Interest rate on a long-term bond equals the average of the interest rates expected on the one year bonds during this holding period. - Explains the slope of the yield curve & why interest rates on ST and LT bonds move together Does not explain why YC is sloping upwards

How does the interest rate on a bond with high information costs compare with the interest rate on a bond with low information costs?

Interest rates are usually higher on a bond with high information costs.

How does the interest rate on an illiquid bond compare with the interest rate on a liquid bond?

Interest rates are usually higher on an illiquid bond.

Would you expect the interest rates on these bonds to be higher or lower than the interest rates on comparable municipal bonds? Briefly explain.

Interest rates on Build America Bonds are likely to be higher because taxing the coupon reduces the coupon paid to the bond purchaser.

Segmented Markets

Interest rates on bonds of different maturities are determined in separate markets. As investors do not all have the same objectives, and investors do not see bonds of different maturities as being substitutes

[Related to the Solved Problem] Suppose that you are an investor who owns $10,000 in U.S. Treasury notes. Will you be more worried about market interest rates rising or falling?

Interest rates rising, as that forces bond prices down.

Though Treasury bonds may have little default risk, what type of risk exists when current interest rates are low?

Interest-Rate Risk: Risk of interest rates rising thus lowering the value of the bond

Interest-rate risk can best be characterized as the risk that A) you could have earned a higher interest rate if you waited to purchase a bond. B) fluctuations in the price of a financial asset in response to changes in market interest rates. C) you could have gotten a lower interest rate if you waited to lock in a mortgage. D) short-term interest rates may exceed long-term interest rates

Following the downgrade of U.S. debt by Standard & Poor's in 2011

Investors were not any more concerned about the default risk, than they were before the downgrade

how you can hedge the risk of investing in bonds.

Investors who own bonds are long in the spot market for bonds, so the appropriate hedge calls for them to go short in the futures market by selling futures contracts.

Issuers of coupon bonds A) make a single payment of principal when the bonds matures, but multiple payments of interest over the life of the bond. B) make a single payment of interest and principal. C) make multiple payments of principal, but a single payment of interest. D) make a single payment of principal at the time the bond is issued and multiple payments of interest over the life of the bond

How can a global savings glut affect the United States?

It can reduce the world real interest rate, thus encouraging borrowing by Americans

Why would the president worry about the possibility that the appearance of Fed independence might be undermined?

It could undermine confidence in the Fed and impact market conditions.

Why isn't the current yield a good indicator of holding a bond?

It doesn't account for capital gains or losses

Which criterion is NOT useful when evaluating a theory?

It fits one's pre-conceived bias.

data mining and inconsistencies with efficient markets hypothesis

It is always possible to search through the data and construct trading strategies that would have earned above-average returns.

trading stocks

It is better to buy and hold a diversified portfolio over a long period of time than to churn a portfolio by moving funds repeatedly between stocks.

Which of the following might explain why investors might expect to receive a higher return in the long run from buying index funds rather than actively managed funds?

It is extremely difficult to outperform the long-run average return on stocks.

Mean reversion refers to the tendency for A) futures prices to revert to the prices of the underlying securities. B) the long-run mean return on stocks to equal the long-run mean return on bonds. C) stocks with high returns today to experience low returns in the future and for stocks with low returns today to experience high returns in the future. D) financial analysts whose stock picks have earned above-normal returns in the past to be unable to pick stocks that will perform as well in the future

Momentum investing can be described as A) consistent with the efficient markets hypothesis. B) similar to mean reversion. C) follow the picks of investors who have been successful in the past. D) the trend is your friend

Monetary policy refers to the government's A) decisions on how much money to spend. B) decisions on how much money to collect in taxes. C) plans for retiring the national debt. D) management of the money supply and interest rates to achieve macroeconomic

Consequences of extended the payback of a student loan from 10 to 30 years

More interest paid over the life of the loan

Quantity theory of money

MxV = PxY; V= PY/M -Irving Fisher asserted that V is constant and turned the equation of exchange (an identity) into the quantity theory of money -theory about the connection between money and prices that assumes that the velocity of money is constant. -Velocity is erratic in the short run, so the quantity theory does not provide accurate short-run forecasts of inflation.

barter formula for prices

N(N-1) / 2

Many U.S. cities increase business taxes to help close their budget deficits. --> effect on demand for loanable funds

Net expected profitability would fall, so the demand for loanable funds would fall.

When Interest Rates Rise

Newly issued bonds will have higher yields, decreasing the prices of already purchased bonds, that now hold a less attractive yield.

Noise traders A) pursue trading strategies based on inflated view of their ability to understand the significance of a piece of news. B) make use of inside information. C) reduce the amount of risk in the market. D) help to ensure that asset prices reflect the fundamental values of the securities being traded.

Noise traders A) tend to lose money on stock trades, but help to stabilize the market. B) tend to make higher returns than do "buy-and-hold" investors. C) create additional risk in the market by increasing price fluctuations. D) trade only when they have inside information

On the day of delivery A) the spot price will equal the futures price. B) the spot price will be greater than the futures price by an amount equal to the current interest rate times the futures price. C) the futures price will be greater than the spot price by an amount equal to the current interest rate times the spot price. D) there is no necessary relation between the spot price and the futures price

One benefit of a swap compared to futures and options is that they A) promote liquidity. B) reduce the risk for both the buyer and seller. C) can be better tailored to meet the needs of market participants. D) can involve financial instruments and not just commodities

One difference between futures and options contracts is A) funds change hands daily in the case of options but not with futures. B) funds change hands daily in the case of futures, but not with options. C) in the case of futures funds only change hands when they are exercised. D) futures are designed to reduce risk while options are not

One implication of the efficient markets hypothesis is that investors should A) concentrate their investments in just a few well-chosen assets. B) hold a diversified portfolio of assets. C) buy stocks rather than bonds. D) buy bonds rather than stocks

small firm effect

Over the long run, investment in small firms has yielded a higher return than has investment in large firms.

Solving coupon rate

Par value * coupon rate = coupon Coupon rate = coupon/par value

pension funds

Pension funds collect contributions from workers and firms and make benefit payments during workers' retirements.

rational expectations

People make forecasts of future values of a variable using all available information; formally, the assumption that expectations equal optimal forecasts, using all available information

In what sense is preferred stock more like bonds than like common stock? (Check all that apply)

Preferred stockholders get fixed dividend payments while common stockholders receive fluctuating dividend payments. If the corporation declares bankruptcy preferred stockholders are paid before common stockholders.

What is the price of a coupon bond that has annual coupon payments of $85, a par value of $1,000, a yield to maturity of 10%, and a maturity of three years?

Price = C/(1+I) + C/(1+I)^2 + C/(1+I)^3 + par-value/(1+I)^3 = 962.7

Profits from speculation arise because of A) the spread between the bid and ask prices on bonds. B) the illiquidity of markets for derivative instruments. C) the high information costs in markets for derivative instruments. D) disagreements among traders about future prices of a commodity or financial instrument

Gordon Growth Model

Pt = D * ((1+g)/(r-g)) where g is the expected growth rate, r is the markets return on equities

gordon growth model equation

Pt = Dt x (1+g)/(Re - g)

example of rate of return from investing in a stock: you purchased a share for $30, with a dividend of $0.60, and the stock price at the end of the year is $33.

R = ($0.60/$30) + ($33-$30/$30) = 12%

What is the rate of return on a bond with a coupon of $55 that was purchased for $900 and sold one year later for $950?

R = (55 / 900) + (50 / 900) R = 11.67%

january effect

Rates of return on stocks have been abnormally high during January.

Rational expectations involve the assumption that A) market participants make use only of information on the past performance of an asset in determining what they believe its price should be. B) market participants rarely change their minds about the correct price of an asset. C) financial markets are good at increasing liquidity, but poor at transmitting information. D) market participants makes use of all available information

The two most important factors that cause the money demand curve to shift are

Real GDP Price Level

Federal agencies that regulate the financial system

SEC - security exchange commission - regulating trade in stock market FDIC - federal deposit insurance corp - deal with risk and commerical banks FED - deals w monetary policy - control of MS in the economy. central bank of the US Comptroller of currency - deals with national commercial banks Consumer finance protection bureau - protect consumers from fraud or deceptive practices in financial markets

Securitization is the process of A) issuing stocks to finance capital spending. B) issuing bonds to finance purchases of equipment and structures. C) reducing risk by decreasing corporate debt loads. D) converting loans into securities

The yield on a thirty−year Treasury bond is 8%, at the same time as the yield on two−year Treasury note is 5%. This is an example of

Segmented markets theory

Better informed investors may be able to profit from the deviations from efficiency caused by noise traders. But the longer these deviations persist, the less likely it is that better informed investors will be able to profit

Shouldn't better informed investors be able to profit from the deviations from pricing efficiency caused by noise traders?

Simple Loan

Simple loan is a debt instrument in which the borrower receives from the lender an amount called the principal and agrees to repay the lender the principal plus interest on a specific date when the loan matures.

Simple loans and discount bonds differ from coupon bonds and fixed-payment loans in that A) interest on simple loans and discount bonds is taxable, while interest on coupon bonds and fixed-payment loans is not. B) interest on coupon bonds and fixed-payment loans is taxable, while interest on simple loans and discount bonds is not. C) interest rates on simple loans and discount bonds are generally higher than interest rates on comparable coupon bonds and fixed-payment loans. D) interest on simple loans and discount bonds is paid in a single payment, while issuers of coupon bonds and fixed-payment loans make multiple payments of interest and principal.

Under the expectations theory, if market participants expect that future short-term rates will be higher than current short-term rates, the yield curve will

Slope Upward

Money Market Model

Slopes Downwards - Lower nominal interest rates cause household and firms to switch from assets to cash - demanding more money - Real GDP & Price level causes shifts in the money demand curve

Speculators are primarily interested in A) betting on anticipated changes in prices. B) reducing their exposure to the risk of price fluctuations. C) increasing market liquidity. D) reducing the spread between bid and ask prices on bonds

Standardization of derivative contracts A) increases their liquidity. B) is the rule with respect to contracts whose underlying asset is a financial security, but not for contracts whose underlying asset is a commodity. C) is the rule with respect to contracts whose underlying asset is a commodity, but not for contracts whose underlying asset is a financial asset. D) has been proposed many times by financial analysts, but has not yet been carried out by the SEC.

Which of the following is not a debt instrument? Simple loans Discount bonds Stocks Coupon bonds

Stocks

Suppose that the inflation rate increases and the Federal Reserve responds by taking actions to raise the short-term nominal interest rate. Which of the following best describes the impact of the Fed's actions on the money market graph?

Supply shifts leftwards.

$2 × [(1.05/.08-.05) = $70.

Suppose 3M pays a dividend of $2 per share which the investor is expected to receive immediately. The dividend is expected to grow by 5% per year and the investor has a required rate of return of 8%. What should be the current price of the stock according to the Gordon-Growth model?

Suppose Matt's New Cars issues a discount bond with a face value of $10,000 payable in one year with an interest rate of 4%. How much will they receive for the bond? A) $9,600 B) $9,615 C) $10,000 D) $10,400

Suppose that research shows that by buying stocks issued by companies whose names begin with the letter G investors can earn above-normal returns in even-numbered years. From the perspective of the efficient markets hypothesis, A) this is further evidence that the hypothesis is correct. B) this would be considered a pricing anomaly. C) investors must have insider information on these companies. D) purchasers of these stocks must have been noise traders

Suppose you are a manager for a company that produces grape jelly. Which of the following is the best way for you to reduce your risk? A) acquire a derivative that increases in value if grape prices increase B) acquire a derivative that increases in value if grape jelly prices increase C) sell a derivative that increases in value if grape prices increase D) sell a derivative that increases in value if grape jelly prices increase

The present value of the stock is $27/1.1 = $24.55. You should pay no more than $24.55 for a share of the stock

Suppose you are considering buying shares of a stock to hold for one year. The stock has an expected annual dividend of $2 and an expected price at the end of the year of $25. If your required rate of return is 10%, what is the most that you should be willing to pay for the stock? Round off to the nearest cent

$2/$20 + ($25 - $20)/$20 = 35%.

Suppose you buy a stock that sells for $20. It's expected annual dividend is $2 and you expect its price to be $25 in one year. What is your expected rate of return on the stock?

Suppose you have a fixed-rate mortgage with a nominal interest rate of 6% and the expected annual inflation rate over the life of the mortgage is 2%. What is the expected real interest rate? A) 3% B) 4% C) 8% D) 12%

The present value of the first contract is $86,777 and the second one is $85,537

Suppose you have two clients who need your services for two years. One agreed to pay you $50,000 one year from now and another $50,000 in two years while the other paid $35,000 after one year, but $65,000 after two years. Assuming an interest rate of 10%, which one has a higher present value? Round off to the nearest dollar.

The January effect A) largely disappeared after receiving attention in the 1980s. B) refers to the gap between futures prices and the prices of the underlying securities that occurs each January. C) was stronger during the 1980s than during previous decades. D) is the observation that stocks tend to be sold off in January

The Troubled Asset Relief Program (TARP) allowed A) the Treasury to inject funds into commercial banks in return for stock in the banks. B) the Fed to provide funds to commercial banks in return for stock. C) the Treasury to insure bank deposits at major U.S. banks. D) the Fed to make loans to banks as the lender of last resort

The amount of funds the borrower receives from the lender with a simple loan is called the A) principal. B) equity. C) claim. D) collateral

rational expectations

The assumption that people make forecasts of future values of a variable using all available information; formally, the assumption that expectations equal optimal forecasts, using all available information

The bid price for a bond is A) the minimum price that you are allowed to bid for a bond that is being auctioned by the government. B) the maximum price that you are allowed to bid for a bond that is being auctioned by the government. C) the price that you will receive from a securities dealer if you sell the bond. D) the price that you must pay a securities dealer to purchase a bond

The bond market is important because A) it is the major source of borrowed funds for U.S. business. B) it provides a rate of return significantly greater than the stock market. C) it provides foreign purchasers of U.S. products a means to exchange their currencies for U.S. dollars. D) it provides a way for businesses and governments to borrow funds from savers and it is the market that determines interest rates

The buyer of a futures contract A) assumes the short position. B) assumes the long position. C) may not sell the contract without the permission of the original seller. D) has the obligation to deliver the underlying financial instrument at the specified future date

The buyer of a futures contract A) assumes the short position. B) has the obligation to deliver the underlying financial instrument at the specified date. C) has the obligation to receive the underlying financial instrument at the specified future date. D) may, at his or her option, deliver or receive the underlying financial instrument at the specified date

Suppose that oil prices decline by 50%. Which counterparty to a forward contract in oil has an incentive to default on the contract?

The buyer of the forward contract since the price they have committed to pay is now above the market price.

The choice between futures and options A) depends on whether the underlying instrument is a debt instrument or an equity. B) reflects a trade-off between the higher cost of using options and the extra insurance benefits that options provide. C) reflects a trade-off between the higher cost of using futures and the extra insurance benefits that futures provide. D) reflects a trade-off between the greater risk from using options and the extra insurance benefits that options provide.

The concept of present value A) reveals that discount bonds have higher interest rates than coupon bonds. B) reveals that fixed payment loans have higher interest rates than discount bonds. C) is useful in comparing interest rates for different financial instruments. D) limits the comparability of returns on different types of bonds.

Why would securitization make renegotiating a loan more difficult?

The cost of negotiation with every investor holding the security may be prohibitively costly.

A business might consider all of the following costs and benefits in making a decision as to whether to go cashless, except:

The cost of printing paper currency.

The current yield is equal to

The coupon divided by the market price of the bond

The coupon rate is the A) annual coupon payment divided by the face value of the bond. B) annual coupon payment divided by the market value of the bond. C) difference between the face value of the bond and its par value. D) coupon paid every 6 months divided by par value

When the price of a coupon bond increases,

The current yield declines

The current yield is equal to A) the coupon divided by the market price of the bond. B) the yield to maturity, if the bond is a coupon bond. C) the coupon divided by the par value of the bond. D) the market price of the bond divided by its par value

Why would the spread between government bonds and junk bonds have been rising?

The default credit risk on junk bonds was increasing.

The Federal Reserve publishes a forecast that the inflation rate will average 5% over the next five years. Previously, the Fed had been forecasting an inflation rate of 3%.

The demand curve shifts to the left and the supply curve shifts to the right.

Investors believe that the level of risk in the stock market has declined.

The demand curve shifts to the left.

Use the loanable funds approach to show the impact of the U.S. budget deficit on the world real interest rate, holding all else constant.

The demand curve shifts to the right, raising interest rates.

Wealth in the economy increases at the same time that Congress raises the corporate income tax.

The demand curve will shift to the right and the supply curve will shift to the left. This increases the price of bonds and the quantity of bonds is indeterminate.

The economy experiences a business cycle expansion.

The demand for bonds shifts to the right, raising price and increasing the quantity of bonds.

Briefly explain what typically happens to interest rates during a recession. Use a demand and supply graph for bonds to illustrate your answer.

The demand for bonds decreases, while the supply of bonds decreases by a greater magnitude than demand, resulting in a lower equilibrium interest rate.

Taxes on businesses are expected to be increased in the future.

The demand for loanable funds would decrease, decreasing the interest rate.

A natural disaster causes extensive damage to homes, bridges, and highways, leading to increased investment spending to repair the damaged infrastructure.

The demand for loanable funds would increase, increasing the interest rate.

The distinguishing feature of a well-functioning financial market is the A) continual increase in the liquidity of most assets. B) continual reduction in the riskiness of most assets. C) increased ease of converting common stocks into bonds. D) incorporation of available information into asset prices

The double taxation of dividends typically refers to A) dividends being taxed first as corporate profits and then as income after being paid to stock holders. B) stock holders paying both income and social security taxes on dividends. C) stock holders paying an income tax and dividend surtax on dividends. D) dividends being taxed at both the state and local level

The economist known for his early empirical work supporting the efficient markets hypothesis is A) Milton Friedman. B) John Muth. C) Eugene Fama. D) Glenn Hubbard

Which of the following best explains the growth rates of M1 and M2 during the early 1990s?

The economy was in a recession.

The efficient markets hypothesis A) assumes that market participants form their expectations adaptively. B) applies rational expectations to the pricing of assets. C) applies to the stock market, but not to the bond market. D) indicates that the stock market is efficient, but not rational

The efficient markets hypothesis implies that stock investments should have the same expected return after adjusting for A) risk. B) information costs. C) liquidity. D) all of the above

portfolio allocation

The efficient markets hypothesis implies that we should hold a diversified portfolio of stocks and other assets, instead of only one stock. -News that may unfavorably affect the price of one stock can be offset by news that will favorably affect the price of another stock.

The efficient markets hypothesis predicts that an investor A) will not be able consistently to earn above-normal profits from buying or selling stocks. B) will be able consistently to earn above-normal profits from buying or selling stocks so long as he or she makes use of rational expectations. C) will be able consistently to earn above-normal profits from buying or selling stocks so long as he makes us of adaptive expectations. D) will be able consistently to earn above-normal profits so long as stock prices in general are rising.

The elimination of riskless profit opportunities is known as A) arbitrage. B) options. C) swaps. D) liquidity.

The existence of counterparty risk A) has no effect on the contracting parties. B) is disallowed under current government regulations. C) results in information costs for buyers and sellers when analyzing the potential creditworthiness of potential trading partners. D) reduces the risk introduced by forward contracts

What is the most important contrast between the segmented markets theory and the expectations theory?

The expectation theory states that investors view similar assets that differ only with respect to maturity as perfect substitutes.

The expected real interest rate approximately equals A) the nominal interest rate minus the tax rate. B) the nominal interest rate minus the expected rate of inflation. C) the nominal interest rate plus the expected rate of inflation. D) the yield to maturity on a coupon bond held to maturity.

What is the difference between the actual real interest rate and the expected real interest rate?

The expected real interest rate equals the nominal interest rate minus expected inflation; the actual real interest rate equals the nominal interest rate minus actual inflation.

The fee charged by the seller of an option is referred to as the A) market price. B) option premium. C) futures fee. D) call price.

The financial crisis of 2007-2009 worsened after the failure of which firm? A) General Motors B) Lehman Brothers C) Bear Stearns D) American International Group (AIG)

The financial system is primarily a means by which A) borrowers can use savers' funds until the savers themselves need the funds. B) money is put into circulation. C) the government puts into operation its plans for the economy. D) business firms distribute their goods.

The financial system performs the role of communicating information by A) constantly increasing the liquidity of most assets. B) constantly reducing the riskiness of most assets. C) incorporating all available information into the prices of financial assets. D) providing to investors for a nominal charge all government reports available about a particular company.

The financial system provides risk sharing by allowing A) borrowers to obtain funds either directly or indirectly. B) savers to earn interest tax-free. C) borrowers to convert liabilities into assets. D) savers to hold many assets

The fundamental value of a stock equals A) the future value of all future dividends. B) the present value of all future dividends. C) the present value of current and future dividends. D) the present value of all future capital gains

The futures price A) reflects traders' expectations of the spot price on the day of delivery. B) is always above the spot price on the day of delivery. C) is always below the spot price on the day of delivery. D) is always equal to the spot price at every point in time

liquidity and assets

The greater an asset's liquidity, the more desirable the asset is to investors. -Desirable characteristics of a financial asset cause the quantity of the asset demanded by investors to increase, and vice versa.

The government eliminates the tax deduction for interest homeowners pay on mortgage loans. --> effect on demand for loanable funds

The increase in the expected after-tax real interest rate would reduce the demand for loanable funds.

Which of the following best describes the effect of a global savings glut?

The increased savings in the rest of the world increases international lending, lowering the world interest rate, and increasing international borrowing in the United States.

margin requirement

The initial deposit required by a buyer or seller of a futures contract

The initial deposit required by a buyer or seller of a futures contract is known as A) credit. B) margin requirement. C) debit. D) marking

The Interest Rate, Present Value, and Future ValueWhy Do Lenders Charge Interest on Loans?

The interest rate on a loan should cover the opportunity cost of supplying credit so the interest should include: -Compensation for inflation: if prices rise, the payments received will buy fewer goods and services. -Compensation for default risk: the borrower might default on the loan. -Compensation for the opportunity cost of waiting to spend the money.

If, while you are holding a coupon bond, its market price falls, you can be sure that

The interest rate on other similar bonds must have risen

The intrinsic value of an option A) is equal to the option premium. B) is the amount the option actually is worth if it is immediately exercised. C) is the amount the option is expected to be worth on its expiration date. D) is impossible to determine in the absence of information on the future prices of the underlying asset.

The key difficulty in answering the question: "Would you be better off financing your new home with a 15-year mortgage at 5% or by borrowing for five years at 4% and refinancing thereafter?" is that A) housing prices are very erratic. B) the tax deductibility of mortgage interest payments has changed over time. C) dollars paid in different periods do not have the same value. D) 15-year mortgages are fixed-payment loans while 5-year mortgages are simple loans

The key to present value calculations is that they A) are appropriate only for funds in the same time period. B) provide a common unit for measuring funds at different times. C) provide accurate answers only in a low-inflation environment. D) provide accurate answers only in a high-inflation environmen

The leading federal regulatory body for financial markets in the United States is the A) Federal Bureau of Investigation. B) Securities and Exchange Commission. C) Federal Financial Market Bureau. D) Investors Protection Agency

How does the link between the growth rate of the money supply and the inflation rate differ between the short run and the long run?

The link between the growth rate of the money supply and the inflation rate is stronger in the long run than in the short run.

For a specific change in the yield to maturity

The longer the time until a bond matures, the greater will be the change in its price

The main role of financial intermediaries is to A) provide funds to the federal government to cover the budget deficit. B) borrow funds from savers and lend them to borrowers. C) provide advice to consumers on how they should handle their finances. D) help ensure that there is enough money in circulation

While holding a coupon bond, the interest rates on other similar bonds fall

The market price of your bond rises

The chapter opener noted that in mid-2016 you could earn an interest rate of 0.25% by buying a 3-month Treasury bill or an interest rate of 2.6% by buying 30-year Treasury bond. How is the Treasury able to find buyers for 3-month Treasury bills when investors could earn an interest rate 10 times as high by buying 30-year Treasury bonds?

The markets for bonds of different maturities are separate or segmented.

The mathematicians and economists who have been hired by Wall Street firms to build mathematical models to aid the pricing of derivatives are generally referred to as A) speculators. B) hedgers. C) rocket scientists. D) market makers

Which of the following was NOT a consequence of the reparations Germany was being forced to pay?

The money supply shrank.

An article in the Wall Street Journal notes that: open double quoteThe Federal Reserve is designed to be independent of Congress and the president.close double quote If the Fed has enormous power over the U.S. economy, what reason would explain why it was designed to be independent of Congress and the president rather than under their direct control?

The more independent a central bank is of the rest of the government, the more it can resist political pressure in making decisions.

Which of the following statements is true?

The more liquid the bond, the lower the yield.

The most common type of simple loan is a(an) A) automobile loan from a bank. B) mortgage loan from a bank. C) commercial loan from a bank. D) corporate bond

The most important derivative instruments are A) futures, options, and swaps. B) common and preferred stocks. C) corporate bonds. D) government bonds

Fischer Effect

The nominal interest rate changes point-for-point with changes in the expected inflation rate - Higher expected inflation increases supply of bonds - Higher expected inflation reduces demand for bonds - E2 is same Q but lower price for bonds

How will the bond market adjust to an increase in the expected inflation rate?

The nominal interest rate will rise point-for-point with increase in the expected inflation rate.

According to an article in the Economist, in Germany 80% of household wealth is in the form of bank deposits, as opposed to only 20% in the United States. The article notes that, open double quoteIf German ... savers are vulnerable to low rates, it is partly due to their own investment habits.close double quote Why would German savers be more vulnerable to low interest rates than U.S. savers?

The percentage of household wealth held in bank deposits is higher in Germany than in the U.S.

The period over which a call or put option exists is A) determined by its delivery date. B) determined by its expiration date. C) determined by whether the contract is written for a commodity or for a financial instrument. D) indeterminate; options contracts continue in existence until either the buyer or the seller desires to discontinue it

The price at which an option may be exercised is called the A) market price. B) equilibrium price. C) strike price. D) fixed price.

How are TIPS adjusted for inflation?

The principal is adjusted for inflation each period

What is the moral hazard problem?

The problem that managers of a financial firm will take on riskier investments because they believe the federal government will save them from bankruptcy.

The purpose of diversification is to A) increase the liquidity of a financial portfolio. B) reduce the brokerage fees involved in managing a financial portfolio. C) reduce risk. D) reduce tax liability

The rate of return of a stock held for one year equals A) the change in the price of the stock. B) the dividend yield plus the rate of capital gain. C) the rate of capital gain minus the dividend yield. D) the dividend yield minus the rate of capital gain

The required return on equity for an individual stock includes which of the following? A) systemic risk B) idiosyncratic risk C) risk-free interest rate D) all of the above

why would equity risk premium be negative

The returns on bonds outpaced the returns on stocks.

The role of the Commodity Futures Trading Commission is to A) set the prices of futures contracts. B) operate the Chicago Mercantile Exchange. C) operate the Chicago Board of Trade. D) monitor potential price manipulation in futures trading

The seller of a futures contract A) assumes the long position. B) has the obligation to deliver the underlying financial instrument at the specified date. C) has the obligation to receive the underlying financial instrument at the specified future date. D) may, at his or her option, deliver or receive the underlying financial instrument at the specified date

The seller of a futures contract A) assumes the short position. B) assumes the long position. C) has the obligation to receive the underlying financial instrument at the specified future date. D) is expecting the price of the underlying financial instrument to rise

The small-firm effect A) shows that investments in the stocks of small firms would have earned a below-normal return during the period beginning in the mid-1920s. B) may be the result of the low liquidity and high information costs of small-firm stock. C) was stronger during the 1980s than in previous decades. D) is the tendency for stocks of large firms to outperform those of small firms.

What is the fundamental value of a share of stock?

The sum of the present value of all dividend payments expected to be received into the infinite future time.

The federal government runs a series of budget surpluses.

The supply curve shifts to the left.

The economy experiences a period of rapid growth, with rising corporate profits.

The supply curve shifts to the right.

The expected rate of inflation increases.

The supply of bonds shifts to the right and the demand for bonds shifts to the left. This decreases the price of bonds and the quantity of bonds is indeterminate.

The government proposes a new tax on saving, based on the value of people's investments as of December 31 each year.

The supply of loanable funds would decrease, increasing the interest rate.

The World Cup soccer matches are being televised, and many people stay home to watch them, reducing consumption spending.

The supply of loanable funds would increase, decreasing the interest rate.

What is a carry trade?

The term is sometimes used to refer to borrowing at a low short-term interest rate and then using the borrowed funds to invest at a higher long-term interest rate.

The total rate of return is equal to A) the coupon rate plus the rate of capital gains. B) the coupon rate plus the current yield. C) the current yield plus the rate of capital gains. D) the coupon rate multiplied by the rate of capital gains

The total rate of return is equal to the A) sum of the coupon rate and the current yield. B) yield to maturity. C) sum of the current yield and the actual rate of capital gain or loss. D) sum of the current yield and the expected rate of capital gain

Who appoints the members of the Federal Reserve's Board of Governors?

They are appointed by the president and confirmed by the Senate.

Would this possible difference be of more concern to you if you were considering making a loan to be paid back in 1 year or a loan to be paid back in 10 years?

This difference would affect the decision to take out a 1-year loan versus a 10-year loan because the real interest rate can change over 10 years.

Which of the following best explains why a resident of Venezuela would wish to use U.S. currencies rather than currencies issued by their government?

To better maintain their purchasing power.

Why might the federal government decide to intervene in the housing market to promote home ownership?

To make it easier for families to borrow money to purchase a home.

U.S. Treasury bonds A) carry no risk of default and are therefore not risky investments. B) have constant yields to maturity and are therefore not risky investments. C) have constant coupon rates and are therefore not risky investments. D) are subject to fluctuations in their market prices and are therefore risky investments

Under the efficient markets hypothesis, for news about a company's prospects to have a large impact on the price of the company's stock the news must A) have an impact on the company's profitability in the short term. B) have an impact on the company's profitability in the long term. C) significantly increase the likelihood that the company will go bankrupt. D) significantly reduce the liquidity of the company's stock

Under the efficient markets hypothesis, what would be the price per share of a company whose current dividend is $10.00 and whose dividends are expected to grow by 3% per year (assume the risk-adjusted interest rate is 10%)? A) $74.62 B) $79.23 C) $142.86 D) $147.14

Using forward transactions allows A) holders of common stock to lock in future dividend payments. B) the federal government to stabilize fluctuations in tax receipts. C) corporations to reduce problems arising from future fluctuations in their dividend payments. D) both buyers and sellers to reduce risks associated with price fluctuations

In an article, "Preparing for the Next Black Swan" (Wall Street Journal, Aug 21, 2010), the point is made that diversification may be insufficient in protecting one's portfolio during a "Black Swan" event. Why may this be TRUE?

Virtually all asset classes may decline at the same time.

wealth

Wealth is the total value of assets a person owns minus the total value of any liabilities that a person owes. -increase in wealth generally increases the quantity demanded for most financial assets.

First, the return investors receive from buying stocks is reduced, which reduces the incentive individuals have to save in the form of stock investments and increases the costs to firms of raising funds. Second, firms have an incentive to retain profits rather than to distribute them to stockholders. Finally, because firms can deduct from their profits the interest payments they make on loans and bonds, the double taxation of dividends gives firms an incentive to take on what may be an excessive level of debt rather than issue stock.

What are the effects of the double taxation of dividends?

It can be merged with a financially healthier bank, voluntarily closed, or closed by federal regulators.

What are the three possible actions that could be taken when a bank becomes insolvent?

Banks charge interest on loans to compensate for inflation, to compensate for default risk, and to compensate for the opportunity cost of waiting to spend your money.

What are three reasons that banks charge interest on loans?

Adaptive expectations is when investors expectations of the price of a firm's stock depended only on past prices of the stock. With rational expectations, people make forecasts using all available information

What is the difference between adaptive expectations and rational expectations?

What is the price of a coupon bond that has annual coupon payments of $75, a par value of $1000, a yield to maturity of 5%, and a maturity of two years? A) $1043.08 B) $1046.49 C) $1000.00 D) $1150.00

What is the price of a coupon bond that has annual coupon payments of $85, a par value of $1000, a yield to maturity of 10%, and a maturity of three years? A) $211.38 B) $898.84 C) $962.70 D) $1255.0

What is the total rate of return on a bond with a coupon of $38 payable in one year that was purchased for $950 and sold one year later for $931? A) 2% B) 4% C) 6% D) 19%

What is the total rate of return on a bond with a coupon of $55 that was purchased for $900 and sold one year later for $950? A) 5.56% B) 6.11% C) 11.67% D) 12.43%

What is the yield on a discount basis for a U.S. Treasury bill that has a face value of $10,000, has a price of $9500, and will mature in 180 days? A) 5.00% B) 5.25% C) 10.00% D) 10.67%

What is the yield to maturity of a consol with a coupon of $85 and a price of $944.44? A) 5.56% B) 8.50% C) 9.00% D) Not enough information has been provided to determine the answer

What is the yield to maturity on a simple loan that requires payment of $500 plus $30 in interest one year from now? A) 6% B) 6.38% C) 5.3% D) Not enough information has been provided to determine the answer.

If new information leads investors to change their opinions about the risk, liquidity, information costs, or tax treatment of the returns from owning the stock, the fundamental price of the stock will change

What should affect the fundamental value of a stock according to the efficient markets hypothesis?

The actions by the Fed and Treasury were meant to restore the flow of funds between savers and borrowers. Without an increase in the flow of funds to a more normal level, households would have a difficult time making certain purchases and businesses would have difficulty financing investments and inventories

What was the intent behind the intervention of the Fed and Treasury in financial markets during the Financial Crisis of 2007-2009?

When market participants have adaptive expectations A) they use all information available to them. B) they only slowly adjust their expectations to news which could affect prices or returns. C) they are more likely to make accurate forecasts than if they have rational expectations. D) they are able to forecast interest rates more accurately than inflation rates

When market participants have rational expectations, A) they use all information available to them. B) they only slowly adjust their expectations to news which could affect prices or returns. C) they are less likely to make accurate forecasts than if they have adaptive expectations. D) they are able to forecast interest rates more accurately than inflation rates

Which of the following factors would tend to increase the size of the premium on an options contract? A) The option is near its expiration date. B) The current default-risk-free interest rate is high. C) The price volatility of the underlying asset is low. D) The option is far away from its expiration date

Which of the following is NOT a financial intermediary? A) NASDAQ B) Allstate Insurance Company C) Bank of America D) Vanguard Total Stock Market Index Fund

Which of the following is NOT a financial intermediary? A) mutual fund B) bank C) stock exchange D) insurance company

Which of the following is NOT a fixed payment loan? A) a home mortgage B) a car loan C) a U.S. Treasury note D) a student loan

Which of the following is NOT a key financial service provided by the financial system? A) risk sharing B) profitability C) liquidity D) information

Which of the following is NOT a popular stock market index? A) Dow Jones Industrial Average B) NASDAQ C) S&P 500 D) Moody's Market Index

Which of the following is NOT fixed on a coupon bond? A) coupon B) coupon rate C) market price D) par value

Which of the following is NOT true of a fixed payment loan? A) The borrower is required to make regular periodic payments to the lender. B) The payments made by the borrower include both interest and principal. C) The borrower is left with a substantial unpaid principal at the maturity of the loan. D) A home mortgage is an example of fixed payment loan.

Which of the following is a coupon bond? A) a U.S. savings bond B) a U.S. Treasury bill C) a U.S. Treasury note D) a zero-coupon bond

Which of the following is a fixed payment loan? A) a home mortgage B) a U.S. Treasury bill C) a U.S. Treasury note D) a zero-coupon bond

Which of the following is an example of behavior that is not rational? A) buying stocks after stock prices have declined B) buying stocks after stock prices have risen C) a significantly higher enrollment in 401K plans if people are automatically enrolled rather than having the option of signing up on their own D) enrollment in 401K plans during a bear market

Which of the following is fixed on a coupon bond? A) coupon rate B) current yield C) market price D) yield to maturity

Which of the following is the correct expression for the approximate expected real interest rate? A) r = i +p^e B) r = i - p^e C) r = i/p^e D) r = ip^e

Which of the following statements about the presence of speculators in futures markets is correct? A) Their main objective is to reduce their exposure to risk. B) They aid hedgers by increasing the liquidity in futures markets. C) They make it difficult for hedgers to find someone to take the opposite side of their positions. D) Once a futures market participant is known to be a speculator he or she is no longer allowed to participate in the market.

Which of the following statements about the total rate of return is NOT correct? A) The total rate of return may be greater or less than the current yield. B) The total rate of return may be greater or less than the rate of capital gain. C) The total rate of return may never be negative. D) The total rate of return is greater than the coupon, holding everything else constant

Which of the following statements is NOT true of the VIX? A) it is calculated based on prices of call and put options of the S&P 500. B) investors who want to hedge against stock market volatility can sell VIX options. C) a VIX of 10 indicates investors expect the S&P 500 to fluctuate by 10% at an annual rate over the next 30 days. D) the VIX is a measure of fear in the stock market

Which of the following statements is true of rational expectations? A) Rational expectations forecasts are always correct. B) For a trader with rational expectations, the expectation of an asset's price equals the optimal price forecast. C) If traders have rational expectations, any announcement by a company will have an effect on its stock price, even if the market was already aware of the facts being announced. D) If a trader really has rational expectations, he or she was always earn a greater than normal return on his or her financial portfolio.

Which type of bond would you purchase if you expected higher rates of inflation during the life of the bond? A) Treasury bond B) TIPS C) corporate bond D) municipal bond

Which type of borrowers were least likely to default in their mortgage at the beginning of the financial crisis? A) those with fixed-rate mortgages who made large down payments B) those with alt-A loans C) subprime borrowers D) those with adjustable-rate mortgages

The main concern was with the moral hazard problem, which is the possibility that managers of financial firms such as Bear Stearns might make riskier investments if they believe that the federal government will save them from bankruptcy.

Why did some economists and policymakers criticize the Fed and Treasury for arranging the sale of Bear Stearns to JP Morgan Chase in 2008?

Investors may be reluctant to sell stocks that have substantial capital gains

Why do some economists think that taxing capital gains results in a locked-in effect?

Why may investors buy a Treasury bill with a negative real interest rate? A) fear of rising inflation B) concern about high yields on other bonds C) fear of default by the US government D) concern about the high default risk of alternative investments

Forward contracts are more flexible than futures contracts

Why may some investors prefer forward contracts to futures?

If there were differences in prices, there would be opportunity for arbitrage

Why must the spot price equal the futures price on the settlement date?

Bonds with fewer years to maturity

Will be less affected by a change in the market interest rates

With respect to U.S. Treasury bills, A) the bid price is always greater than the asked price. B) the asked price is always greater than the bid price. C) the bid price is only greater than the asked price if investors expect interest rates to decline in the future. D) the asked price is only greater than the bid price if investors expect interest rates to decline in the future.

equity

a claim to part ownership of a firm: common stock issued by a corporation

portfolio

a collection of assets owned by an investor

currency swap

a contract in which counterparties agree to exchange principal amounts denominated in different currencies

credit swap

a contract in which interest-rate payments are exchanged, with the intention of reducing default risk -Example: If two banks have difficulty diversifying their portfolios, they can reduce their risk by swapping payment streams on some of their loans.

interest-rate swap

a contract under which counterparties agree to swap interest payments over a specified period on a fixed dollar amount, called the notional principal -One motivation is transferring interest-rate risk to parties that are more willing to bear it

publicly traded company

a corporation that sells stock in the U.S. stock market.

a consol is

a coupon bond that pays a fixed coupon rate and does not mature.

consol

a coupon bond that pays a fixed coupon rate and does not mature.

simple loan

a debt instrument in which the borrower receives from the lender an amount called the principal and agrees to repay the lender the principal plus interest on a specific date when the loan matures.

discount bond

a debt instrument in which the borrower repays the amount of the loan in a single payment at maturity but receives less than the face value of the bond initially.

coupon bond

a debt instrument that requires multiple payments of interest on a regular basis, such as semiannually or annually, and a payment of the face value at maturity.

fixed payment loan

a debt instrument that requires the borrower to make regular periodic payments of principal and interest to the lender

The supply curve for bonds would be shifted to the left by

a decrease in government borrowing

Which of the following will cause the money demand curve to shift to the left?

a decrease in real GDP

The supply curve for bonds would be shifted to the right by

a decrease in the corporate tax on profits

The expected change in the supply and demand for bonds due to an increase in expected inflation will definitely result in

a decrease in the equilibrium price of bonds.

capital loss

a decrease in the market price of an asset

credit default swaps

a derivative that requires the seller to make payments to the buyer if the price of the underlying security declines in value; in effect, a type of insurance

security

a financial asset that can be bought and sold in a financial market; traded in markets

Which of the following can best be characterized as a "Black Swan" event?

a financial crisis causing credit to dry up

Many hedgers buy options, not on the underlying asset, but on

a futures contract derived from that asset.

Commodity Money

a good used as money that also has value independent of its use as money

commodity money

a good used as money that also has value independent of its use as money -supply is fixed, not flexible -nature controls the supply -issues with storing, carrying around, etc. -serves primary purpose

Which is the best example of idiosyncratic risk?

a lawsuit because the corporation produced a faulty product

corporation

a legal form of business that provides owners with protection from losing more than their investment if the business fails

limited liability

a legal provision that shields owners of a corporation from losing more than they have invested in the firm.

over-the-counter market

a market in which financial securities are bought and sold by dealers linked by computer

over the counter market

a market in which financial securities are bought and sold by dealers linked by computers.

gordon growth model

a model that uses the current dividend paid, the expected growth rate of dividends, and the required return on equities to calculate the price of a stock

During most of the time in recent decades, the domestic government sector was

a net borrower

dividend

a payment that a corporation makes to stockholders, typically on a quarterly basis

perpetuities

a perpetuity does not mature. the price of a coupon bond that pays an infinite number of coupons: P = C/i -So a perpetuity with a coupon of $25 and a price of $500 has a yield to maturity of i=$25/$500 = 0.05, 5%

income

a person's earnings during a particular period

stock exchange

a physical location where stocks are bought and sold face-to-face on a trading floor

A debt instrument represents

a promise by a borrower to repay principal plus interest to a lender.

bubble

a situation in which the price of an asset rises well above the asset's fundamental value

futures contract

a standardized contract to buy or sell a specified amount of a commodity or financial asset on a specific future date.

options

a type of derivative contract in which the buyer has the right to buy or sell the underlying asset at a set price during a set period of time

call option

a type of derivative contract that gives the buyer the right to BUY the underlying asset at a set price during a set period of time

call option

a type of derivative contract that gives the buyer the right to buy the underlying asset at a set price during a set period of time

put option

a type of derivative contract that gives the buyer the right to sell the underlying asset at a set price during a set period of time

put option

a type of derivative contract that gives the buyer the right to sell the underlying asset at a set price during a set period of time.

expectations theory implies:

a. upward yield curve result of investors expecting future short term rates to be higher b. flat yield curve result of investors expecting short term to be same c. downward expect short term to be lower than current

forward contract

agreement to buy or sell at an AGREED UPON PRICE at a future time - negotiation involved allows savers and borrowers to conduct a transaction now and settle in the future. (allows you to hedge risk on transactions that depend on future prices)

bank capital

aka shareholders equity assets - liabilities

all of M1 plus time deposits, savings accounts, money market mutual fund shares

forward contract

an agreement to buy or sell an asset at an agreed upon price at a future time -make forward transactions possible - agreed in the present but settled in the future -provide risk sharing - hedge risk -tend to be iliquid -subject to default risk -involve an agreement in the present to exchange a given amount of a commodity (e.g., oil, gold, or wheat) or a financial asset (e.g., Treasury bills) at a future date for a set price

put option - who would buy it?

an investor who wants to bet that the price of the underlying asset will decrease

efficient markets hypothesis

an investor will not be able to consistently earn above average returns on stocks/groups of stocks price of an asset equals the markets best estimate of its fundamental value

A bubble

an unsustainable increase in the price of a class of assets

duration analysis

analysis of how sensitive a banks capital is to changes in market interest rates longer duration = value of assets and liabilities more sensitive to changes in interest rates

adaptive expectations

assumption that people forecast future values of a variable using only past values of the variable -economists assumed that investors' expectations of the price of a firm's stock depended only on past prices of the stock

actively managed funds

attempt to earn high returns by frequently buying and selling individual stocks

As wealth increases in the economy, savers are willing to

buy more bonds at any given price.

with options contracts the _________ (buyer/seller) has rights and the ________ has obligations

buyer has rights, seller has obligations ** in futures contracts buyers and seller have the same rights/obligations **

reverse repurchase agreement

buying Treasury securities and agreeing to sell them back later

negotiable order of withdrawal (NOW)

checking accounts that pay interest

transaction costs

costs in time or other resources that parties incur in the process of agreeing and carrying out an exchange of goods and services.

what causes a bear market in bonds

could result from investors believing that inflation rate might rise in the future. The Fisher effect tells us that a higher expected inflation rate will result in higher nominal int rates. Higher nominal int rates means lower bond prices

Differences in the taxation of returns

create differences in yields among credit market instruments.

marking to market

crediting or debiting the margin account based on the net change in the value of the futures contract

Suppose a coupon bond with a par value of $1,000 is currently priced at $950 and has a coupon of $40. Which of the following is TRUE?

current yield > coupon rate

Suppose a coupon bond with a par value of $1000 is currently priced at $950 and has a coupon of $40. Which of the following is true?

current yield > coupon rate

Suppose a coupon bond with a par value of $1,000 is currently priced at $950 and has a coupon of $40.

current yield > coupon rate (1,000) * coupon rate = 40 coupon rate = 40/1,000 coupon rate = 0.04, 4% Current Yield = 40 / 950 Current Yield = .042, 4.2%

In the liquidity preference framework, A) the demand for bonds must equal the supply of money B) the demand for money must equal the supply of bonds C) an excess demand of bonds implies an excess demand for money D) an excess supply of bonds implies an excess demand for money

marking to market

daily settlement where the exchanges transfers funds from a buyers account to a sellers account or vice versa depending on changes in price

settlement date

date for delivery that is specified (illiquid)

simple loan

debt instrument in which borrower receives from lender an amount called the principal and agrees to repay the lender the principal plus interest on a specific date when loan matures

discount bond

debt instrument in which borrower repays the amount of the loan in single payment at maturity but receives less than the face value

simple loan

debt instrument in which the borrower receives from the lender an amount called the principal and agrees to repay the lender the principal plus interest on a specific date when the loan matures -transfer between the lender and borrower. Ex. at a future date (agreed upon), transfer $1000 back with something in addition (interest). Receive something, pay something back but it'll be at a greater amount.

discount bond

debt instrument in which the borrower repays the amount of the loan in a single payment at maturity but receives less than the face value of the bond initially.

coupon bond

debt instrument that requires multiple payments of interest on a regular basis, and a payment of the face value at maturity

coupon bond

debt instrument that requires multiple payments of interest on a regular basis, and a payment of the face value at maturity. -IBM issued a $1,000 30-year bond with a coupon rate of 10%, it would pay $100 per year for 30 years and a final payment of $1,000 at the end of 30 years.

fixed payment loan

debt instrument that requires the borrower to make regular periodic payments of principal and interest to the lender

fixed payment loan

debt instrument that requires the borrower to make regular periodic payments of principal and interest to the lender. -You are repaying a $10,000 10-year student loan with a 9% interest rate, so your monthly payment is approximately $127.

bonds represent ____ rather than ____

debt, equity

increase in information costs of bonds relative to other assets causes demand for bonds to

decrease b/c holding bonds is less attractive

increase in business taxes causes supply for bonds to

decrease b/c taxes reduce profitability of investment

Since most banks have negative gaps and positive duration gaps, an increase in market interest rates will

decrease bank profits and decrease bank capital.

expected inflation increases, then in bond market demand will

decrease because holding bonds is relatively less attractive

if interest rate increases, Pt will

decrease. price will be lower than FV.

information costs (shift demand)

decrease: demand right

risk (shift demand)

decrease: right

A decrease in real GDP will result in a(n) ________ in the demand for money and cause the nominal interest rate to ________.

decrease; decrease

A decrease in money supply will result in a(n) ________ in the quantity of money demanded and cause the nominal interest rate to ________.

decrease; increase

higher federal tax rate ____ demand for treasury bonds

decreases

if riskiness of bonds relative to other assets increases, demand for bonds

decreases b/c holding bonds is relatively less attractive

expected inflation (shift supply)

decreases: increases the real interest rate

risk

degree of uncertainty in the return on an asset.

Many economists assume that a boom in the stock market is a sign that profitable business opportunities are expected in the future. In other words, the expected return on stocks increases.

demand for bonds shifts in; EQ interest rate will be higher

decrease in bond's liquidity or increase cost of info about the bond, _____ for bond will shift ____ and ____

demand, left, decline.

commodity derivatives value

depends on underlying commodity, such as wheat, crude oil, or gold

price of an asset

determined by adding up the present values of all the payments from its sellers to buyers. -equal to the present value of the payments to be received from owning it.

The world real interest rate is

determined in the international capital market

default risk premium

difference between interest rate on bond and interest rate on Treasury bond with same maturity

default risk premium

difference between the interest rate on the bond and the interest rate on a Treasury bond that has the same maturity -additional yield that an investor requires for holding a bond with some default risk

equity

difference between the value of the firm's assets and the value of its liabilities -Stocks are called equities because ownership of stocks represents partial ownership of a firm.

equity

difference between the value of the firm's assets and the value of its liabilities.

interest rate parity condition

differences in interest rates on similar bonds in different countries reflect expectations of future changes in exchange rates

e-money

digital cash people use to buy goods and services over the Internet. ex. bitcoin ex.

Since all assets typically do NOT move together, how can investors typically reduce risk?

diversify one's portfolio across different asset classes

gordon growth model

dividend discount model -a model that uses the current dividend paid (D), the expected growth rate of dividends (g), and the required return on equities (Re) to calculate the price of a stock. -shows that investors' expectations of future profitability of firms plays a crucial role in determining stock prices

double taxation of dividends

dividends are taxed as corporate profits and then also as income tax once paid to stockholders

Many companies issue preferred stock with a provision that allows the company to buy back the preferred stock at its original price after five years. The article notes that this provision "can produce unexpected losses for investors." Companies would be likely to buy back their preferred shares when _______.

dividends on new issues of preferred stock are lower than those on outstanding shares

diversification

dividing wealth among many different assets to reduce risk

diversification

dividing wealth among many different assets to reduce risk.

shortcoming of segmented markets theory

does not explain why short term interest rates would ever be greater than long term interest rates - why yield curve is sometimes downward sloping -hard to understand why interest rates of all maturities tend to rise and fall together

Consider an open economy that is a net borrower (like the United States). What would be the impact of a shift to a closed economy?

domestic investment would decline

perpetuities

dont mature

dividends are subject to ____ b/c:

double taxation; they are taxed at both the firm level and the individual level

The risk premium of corporate bonds typically increases

during a recession.

Which of the following is the most likely explanation of Japan's very low market interest rates in the early 2000s?

expected deflation

required return on equities

expected return necessary to compensate for the risk of investing in stocks -rte of return firms need to pay to attract investors - called equity cost of capital -sum of risk-free interest rate and a risk premium b/c investments in stocks are riskier than investments in treasury bills

exchange rate and risk

exposure to risk could increase with foreign exchange because exchange rate can change/move in dramatic ways. -NX changes are nominal exchange rate changes -our currency loses value, our goods get cheaper, NX increases

hyerinflation

extremely high inflation rates

information

facts about borrowers and expectations of returns on financial assets. ex. prices of stocks, bonds, and other securities available to savers and borrowers

interest rates rise, present values...

fall

increase in the supply of USD causes the exchange a rate to ______ (rise/fall)

fall supply shifts out

If expected inflation declines by 2%, what should happen to nominal interest rates according to the Fisher effect?

fall by 2%

increase in bond's liquidity causes its yield to _____ because ____

fall, investors incur lower costs in selling the bond

If the Fed decreases the money supply and as a result, households and firms buy fewer short-term financial assets, the prices of those short-term financial assets will ________ and the interest rates on those assets will ________.

fall; rise

When business taxes are raised, the profits on new investments in physical capital decline, and firms issue/supply

fewer bonds - shift left

reasons to participate in currency swaps

firms may have comparative advantage in borrowing in their domestic currency --> can swap proceeds with a foreign counterparty to obtain foreign currency --> both parties may be able to borrow more cheaply

fintech

firms that use technology to make loans to individuals + small businesses from funds provided by individuals/financing firms Ex: SoFi, LendingClub, Kabbage

Interest−rate risk can best be characterized as the risk that

fluctuations in the price of a financial asset in response to changes in market interest rates.

if worried about rising interest rates and falling bond prices, appropriate hedge would be...

for you to sell futures contracts. -by owning bonds, you are in the spot market for bonds, so the appropriate hedge would be fore you to go short in the futures market for bonds by selling futures contracts

Black-Scholes formula

formula for the optimal pricing of options low volatility = low option premium = cheaper option

most important derivatives:

forward contracts, future contracts, options contracts, swaps

futures vs forward contracts

futures - set amount, traded on exchanges, prices can change based on the market for futures forward - set price that is negotiated between two parties both used to hedge or speculate about price changes

gap analysis

gap between dollar value of banks assets and dollar value of liabilities used to calculate vulnerability of banks profits to changes in market interest rates

Eurodollars

general term for deposits in any bank outside of the US

call option

gives the buyer the right to BUY the underlying asset at the strike price during a SET PERIOD (up to the options expiration date) buy if you think the asset will increase in price

commodity money

good used as money that also has value independent of its use as money

legal tender

government designation that currency is accepted for payment of taxes and debts

legal tender

government designation that currency is accepted for payment of taxes and people must accept it in payment of debts

federal deposit insurance

government guarentee of deposit account balances up to $250k

If lenders anticipate no changes in liquidity, information costs, and tax differences, the yield on a risky security should be

greater than that on a safe security and the price of a risky security should be lower than that of a safe security.

The expectations theory has a difficult time explaining

has difficulty explaining why yield curves usually slope upward.

shareholder

has legal claim on the firm's profits and on its equity

During most of the time in recent decades, the government sector

has run large deficits

call option and seller

has the obligation to SELL the underlying asset at the strike price if the buyer exercises the option

put option and seller

has the obligation to buy the underlying asset at the strike price if the buyer exercises the option

call option and buyer

has the right to PURCHASE the underlying option at the strike price on or before the expiration date

put option and buyer

has the right to SELL the underlying asset at the strike price on or before expiration date

younger households wealth

have most of their wealth in homes and small businesses they own.

hedging short position

hedging involves taking a short position in the futures market to offset a long position in the spot market or taking a long position in the futures market to offset a short position in the spot market

investors want _____ (high/low) leverage because it means _____ (high/low) ROE

high leverage high ROE

When nominal interest rates on financial assets are high, the opportunity cost of holding money is ________, so the quantity of money demanded by households and firms will be ________.

high; low

interest rates on long-term bonds are usually _____ than interest rates on short term bonds

higher

interest rates on short term bonds are occasionally ______ than interest rates on long- term bonds

higher

As a result of the perceived riskiness of alternative investments following the financial crisis of 2007-2009, the bond market was affected in all of the following ways

higher demand for bonds, lower nominal interest rates, higher price of bonds.

Other things equal, an increase in the tax on dividends is likely to result in all of the following

higher expected return on bonds relative to stocks, increased demand for bonds, lower interest rates

bonds with less favorable characteristics have

higher interest rates b/c investors require higher expected returns on those bonds

According to the Fisher effect, an increase in expected inflation results in

higher nominal interest rates

An increase in expected inflation results in

higher nominal interest rates and lower bond prices

Which group of investors vote for a corporation's board of directors?

holders of common stock

If a corporation pays a dividend, which group receives priority in receiving the dividend?

holders of preferred stock

Which combination of assets represents the most diversification?

holding shares of Google along with Treasury bonds

open economy

households, firms, and governments borrow and lend internationally.

closed economy

households, firms, and governments do notborrow or lend internationally.

Periods of hyperinflation often _____ bank profits, especially if inflation is _____ than the bank expected it to be when making loans.

hurt, higher

The formula for the yield to maturity, i, on a discount bond is

i = (Face value - Price)/Price

interest rate parity condition equation

i(domestic) = i(foreign) - expected appreciation of domestic

law of one price

idea that identical products should sell for the same price

law of one price

identical products should sell for same price everywhere

law of one price

identical products should sell for the same price everywhere.

compensation for inflation

if prices rise, the payments received will buy fewer goods/services

zero-sum game

in a future contract - if the seller makes a profit the buyer must suffer a loss of exactly the same amount and vice versa

long position

in a futures contract, the right and obligation of the buyer to receive or buy the underlying asset on the specified future date BUYER OBLIGATIONS

long position

in a futures contract, the right and obligation of the buyer to receive or buy the underlying asset on the specified future date.

short position

in a futures contract, the right and obligation of the seller to sell or deliver the underlying asset on the specified future date SELLER OBLIGATIONS

marking to market

in the futures market, a daily settlement in which the exchange transfers funds from a buyer's account to a seller's account or vice versa, depending on changes in the price of the contract

margin requirement

in the futures market, the minimum deposit that an exchange requires from the buyer and seller of a financial asset; reduces default risk

a "primary market" is a market

in which newly issued claims are sold to BUYERS by BORROWERS

An increase in expected inflation will _______ the nominal interest rate on both short-term and long-term bonds.

increase

wealth (shifts demand)

increase : right decrease : left

increase in expected inflation causes supply for bonds to

increase b/c at any given bond price, the real cost of borrowing falls.

increase in expected profitability causes supply for bonds to

increase b/c businesses borrow to finance profitable investments

increase in investment tax credits causes supply for bonds to

increase b/c government tax credits lower the cost of investment, thereby increasing profitability of investment

if liquidity of bonds increases relative to other assets, demand for bonds

increase b/c holding bonds is more attractive

increase in government borrowing causes supply for bonds to

increase b/c more bonds are offered in the economy at any given interest rate

increase in bond's default risk causes its yield to ______ because ____

increase, investors must be compensated fro bearing additional risk

expected return on bonds (shift demand)

increase: right

business taxes (shift supply)

increase: supply left

An increase in the price level will result in a(n) ________ in the demand for money and cause the nominal interest rate to ________.

increase; increase

An increase in the tax rate on dividends, other things equal, is likely to result in a(n)

increased demand for bonds due to an increase in the expected return on bonds relative to stocks

higher federal tax rate ____ demand for municipal bonds

increases

A decrease in the riskiness of bonds relative to the riskiness of other assets...

increases the willingness of investors to buy bonds.

Higher expected inflation ________ the supply of bonds and ________ the demand for bonds.

increases; reduces

fischer effect

indicates that the nominal interest rate changes point for point with changes in the expected inflation rate

specialization

individuals produce goods for which they have best ability for

The implication of the expectations theory that expected returns for a holding period must be the same for bonds of different maturities depends on the assumption that

instruments with different maturities are perfect substitutes.

______ is taxed at the same rate as wage and salary income while _____ is taxed at a lower rate.

interest income, capital gain

credit swap

interest payments are exchanged to reduce default risk (rather than interest rate risk like interest rate swaps) good for banks that can't necessarily diversify their portfolios but want to reduce risk

segmented markets theory

interest rate on a bond of a particular maturity is determined only by the demand and supply of bonds of that maturity

real interest rate

interest rates that are adjusted for changes in purchasing power

nominal interest rate

interest rates that are not adjusted for changes in purchasing power

Though Treasury bonds may have little default risk, what type of risk exists when current interest rates are low?

interest-rate risk

What risk exists when current interest rates are low - even if risk of default is very low

interest-rate risk

The price of an option represents the option's

intrinsic value plus time value

relationship b/w bond yields and bond prices is

inverse

As a result of the lower information costs

investors are more willing to buy bonds.

If the liquidity of bonds increases

investors demand more bonds at any given price.

Following the downgrade of U.S. debt by Standard & Poor's in August, 2011:

investors didn't seem to be any more concerned about default risk than before the downgrade

according to the expectations theory, a downward sloping yield curve is the result of

investors expecting future short term rates to be lower than the current short term rate

according the expectations theory, an upward sloping yield curve is the result of

investors expecting future short-term rates to be higher than the current short-term rate

according to the expectations theory, a flat yield curve is the result of

investors expecting future short-term rates to be the same as the current short-term rate

herd behavior

investors imitating behavior of other investors

trading

investors should not move funds repeatedly from one stock to another (churn a portfolio) b/c they have to pay a commission to a broker on each sale/purchase -buy and hold a diversified portfolio over a long period of time

segmented markets theory over simplification

investors view bonds of different maturities as not being substitutes at all

expectations theory over simplification

investors view bonds of different maturities as perfect substitutes for each other

Default risk

is the probability that a borrower will not pay in full the promised coupon or principal.

Securitization

is the process of converting loans into securities

A small open economy

is unable to affect the world real interest rate by its borrowing and lending decisions

The yield on a thirty-year Treasury bond is 8% at the same time as the yield on two-year Treasury note is 5%. This occurrence

is well explained by the segmented markets theory.

When a country's real exchange rate depreciates,

it can trade its goods for fewer units of foreign goods.

When a company whose ability to repay its obligations in full is uncertain,

it must offer investors higher yields to compensate them for the risk they take in buying their bonds or making loans.

older household wealth

large fraction of their wealth in bank deposits.

Changes in stock prices sometimes appear to be _____ than changes in the fundamental values of the stocks.

larger

for both stocks and bonds, the secondary market is _____ than the primary market

larger

If the federal government decreases its spending and doesn't decrease taxes, the bond supply shifts to the

left and the equilibrium interest rate falls

If the federal government decreases its spending and doesn't decrease taxes, the bond supply shifts to the

left and the equilibrium interest rate falls.

An investor who owns stock in a firm organized as a corporation is protected by

limited liability

capital requirements

limits on value of assets commercial banks can acquire

An investor who desires the ability to have quick and easy access to cash would prefer to hold which type of asset?

liquid

Investors value liquidity in an asset because

liquid assets incur lower selling costs

marketable securities

liquid assets that banks trade in financial markets

When looking at the flow of funds between the U.S. and foreign financial markets

loanable funds approach is more useful than the demand and supply of bonds approach.

securitized loans

loans that have been bundled with other loans and resold to investors; they are both financial assets and financial securities.

Taxing capital gains creates a _____ b/c ___

lock-in-effect because investors may be reluctant to sell stocks that have substantial capital gains

When nominal interest rates fall on financial assets such as U.S. Treasury bills, the amount of interest that households and firms

lose by holding money decreases

When nominal interest rates rise on financial assets such as U.S. Treasury bills, the amount of interest that households and firms

lose by holding money increases

When nominal interest rates on financial assets are low, the opportunity cost of holding money is ________, so the quantity of money demanded by households and firms will be ________.

low; high

bond with more favorable characteristics have

lower interest rates because investors are willing to accept lower expected returns on those bonds.

In late 2012, President Obama proposed raising the top income tax rate. All of the following are likely impacts of higher income tax rates on bonds EXCEPT:

lower prices for Municipal bonds

if rating agencies believe a firm's ability to make payments on a bond has declined, they will give the bond a _____ rating, and if investors agree they'll demand a _____ quantity of the bond at any given price, so _____ curve for the bond will shift ______, so prices will _____, and yield will ______.

lower, smaller, demand, left, decrease, increase

Jumpstart Our Business Startups Act (JOBS)

made it easier for small businesses to obtain funding people with incomes of less than $100,000 were allowed to invest up to $2000 into startups

`risk neutral

make decisions on basis of expected returns, ignore risk

risk-neutral investors

make decisions on the basis of expected returns, ignoring risk.

payments system

mechanism for conducting transactions in the economy

payments system

mechanism for conducting transactions in the economy.

debt instruments

methods of financing debt, including simple loans, discount bonds, coupon bonds, and fixed payment loans -also known as credit market instruments or fixed income assets

debt instruments

methods of financing debt, including simple loans, discount bonds, coupon bonds, and fixed payment loans.

money market model

model that shows how the short-term nominal interest rate is determined by the demand and supply for money. -liquidity preference model

Fed is responsible for

monetary policy - the actions to manage the money supply and interest rates to pursue macroeconomic policy objectives.

standard of deferred payment

money can facilitate exchange over time (not only at a point in time).

Why are corporations more likely to raise funds externally by debt instead of equity?

moral hazard is less of a problem with debt contracts

What is a consequence of extending the payback period of a student loan from 10 to 30 years?

more interest paid over the life of the loan

Which of the following is a consequence of extending the payback period of a student loan from 10 to 30 years?

more interest paid over the life of the loan

primary source of external financing for small to medium-size firms

mortgages

A closed economy is one that

neither borrows from nor lends to foreign countries

fiat money

no value apart from its use as money

fiat money

no value apart from its use as money, e.g., paper currency. useless with no value allows us to shift resources across periods -not fixed - chosen, can be changed, etc. we control all the time - our control in the money supply has lead to an increase in price level.

One economic argument for taxing capital gains differently than other income is that investors have to pay taxes on their _____ gain ______ for inflation.

nominal; without an adjustment

nominal interest rates

not adjusted for changes in purchasing power

forward contracts

an agreement to buy or sell an asset at an agreed-upon price at a future time.

derivative securities

an asset that derives its economic value from an underlying asset, such as a stock or a bond -can serve as a type of insurance (or hedging) against price changes in underlying assets.

stock market index

an average of stock prices that is used to measure the overall performance of the stock market

large open economy

an economy in which changes in the demand and supply for loanable funds are large enough to affect the world real interest rate

small open economy

an economy in which the quantity of loanable funds supplied or demanded is too small to affect the world real interest rate.

The supply curve for bonds would decline due to

an increase in expected inflation.

The demand curve for bonds would be shifted to the left by

an increase in expected returns on other assets

In a large open economy

an increase in the domestic supply of loanable funds would lower the world real interest rate

Suppose that a new bond rating service is established that specializes in rating municipal bonds that had not previously been rated. The likely result would be

an increase in the equilibrium interest rate

The demand curve for bonds would be reduced by

an increase in the information costs of bonds relative to other assets

capital gain

an increase in the market price of an asset

Which of the following will cause the money demand curve to shift to the right?

an increase in the price level

Since Germany is a large open economy, the increase in German borrowing and investment in what was formerly East Germany in the early 1990s resulted in

an increase in the real interest rate in the United States

real interest rate

an interest rate that is adjusted for changes in purchasing power

nominal interest rate

an interest rate that is not adjusted for changes in purchasing power

put option - who would sell it?

an investor who wants to bet that the price of an underlying asset will not decrease

call option - who would sell it?

an investor who wants to bet that the price of an underlying asset will not increase

call option - who would buy it?

an investor who wants to bet that the price of the underlying asset will increasse

asset

anything of value owned by a person or a firm

Economist definition of money

anything people are willing to accept as payment for goods and services or to pay off debts

efficient markets hypothesis

application of rational expectations to financial markets; the hypothesis that the equilibrium price of a security is equal to its fundamental value -says stock prices are not predictable -stock of a more profitable firm will not be a better investment than the stock of a less profitable firm

Standby letters of credit

are a promise by a bank to lend the borrower funds to pay off its maturing commercial paper.

Bond ratings

are published by private bond-rating agencies.

derivative security

asset that derives its economic value from an underlying asset (can serve as a type of insurance against price changes)

financial asset

asset that represents a claim on someone else for a payment - at some certain date you can expect a monetary payment

collateral

assets that a borrower pledges to a lender that the lender may seize if borrower defaults

investment banks

assist firms in underwriting stocks and bonds. Examples are Goldman Sachs and Morgan Stanley. -own capital usually funds projects; assets, firms, business, projects, and provide funds -underwriting: if someone wants to sell asset like stocks of business (IPO) --> decision made by market particiapnts how much to pay (high - low value) --> want to secure highest value possible and underwriting guarantees this price.

incentive contracts

attempt to reduce the principle agent problem and align goals of shareholders and managers

A lower expected real interest rate is

attractive for a firm as it will pay less in real terms to borrow funds.

national bank

authorized and regulated by the federal govt

stock market index

average of stock prices that investors use to measure the overall performance of the stock market

stock market index

average of stock prices that investors use to measure the overall performance of the stock market -changes in the values of index numbers are important -set equal to 100 in base period

the dow

average of the stock prices of 30 large corporations

loan sales

bank agrees to sell expected future returns from an underlying bank loan to a third party

secondary reserves

bank holdings of US Treasury securities

The United States has a dual banking system in the sense that

banks are chartered by the federal government and by state governments.

relationship banking

banks can assess credit risks on the basis of private info about borrowers (reduces the costs of adverse selection)

demand deposits

banks do not pay interest

originate-to-distribute

banks sell loans rather than holding them to maturity

momentum investing

based on the idea that there can be persistence in stock movements, so that a stock that is increasing in price is somewhat more likely to rise than to fall, and a stock that is decreasing in price is somewhat more likely

Suppose that Google announces that its profits for the third quarter of 2011 were $1.6 billion. As a result of this announcement the price of Google's stock declines. The best explanation of this is A) market participants expected Google's profits to be greater than $1.6 billion for the third quarter. B) market participants expected Google's profits to be less than $1.6 billion for the third quarter. C) the stock market is not an efficient market. D) market participants have adaptive expectations

The first investment which earned 5% a year for two years would result in $1,102.50 after two years. The second investment would result in $1,101.60. Thus, the first investment provides the higher return

Suppose you had $1000 and were deciding between two investments. One pays 5% a year for two years while the other pays 8% the first year and 2% the second year. Which investment would provide a higher return?

The rate of return is $30/$1025 + ($1050 - $1025)/$1025 = 5.37%.

Suppose you purchase a bond with a coupon of $30 for $1025. You sell it one year later for $1050. What rate of return did you earn? Report a percentage with two decimal places.

The rate of return is $50/$1010 + ($900 - $1010)/$1010 = -5.94%.

Suppose you purchase a bond with a coupon of $50 for $1010. You sell it one year later for $900. What rate of return did you earn? Report a percentage with two decimal places.

$540.80

Suppose you put $500 in your savings account and earn 4% interest per year. How much will you have in your account after two years? Be sure to round off to the nearest cent

Swaps differ from futures and options in all of the following ways EXCEPT: A) intended to reduce the risk faced by participants. B) more flexibility. C) more privacy. D) less regulation

A borrower and a lender agree on a mortgage interest rate. If inflation turns out to be less than expected A. the actual nominal interest rate will be higher than expected. B. the actual nominal interest rate will be less than expected. C. the actual real interest rate will be less than the expected real interest rate. D. the actual real interest rate will exceed the expected real interest rate

A debt instrument represents A. a nontaxable asset, owned primarily by large corporations. B. an attempt by a borrower in default to restore his or her credit. C. an ownership claim by the purchaser on the issuer. D. a promise by a borrower to repay principal plus interest to a lender.

A rise in the price level causes the demand for money to _____ and the interest rate to ______, everything else held constant. A) decrease; decrease B) decrease; increase C) increase; decrease D) increase; increase

A rise in the price level causes the demand for money to _____ and the interest rate to ________, everything else held constant. A) decrease; decrease B) decrease; increase C) increase; decrease D) increase; increase

An increase in interest rates can be caused by a(n) _____ in the demand for bonds or a(n) _____ in the supply of bonds A) increase; decrease B) increase; increase C) decrease; decrease D) decrease; increase

trading costs and taxes and inconsistencies with efficient markets hypothesis

Taking into account trading costs and taxes eliminates the above-average returns supposedly earned using many trading strategies

The "greater fool" theory assumes that A) markets are efficient. B) bubbles cannot exist in well-organized markets. C) it makes sense for an investor to buy an asset as long as there is someone else to buy it later for a higher price. D) bond market returns are always above stock market returns

The Federal Reserve System A) is in charge of managing the New York Stock Exchange. B) is headed by the Secretary of the Treasury. C) is the central bank of the United States. D) is responsible for conducting fiscal policy for the United States

A borrower and a lender agree on a mortgage interest rate. If inflation turns out to be less than expected

The actual real interest rate will exceed the expected real interest rate

During a period of economic expansion, when expected profitability is high, A. the equilibrium price of bonds rises. B. the demand curve for bonds shifts to the left. C. the equilibrium interest rate falls. D. the supply curve of bonds shifts to the right.

Economists define money as A. cash in circulation. B. deposits in commercial banks. C. bonds issued by large corporations. D. anything that people are willing to accept in payment for goods and services or to pay off debts.

Following the downgrade of U.S. debt by Standard & Poor's in 2011 A. interest rates spiked as investor's perception of risk increased. B. the U.S. implemented a plan to significantly reduce its budget deficit later that year. C. other rating agencies also downgraded U.S. debt. D. investors didn't seem to be any more concerned about default risk than before the downgrade.

How are TIPS adjusted for inflation? A. the interest rate is adjusted once the bond reaches maturity B. the interest rate is adjusted for inflation during each period C. the principal is adjusted once the bond reaches maturity D. the principal is adjusted for inflation each period

If asset A is a risky asset yielding 10% and asset B is a riskless asset with the same maturity with a yield of 8% investors would A) prefer asset A B) prefer asset B C) be indifferent D) require more information

If fluctuations in interest rates become less volatile, then, other things equal, the demand for short-term bonds_____ and the demand for long-term bonds____. A) increases; decreases B) increases; increases C) decreases; decreases D) decreases; increases

If fluctuations in interest rates become less volatile, then, other things equal, the demand for stocks _____ and the demand for long-term bonds _______. A) increase; decrease B) increase; increase C) decrease; decrease D) decrease; increase

If the annual interest rate is 8%, what would you expect to pay for a bond paying a lump sum of $10,000 in ten years? A. $9,259 B. $21,589 C. $10,000 D. $4,632

If the current price of a bond is less than its face value, A. the coupon rate must be equal to the current yield. B. the yield to maturity must be less than the current yield. C. the coupon rate must be greater than the current yield. D. an investor will receive a capital gain by holding the bond until maturity.

If the expected gains on stocks falls, while the expected returns on bonds do not change, then A) the demand curve for bonds will shift to the left B) the supply curve for loanable funds will shift left C) the equilibrium price on bonds will fall D) the equilibrium interest rate will fall

If the expected returns on stocks fall, while the expected returns on bonds do not change, then A) the equilibrium interest rate will rise B) the demand curve for bonds will shift to the left C) the supply curve for bonds will shift to the right D) the equilibrium interest rates will fall

In the Bs/Bd model, which of the following would likely lead to a decrease in interest rates? A) an increase in federal entitlement expenditures B) an increase in expected inflation C) an increase in business confidence D) an increase in the public's propensity to save rather than consume

Interest−rate risk can best be characterized as the risk that A. you could have earned a higher interest rate if you waited to purchase a bond. B. you could have gotten a lower interest rate if you waited to lock in a mortgage. C. short−term interest rates may exceed long−term interest rates. D. fluctuations in the price of a financial asset in response to changes in market interest rates.

Suppose there's a 50% chance of a stock rising by 20% and a 50% chance of it falling by 20%. What is the expected rate of return on the stock? A. minus20% B. 20% C. 10% D. 0%

The bond supply curve slopes up because A) the borrower is willing and able to offer more bonds when the price of a bond is low B) the lender is willing and able to offer more bonds when the price of the bond is high C) the lender is willing and able to offer more bonds when the price of a bond is low D) the borrower is willing and able to offer more bonds when the price of the bond is high

Under the expectations theory, if market participants expect that future short-term rates will be higher than current short-term rates, the yield curve will A. slope upward, slope downward, or be flat, depending on risk, liquidity, cost of information, and tax considerations. B. slope downward. C. be flat. D. slope upward

What is the rate of return on a bond with a coupon of $38 payable in one year that was purchased for $950 and sold one year later for $931? A. 6% B. 19% C. 4% D. 2%

What made the recession of 2007-2009 different than any other recession since the Great Depression? A. The impact was primarily limited to the financial sector. B. The government did not implement a fiscal stimulus. C. The Fed failed to reduce interest rates. D. It was accompanied by a financial crisis.

When the Fed decreases the money stock, the money supply curve shifts to the ______ and the interest rate ______, everything else held constant. A) right; rises B) right; falls C) left; falls D) left; rises

Which of the following is included in M1, but not in M2? A. currency B. checking account deposits C. travelers' checks D. Everything in M1 is in M2.

Which of the following represents the equation that would be used to determine the yield to maturity of a three-year fixed payment loan of $1400 which has payments of $500 per year? A. $1400 = $500/(1+i) + $500/(1+i)2 + $500(1+i)3 + 1400/(1+i)3 B. i = (1400−500)/1400 C. $1400 = $500/(1+i)3 D. $1400 = $500/(1+i) + $500/(1+i)2 + $500/(1+i)3

Which of the following would lead to an increase in bond supply A) a decrease in government spending B) an increase in corporate taxes C) a decrease in expected inflation D) an improvement in general business

Why isn't the current yield a good indicator of holding a bond? A. It assumes that the current price equals its par value. B. It doesn't account for the yield to maturity. C. It doesn't account for the coupon. D. It doesn't account for capital gains or losses.

lmost every time that there has been an inverted yield curve, what took place within one year? A. financial crisis B. higher bond yields C. rising inflation D. recession

which of the following would not cause the demand curve for bonds to shift A) a change in the business cycle B) an increase in the relative transaction costs of bonds C) a change in the liquidity of stocks D) a change in the price of bonds

Currently, a three-year Treasury note pays 4.75%. Assuming that your tax rate is 20%, what is the minimum interest rate that you would you need to earn on a tax-free municipal bond in order to buy it instead? A. 15.25% B. 0.95% C. 5.7% D. 3.8%

Debt instruments are also called A) equities. B) credit market instruments. C) prospectuses. D) units of account

Declining default risk in late 2009 and 2010 led to A) increase in the price of junk bonds. B) increase in the yield of junk bonds. C) increase in yield of Treasury bonds. D) increase in the price of Treasury bonds

For several decades in the late nineteenth century, the price level in the United States declined. Was this likely to have helped or hurt U.S. farmers who borrowed money to buy land? Does your answer depend on whether the decline in the price level was expected or unexpected?

Deflation was bad for farmers because the value of their debt stayed the same while the price of their products fell. The answer depends on whether deflation was expected. If deflation was expected, the interest rate may have stayed sufficiently low to compensate.

Derivative instruments are A) assets such as bonds or common stock that derive their value from the value of the companies which issue them. B) assets whose rates of returns must be derived from information published in financial tables. C) assets which derive their value from underlying assets. D) computers which display real-time financial information

Suppose financial intermediaries did not exist and only direct finance was possible. How would this affect the process of an individual buying a car or a house?

Direct financing would increase the price the lender charges and reduce the number of loans.

arbitrage opportunity

During the period before bond prices fully adjust to changes in interest rates

Which of the following best describes why younger investors are more likely to invest in equity funds while other investors are more likely to invest in bond funds?

Equity funds are favored by those with a long-term perspective.

Values in M1, but not M2

Everything in M1 is in M2

Expectations of asset values by participants in financial markets A) are not possible to model, given the current state of economic knowledge. B) determine market prices, but are not related to changes in market prices. C) generally do not change. D) determine current market prices and changes in market prices

Nominal interest rates are higher than real interest rates as long as

Expected inflation is positive

Widespread use of handheld computers helps reduce business costs. --> effect on demand for loanable funds

Expected profitability would rise, so the demand for loanable funds would rise.

Fannie Mae and Freddie Mac both A) sell bonds to investors and use the funds to purchase mortgages. B) help regulate the banking system. C) directly lend funds to people seeking mortgages. D) reduce access to funds for mortgages by purchasing existing mortgages

Financial futures contracts are regulated by A) the Commodity Futures Trading Commission. B) the Federal Trade Commission. C) the Interstate Commerce Commission. D) the Options and Futures Commission

Financial intermediaries A) include banks and other depository institutions. B) include the New York and American Stock exchanges. C) directly issue claims on individual borrowers to savers. D) are owned and operated by the federal government

Forward transactions A) provide substantial liquidity. B) entail small information costs. C) provide risk sharing. D) provide reduced tax payments

Forward transactions originated in the market for A) common stock. B) corporate bonds. C) government bonds. D) agricultural and other commodities

Forward transactions would be useful to A) a government wanting to know the size of its future debt. B) a household wanting to reduce its future tax liability. C) a business wanting to know the cost of its funds on future loans. D) a business wanting to expand its operations in overseas markets

Funds flow from lenders to borrowers A) indirectly through financial markets. B) directly through financial intermediaries. C) indirectly through financial intermediaries. D) primarily through government agencies

Futures trading has traditionally been dominated by A) the New York Stock Exchange. B) the Chicago Board of Trade and the Chicago Mercantile Exchange. C) the London Stock Exchange. D) the Omaha Grain Exchange

Futures trading practices in the United States are regulated by A) the Chicago Board of Trade. B) the Chicago Mercantile Exchange. C) the Commodities Futures Trading Commission. D) the Board of Futures Trading

George is trying to forecast the future price of IBM's common stock. To do so he makes use only of past prices of IBM stock. George A) has adaptive expectations. B) has rational expectations. C) is likely to rapidly adjust his forecast to news affecting the future profitability of IBM. D) is likely to make forecasts that reflect closely IBM stock's fundamental value

Given the financial market bubbles since the late 1990s, most economists think A) asset prices always equal their fundamental value. B) investors can consistently outperform the market. C) it is unlikely that investors can earn above normal profits in the long run by following trading strategies. D) there is no such thing as a fundamental value of an asset

The federal government runs a budget deficit.

The supply of bonds increases, shifting the supply curve to the right, thus forcing the price down and the quantity up.

If a bank grants you a mortgage, the mortgage is A) an asset to you as well as an asset to the bank. B) an asset to you, but a liability to the bank. C) a liability to you, but an asset to the bank. D) a liability to you as well as a liability to the bank

If a corporation pays a dividend, which group receives priority in receiving the dividend? A) bond holders B) holders of common stock C) holders of preferred stock D) dividends are evenly divided by holders of common and preferred stock

If an investor is certain that market interest rates will decline in the future, which of the following will she be most likely to purchase? A) a six-month government bill B) a two-year government note C) a ten-year government bond D) a fifty-year government bond

Bond Prices and Yields to Maturity Move in Opposite Directions

If interest rates on newly issued bonds rise, the prices of existing bonds will fall, and vice versa. -Reason: If interest rates rise, existing bonds issued with lower interest rates become less desirable to investors, and their prices fall. •This relationship should also hold for other debt instruments.

market bond approach

(bond as the good) - useful when considering how the factors affecting the demand and supply for bonds affect the interest rate

strike price

(exercise price) the price at which the buyer of an option has the right to buy or sell the underlying asset

rate of return from investing in a stock

(expected annual dividend/initial price) + (expected change in price/initial price).

market for loanable funds appraoch

(funds as the good) - useful when considering how changes in the demand and the supply of funds affect the interest rate

net interest margin

(interest recieved on loans) - (interest paid on debt) / total value of earning assets aka spread/assets

calculating buyers profits

(spot price @ settlement) - (futures price @ purchase)

net worth

(value of firms assets) - (value of liabilities)

Why did interest rates on bonds remain at historical low levels years after the end of the financial crisis

- Actual and expected inflation were very low - Fischer effect - the nominal interest rates on bonds would also be low

Does the Performance of the Stock Market Matter to the Economy?

-Fluctuations in stock prices can affect the economy by affecting the spending of households and firms. •The stock market is an important source of funds for corporations. Stocks also make up a significant portion of household wealth. •Households spend more when their wealth increases and less when their wealth decreases •Stock market fluctuations can heighten uncertainty and lead households and firms to postpone their spending.

Four basic categories of debt instruments:

-Simple loans -Discount bonds -Coupon bonds -Fixed-payment loans

commercial banks

-Take in deposits and use them to make loans; loans should be repaid and get interest on deposits. -Households rely on borrowing money from banks to purchase "big ticket items." -Firms rely on banks to meet their short- and long-term needs for credit. -iliquid but solven

demand for USD increases when...

-foreign demand for US goods increases -US interest rates rise relative to foreign interest rates -increase in desirable characteristics of US financial securities

non-transaction deposit types

-savings account -money market mutual funds -time deposits - certificates of deposit (CDs)

portfolio allocation

-should hold diversified portfolio of assets so news that may unfavorably affect price of one stock can be offset by news that will favorably affect the price of another stock

key features of forward contracts

-spot price -settlement date -counter party risk

time value

-trait of option premium -determined by the option's expiration date and the stock price's volatility

5 key reasons firms and financial institutions participate in interest-rate swaps

1) swaps allow transfer of interest-rate risk to parties that are more willing to bear it 2)bank that has more floating-rate assets might want to engage in an interest-rate swap with a bank that has many fixed-rate mortgages 3) swaps are more flexible than futures or options b/c they can be custom tailored to meet the needs of counterparties 4) swaps also offers more privacy than exchange trading 5) swaps can be written for long periods - offer longer-term hedging than is possible with financial futures and options

segmented markets theory indicates that investors do not view bonds of different maturities as being perfect substitutes for each other b/c long term bonds have 2 short comings:

1) they are subject to greater interest-rate risk than short term bonds 2) they are often less liquid than short term bonds

basic currency swap 3 steps:

1)two parties exchange the principal amount in the 2 currencies 2) parties exchange periodic interest payments over the life of the agreement 3) parties exchange the principal amount again at the conclusion of the swap

3 components of financial system

1. Financial Assets 2.Financial Institution 3. The Federal Reserve and other financial regulators

5 key categories of financial assets

1. Money 2. Stocks 3. Bonds 4. Foreign exchange 5. Securitized loans

important points about real rate of return equation

1. calculation uses the initial price 2. if you sell the bond, you have a realized capital gain or loss; otherwise your gain or loss is unrealized 3. current yield and the yield to maturity ignore capital gain or loss, so might not be good indicator

A decrease in interest rates can be caused by a(n) ______ in the demand for bonds or a(n) ______ in the supply of bonds A) increase; decrease B) increase; increase C) decrease; decrease D) decrease; increase

A lower level of income causes the demand for money to ______ and the interest rate to _______, everything else held constant. A) decrease; decrease B) decrease; increase C) increase; decrease D) increase; increase

An increase in the corporate profits tax is likely to cause A. the equilibrium interest rate to rise and the equilibrium price of bonds to fall. B. the equilibrium interest rate and the equilibrium price of bonds to both fall. C. the equilibrium interest rate and the equilibrium price of bonds to both rise. D. the equilibrium interest rate to fall and the equilibrium price of bonds to rise.

During an economic expansion A) the demand and supply curves for loanable funds both shift to the right and the equilibrium interest rate usually rises B) the demand and supply curves for loanable funds both shift to the left and the equilibrium interest rate usually falls C) the demand curve for loanable funds shifts to the right, the supply curve for loanable funds shifts to the left, and the equilibrium interest rate usually falls D) the demand curve for loanable funds shifts to the left, the supply curve for loanable funds shifts to the right, and the equilibrium interest rate usually rises

How can a bond have a negative rate of return?

If the rate of capital loss exceeds the current yield

If, while you are holding a coupon bond, the interest rates on other similar bonds fall, you can be sure that A) the coupon payments on your bond will fall. B) the market price of your bond will rise. C) the market price of your bond will fall. D) the par value of your bond will rise.

The Quantity Theory Explanation of Inflation

Inflation rate = % Change in M - % Change in Y

Suppose you have a fixed−rate mortgage with a nominal interest rate of 6% and the expected annual inflation rate over the life of the mortgage is 2%. What is the expected real interest rate? A. 4% B. 3% C. 8% D. 12%

The Federal Reserve issues a report indicating that future inflation will increase from 3% to 4%. As a result A) the demand for loanable funds shifts right B) the supply curve for bonds shifts left C) the equilibrium interest rate falls D) the equilibrium price of bonds rises

The purpose of diversification is to A. reduce risk. B. reduce the brokerage fees involved in managing a financial portfolio. C. reduce tax liability. D. increase the liquidity of a financial portfolio.

When price level falls, the ____ curve for nominal money ______, and interest rates ____, everything else held constant A) demand; decrease; fall B) demand; increase; rise C) supply; increase; rise D) supply; decrease; fall

A simple loan involves A) interest payments from the borrower to the lender periodically during the life of the loan. B) no payment of interest by the borrower to the lender. C) payment of interest by the borrower to the lender only at the time the loan matures. D) payment only of principal. by the borrower to the lender at maturity.

A speculator who believes strongly that interest rates will fall would be likely to A) buy futures contracts on Treasury bills. B) sell futures contracts on Treasury bills. C) sell Treasury bonds in the spot market. D) decrease now the amount of money which he lends

A speculator who believes strongly that interest rates will rise would be likely to A) buy futures contracts on Treasury bills. B) sell futures contracts on Treasury bills. C) buy Treasury bonds in the spot market. D) increase now the amount of money which he lends

A sustained decrease in the price level is known as A) inflation. B) disinflation. C) reflation. D) deflation.

A swap is A) another name for a put option. B) another name for a call option. C) an agreement between two or more persons to exchange sets of cash flows over some future period. D) the name for the replacement of a futures contract by an options contract

The terms of futures contracts traded in the United States are A) standardized as to amount or value, but not as to location or time of delivery. B) standardized as to location or time of delivery, but not as to amount or value. C) not standardized, but are determined entirely on the basis of the agreement entered into by the buyer and seller. D) standardized as to amount or value and as to location or time of delivery

What are the determinants of asset demand?

The total amount of savings to be allocated among investments. The expected rate of return and the degree of risk for an investment compared to alternative investments. The liquidity of the investment compared with other investments.

The total payment to a lender for a one-period simple loan is A) (P + i)n. B) P + i. C) i(1 + i). D) P(1 + i).

Why do consumers usually prefer fixed-payment loans to simple loans when buying cars and houses?

A. The payments are of equal amounts and include both principal and interest. B. There will be no large final payment to worry about like with a simple loan. C. As long as the household makes all the payments the loan will be completely paid off.

Why do consumers usually prefer fixed-payment loans to simple loans when buying cars and houses?

A.There will be no large final payment to worry about like with a simple loan. B. As long as the household makes all the payments the loan will be completely paid off. C. The payments are of equal amounts and include both principal and interest.

AIG almost went bankrupt in 2008 because A) the value of the securities underlying its credit default swaps declined significantly. B) it lacked the collateral required by buyers of its credit default swaps. C) prices of securities underlying their credit default swaps were hard to determine since they were no longer actively traded. D) all of the above.

What is Moody's highest possible credit rating?

Aaa

According to the Efficient Markets Hypothesis, prices of securities A) change infrequently. B) change frequently to reflect news about changes in the fundamental values of the securities. C) change frequently as evaluations of existing information about the securities change. D) are not allowed, under federal securities laws, to change more frequently than once a month

According to the Gordon-Growth model, an increase in the required return on equity A) increases the future value of the stock. B) reduces the current dividend. C) reduces the value of a stock. D) reduces the expected growth rate of the dividend

The yield to maturity is equal to A) the interest rate at which the present value of an asset's returns is equal to its price today. B) the face value or par value of a coupon bond. C) any payments received from an asset at the date the asset matures. D) interest rate on the asset minus any taxes owed on the interest received

If the current price of a bond is greater than its face value

The yield to maturity must be less than the coupon rate

According to the efficient markets hypothesis, A) common stock prices should be constant. B) the price of a corporation's stock is likely to fluctuate substantially in response to news about changes in the company's short-term prospects. C) the price of a corporation's stock will fluctuate significantly only in response to news about changes in the company's long-term prospects. D) price fluctuations in common stock are a response to fads and are only infrequently the result of changes in the expected profitability of the companies involved

According to the efficient markets hypothesis, the difference between today's price for a share of stock and tomorrow's price is A) predictable given currently available information. B) equal to today's price minus yesterday's price. C) unforecastable. D) zero.

The yield to maturity on a new one-year discount bond equals A) (F V- P)/P. B) (D - FV)/P. C) (FV - P)/FV. D) (P - FV)/FV.

All of the following are possible consequences of noise traders EXCEPT A) increased volatility in the financial market. B) asset prices differing from fundamental values. C) herd behavior contributing to speculative bubbles. D) reduced volatility of asset prices

All of the following are problems cited by Warren Buffet as problems with derivatives not traded on exchanges EXCEPT A) they are thinly traded which makes it difficult to determine their value. B) firms do not set aside reserves against potential losses. C) they involve substantial counterparty risk. D) they were not flexible enough due to lack of standardization

All of the following are roles of a exchange EXCEPT A) instituting margin requirements on futures contracts. B) marking to market at the end of each day. C) eliminate the need for buyers and sellers of futures contracts to be concerned about the creditworthiness of each other. D) reducing the default risk involving forward contracts

All of the following are steps involved in basic currency swaps EXCEPT A) counterparties exchange the net interest at the end of the swap. B) the parties exchange principals in two currencies. C) the parties exchange periodic interest payments over the life of the agreement. D) the parties exchange the principal amount at the end of the agreement

All of the following describe the market for credit default swaps on mortgage-backed securities in the mid 2000s EXCEPT A) an increasing number of buyers were speculators. B) AIG apparently underestimated the risk involved with mortgage-backed securities. C) the volume of credit default swaps was too low making it difficult to assess their value. D) payments by buyers were too low relative to risk

All of the following were significant changes in the mortgage market in the 2000s EXCEPT A) investment banks became significant participants in the secondary mortgage market. B) lenders loosened lending standards. C) mortgage-backed securities became more popular with investors. D) borrowers tended to increase the amount of their down payments

Alt-A borrowers were those who A) used mortgages to purchase apartments. B) chose adjustable-rate mortgages instead of fixed-rate mortgages. C) borrowed using "interest-only" mortgages. D) did not provide documentation of their income when applying for a mortgage

An advantage of a swap over futures and options is that A) they can be written for long periods. B) they are more liquid. C) they carry less default risk. D) there is no need to assess the creditworthiness of participants

An asset's fundamental value equals A) its face value. B) its maturity value. C) the market's best guess of the present value of the asset's expected future returns. D) the weighted sum of its market price over the recent past

An implication of the efficient markets hypothesis is that A) only sophisticated investors will be able to earn above-normal profits from financial investments. B) above-normal profits are available only to major traders. C) above-normal profits will be eliminated in the trading process. D) unless he or she acts recklessly, the average investor should be able to make above-normal profits

When investors decided that the election of President Trump would lead to higher inflation, what was the effect on bond prices? Be sure to include in your answer a demand and supply graph on bond market.

An increase in expected inflation reduced the demand for bonds and raised the supply of bonds.

If expected inflation is increasing, would you have made a worse investment if you had invested in long-term bonds than if you had invested in short-term bonds?

An increase in expected inflation will increase the nominal interest rate on all bonds, but the increases will be more on bonds with a longer maturity. So, the capital losses on long-term bonds will be greater than on short-term bonds.

An interest rate swap involving the exchange of floating-rate obligations for fixed-rate obligations is known as A) swaption. B) swap option. C) forward swaps. D) plain vanilla

If the current price of a bond is less than its face value,

An inventor will receive a capital gain by holding the bond until maturity

An investor will generally find that hiring an investment firm to actively manage his or her portfolio will A) result in a higher return than would be received from an index mutual fund. B) be less expensive than simply placing money in an index mutual fund. C) result in a higher return, but will be more expensive than placing money in an index mutual fund. D) result in about the same return, but be more expensive than placing money in an index mutual fund.

An option buyer A) has a greater insurance benefit than the purchaser of a futures contract. B) bears the risk of unfavorable price movements. C) is purchasing a naked option if he or she does not also own the underlying asset. D) generally will incur a lower cost than will the purchaser of a futures contract

An options contract A) confers the rights to buy or sell an underlying asset at a predetermined price by a predetermined time. B) is another name for a futures contract. C) may be written for debt instruments, but not equities. D) may be written for equities, but not for debt instruments

An speculator who buys a fifty-year corporate bond A) must be expecting to still be alive in fifty years. B) is subject to substantial reinvestment risk. C) is probably expecting market interest rates to increase in the future. D) is probably expecting market interest rates to decrease in the future

As an option nears its expiration date, the size of the premium approaches A) zero. B) infinity. C) its intrinsic value. D) an amount which varies, depending on prevailing market interest rates on the expiration date

Why do higher interest rates increase adverse selection problems in the loan market?

As interest rates rise, the creditworthiness of the average loan applicant declines.

At an interest rate of 3%, what is the present value of $1000 to be received five years from now? A) $863 B) $1,667 C) $1,159 D) $850

At an interest rate of 6%, how much will need to be invested today to have $10,000 in 5 years? A) $5,000 B) $7,473 C) $10,000 D) $13,382

At the beginning of the financial crisis, banks were hurt by all of the following EXCEPT A) declines in the value of mortgage-backed securities. B) defaults on mortgages by those with subprime mortgages. C) holding too many Treasury bonds. D) not being repaid on loans to real estate developers

Why should a debate over the cause of low interest rates matter to Alan Greenspan?

There is a debate over whether the Federal Reserve was responsible for low interest rates or whether the global savings glut was responsible. If the global savings glut was responsible, we could argue that the Federal Reserve should take less blame for the artificially low interest rates that helped facilitate the housing bubble.

When will the real interest rate differ from the expected real interest rate?

There will be a difference between the real interest rate and the expected real interest rate when future inflation is unknown.

How is the price of a financial asset related to the payments to be received from owning it?

Through the present value formula.

What are the main reasons that lenders charge interest on loans?

To compensate for inflation. To compensate for the opportunity cost of spending the funds being loaned. To compensate for default risk.

Which of the following would explain why an investor would sell one of these bonds for 31 cents on the dollar rather than hold the bond for two years and receive 100 cents on the dollar when the bond matured?

Toys R Us bonds have a high default risk.

Treasury STRIPS are A) tax-exempt bonds. B) simple loans. C) discount bonds. D) fixed payment loans

Treasury STRIPS came into existence because A) investors demanded a tax-free long-term bond. B) the Treasury wished to shift from long-term borrowing to short-term borrowing. C) high inflation rates led to an increased demand for high-yield bonds. D) investors demanded long-term discount bonds

financial futures

Treasury securities, stock indexes, and currencies.

Which of the following assets had both the lowest average annual return and lowest risk between 1926 and 2015?

U.S. Treasury bills

A capital gain occurs when the A. coupon rate increases. B. price of an asset increases. C. yield to maturity increases. D. current yield increases.

At an interest rate of 6%, how much will need to be invested today to have $10,000 in 5 years? A. $10,000 B. $7,473 C. $13,382 D. $5,000

At the beginning of the financial crisis, banks were hurt by all of the following EXCEPT A. declines in the value of mortgageminusbacked securities. B. holding too many Treasury bonds. C. defaults on mortgages by those with subprime mortgages. D. not being repaid on loans to real estate developers.

Everything else held constant, if the expected return on GE stock falls from 10 to 9 percent and the expected return on US Treasury bonds falls from 7 to 6%, then the expected return of holding GE stock _______ relative to US Treasury Bonds and the demand for US Treasury Bonds _______ A) rises; rises B) rises; falls C) falls; rises D) falls; falls

Suppose Matt's New Cars issues a discount bond with a face value of $10,000 payable in one year with an interest rate of 4%. How much will they receive for the bond? A. $9,600 B. $9,615 C. $10,000 D. $10,400

The yield to maturity equals $40/$800 = 5%.

What is the yield to maturity of a perpetuity with a coupon of $40 and a price of $800?

When market participants have rational expectations, A) the information they use contains only past experiences. B) the information they use contains not only past experiences, but also their expectations for the future. C) the information they use contains only their expectations for the future. D) their forecasts are always correct.

Ford Motor Company has issued bonds with a maturity date of November 1, 2046 that have a coupon rate of 7.40%, and coupon bonds with a maturity of February 15, 2047 that have a coupon rate of 9.80%. Why would Ford issue bonds with coupons of $74 and then a little more than a year later issue bonds with coupons of $98? Why didn't the company continue to issue bonds with the lower coupon?

It is likely that Ford had to increase the coupon rate because either the price increased or the interest rate fell.

Limited liability can best be defined as the legal provision that A) shields owners of a corporation from losing more than what they invested in a firm. B) protects bond holders from being sued by other creditors. C) gives holders of preferred stock priority over holders of common stock. D) reduces the exposure of sole proprietorships to law suits.

Liquidity A) is the best available measure of the riskiness of an asset. B) is a characteristic of money, and of no other asset. C) is the ease with which an asset can be exchanged for money. D) was declining for many financial assets during the 1990s

Define liquidity. Rank the following assets in terms of liquidity, from most to least liquid: money market mutual fund, savings account, corporate stock, dollar bill, house, gold bar, checking account.

Liquidity is the ease with which an asset can be converted to definitive money. Ranking from most to least liquid: dollar bill, checking account, money market mutual fund, savings account, corporate stock, gold, house.

Marking to market involves A) changing the futures price to the spot price each day. B) engaging in arbitrage so as to reduce the risk involved with futures contracts. C) crediting or debiting the margin account based on the net change in the value of the futures contract. D) updating the futures price after the market closes each day

Marking to market refers to A) the determination of the prices of options contracts by the interaction of demand and supply. B) the determination of the prices of futures contracts by the interaction of demand and supply. C) the settlement of gains and losses on futures contracts each day. D) the settlement of gains and losses on forward contracts each day

credit rating agencies

Moody, Standard & Poor's, Fitch ratings - provide info on creditworthiness of corporations and governments that issue bonds

Noise traders involves investors who A) overreact to good and bad news. B) strictly follow the efficient markets hypothesis. C) filter out the noise involved in following their stocks. D) ignore new information about stocks

Nominal interest rates are higher than real interest rates as long as A) expected inflation is positive. B) the government taxes interest income. C) inflation is expected to decline in the future. D) long-term interest rates are higher than short-term interest rates

On a coupon bond, the yield to maturity A) always equals the coupon rate. B) equates the present value of all the bond's payments to its price today. C) increases when the market price of the bond increases. D) equals the coupon payment divided by the current price of the bond.

Increase in expected inflation will

Be heavier on bonds with a longer maturity

Speculators in derivatives markets A) reduce the efficiency of these markets. B) are acting contrary to U.S. securities laws. C) accept risk transferred to them by hedgers. D) reduce the liquidity of these markets

Spot transactions A) involve immediate settlement. B) may only take place in face-to-face trading. C) take place on-the-spot, rather than on an organized exchange. D) are relatively unimportant in financial markets.

When market participants have rational expectations, the deviation of the expected price from the actual future price is A) zero. B) predictable, provided all relevant information is made use of. C) not predictable. D) predictable under certain circumstances, but not under others

Interest rates on U.S. Treasury bills are typically much lower than interest rates on U.S. Treasury notes and bonds. If the federal government wants to reduce the interest charges it pays when it borrows money, why doesn't the Treasury stop selling Treasury notes and bonds and sell only bills?

When the Treasury rolls over the short-term bills, it faces the risk that interest rates on new short-term bills may have risen.

Which best describes a credit default swap? A) It is designed to reduce interest-rate risk. B) The issuer receives payments from the buyer in return for agreeing to make payments to the buyer if the security goes into default. C) Issuers are taking out insurance in case of default. D) It represents a way for the issuer to establish its creditworthiness

Which firm did the Treasury allow to fail during the financial crisis? A) J.P. Morgan B) Bear Stears C) Lehman Brothers D) American International Group (AIG)

Which group is hurt by inflation being less than expected? A) holders of TIPS B) lenders of fixed-rate mortgages C) borrowers with fixed-rate mortgages D) all of the above

Which group of investors vote for a corporation's board of directors? A) bond holders B) holders of preferred stock C) holders of common stock D) both holders of common and preferred stock

Which of the following assets is the least liquid? A) money market mutual fund B) stock C) treasury bond D) house

Which of the following assets is the most liquid? A) money market mutual fund B) computer C) washing machine D) U.S. Treasury bond

Which of the following best describes a "bubble"? A) when the price of an asset reaches a new high B) an unsustainable increase in the price of a class of assets C) rapid increases in inflation D) when bond prices rise more quickly than stock prices

Which of the following expressions gives the present value of future dividends for a company whose current dividend is $5.00 and whose future dividends are expected to grow at rate g? A) [$5.00(1 - g)]/(i - g) B) [$5.00(1 + g)]/(i + g) C) [$5.00(1 - g)]/(i + g) D) [$5.00(1 + g)]/(i - g)

A coupon bond involves A. periodic payments by the borrower to the lender that include principal, but not interest. B. interest and principal payments from the borrower to the lender periodically during the life of the loan. C. interest payments from the borrower to the lender periodically during the life of the loan and payment by the borrower to the lender of the face value of the loan at maturity. D. periodic payments by the borrower to the lender that include both principal and interest.

A one−year discount bond with a par value of $5000 sold today, at issuance, for $4750 has a yield to maturity of A. 2.50%. B. 9.75%. C. 5.26%. D. 5.00%.

According to the quantity theory of money, if the long run economic growth rate is 2.5%, by how much should the Fed increase the money supply if it wants inflation to be 2%? − A. 1.25% B. 4.5% C. 5% D. 0.5%

As of May 2016, the amount of money as measured by M2 was about A. $880 billion. B. $3.2 trillion. C. $12.7 trillion. D. $16 trillion.

Which of the following financial futures contracts are traded in the United States? A) Interest rates B) Stock indexes C) Currencies D) All of the above

Which of the following forms the largest share of household holdings of financial assets? A) corporate equities B) bank deposits C) pension funds reserves D) life insurance

Which of the following is NOT a benefit of derivatives? A) risk sharing B) guaranteed minimum profit C) liquidity D) information services

Which of the following is NOT a discount bond? A) a U.S. savings bond B) a U.S. Treasury bill C) a U.S. Treasury note D) a zero-coupon bond

Which of the following is NOT a financial asset? A) a bond issued by Google B) Wells Fargo Bank C) a home mortgage loan D) a certificate of deposit

momentum investing

a stock increasing in price is more likely to continue to rise and vice versa

deflation

a sustained decline in the price level

Everything else held constant, if the expected return on RST stock declines from 12 to 9 percent and the expected return on XYZ stock declines from 8 to 7 percent, then the expected return of holding RST stock _____ relative to XYZ stock and demand for XYZ stock ______. A) rises; rises B) rises; falls C) falls; rises D) falls; falls

Everything else held constant, if the expected return on RST stock rises from 9 to 10 percent and the expected return on XYZ stock rises from 7 to 8 percent, then the expected return of holding RST stock _______ relative to XYZ stock and demand for XYZ stock ______. A) rises; rises B) rises; falls C) falls; rises D) falls; falls

Evidence indicates that there's a strong relationship between money and inflation in: A. short run, but not the long run B. both the short and long run C. long run, but not the short run D. neither the short nor the long run

How can a bond have a negative rate of return? A. if the current yield is greater than the coupon rate B. if the rate of capital gains is less than the current yield C. if the rate of capital loss exceeds the current yield D. if the current yield is less than the coupon rate

If the expected gains on bonds rise, while the expected returns on stocks fall, then A) the equilibrium interest rate will rise B) the demand curve for bonds will shift to the left C) the supply curve for loanable funds will shift to the right D) the equilibrium price of bonds will fall

If the liquidity effect is larger than the other effects, and the adjustment to expected inflation is slow, then the A) interest rate will fall B) interest rate will rise C) interest rate will fall immediately below the initial level when the money supply grows D) interest rate will rise immediately above the initial level when the money supply grows

In the Bs/Bd model, which of the following would lead to an increase in interest rates? A) a cutback in federal entitlement expenditures B) an announcement of a reduction in the growth rate of the money supply C) an increase in business confidence D) an increase in the public's propensity to save rather than consume

In what sense do self − fulfilling expectations determine the acceptability of a medium of exchange? A. People expect that money will never lose its value. B. People like to do what the government expects them to do. C. People value something as money only if they believe others will accept it from them as payment. D. People expect that eventually every country will use the same medium of exchange.

Interest rates typically display a _____ pattern A) countercyclical B) cyclically neutral C) procyclical D) none of the above

Of the three effects on interest rates below that occur from an increase in the money supply, the one that begins to impact interest rates the soonest is the A) income effect B) price level effect C) expected inflation effect D) none of the above

Other things being equal, an increase in the default risk of corporate bonds shifts the demand curve for corporate bonds to the _____ and the demand curve for Treasury bonds to the _____. A) right; right B) right; left C) left; right D) left; left

Suppose that you own $10,000 worth of stock in General Motors. Adding stock in which of the following companies would be least likely to reduce the risk in your portfolio? A. Google B. General Electric C. Ford D. Wal − Mart

Suppose you have a strong feeling that the economy is poised on the brink of a recession. As an individual investor, your best strategy would likely be to A) Sell your treasury bonds and put your money under a mattress B) sell your treasury bonds and out the money in stocks C) sell your short-term treasury instruments and buy long-term treasury instruments D) sell your long-term treasury instruments and buy long-term treasury instruments

future

"Most financial transactions involve payments in the ______"

$1 received n years from now has a value today of A) ($1 + i)/i. B) $1/(1 + i). C) ($1 + i)n/i. D) $1/(1 + i)n.

The role of the financial system is to A. protect commercial banks from government regulation. B. ensure that investment banks remain profitable. C. channel funds from households and other savers to businesses. D. provide loans from the Federal Reserve to households and businesses

The supply curve for bonds would be shifted to the right by A) a decrease in government borrowing B) an increase in the corporate tax on profits C) an increase in subsidies for investment D) a decrease in expected inflation

What is the price of a coupon bond that has annual coupon payments of $85, a par value of $1,000, a yield to maturity of 10%, and a maturity of three years? A. $211.38 B. $898.84 C. $962.70 D. $,1255.00

What is the price of a coupon bond that has annual coupon payments of $85, a par value of $1000, a yield to maturity of 10%, and a maturity of three years? A. $211.38 B. $898.84 C. $962.70 D. $1255.0

Which of the following is a consequence of extending the payback period of a student loan from 10 to 30 years? A. higher monthly payments B. lower monthly payments initially, but higher monthly payments in the future C. more interest paid over the life of the loan D. faster payoff of principal

Which of the following would NOT cause the demand curve for bonds to shift? A) A change in expected inflation B) A change in the liquidity of bonds C) A change in the price of bonds D) A change in wealth E) None of the above since each event listed causes demand to change

Which one of these will cause the equilibrium price of bonds to rise A) the savings rate decreases B) business borrowing increases C) the federal deficit decreases D) national wealth increases

Why do individuals hold money when it does not provide the services that, say, a house does? A. Money increases in value faster than other assets. B. Money is useful in avoiding taxes on certain transactions. C. Money is the most liquid asset. D. Money is the only form in which wealth may be held

Suppose Apple announces that its earnings for the fourth quarter of 2011 rose to $2 billion. As a result of this announcement the price of Apple's stock does not change. The best explanation of this is A) market participants were expecting Apple's earnings to be greater than $2 billion. B) market participants expected Apple's earnings to be $2 billion. C) market participants expected Apple's earnings to be less than $2 billion. D) market participants have adaptive expectations.

Suppose Exxon-Mobil announces that its profits in the third quarter of 2011 were $40 billion. This will cause the price of Exxon-Mobil stock to A) rise. B) fall. C) remain unchanged. D) rise, fall, or remain unchanged depending on the expectations of market participants before the announcement

Suppose First National Bank makes a one-year simple loan of $1,000 at 7% interest to Harry's Restaurant. At the end of one year Harry's Restaurant will pay First National A) $934.58. B) $1007. C) $1700. D) $1070.

Suppose Matt's New Cars issues and sells a one-year discount bond for $9,259 and repays $10,000 at maturity. The interest rate on this bond would be A) 2.6%. B) 7.41%. C) 8%. D) 10%

The coupon rate is $75/$1000 = 7.50%. The current yield is $75/$1100 = 6.82%.

Suppose a bond has a coupon of $75, face value of $1000, and current price of $1100. What is the coupon rate? What is its current yield? Report a percentage with two decimal places.

The amount of interest is $1000 - $975 or $25. the interest rate is $25/$975 which equals 2.56%

Suppose a firm receives $975 for a discount bond with a face value of $1000 to be repaid in one year. What is the amount of interest on the bond? What is the interest rate on the bond? Report a percentage with two decimal places.

Suppose that Acme Widget is currently selling for $100 per share and you own a call option to buy Acme Widget at $75 per share. The intrinsic value of your option is A) $25. B) $75. C) $100. D) not possible to determine in the absence of information on values of the share price of Acme Widget between now and the expiration date of the call

According to an article in the Wall Street Journal, bonds issued in 2016 by the toy store chain Toys R Us that matured in 2018 and had a 10% coupon were trading at open double quote31 cents on the dollar.close double quote

CCC

Why do CDs have lower rates of return than stocks?

CDs are less risky than stocks

Suppose that you expect a greater increase in inflation than do other investors, but that you don't expect the increase to occur until three years in the future. Should you wait until three years to sell your bonds? Briefly explain.

Changes in bond prices result from changes in the expected rate of inflation. If buyers and sellers change their expectations, the nominal interest rate will adjust. Waiting until the nominal interest rate had risen would be too late to avoid the capital losses from owning bonds.

You expect a greater increase in inflation than other investors in three years. Should you wait until three years to sell your bonds.

Changes in bond prices result from changes in the expected rate of inflation. Waiting until the nominal interest rate had risen would be too late to avoid.

liquidity

ability of asset to be turned into money greater the liquidity, more desirable the asset is to investors

quantity theory of money

about connections between money and prices that assumes that the velocity of money is constant

what can be used as medium of exchange

acceptable to most people standardized in terms of quality durable valuable relative to its weight divisible

money

accepted as payment for goods and services

checkable deposits

accounts against which depositors can write checks

currency premium

accounts for the additional risk of investing in a foreign asset

store of value

accumulation of wealth by holding dollars or other assets that can be used to buy goods and services in the future. •Even though other assets offer a greater return as a store of value, people hold money because it is perfectly liquid.

store of value

accumulation of wealth by holding dollars/assets that can be used to buy goods/services in future

Why might cigarettes, rather than another commodity, have been used as currency in this situation?

Cigarettes are smaller and more convenient to carry as a form of payment than another commodity. Cigarettes must have been an acceptable equivalent to the Reichsmark as payment. Cigarettes are more easily divisible to use as a source of payment than another commodity may be.

Clearinghouses help to reduce default risk by A) being the intermediary in trades for buyers and sellers. B) margin requirements. C) marking to market. D) all of the above

term premium

additional interest investors require in order to be willing to buy a long term bond rather than comparable sequence of short term

equity premium

additional return investors must receive in order to invest in equities rather than Treasury bills -how much return investors need to get in order for them to want to invest in more stocks and not treasury bills

real interest rate

adjusted for changes in purchasing p9ower

return on assets (ROA)

after tax profit/bank assets

return on equity (ROE)

after tax profits/bank capital

swap

agreement between two or more counter parties to exchange sets of cash flows over some future period

loan commitment

agreement by a bank to provide a borrower with a stated amount of funds during a specific period

Pricing anomalies

allow investors to earn consistently above-average returns.

Compounding refers to A) the calculation of interest rates after the compounding effect of taxes has been allowed for. B) the paying back of both interest and principal during the life of a fixed payment loan. C) the process of earning interest on both the interest and the principal of an investment. D) the increased value of an investment that arises from the payment of periodic interest.

risk sharing

allows savers to spread and transfer risk by holding different assets along with other savers

swap

an agreement b/w two or more counterparties to exchange sets of cash flows over some future period -resembles futures contract but terms are flexible

Why aren't credit cards included in M1 or M2?

Credit is not a form of money, since it is a debt that is owed to the issuer of the card.

Currently, A) trading futures contracts on agricultural and mineral commodities makes up a majority of all trading. B) trading in financial futures involves more transactions than trading in commodity futures. C) futures trading is allowed only for financial assets. D) futures trading is allowed only for commodities

According to the liquidity premium theory, if market participants expect that inflation in the future will be lower than it currently is, the yield curve will

be inverted.

why does money demand curve slope downward

because lower nominal interest rates cause households and firms to switch from financial assets to money. -The nominal interest rate is the opportunity cost of holding money.

liquidity and interest rates

bond investors care about liquidity, so are willing to accept a lower interest rate on more liquid investments than on illiquid. So investors expect to receive a higher return on an illiquid bond to compensate them for sacrificing liquidity.

creditworthiness

bond issuer's ability to repay

By determining the price of bonds,

bond market also determines the interest rate on bonds.

As wealth increases in the economy, we would expect to observe

bond prices rise and interest rates fall.

municipal bonds

bonds issues by state and local governments

short sale

borrow the stock from your broker and sell it now, with the plan of buying it back - and repaying your broker - after the stock declines in price

compensation for default risk

borrower might default on the loan

Alt-A borrower

borrower who states his or her income but does not document or prove the amount of income.

subprime borrower

borrower with a flawed credit history

broader definition of the money supply: All the assets that are included in M1, as well as time deposits with <$100,000, savings accounts, money market deposit accounts, and non-institutional money market mutual fund shares. -since 1960, M2 has increased much more rapidly than has M1.

securitization

bundling loans into securities that can be sold

Alternating periods of economic expansion and recession are known as the

business cycle

index funds

buy a set portfolio of stocks

propriety trading

buying and selling securities for banks own account

trader

buys and sells securities to profit from small differences in prices.

How is the interest rate that prevails in the bond market determined?

by the intersection of the demand for and supply of bonds

You would be less willing to purchase US treasury bonds, other things equal, if A) you inherit $1 million from your uncle Harry B) you expect interest rates to fall C) gold becomes more liquid D) stock prices are expected to fall

European option

can be exercised only ON expiration date

American option

can be sold at any time UP TO the expiration date

As wealth decreases, which of the following is likely to account for a smaller fraction of a saver's portfolio?

cash

A decrease in real GDP or a decrease in the price level effect on MD curve

cause the money curve to shift to the left.

increase in GDP or price level effect on MD curve

cause the money curve to shift to the right.

risk

chance that the value of financial assets will change relative to what you expect.

large open economy

changes in the demand and supply for loanable funds are large enough to affect the world real interest rate -we cannot assume that the domestic real interest rate is equal to the world real interest rate.

As a person's wealth increases, which of the following portfolio holdings is likely to increase the least?

checking account

The wealth of most people declined as a result of the financial crisis of 2007-2009. As a result, which asset most likely became a larger portion of their portfolio?

checking account

As wealth decreases, which of the following is likely to account for a larger fraction of a saver's portfolio?

checking account balance

risk averse investors

choose the asset with the lower risk when two assets have the same expected returns - resulting in trade-offs between risk and return.

equity

claim part ownership of a firm

equity

claim to part ownership of a firm ex. common stock issues by a corporation

restrictive covenants

clause in bond contracts that limits the use of funds a borrower receives -can only buy this with these funds -if your net worth drops below X you have to pay off the bond

A portfolio is a

collection of assets

portfolio

collection of assets, such as stocks and bonds.

2 main categories of stock

common and preferred

market risk

common to all assets of a certain type

index fund

consists of a fixed market basket of securities such as stocks in the S&P 500

decisions for income

consume or save

futures contract

contract to buy a specified AMOUNT on a specific future price

currency swap

contract where you agree to exchange principle amounts denominated in different currencies 1. exchange principle amount at start (in the two currencies) 2. exchange periodic interest payments 3. exchange principle amount at end

interest rate swap

contract where you agree to swap interest payments over a period on a fixed dollar amount

securitization is the process of

converting loans into securities

publicly traded company

corporation that sells stock in the U.S. stock market

publicly traded company

corporation that sells stock in the US stock market; only 5100 of the 5 million US corporations are publicly traded companies -remaining are private firms - they dont issue stock that is bought and sold on the stock market

interest rate

cost of borrowing funds (or the payment for lending funds), usually expressed as a percentage of the amount borrowed.

transaction costs

cost of making a direct financial transaction

information costs

costs incurred trying to determine the creditworthiness of borrows and how they use the acquired funds

Current yield formula

current yield = coupon price / current price

if expected returns to assets increases demand for bonds will

decrease because holding bonds is less attractive

interest compounded

earning interest on top of interest as savings accumulate over time -after many periods, compounding makes a big difference -if you invest the principal for n years, then at the end of n years you'll have: principal x (1+i)^n = FVn

liquidity

ease with which an asset can be exchanged for money. Financial markets and intermediaries help make financial assets more liquid.

fundamental value of stocks

equal to the present value of all the dividends investors expect to receive into the indefinite future

The equilibrium real interest rate in Belgium will be

equal to the world real interest rate

In an efficient market with rational expectations, the actual price of an asset

equals its expected price plus a random error term.

direct quotation

exchange rate as domestic per foreign

indirect quotation

exchange rate as foreign per domestric

theory of purchasing power parity (PPP)

exchange rates move to equalize the purchasing power of currencies real exchange rate = 1 if this holds inflationForeign = inflationDomestic if this holds

why is counterparty risk reduced with futures contracts

exchange serves as a clearinghouse (or clearing corporation) that matches up buyers and sellers, and the exchange - rather than buyers and sellers - stands as the counterparty on each trade

According to the liquidity premium theory, a steep yield curve may be an indicator of

expectations of a significant increase in inflation.

In 2016, when the interest rate on 10-year German government bonds became negative, an article in the Wall Street Journal noted that the interest rate on 10-year bonds depended in part on investors' expectations of future short-term interest rates. The article also noted that "investors don't seem to have changed their perception of ... [short-term] interest rates in the future ...." Which of the following theories best explains the scenario described?

expectations theory

three theories to explain term structure

expectations theory segmented markets theory liquidity premium theory

dividend yield

expected annual dividend divided by the current price of a stock

financial liability

financial claim owed by a person or a firm. ex. a loan

secondary markets

financial markets in which investors buy and sell existing securities.

primary markets

financial markets in which stocks, bonds, and other securities are sold for the first time.

derivative

financial securities that derive their economic value from an underlying asset, such as a stock or a bond.

financial derivatives

financial securities whose economic value depends on an underlying financial asset, such as a stock, bond, or unit of foreign currency

discounting

finding the present value of funds that will be received in future

how firms reduce adverse selection

firms disclose material info that may impact stock price some young firms don't have enough info to do this though

January effect

firms experience abnormally high returns during January

actively managed stocks

frequently buy and sell individual stocks

put option

gives the buyer the right to SELL the asset at a set price at the strike price at any time up to the options expiration buy if you think the asset will decrease in price

The longer the maturity of a bond, the _____ the change in price as a result of a change in market interest rates.

greater

capital losses on long-term bonds will be _______ than capital losses on short-term bonds.

greater

if FV is greater than Pt, i will be

greater than the coupon rate (C/F).

increase in bond's liquidity or decrease in cost of acquiring information about the bond will ________ ______ for the bond

increase demand -increasing bond's price and decreasing bond's interest rate

The demand curve for bonds would be shifted to the left by an

increase in expected inflation

economies of scale

increase in volume of G+S produced to reduce average costs

Economists believe that as a saver's wealth increases, the saver will generally

increase the fraction of wealth held as common stock

An increase in expected inflation will

increase the nominal interest rate on both short-term and long-term bonds

liquidity (shift demand)

increase: demand right

nominal interest rate will be lower than real interest rate when

inflation rate is negative (i.e. deflation- sustained decline in price leve)

The efficient markets hypothesis implies that stock investments should have the same expected return after adjusting for

info costs, risk, liquidity

The financial system provides three services to savers and borrowers:

information

If bond investors think they lack enough details to evaluate the likelihood of defaults on certain bonds, this will result in higher

information costs

During the financial crisis of 2007-2009,

information costs of mortgage-backed securities rose.

Capital Purchase Program (CPP)

initiative to inject capital into banks by purchasing stock in troubled banks

Federal Deposit Insurance Corporation (FDIC)

insures deposits established after Great Depression

expectations theory

interest rate on long term bond is an average of the interest rates investors expect on short term bonds over the lifetime of the long term bond

liquidity premium theory

interest rate on long term bond is avg of interest rates investors expect on short term over lifetime of long term

federal funds rate

interest rate that banks charge each other on short-term loans.

yield to maturity

interest rate that makes the present value of the payments from an asset equal to the asset's price today -interest rate on a financial asset for financial markets participants

yield to maturity

interest rate that makes the present value of the payments from an asset equal to the assets price today

speculators

investors who buy and sell derivatives with the hope of profiting from price changes in the underlying commodity or financial assets, such as oil.

If the expected return on bonds rises relative to expected returns on other assets,

investors will increase their demand for bonds because holding bonds is relatively more attractive

gordon growth model shows that

investors' expectations of the future profitability of firms play a crucial role in determining stock prices.

Following the downgrade of U.S. debt by Standard & Poor's in 2011

investors didn't seem to be any more concerned about default risk than before the downgrade.

money market mutual fund

invests exclusively in short term assets - popular with small savers

asset management

involves lending funds in federal funds market

Discount Bond

is a debt instrument in which the borrower repays the amount of the loan in a single payment at maturity but receives less than the face value of the bond initially.

Coupon Bond

is a debt instrument that requires multiple payments of interest on a regular basis, and a payment of the face value at maturity.

Fixed-Payment Loans

is a debt instrument that requires the borrower to make regular periodic payments of principal and interest to the lender.

Primary Market

is a market in which newly issues claims are sold to buyers by borrowers

market makers

large commercial banks

If firms become pessimistic about the profits they could earn from investing in physical capital, the supply curve for bonds will shift

left -equilibrium price increases and the equilibrium quantity of bonds decreases.

If the federal government decreases its spending and doesn't decrease taxes, the bond supply shifts to the

left -> prices rise -> interest rates fall

An increase in expected inflation will shift the demand curve ____ and the supply curve ____, resulting in a new equilibrium with a ____ price

leftward, rightward, lower

corporation

legal form of business that provides owners with protection from losing more than their investment if the business fails

corporation

legal form of business that provides owners with protection from losing more than their investment if the business fails -run by boards of directors who appoint officers, such as the CEO, the CFO, and the COO.

limited liability

legal provision that shield owners of a corporation from losing more than they have invested in the firm.

limited liability

legal provision that shields owners of a corporation from losing more than they have invested

As wealth decreases in the economy, savers are likely to

lend less at any given interest rate

An open economy is one that

lends and borrows in the international capital market.

maturity of coupon bond

length of time before the bond expires and the issuer makes the face value payment to the buyer.

quota

limit on quantity that can be imported

A flight to quality refers to a shift by savers from

low-quality bonds and into high-quality bonds.

A rise in expected inflation will result in all of the following

lower real interest rates, reduced demand for bonds, increased supply of bonds

Investors will accept a _____ expected return on assets with lower costs for acquiring info than they will on a bond with _____ costs for acquiring info

lower, higher

principle agent problem

managers (agents) pursuing their own interests rather than those of shareholders (principals) related to moral hazard

over the counter market

market in which financial securities are bought and sold by dealers linked by computer ex. NASDAQ

in the money on a call option

market price is above strike price

in the money on a put option

market price is below the strike price

capital loss

market price of an asset declines.

capital gain

market price of an asset increases.

Diversification is most effective in reducing

market risk.

In November 2012, HP claimed that they had weak earnings due to questionable accounting by a company that they had taken over. This is an example of

market risk.

benefit of a currency swap

may allow both parties to borrow foreign currency more cheaply

By "negative real yield" Siegel and Schwartz:

meant that the real interest rate on 10-year Treasury notes was negative, because even though there was a very small positive nominal yield, when inflation is considered the real yield actually becomes negative.

leverage

measure of how much debt an investor assumes in making investments assets/value

monetary aggregates

measures of the quantity of money that are broader than currency

money aggregates

measures of the quantity of money that are broader than currency.

unit of account

measuring value in economy in terms of money

debt instruments

methods of financing debt

If the government were to simultaneously cut the personal income tax and the corporate profits tax, the equilibrium interest rate

might either rise or fall

margin requirement/maintenance margin

minimum deposit that an exchange requires from the buyer or seller limits defaults on futures

standard of deferred payment

money can facilitate exchange over time

risk averse

most investors ; choose asset with lower risk when two assets have the same expected returns

fisher effect

movement of interest rates in response to changes in the inflation rate. -indicates that the nominal interest rate changes point-for-point with changes in the expected inflation rate. 1.Higher inflation rates result in higher nominal interest rates, and vice versa. 2.Changes in expected inflation can lead to changes in nominal interest rates before a change in actual inflation occurs.

In an open economy, desired domestic lending

must equal desired domestic borrowing plus the amount of international lending

narrow definition of the money supply. the sum of currency in circulation, checking account deposits , and travelers checks

narrow definition of the money supply: The sum of currency in circulation, checking account deposits, and holdings of traveler's checks. M1 has experienced much more instability than has M2

most banks have a ________ gap and a _______ duration gap

negative gap positive duration gap

an interest rate swap is based on a fixed doller amount called the ___________

notional principle

In late 2008, the average risk premium rose because

of the financial crisis.

people w resources vs people w ideas

old vs young; households vs firms. the idea is you have to match people with resources to people with good ideas.

asymmetric information

one party knows more about the transaction than the other party

If the expected path of interest rates on one-year bonds over the next five years is 2%, 4%, 3%, 2%, and 1%, the expectations theory predicts that the bond with the lowest interest rate today is the one with a maturity of

one year.

bond prices and yield to maturity move in

opposite directions

interest rates and the prices of financial securities move in

opposite directions

option premium

price of an option

option premium

price of an option -reflects the probability that the option will be exercised

nominal exchange rate

price of one currency in terms of another

notional principle

principal amount used to calculate swap payments

discounting

process of finding the present value of funds that will be received in the future PV = FVn/(1+i)^n -lets you compare financial assets

profits and losses of buyers and sellers of future contracts

profit (or loss) to buyer = spot price at settlement - futures price at purchase profit (or loss) to seller = futures price at purchase - spot price at settlement

Dodd Frank Act

prohibits banks to trade with their own funds (propriety trading)

standby letters of credit

promise to lend funds to a seller of commercial paper at the time it matures

checks

promises to pay on demand money deposited with a bank or other financial institutions

checks

promises to pay on demand money deposited with a bank or other financial institutions. -avoids the drawbacks of paper money but also requires more trust on the part of the seller.

excess reserves

provide a source of liquidity reserves - required

interest rate

provides a link between the financial present and the financial future

financial crisis and gordon growth model

rE increases and g decreases in the Gordon growth model, causing stock prices to decline -When investors believe a category of investment has become riskier, they raise the expected return they require from that investment category.

venture capital firms

raise equity capital from investors to invest in start ups

increase in income tax rates will tend to _____ interest rate on treasury bonds and ____ interest rate on municipal bonds

raise, lower

private equity firm

raises equity capital to acquire shares in other firms to reduce free-rider and moral hazard problems

crowdfunding

raising small amounts of money from a large # of people investors become part owners

real exchange rate

rate at which G+S in one country can be exchanged for G+S in another

exchange rate equation

real = nominal (pDomestic/pForeign)

The two most important factors that cause the money demand curve to shift are

real GDP and the price level

common stockholders

receive a dividend that fluctuates as the profitability of the corporation varies over time

risk structure of interest rates

relationship among interest rates on bonds that have different characteristics but the same maturity

term structure of interest rates

relationship among the interest rates on bonds that are otherwise similar but have different maturities

medium households wealth

relatively more of their wealth in retirement accounts and in corporate stock owned outside of retirement accounts.

herd behavior

relatively uninformed investors imitate the behavior of other investors rather than attempt to trade on the basis of fundamental values

inside information

relevant info about a security that is not publicly available -A strong version of the efficient markets hypothesis holds that even inside information is incorporated into stock prices.

inside information

relevant information about a security that is not publicly available

fundamental analysts

rely on forecasting future profits of firms in order to forecast future stock prices -more consistent with rational expectations approach b/c uses all available info

technical analysts

rely on patterns of past stock prices to predict future stock prices

The term structure of interest rates

represents the relationship among the interest rates on bonds that are otherwise similar but that have different maturities

compensating balance

required minimum amount that the business taking out the loan must maintain in a checking account

required reserves

reserves the Fed requires banks to hold against demand deposits and NOW account balances

An increase in firms' expectations of the profitability of investment in physical capital will shift the supply curve for bonds

right -equilibrium price of bonds falls and the equilibrium quantity of bonds rises

long

right of the buyer to receive the underlying asset

short

right of the seller to deliver the underlying asset

increase in the demand for USD causes the exchange rate to ________ (rise/fall)

rise demand shifts out

increase in a bond's tax liability causes its yield to _____ b/c ____

rise, investors care about after-tax returns and must be compensated for paying higher taxes

increase in a bond's information costs causes its yield to _____ b/c ____

rise, investors must spend more resources to evaluate the bond

If the Fed increases the money supply and as a result, households and firms buy more short-term financial assets, the prices of those short-term financial assets will ________ and the interest rates on those assets will ________.

rise; fall

Which type of investor is most likely to have a diversified portfolio?

risk averse

Suppose there's an 80% chance of a stock rising by 20% and a 20% chance of it falling by 40%. Which type of investor would prefer an investment with a guaranteed return of 5%?

risk averse investor

An investor who bases the decision to buy an asset solely on the expected return of an asset is considered to be

risk neutral

credit risk

risk of borrowers defaulting on their loans

derivatives are important for the financial system by providing investors with

risk sharing, liquidity, and information services

default risk (credit risk)

risk that a bond issuer will fail to make payments of interest or principal

market (systematic) risk

risk that is common to all assets of a certain type, e.g., changes in stock returns as a result of the business cycle.

market risk

risk that is common to all assets of a certain type, such as the increase and decrease in stocks resulting from business cycle.

Idiosyncratic (unsystematic) risk

risk that pertains to a particular asset (or a firm) rather than to the market as a whole

idiosyncratic risk

risk that pertains to a particular asset rather than to the market as a whole, as when the price of a particular firm's stock fluctuates because of the success or failure of a new product.

idiosyncratic risk

risk that pertains to particular asset rather than to the market as a whole

counter party risk

risk that the other side of the transaction will default

The bond supply curve

shows the quantity of bonds borrowers are willing to supply as bond prices change

changes in the expectations of households and firms - stocks

significant declines in stock prices are followed by economic recessions --> consumers aware of this pattern may become more uncertain about their future incomes and jobs when theres a fall in stock prices --> uncertainty so postpone spending on houses and consumer durables- -significant decline in stock prices may lead firms to err on the side of safety and postpone spending until the uncertainty about the economy has diminished

financial crisis

significant disruption in the flow of funds from lenders to borrowers. -The financial crisis of 2007−2009 was caused in part by the housing bubble of 2000−2005.

Some claim that ratings agencies have a conflict of interest since:

since agencies charge firms for their services rather than investors, they have an incentive to give high ratings to gain business

bond rating

single statistic summarizes a rating agencies view of issuer's likely ability to make required payments on its bonds

bond rating

single statistic that summarizes a rating agency's view of the issuer's likely ability to make the required payments on its bonds

small firm effect

smaller firms experience higher returns

If a government's income tax receipts exceed its expenditures, the government is running a

surplus and is a net saver of funds

deflation

sustained decline in the price level

barter

system of exchange in which individuals trade goods and services directly for other goods and services. -prevailed in the early stages of development in our economy, but they were inefficient.

barter

system of exchange in which individuals trade goods and services directly for other goods/services

Risk that is common to all assets of a certain type is referred to as

systematic risk

in hedging: you take a ________ (short/long) position in the ________(futures/spot) market to offset a ______ (short/long) position in the ________ (futures/spot) market

take a short position in futures to offset a long position in spot

tariff

tax imposed on imports

mean reversion

tendency for a high earning stock to experience low returns in the future and vice versa

mean reversion

tendency for stocks that have recently been earning high returns to experience low returns in the future, and vice versa

efficient market hypothesis

the application of rational expectations to financial markets; the hypothesis that the equilibrium price of a security is equal to its fundamental value

rational expectations

the assumption that people make forecasts of future values of a variable using all available information: formally, the assumption that expectations equal optimal forecasts, using all available information

adaptive expectations

the assumption that people make forecasts of future values of a variable using only past values of the variable.

During an economic recession

the bond demand and supply curves both shift to the left and the equilibrium interest rate usually falls

If the government increases taxes while holding expenditures constant

the bond supply curve will shift to the left and the equilibrium interest rate will fall

In the bond market, the seller is considered to be

the borrower

The bond supply curve slopes up because

the borrower is willing and able to offer more bonds when the price of the bond is high

The risks of holding long-term corporate bonds at low interest rates include the risk that _______ and, more importantly for investors, the risk that ________.

the corporations will default: interest rates will rise

Investors often pay professional analysts to gather and monitor information on the creditworthiness of borrowers because

the cost of acquiring information about a borrower's creditworthiness can be high.

Suppose that a small economy that had previously been closed becomes open. If its real interest rate had previously been below the world real interest rate, we would expect that

the country would become a net lender abroad

settlement date

the date on which the delivery of a commodity or financial asset specified in a forward contract must take place

settlement date

the date on which the delivery of a commodity or financial asset specified in a forward contract must take place.

risk

the degree of uncertainty in the return on an asset

During an economic recession

the demand and supply curves for bonds both shift to the left and the equilibrium interest rate usually falls

As a result of higher expected inflation

the demand curve for bonds shifts to the right, the supply curve for bonds shifts to the left, and the equilibrium interest rate usually rises

If the expected gains on stocks rise, while the expected returns on bonds do NOT change, then

the demand curve for bonds will shift to the left

diversification

the division of wealth among many different assets to reduce risk

An increase in the corporate profits tax is likely to cause

the equilibrium interest rate to fall and the equilibrium price of bonds to rise.

If the expected gains on stocks rise, while the expected returns on bonds do NOT change, then

the equilibrium interest rate will rise.

If the expected gains on stocks rise, while the expected returns on bonds do not change, then

the equilibrium interest rate will rise.

margin call

the exchange requires the seller/buyer to add funds to their account of meet the maintenance margin

dividend yield

the expected annual dividend divided by the current price of a stock

required return on equities

the expected return necessary to compensate for the risk of investing in stocks.

As the time to deliver approaches (in terms of future and spot price)

the futures price comes closer to the spot price, eventually equaling the spot price on the settlement date.

the higher the default risk,

the higher the interest rate

prime rate

the interest rate banks charged on six-month loans to high-quality borrowers (this practice has died out and now the lower rate is only charged to small borrowers)

yield to maturity

the interest rate that makes the present value of the payments from an asset equal to the asset's price today

If there is an excess demand for bonds at a given price of bonds, then

the interest rate will fall.

If there is an excess supply of bonds at a given price of bonds, then

the interest rate will rise

the greater the volatility in the price of the underlying asset,

the larger the option premium

The further away in time an option's expiration date, and the greater the volatility in the price of the underlying asset,

the larger the option premium.

limited liability

the legal provision that shields owners of a corporation from losing more than they have invested in the firm -can't lose more than you invested

In the bond market, the buyer is considered to be

the lender

The bond demand curve slopes down because

the lender is willing and able to purchase more bonds when the price of the bond is low.

A call or put option is at the money if

the market price equals the strike price.

A call (put) option is out of the money (underwater) if

the market price of the underlying asset is below (above) the strike price.

If, while you are holding a coupon bond, the interest rates on other similar bonds fall, you can be sure that

the market price of your bond will rise.

The expected real interest rate approximately equals

the nominal interest rate minus the expected rate of inflation.

intrinsic value

the payoff to the buyer of the option from exercising it immediately.

discounted value

the present value of a series of future payments is simply the sum of the _____ _______ of each individual payment

The price of a financial asset is equal to

the present value of the payments to be received from owning it

spot price

the price at which a commodity or financial asset can be sold at the current date

strike price

the price at which the buyer of an option has the right to buy or sell the underlying asset.

financial arbitrage

the process of buying and selling securities to profit from price changes over a brief period of time

financial arbitrage

the process of buying and selling securities to profit from price changes over a brief period of time.

securitization

the process of converting loans and other financial assets that are not tradable into tradable securities.

compounding

the process of earning interest on interest, as savings accumulate over time

discounting

the process of finding the present value of funds that will be received in the future

expected return

the rate of return expected on an asset during a future period

term structure of interest rates

the relationship among the interest rates on bonds that are otherwise similar but that have different maturities

rate of return, R

the return on a security as a percentage of the initial price: for a bond during a holding period of one year, the coupon payment plus the change in the price of a bond divided by the initial price.

counterparty risk

the risk that the counterparty (the person or firm on the other side of the transaction) will default -so buyers and sellers of forward contracts incur info costs

counterparty risk

the risk that the person or firm on the other side of the transaction will default.

interest rate risk

the risk that the price of your bond will fluctuate in response to changes in market interest rates.

under the assumptions of the expectations theory, the returns from the 2 strategies must be

the same

the further in the future a payment is to be received,

the smaller its present value

the higher the interest rate used to discount future payments

the smaller the present value of the payments.

diversification

the splitting wealth among many different assets to reduce risk.

Interest rates typically fall during recessions, suggesting that

the supply curve for bonds shifts more to the left than does the demand curve for bonds

In an effort to increase government revenue, Congress and the president decide to increase the corporate profits tax. The likely result will be

the supply curve for bonds shifts to the left.

The Federal Reserve issues a report indicating that future inflation will be higher than had previously seemed likely. As a result

the supply curve for bonds shifts to the right

Suppose that Congress passes an investment tax credit. The likely result will be

the supply curve for bonds will shift to the right.

During a period of economic expansion, when expected profitability is high

the supply curve of bonds shifts to the right

return

the total earnings from a security: for a bond during a holding period of one year, the coupon payment plus the change in the price of the bond.

TARP

troubled asset relief program - US Treasury purchasing stock in banks to increase bank capital

options

type of derivative contract in which the buyer has the right to buy or sell the underlying asset at a set price during a set period of time -traded over the counter and on exchanges (listed options)

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