Finance 3000 chapter 6

11. This is a security formalizing an agreement between two parties to exchange a standard quantity of an asset at a predetermined price on a specified date in the future. A. derivative security B. initial public offering C. liquidity asset D. trading volume

A. derivative security

9. These capital market instruments are long-term loans to individuals or businesses to purchase homes, pieces of land, or other real property. A. Treasury notes and bonds B. Mortgages C. Mortgage-backed securities D. Corporate bonds

B. Mortgages

20. This is a comparison of market yields on securities, assuming all characteristics except maturity are the same. A. liquidity risk B. market risk C. maturity risk D. term structure of interest rates

D. term structure of interest rates

19. Which of these statements is true? A. The higher the default risk, the higher the interest rate that security buyers will demand. B. The lower the default risk, the higher the interest rate that security buyers will demand. C. The higher the default risk, the lower the interest rate that security buyers will demand. D. The default risk does not impact the interest rate that security buyers will demand.

A. The higher the default risk, the higher the interest rate that security buyers will demand.

17. This is the risk that a security issuer will miss an interest or principal payment or continue to miss such payments. A. default risk B. liquidity risk C. maturity risk D. price risk

A. default risk

3. Primary market financial instruments include stock issues from firms allowing their equity shares to be publicly traded on stock market for the first time. We usually refer to these first-time issues as which of the following? A. initial public offerings B. direct transfers C. money market transfers D. over-the-counter stocks

A. initial public offerings

2. In the U.S., these financial institutions arrange most primary market transactions for businesses. A. investment banks B. asset transformer C. direct transfer agents D. over-the-counter agents

A. investment banks

5. These feature debt securities or instruments with maturities of one year or less. A. money markets B. primary markets C. secondary markets D. over-the-counter stocks

A. money markets

15. This is the interest rate that is actually observed in financial markets. A. nominal interest rates B. real interest rates C. real risk free rate D. market premium

A. nominal interest rates

27. Interest rates A corporation's 10-year bonds have an equilibrium rate of return of 7 percent. For all securities, the inflation risk premium is 1.50 percent and the real interest rate is 3.0 percent. The security's liquidity risk premium is 0.15 percent and maturity risk premium is 0.70 percent. The security has no special covenants. What is the bond's default risk premium? A. 1.40% B. 1.65% C. 5.35% D. 9.35%

B. 1.65% 7.00% = 1.5% + 3% + DRP + 0.15% + 0.70% => DRP = 7.00% - (1.5% + 3% + 0.15% + 0.70%) = 1.65%

30. Unbiased Expectations Theory One-year Treasury bills currently earn 5.50 percent. You expect that one year from now, one-year Treasury bill rates will increase to 5.75 percent. If the unbiased expectations theory is correct, what should the current rate be on two-year Treasury securities? A. 5.50% B. 5.625% C. 5.75% D. 11.25%

B. 5.625% 1R2 = [(1 + .055)(1 + .0575)]1/2 -1 = 5.62492604%

7. These money market instruments are short-term funds transferred between financial institutions, usually for no more than one day. A. Treasury bills B. Federal funds C. Commercial paper D. Banker acceptances

B. Federal funds

23. This is the expected or "implied" rate on a short-term security that will originate at some point in the future. A. Current yield B. Forward rate C. Spot rate D. Yield to maturity

B. Forward rate

22. This theory argues that individual investors and financial institutions have specific maturity preferences, and to encourage buyers to hold securities with maturities other than their most preferred requires a higher interest rate. A. Liquidity Premium Hypothesis B. Market Segmentation Theory C. Supply and Demand Theory D. Unbiased Expectations Theory

B. Market Segmentation Theory

8. Which of the following is NOT a capital market instrument? A. U.S. Treasury notes and bonds B. U.S. Treasury bills C. U.S. government agency bonds D. Corporate stocks and bonds

B. U.S. Treasury bills

18. This is the continual increase in the price level of a basket of goods and services. A. deflation B. inflation C. recession D. stagflation

B. inflation

13. This is the ease with which an asset can be converted into cash. A. direct transfer B. liquidity C. primary market D. secondary market

B. liquidity

16. This is the interest rate that would exist on a default-free security if no inflation were expected. A. nominal interest rate B. real interest rate C. real risk free rate D. market premium

B. real interest rate

12. Which of these does NOT perform vital functions to securities markets of all sorts by channeling funds from those with surplus funds to those with shortages of funds? A. commercial banks B. secondary markets C. insurance companies D. mutual funds

B. secondary markets

26. Interest rates You are considering an investment in 30-year bonds issued by a corporation. The bonds have no special covenants. The Wall Street Journal reports that 1-year T-bills are currently earning 3.50 percent. Your broker has determined the following information about economic activity and the corporation bonds: Real interest rate = 2.50% Default risk premium = 1.75% Liquidity risk premium = 0.70% Maturity risk premium = 1.50% What is the inflation premium? What is the fair interest rate on the corporation's 30-year bonds? A. 1% and 1.49%, respectively B. 1% and 6.45%, respectively C. 1% and 7.45%, respectively D. 3.50% and 9.95%, respectively

C. 1% and 7.45%, respectively Expected (IP) = i - RIR = 3.50% - 2.50% = 1.00% ij* = 1.00% + 2.50% + 1.75% + 0.70% + 1.50% = 7.45%

33. Interest rates The Wall Street Journal reports that the rate on 3-year Treasury securities is 7.00 percent, and the 6-year Treasury rate is 7.25 percent. From discussions with your broker, you have determined that expected inflation premium is 1.75 percent next year, 2.25 percent in Year 2, and 2.40 percent in Year 3 and beyond. Further, you expect that real interest rates will be 3.75 percent annually for the foreseeable future. What is the maturity risk premium on the 6-year Treasury security? A. 0.83% B. 0.983% C. 1.10% D. 1.233%

C. 1.10% 7.25% = 2.40% + 3.75% + MP => MP = 7.25% - (2.40% + 3.75%) = 1.10%

31. Liquidity Premium Hypothesis One-year Treasury bills currently earn 5.50 percent. You expect that one year from now, one-year Treasury bill rates will increase to 5.75 percent. The liquidity premium on two-year securities is 0.075 percent. If the liquidity theory is correct, what should the current rate be on two-year Treasury securities? A. 3.775% B. 5.625% C. 5.662% D. 11.325%

C. 5.662% 1R2 = [(1 + .055)(1 + .0575 + .00075)]1/2 - 1 = 5.66237504%

25. Interest rates A particular security's default risk premium is 3 percent. For all securities, the inflation risk premium is 2 percent and the real interest rate is 2.25 percent. The security's liquidity risk premium is 0.75 percent and maturity risk premium is 0.90 percent.The security has no special covenants. What is the security's equilibrium rate of return? A. 1.78% B. 3.95% C. 8.90% D. 17.8%

C. 8.90% ij* = 2.00% + 2.25% + 3.00% + 0.75% + 0.90% = 8.90%

6. Which of the following is NOT a money market instrument? A. Treasury bills B. Commercial paper C. Corporate bonds D. Banker's acceptances

C. Corporate bonds

10. These markets trade currencies for immediate or for some future stated delivery. A. money markets B. primary markets C. foreign exchange markets D. over-the-counter stocks

C. foreign exchange markets

14. This is the risk that an asset's sale price will be lower than its purchase price. A. default risk B. liquidity risk C. price risk D. trading risk

C. price risk

1. These provide a forum in which demanders of funds raise funds by issuing new financial instruments, such as stocks and bonds. A. investment banks B. money markets C. primary markets D. secondary markets

C. primary markets

4. Once firms issue financial instruments in primary markets, these same stocks and bonds are then traded in which of these? A. initial public offerings B. direct transfers C. secondary markets D. over-the-counter stocks

C. secondary markets

24. Which of these is NOT a theory that explains the shape of the term structure of interest rates? A. liquidity theory B. market segmentation theory C. short-term structure of interest rates theory D. unbiased expectations theory

C. short-term structure of interest rates theory

21. According to this theory of term structure of interest rates, at any given point in time, the yield curve reflects the market's current expectations of future short-term rates. A. Expectations Theory B. Future Short-term Rates Theory C. Term Structure of Interest Rates Theory D. Unbiased Expectations Theory

D. Unbiased Expectations Theory