BUS 171A Final Exam Review

Carlos is considering buying either a corporate bond or a municipal bond that are exactly the same except for their yield. Carlos is in the 35% marginal tax bracket, and the muni bond he is considering pays a 5% interest rate. To make Carlos indifferent between the two bonds, the corporate bond must offer an interest rate of?

7.69% --> 5% / ( 1 - 35% ) = 7.69%

What FICO score would offer the lowest interest rate?

800 and above

Assets & Liabilities on a banks balance sheet:

Assets: - Cash/Reserves - Business loans - Consumer loans - Mortgages - Bonds - Other assets Liabilities: - Demand deposits - Savings accounts - Loans from other banks - Other borrowings Bank capital

Bank regulators use the CAMELS system to provide a standardized assessment of a bank, where CAMELS stands for?

Capital, Asset, Management, Earnings, Liquidity, and Sensitivity

True or False: Lenders benefit from inflation in the short run.

False (bc lenders will get paid back with dollars that have less purchasing power)

True or False: A standby letter of credit is a much more focused commitment than a commercial letter of credit because it is tied to a specific transaction.

False - commercial letter is tied to specific transaction

True or False: The higher a person's rate of time preference, the lower the interest rate needed to get them to defer their consumption to the future.

False - it would need to be a higher interest rate.

True or False: The FOMC is comprised of seven Federal Reserve governors and five Federal Reserve bank presidents, all of whom rotate out of the committee every 3 years.

False - only 4 of the 5 presidents rotate out

True or False: Both finance companies and commercial banks are depository institutions i.e., they accept deposits from customers, pool together the funds, and then use the funds to make loans to other customers.

False - only commercial banks do this

True or False: The Federal Funds Rate is the interest rate that the Federal Reserve charges when lending money to banks as the lender of last resort.

False - that's the discount rate

True or False: Bond prices and interest rates are positively related.

False - they are inversely related.

True or False: In proprietary trading, investment bank traders have to trade solely with the bank client's interest in mind.

False - they sell and buy based solely on the firms behalf

True or False: In a defined contributions plans such as a 401(K), the employer has the responsibility to ensure that funds are appropriately invested so that the employee will have sufficient funds during retirement.

False --> employers are only responsible for employee benefits plans

True or False: The interest rate charged by the Federal Reserve when lending money to other banks in its role as a lender of last resort is called the Federal Funds rate.

False -- it's called the discount rate

Upon purchasing some mutual fund shares, Daisy was charged a 7% fee for the purchase. What kind of fee could this be classified as?

Front-end load

Amy is switching employers and can take the full balance of her defined contributions plan with her, including all employer contributions. Amy can be considered?

Fully Vested

Dana is unhappy with the low rate of returns that she is earning on her government bond mutual fund. She sees another bond fund that invests in corporate securities offered by firms that are in financial distress and/or do not have much experience in offering bonds to that general public. She also notices that the return on this bond mutual fund is much higher than the mutual fund she is currently invested in. What kind of mutual fund has Dana discovered?

High-yield or junk bond fund

If the goal of monetary policy is to keep interest rates stable, the Federal Reserve's response to increases in the demand for money will be to

Increase the supply of money - All else equal, an increase in the demand for money will cause interest rates to rise. In order to keep interest rates constant, the FED must counteract an increase in the demand with an increase in supply.

In a private equity fund, __________ do not make investment decisions, nor are they involved in the firms in which the fund invests. Instead, their involvement is limited only to the funds that they invest in the fund. On the other hand, the _______________ manage the fund and decide which companies the private equity fund will invest in.

Limited Partners (LPs) ; General Partners (GPs)

Nick has $12,000 in time deposits. In which money aggregate would this amount belong?

M2 - M1 = Currency in the hands of the public, Traveler's checks, Demand Deposits, other checkable deposits - M2 = all of M1, Small time deposits, Savings deposits, Money Market Deposit Account, Non-retirement retail money market accounts

Commercial banks and thrifts claim that ___________ gives credit unions an unfair advantage.

Not paying corporate income taxes

If a banks systems are hacked by foreign agents leading to bank assets and customer information being compromised, this kind of risk is known as?

Operational Risk

_______________ is an issue that arises due to multiple entities being responsible for the issuance of bank charters in the US.

Regulator shopping

A banks sells Treasury securities to the Federal Reserve with the promise of buying the securities back at a later date at a higher price. This kind of transaction is called?

Repurchase Agreement (REPO)

Imagine that Ronald goes to his bank and deposits $10,000 in cash into his savings. The bank, wanting to use those funds to generate revenue for itself, will look to make a loan with his cash. An important determinant of how much of that $10,000 the bank can lend is the?

Required Reserve Ratio

Suppose that the Treasury Department wants the US dollar to depreciate against the euro. The treasury will order the Federal Reserve Bank of New York ________ dollars and ________ euro through the foreign exchange department of American commercial banks.

Sell ; Buy

A yield curve illustrates the relationship between the

Term to maturity of bonds and the interest rate they pay, at a particular point in time.

The sum of the Federal Reserve notes in circulation, plus US coins, plus bank reserves is collectively referred to by what?

The Monetary Base one of the most narrowest measurements of the money supply --> sum of paper currency in circulation(dollars), bank reserves, and US Treasury coins in circulation.

In order to overcome the stigma that might come from borrowing from the Federal Reserve following the 2007 crisis, the Federal Reserve created?

The Term Auction Facility (TAF)

Systemic risk in the current banking system refers to?

The collapse of a single megabank could result in the collapse of the entire financial system.

What is one of the motivations that causes private equity firms to use leverage in a buyout?

The interest payments are tax decutible

Richardo and Friedman agree that if the money supply increases "too quickly," the following will happen?

The rate of inflation increases.

Harper just got a big raise at work, which pushed her from the 15% federal marginal tax bracket to the 25% marginal tax bracket. Which of the following best describes how this might affect her decision to buy municipal bonds?

This will likely make her more likely to buy muni bonds because it will increase the difference between the nominal interest rate paid on the bonds and the after-tax interest rate she will receive relative to corporate bonds.

True or False: A hedge fund investment is not a short-term or liquid investment.

True

True or False: ETFs generally have much lower expense ratios than a typical mutual fund.

True

True or False: Earthquake insurance is a form of named-peril insurance policy.

True

True or False: If the market interest rate exceeds the coupon rate of the bond, the bond's face value will be greater than the selling price of the bond.

True

True or False: One of the Federal Reserve's must used tools is the buying and selling of US government securities in the secondary market.

True

True or False: The FED chair is confirmed to the position by the US Senate after being appointed by the US president.

True

True or False: A yield curve generally slopes upward but may slope downward if short-term interest rates on bonds are higher than longer-term interest rates.

True (downward means ST rates are perceived as too high)

True or False: Suppose a relative has promised to give you $1,000 as a gift the day you graduate. Assuming a constant interest rate of 5%, the present value of the gift is smaller if you graduate in 2 years than it is if you graduate in 1 year.

True -- a dollar today is worth more than a dollar tomorrow.

When the currency ratio increases, the impact of changes in the monetary base on the money supply is

Weakened (bc it is getting divided by a larger number in the money multiplier equation)

Liquidity Trap happens when?

When borrowers are unwilling to borrow, and lenders are unwilling to lend due to pessimism of the future.

Through which method can the FED impact the money supply?

- Bank reserves - Open market operation (buying + selling gov securities) - Interest rate

You own a 10-year, annual, $10,000 US Treasury bond with a coupon rate of 2%. There are two years left to maturity, and you are planning to sell the bond in the secondary market. If the interest rate is 5%, how much can you expect to get for the bond?

$9,442 --> 200/1.05 + 10,200/(1.05)^2 = 9,442

In the United States, who issues bank charters?

- Office of the Comptroller of the currency - Each state's banking commission

Suppose that North bank currently charges a 3.5% fixed interest rate on a 15-year mortgage and pays a 2.5% interest rate to customers who buy 6-month CDs. Suppose that at the end of the six-month period depositors roll over the funds in the CD for another six months. Then the original interest rate spread is _____. Suppose now that market interest rates increased by 0.2%. After six months, when the CD mature and the depositors rolls over the funds into a new six-month CD, the bank's interest rate spread is _______.

1% ; 0.8% --> (3.5% - 2.5%) = 1 ; (3.5% - 2.7%) = 0.8%

Examples of Moral Hazard:

1. an individual begins to drive rashly because they know they have good coverage 2. after purchasing fire insurance, homeowners may be more likely to leave candles burning unattended bc they know they have coverage 3. an individual begins to skydive after obtaining a $1 million life insurance policy

Consider the following data about the economy: currency outstanding (C) = $1 trillion, total deposits (D) = $750 billion, total reserves (R) = $76 billion, and the required reserve ratio (RR ratio) = 10%. What is the money multiplier?

1.63 --> (1 + k) / (k + rr + re) --> (1+1.33) / (1.33 + 0.1 + 0.00133) = 1.63

If the total market value of a mutual fund is $10 million and the fund has 100,000 shares outstanding currently, what is the price of each share?

100 --> 10 M / 100,000 = 10

An asset manger manages a $1.5 billion portfolio for a client for a fee if 150 basis points. What is the annual dollar management fee charged?

22,500,000 --> 1.5 billion * 15% = 22.5 million

GeoGreen is a company that wishes to go public and thus hires an investment bank to help with the process. If the underwriting syndicate organized by the investment bank purchases all 1 million shares from GeoGreen at $45 per share and then sells it in the market for $48 per share, what is the underwriting gross profit spread?

3 dollars --> (48-45)

A one-time deposit in a bank will result in?

An expansion in the money supply that is larger than the size of the one-time deposit

What could lead to a shift in demand for bonds?

A decrease in societal wealth, a decline in expected returns of bonds or other assets

Annual Payment Formula:

AP = 2% * AVG of 3 highest years income * years w/ firm

The loan application process that banks require potential borrowers to go through is an attempt to deal with?

Adverse Selection - banks deal with asymmetric info and try to overcome this by collecting a great deal of info about potential borrower

When the Federal Reserve increases the required reserve ratio, the impact will be to?

Decrease the size of the money multiplier.

The risk that a bond issuer will not be able to live up to the promise they make when they issue a bond is known as ___________.

Default (risk)

True or False: Insurance companies in the United States are federally regulated by the Federal Insurance Office (FIO).

False

True or False: It is illegal for an employer to underfund a pension plan.

False