ECON 380 FINAL COMBINED SET
Which of the following types of orders does not involve specifying a price limit or trigger price as part of the order?
A spread order
In a blog post, former Federal Reserve Chair Ben Bernanke described the four "basic elements" of a financial crisis: "broad-based loss of confidence in banks, runs by providers of short-term funding, fire sales of bank loans and other assets, [and] disruption of credit flows." Source: Ben S. Bernanke, "Ending Too Big to Fail: What's the Right Approach?" brookings.edu, May 13, 2016. Why might each of these four elements occur during a financial crisis?
Each of these elements is connected to another.
C. The breakout of war in the Europe.
Economist Peter Temin of MIT argues that, open double quoteIf the crash of 1929 was an important independent shock to the economy, then the crash of 1987 should have been equally disastrous.close double quote Source: Peter Temin, Lessons from the Great Depression, Cambridge, MA: MIT University Press, 1989 p. 41. Which of the following events would be considered an "important independent shock to an economy"? A. Inflation. B. An increase in the Federal Funds rate. C. The breakout of war in the Europe. D. A stock market crash.
Consider a ratio spread comprising a call at strike and short two calls at strike . The current stock price is at . The market view for this trade is most likely to be:
That the stock will rise but not by an indefinite amount.
Forward pricing by replication depends on the following assumption:
That the underlying is a traded asset which is storable.
What is pegging?
The decision by a country to keep the exchange rate fixed between its currency and another country's currency.
decreasing, more increasing, lowering
The decline in spreads between yields on AAA-rated corporate bonds and government bonds indicates that investors view the default risk on corporate bonds to be _____ . As such, these bonds are becoming _____ desirable, _____ their price and _____ their yield.
C. the Fed's deflationary policies.
The depression continued well beyond June, 1930 because of A. the increase in wealth. B. the increase in international trade. C. the Fed's deflationary policies. D. bank success.
D. bank failures.
The depression continued well beyond June, 1930 because of A. the increase in wealth. B. the increase in international trade. C. the Fed's inflationary policies. D. bank failures.
What would have to be true of a derivatives security if the security were to help you to hedge this risk?
The derivative would need to go up in value if corn prices fell.
When the futures-spot basis weakens
The difference between futures and spot prices drops.
Consider five put options at strikes 40, 45, 50, 55, and 60. The price of the 40-strike option is $4, the price of the 50-strike put is $5, and the price of the 60-strike option is $8. Which of the following statements is most accurate? (Assume all options have the same maturity.)
The difference between the maximum prices of the 55-strike put and the 45-strike put is $2.00
what is the shadow banking system
a collection of non bank financial insitutions that channel money from savers to borrowers
Depreciation
a decrease in value of a currency in exchange for another currency
Spot
market transactions involve an exchange of currencies or bank deposits immediately at the current exchange rate
speculating
may increase risk by placing bets on assets in an attempt to earn higher profits in the market
slope of capital market line
mean m - rf / theta m - 0
capital market line
mean p = rf + [mean m - rf)/theta m]theta p
burton malkiel sleep test
are you sleeping well with your current choice? if no, hold smaller percentage of wealth in stocks and reduce risk
the demand for agricultural products are typically price inelastic because....
fluctuations in supply cause large swings in the equilibrium price
All else being equal, a bond with a higher coupon has a duration that is ________ than that of a bond with a lower coupon
greater than.
bond price, interest rate
in the bond market, the price is the _________ and in the loanable funds market, the price is the ________
borrower, lender
in the bond market, the seller is the _______ and in the loanable funds market, the seller is the _________
The supply of dollars in exchange for yen
is determined by the willingness of households an firms that own dollars to exchange them for yen
yen91 = $1 to yen79 = $1, Because US Goods are now ___ expensive, this is __ news for Japanese consumers
less, good
When the correlation between two assets is exactly , which of the following statements is true?
There is no basis risk in hedging.
What happens to the long position in a 90-100-110-strike call butterfly spread if all the calls are replaced with puts of identical strike and maturity?
There is no change in the risks and cash flows of the original position.
There are three- and six-month European calls on stock. Suppose the three-month option costs $5 and the six-month option costs $3. Then, there is an arbitrage strategy that involves, among other things,
There is not enough information given to answer this question.
The risk-free interest rate drops but the futures on a stock market index rises. Which of the following statements is the most accurate?
There is not enough information in the question to identify if there is an arbitrage or not
The price of oil is $100 per barrel. Oil prices are expected to grow at 4% a year. The one-year risk-free rate of interest is 2% in simple terms. It costs $1 to store a barrel of oil for one year. If you observe a one-year forward price of oil of $98, what inference could you draw?
There may be a benefit of carry in the oil market.
The problem that managers of a financial firm will take on riskier investments because they believe the federal government will save them from bankruptcy.
What is the moral hazard problem?
What are the main reasons that interest-rate parity may not hold exactly?
Transaction costs. B. Differences in default risk and liquidity. C. Exchange-rate risk.
real rate
relative prices
C
the lower the price of bonds, the smaller the quantity of bonds supplied A. false- the price of bonds does not influence the quantity of bonds supplied B. false- the lower the price, the lower the yield, which increases the cost of borrowing C. true- the lower the price, the higher the yield, which increases the cost of borrowing D. true- the lower the price, the higher the yield, which decreases the cost of borrowing
A call option is :in the money" if ..
the market price of the underlying asset is greater than the strike price
Real Exchange Rate
the rate at which goods and services in one country can be exchanged for goods and services in another country
interest rates, maturity
the term structure of interest rates is the relationship among the ________ on bonds that are otherwise similar but differ in _________.
What effect would these increases in household wealth have on consumption spending? A. Consumption spending would increase. B. Consumption spending would decrease. C. Consumption spending would not change.
A. Consumption spending would increase.
Instead of fine-tuning, what do economists generally advocate that policymakers do? (Check all that apply.) A. Focus on promoting low inflation. B. Focus on keeping interest rates as low as possible. C. Focus on eliminating both public and private debt. D. Focus on achieving steady economic growth.
A. Focus on promoting low inflation. D. Focus on achieving steady economic growth.
In 2016, in an opinion column in the Wall Street Journal, Harvard economist Martin Feldstein referred to "a possible negative shock--such as a sharp fall in exports or in construction--that could push the economy into a new recession.close double quote Source: Martin Feldstein, "Federal Reserve Oblivious to Its Effect on Financial Markets," Wall Street Journal, January 13, 2016. A sharp fall in exports or in construction would be a negative shock to aggregate___.
demand
Explain whether each of the following shifts the aggregate demand curve to the right or to the left. The Federal Reserve sells $12 billion of U.S. Treasury securities. It would ___ the interest rate, causing the AD curve to shift to the ___. The federal government launches a massive program to rebuild the nation's highways. It would directly ___ aggregate expenditure, causing the AD curve to shift to the ___. The federal government cuts the corporate profits tax. It would ___ the after-tax rate of return on investment projects, ___ investment spending and causing the AD curve to shift to the ___. The foreign exchange value of the dollar falls. It would ___ the cost of U.S. exports and ___ the cost of foreign imports, causing the AD curve to shift to the ___. Firms become optimistic about the future profitability of spending on factories and machinery. It would ___ current investment spending, causing the AD curve to shift to the ___.
increase, left increase, right increase, increasing, right decrease, increase, right increase, right
"Turning more stimulative" means that fiscal policy was becoming more expansionary with ___ in government spending or ___ in taxes.
increases, decreases
Fiscal policy is intended to achieve ___ policy objectives.
macroeconomic
A. Underwriting is financial intermediation because the bank brings together savers and the issuers of securities.
In what sense is an investment bank that engages in underwriting acting as a financial intermediary? A. Underwriting is financial intermediation because the bank brings together savers and the issuers of securities. B. The statement is not correct and an investment bank that engages in underwriting does not act as a financial intermediary. C. Underwriting is financial intermediation because the bank creates the financial instruments. D. Underwriting is financial intermediation because the bank gains profit from the procedure.
positive intrinsic value
"in the money"
Suppose that National Bank of Guerneville has $30 million in checkable deposits, Commonwealth Bank has $41 million in checkable deposits, and the required reserve ratio for checkable deposits is 10%. If National Bank of Guerneville has $4 million in reserves and Commonwealth has $5 million in reserves, how much in excess reserves does each bank have? (Enter your answers rounded to one decimal place.) National Bank of Guerneville has _________ in excess reserves. Commonwealth Bank has ____________ in excess reserves. Now suppose that a customer of National Bank of Guerneville writes a check for $2 million to a real estate broker who deposits the check at Commonwealth. After the check clears, how much in excess reserves does each bank have? National Bank of Guerneville has ____ in excess reserves. Commonwealth Bank has ________ in excess reserves.
$1 million $.9 million $−.8 million $2.7 million
Which of the following features distinguish futures markets from forwards markets?
(a) Standardization of contracts. (b) The use of margin accounts to manage risk. (c) Ease in reversing positions. (d) All of the above. Answer d.
Would General Mills buy or sell futures contracts in wheat? What would General Mills hope to gain by doing so?
General Mills would buy futures contracts in wheat to reduce the risk of prices rising .
B. It was difficult to determine whether an asset bubble existed.
Given the subsequent crash of technology stocks, why might the Fed have not intervened during this period of time? A. Professional investors were raising alarms. B. It was difficult to determine whether an asset bubble existed. C. Buffet's changed his mind and bought technology stocks. D. The Fed determined no asset bubble existed.
March what futures are trading at $4.20 a bushel and May wheat futures are trading at $4.35 a bushel. You expect the spread between May and March futures prices to widen. To speculate on this view, you would
Go long May futures and short March futures.
September corn futures are currently trading at $3.80 a bushel while the spot price of corn is $3.65 a bushel, so the "basis" (the futures price minus the spot price) is $0.15 a bushel. If you expect the basis to weaken (i.e., to fall) significantly in the next few days, you can speculate on your view by
Going long spot corn and short September futures
A yen depreciation is ____________ news for Sony.
Good.
This is _________ news for U.S. consumers, as Japanese goods become _____________ expensive, and __________ news for U.S. firms, as the dollar has ____________ against the yen.
Good; less; bad; appreciated.
What is a long position in the futures market?
The right and obligation of the buyer to receive or buy the underlying asset on the specified future date.
An option gives the buyer
The right but not the obligation to undertake the trade specified in the contract at maturity
Exchange rate risk
The risk that a firm will suffer losses because of fluctuations in exchange rates
The replication method identifies the price of a USD/GBP forward rate as a function of
The spot USD/GBP exchange rate, the GBP interest rates, and the USD interest rates
At maturity of the forward contract, the following is true of the spot price and delivery price locked-in using the forward contract:
The spot price can be greater, equal to, or less than the delivery price.
In the absence of arbitrage, the futures price at maturity should equal
The spot price of the underlying asset at that point.
Theory of purchasing power parity (PPP)
The theory that exchange rates move to equalize the purchasing power of different currencies
Forward transactions
traders agree today to a forward contract to exchange currencies or bank deposits on a future data at an exchange rate known as the forward rate
Suppose that the interest rate on a one-year Treasury bill is currently 7% and that investors expect that the interest rates on one-year Treasury bills over the next three years will be 8%, 9%, and 7%. Use the expectations theory to calculate the current interest rates on two-year, three-year, and four-year Treasury notes.
two: 7 + 8 = 15/2 = 7.5 three: 7 + 8 + 9 = 24/3 = 8 four: 7 + 8 + 9 + 7 =31/4 7.75
how do you calculate the intrinsic value of a call option?
underlying stock price - strike price
In describing the performance of the Federal Reserve during the Great Depression, former Federal Reserve Chairman Ben Bernanke has written: "The Fed proved far too passive during the Depression. It was ineffective in its role of lender of last resort, failing to stop the runs that forced thousands of small banks to close ...." Source: Ben S. Bernanke, The Courage to Act: The Financial Crisis and Its Aftermath, New York: W.W. Norton, 2015, p. 47. A lender of last resort is a ________ that acts as the ultimate source of credit to the _____, making loans to solvent banks against their ______, but illiquid, loans.
central bank banking system good
A ____ increases asset or expense accounts, and decreases liability, revenue or equity accounts.
debit
The foreign exchange value of the dollar falls. It would _______ the cost of U.S. exports and ____ the cost of foreign imports, causing the AD curve to shift to the ____
decrease increase right
Which of the following statements is true of the value of European (E) options, American (A) options, and Bermudan (B) options?
(a) (b) (c) (d) Answer a.
A US-based exporter anticipated receiving €100 million in six months, and took a short forward position, locking-in an exchange rate of $1.38/€. If after six months, at maturity, the exporter calculates that she has made a profit of $2 million from the hedging strategy, the spot exchange rate at maturity must be
(a) $ 0.50/€. (b) $ 1.36/€ (c) $1.40/€ (d) $ 2.00/€ Answer b.
An investor enters into a long position in 10 gold futures contracts at a futures price of $1000/oz and closes out the position at a price of $1020/oz. If one gold futures contract is for 50 ounces, what are the investor's gains or losses?
(a) $100 (b) $1,000 (c) $5,000 (d) $10,000 Answer d
The price of oil is $100 per barrel. Oil prices are expected to grow at 4% a year. The one-year risk-free rate of interest is 2% in simple terms. It costs $1 to store a barrel of oil for one year. If oil has no costs or benefits of carry, what is the theoretical one-year forward price of oil?
(a) $100.00 (b) $102.00 (c) $103.02 (d) $104.00 Answer c.
A stock has a current price of $20. The risk-free interest rate for a half-year maturity is 6% and the dividend rate is 3%. Assume continuous compounding. What is the six-month forward price of the stock?
(a) $20.30 (b) $20.61 (c) $20.92 (d) $21.24 Answer a.
Plutonium is trading at a one-year futures price of $5,000 per gram. A futures contract comprises 100 grams. The initial margin is $100,000 and the maintenance margin is $80,000. You are short one futures contract. There is a margin call when the price per gram of plutonium changes to
(a) $4,750 (b) $4,900 (c) $5,100 (d) $5,250 Answer d.
A forward contract is struck at a forward price of $40. At maturity the spot price of the asset is $45. The short forward position earns the following payoff:
(a) $5 (b) -$5 (c) $45 (d) -$45 Answer b.
The spot price of an asset is $50. The expected return on the asset is 10% a year (in simple terms) and the standard deviation of these returns is 20%. The risk-free rate of interest is 5% a year in simple terms. Assuming no costs or benefits of carry, what is the one-year forward price of the asset?
(a) $52.50 (b) $55.00 (c) $57.50 (d) $60.00 Answer a.
How many options does a callable, convertible bond contain?
(a) 0 (b) 1 (c) 2 (d) 3 Answer c. There are two options: (a) the issuer holds a call on the bond, and (b) the buyer has the right to convert the bond into equity. One may extend the idea and say that there is an additional option—the option to default held by the issuer of the convertible. If such a response is provided, then the correct answer would be 3 options, i.e., answer (d).
Eurodollar deposits follow the money-market day-count convention. Suppose a deposit is made for 92 days at a Libor rate of 4% on a notional amount of $100. The interest amount is
(a) 1.0082 (b) 1.0099 (c) 1.0101 (d) 1.0222 Answer d. The eurodollar money-market convention is Actual/360, so the interest is 100×4×92/360 = 1.0222.
The US dollar-euro spot exchange rate is $1.50/€. If the one-year simple interest rate on dollars is 1% and on euro is 2%, what is the one-year forward rate of dollars per euro?
(a) 1.4748 (b) 1.4853 (c) 1.5000 (d) 1.5149 Answer b.
How many years does it take to double your money if the continuously-compounded interest rate is 6%?
(a) 11.55 (b) 12.66 (c) 13.77 (d) 16.66 Answer a. The answer is the solution to the following equation: ln(2) / 0.06 = 11.55
State which of these statements is false
(a) A futures contract is traded on an exchange. (b) A futures contract involves counterparty credit risk. (c) A futures contract is fully customizable. (d) A futures contract may be reversed unilaterally. Answer c.
An investor enters into a forward contract to buy 4,000 barrels of oil in three months at $80 a barrel. At the maturity of the contract, the spot price of oil is $65 a barrel. The investor's payoff (gain/loss) from the forward contract is
(a) A gain of $60,000 (b) A loss of $60,000 (c) A gain of $260,000 (d) A loss of $260,000 Answer b.
The value of the following position for options at the same strike price is always zero
(a) A long call and a long put. (b) A short call and a short put. (c) Both (a) and (b). (d) Neither (a) nor (b). Answer d.
A forward contract may be used for
(a) Hedging price exposure at a future date. (b) Speculating on price. (c) Locking-in a price for a future transaction. (d) All of the above. Answer d.
The relationship of forwards and futures is best represented by the following statement(s)
(a) If futures price movements and interest rate movements are positively correlated, then futures prices will be higher than forward prices. (b) If futures price movements and interest rate movements are negatively correlated, then futures prices will be lower than forward prices. (c) If futures price movements and interest rate movements are uncorrelated, then futures and forward prices will coincide. (d) All of the above. Answer d
If your directional view is that stock prices are going to fall, you should
(a) Sell stock now. (b) Sell call options. (c) Buy put options. (d) All of the above are profitable strategies. Answer d. All or any of these in combination will gain when stock prices fall. Some of the alternatives have less downside in the even that your view is wrong, so depending on your risk appetite, choose the one that is most palatable.
If the market is in backwardation
(a) Spot prices are less than forward prices. (b) Futures prices are less than forward prices. (c) Spot prices are less than futures prices. (d) None of the above. Answer d.
Which of the following statements is true of forward contracts?
A forward contract is customizable and traded over-the-counter.
Quota
A limit a government imposes on the quantity of a good that can be imported
The combination of a position in a covered call and a position in a protective put on a stock index (where the options have the same strike and maturity) is similar to
A long position in a balanced index fund (i.e., long stock and long investment at the risk-free rate).
A calendar spread futures position comprises
A long position in a futures contract of one maturity and a short position in another futures contract of a different maturity.
If you go short a covered call and buy a protective put portfolio on a given stock (with the options having the same strike and maturity), what you have is
A long position in a straddle.
If you are interested in creating a retirement portfolio where the downside is protected and you retain at least some upside, the following portfolio will be consistent with your goal
A long stock position plus a long collar position
A replicating portfolio for a derivative security is
A portfolio that has the same payoffs as the derivative.
C. A high net worth or high income individual.
A publication of the Securities and Exchange Commission (SEC) notes that to invest in a hedge fund: open double quoteYou generally must be an accredited investor.close double quote Source: Securities and Exchange Commission, Investor Bulletin: Hedge Funds. What is an accredited investor? A. An investor who has been accredited by the SEC. B. An investor who only buys accredited investments. C. A high net worth or high income individual. D. An investor who completes a financial literacy course.
A long position in a bearish 90/100 call spread plus a long position in a bullish 90/100 put spread for the same maturity is:
A sophisticated approach to borrowing money.
A long position in a FRA can be replicated using
A six-month investment combined with a 9-month borrowing
Suppose that Coca-Cola is currently paying a dividend of $2.71 per share, the dividend is expected to grow at a rate of 7% per year, and the rate of return investors require to buy Coca-Cola's stock is 10%. Calculate the price per share for Coca-Cola's stock. The price per share of Coca-Cola stock is $____. (Round your response to two decimal places.)
$96.66 Gordon's Growth Model: Pt = Dt x (1+g)/(re - g)
Suppose that an Apple iPhone costs $180 in the United States, £70 in the United Kingdom, and ¥35000 in Japan. what is real exchange rate? for pound and dolalr
($1.80 X £70 / $180_
Suppose that the current exchange rate between the yen and the dollar is yen99=$1 and that the interest rate is 6% on a one-year bond in Japan and 5% on a comparable bond in the United States. According to the interest-rate parity condition, what do investors expect the exchange rate between the yen and the dollar to be in one year Formula for exchange rate is
(.06-.05) X yen99, then add previous yen
"Basis" risk may arise in a hedging situation if
(a) The expiry date of the futures contract and the date on which the hedge is unwound do not coincide. (b) The futures contract used for hedging relates to a commodity that is somewhat different than that being hedged. (c) A disconnect between spot and futures markets causes the failure of the convergence of futures to spot at expiry of the futures contract. (d) All of the above. Answer d. While (c) is not mentioned explicitly in the text, it evidently causes uncertainty in the cash flows of the hedged position.
The premium of an option is
(a) The price of the option. (b) The value of the right but not the obligation to undertake a purchase or sale of the underlying asset. (c) Is always non-negative. (d) All of the above. Answer d.
You are long an at-the-money straddle on a stock index. Which of the following statements is valid?
(a) Your position increases in value if, ceteris paribus, the index rises. (b) Your position increases in value if, ceteris paribus, the index falls. (c) Your position increases in value if, ceteris paribus, the volatility of the index rises. (d) All of the above. Answer d.
Futures flexibility that lacks compared to forward:
- forwards can choose any date - future may only be given several dates to choose from
futures are better than forwards becasue:
- less counterparty risk (said to be reduced because exchange serves as a "clearing house" that matches up buyers and sellers and the exchange) - lower information costs - more liquid (An asset is said to be liquid if it is easy to sell or convert into cash without any loss in its value)
Consider a condor made up of calls at strikes 90, 95, 100, 105, and a butterfly call spread at strikes 90, 97.5, 105. Which of the following statements is valid?
-A condor is worth more than the butterfly spread irrespective of the level of the stock price. -The condor pays off at least as much as the butterfly spread at all possible stock price levels at maturity. Therefore, it will always be worth more irrespective of what the current stock price might be.
Suppose your portfolio consists of one share of Goldman Sachs (GS) and a European put option on GS with a strike of $105 and a maturity of a year. At maturity, the value of your portfolio must be
-Equal to or greater than $105 -This is a protective put position
You hold the following portfolio: a long position in a European call option on gold with a strike of $975 per oz, a short position in a European put option on gold with a strike of $975 per oz, and a short forward position in gold with a delivery price of $1,000 per oz. All three contracts expire in one month. The value of your position is
-Positive -The combined portfolio results in a guaranteed payoff of $25 after one month, so its value today must be positive
Consider a position in a long straddle at strike 90 and a short straddle at strike 100, both for the same maturity. which of the following properties is valid for this position?
-The payoff is increasing in the stock price. -The portfolio is which is the same thing as being long a 90/100 call bull spread and long a 90/100 put bull spread. Both spreads are bullish, so the combined position is also bullish.
There are three- and six-month American calls on stock. Suppose the three-month option costs $5 and the six-month option costs $3. Which of the following statements is most accurate given this information?
-There is an arbitrage strategy which involves buying the six-month call and selling the three-month call. -American calls must be non-decreasing in price with maturity. Else one can buy the long-dated call, sell the short-dated call, and exercise the long-dated call whenever the short-dated one is exercised.
All of the following are reasons why the Fed didn't take action to rescue insolvent banks, except:
. Many Fed officials believe that taking such action was poor policy. Your answer is not correct. B. Some Fed officials believed they were barred from lending to insolvent banks. C.answer Some Fed officials didn't think the problem was as bad as it was. This is the correct answer. D. Moral hazard.
For each of the following events, is the immediate problem of a typical bank most likely to be illiquidity or insolvency: 1) The government closes the FDIC and there is no longer deposit insurance. 2) The economy goes into a recession. 3) The central bank doubles the required reserve requirements.
1) Illiquidity 2) Insolvency 3) Illiquidity
Which of the following are advantages of pegging?
1) Protection for firms that have taken out loans in foreign currencies. 2) A check against inflation.
What are the Fed's traditional monetary policy tools?
1) Reserve requirements. 2) Open market operations. 3) Discount policy.
Which of the following is true of quantitative easing (QE)?
1) The Fed increases the supply of reserves beyond the level needed maintain its target federal funds rate. 2) It is a useful tool when the target federal funds rate is near zero.
If Europeans become wealthier, what changes should we observe in the dollar-euro market?
1) The demand for dollars will increase. 2) The euro will depreciate relative to the dollar.
What key assumptions does the Gordon growth model make?
1-The required rate of return is greater than the dividend growth rate of the stock. 2-The growth rate of dividends is constant. 3-Investors receive their first dividend immediately rather than at the end of the year.
Suppose that the U.S. firm Alcoa sells $3 million worth of aluminum to a British firm. If the exchange rate is currently $1.72=£1 and the British firm will pay Alcoa £1,744,186.05 in 90 days, answer the following questions. 1. What exchange-rate risk does Alcoa face in this transaction? 2. What alternatives does Alcoa have to hedge this exchange-rate risk? 3.To hedge this exchange-rate risk, Alcoa can sell ________________pounds for dollars at the forward rate to hedge the risk of the pound __________
1. A falling British pound. 2. Alcoa can buy options contracts. Alcoa can enter into a forward contract. Alcoa can sell currency futures. 3. 1,744,186.05, falling
most important derivatives:
1. forward contracts 2. futures contracts 3. options contracts 4. swaps
If the exchange rate between the yen and the dollar changes from ¥74 = $1 to ¥82 = $1, the yen has _________ against the dollar, and the dollar has __________ against the yen.
1. depreciated 2. appreciated
After the United Kingdom's electorate voted on June 23, 2016 to leave the European Union an article in the Wall Street Journal noted: "Credit-default swaps on the debt of Bank of America and Citigroup Inc. are up 25% from a day earlier." Source: John Carney, "Bank Credit Default Swaps Surge on Brexit Fears," Wall Street Journal, June 24, 2016. The increase in the ________ of credit-default swaps on these bonds indicates investors believe the default________ on Bank of America and Citigroup Inc. debt has _________ from the previous day. What likely happened to the yields on those bonds?
1. price 2. risk 3. increased The yield increased as the price of the bonds decreased.
An option writer is the _____________ of an option and he/she has _______________ the underlying asset.
1. seller 2. the obligation to sell
hedging involves taking a ____ position in the futures market to offset a ___ position in the spot market or taking a ____ position in the futures market to offset ____ in the spot market
1. short 2. long 3. long 4. lomg
Consider the following listing for 10-year Treasury note futures on the Chicago Board of Trade. One futures contract for Treasury note=$100,000 face value of 10-year 6% notes. Month Last Chg Open High Low Volume OpenInt Dec '12 108'18.5 0'03.5 108'13.0 108'21.0 108'06.5 564,322 2,380,328 Mar '13 108'07.0 0'05.5 108'00.0 108'05.0 107'26.0 4,325 118,728 Jun '13 107'27.0 0'05.5 107'27.0 107'27.0 107'21.5 2 19 Sep '13 107'21.5 0'05.5 107'21.5 107'21.5 107'21.5 0 0 Dec '13 107'21.5 0'05.5 107'21.5 107'21.5 107'21.5 0 0 If on this day you bought two contracts expiring in December 2012, you would have paid $ ______. (Round your response to the nearest whole number.) The OpenInt on the contract expiring in March 2013 was______.
217156 The last price for the contract in the first row is $108. Thus: 18.5/32 =0.578125 , or $108.578125 per $100 of face value. The futures contracts for U.S. Treasury notes are standardized at a face value of $100,000 of notes, or the equivalent of 1,000 notes of $100 face value each. Therefore, the price of this contract is: $ 108.578125 * 1,000 = $ 108,578.125. So, the price of two contracts is: $ 108,578.125 * 2 = $ 217,156.250. 118728
Now suppose that a customer of National Bank of Guerneville writes a check for $2 million to a real estate broker who deposits the check at Commonwealth. After the check clears, how much in excess reserves does each bank have?
35 (checkable deposits)- 2 = 33 33 x .1 = 3.3 2-3.3 = -1.3 42 + 2 = 44 44 x .1 = 4.4 5 million in reserves + 2 = 7 7-4.4 = 2.6
Suppose that National Bank of Guerneville has $35 million in checkable deposits, Commonwealth Bank has $42 million in checkable deposits, and the required reserve ratio for checkable deposits is 10%. If National Bank of Guerneville has $4 million in reserves and Commonwealth has $5 million in reserves, how much in excess reserves does each bank have? (Enter your answers rounded to one decimal place.)
35 x 0.1 = 3.5 4-3.5 = 0.5 national bank of G had 0.5 in excess reserves 42 x 0.1 - 4.2 5 - 4.2 = 0.8 common wealth bank has 0.8
Suppose that at the beginning of the year, you buy a share of IBM stock for $146. If during the year you receive a dividend of $1.26 and IBM stock is selling for $159 at the end of year, what was your rate of return from investing in the stock? The rate of return is ___________%. (Round your response to two decimal places.)
9.77%
A long position in a eurodollar futures contracts expiring in June may be used to hedge interest-rate exposure resulting from a planned
90-day investment beginning in June
What is the difference between a spot transaction and a forward transaction in the foreign-exchange market?
A spot transaction is trade today, and a forward transaction is trade in the future.
standard of deferred payment
A ______ is a characteristic of money by which it facilitates exchange over time.
unit of account
A ______ is a way of measuring value in an economy in terms of money.
large open economy
A __________ is an economy in which total saving is large enough to affect the world interest rate
small open economy
A ____________ is an economy in which total saving is too small to affect the world real interest rate
closed economy
A ____________ is an economy where households, firms, and governments do not borrow or lend internationally
B. is the process by which depositors who have lost confidence in a bank simultaneously withdraw enough funds to force the bank to close.
A bank run A. occurs when the majority of commercial banks in the country withdraw their reserve funds from the central bank. B. is the process by which depositors who have lost confidence in a bank simultaneously withdraw enough funds to force the bank to close. C. involves a bank increasing its holdings of demand deposits. D. is a reduction of the interest below zero.
What do the authors mean by a "contagion of fear"?
A bank run that is fueled by fear of bank failure.
Which of the following securities is not a derivative?
A bond issued by a BBB-rated corporate firm
What are the two methods that governments typically use to avoid bank panics? (Check all that apply.)
A central bank can act as a lender of last resort. Your answer is correct. C. The government can insure deposits.
C. Technology stocks were rising with the dot-com boom.
A column in the Wall Street Journal mentions the famous billionaire investor "Warren Buffet, who in 1999 and early 2000 was widely derided as 'a dinosaur' and 'out of touch' for his refusal to buy technology stocks." Source: Jason Zweig, "When Does A Bubble Spell Trouble?" Wall Street Journal, January 10, 2014. Why would anyone refer to an investor as out of touch if he wasn't investing in technology stocks in 1999 and early 2000? A. Investor expectations for technology stocks were based on the proven performance of long-term market leaders. B. Technology stocks were overvalued in what is known as a "bubble". C. Technology stocks were rising with the dot-com boom. D. Technology companies were generated huge profits at the time.
A profit from the sale of an investment.
A column in the Wall Street Journal, asks the question: open double quoteAre capital gains so different from earned income that they should be taxed at a different rate?close double quote Source: Scott Sumner and Leonard E. Burman, open double quoteIs It Fair to Tax Capital Gains at Lower Rates Than Earned Income?close double quote Wall Street Journal, March 1, 2015. What is a capital gain?
C. A and B only.
A columnist in the Economist argues that: The past ten years have dealt a series of blows to efficient-market theory, the idea that asset prices accurately reflect all available information. In the late 1990s dotcom companies with no profits and barely any earnings were valued in billions of dollars; and in 2006 investors massively underestimated the risks in bundling together portfolios of American subprime mortgages. Source: Buttonwood, "The Grand Illusion," Economist, May 5, 2009. Explain how the incidents this columnist discusses may be inconsistent with the efficient markets hypothesis. A. Despite the availability of information, investors overvalued the price of tech stocks for an extended period of time, which may indicate that asset prices do not accurately reflect all available information. B. The magnitude of the market's inability to assess value in technology stocks and to assess risk in mortgage-backed securities may indicate that asset prices do not accurately reflect all available information. C. A and B only. D. Neither answer is correct.
Suppose that the U.S. firm Alcoa sells $4 million worth of aluminum to a British firm. If the exchange rate is currently $ 1.84 equals pound 1 and the British firm will pay Alcoa pound2 comma 173 comma 913.04 in 90 days, what exchange risk do they face? What alternatives do they have to exchange change risk?
A falling British pound. Alcoa can enter into a forward contract. Alcoa can buy options contracts. Alcoa can sell currency futures.
Would a farmer buy or sell futures contracts? What would a farmer hope to gain by doing so?
A farmer would sell futures contracts to reduce the risk of agricultural prices falling
Suppose you are short a call and long a put on the S&P 500 index with the same strike and same maturity. Then, you are essentially holding
A short forward on the S&P 500 index
A combination of a long position in a strip and a long position in a strap for the same strike and maturity (and with similar but opposite proportions of calls and puts) is similar to:
A straddle position.
You anticipate a recession with increased stock volatility and greater negative skewness in stock prices. Which of the following option positions would be most consistent with your view?
A strip.
No, exchange rates do not measure the wealth of a country.
A student makes the following observation: It currently takes 80 yen to buy 1 U.S. dollar, which shows that the United States must be a much wealthier country than Japan. But it takes more than 1 U.S. dollar to buy 1 British pound, which shows that Great Britain must be a wealthier country than the United States. Do you agree with the student's reasoning? Why?
No, these indexes are averages of stock prices and indicate the overall performance of the stock market.
A student makes the following observation: "The Dow Jones Industrial Average currently has a value of 13,500, while the S&P 500 has a value of 1,500. Therefore, the prices of the stocks in the DJIA are nine times as high as the price of the stocks in the S&P 500." Is the student's observation correct?
No, these shares were likely traded in the secondary market, so General Electric would not receive any of the money.
A student remarks: "135,000,000 shares of General Electric were sold yesterday on the New York Stock Exchange, at an average price of $25 per share. That means General Electric just received a little over $3.4 billion from investors." Do you agree with the student's analysis?
What difficulties did credit default swaps cause during the financial crisis of 2007-2009?
A. Because credit default swaps were NOT issued against collateralized debt obligations, but should have, (CDOs), owners of those securities experienced severe losses when the price of the underlying security declined in value. B. Those selling credit default swaps undercharged buyers relative to the actual risk involved. Thus, when buyers attempted to collect on payments from the price declines, firms lacked sufficient collateral to meet their obligations and faced possible bankruptcy.
Despite these potential drawbacks, economists and members of Congress overwhelmingly support deposit insurance for all of the following reasons, except:
A. FDIC monitors and addresses risks to deposit insurance funds. B. FDIC limits the effect on the economy when a bank fails. C. answer FDIC protects every dollar a customer has in a bank. This is the correct answer. D. FDIC promotes public confidence in the U.S. financial system.
Which from the following are off-balance-sheet activities? (Check all that apply.)
A. Loan sales. D. Standby letters of credit. E. Trading activities. . F. Loan commitment.
Which of the following is true regarding the bursting of the housing bubble in the U.S. economy?
A. Many financial assets were based on the bet that housing prices would only increase. B. Once housing prices started to fall, the banks that owned mortgaged-backed securities experienced losses. C. Once housing prices started to fall, homeowners realized their mistake and began defaulting on their mortgages.
According to the theory of purchasing power parity, what should happen to the value of the U.S. dollar relative to the Mexican peso if the following occurs? Over the next 10 years, the U.S. experiences an average annual inflation rate of 3%, while Mexico experiences an average annual inflation rate of 8%.
A. The peso depreciates relative to the dollar.
A columnist writing in the Wall Street Journal observed: "Franklin D. Roosevelt's March 1933 inaugural line 'that the only thing we have to fear is fear itself' was inspiring, but wrong. There was plenty to fear, not least the deflation that then gripped the nation". Source: George Melloan, "Rising Global Debt and the Deflation Threat," Wall Street Journal, March 7, 2016. All of the following are reasons why deflation might not be good for consumers, except:
A. it causes higher interest rates. B. it causes nominal wage cuts. C.answer it causes lower interest rates. Your answer is correct. D. it causes a higher burden of debt ratio.
Suppose that the Dow Jones Industrial Average is above the 12,500 level. If the Dow were to fall to 9,500, who would gain the most? A. Investors who had bought put options. B. Investors who had sold call options. C. Investors who had sold put options. D. Investors who had bought call options. Who would be hurt the most? A. Investors who had sold put options. B. Investors who had bought put options. C. Investors who had bought call options. D. Investors who had sold call options.
A. Investors who had bought put options. A. Investors who had sold put options.
The presence of the delivery option in a futures contract means that
All else remaining the same, a futures contract will trade at a lower price than a forward
What services do forward contracts provide in the financial system? (Check all that apply) A. They allow an agreement in the present to exchange a given amount of a commodity or a financial asset at a particular date in the future for a set price. B. They allow firms to delay signing contracts until a commodity or financial asset is actually delivered. C. They allow transactions to be agreed to in the present but to be settled in the future. D. They add additional risk to the market which increases the returns that farmers earn since demand for agricultural products is usually price elastic. E. They give firms and investors an opportunity to hedge the risk on transactions that depend on future prices.
A. They allow an agreement in the present to exchange a given amount of a commodity or a financial asset at a particular date in the future for a set price. C. They allow transactions to be agreed to in the present but to be settled in the future. E. They give firms and investors an opportunity to hedge the risk on transactions that depend on future prices.
All of the following are ways, other than through their effects on aggregate demand, that higher exchange rates can affect the U.S. economy, except: A. increase the prices of imports. B. help U.S. firms that import products for resale. C. reduce the price of imports. D. hurt U.S. exporters.
A. increase the prices of imports.
Two stocks, A and B, have expected returns for one year of and respectively. The stocks have identical prices of $100 each, do not pay dividends, and the one-year risk-free rate of return is 2% in simple terms. The one-year forward prices of the two stocks are:
A; 102; B: 102
A. Day-to-day movements in currencies are driven by the news. B. Day-to-day movements in currencies are driven by short-term economic events. C. Day-to-day movements in currencies can be driven by a large degree of random movements. long-run, long
According to a survey of professional foreign-exchange traders, the theory of purchasing power parity is considered to be "academic jargon." Source: Cheung, Yin-Wong, and Menzie David Chinn, "Currency Traders and Exchange Rate Dynamics: A Survey of the U.S.Market," Journal of International Money and Finance, Volume 20, Issue 4, August 2001, pp. 439-471. Which of the following are reasons why foreign-exchange traders might not find PPP to be useful as they trade currencies day-to-day? (Check all that apply): A. Day-to-day movements in currencies are driven by the news. B. Day-to-day movements in currencies are driven by short-term economic events. C. Day-to-day movements in currencies can be driven by a large degree of random movements. D. Day-to-day movements in currencies are driven by long-term economic events. PPP is a ______ theory that generally only holds over a ______ period of time.
Invest in index funds.
According to an article in the New York Times, "millions of amateur investors continue to actively buy and sell securities regularly." Source: Gary Belsky, "Why We Think We're Better Investors Than We Are," New York Times, March 25, 2016. What alternative strategy might be better for an investor to follow instead of actively buying and selling securities regularly?
leftward, rightward, lower increase, greater, greater
According to an article in the Wall Street Journal in early 2016, "U.S. government bonds maturing in more than 25 years returned a negative 1.2% in the month through Thursday ... after chalking up a 8.7% gain between January and March.... The reversal reflects a shift in financial markets' preoccupation from the prospect of a recession to the risk of higher inflation." Source: Min Zeng, "It Didn't Pay to Bet Against Inflation in April," Wall Street Journal, April 29, 2016. An increase in expected inflation will shift the demand curve _____ and the supply curve _____, resulting in a new equilibrium with a _____ price. An increase in expected inflation will _____ the nominal interest rate on both short-term and long-term bonds. The longer the maturity of a bond, the _____ the change in price as a result of a change in market interest rates. As a result, capital losses on long-term bonds will be _____ than capital losses on short-term bonds.
Aaa
According to an article in the Wall Street Journal, in May 2016, open double quoteSocial Finance Inc., known as SoFi, for the first time received the highest possible credit rating from Moody's on a new bond deal.close double quote Source: Telis Demos and Peter Rudegeair, open double quoteOnline Lender SoFi's Bond Deal Receives Highest Moody's Rating,close double quote Wall Street Journal, May 21, 2016. What is Moody's highest possible credit rating?
appreciate, lower
According to the theory of purchasing power parity, if the inflation rate in Japan is lower than the inflation rate in Canada, what should happen to the exchange rate between the Japanese yen and the Canadian dollar in the long run? In the long run, the Japanese yen will ______ relative to the Canadian dollar because of _____ inflation in Japan.
B. The peso depreciates relative to the dollar.
According to the theory of purchasing power parity, what should happen to the value of the U.S. dollar relative to the Mexican peso if the following occurs? The United States puts quotas and tariffs on many imported goods. nothing. A. The value of the peso does not change relative to the dollar. B. The peso depreciates relative to the dollar. C. The peso appreciates relative to the dollar. D. There is not enough information to answer the question.
The obligation the bond issuer has to pay the bond holder.
According to Moody's, "Obligations rated Aaa are judged to be of the highest quality, with minimal credit risk." Source: Moody's Investors Services, Moody's Rating Symbols and Definitions, September 2012, p.5. What "obligations" is Moody's referring to?
What is the difference between adaptive expectations and rational expectations?
Adaptive expectations assume that investors' expectations are based on past values of a variable, whereas rational expectations assume that investors make forecasts of future values using all available information.
Why does the article describe additional easing as "pushing on a string"?
Additional easing would only create more reserves in the economy and since the "policy rate is effectively zero", those increases would not stimulate additional loans.
What is the difference between moral hazard and adverse selection?
Adverse selection occurs when bad risks are more likely to seek/accept a financial contract than are good risks. Moral hazard occurs in financial markets when borrowers use borrowed funds differently than they would have used their own funds.
"Insurance companies often suspect the only people who buy insurance are the ones most likely to collect." What do economists call the problem being described here?
Adverse selection.
"A bank that expects interest rates to fall will want the duration of its assets to be greater than the duration of its liabilities - a positive duration gap." Do you agree with this statement?
Agree. A fall in interest rates with a positive duration gap will increase a bank's capital.
"Simply put, the Fed must choose between managing the level of reserves and managing rates. It cannot do both." Do you agree?
Agree. In the federal funds market, the federal funds rate is the "price" and reserves are the "quantity". Only one of these variables can be controlled at any one time.
"A bank that expects interest rates to increase in the future will want to hold more rate-sensitive assets and fewer rate-sensitive liabilities." Do you agree with this statement?
Agree. Rate-sensitive assets will increase in value thus holding more of them as assets, while reducing them as liabilities, will increase bank profits.
D. noise trading.
All of the following are concepts from behavioral economics that help us understand how people make choices in financial markets, except: A. overconfidence. B. loss aversion. C. hindsight bias. D. noise trading.
C. Rating agencies charge investors for their services.
All of the following are reasons why investors might be concerned about Moody's rating of these bonds, except: A. Rating agencies charge issuers for their services. B. SoFi chose the agency that rated its bonds. C. Rating agencies charge investors for their services. D. Moody's may have an incentive to give higher ratings than might be justified.
Which option gives the right to sell an asset at any time prior to or at maturity?
American put
A swap is:
An agreement between two or more counterparties to exchange sets of cash flows over some future period.
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.
An anonymous billionaire investor was quoted in the Wall Street Journal as asking: "Has there ever been a carry trade that hasn't ended badly?" What is a carry trade?
That demand was decreasing, causing interest rates to rise.
An article appeared in the New York Times in 2012 under the headline "Spanish Bond Yields Soar." Source: Raphael Minder and Liz Alderman, "Spanish Bond Yields Soar," New York Times, July 23, 2012. What does this headline tell us about the demand for Spanish government bonds?
impossible, existing
An article in the Economist notes that according to the efficient markets hypothesis: "Buying shares in Google because its latest profits were good, or because of a particular pattern in the price charts, was unlikely to deliver an excess return." Source: "What's Wrong with Finance," Economist, May 1, 2015. The efficient market hypothesis states it is ______ to "beat the market" because stock market efficiency causes ______ share prices to always incorporate and reflect all relevant information.
fewer D. Japanese products become more expensive in foreign markets. A. A high yen makes imports less expensive, which could lead to deflationary conditions, boosting the purchasing power of the elderly population.
An article in the New York Times observes that the high value of the yen "is dealing crippling blows to the country's once all-important export machine." The article also observes, though, that "a high yen benefits Japan's rapidly expanding elderly population." Source: Martin Fackler, "Strong Yen Is Dividing Generations in Japan," New York Times, July 31, 2012. A "high yen" means that it takes ______ yen to exchange for one U.S. dollar. How does a high yen hurt Japanese exports? A. Japanese producers would rather sell their products in the domestic market. B. Japan's domestic demand outstrips supply, leading to a decrease in exports. C. Japanese products become less expensive in foreign markets. D. Japanese products become more expensive in foreign markets. How might a high yen help the elderly population in Japan? A. A high yen makes imports less expensive, which could lead to deflationary conditions, boosting the purchasing power of the elderly population. B. The debt of the elderly population is now cheaper to repay. C. A high yen counteracts the inflation that accompanies it, boosting the purchasing power of the elderly population. D. The savings of the elderly population is now worth more.
B. Traditional plans are "defined benefit plans" whereas 401(k) plans are "defined contribution plans."
An article in the New York Times observes that 401(k) plans: have largely supplanted traditional pensions and become the central pillar of America's employer-sponsored retirement system, with 60 million workers participating in them. Source: Steven Greenhouse, "Should the 401(k) Be Reformed or Replaced?" New York Times, September 11, 2012. What are "traditional pension plans," and how do they differ from 401(k) plans? A. Traditional plans grant employees ownership of the funds while 401(k) plans give employers ownership of the funds. B. Traditional plans are "defined benefit plans" whereas 401(k) plans are "defined contribution plans." C. Traditional plans yield a contingent dollar benefit payment while 401(k) plans promise employees a particular dollar benefit payment. D. All of the above. E. A and C only.
C. occurs when house prices move beyond their fundamental values.
An article in the New York Times quoted former Fed Chairman Alan Greenspan as arguing in 2010: "The global house price bubble was a consequence of lower interest rates, but it was long-term interest rates that galvanized home asset prices, not the overnight rates of central banks, as has become the seemingly conventional wisdom." Source: Sewell Chan, "Greenspan Concedes That the Fed Failed to Gauge the Bubble," New York Times, March 18, 2010. A house price bubble A. means that asset prices have increased beyond the point that could be justified by property appraisers. B. means that asset prices have decreased below the point that could be justified by fundamental evaluation. C. occurs when house prices move beyond their fundamental values. D. means that the decline in the housing market caused a decrease not only in spending on residential construction, but also affected markets for furniture and appliances.
D. all of the above
An article in the Wall Street Journal contained the following: "Burberry Group issued a surprise profit warning on Tuesday. . . . The announcement sent Burberry's stock down 21%." Source: Paul Sonne and Peter Evans, "Burberry Sends a Warning," Wall Street Journal, September 12, 2012. Buying stock in a company gives an investor a legal claim on _____. A. a firm's profits B. a firm's equity C. the value of a firm's assets minus the value of its liabilities D. all of the above
Index funds.
An article in the Wall Street Journal described "a sea change in the fund business in which investors are increasingly opting for products that track the market rather than relying on managers to pick winners." Source: Kirsten Grind, "Investors Pour Into Vanguard, Eschewing Stock Pickers," Wall Street Journal, August 21, 2014. Based on the information in the article, which of the following investments are investors increasingly choosing?
C. Efficient markets hypothesis.
An article in the Wall Street Journal in 2016, observed that the price of Apple's stock had started to decline a year before "when fears of an iPhone slowdown surfaced." At the time the article was written, the author claims that, "The iPhone slump is now more than priced in." Source: Dan Gallagher, "Apple Has Upside as Investors Worry," Wall Street Journal, April 24, 2016. Which of the following best explains the author's comment, "The iPhone slump is now more than priced in"? A. Unsystematic risk component of equity premium. B. Equity premium. C. Efficient markets hypothesis. D. Systematic risk component of equity premium.
sells, to, buy
An article in the Wall Street Journal noted that the Fed sets "the lower bound, or a floor under short-term rates, with the interest rate it pays institutions like money-market funds on ... reverse repurchase agreements." Source: Michael S. Derby and Katy Burne, "Fed Bolsters Tool Kit for Lifting Interest Rates,"Wall Street Journal, December 16, 2015. With a reverse repurchase agreement the Fed ___a security ___ a financial firm while at the same time promising to ___ the security back the next day.
buy a set portfolio of stocks, frequently buy and sell individual stocks
An article in the Wall Street Journal says this about Burton Malkiel: "Even before index funds existed, the now-retired Princeton University professor argued that they could outperform actively managed funds....." Source: Silvia Ascarelli, "Burton Malkiel Is Still an Indexing Fan, but a 'Smart Beta' Skeptic," Wall Street Journal, May 8, 2016. Index funds ______, whereas actively managed funds ______ .
Dollar deposits in banks outside the United States.
An article on the web site of the Financial Times describes Eurodollars as "dollars which somehow escaped the US system.close double quote Source: Izabella Kaminska, open double quoteAll about the Eurodollars," ft.com, September 5, 2014. Eurodollars are:
Why is the AD curve downward sloping?
An increase in the price level decreases real money balances, which raises the interest rate. The higher interest rate decreases consumption spending, investment spending, and net exports.
Foreign Exchange Market
An over the counter market where international currencies are traded
3. A derivative security derives its value from an "underlying" security that is
Any other security
According to the theory of purchasing power parity, if the inflation rate in Japan is lower than the inflation rate in Canada, what should happen to the exchange rate between the Japanese yen and the Canadian dollar in the long run? -In the long run, the Japanese yen will _____________ relative to the Canadian dollar because of _____________ inflation in Japan.
Appreciate; lower.
C. Yes, employees must now make informed decisions minus not an easy task.
Are there any reasons why 401(k) plans might be less desirable to employees? A. Yes, these plans invite government intrusion into the employer-employee relationship. B. No, employees are unambiguously better off with these plans. C. Yes, employees must now make informed decisions minus not an easy task. D. A and C are correct.
C. Yes, employers may no longer reap any excess of plan funds.
Are there any reasons why 401(k) plans might be less desirable to employers? A. Yes, these plans invite government intrusion into the employer-employee relationship. B. No, employers are unambiguously better off with these plans. C. Yes, employers may no longer reap any excess of plan funds. D. A and C are correct.
A. Yes. Some would argue that the Bank of United States was not as interconnected as Friedman/Schwartz argue because there is not a lot of evidence that other bank failures were tied to this particular bank's failure.
Are there counterarguments to Rolnick's view? A. Yes. Some would argue that the Bank of United States was not as interconnected as Friedman/Schwartz argue because there is not a lot of evidence that other bank failures were tied to this particular bank's failure. B. No. There are no counterarguments to this view.
A. one of the largest banks at the time, and it failed in December 1930, largely from falling real estate prices.
Arthur Rolnick of the Federal Reserve Bank of Minneapolis has argued that in their account of the failure of the Bank of United States: Friedman and Schwartz provide the rationale for the policy that today is known as "too big to fail"long dashthat there are some institutions that are so big that we can't afford to let them fail because of the systemic impact on the rest of the economy.... They suggest that if the Fed had rescued this bank, the Great Depression might only have been a short, albeit severe, recession. Source: Arthur J. Rolnick, "Interview with Ben S. Bernanke," Federal Reserve Bank of Minneapolis, The Region, June 2004. What was the Bank of United States, when did it fail, and why did it fail? The Bank of United States was A. one of the largest banks at the time, and it failed in December 1930, largely from falling real estate prices. B. labeled by Friedman/Schwartz as too big to fail, but it failed in October 1929 largely from falling T-bills. C. one of the largest banks at the time, and it failed in August 1929 largely from a real estate boom. D. labeled by Friedman/Schwartz as too big to fail, but it failed in October 1929 largely from mortgage defaults.
Why is the demand curve for foreign exchange downward sloping?
As the exchange rate falls, it becomes cheaper to convert a foreign currency into dollars, so there is a larger quantity of dollars demanded.
Using a linear regression of changes in spot asset prices on changes in futures asset prices, the minimum-variance hedge ratio may be obtained
As the slope coefficient in the regression.
Two assets and have the same spot price today. Asset is expected to grow at 10% over the year and asset is expected to grow at 12%. Which of the following is true if there are no holding costs or benefits for either asset?
Asset 's one-year forward price will be equal to that of asset .
Two assets and have the same spot price today. The price of asset is expected to grow at 10% over the next year and that of asset is expected to grow at 10% also. Asset has a standard deviation of returns of 10% over the year and asset has standard deviation of 15%. Which of the following is true if there are no holding costs or benefits?
Asset 's one-year forward price will be equal to that of asset .
Suppose that Lena, who has an account at SunTrust Bank, writes a check for $110 to Jose, who has an account at National City Bank. Use following the T-account for SunTrust Bank to show how it is affected after the check clears. Use following the T-account for National City Bank to show how it is affected after the check clears.
Assets Liabilities Reserves (110) Checkable deposits (110) Assets Liabilities Reserves 110 Checkable deposits 110
describe derivatives
Assets that derive their economic value from an underlying asset, such as a stock or bond, often used to hedge against risk, used to speculate.
The key accounting equation on which balance sheets are based is given by
Assets = Liabilities + Shareholders' Equity.
15/(1.04^3) + 15/(1.04^2) + 15/1.04 = $39.4 million
Assume for simplicity that Scherzer receives his $15 million per year salaries for 2018, 2019, and 2020 at the end of each calendar year. The interest rate for this period of time is 7%. The present value of the salaries he will receive for these three years on January 1, 2018 is approximately______
$92 four years from now
Assume that the interest rate is 13%. What would you prefer to receive?
A. At the interest rate the Fed pays on banks' reserve balances.
At what interest rate does the demand curve for reserves become perfectly elastic? A. At the interest rate the Fed pays on banks' reserve balances. B. At the equilibrium federal funds rate. C. At the discount rate the Fed sets. D. The demand curve for reserves never becomes perfectly elastic.
Which of the following will NOT shift the aggregate demand curve to the right? A. an increase in investment B. an increase in the money supply C. a decline in the price level D. an increase in government expenditures
C. a decline in the price level
In the early to mid-2000s, stock prices and housing prices rose substantially. What effect would these increases in household wealth have on the savings rate? A. The savings rate would not change. B. The savings rate would decrease. C. The savings rate would increase.
B. The savings rate would decrease. Your answer is correct.
Which of the following would shift the aggregate demand curve to the left? A. an increase in the money supply B. an expected decrease in future income C. a cut in federal income taxes D. an increase in the price level
B. an expected decrease in future income Your answer is correct.
Why would low oil prices cause airlines to be "burned"? A. Airlines would be on the hook to sell oil at an above market cost. B. Airlines would be on the hook to buy oil at an above market cost. C. Airlines would be on the hook to buy oil at a below market cost. D. Airlines would be on the hook to sell oil at a below market cost.
B. Airlines would be on the hook to buy oil at an above market cost.
Which of the following is a correctly explained key feature of the financial system? (Check all that apply.) A. Debt contracts usually require collateral or restrictive covenants. The purpose of the collateral is to reduce adverse selection. B. Debt contracts usually require collateral or restrictive covenants. The purpose of the collateral is to reduce moral hazard. C. Loans from financial intermediaries are the most important external source of funds for small- to medium-sized firms. Financial intermediaries can reduce the transaction costs of borrowing for small firms. D. The stock market is a less important source of external funds to corporations than is the bond market. This is because there is less moral hazard involved with bonds than with stocks. E. The bond market is a less important source of external funds to corporations than is the stock market. This is because there is less moral hazard involved with stocks than with bonds. F. Trade credit is the most important external source of funds for small- to medium-sized firms. Trade credit can reduce the transaction costs of borrowing for small firms.
B. Debt contracts usually require collateral or restrictive covenants. The purpose of the collateral is to reduce moral hazard. C. Loans from financial intermediaries are the most important external source of funds for small- to medium-sized firms. Financial intermediaries can reduce the transaction costs of borrowing for small firms. D. The stock market is a less important source of external funds to corporations than is the bond market. This is because there is less moral hazard involved with bonds than with stocks.
if you think interest rates will be lower, you will
BUY as a speculator. Margin account will be debited
Suppose that Bank of America sells $10 million in Treasury bills to PNC Bank. Use T-accounts to show the effect of this transaction on the balance sheet of each bank.
Bank of America Assets Liabilities Reserves $10 mil Securities $−10 mil PNC Bank Assets Liabilities Reserves $−10 mil Securities $10mil
What do the authors mean that "such contagion knows no geographical limits"?
Bank panics may start in an isolated area, but the fear they engender quickly spreads to banks elsewhere.
How do banks manage liquidity risk? (Check all that apply.)
Banks can increase their borrowings to cover liquidity risk. Banks manage this risk by keeping some funds very liquid, such as in the federal funds market. Banks manage this risk by keeping some funds very liquid, such as a reverse repurchase agreement.
How does deposit insurance encourage banks to take on too much risk?
Banks can make riskier investments without worrying about deposit withdrawals because the government has insured depositors against losses.
How do banks manage credit risk?
Banks can manage credit risk by diversifying their assets. B. Banks can manage credit risk by performing credit risk analysis, requiring borrowers to put up collateral, and using credit rationing. C. Banks can manage risk by creating long-term business relationships by which the bank could acquire information about the creditor
decreasing, inversely
Based on the headline above the price of Spanish government bonds were ______ since the price of a bond and its yield are ______ related.
An investor who holds a short call option on IBM stock is implicitly
Bearish on direction and volatility
A history of deposit insurance on the Web site of the FDIC notes that: "Some have argued at different points in time that there have been too few bank failures because of deposit insurance, that it undermines market discipline, ... and that it amounts to a federal subsidy for banking companies." Source: FDIC Bureau of Research and Statistics, "A Brief History of Deposit Insurance in the United States," https://www.fdic.gov/bank/historical/brief/brhist.pdf. What does it mean to describe deposit insurance as undermining "market discipline"? From this perspective, why might there be too few bank failures as the result of deposit insurance?
Because most depositors are fully insured, they have little incentive to withdraw their money and cause their bank to fail. This encourages risk-taking by bank managers as depositors are protected regardless of how the bank actually performs. Rather than let banks fail, the FDIC steps in to minimize the amount of money it will have to pay out.
Do depositors today face similar fears?
Because FDIC insurance did not exist in the early 1930s, depositors today do not face similar fears.
The Fed has expanded its balance sheet since 2008:
Because the Fed was trying to stimulate the economy and maintain financial market stability.
Achieving the goal of price stability with low and steady inflation allows the Fed to achieve other goals, such as stable interest rates and stable foreign exchange rates. If the Fed fails to achieve low and steady inflation, why will it be hard to achieve stable interest rates?
Because the nominal interest rate includes an inflation premium.
If the futures contract used to hedge a spot position is marked-to-market daily, then the minimum-variance hedge ratio formula computed ignoring daily resettlement is, in absolute terms,
Biased upwards.
are not, debt for a firm
Bonds ______ equities because they represent ______.
For a call and a put written on the same underlying but at at possibly different strike prices,
Both call and put options may be in-the-money at the same time.
B
Briefly explain what typically happens to interest rates during a recession A. the demand for bonds increases, while the supply of bonds decreases, resulting in a lower equilibrium interest rate. B. the demand for bonds decreases, while the supply of bonds decreases by a greater magnitude than demand, resulting in a lower equilibrium interest rate C. the demand for bonds increases, while the supply of bonds increases by a greater magnitude of demand, resulting in a higher equilibrium interest rate D. the demand for bonds decreases, while the supply of bonds increases, resulting in a higher equilibrium interest rate
A. The demand for bonds decreases, while the supply of bonds decreases by a greater magnitude than demand, resulting in a lower equilibrium interest rate.
Briefly explain what typically happens to interest rates during a recession. Use a demand and supply graph for bonds to illustrate your answer. A. The demand for bonds decreases, while the supply of bonds decreases by a greater magnitude than demand, resulting in a lower equilibrium interest rate. B. The demand for bonds increases, while the supply of bonds increases by a greater magnitude than demand, resulting in a higher equilibrium interest rate. C. The demand for bonds increases, while the supply of bonds decreases, resulting in a lower equilibrium interest rate. D. The demand for bonds decreases, while the supply of bonds increases, resulting in a higher equilibrium interest rate.
You borrow money at Libor with a floating-rate note for one year with two semi-annual payments. What position do you need to add to this note to fix the cost of borrowing for the entire year?
Buy a 6x12 FRA.
If you believe that stock prices are going to fall for sure, then given a fixed amount of capital, you should
Buy put options.
If you expect stock volatility to rise but have no particular view of direction, then you should
Buy put options.
Which of the following is an example of speculating using financial futures?
Buying Treasury futures expecting future interest rates to be lower than indicated by the current price of Treasury futures.
Which of the following is an example of speculating using commodity futures?
Buying a wheat futures contract expecting the future spot price to exceed the current futures price.
XYZ stock is currently trading at 100. The stock is not expected to pay any dividends over the next three months. A three-month European call option on the stock with a strike of 95 is quoted at 3. Then, an arbitrage can be created by:
Buying the call, selling the stock, and investing the present value of for three months.
How might an investor use excess volatility to earn above-average returns?
By buying stocks when they are below their fundamental values. By selling stocks when they are above their fundamental values.
How might an investor use mean reversion to earn above-average returns?
By buying stocks whose returns have recently been low. By selling stocks whose returns have recently been high.
Mutual funds that follow a "momentum trading" strategy are known on Wall Street as "momos." How might a mutual fund manager use a momentum trading strategy?
By buying when stock prices are rising and selling when prices are falling.
What effect would these increases in household wealth have on consumption spending? A. Consumption spending would decrease. B. Consumption spending would not change. C. Consumption spending would increase.
C. Consumption spending would increase.
How would the increase in stock prices and housing prices have affected aggregate demand? A. The aggregate demand curve would not change. B. The aggregate demand curve would shift leftward. C. The aggregate demand curve would shift rightward.
C. The aggregate demand curve would shift rightward.
The article also noted that: "Speculative investors in oil cut their bullish bets on the price of crude ..." What does the article mean by a "cut their bullish bet"? A. Investors were betting oil futures would not continue to fall. B. Investors were betting oil prices would rise. C. Investors were betting oil prices would not continue to rise. D. Investors were betting oil prices would fall.
C. Investors were betting oil prices would not continue to rise.
An article in the Wall Street Journal on the futures market for oil in the United Kingdom noted that on the day the article was published, "the number of long positions ... fell by 6%." Source: Georgi Kantchev, "Speculative Investors Cut Bullish Crude Oil Price Bets," Wall Street Journal, May 9, 2016. What is a long position in the futures market? A. The right of the buyer to sell the underlying asset on the specified future date. B. The right and obligation of the buyer to sell the underlying asset on the specified future date. C. The right and obligation of the buyer to receive or buy the underlying asset on the specified future date. D. The right of the buyer to receive or buy the underlying asset on the specified future date.
C. The right and obligation of the buyer to receive or buy the underlying asset on the specified future date.
1929, consumer confidence, lack
Christina Romer would argue that the impact of the crash of ______ was more severe because of its effect on ______ as well as the ______ of regulations in place at the time.
bond, use of funds lender, borrower borrower, lender the bond price, the interest rate
Compare the bond market approach to the loanable funds approach by explaining the following for each approach. What the good is In the bond market, the good is the _____ and in the loanable funds market, the good is the _____. Who the buyer is In the bond market, the buyer is the _____ and in the loanable funds market, the buyer is the _____. Who the seller is In the bond market, the seller is the _____ and in the loanable funds market, the seller is the _____. What the price is In the bond market, the price is _____ and in the loanable funds market, the price is _____.
11% Price = Face Value / ((1+i)^2) (sqrt(1000/810)-1)*100% = 11.11%
Consider the case of a two-year discount bond——that is, a bond that pays no coupon and pays its face value after two years rather than one year. Suppose the face value of the bond is $1 comma 000, and the price is $810. What is the bond's yield to maturity? The bond's yield to maturity is _____.
Bond A has a low coupon rate and a lower price. Bond B has a higher coupon rate and a higher price. Because of the bond price formula, if coupon rates fall, the yield will fall, which requires prices to fall to keep the yield the same. If both bonds have the same risk profile, the law of one price brings bond yields to the same level.
Consider the following information on two U.S. Treasury bonds: Maturity Coupon Bid Asked Chg Asked Yield Bond A 2018 Nov 15 3.375 100:26 100:27 +1 2.26 Bond B 2018 Nov 15 4.750 101:29 101:30 +1 2.26 Briefly explain how two securities that have the same yield to maturity can have different prices.
Ignoring convenience yields, the theoretical futures price for a commodity with a positive cost of carry should typically exhibit
Contango.
For commodity forwards and futures, which of the following statements is valid?
Convenience yields may lead to the market being in backwardation.
Yes, financial firms such as Bear Stearns may continue taking on riskier investments because they believe a federal bailout is likely.
Could the actions of the Federal Reserve and Treasury be viewed as a moral hazard problem?
For a futures contract on an asset to be successful compared to the alternative of forward contracts, which of the following features would help?
Counterparty credit risk is high
1. Which class of derivatives have been blamed most widely for causing the financial crisis of 2008?
Credit Derivatives
In what way is a credit swap different from an interest-rate swap?
Credit swaps reduce default risk, or credit risk, rather than interest-rate risk.
Movements in the exchange rate affect all of the following, except: A. net exports. B. aggregate demand. C. aggregate expenditures. D. aggregate supply.
D. aggregate supply.
All of the following are ways, other than through their effects on aggregate demand, that higher exchange rates can affect the U.S. economy, except: A. hurt U.S. exporters. B. help U.S. firms that import products for resale. C. reduce the price of imports. D. increase the prices of imports.
D. increase the prices of imports.
An increase in the price level reduces net exports because A. it leads indirectly to a lower real interest rate. B. it leads directly to higher real money balances. C. it leads indirectly to a lower exchange rate. D. it leads indirectly to a higher exchange rate.
D. it leads indirectly to a higher exchange rate.
Stanley Fischer, vice-chair of the Federal Reserve, remarked that the exchange rate would affect aggregate demand in the United States: "So that is the channel through which the exchange rate will affect our decisions." Source: Ben Leubsdorf, "Fischer Says Fed Officials Will Watch Dollar for Impact on Aggregate Demand," Wall Street Journal, October 9, 2014. The decisions Fischer would likely have been referring to include all of the following, except: A. asset purchases under quantitative easing. B. target range for the federal funds rate. C. monetary policy decisions on interest rates. D. target range for the monetary base.
D. target range for the monetary base.
What difficulties did credit default swaps cause during the financial crisis of 2007dash2009? A. Those selling credit default swaps undercharged buyers relative to the actual risk involved. Thus, when buyers attempted to collect on payments from the price declines, firms lacked sufficient collateral to meet their obligations and faced possible bankruptcy. B. Because credit default swaps were NOT issued against collateralized debt obligations, but should have, (CDOs), owners of those securities experienced severe losses when the price of the underlying security declined in value. C. Credit default swaps were issued against mortgage-backed securities without having sufficient reserves to offset the losses incurred when the housing bubble burst. Thus, when the value of the underlying asset plummeted, firms were liable to the buyers of CDSs. D. A and B are correct. E. All of the above.
D. A and B are correct.
An article in the Wall Street Journal quoted a young investor who works for the social network site LinkedIn who explained that after losing money trading securities linked to crude oil futures prices he was going to "stick to investing in what he knows, like tech." Source: Ben Eisen, Nicole Friedman, and Saumya Vaishampayan, "The New Oil Traders: Moms and Millennials," Wall Street Journal, May 26, 2016. All of the following are reasons why might someone like this investor who has a full-time job would have trouble earning a profit buying and selling oil futures (or other securities linked to the prices of oil futures), except: A. He would need a superior knowledge of how the oil market works. B. He would need to have a better understanding than Wall Street professionals of how news is likely to affect oil prices. C. He would need to follow news about the oil industry carefully. D. His trading costs are higher than those of Wall Street professionals. Is it likely that the investor would have more success buying and selling derivatives or other securities related to tech firms? A. No; few individual investors are able consistently to earn a profit by buying and selling derivatives. B. Yes; everyone is making money in tech derivatives and securities. C. No; he's not a Wall Street professional so he wouldn't have success in the derivatives market. D. Yes; his has a more intimate working knowledge of the tech industry.
D. His trading costs are higher than those of Wall Street professionals. A. No; few individual investors are able consistently to earn a profit by buying and selling derivatives.
How would these investors have cut their bets? A. Buy futures in coal. B. Buy futures in natural gas. C. Take short positions in crude. D. Liquidate their futures contracts.
D. Liquidate their futures contracts.
An article in the Wall Street Journal in 2016 states: "After decades of spending billions of dollars to hedge against rising fuel costs, more airlines, including some of the world's largest, are backing off after getting burned by low oil prices." Source: Susan Carey, "Airlines Pull Back on Hedging Fuel Costs," Wall Street Journal, March 20, 2016. How would airlines hedge against rising fuel costs? A. Take short positions in the futures market. B. Purchase more fuel efficient planes. C. Increase ticket prices. D. Take long positions in the futures market.
D. Take long positions in the futures market.
How does a credit default swap differ from the other swap contracts discussed in this chapter? Credit default swaps are: A. contracts where counterparties agree to swap interest payments over a specified period on a fixed dollar amount. B. contracts in which interest-rate payments are exchanged, with the intention of reducing default risk. C. contracts where counterparties agree to exchange principle amounts denominated in different currencies. D. derivatives requiring sellers to make payments to buyers if the price of the underlying security declines in value.
D. derivatives requiring sellers to make payments to buyers if the price of the underlying security declines in value.
Differences in interest rates on similar bonds in different countries do not always reflect expectations of future changes in exchange rates for several reasons
Differences in default risk and liquidity Transactions costs Exchange-rate risk
"If a bank manager expects interest rates to fall in the future, he should increase the duration of his bank's liabilities." Do you agree with this statement?
Disagree. Higher duration of its liabilities will reduce the value of the bank's capital.
The following appeared in a feature in the New York Times that provides an overview of the Federal Reserve System: "The federal funds rate is set by the Fed's Open Market Committee, composed of the chairman, the six other governors, and five of the 12 regional bank presidents, on a rotating basis." Do you agree that the federal funds rate is set by the FOMC?
Disagree. The federal funds rate is actually determined by the demand for and supply of reserves. The FOMC only sets a target for the federal funds rate.
The ____________ is typically higher than the _____________.
Discount rate; federal funds rate.
A. Because FDIC insurance did not exist in the early 1930s, depositors today do not face similar fears.
Do depositors today face similar fears? A. Because FDIC insurance did not exist in the early 1930s, depositors today do not face similar fears. B. Because TARP insurance did not exist in the early 1930s, depositors today do not face similar fears. C. Depositors face the same fears now as in the early 1930s. D. It is impossible to compare problems depositors face now and those in the early 1930s.
No
Does a bank have to be insolvent to experience a run?
Eurodollar deposits are
Dollar denominated deposits made in banks in Europe
Eurodollars are:
Dollar deposits in banks outside the United States.
Bonds A and B both have a duration of exactly one year. An equally-weighted portfolio of these bonds will have a duration of
Equal to one year because the average duration is still one year.
Suppose that the euro falls in value relative to the dollar. What is the likely effect on European exports to the United States? What is the likely effect on U.S. exports to Europe?
European exports will increase and U.S. exports will decrease .
Suppose that the euro falls in value relative to the dollar. What is the likely effect on European exports to the United States? What is the likely effect on U.S. exports to Europe?
European exports will increase and U.S. exports will decrease .
Suppose that the euro RISES in value relative to the dollar. What is the likely effect on European exports to the United States? What is the likely effect on U.S. exports to Europe?
European exports will decrease and US exports will increase
Suppose that the euro FALLS in value relative to the dollar. What is the likely effect on European exports to the United States? What is the likely effect on U.S. exports to Europe?
European exports will increase and US exports will decrease
is not
Every financial asset ______ a financial security.
Draw a graph of the demand and supply of U.S. dollars in exchange for Japanese yen to illustrate the following situation: The interest rate on one minus year Japanese government bonds rises relative to the interest rate on one minus year U.S. Treasury bills.
Exchange rate supply moves right
Asset purchases _________the Fed"s balance sheet by _________the amount of assets and _____________ liabilities typically through reserve balances.
Expand; increasing; increasing.
In what sense might deposit insurance be considered a federal subsidy for banks?
FDIC insurance is backed by the full faith and credit of the United States government.
Other things being equal, if the Fed makes open market purchases of securities to increase the amount of reserves in the banking system, the federal funds rate is expected to:
Fall.
Suppose you are buying Treasury bonds to finance your child's future college tuition. What risk do you face from price fluctuations?
Falling bond prices
Suppose you are a corn farmer. What risk do you face from price fluctuations?
Falling corn prices.
Suppose you are a corn farmer. What risk do you face from price fluctuations? What would have to be true of a derivatives security if the security were to help you to hedge this risk?
Falling corn prices. The derivative need to go up in value if corn prices fell.
All else the same, when the interest rate rises, the lower bound on a put option
Falls or stays the same.
The FDIC stands for Why was it established?
Federal Deposit Insurance Corporation The FDIC was established to ameliorate bank runs. The FDIC was established in 1934 after a series of bank failures.
The ___________ is the interest rate that banks charge each other on very short-term loans, while the ____________ is the interest rate the Fed charges banks for loans.
Federal funds rate; discount rate.
C. A and B are correct.
Financial journalist David Wessel has described what happened with the Reserve Primary Fund, a money market mutual fund, on September 16, 2008: At 4:15 P.M., the fund issued a press release. The Lehman paper in its portfolio was worthless and the fund's shares were worth not $1, but only 97 cents: breaking the buck. The news triggered a run that spread through the $3.4 trillion [money market mutual fund] industry. Source: David Wessel, In Fed We Trust, New York: Crown Business, 2009, p. 207. What is "Lehman paper"? A. Lehman Brothers debt. B. Lehman Brothers commercial paper. C. A and B are correct. D. Neither A, nor B is correct.
Which of the following might explain why a country without a strong financial system would struggle to achieve high rates of economic growth?
Firms are unable to acquire funds they need to expand.
The demand curve shifts to the left and the supply curve shifts to the right.
For each of the following situations, explain whether the demand curve for bonds, the supply curve for bonds, or both would shift. Be sure to indicate whether the curve(s) would shift to the right or to the left. 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%.
Why might bubbles be difficult to identify?
For every overvalued asset, there is always an investor willing to buy the asset at an even higher price. B. Investors may not exhibit rational behavior when purchasing an overvalued stock. C. Poor investor psychology, such as herd behavior, may not allow investors to see an asset as overvalued.
B. The value of a bank's assets is more than the value of its liabilities, so its net worth, or capital, is positive.
Former Federal Reserve Chair Ben Bernanke has observed that; open double quoteEven a bank that is solvent under normal conditions can rarely survive a sustained run.close double quote Source: Ben S. Bernanke, The Courage to Act: The Financial Crisis and Its Aftermath, New York: W.W. Norton, 2015, p. 45. What does Bernanke mean by "solvent under normal conditions"? A. The value of a bank's assets is more than the value of its liabilities, so its net worth, or capital, is negative. B. The value of a bank's assets is more than the value of its liabilities, so its net worth, or capital, is positive. C. The value of a bank's assets is less than the value of its liabilities, so its net worth, or capital, is negative. D. The value of a bank's assets is less than the value of its liabilities, so its net worth, or capital, is positive.
rises above D. All of the above.
Former Federal Reserve Chairman Alan Greenspan once argued that it is very difficult to identify bubbles until after they pop. What is a bubble, and why might they be difficult to identify? A bubble is a situation in which the price of an asset ______ its fundamental value. Why might bubbles be difficult to identify? A. Investors may not exhibit rational behavior when purchasing an overvalued stock. B. For every overvalued asset, there is always an investor willing to buy the asset at an even higher price. C. Poor investor psychology, such as herd behavior, may not allow investors to see an asset as overvalued. D. All of the above.
What are the key differences between foreign-exchange forward contracts and foreign-exchange futures contracts?
Forward contracts are private agreements among traders to exchange any amount of currency on any future date, while futures contracts are traded on exchanges and are standardized, including a stated settlement date. With futures contracts, the exchange rate changes continually as contracts are bought and sold on the exchange, and with forward contracts, the exchange rate is fixed at the time the contract is agreed to.
Why are forward contracts more widely used in the foreign-exchange market than are futures contracts?
Forward contracts are used 10 times more than futures contracts because the counterparty risk between big banks is relatively low , and these banks value the flexibility of the forward contract.
What are the key differences between foreign-exchange forward contracts and foreign-exchange futures contracts? ___contracts are private agreements among traders to exchange any amount of currency on any future date, while ____ contracts are traded on exchanges and are standardized, including a stated settlement dat
Forward, future
What is the difference between a spot transaction and a forward transaction in the foreign-exchange market? A __forward transaction is trade in the future and a __spot transaction is trade today
Forward, spot
The FTSE index is at 5,100. You are short a straddle on the FTSE 100. struck at 5,100 and long a 5,000/5,200 strangle. You are also short a 5,000-5,100-5,200 butterfly. Ceteris paribus, an increase in the level of the FTSE
Has no effect on the value of your portfolio
Consider hedging an exposure with (i) a futures contract, or (ii) an option with a strike price close to the futures price. The hedge with the futures contract
Has no upfront cost
The growth rate of M2 has been more stable than the growth rate of M1.
Has the growth rate of M1 been more or less stable than the growth rate of M2?
The writer of a put option on a stock
Has the obligation but not the right to buy the stock
What is the difference between hedging and speculating?
Hedging serves to reduce risk in financialmarkets, while speculating may increase risk by placing financial bets on assets in an attempt to earn higher profits in the market.
What is the difference between hedging and speculating? ______ serves to reduce risk in financial markets, while ______ may increase risk by placing financial bets on assets in an attempt to earn higher profits in the market. Which of the following is an example of speculating using commodity futures? Which of the following is an example of speculating using financial futures?
Hedging, speculating Buying a wheat futures contract expecting the future spot price to exceed the current futures price. Buying Treasury futures expecting future interest rates to be lower than indicated by the current price of Treasury futures.
An article in the Wall Street Journal quoted a young investor who works for the social network site LinkedIn who explained that after losing money trading securities linked to crude oil futures prices he was going to "stick to investing in what he knows, like tech." Source: Ben Eisen, Nicole Friedman, and Saumya Vaishampayan, "The New Oil Traders: Moms and Millennials," Wall Street Journal, May 26, 2016. All of the following are reasons why might someone like this investor who has a full-time job would have trouble earning a profit buying and selling oil futures (or other securities linked to the prices Is it likely that the investor would have more success buying and selling derivatives or other securities related to tech firms?
His trading costs are higher than those of Wall Street professionals. No; few individual investors are able consistently to earn a profit by buying and selling derivatives.
A. short term in the repo market, the refusal of lenders to renew their repos is akin to a commercial bank's depositors withdrawing funds.
How can an investment bank experience a "run"? Because investment banks borrow A. short term in the repo market, the refusal of lenders to renew their repos is akin to a commercial bank's depositors withdrawing funds. B. from the U.S. Treasury, a "run" can happen to an investment bank if the Treasury allows expenditures to exceed tax revenues. C. short term from commercial banks, they will experience a "run" whenever commercial banks do. D. long term from a variety of lenders, they cannot experience a "run."
B. Banks can make riskier investments without worrying about deposit withdrawals because the government has insured depositors against losses.
How does deposit insurance encourage banks to take on too much risk? A. Deposit insurance encourages banks to increase investments in riskless assets. B. Banks can make riskier investments without worrying about deposit withdrawals because the government has insured depositors against losses. C. With deposit insurance, depositors have more incentive to withdraw their deposits if the managers make reckless investments. D. Banks can make riskier investments because the government has insured banks against losses on their investments.
Interest rates are usually higher on a bond with high information costs.
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 an illiquid bond.
How does the interest rate on an illiquid bond compare with the interest rate on a liquid bond?
D. The differences reflect expected changes in the exchange rate. D. All of the above.
How does the interest-rate parity condition account for differences in interest rates in different countries on similar bonds? A. The differences expected changes in the bond's interest rate. B. The differences unexpected changes in the bond's interest rate. C. The differences expected changes in inflation. D. The differences reflect expected changes in the exchange rate. What are the main reasons that interest-rate parity may not hold exactly? A. Transaction costs. B. Exchange-rate risk. C. Differences in default risk and liquidity. D. All of the above.
D. A and B only.
How might an investor use excess volatility to earn above-average returns? A. By selling stocks when they are above their fundamental values. B. By buying stocks when they are below their fundamental values. C. By repeatedly buying and selling stocks in a short period of time. D. A and B only. E. All of the above.
D. A and B only.
How might an investor use mean reversion to earn above-average returns? A. By selling stocks whose returns have recently been high. B. By buying stocks whose returns have recently been low. C. By buying only blue-chip stocks. D. A and B only.
A. Fed raised the rate it pays on excess reserves and reverse purchase agreements.
How was the Fed able to use its new monetary policy tools to increase the federal funds rate in December 2015? A. Fed raised the rate it pays on excess reserves and reverse purchase agreements. B. The Fed raised the rate it pays on reverse purchase agreements. C. The Fed established a new federal funds rate. D. The Fed raised the rate it pays on excess reserves.
C. Net expected profitability would fall, so the demand for loanable funds would fall.
How would the following events affect the demand for loanable funds in the United States? Many U.S. cities increase business taxes to help close their budget deficits. A. Net expected profitability would fall, but the demand for loanable fund would rise. B. The demand for loanable funds would remain constant. C. Net expected profitability would fall, so the demand for loanable funds would fall. D. Net expected profitability would rise, so the demand for loanable funds would rise.
The cheapest-to-deliver option
Hurts the holder of the long position in the futures contract.
What did bank depositors have to fear in the early 1930s?
If a bank failed, then depositors would potentially lose all their money.
4.1% rate of return = (51 + (1027.7 - 1036.21) /1036.21 = 4.1%
If another investor had bought the bond a year ago for the amount that was calculated in (b), the total return would have been _____%.
an increase, an increase
If a firm's profits are expected to increase there will be ______ in demand for that firm's stock and therefore _____ in its price.
A. No, the share price already reflects the expected future sales decline.
If iPhone sales continue to decline as investors expect them to, will the decline lead to a further fall in the price of Apple's stock? A. No, the share price already reflects the expected future sales decline. B. Yes, a decline in sales will lead to a decline in profit. C. No, Apple will make up for the decline by selling more Apple Watches. D. Yes, a decline in sales will lead to a price decrease.
The classic account of bank panics was published in 1879 by Walter Bagehot, editor of the Economist, in his book Lombard Street: "In wild periods of alarm, one failure makes many, and the best way to prevent the derivative failures is to arrest the primary failure which causes them." Source: Walter Bagehot, Lombard Street: A Description of the Money Market, New York: John Wiley, 1999 (first published 1873), p. 51. All of the following are reasons why one bank failure might lead to many bank failures, except: What are the two main ways in which the government can keep one bank failure from leading to a bank panic?
If multiple banks have to sell the same assets, the prices of those assets are likely to rise. A central bank can act as a lender of last resort, and the government can insure deposits.
PPP makes an important prediction about movements in exchange rates in the long run
If one country has a higher inflation rate than anther, the currency of the high inflation country will depreciate relative to the currency of the low inflation country
an increase, an increase
If the Fed uses the federal funds rate as a policy instrument, then increases in the demand for reserves will lead to _____ in the level of reserves. If the Fed uses the level of reserves as a policy instrument, then increases in the demand for reserves will lead to _____ in the federal funds rate.
In what sense is preferred stock more like bonds than like common stock? (Check all that apply)
If the corporation declares bankruptcy preferred stockholders are paid before common stockholders. Your answer is correct. Preferred stockholders get fixed dividend payments while common stockholders receive fluctuating dividend payments.
Yes, investors would have already decreased their demand for this stock causing its price to drop before the announcement was made.
If the decrease in Burberry's profits had not been a surprise, would the effect of the announcement on its stock price have been different?
bad bad, more, good, depreciated less, good
If the exchange rate between the yen and the dollar changes from yen95 = $1 to yen71 = $1, is this good news for Sony? A yen appreciation is ______ news for Sony. This is ______ news for U.S. consumers, as Japanese goods become ______expensive, and ______ news for U.S. firms, as the dollar has ______ against the yen. Because U.S. goods are now ______expensive, this is ______ news for Japanese consumers.
Why might the fund manager expect to earn an above-average return through a momentum strategy?
If the fund manager follows a momentum strategy and buys a stock as the price is increasing and other investors also follow a momentum strategy, then it is likely the stock price will continue to rise.
1/0.18=5.56 simple deposit multiplier = 1/required reserve ratio
If the required reserve ratio is 18%, the value of the simple deposit multiplier is _____.
What is the difference between illiquidity and insolvency?
Illiquidity is when the bank does not have enough cash+reserves needed. Insolvency is when the banks assets is less than the banks capital.
A. two months before the October 1929 stock market crash.
In June 1930, a delegation of businessmen appeared at the White House to urge President Herbert Hoover to propose an economic stimulus package. Hoover told them: "Gentlemen, you have come sixty days too late. The depression is over." Source: Arthur M. Schlesigner, Jr., The Crisis of the Old Order, Boston: Houghton-Mifflin, 1957, p. 331. The Great Depression began A. two months before the October 1929 stock market crash. B. in October 1929. C. two months after the October 1929 stock market crash. D. four months before the October 1929 stock market crash.
A. In the event of a nonbank financial institution run, there is no equivalent of the FDIC. B. Nonbank financial institutions are not required to maintain the equivalent of reserve requirements even though, like traditional banks, they borrow short and lend long.
In a paper written in April 2010, looking back at the financial crisis, former Fed Chair Alan Greenspan argued: At least partly responsible [for the severity of the financial collapse] may have been the failure of risk managers to fully understand the impact of the emergence of shadow banking that increased financial innovation, but as a consequence, also increased the level of risk. The added risk had not been compensated by higher capital. Source: Alan Greenspan, "The Crisis," April 15, 2010, p. 21. How did the emergence of shadow banking increase the risk to the financial system? (Check all that apply.) A. In the event of a nonbank financial institution run, there is no equivalent of the FDIC. B. Nonbank financial institutions are not required to maintain the equivalent of reserve requirements even though, like traditional banks, they borrow short and lend long. C. Nonbank financial institutions are required to maintain the equivalent of reserve requirements. D. Nonbank financial institutions are not required to maintain the equivalent of reserve requirements even though, like traditional banks, they borrow long and lend short.
C. Reserves are so large that banks have little need to borrow reserves from other banks.
In a speech to the Fed conference in Jackson Hole, Wyoming mentioned in the chapter opener, Fed Chair Janet Yellen observed that the financial crisis revealed the Fed's "inability to control the federal funds rate once reserves were no longer relatively scarce." She went on to state that: "To address the challenges posed by the financial crisis ...the Federal Reserve significantly expanded its monetary policy toolkit.... Our current toolkit proved effective last December. In an environment of superabundant reserves, the FOMC raised the effective federal funds rate" Source: Janet L. Yellen, "The Federal Reserve's Monetary Policy Toolkit: Past, Present, and Future,"Remarks at "Designing Resilient Monetary Policy Frameworks for the Future" a symposium sponsored by the Federal Reserve Bank of Kansas City, Jackson Hole, Wyoming, August 26, 2016. What does Yellen mean by saying that "reserves were no longer relatively scarce"? A. Reserves are so large that banks can easily increase their lending activities. B. Reserves are so large that banks can easily borrow reserves from other banks. C. Reserves are so large that banks have little need to borrow reserves from other banks. D. Reserves are so large that banks have little need to increase the level of their depository accounts.
What trade-offs does the Fed face, particularly in the short run, in attempting to reach its goals?
In attempting to reach high economic growth or high employment, the Fed would pursue expansionary monetary policy, but this policy could cause higher inflation.
A. A bank run that is fueled by fear of bank failure.
In describing the bank panic that occurred in the fall of 1930, Milton Friedman and Anna Schwartz wrote: A contagion of fear spread among depositors, starting from the agricultural areas, which had experienced the heaviest impact of bank failures in the twenties. But such contagion knows no geographical limits. Source: Milton Friedman and Anna Schwartz, A Monetary History of the United States, 1867-1960, Princeton, NJ: Princeton University Press, 1963, p. 308. What do the authors mean by a "contagion of fear"? A. A bank run that is fueled by fear of bank failure. B. The fear of bad weather, which causes an increase in the prices of agricultural goods. C. The bankruptcy of depositors. D. A recession.
A. credit unions
In discussing the 2007-2009 financial crisis, Federal Reserve Vice Chair Stanley Fischer observed that: "The fact that losses in what was a relatively small part of the mortgage market quickly spread through the rest of the financial system illustrates how the complex interconnections among banks and nonbanks can amplify shocks in significant and unanticipated ways." Source: Stanley Fischer, "The Importance of the Nonbank Financial Sector," remarks at a conference on "Debt and Financial Stability--Regulatory Challenges" sponsored by the Bundesbank and the German Ministry of Finance, March 27, 2015. All of the following are considered "nonbanks," except: A. credit unions B. investment banks C. mutual funds D. hedge funds
B. No. Because of deflation, real rates were high.
In the context of the early 1930s, were low nominal interest rates a good indicator that policy was easy? A. Yes. Because of inflation, real rates were low. B. No. Because of deflation, real rates were high. C. Yes. Because of deflation, real rates were low. D. No. Because of inflation, real rates were high.
[Related to the Chapter Opener] In a paper written in April 2010, looking back at the financial crisis, former Fed Chair Alan Greenspan argued: At least partly responsible [for the severity of the financial collapse] may have been the failure of risk managers to fully understand the impact of the emergence of shadow banking that increased financial innovation, but as a consequence, also increased the level of risk. The added risk had not been compensated by higher capital. Source: Alan Greenspan, "The Crisis," April 15, 2010, p. 21. How did the emergence of shadow banking increase the risk to the financial system? (Check all that apply.)
In the event of a nonbank financial institution run, there is no equivalent of the FDIC. Your answer is correct. C. Nonbank financial institutions are not required to maintain the equivalent of reserve requirements even though, like traditional banks, they borrow short and lend long.
Is PPP a theory of exchange rate determination in the long run or in the short run?
In the long run.
According to the theory of purchasing power parity, if the inflation rate in Japan is lower than the inflation rate in Canada, what should happen to the exchange rate between the Japanese yen and the Canadian dollar in the long run?
In the long run, the Japanese yen will appreciate relative to the Canadian dollar because of lower inflation in Japan.
A. A recession that includes a financial crisis is generally more complex and has more severe consequences comma such as increasing asset prices and lending comma which affects the economy for a longer time period than a traditional recession.
In their book This Time Is Different, Carmen Reinhart and Kenneth Rogoff conclude: "An examination of the aftermath of severe postwar financial crises shows that they have had a deep and lasting effect on asset prices, output, and employment." Source: Carmen M. Reinhart and Kenneth S. Rogoff, This Time Is Different: Eight Centuries of Financial Folly, Princeton, NJ: Princeton University Press, 2009, p. 248. Why should a recession connected with a financial crisis be more severe than a recession that did not involve a financial crisis? A. A recession that includes a financial crisis is generally more complex and has more severe consequences comma such as increasing asset prices and lending comma which affects the economy for a longer time period than a traditional recession. B. When financial institutions fail comma credit markets can be damaged comma and the amount of borrowing comma and hence economic activity comma can decrease comma further affecting real output. C. Both A and B are correct. D. None of the above. A recession connected with a financial crisis will be less severe than a recession that did not involve a financial crisis.
The higher the risk that an asset has, the lower the demand for the asset. This raises the yield or return if the asset performs well. Low-risk assets have a high demand, which lowers their yield or return.
In what sense do investors face a trade-off between risk and return?
A. The higher the risk that an asset has, the lower the demand for the asset. This raises the yield or return if the asset performs well. Low-risk assets have a high demand, which lowers their yield or return.
In what sense do investors face a trade-off between risk and return? A. The higher the risk that an asset has, the lower the demand for the asset. This raises the yield or return if the asset performs well. Low-risk assets have a high demand, which lowers their yield or return. B.The lower the risk that an asset has, the lower the demand for the asset. This raises the yield or return if the asset performs well. High-risk assets have a high demand, which lowers their yield or return. C. The higher the risk that an asset has, the higher the demand for the asset. This raises the yield or return if the asset performs well. Low-risk assets have a lower demand, which lowers their yield or return. D. If an investor acquires enough accurate information, there should be no trade-off involved.
Capital gains are taxed at a lower rate than salary and wage income.
In what way are capital gains taxed differently than salary and wage income?
A. They both borrow short and lend long.
In what ways are investment institutions similar to commercial banks? A. They both borrow short and lend long. B. They both provide monetary policies. C. They both offer traditional banking activities, such as taking deposits and making loans. D. They are completely different financial organizations.
C. Investment institutions are different from commercial banks because they do not engage in traditional commercial banking activities, such as taking deposits and making loans.
In what ways are they different? A. Commercial banks are different from investment institutions because they do not offer short-term assets to borrow short and thus are unable to lend long. B. Investment institutions are different from commercial banks because they do not research the financial markets as commercial banks do. C. Investment institutions are different from commercial banks because they do not engage in traditional commercial banking activities, such as taking deposits and making loans. D. There are no differences between investment institutions and commercial banks.
D. All of the above are correct.
In what ways does the shadow banking system differ from the commercial banking system? A. The shadow banking system, unlike the commercial banking system, does not offer traditional banking services such as taking in deposits. B. The commercial banking system, unlike the shadow banking system, is heavily regulated by the government. C. The shadow banking system invests in more risky assets and tends to be highly leveraged than commercial banks. D. All of the above are correct.
A. This Taylor rule federal funds rate target is lower than the Fed's actual target range.
In your calculations, the inflation gap is negative if the current inflation rate is below the target inflation rate. How does the targeted federal funds rate calculated using the Taylor rule compare to the actual federal funds rate of 0% to 0.25%? A. This Taylor rule federal funds rate target is lower than the Fed's actual target range. B. This Taylor rule federal funds rate target is higher than the Fed's actual target range. C. This Taylor rule federal funds rate target fits within the Fed's actual target range.
All else the same, when the interest rate rises, the lower bound on a call option
Increases or stays the same.
"Additional easing" occurs when the Fed:
Increases the quantity of money with open market purchases.
How could the Federal Reserve use the interest rate it pays on bank reserves to restrain banks from lending large amounts of excess reserves and increasing the money supply excessively? -By _____________ the interest rate it pays on bank reserves, the Fed can ______________ the level of reserves banks are willing to hold, thereby restraining bank lending and increases in the money supply.
Increasing; increase.
You are hedging a spot position with futures. If the spot asset is more volatile than the corresponding futures, the minimum-variance hedge ratio is
Indeterminate, given the information available
Which of the following statements about index futures is false?
Index futures are rarely shorted because it is very difficult to borrow all the stocks in the index in the correct proportions in order to effect the short.
What is the difference between a direct quotation of an exchange rate and an indirect quotation?
Indirect quotations express exchange rates as units of foreign currency per unit of domesticcurrency, whereas direct quotations are exchange rates as units of domestic currency per unit of foreign currency.
What is the difference between a direct quotation of an exchange rate and an indirect quotation?
Indirect quotations: 10 pesos per dollar Direct quotation: 0.10 dollars per peso If the exchange rate between the yen and the dollar changes from yen88 = $1 to yen80 = $1, the yen has appreciated against the dollar, and the dollar has depreciated against the yen (dollar is worth less yen).
Which of the following does not describe derivatives?
Insurance is required when purchasing derivative securities.
The most widely traded futures are of the following type
Interest Rate
Interest rate on domestic bond = Interest
Interest rate on foreign bond-expected appreciation of the domestic currency
To account for the additional risk or investing in a foreign asset can include a currency premium in the interest rate parity equation:
Interest rate on the domestic bond = interest rate on the foreign bond = expected appreciation of the domestic currency - currency premium
Backwardation becomes more likely when, ceteris paribus,
Interest rates decline
Consider futures on a stock market index. Which of the following scenarios is most likely to increase the futures-spot basis?
Interest rates increase and dividend yields decline.
The tailed hedge ratio becomes lower in comparison to the untailed one when
Interest rates rise and hedge maturity increases.
All of the following are reasons why savers with small amounts to invest rarely make loans directly to individuals or firms, except -Transaction costs associated with these loans are too high. -Information costs associated with these loans are too high. -Interest rates would not be high enough. -They cannot take advantage of economies of scale.
Interest rates would not be high enough.
Suppose the December futures contract is sold, and one day later the Chicago Board of Trade informs you that it has credited funds to your margin account. What happened to interest rates during that day?
Interest rates increased, bond prices decreased, and the value of the contract increased.
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.
2. Which class of derivatives accounts for the largest dollar share in the world market in terms of notional amount outstanding?
Interest-Rate Derivatives
The largest markets for derivatives based on notional outstandings are
Interest-rate derivatives.
The demand curve shifts to the left.
Investors believe that the level of risk in the stock market has declined.
Suppose that the current exchange rate between the yen and the dollar is yen 110=$1 and that the interest rate is 5% on a one-year bond in Japan and 4% on a comparable bond in the United States. According to the interest-rate parity condition, what do investors expect the exchange rate between the yen and the dollar to be in one year?
Investors believe the dollar will appreciate by 1%, which would change the exchange rate to: yen110 x ( 1 + 0.01) = yen 111.1
Suppose that the Dow Jones Industrial Average is above the 12,500 level. If the Dow were to fall to 9,500, who would gain the most?
Investors who had bought put options.
Who would be hurt the most?
Investors who had sold put options.
the corporations will default: interest rates will rise
In 2012, an article in the Wall Street Journal had the headline "As Corporate-Bond Yields Sink, Risks for Investors Rise." Source: Matt Wirz, "As Corporate-Bond Yields Sink, Risks for Investors Rise," Wall Street Journal, August 14, 2012. 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 actual value of the contract is less than $30 million for each year he plays. The longer the time period of future payments, the less the present value of those payments. In this case, although the face value of the contract is $30 million for each year played, because the payments are spread out further into the future, the actual value of those payments is less than $30 million for each year played.
In 2015, the Washington Nationals baseball team signed pitcher Max Scherzer to a contract to play for them for seven years. He would be paid $15 million dollars per year for 14 years——an additional 7 years beyond the end of the time he would be committed to play for the Nationals. The contract was widely reported as being worth $210 million (or $15 million per year times 14 years). One baseball writer argued, though, that "this deal serves as a nice reminder that the payment terms of a deal can have an impact on the actual value of the contract." Which of the following statements best represents the actual value of the contract?
Who would be interested in exchanging yen for dollars?
Japanese companies importing or buying U.S. products.
The Expectations Theory.
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 open double quoteinvestors don't seem to have changed their perception of ... [short-term] interest rates in the future ....close double quote Source: Jon Sindreu, open double quoteAre German Bonds Riding a Bubble?close double quote Wall Street Journal, June 14, 2016. Which of the following theories best explains the scenario described?
R = D<t+1>^e/P<t> + (P<t+1>^e - P<t>)/P<t>
In symbols, write the two components of the rate of return on a stock investment.
The rate of return is equal to the rate of return on the dividend plus the rate of return on the price change from the purchase price.
In words, write the two components of the rate of return on a stock investment.
C. A and B are correct.
Is an investment bank that buys securities with its own capital acting as a financial intermediary? A. An investment bank that buys securities with its own capital is not acting as a financial intermediary. B. By buying securities with its own capital the bank expects to get profit from the yield or the changes in price. C. A and B are correct. D. Neither A, nor B is correct.
Which of the following is a valid completion of the sentence—"An American option ..."?
Is exercisable prior to maturity whereas European options are not.
D. All of the above.
Is it possible that these incidents might have occurred even though the efficient markets hypothesis is correct? A. Rational expectations does not mean perfect foresight. B. It is possible that even with full information investors overestimated the profitability of tech companies. C. It is possible that even with full information investors underestimated the risk of mortgage-backed securities. D. All of the above.
No, a theory is a statement about the world that might possibly be false.
Is the equation of exchange a theory?
The payoff of the FRA has the following property
It is concave in the Libor rate.
When a currency is described as overvalued, this implies:
It is overvalued relative to purchasing power parity.
When the Fed changes the composition of its assets, for example, by selling Treasury securities and using the proceeds to buy mortgage-backed securities:
It leaves the size of the Fed's balance sheet unchanged.
Consider two six-month European calls at strikes 90 and 100. The risk free rate is 2%. Which of the following alternatives best describes the condition that must be met by the difference in prices ?
It must be strictly less than $10.
Was deflation during the early 1930s good or bad for firms?
It was bad because it effectively raised interest rates.
How would these investors have cut their bullish bets?
Liquidate their futures contracts.
You anticipate a three-month borrowing in 6 months' time. To hedge the interest-rate exposure you can go either
Long a 6x9 FRA or short a eurodollar futures contract maturing in 6 months
If you expect the price of a stock to decrease and its volatility to increase, then the most appropriate strategy to use is a
Long put
You go short oil 10 futures contracts on NYMEX when the futures price of oil is $79 a barrel and close out your position three days later at a futures price of $83 a barrel. One futures contract is for 1,000 barrels. Ignoring interest on the margin account, the futures trading has resulted in a
Loss of $40,000
An article in the Wall Street Journal contained the following observation: "Falling interest rates tend to boost bond prices ... but weigh on currencies." Source: James Glynn and James Ramage, "Aussie Dollar Parity Talk Resumes," Wall Street Journal, July 1, 2014. Why do falling interest rates increase bond prices? Falling interest rates would "weigh on currencies" as a decrease in rates will shift the supply curve ____ resulting in a _____ equilibrium exchange rate.
Lower interest rates increase the present value of bonds. right, lower
Why might the managers of a bank want the bank to be highly leveraged?
Managers of the bank make bonuses on quarterly performance of the company and on its stock, which gives them an incentive to take high risks and keep the banks highly leveraged to increase ROE.
I hold a long position in a call option on IBM stock. If the price of IBM goes down and its volatility goes up, then the value of my call option
May increase, decrease, or stay the same.
Aaron Levie, one of the founders of the Internet file-sharing site Box, Inc. explained the difficulty the firm had in raising funds from investors: "...investors had a hard time investing in a company where the founders acted 40, were 19 and looked 12. They thought we'd run off to Disneyland with the funding money." What do economists call the problem Levie encountered?
Moral hazard.
Because U.S. goods are now __________ expensive, this is ___________ new for Japanese consumers.
More; bad.
If the minimum-variance hedge ratio is +1, then which of the following is true?
Neither (a) nor (b) is necessarily true.
Can the economy be in a long-run macroeconomic equilibrium without being in a short-run macroeconomic equilibrium?
No
If the short-run aggregate supply curve shifts, does the long-run aggregate supply curve also have to shift? (Hint: Consider the factors that shift each curve and determine whether these factors also shift the other curve.)
No
Would derivative markets be better off if the only people buying and selling derivative contracts were hedgers?
No, as in all markets, at least two parties are required for each transaction, and speculators help provide liquidity and efficiency in financial markets.
A student makes the following observation: "The Dow Jones Industrial Average currently has a value of 13,500, while the S&P 500 has a value of 1,500. Therefore, the prices of the stocks in the DJIA are nine times as high as the price of the stocks in the S&P 500." Is the student's observation correct?
No, these indexes are averages of stock prices and indicate the overall performance of the stock market.
Would an investor be able to earn an above-average return on her stock investments by selling industrial stocks whenever she saw declines in transportation stocks and buying industrial stocks whenever she saw increases in transportation stocks?
No, this strategy neglects all available information except for past stock prices.
Is a firm likely to have a long position in both the spot market and the futures market?
No, this would imply the firm intends to both buy and sell the same asset in the future.
Is a firm likely to have a long position in both the spot market and the futures market? Hedging involves taking a long position in the futures market to offset a _____ position in the spot market.
No, this would imply the firm intends to both buy and sell the same asset in the future. short
Financial intermediaries take advantage of economies of scale, which refers to the reduction in average cost that results from an increase in the volume of a good or a service produced. If we lived in a world in which everyone was perfectly honest, would the difference in the transactions costs faced by financial intermediaries when they make loans and those faced by small savers when they make loans disappear?
No; while information costs might decrease there are still significant legal and other transaction costs involved in matching savers and borrowers.
What is the difference between the nominal exchange rate and the real exchange rate?
Nominal exchange rates tell you how many, say, euros you will receive in exchange for a U.S. dollar, but they do not tell you how much of another country's goods and services you can buy with that U.S. dollar.
What is the difference between the nominal exchange rate and the real exchange rate?
Nominal exchange rates tell you how many, say, euros you will receive in exchange for a U.S. dollar, but they do not tell you how much of another country's goods and services you can buy with that U.S. dollar. Real includes PPP (purchasing power parity)
The tailed minimum-variance hedge ratio becomes lower in comparison to the untailed one when
Nominal interest rates rise and hedge maturity increases.
When a newspaper article uses the term "the exchange rate," it is typically referring to the ____________ exchange rate.
Nominal.
Three real world complications keep PPP from being a complete explanation of exchange rates
Not all products can be traded internationally Products are differentiated Governments impose barriers to trade
1027.7 P = 51 / 1.041 + 51 / 1.041^2 + 51 / 1.041^3 + 1000 / 1.041^3 = 1027.7
Now suppose that one year has gone by since you bought the bond, and you have received the first coupon payment. The market interest rate on similar bonds is still 4.1%. The price of the bond another investor will be willing to pay is $ _____.
914.96 P = 51/1.1 + 51/1.1^2 + 1000/1.1^2 = 914.96
Now suppose that two years have gone by since you bought the bond and that you have received the first two coupon payments. At this point, the market interest rate on similar bonds unexpectedly rises to 10%. The price of the bond another investor will be willing to pay is $ _____.
writing/selling a put option
OBLIGATION to buy the underlying commodity or financial instrument at the strike price
writing/selling a call option
OBLIGATION to sell the underlying commodity or financial instrument at the strike price
A firm enters into a one-year forward contract to buy refined oil. To hedge itself, the firm simultaneously sells one-year futures contracts on crude oil. In which of the following scenarios might the firm come under cash flows pressure related to these contracts?
Oil prices skyrocket a day after the firm enters the contracts
nominal, without an adjustment
One economic argument for taxing capital gains differently than other income is that investors have to pay taxes on their ______ gain ______ for inflation.
Forward contracts have counterparty risk since _______.
One of the parties may go bankrupt after signing the contract and be unable to fulfill their obligation.
What are the Fed's traditional monetary policy tools?
Open market operations Reserve requirements. Discount policy.
Which of the Fed's traditional monetary policy tools is the most important?
Open market operations.
policy tools, policy instruments, intermediate targets, policy goals
Place the following in sequence, from what the Fed has the most influence on to what the Fed has the least influence on: policy goals, policy tools, policy instruments, intermediate targets. From the most influence to the least influence: _____ , _____, ______, and _____.
The law of one price states that
Portfolios with identical cashflows will have the same price.
An embedded option is one where the security contains features that are option-like. Which of the following is not an example of a security with an embedded option?
Preferred stock.
Write the equation for the Gordon growth model.
Pt = Dt * (1+g)/(re-g)
Gordon's Growth Model:
Pt = Dt x (1+g)/(re - g)
buying a call option
RIGHT to buy the underlying commodity or financial instrument at the strike price
buying a put option
RIGHT to sell the underlying commodity or financial instrument at the strike price
Suppose First National Bank has $260 million in assets and $26 million in equity capital. If First National has a 4% ROA, what is its ROE? (Enter your answer rounded to two decimal places). Now suppose First National's equity capital declines to $13 million, while its assets and ROA are unchanged. What is First National's ROE now? (Enter your answer rounded to two decimal places)
ROE=40% ROE=80%
The most important bank assets are
Real estate loans and U.S. government/agency securities.
How have the types of loans banks make changed over time?
Real estate loans have become a much higher percentage of total loans since 1973, while commercial loans have declined.
If you expect stock volatility to fall but have no particular view of direction, then you should
Sell call options.
Suppose you are a manufacturer of cornbread. What risk do you face from price fluctuations? What would have to be true of a derivatives security if the security were to help you to hedge this risk?
Rising corn prices. The derivative need to go up in value if corn prices rose.
Suppose that the price of Goldman Sachs stock is currently $145 per share. You expect that the firm will pay a dividend of $1.24 per share at the end of the year, at which time you expect that the stock will be selling for $173 per share. If you require a return of 18% to invest in this stock, you ____________ buy the stock.
SHOULD R= [(Det + 1 )/Pt] + [(Pet+1 - Pt)/Pt] ((1.24+1)/145) + ((173-145)/145) = 20% 20% > 18% thus, yes should invest
If the implied repo rate is lower than the borrowing rate and the lending rate for the same maturity, what strategy would you adopt to undertake an arbitrage?
Sell the asset spot, buy it forward, lend at rate .
A short position is the right and obligation of the ____________ the underlying asset on the specified future date.
Seller to deliver.
Using the spot and forward markets to borrow at the implied repo rate entails
Selling the spot asset and buying it forward.
Speculators "liquidate" their positions by _______.
Selling their futures contracts for cash.
Why might the bank's shareholders want the bank to be less highly leveraged?
Shareholders who have invested in the company often want the best return over 10-20 years, and want the bank to take less risk which would typically be associated with less leverage.
You anticipate that volatility will increase sharply and the stock price will fall. Select the most profitable of the following portfolios to hold, given your views:
Short stock and long puts.
When you are short a position in a FRA, you are effectively
Short the three-month zero-coupon bond, and long the six-month zero-coupon bond.
Suppose that the price of Goldman Sachs stock is currently $141 per share. You expect that the firm will pay a dividend of $2.25 per share at the end of the year, at which time you expect that the stock will be selling for $172 per share.If you require a return of 22% to invest in this stock, you _____ buy the stock.
Should
Someone with no connection to an industry that places financial bets on futures contracts within the industry in an attempt to profit from changes in asset prices is called a
Speculator.
The traders the article describes are most likely _______ who had been _______ of coffee futures contracts.
Speculator: buyers.
Quantitative easing is the central bank policy that attempts to:
Stimulate the economy by buying long-term securities.
D. A and B only.
Stocks are called "equities" because: A. ownership of a firm's stock represents a legal claim on the firm's profits. B. ownership of a firm's stock represents partial ownership of the firm. C. owners of a firm's stock are protected by the legal provision of limited liability. D. A and B only. E. all of the above.
Draw Graph Interest rate on one year Japanese Government bond rises relative to the interest rate on one year U treasury build.
Supply Shifts Right
133.33 16/0.12=133.33
Suppose that a company is expected to pay a dividend per share of $16 per year forever. If investors require a rate of return of 12% to invest in this stock, what is its price? The stock price is $______. (Round your response to two decimal places.)
-6.01% rate of return = (51+914.96 - 1027.7)/1027.7 = -6.01%
Suppose that another investor had bought the bond at the price you calculated in (c). The total return would have been negative _____%.
9.51 (1000-913.15)/913.15 = 9.51% nominal interest rate = YTM = (face value - price) / price
Suppose that on January 1, 2018, the price of a one-year Treasury billlong dashwith a face value of $1000long dash is $913.15. Investors expect that the inflation rate will be 8% during 2018, but at the end of the year, the inflation rate turns out to have been 1%. The nominal interest rate on the bill is ___%.
B. A falling British pound. D. All of the above. sell 2,051,282.05, falling
Suppose that the U.S. firm Alcoa sells $4 million worth of aluminum to a British firm. If the exchange rate is currently $ 1.95 equals pound 1 and the British firm will pay Alcoa pound2 comma 051 comma 282.05 in 90 days, answer the following questions. What exchange-rate risk does Alcoa face in this transaction? A. A rising British pound. B. A falling British pound. C. A falling dollar. D. As long as the British firm pays Alcoa, there is no risk. What alternatives does Alcoa have to hedge this exchange-rate risk? A. Alcoa can enter into a forward contract. B. Alcoa can sell currency futures. C. Alcoa can buy options contracts. D. All of the above. To hedge this exchange-rate risk, Alcoa can ______ pounds for dollars at the forward rate to hedge the risk of the pound _____.
a. (270e6/108)*(1/1.07)=2336448.60 b. 270e6/106/1.09=2336853.04 c. D. Both A and B are correct. d. D. Hedges are provided by (a) and (b) but not (c), and Halliburton prefers (a) because it costs less.
Suppose that the U.S. firm Halliburton buys construction equipment from the Japanese firm Komatsu at a price of yen270 million. The equipment is to be delivered to the United States and paid for in one year. The current exchange rate is yen 108 equals $ 1. The current interest rate on one-year U.S. Treasury bills is 9%, and on one-year Japanese government bonds the interest rate is 7%. a. If Halliburton exchanges dollars for yen today and invests the yen in Japan for one year, it will need $______ to exchange today in order to have yen270 million in one year. (Round your response to the nearest dollar.) b. If Halliburton enters a forward contract, agreeing to buy yen270 million in one year at an exchange rate of yen 106 equals $ 1, it will need $______ today if it plans to invest the dollars at the U.S. interest rate of 9%. (Round your response to the nearest dollar.) c. If Halliburton invests today at the U.S. interest rate of 9%, without entering into any other type of contract, does the firm know how many dollars it needs today to fulfill its equipment contract in one year? A. No, it depends on the exchange rate at the end of the contract. B. No, but it takes the risk. C. Yes, it would need $2 comma 336 comma 853. D. Both A and B are correct. d. Which method(s) described in (a) through (c) provide(s) a hedge against exchange-rate risk? Which do(es) not? Which method is Halliburton likely to prefer? A. Hedges are provided by (a) and (c) but not (b), and Halliburton prefers (c) because it costs less. B. A hedge is provided by (a) but not (b) and (c), and thus Halliburton only prefers (a). C. Hedges are provided by (a) and (b) but not (c), and Halliburton prefers (b) because it costs less. D. Hedges are provided by (a) and (b) but not (c), and Halliburton prefers (a) because it costs less.
103.02 102*(1+(7%-6%))=103.02
Suppose that the current exchange rate between the yen and the dollar is yen102=$1 and that the interest rate is 7% on a one-year bond in Japan and 6% on a comparable bond in the United States. According to the interest-rate parity condition, what do investors expect the exchange rate between the yen and the dollar to be in one year? The exchange rate will be yen _____=$1.
1.84/1.06=1.7358 1.7358/1.78=0.9752 1-0.9572=0.248=2.48%
Suppose that the current exchange rate is euro1.84=pound1, but it is expected to be euro1.78=pound1 in one year. If the current interest rate on a one-year government bond in the United Kingdom is 6%, what does the interest-rate parity condition indicate the interest rate will be on a one-year government bond in Germany? Assume that there are no differences in risk, liquidity, taxation, or information costs between the bonds. The German interest rate will be 2.48%.
decrease, increase
Suppose that the euro rises in value relative to the dollar. What is the likely effect on European exports to the United States? What is the likely effect on U.S. exports to Europe? European exports will ______ and U.S. exports will ______.
(3%+4%)/2 = 3.5% (3%+4%+5%)/3 = 4% (3%+4%+5%+3%)/4 = 3.75%
Suppose that the interest rate on a one-year Treasury bill is currently 3% and that investors expect that the interest rates on one-year Treasury bills over the next three years will be 4%, 5%, and 3%. Use the expectations theory to calculate the current interest rates on two-year, three-year, and four-year Treasury notes. The current interest rate on two-year Treasury notes is ______. The current interest rate on three-year Treasury notes is ______. The current interest rate on four-year Treasury notes is ______.
(6%+7%)/2 = 6.5% (6%+7%+8%)/3 = 7% (6%+7%+8%+6%)/4 = 6.75%
Suppose that the interest rate on a one-year Treasury bill is currently 6% and that investors expect that the interest rates on one-year Treasury bills over the next three years will be 7%, 8%, and 6%. Use the expectations theory to calculate the current interest rates on two-year, three-year, and four-year Treasury notes. The current interest rate on two-year Treasury notes is 6.5%. (Round your response to two decimal places.) The current interest rate on three-year Treasury notes is 7%. (Round your response to two decimal places.) The current interest rate on four-year Treasury notes is 6.75%. (Round your response to two decimal places.)
should
Suppose that the price of Goldman Sachs stock is currently $146 per share. You expect that the firm will pay a dividend of $1.54 per share at the end of the year, at which time you expect that the stock will be selling for $159 per share. If you require a return of 8% to invest in this stock, you ______ buy the stock.
1000 P=C/(1+i) + C/((1+i)^2) + C/((1+i)^3) + ... + C/((1+i)^n) + FV/((1+i)^n) P = (0.051*1000) / (1+0.051) + (0.051*1000) / ((1+0.051)^2) + (0.051*1000) / ((1+0.051)^3) + (0.051*1000) / ((1+0.051)^4) + 1000 / ((1+0.051)^4) = 1000
Suppose that you are considering investing in a four-year bond that has a face value of $1 comma 000 and a coupon rate of 5.1%. If the market interest rate on similar bonds is 5.1%, the price of the bond is $ _____. (Round your response to the nearest cent.)
1036 P=C/(1+i) + C/((1+i)^2) + C/((1+i)^3) + ... + C/((1+i)^n) + FV/((1+i)^n) P = (0.051*1000) / (1+0.041) + (0.051*1000) / ((1+0.041)^2) + (0.051*1000) / ((1+0.041)^3) + (0.051*1000) / ((1+0.041)^4) + 1000 / ((1+0.041)^4) = 1036
Suppose that you purchase the bond, and the next day the market interest rate on similar bonds falls to 4.1%. The price of the bond will be $ _____. (Round your response to the nearest cent.)
53 P= (1+g)*D/(r-g) (1.06)*1.5/0.03=53
Suppose that Coca-Cola is currently paying a dividend of $1.5 per share, the dividend is expected to grow at a rate of 6% per year, and the rate of return investors require to buy Coca-Cola's stock is 9%. Calculate the price per share for Coca-Cola's stock. The price per share of Coca-Cola stock is $______. (Round your response to two decimal places.)
5%, 7.94% 5%/(1-37%) = 7.94%
Suppose that, holding yield constant, investors are indifferent as to whether they hold bonds issued by the federal government or bonds issued by state and local governments (that is, they consider the bonds the same with respect to default risk, information costs, and liquidity). Suppose that state governments have issued perpetuities (or consoles) with $71 coupons and that the federal government has also issued perpetuities with $71 coupons. If the state and federal perpetuities both have after-tax yields of 5%, what are their pre-tax yields? (Assume that the relevant federal income tax rate is 37%.) The pre-tax yield on the state perpetuity will be ______. The pre-tax yield on the federal perpetuity will be ______.
5%, 7.66% 5%/(1-34.77%) = 7.66%
Suppose that, holding yield constant, investors are indifferent as to whether they hold bonds issued by the federal government or bonds issued by state and local governments (that is, they consider the bonds the same with respect to default risk, information costs, and liquidity). Suppose that state governments have issued perpetuities (or consoles) with $81 coupons and that the federal government has also issued perpetuities with $81 coupons. If the state and federal perpetuities both have after-tax yields of 5%, what are their pre-tax yields? (Assume that the relevant federal income tax rate is 34.77%.) The pre-tax yield on the state perpetuity will be ______ The pre-tax yield on the federal perpetuity will b ______
A swap is different from a futures contract because:
Swaps are private agreements between counterparties and its terms are flexible.
ABC Inc. has to borrow money to undertake a seasonal business expansion in six months time. They will need additional working capital funding for six months and wish to hedge themselves against a rise in interest rates in six month's time. They should
Take a long position in a 6×12 FRA.
D. The default risk premium on the AMD bond is higher than on the Aflac bond.
The Aflac bond mentioned in the chapter opener was rated A- by Moody's, while the AMD bond was rated CCC. Based on these ratings, which of the following statements is true? A. The default risk premium on the Aflac bond is higher than on the AMD bond. B. The AMD bond is a safer investment. C. The Aflac bond is a riskier investment. D. The default risk premium on the AMD bond is higher than on the Aflac bond.
Which of the following statements in an FOMC Press Release would be an example of forward guidance?
The Committee expects that economic conditions will evolve in a manner that will warrant only gradual increases in the federal funds rate.
Asset purchases by the Fed occur when:
The Fed buys any type of security from banks, financial institutions, or the public.
How might the Fed have stopped the bank runs during the early 1930s?
The Fed could have lent money to insolvent banks.
Suppose that the current exchange rate is €1.09=£1, but it is expected to be €1.07=£1 in one year. If the current interest rate on a one-year government bond in the United Kingdom is 2%, what does the interest-rate parity condition indicate the interest rate will be on a one-year government bond in Germany? Assume that there are no differences in risk, liquidity, taxation, or information costs between the bonds.
The German interest rate will be 0.17%. 2% + ((1.07-1.09)/1.09) x 100%
Suppose that the current exchange rate is 1.09 euros = 1pound but it is expected to be euro1.07=1 pound in one year. If the current interest rate on a one-year government bond in the United Kingdom is 5%, what does the interest-rate parity condition indicate the interest rate will be on a one-year government bond in Germany? HINT: The interest-rate parity condition states that the interest rate on a domestic bond is equal to the interest rate on a foreign bond minus the expected appreciation of the domestic currency (expressed as the percentage change in the indirect exchange rate).
The German interest rate will be 5% + (1.07 - 1.09)/1.09 x 100% = 3.17%
liquidity premium theory
The ______ holds that interest rates on long-term bonds are averages of the expected interest rates on short-term bonds plus a term premium.
segmented markets theory
The ______ holds that the interest rate on a bond of a particular maturity is determined only by the demand and supply of bonds of that maturity.
expectations theory
The ______ states that interest rates on long-term bonds are an average of the interest rates investors expect on short-term bonds over the lifetime of the long-term bond.
Borrowing at a low interest rate in one currency to lend at a higher interest rate in another currency is sometimes called a "carry trade." An article in the New York Times describes an investment strategy of this type: "A speculative carry trade in which investors borrowed euros at low interest rates to buy the higher-yielding Hungarian currency." -The article notes that the Hungarian currency, the forint, was "buoyed" by this strategy. Why would investors engaging in this carry trade cause an increase in the exchange value of the forint?
The acquisition of assets denominated in the Hungarian currency requires, as a first step, that the Hungarian forint be acquired. This entails an increase in the demand for that currency and thus a rise in its exchange value.
8.51 9.51-1=8.51 actual real interest rate = nominal - actual inflation
The actual real interest rate is ___%
B. increased spending resulted in unmanageable levels of government debt. C. unchecked spending can increase the default risk on government bonds. E. investors worry about whether Spain will be able to pay off its large spending programs without drastic action.
The article states, in part, that Spain is "reaping the bitter harvest of a decade of ambitious and often unchecked spending on infrastructure and services." This observation directly relates to the headline "Spanish Bond Yields Soar" since: (Check all that apply) A. this ambitious spending resulted in significantly greater tax revenues during the recession. B. increased spending resulted in unmanageable levels of government debt. C. unchecked spending can increase the default risk on government bonds. D. spending on infrastructure instead of social programs increases the default risk on government bonds. E. investors worry about whether Spain will be able to pay off its large spending programs without drastic action.
Futures contracts are more likely to be cash-settled when
The asset underlying the contract is too costly to deliver physically
Yes, according to the efficient markets hypothesis, if you could derive an efficient model to forecast stock returns, it is possible to earn infinitely high profits.
The business writer Michael Lewis has quoted Michael Burry, a fund manager, as saying: "I also immediately internalized the idea that no school could teach someone how to be a great investor. If that were true, it'd be the most popular school in the world, with an impossibly high tuition. So it must not be true." Do you agree with Burry's reasoning? Source: Michael Lewis, The Big Short: Inside the Doomsday Machine, New York: W.W. Norton, 2010, p. 35.
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 forward price of an asset that has no holding costs or benefits is equal to
The compounded price of the spot asset, where the compounding takes place at the risk-free rate
4.92% coupon yield = face value * coupon rate bond's current yield = coupon / current price 1000*5.1% / 1036 = 4.92%
The current yield will be ____%. (Round your response to two decimal places.)
How does the interest-rate parity condition account for differences in interest rates in different countries on similar bonds?
The differences reflect expected changes in the exchange rate.
If Americans lose their taste for Mexican-made goods, we should see which of the following changes in the dollar-peso market?
The dollar will appreciate relative to the peso.
duration gap
The duration gap is an accounting term for the difference between the duration of assets and liabilites. The duration gap measures how well cash flows for assets and liabilities are matched. When the duration of assets exceeds the duration of liabilities the duration gap is positive. A positive duration gap means greater exposure to rising interest rates; if interest rates go up then the price of assets fall more than the price of liabilities. Conversely, when the duration of assets is less than the duration of liabilities the duration gap is negative; if interest rates fall then the price of assets goes up less than the price of liabilities. Duration has a double-facet view. While a positive duration gap means greater risk, it also means that, on average, payables became due before receivables.
Ceteris paribus, as interest rates rise, which of these statements is most likely to be true?
The duration of bonds falls.
The supply curve shifts to the right.
The economy experiences a period of rapid growth, with rising corporate profits.
If it is true that investors rely on "animal spirits" rather than expected values when making investments, is the efficient markets hypothesis accurate?
The efficient markets hypothesis assumes people are perfectly rational, whereas animal spirits by definition are people acting irrational. If people act upon animal spirits, then the efficient markets hypothesis might not hold.
Suppose that the current exchange rate between the yen and the dollar is ¥109=$1 and that the interest rate is 4% on a one-year bond in Japan and 3% on a comparable bond in the United States. According to the interest-rate parity condition, what do investors expect the exchange rate between the yen and the dollar to be in one year?
The exchange rate will be ¥110.09=$1. 109 x (1+0.01)
1.51 9.51-8=1.51 expected real interest rate = nominal - expected inflation
The expected real interest rate is ___%
What is the required return on equities?
The expected return necessary to compensate investors for the risk of investing in the stock.
Both the demand and supply curves shift to the left.
The federal government imposes a tax of $10 per bond on bond sales and bond purchases.
The supply curve shifts to the left.
The federal government runs a series of budget surpluses.
6.48% coupon yield = face value * coupon rate bond's current yield = coupon / current price 1000*7.5%/1158=6.48%
The following information from the close of trading on November 24, 2010 is for an IBM bond with a face value of $1 comma 000 and a maturity date of June 15 comma 2013: Coupon rate: 7.5% Price: $1 comma 158 Yield to maturity: 1.22% The bond's current yield was _____%.
If there is a convenience yield, then the following is true of the forward price:
The forward price is lower than it would be with no convenience yield.
Consider that the one-year Euro interest rate is greater than the US one-year interest rate. How does the one-year forward exchange rate (USD per EUR) compare to the spot exchange rate (USD per EUR)?
The forward rate is smaller than the spot rate
Law of one price
The fundamental economic idea that identical products should sell for the same price everywhere
Counterparty risk in a futures contract is lower than in a forward contract because
The futures exchange bears the counterparty risk.
When a counterparty to a futures contract fails to perform under the contract,
The futures exchange bears the loss,
The following is not a point of difference between futures and forwards
The futures payoff depends on the spot price of the asset at contract maturity
The volatility of a stock index falls sharply, the index drops in value, and its expected return increases. Assuming all else (dividend yield, interest rates, etc.) are constant, which of the following is true?
The futures price decreases because of the drop in the level of the index.
The convexity bias between FRAs and eurodollar futures implies that
The futures results in greater cash inflows or lower cash outflows than the FRA.
D. The increase in the expected after-tax real interest rate would reduce the demand for loanable funds.
The government eliminates the tax deduction for interest homeowners pay on mortgage loans. A. The demand for loanable funds would remain constant. B. An individual's desire to earn more due to changes in the interest rate would increase the demand for loanable funds. C. The increase in the expected after-tax real interest rate would increase the demand for loanable funds. D. The increase in the expected after-tax real interest rate would reduce the demand for loanable funds.
Financial crisis typically results in a recession for all of the following reasons EXCEPT?
The government is unwilling to intervene during a financial crisis.
Which of the following statements is true of an option's payoff?
The gross payoff can be greater or less than than the net payoff
In a covered call strategy:
The gross payoff is smaller than the net payoff.
Why is the demand for real money balances downward sloping?
The higher the interest rate on short-term assets, the more households and firms give up when they hold large money balances.
A
The higher the price of bonds, the greater the quantity of bonds demanded A. false-- the higher the price of bonds the lower the quantity of bonds demanded B. false-- the price of bonds does not influence the quantity of bonds demanded C. true -- the higher the price of bonds, the higher the interest paid on the bonds is and therefore the greater the quantity of bonds demanded. D. true -- the higher the price of bonds, the higher their future value and therefore the greater the quantity of bonds demanded
What is the efficient markets hypothesis?
The hypothesis that the equilibrium price of a stock is equal to its fundamental value. The application of rational expectations to financial markets. The assumption that stock prices are not predictable and follow a random walk.
The tailed hedge ratio (which takes into account daily resettlement of the futures contract) is smaller than the untailed one in absolute value. Which of these statements is true in relation to this mathematical fact?
The interest earned or lost on the daily mark-to-market gains and losses increases the volatility of the changes in value of the hedging futures position, thereby reducing the hedge ratio.
Rolling over short-dated futures contracts is the same as taking one long-dated futures contract if
The interest rates are constant
How is it related to the theory of purchasing power parity (PPP)? (law of one price)
The law of one price is the basis for PPP.
C. identical products should sell for the same price everywhere. B. The law of one price is the basis for PPP.
The law of one price states that: A. arbitrage profits are always possible with identical products. B. all products should sell for the same price everywhere. C. identical products should sell for the same price everywhere. D. similar (yet differentiated) products should sell for the same price everywhere. How is it related to the theory of purchasing power parity (PPP)? A. As the law of one price states that identical products should sell for the same price, PPP predicts that in the long run, the purchasing power of one unit of a currency should be the same in another country. B. The law of one price is the basis for PPP. C. As the law of one price states that identical products should sell for the same price, PPP predicts that in the short run only, the purchasing power of one unit of a currency should be the same in another country. D. Both A and B are correct. E. Both A and C are correct.
It is now November, and you sell 40,000 bushels of wheat at the spot price of $2.86 per bushel. If the futures price is $3.11 and you settle your position in the futures market, what was your gain or loss on your futures market position?
The loss on your futures market position was $4,000. (Enter your response as an integer.) The gain on your spot market position was $4,000. (Enter your response as an integer.) Therefore, you were successful in completely hedging your risk from price fluctuations in the wheat market. to calculate gain/loss: Profit (loss) = contracts value in september - contracts value in november
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 ______.
What does it mean to describe the foreign-exchange market as an "over-the-counter market"?
The market consists of market makers linked together by computers.
A "stack-and-roll" strategy makes profits from the "roll" part when
The market is in backwardation
Which of the following statements is TRUE?
The maximum possible loss to the seller of a call option is unlimited
A price tick is
The minimum amount by which the price can move
Which of the following statements is true when comparing the payoffs at maturity of a long forward contract with a long position in a call option, assuming the strike price of the option is the same as the delivery price in the forward contract?
The minimum payoff of the option exceeds that of the forward contract.
Consider a pair of at-the-money European call and a put options written on the same non-dividend-paying stock with the same maturity. Which of the following statements is most accurate?
The minimum price of the call is at least as much as that of the put.
If changes in spot and futures prices are uncorrelated, then
The minimum variance hedge ratio is zero.
If the minimum-variance hedge ratio is , then which of the following statements is true?
The minimum-variance hedge for a long spot exposure is a short futures exposure of the same size
You are hedging a spot position with futures. If the spot asset is less volatile than the futures, and there is basis risk, which of the following is surely false:
The minimum-variance hedge ratio is greater than 1
What are real money balances? (Check all that apply.)
The money supply adjusted for inflation. The money supply, such as M1, divided by the price level.
A month ago, the price of an IBM stock was $110 and its volatility was 28%. Today, its price is still $110 but its volatility has gone up to 40%. If the one-month interest rate has not changed over the last month and IBM stock does not pay any dividends (i.e., there are no costs or benefits of carry,) then
The one-month forward prices of IBM today equals the one-month forward price a month ago
Which of the following statements about forwards is false?
The payoff at maturity from a long forward contract is always non-negative (either positive or zero).
According to the theory of purchasing power parity, what should happen to the value of the U.S. dollar relative to the Mexican peso if the following occurs? The US enters a period of deflation while Mexico experiences inflation?
The peso depreciates relative to the dollar
A "no-arbitrage restriction" on option prices is the statement that
The price of an option is such that no strategy can be constructed using the option and the underlying that generates arbitrage profits.
Interest-Rate Parity Condition.
The proposition that differences in interest rates on similar bonds in different countries reflect expectations of future changes in exchange rates
increase, more
The publication also notes that hedge funds often use leverage and that: "The use of leverage can turn an otherwise conservative investment into an extremely risky investment." Leverage increases the risk of an investment because although borrowing may ______ the potential return of an investment, in a market downturn a company may owe ______ than the value of the underlying asset.
What do open market operations imply?
The purchase or sale of securities, typically U.S. Treasury securities, in financial markets.
The Fed's purchase of Treasury bills leads to "multiple deposit expansion" because:
The purchase raises the amount of reserves at banks.
Why is the supply curve for foreign exchange upward sloping?
The quantity of dollars supplied will increase as the exchange rate increases.
Suppose that you manage a bank that has made many loans at a fixed interest rate. You are worried that inflation might rise and the value of the loans will decline. Why would an increase in inflation cause the value of your fixed-rate loans to decline?
The real return of fixed-rate loans will be lower.
What key assumptions does the Gordon growth model make? (Check all that apply.)
The required rate of return is greater than the dividend growth rate of the stock. The growth rate of dividends is constant. Investors receive their first dividend immediately rather than at the end of the year.
What is the relationship between the required return on equities and the cost of equity capital?
The required return on equities and the cost of equity capital are the same rate.
Borrowing at a low interest rate in one currency to lend at a higher interest rate in another currency is sometimes called a "carry trade." An article in the New York Times describes an investment strategy of this type: "A speculative carry trade in which investors borrowed euros at low interest rates to buy the higher-yielding Hungarian currency." -Why does the article describe the strategy as speculative? Wouldn't investors be certain to make a profit by following this strategy? Briefly explain.
The strategy is speculative because the future value of the exchange rate between the Hungarian currency and the euro is unknown.
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.
Why did futures markets originate in agricultural markets?
The supply of agricultural products depends on the weather and can be subject to wide price fluctuations.
Why did futures markets originate in agricultural markets? Would a farmer buy or sell futures contracts? What would a farmer hope to gain by doing so? A farmer would _______ futures contracts to reduce the risk of agricultural prices ______. Would General Mills buy or sell futures contracts in wheat? What would General Mills hope to gain by doing so? General Mills would ______ futures contracts in wheat to reduce the risk of prices _______.
The supply of agricultural products depends on the weather and can be subject to wide price fluctuations. sell, falling buy, rising
Suppose you want to hedge a futures contract A with another futures contract B. You calculate the minimum-variance hedge ratio ignoring daily resettlement (for example, by regressing daily changes in Contract A's prices on daily changes in Contract B's prices). Suppose, however, that both contracts are marked-to-market daily. Which of the following statements is always true?
The tailed hedge ratio is equal to the untailed one
The Fed's "policy rate" is:
The target federal funds rate.
interest rates, maturity graph, Treasury yield curve
The term structure of interest rates is the relationship among the _______ on bonds that are otherwise similar but differ in _______. The most common way to analyze the term structure is by using a _____ known as the ______.
Consider two European call options, with maturities three months and six months on the same stock and same strike price. The stock pays dividends in two months time and every quarter thereafter. Which of the following statements is most accurate?
The three-month option may be worth more than the six-month option.
Consider two European put options, with maturities three months and six months on the same stock and same strike price. The stock pays no dividends. Which of the following statements is most accurate?
The three-month option may be worth more than the six-month option.
Consider two American call options, with maturities three months and six months on the same stock and same strike price. The stock pays dividends in two months time and every quarter thereafter. Which of the following statements is most accurate?
The three-month option must be worth less than the six-month option.
7.87% rate of return = (51 + (1027.7 - 1000) ) / 1000 = 7.87%
The total return on the bond was _____%.
-3.4% rate of return = (51 + 914.96 - 1000)/1000 = -3.4%
The total return on the bond was negative _____%.
Commodity forward contracts differ from financial forwards in the following manner:
The underlying asset in a commodity forward is an asset that may be used in production and that gets consumed in the process
Former Federal Reserve Chair Ben Bernanke has observed that; "Even a bank that is solvent under normal conditions can rarely survive a sustained run." Source: Ben S. Bernanke, The Courage to Act: The Financial Crisis and Its Aftermath, New York: W.W. Norton, 2015, p. 45. What does Bernanke mean by "solvent under normal conditions"? What does he mean by a "sustained run"? Why can't a bank by itself survive a sustained run?
The value of a bank's assets is more than the value of its liabilities, so its net worth, or capital, is positive. By "sustained run," Bernanke means a bank run that lasts for a significant period of time. A bank cannot by itself survive a sustained run because it does not have enough reserves to match the deposit withdrawals and its assets are long term and not easily liquidated.
You are long a forward on the S&P 500 index that you entered into two months ago and has a month left to maturity. If the one-month rate of interest increases, then, ceteris paribus,
The value of your forward contract is unaffected since the delivery price on your contract was already locked in two months ago
The FTSE index is at 5,100. You are short a straddle on the FTSE 100 struck at 5,100 and long a 5,000/5,200 strangle. If volatility were to increase
The value of your position would decrease.
If changes in spot and futures prices are perfectly correlated over the horizon of a hedge, then
The variance of cash flows from a hedged position under the minimum-variance hedge ratio is zero
If changes in spot and futures prices have a correlation of , then
The variance of cash flows from a hedged position under the minimum-variance hedge ratio is zero
The level of margining in a futures contract takes as an important input
The volatility of the asset underlying the futures contract.
HW5, Question 7 (do math problem) What is meant by the "OpenInt" on a futures contract?
The volume of contracts outstanding.
What is meant by the "OpenInt" on a futures contract?
The volume of contracts outstanding.
Suppose the duration of a bond portfolio is 2. This means
The weighted-average maturity of the portfolio's cash flows is 2 years
What services do forward contracts provide in the financial system?
They allow an agreement in the present to exchange a given amount of a commodity or a financial asset at a particular date in the future for a set price, allow transactions to be agreed to in the present but to be settled in the future, give firms and investors an opportunity to hedge the risk on transactions that depend on future prices.
Future contracts
They are traded on exchanges, such as the CBOT, and are standardized in terms of quantity and settlement date. The exchange reduced counterparty risk, which in turn reduced default risk
5.1% coupon yield = face value * coupon rate bond's current yield = coupon / current price 1000*5.1% / 1000=5.1%
The bond's current yield is ______%. (Round your response to two decimal places.)
increasing bankruptcies and defaults increasing increased more
The debt-deflation process is the process of ______ that can increase the severity of an economic downturn. The debt-deflation process contributed to the severity of the Great Depression by ______ the real interest rate and the real value of debts, which ______ the burden on borrowers and led to ______ loan defaults.
Explain the effect on the demand for reserves or the supply of reserves of the following Fed policy action: An increase in the discount rate?
This would raise the interest rate at which the supply for reserves becomes horizontal.
What is the primary reason that households and firms demand money?
To facilitate buying and selling.
Why did the Fed use it during the financial crisis of 2007-2009?
To reduce the interest rates on mortgages and other long-term rates.
Direct lending would allow a saver the opportunity to participate in spreading out the risk of lending.
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?
Who would be interested in exchanging dollars for yen?
U.S. companies importing or buying Japanese products.
Real exchange rate formula
US consumer price index / British price index times nominal exchange rate
What is the controversy over China's pegging the value of the yuan? -The value of the yuan is ____________ , making Chinese exports ___________ and imports into China _______________.
Undervalued; cheaper; more expensive.
The sum of the present value of all dividend payments expected to be received into the infinite future time.
What is the fundamental value of a share of stock?
The liquidity of the investment compared with other investments. 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.
What are the determinants of asset demand?
A. To meet their legal obligation to hold required reserves. B. To hold excess reserves to meet their short-term liquidity needs.
What are the reasons banks demand reserves? (Check all that apply.) A. To meet their legal obligation to hold required reserves. B. To hold excess reserves to meet their short-term liquidity needs. C. To make money by earning interest on reserve balances. D. To hold excess reserves to meet their long-term liquidity needs.
A. NASDAQ Composite. B. Dow Jones Industrial Average. C. S&P 500.
What are the three most important stock market indexes? (Check all that apply.) A. NASDAQ Composite. B. Dow Jones Industrial Average. C. S&P 500. D. Standard & Poor's. E. AMERITRADE.
D. All of the above.
What is the efficient markets hypothesis? A. The application of rational expectations to financial markets. B. The hypothesis that the equilibrium price of a stock is equal to its fundamental value. C. The assumption that stock prices are not predictable and follow a random walk. D. All of the above.
B. The government can insure deposits. D. A central bank can act as a lender of last resort.
What are the two methods that governments typically use to avoid bank panics? (Check all that apply.) A. The government can nationalize banks. B. The government can insure deposits. C. The government can increase the refinance rate. D. A central bank can act as a lender of last resort.
Interest income from coupon payments and capital gains from price changes.
What are the two types of income an investor can earn on a bond?
TIPS are Treasury Inflation Protected Securities, which are securities that adjust the interest rate to compensate for inflation. Investors would buy TIPS to hedge against high expected inflation rates.
What are TIPS? Why would investors buy TIPS rather than conventional Treasury bonds?
C. If a bank failed, then depositors would potentially lose all their money.
What did bank depositors have to fear in the early 1930s? A. Depositors had fear of a reduction of interest rates. B. Depositors had fear of the nationalization of commercial banks. C. If a bank failed, then depositors would potentially lose all their money. D. Depositors had fear of hyperinflation.
A. Bank panics may start in an isolated area, but the fear they engender quickly spreads to banks elsewhere.
What do the authors mean that "such contagion knows no geographical limits"? A. Bank panics may start in an isolated area, but the fear they engender quickly spreads to banks elsewhere. B. Bank panics always start in agricultural area banks, then spread to urban area banks. C. Bank panics produce a contagion that spreads from country to country. D. None of the above.
A. increased their capital.
What does Greenspan mean that "the added risk had not been compensated by higher capital"? In order to compensate for the risk, Greenspan believes that nonbank financial institutions should have voluntarily A. increased their capital. B. decreased excess reserves. C. increased the interest rate. D. decreased their debt.
B. Simultaneous withdrawals by a bank's depositors result in the bank closing.
What does he mean by a "sustained run"? Why can't a bank survive a sustained run? A. Simultaneous devaluation of assets result in a bank closing. B. Simultaneous withdrawals by a bank's depositors result in the bank closing. C. The closing of other banks causes a bank to close. D. Simultaneous deposits result in a bank closing.
D. asset prices have increased beyond the point that could be justified by fundamental evaluation.
What does it mean to say that there is a bubble in the housing market? A bubble means that A. asset prices have increased beyond the point that could be justified by property appraisers. B. the decline in the housing market caused not only decreases in spending on residential construction, but also affected markets for furniture and appliances. C. asset prices have decreased below the point that could be justified by fundamental evaluation. D. asset prices have increased beyond the point that could be justified by fundamental evaluation.
B. Breaking the buck occurs when a money market mutual fund's share price falls below $1.00.
What does "breaking the buck" mean? A. Breaking the buck occurs when a money market mutual fund's share price falls below $0.50. B. Breaking the buck occurs when a money market mutual fund's share price falls below $1.00. C. Breaking the buck occurs when a money market mutual fund's share price falls below $1.50. D. Breaking the buck occurs when a money market mutual fund's share price falls below $0.98.
The risk that the bond issuer will fail to make payments of interest or principal.
What does Moody's mean by "credit risk"?
B. The failure of Lehman Brothers marked a turning point in the crisis. C. Many parts of the financial system became frozen, as trading in securitized loans largely stopped.
What effects did the run on Lehman Brothers have on the U.S. economy? (Check all that apply.) A. Large firms had difficulty arranging for even short-term loans, while small firms were able to escape this difficulty. B. The failure of Lehman Brothers marked a turning point in the crisis. C. Many parts of the financial system became frozen, as trading in securitized loans largely stopped. D. The failure of Lehman Brothers had no effect on the U.S. economy.
A. Nominal exchange rates tell you how many, say, euros you will receive in exchange for a U.S. dollar, but they do not tell you how much of another country's goods and services you can buy with that U.S. dollar. nominal
What is the difference between the nominal exchange rate and the real exchange rate? A. Nominal exchange rates tell you how many, say, euros you will receive in exchange for a U.S. dollar, but they do not tell you how much of another country's goods and services you can buy with that U.S. dollar. B. The real exchange rate is the price of one country's currency in terms of another country's currency. C. The nominal exchange rate measures the rate at which goods and services of one country can be exchanged for goods and services of another country. D. All of the above. When a newspaper article uses the term "the exchange rate," it is typically referring to the ______ exchange rate.
A single statistic summarizing a rating agency's view of the bond issuer's likely creditworthiness.
What is a bond rating?
If the price of an asset increases, it is called a capital gain. When the market interest rate increases, the price of the bond falls and you incur a capital loss.
What is a capital gain on a financial security? If you own a bond and market interest rates increase, will you experience a capital gain or a capital loss?
B. A "run" is a rush to withdraw money before everyone else does.
What is a "run"? A. A "run" is a rush to invest money before everyone else does. B. A "run" is a rush to withdraw money before everyone else does. C. A "run" means that investors froze all current investing activities. D. A "run" has no special meaning in the context of mutual funds' performance.
The ability of a bond issuer to make the required payments on its bonds.
What is meant by a bond issuer's creditworthiness?
C
What is meant by the term "risk averse"? A. it refers to investors who prefer risk to safe investment, meaning that risk-averse investors would choose gambling over any form of investment B. it refers to investors who have an aversion to risk, meaning that when choosing between two assets, risk-averse investors would ignore risk and only consider expected return C. it refers to investors who have an aversion to risk, meaning that when choosing between two assets with the same expected returns, risk-averse investors would choose the asset with the lower risk
indirect, direct appreciated, depreciated
What is the difference between a direct quotation of an exchange rate and an indirect quotation? ______ quotations express exchange rates as units of foreign currency per unit of domestic currency, whereas ______ quotations are exchange rates as units of domestic currency per unit of foreign currency. If the exchange rate between the yen and the dollar changes from yen95 = $1 to yen70 = $1, the yen has ______ against the dollar, and the dollar has ______ against the yen.
spot, forward Forward, futures futures, forward low, flexibility
What is the difference between a spot transaction and a forward transaction in the foreign-exchange market? A ______ transaction is trade today, and a ______ transaction is trade in the future. What are the key differences between foreign-exchange forward contracts and foreign-exchange futures contracts?______ contracts are private agreements among traders to exchange any amount of currency on any future date, while______ contracts are traded on exchanges and are standardized, including a stated settlement date. With ______ contracts, the exchange rate changes continually as contracts are bought and sold on the exchange, and with ______ contracts, the exchange rate is fixed at the time the contract is agreed to. Why are forward contracts more widely used in the foreign-exchange market than are futures contracts? Forward contracts are used 10 times more than futures contracts because the counterparty risk between big banks is relatively ______ , and these banks value the ______ of the forward contract.
A stock exchange is a physical location where trading occurs face-to-face, while over-the-counter markets are virtual markets where dealers are linked by computers to buy and sell stocks.
What is the difference between a stock exchange and an over-the-counter market?
B. Adaptive expectations assume that investors' expectations are based on past values of a variable, whereas rational expectations assume that investors make forecasts of future values using all available information.
What is the difference between adaptive expectations and rational expectations? A. Adaptive expectations assume that investors' expectations are based on the future values of a variable, whereas rational expectations assume that investors make forecasts using all available information. B. Adaptive expectations assume that investors' expectations are based on past values of a variable, whereas rational expectations assume that investors make forecasts of future values using all available information. C. Rational expectations assume that investors' expectations are based on past values of a variable, whereas adaptive expectations assume that investors make forecasts of future values using all available information. D. Adaptive expectations assume that investors' expectations are based on one variable, whereas rational expectations assume that investors make forecasts of future values using multiple variables.
Yield to maturity is the return on a bond assuming the bondholder holds the bond for the full maturity. Rate of return is the return over a specific holding period that takes into account not just the coupon rate but the price change.
What is the difference between the yield to maturity on a coupon bond and the rate of return?
1500/(1.14^4) = 888.12
What is the present value of $1,500 to be received in four years if the interest rate is 14%? The present value is _____. (Round your response to the nearest cent.)
P = D<t+1>^e/(1+r<e>) + D<t+2>^e/(1+r<e>)^2 + P<t+2>^e/(1+r<e>)^2
What is the relationship between the price of a financial asset and the payments investors will receive from owning that asset?
A. A collection of nonbank financial institutions that channel money from savers to borrowers.
What is the shadow banking system? A. A collection of nonbank financial institutions that channel money from savers to borrowers. B. A part of the banking system, which is not regulated by law. C. An addition to the commercial banking system, created by the Fed after the financial crisis, in order to reduce banking instability. D. A small system of financial institutions that offer traditional banking services.
D
What is the tax treatment of the coupons on a bond issued by GE? A. the bond is subject to state and local taxes only B. the bond is not subject to federal, state, or local taxes C. the bond is subject to federal tax only D. the bond is subject to federal, state, and local taxes
The bond is subject to federal tax only.
What is the tax treatment of the coupons on a bond issued by the U.S. Treasury?
C
What is the tax treatment of the coupons on a bond issued by the city of Houston? A. the bond is subject to federal, state, and local taxes B. the bond is subject to state and local taxes only C. the bond is not subject to federal, state, or local taxes D. the bond is subject to federal tax only
The bond is not subject to federal, state, or local taxes.
What is the tax treatment of the coupons on a bond issued by the city of Houston?
The bond is subject to federal, state, and local taxes.
What is the tax treatment of the coupons on a bond issued by GE?
The interest rate that equates the present value of future payments of an asset with its current value.
What is the yield to maturity?
B. Congress authorized NOW accounts on which banks can pay interest. D. Banks developed automated transfer of saving accounts, which move checkable deposit balances into higher-interest CDs each night and then back into checkable deposit balances in the morning.
What legislative change and financial innovations occurred after 1979 that changed M1 from representing a pure medium of exchange to also representing a store of value? (Check all that apply.) A. The shadow banking system was created by Congress to compete with traditional banks. B. Congress authorized NOW accounts on which banks can pay interest. C. Banks developed sweep accounts, which move savings deposits of businesses into checkable deposits each morning and then move the funds back into savings deposits at the end of the day. D. Banks developed automated transfer of saving accounts, which move checkable deposit balances into higher-interest CDs each night and then back into checkable deposit balances in the morning.
Economic conditions were more severe after the crash of 1929 even th
What reason might Temin give to support his argument that what happened to the economy following the crash of 1987 is evidence against the crash of 1929 being an important shock to the economy?
Economic conditions were more severe after the crash of 1929 even though the decline in the market in 1987 was twice as large as the decline in the market in 1929.
What reason might Temin give to support his argument that what happened to the economy following the crash of 1987 is evidence against the crash of 1929 being an important shock to the economy?
D. The potential freezing of $1 trillion of positions due to the fund's high leverage posed a systemic risk to the system.
What risks did it pose to the financial system? A. The financial system in most countries is regulated by the government, so no individual firm can disrupt the system's stability. B. The high leverage of a firm posed the risk of decreased equilibrium prices in the given market. C. The high leverage of a firm does not pose any risk to the financial system. D. The potential freezing of $1 trillion of positions due to the fund's high leverage posed a systemic risk to the system.
B. Leverage is a double-edged sword: it can increase profits, but it can also magnify losses.
What risks did Long-Term Capital Management's high leverage pose to the firm? A. High leverage increases the moral hazard problem to the firm. B. Leverage is a double-edged sword: it can increase profits, but it can also magnify losses. C. Leverage increases the interest-rate risk to the firm. D. High leverage does not pose any risk to the firm.
B. Bank panics exacerbated the effects of the Great Depression by reducing the ability for people to safely store their money comma which further reduced economic activity.
What role did the bank panics of the early 1930s play in explaining the severity of the Great Depression? A. Bank panics aggravated the effects of the Great Depression by making residential and commercial loans easier to get comma which further reduced economic activity. B. Bank panics exacerbated the effects of the Great Depression by reducing the ability for people to safely store their money comma which further reduced economic activity. C. Bank panics of the early 1930s did not play any role in explaining the severity of the Great Depression. D. Both A and B are correct.
$55 one year from now
What would you prefer to receive if the interest rate is 26%?
If others were unwilling to accept a dollar bill or a check as a means of payment.
What factors, if changed, would affect your willingness to accept a dollar bill or a check as money?
C
When are economists most likely to use the bond market approach to analyze changes in interest rates? when are economists most likely to use the loanable funds approach? A. both models are used to identify the relationship between bond prices and interest rates B. the bond market model is generally a long-term model that focuses on movements in the bond market. the loanable funds model is a medium-term model that focuses on movements in the loan market C. the bond market model is a medium-term model that focuses on movements in the bond market. the loanable funds model is generally a long-term model when discussing global savings and long-term global interest rates D. the bond market model is a medium term-model that focuses on movements in the bond market. the loanable funds model distinguishes the correlation bw the interest rate and the exchange rate
B. The Board of Governors since they control reserve requirements, the discount rate, and hold a majority of the seats on the Federal Open Market Committee.
Which body is more important within the Federal Reserve System, the Board of Governors or the Federal Open Market Committee? A. The Board of Governors since it is made up of the top 7 of the 12 Federal Reserve branch bank presidents who directly control monetary policy in their regions. B. The Board of Governors since they control reserve requirements, the discount rate, and hold a majority of the seats on the Federal Open Market Committee. C. The Federal Open Market Committee since they control reserve requirements, the discount rate, and are independent of any influence from Congress. D. The Federal Open Market Committee since they are the main policy making arm of the Federal Reserve System and took over control of monetary policy from the Board of Governors during the 2007-2009 financial crisis.
Real GDP growth Unemployment rate
Which from the following variables is most likely to be a goal of monetary policy?
Open market purchases, Discount rate
Which from the following variables is most likely to be a monetary policy tool? (Check all that apply.)
M2, Monetary base, M1
Which from the following variables is most likely to be an intermediate target of monetary policy?
Nonborrowed reserves, Federal funds rate
Which from the following variables is most likely to be an operating target of monetary policy?
Direct finance requires financial markets, while indirect finance involves financial intermediaries.
Which involves financial intermediaries, and which involves financial markets?
B. Employees bear the risk of bad investments by the plan. C. Employers are no longer liable for plans being underfunded. D. Employers no longer promise to make a particular benefit payment.
Which of the following are reasons why 401(k) plans might be more desirable to employers than traditional pension plans? (Check all that apply.) A. Employers retain managerial control over the plans. B. Employees bear the risk of bad investments by the plan. C. Employers are no longer liable for plans being underfunded. D. Employers no longer promise to make a particular benefit payment.
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.
Which of the following best describes the effect of a global savings glut?
A. The Fed failed to understand that with deflation, low nominal interest rates did not imply low real interest rates.
Which of the following is a reason that the Federal reserve failed to intervene to stabilize the banking system in the early 1930s? A. The Fed failed to understand that with deflation, low nominal interest rates did not imply low real interest rates. B. The Fed wanted to purge speculative excess, believing that it was necessary for the price level to rise and weak banks and weak firms to fail before a recovery could begin. C. Power within the Federal Reserve was much more unified than today comma making it more difficult for the Fed to act. D. The Fed was reluctant to rescue insolvent banks comma believing that doing so would discourage risky behavior by bank managers (the moral hazard problem).
C. Falling prices of mortgage-backed securities and other housing-related assets led to losses at banks and other intermediaries.
Which of the following is an example of the interconnections among banks and nonbanks he was referring to? A. Customers could transfer money through ACH from banks to nonbanks. B. Banks would purchase short-term commercial paper from non-banks. C. Falling prices of mortgage-backed securities and other housing-related assets led to losses at banks and other intermediaries. D. Banks made money off mortgage-backed securities they purchased as a steep discount.
Stocks
Which of the following is not a debt instrument?
D. All of the above.
Which of the following is true regarding the bursting of the housing bubble in the U.S. economy? A. Once housing prices started to fall, the banks that owned mortgaged-backed securities experienced losses. B. Once housing prices started to fall, homeowners realized their mistake and began defaulting on their mortgages. C. Many financial assets were based on the bet that housing prices would only increase. D. All of the above.
It is extremely difficult to outperform the long-run average return on 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?
An arbitrage opportunity is any situation in which
You can construct a strategy whose cash flows are non-negative at all times with at least one positive cash flow at one or more points in time.
A. Expected inflation increases. C. The expected return on stocks increases. D. Households' wealth decreases.
Which of the following would shift the demand curve for bonds to the left? (Check all correct answers.) A. Expected inflation increases. B. The liquidity of bonds increases. C. The expected return on stocks increases. D. Households' wealth decreases. E. The expected return on bonds relative to other assets increases.
A. Firm's expected profitability increases. B. Government borrowing increases. D. Subsidies to business increase.
Which of the following would shift the supply curve for bonds to the right? (Check all correct answers.) A. Firm's expected profitability increases. B. Government borrowing increases. C. Corporate taxes increase. D. Subsidies to business increase. E. Expected inflation decreases.
B C E
Who are the major credit rating agencies? (check all that apply) A. Dow Jones Industrial Average B. Moody's Investors Service C. Fitch Ratings D. NASDAQ E. Standard & Poor's
B. Fitch Ratings D. Moody's Investors Service E. Standard & Poor's
Who are the major credit rating agencies? (Check all that apply.) A. Dow Jones Industrial Average B. Fitch Ratings C. Nasdaq D. Moody's Investors Service E. Standard & Poor's
increases, goes up
Why does an increase in the federal funds rate decrease the quantity of reserves demanded? As the federal funds rate increases, the opportunity cost to banks of holding excess reserves _____ because the return they could earn from lending out those reserves _____.
Because the coupon rate does not take into account the present value adjusted yield on the purchase price.
Why is the yield to maturity a better measure of the interest rate on a bond than is the coupon rate?
The price is higher than the face value, which lowers the yield to maturity.
Why is the bond's yield to maturity less than its coupon rate?
A. Low nominal interest rates would indicate to the Federal Reserve that it did not need to intervene in the banking system.
Why might Fed officials have believed that low nominal interest rates were a good indicator that policy was easy? A. Low nominal interest rates would indicate to the Federal Reserve that it did not need to intervene in the banking system. B. In the Fed's view comma low nominal interest rates indicated that there was not an adequate supply of excess reserves to beused for losses or loans. C. Both A and B are correct. D. None of the above is correct.
A. Hoover did not foresee the financial panic that would ensue for the next three years, and which would magnify the impact of the recession.
Why might Hoover have reasonably expected that it would have ended by June, 1930? A. Hoover did not foresee the financial panic that would ensue for the next three years, and which would magnify the impact of the recession. B. Hoover did not foresee that hyperinflation would occur and the unemployment rate would remain high. C. Hoover did not have any mathematical models (as we have today) that would have given him an accurate forecast. D. All of the above.
The spot price of gold is $1000 per oz. The one-year risk-free rate is 2% in simple terms. There are no costs or benefits of holding gold. If the one-year forward price of gold is $103, what can you say about the market?
You can make arbitrage profits by selling forward and buying spot
D. A and B only.
Why might a carry trade end badly? A. 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. B. 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. C. Because there is an increased risk of default on high-yield bonds, the price of the investment will decrease, thus eliminating any potential profits from the carry trade. D. A and B only. E. All of the above.
A. Friedman/Schwartz argue that the Bank of United States had so many deposits and was so interconnected to other banks that letting this bank fail caused a cascade of other bank failures.
Why might the Fed's failure to save the Bank of United States provide a rationale for the policy of "too big to fail"? A. Friedman/Schwartz argue that the Bank of United States had so many deposits and was so interconnected to other banks that letting this bank fail caused a cascade of other bank failures. B. According to Friedman/Schwartz, the Fed does not need to help huge banks if they have trouble because no one would be hurt from the failure. C. The Fed's failure to save the Bank of United States does not provide a rationale for the policy of "too big to fail" because the bankruptcy of the Bank of United States was the main cause of the Great Depression. D. The Fed's failure to save the Bank of United States has no connection to the policy of "too big to fail."
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.
Why should a debate over the cause of low interest rates matter to Alan Greenspan?
A. It signaled an unanticipated decline in value of a money market mutual fund's assets.
Why was it significant to the financial system? A. It signaled an unanticipated decline in value of a money market mutual fund's assets. B. It signaled an unanticipated increase of investors' interest to money market mutual funds. C. It signaled an unexpected rise of inflation. D. It signaled an unexpected rise of deflation.
C. Lehman brothers went bankrupt which substantially reduced the value of its commercial paper.
Why was the Lehman paper in the fund's portfolio worthless? A. The value of its commercial paper was underestimated before the financial crisis. B. Lehman brothers was bought by the Fed. C. Lehman brothers went bankrupt which substantially reduced the value of its commercial paper. D. A and C are correct.
C. To lessen the Federal Reserve's responsibility under Greenspan's watch as Chairman for causing, at least partially, the housing bubble with low interest rates.
Why would it matter to Greenspan whether low long-term interest rates were more responsible for the housing bubble than low short-term interest rates? A. Mortgage-backed securities are usually short-term loans. B. Buying a house is linked with short-term borrowings, which were insured by mortgage-backed securities. C. To lessen the Federal Reserve's responsibility under Greenspan's watch as Chairman for causing, at least partially, the housing bubble with low interest rates. D. All of the above.
D. It signals that the firm's assets are less secure than anticipated.
Why would one money market fund having broken the buck cause a run on other money market funds? A. It signals an unexpected rise of deflation. B. It signals an unexpected rise of inflation. C. It signals that the role of government will increase, which will definitely lead to decrease in investors' profit. D. It signals that the firm's assets are less secure than anticipated.
B. Financial institutions would be unlikely to lend elsewhere at a lower rate.
Why would the interest rate the Fed pays on reverse repurchase agreements set a floor under short-term interest rates? A. Financial institutions use the interest rate on reverse purchase agreements to set the rates for institutional loans. B. Financial institutions would be unlikely to lend elsewhere at a lower rate. C. Financial institutions use the interest rate on reverse purchase agreements to set the rates for inter-bank loans. D. Financial institutions are prohibited from lending at rates lower than that set in reverse purchase agreements.
C. M1 became more a store of value than a pure medium of exchange.
Why would this change in M1 break the short-run link between money and inflation? A. M1 became more a world currency than a currency for usage within the country. B. M1 narrowed significantly. C. M1 became more a store of value than a pure medium of exchange. D. M1 became more a medium of exchange than a pure store of value.
C. The average holding of a house is 10 years.
Why would long-term interest rates have a closer connection to house prices than overnight interest rates? A. The Fed can control and change long-term interest rates more easily than short-term interest rates. B. Mortgage companies generally markup mortgages 8 - 10 % above the 10 - year Treasury bond yield. C. The average holding of a house is 10 years. D. Housing purchases are typically short-term investments.
The spot price trades at a bid/ask quote of 100-101 (you can buy at 101 and sell at 100). The one-year forward trades at 99-101.90 (you can buy forward at 101.90 and sell forward at 99). If the simple interest rate for one year is 2%, which of the following statements is most accurate?
You can execute an arbitrage by selling spot, buying forward, and investing the proceeds of the spot sale at 2%.
D. Using the tools the Fed had available would have disrupted the financial system.
Why, with the monetary policy tools it had used prior to the financial crisis, could the Fed not control the federal funds rate? A. Reserves would have needed to be increased by too large an amount. B. Investor and consumer behavior was not conforming to normal patterns. C. The Fed would have needed to conduct a massive open market purchase of government securities. D. Using the tools the Fed had available would have disrupted the financial system.
C. Expected profitability would rise, so the demand for loanable funds would rise.
Widespread use of handheld computers helps reduce business costs. A. Expected profitability would fall, so the demand for loanable funds would fall. B. Expected profitability would rise, but the demand for loanable funds would fall. C. Expected profitability would rise, so the demand for loanable funds would rise. D. The demand for loanable funds would remain constant.
A long position in a strangle is:
Worth less than a straddle whose strike lies within that of the strangle.
With short-term interest rates at or near zero and long-term interest rates at historic lows, additional quantitative easing by the Fed:
Would be more than pushing on a string because the Fed can utilize policies outside of just interest rates and doing so could stimulate spending and increase aggregate demand.
A. Unanticipated deflation redistributes income just as unanticipated inflation does, but from borrowers to lenders rather than from lenders to borrowers. D. Deflation, just like inflation, complicates the ability to distinguish overall price changes from relative price changes, which determine resource allocation.
Would deflation create some of the same problems as inflation in terms of the information communicated by price changes and the arbitrary redistribution of income? (Check all that apply.) A. Unanticipated deflation redistributes income just as unanticipated inflation does, but from borrowers to lenders rather than from lenders to borrowers. B. Unanticipated deflation redistributes income just as unanticipated inflation does, with lower income households losing purchasing power to higher income households. C. Deflation does not create any problem for the economy; on the contrary, it helps to spur economic growth. D. Deflation, just like inflation, complicates the ability to distinguish overall price changes from relative price changes, which determine resource allocation.
YTM= (required loan payment - principal) / principal
Write an expression showing the relationship among the amount borrowed on a simple loan, the required loan payment, and the yield to maturity.
Loan value = FP/(1+i) + FP/((1+i)^2) + ... +FP/((1+i)^n)
Write an expression showing the relationship among the amount borrowed on a fixed-payment loan, the payments on the loan, and the yield to maturity.
P=C/(1+i) + C/((1+i)^2) + C/((1+i)^3) + ... + C/((1+i)^n) + FV/((1+i)^n)
Write an expression showing the relationship among the price of a coupon bond, the coupon payments, the face value, and the yield to maturity.
YTM = (face value - price) / price
Write an expression showing the relationship among the price of a discount bond, the bond's face value, and the yield to maturity.
Is it difficult for a lender of last resort to tell the difference between insolvency and illiquidity? Why does the distinction matter?
Yes because he definitely does not want to lend to an insolvent bank.
You are a lender of last resort and a bank asks you for a loan. The bank has $700 million in assets, mostly in long-term loans, and $500 million in liabilities. It has unusually high withdrawal rates on its deposits and needs a loan to tide it over. Should you grant the loan?
Yes because the bank has a good amount of bank capital so the bank is solvent.
A student makes the following observation: This month the euro depreciated sharply against the U.S. dollar. That was good news for attendance at Disneyland Paris and bad news for attendance at Walt Disney World in Orlando, Florida. Do you agree with the student?
Yes, as the euro depreciates, it becomes less expensive for U.S. citizens to travel to Disneyland Paris.
According to an article in the Wall Street Journal, Canadian firms that import goods that are priced in U.S. dollars "buy futures contracts that guarantee that they can exchange Canadian dollars for U.S. [dollars] at fixed prices..." Source: Phred Dvorak and Andy Georgiades, "Strong Loonie Sets Off a Retail Tiff," Wall Street Journal, May 19, 2010. Do you agree that futures contracts make it possible to fix the price of the underlying asset?
Yes, futures contracts make it possible to lock into a price if futures contracts are not sold for profit or loss.
If the decrease in Burberry's profits had not been a surprise, would the effect of the announcement on its stock price have been different?
Yes, investors would have already decreased their demand for this stock causing its price to drop before the announcement was made.
Dow Theory
Yes. The Dow Jones Industrial Average and the Dow Jones Transportation Average rarely move in opposite directions because the Dow Jones Transportation Average influences the Dow Jones Industrial Average.
The spot price trades at the following bid/ask quote: 100-101 (i.e., you can buy at 101 and sell at 100). The one-year forward trades at 102-103 (you can buy forward at 103 or sell forward at 102). If the simple interest rate for one year is 2%, which of the following statements is most accurate?
You cannot execute an arbitrage at these prices.
An arbitrage is a strategy where
You construct a series of trades that lead to non-negative cash flows at all points in time and at least one positive cash flow
Suppose that you are a wealthy investor. Although you have no connection with the oil industry, you are convinced from studying the determinants of demand and supply in the oil market that the price of oil will decline sharply in the future. How might you use forward contracts to profit from your forecast?
You could sell oil futures with the intention of buying them back at the lower price on or before the settlement date.
You are short an FRA and short a eurodollar futures contract expiring in 3 months. Assume the fixed rate in the FRA is the same as the rate locked in via the eurodollar futures contract. If interest rates jump up by 100 basis points,
You lose money on the FRA but make money on the eurodollar futures.
You are long an FRA and long a eurodollar futures contract expiring in 3 months. Assume the fixed rate in the FRA is the same as the rate locked-in via the eurodollar futures contract. If interest rates jump down by 100 basis points
You will lose more on the FRA than you will make on the eurodollar futures.
If you were a speculator who expected interest rates to fall, would you have bought or sold these futures contracts?
You would buy these futures contracts, anticipating a rise in the price.
How might you hedge against the risk of interest rates rising and bond prices falling?
You would sell Treasury futures.
Suppose that you are an investor who owns $10,000 in U.S. Treasury notes. How might you hedge against this risk you identified above?
You would sell Treasury futures.
Suppose that you manage a bank that has made many loans at a fixed interest rate. You are worried that inflation might rise and the value of the loans will decline. How might you use swaps to reduce your risk?
You would swap some of the fixed-interest rate loans for variable interest-rate payments.
You have a portfolio with long positions in both puts and calls. The volatility in the market rises
Your portfolio gains in value.
Market risk, idiosyncratic risk C. By allocating savings among many different assets, if one asset class performs poorly, the rest of the portfolio may perform well.
_____ is the risk that is common to all assets of a certain type, while _____ is the risk that pertains to a particular asset rather than to the market as a whole. How does diversification reduce the risk of a financial portfolio? A. By determining if an asset produces market risk or idiosyncratic risk, an investor can then determine how well the asset will perform. B. By accurately calculating the expected return of an asset, investors will be guaranteed a strong return. C. By allocating savings among many different assets, if one asset class performs poorly, the rest of the portfolio may perform well. D. By allocating savings to only one asset class, if the asset performs well, the benefit from the investment will be huge.
A stock
______ is a financial security that represents partial ownership of a firm.
Interest income, a capital gain
______ is taxed at the same rate as wage and salary income while ______ is taxed at a lower rate.
interest income
____________ is taxed at the same rate as wage and salary income
capital gain
a ________ is taxed at a lower rate than interest income
Loan sales is
a financial contract in which a bank agrees to sell the expected future returns from an underlying bank loan to a third party.
Buying stock in a company gives an investor a legal claim on ______
a firm's equity, a firm's profit, value of a firm's assets minus the value of its liabilities
Standby letters of credit are
a promise by a bank to lend funds, if necessary, to the seller of commercial paper at the time that the commercial paper matures.
define depreciation
a reduction in the value of an asset with the passage of time, due in particular to wear and tear.
zero-sum game
a situation in which one person's gain is another's loss
Suppose that the U.S. firm Halliburton buys construction equipment from the Japanese firm Komatsu at a price of ¥260 million. The equipment is to be delivered to the United States and paid for in one year. The current exchange rate is ¥106=$1. The current interest rate on one-year U.S. Treasury bills is 8%, and on one-year Japanese government bonds the interest rate is 6%. a. If Halliburton exchanges dollars for yen today and invests the yen in Japan for one year, it will need _________ to exchange today in order to have ¥260 million in one year. b. If Halliburton enters a forward contract, agreeing to buy ¥260 million in one year at an exchange rate of ¥104=$1, it will need _________ today if it plans to invest the dollars at the U.S. interest rate of 8%. c. If Halliburton invests today at the U.S. interest rate of 8%, without entering into any other type of contract, does the firm know how many dollars it needs today to fulfill its equipment contract in one year? d. Which method(s) described in (a) through (c) provide(s) a hedge against exchange-rate risk? Which do(es) not? Which method is Halliburton likely to prefer? e. In order for the results in (a) and (b) to be equivalent, the forward contract exchange rate in (b) has to be ¥104.00 per dollar
a. 260 M yen in one year / (1+.06) = $2313991 b. 260 M yen / 104 yen/$ = $2,500,000 $2,500,000/(1.08) = $2314815 c.No, it depends on the exchange rate at the end of the contract. No, but it takes the risk. d. Hedges are provided by (a) and (b) but not (c), and Halliburton prefers (a) because it costs less. e. 260,000,000 / 2,500,000 = 104 yen
Off-balance-sheet activities are
activities that do not affect a bank's balance sheet because they do not change either the bank's assets or its liabilities.
Trading activities are
activities that include trading in the futures, options, or swaps market.
Monetary policy aims to
advance the economic well-being of the country's citizens.
To hedge
against a fall in the value of the pound , a firm sells pounds in the forward market; to hedge against a rise in the value of the pound. A firm buys pounds in the forward market
Appreciation
an increase in the value of a currency in exchange for another currency
If a firm's profits are expected to increase there will be __ ________ in demand for that firm's stock and therefore __ ______ in its price.
an increase, an increase
Bonds ____ ____ equities because they represent ____ to a firm
are not, debt
D
as the wealth of investors increases, all else held constant, the interest rate on bonds should fall A. true-- a shift to the left in the demand curve will push prices down and yield up B. False-- a shift to the right in the demand curve will push both prices and yield down C. false-- a shift to the left in the demand curve will push prices down and yield up D. true-- a shift to the right in the demand curve will push prices up and yield down
futures market
as you go to the settlement date, futures price converges to the spot price futures price will be the same as the spot price
What does it mean to say that there is a bubble in the housing market? A bubble means that
asset prices have increased beyond the point that could be justified by fundamental evaluation.
Loan commitment is
a bank's consent to provide a borrower with a stated amount of funds during some specified time.
If the exchange rate between the yen and the dollar changes from yen91 = $1 to yen79 = $1, is this good news for Sony? A yen appreciation is ____ news for Sony.
bad
yen91 = $1 to yen79 = $1, This is __ news for US consumers as Japanese goods become ___ expensive and ___news for Us firms as the dolalr has depcreated against the yen
bad, more, good, depreciated
n article in the Wall Street Journal in mid-2016 noted the persistence of slow economic growth and very low interest rates seven years after the end of the financial crisis. One consequence was "the persistence of the Fed's large balance sheet and financial institutions' desire to store large amounts of reserves at the central bank.'' Source: David Harrison, "Fed Discussed New Ways of Making Policy at July Meeting," Wall Street Journal, August 17, 2016. Slow U.S. economic growth rate impacts the size of the Fed's balance sheet as:
banks maintain high levels of excess reserves.
Suppose that the Dow Jones Industrial Average is above the 13,500 level. If the Dow were to fall to 10,500, who would gain the most? Investors who _____ ______ options.
bought put
The difference between a call option and a put option is that a call option gives the buyer the right to _______ while the buyer of a put option has the right to _______.
buy the underlying asset at a predetermined price before its expiration date: sell the underlying asset asset at a predetermined price during a set period of time
The difference between a call option and a put option is that a call option gives the buyer the right to _______ the underlying asset at a predetermined price before its expiration date, while the buyer of a put option has the right to _______ the underlying asset at a predetermined price during a set period of time.
buy, sell
what is a derivative contract giving the buyer the right to buy the underlying asset at a set price during a set period of time?
call option
If the future price of Facebook stock increased above the current market price, traders would exercise the ______ options, ______ Facebook stock for less than the then market price. If the price of Facebook stock decreased from the current market price, traders would exercise the ______ options, ______ Facebook stock for more than the then market price
call, buying, put, selling
The $18 ______ is cheaper than the $17 ______ because the stock price will reach $17 before it hits $18, making the option _____ valuable at $17 than $18.
call, call, more
in what ways does the shadow banking system differ from the commercial banking system
commercial banking system is heavily regulated; the shadow banking system does not offer traditional banking services such as taking deposits; the shadow banking system invests in more risky assets and tends to be highly leveraged than commercial banks
Selling oil futures to hedge against falling oil prices and selling corn futures to hedge against falling corn prices are examples of ...
commodity futures
Commodity futures take a long or short position in the _______, while financial futures take a long or short position on a _______
commodity market, financial asset
Credit swaps are:
contracts in which interest-rate payments are exchanged, with the intention of reducing default risk.
A ______ is always positioned on the right side of an entry. It increases liability, revenue or equity accounts and decreases asset or expense accounts.
credit
forward transactions started in ag markets
demand for ag products are typically price inelastic, thus fluctuations in supply cause large seings in the equilibrium price
If the exchange rate between the yen and the dollar changes from yen76 = $1 to yen93 = $1, the yen has __against the dollar, and the dollar has ___appreciated against the yen
depreciated, appreciated
How does a credit default swap differ from the other swap contracts discussed in this chapter? Credit default swaps are:
derivatives requiring sellers to make payments to buyers if the price of the underlying security declines in value.
___ quotations are exchange rates as units of domestic currency per unit of foreign currency.
direct
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
Law of one price
ePf/P = 1 if they are the same good in different counties, their relative price has to be one
Futures contracts are traded on ______
exchanges
futures contracts are traded on
exchanges - specify the quantity of the underlying asset but not the price - standardized in terms of quantity of underlying asset to be delivered
required return on equities
expected amount necessary to compensate investors for the risk of investing in the stock
Suppose that the current exchange rate is euro1.28=pound1, but it is expected to be euro1.22=pound1 in one year. If the current interest rate on a one-year government bond in the United Kingdom is 5%, what does the interest-rate parity condition indicate the interest rate will be on a one-year government bond in Germany? Assume that there are no differences in risk, liquidity, taxation, or information costs between the bonds german interest rate is formula
expected(1.22)-current(1.28)/(current(1.28)+5%(.05_ then times 100%
Indirect quotations
express exchange rates as units of foreign currency per unit of domestic currency
derivative securities
financial contracts whose values are derived from the values of underlying assets
Selling Treasury note futures contracts and selling U.S. dollar futures contracts are examples of...
financial futures
futures markets
first evolved in the commodity markets to keep risk sharing benefits of a forward contract while increasing the liquidity and lowering counterparty risk and information costs - traded on exchanges - specify the quantity of the underlying asset, not the price - standardized in terms of quantity of the underlying asset to be delivered
we face lower transaction costs and eliminate counter party risk when we fo to ___________ rather than _______
future markets forward markets
futures contract, profit to seller:
futures price at purchase - spot price at settlement
profit to seller:
futures price at purchase - spot price at settlement
With ___ contracts the exchange rate changes continually as contracts are bought and sold on the exchange, and with ___contracts the exchange rate is fixed at the time the contract is agreed to
futures, forward
With ______ contracts, buyers and sellers have symmetric rights and obligations; however, with _______ contracts, buyers have rights and sellers have obligations.
futures, options
forward contracts
give investors and firms an opportunity to hedge against risk on transactions that depend on future prices - farmer plants wheat that will not be harvested for months, profit and loss will depend on the price of wheat at the time it is harvested - make possible forward transactions which are transactions agreed upon now, but settled in the future. - agreed in present for given commodity: wheat, oil, gold, tbill, at a particular date in the future for a set price
The fact that airlines were burned by their fuel hedges in 2016 means that hedging their fuel costs was a _____ idea because _____.
good, market conditions at the time indicated prices would continue to rise
derivatives enable individuals and firms to ____, or reduce risk they face from price fluctuations
hedge ex: both firms that use oil, such as airlines, and firms that help produce oil, such as drilling companies, can use derivatives to hedge against fluctuations in the price of oil
B
how does the interest rate on a bond with high information costs compare with the interest rate on a bond with low information costs? A. interest rates are usually lower on a bond with high information costs B. interest rates are usually higher on a bond with high information costs C. interest rates are usually the same regardless of information costs D. the bond rating is needed to determine the effect on interest rates
A
how does the interest rate on an illiquid bond compare with the interest rate on a liquid bond? A. interest rates are usually higher on an illiquid bond B. interest rates are usually lower on an illiquid bond C. interest rates are usually the same on liquid and illiquid bonds D. the bond rating is needed to determine the effect on interest rates
lender, borrower
in the bond market, the buyer is the ________ and in the loanable funds market the buyer is the _________
bond, use of funds
in the bond market, the good is the _______ and in the loanable funds market, the good is the ________
D
how is default risk measured? A. by measuring the difference between the interest rate on the bond and the interest rate of a similar bond with the same maturity B. By measuring the demand of the bond and the demand for a Treasury bond with the same maturity C. by measuring the demand of the bond and the demand for a Treasury bond with the same interest rate D. by measuring the difference between the interest rate on the bond and the interest rate on a treasury bond with the same maturity
The law of one price states that:
identical products should sell for the same price everywhere.
The law of one price states that ____ and how it does it relate to purchasing power parity (PPP)?
identical products should sell for the same price everywhere. The law of one price is the basis for PPP.
A
if investors start to believe that the U.S. government might default on its bonds, the interest rate on those bonds will fall A. false-- this would cause a shift to the left, pushing price down and yield up B. true-- this would cause a shift to the left, pushing both price and yield down C. false-- this would cause a shift to the left, pushing both price and yield up D. True-- this would cause a shift to the right, pushing price down and yield up
C
if the current price in the bond market is above the equilibrium price, explain how the bond market adjusts to equilibrium A. the price of bonds would fall, reducing both the quantity demanded and quantity supplied B. the price of bonds would fall, reducing the quantity demanded and increasing the quantity supplied C. the price of bonds would fall, increasing the quantity demanded and reducing the quantity supplied D. none of the above
C
in the loanable funds model, why is the demand curve downward sloping? why is the supply curve upward sloping? A. the demand curve is downward sloping because the lower the interest rate, the less demand for borrowing. the supply curve is upward sloping because the higher the interest rate, the more willing supplier of loanable funds will be to lend money B. the demand curve is downward sloping because the higher the interest rate, the less demand for borrowing, the supply curve is upward sloping because the higher the interest rate, the less willing suppliers of loanable funds will be to lend lend money C. the demand curve is downward sloping because the higher the interest rate, the less demand for borrowing. the supply curve is upward sloping because the higher the interest rate, the more willing suppliers of loanable funds will be to lend money D. the demand curve is downward sloping because the higher the bond price, the less demand for borrowing. the supply curve is upward sloping because the higher the loan price, the more willing suppliers of loanable funds will be to lend money
How does a decrease in the interest rate affect the following type of spending on aggregate output? Consumption spending by households would ________ .
increase
How does a decrease in the interest rate affect the following type of spending on aggregate output? Consumption spending by households would ___.
increase
The federal government cuts the corporate profits tax. It would ______ the after-tax rate of return on investment projects, _____ investment spending and causing the AD curve to shift to the ___
increase increase right
The Federal Reserve sells $19 billion of U.S. Treasury securities. It would ____ the interest rate, causing the AD curve to shift to the ____.
increase left
Firms become optimistic about the future profitability of spending on factories and machinery. It would increase current investment spending, causing the AD curve to shift to the right.
increase right
The federal government launches a massive program to rebuild the nation's highways.It would directly ____aggregate expenditure, causing the AD curve to shift to the _____
increase right
define appreciation
increase in monetary value.
A seller of a naked put option will want the value of the underlying asset to _______ and a buyer of a naked call option will want the value of the underlying asset to ______.
increase, increase
The increase in the price of credit-default swaps on these bonds indicates investors believe the default risk on Bank of America and Citigroup Inc. debt has ______ from the previous day
increased
What does Greenspan mean that "the added risk had not been compensated by higher capital"? In order to compensate for the risk, Greenspan believes that nonbank financial institutions should have voluntarily
increased their capital.
S&P stock ____ up to recession. S&P stock ______ _______ during recession. S&P stock ____ __ _____ __ _____ just after recession.
increasing, decreased significantly, began to regain its value
_____quotations express exchange rates as units of foreign currency per unit of domestic currency,
indirect
option premium =
intrinsic value of option + time value
what are the key differences between investment banks and central banks?
investment banks, among other activities, underwrite new security issues ans provide advice on mergers and acquisitions, whereas commercial banks primarily take deposits and issue loans
in what ways are investment inst. and commercial banks different
investment inst. are different from commercial banks because they do not engage in traditional commercial banking activities such as taking deposits and making loans
A bank run
is the process by which depositors who have lost confidence in a bank simultaneously withdraw enough funds to force the bank to close.
counterparty/default risk
is the risk that the buyer will not fulfill his/her obligation to the seller or that the seller will not fulfill his/her obligation to the buyer
Futures contracts _____ the flexibility of forward contracts
lack
According to an article in the Wall Street Journal, in 2016 J.P. Morgan Chase's leverage ratio was 6.2%. The bank's return on equity was 9%. Calculate the bank's ROA. Source: Stephen Grocer, open double quoteCitigroup, Wells Fargo Report Earnings dash Recap,close double quote Wall Street Journal, July 15, 2016. The banks ROA was
leverage ratio = net income/ total assets 0.62 = net income/ total assets 0.62 x total assets = net income 0.62 x .09 = 0.558
What is the relationship between the price of a financial asset and the payments investors will receive from owning that asset?
look at formula hw 5 q 20
Why are forward contracts more widely used in the foreign-exchange market than are futures contracts? Forward contracts are used 10 times more than futures contracts because the counterparty risk between big banks is relatively ___ and these banks value the ___ of the forward contract.
low, flexibility
D. an increasing money supply and falling interest rates.
n his history of the Federal Reserve, Allan Meltzer of Carnegie Mellon University describes the views of Federal Reserve officials in the fall of 1930: Most of the policymakers regarded the substantial decline in short-term market interest rates ... as the main ... indicators of the current position of the monetary system.... [Policy] was "easy" and had never been easier in the experience of the policymakers of the Federal Reserve System. Source: Alan H. Meltzer, A History of the Federal Reserve: Volume 1: 1913-1951, Chicago: University of Chicago Press, 2003, p. 315. What does it mean to say that Fed policy is "easy"? An "easy" Fed policy suggests A. a decreasing money supply and rising interest rates. B. an increasing money supply and rising interest rates. C. a decreasing money supply and falling interest rates. D. an increasing money supply and falling interest rates.
Does a bank have to be insolvent to experience a run?
no
When a newspaper article uses the term "the exchange rate," it is typically referring to the _______ exchange rate
nominal
purchasing power of parity does not hold for _____ since arbitrage involving such goods is not possible.
non-traded goods
Seller (writer of the option) PUT
obligation to buy underlying asset at the strike price
seller (writer of the option) CALL
obligation to sell underlying asset at the strike price
nominal rate:
one currency in terms of another
Forward contracts have counterparty risk since _______.
one of the parties may go bankrupt after signing the contract and be unable to fulfill their obligation
Put: time value =
option premium - intrinsic value
time value (of our option) =
option premium - intrinsic value of option
The payoff to the buyer of the option from exercising it immediately is the...
option's intrinsic value
Stocks are called equities because:
ownership of a firm's stock represents legal claim on the firm's profits, and partial ownership of the firm
Suppose that, holding yield constant, investors are indifferent as to whether they hold bonds issued by the federal government or bonds issued by state and local governments (that is, they consider the bonds the same with respect to default risk, information costs, and liquidity). Suppose that state governments have issued perpetuities (or consoles) with $83 coupons and that the federal government has also issued perpetuities with $83 coupons. If the state and federal perpetuities both have after-tax yields of 8%, what are their pre-tax yields? (Assume that the relevant federal income tax rate is 30.26%.)
pre tax yield on state perpetuity is 8% pre tax yield on federal perpetuity is 11.47 AS FEDERAL TAXES ARE THERE, THE PRE TAX YIELD ON FEDERAL PERPETUITY WILL BE = AFTER TAX YIELD/(1-TAX RATE) = 8%/(1-0.3026) SO ANSWER = 8%/0.6974 = 11.47%
call: time value =
premium - intrinsic value
An option premium is the ______ of the option
price
Suppose that a company is expected to pay a dividend per share of $27 per year forever. If investors require a rate of return of 14% to invest in this stock, what is its price? The stock price is $________. (Round your response to two decimal places.)
price = D/re = 27/.14 = $192.86
After the United Kingdom's electorate voted on June 23, 2016 to leave the European Union an article in the Wall Street Journal noted: "Credit-default swaps on the debt of Bank of America and Citigroup Inc. are up 25% from a day earlier." Source: John Carney, "Bank Credit Default Swaps Surge on Brexit Fears," Wall Street Journal, June 24, 2016. The increase in the _____ of credit-default swaps on these bonds indicates investors believe the default _____ on Bank of America and Citigroup Inc. debt has _____ from the previous day. What likely happened to the yields on those bonds? A. The yield decreased as the price of the bonds increased. B. The yield increased as the price of the bonds decreased. C. The yield decreased as the price of the bonds decreased. D. The yield increased as the price of the bonds increased.
price, risk, increased B. The yield increased as the price of the bonds decreased.
what is a derivative contract giving the buyer the right to sell the underlying asset at a set price during a set period of time?
put option
The $18 _____ is more expensive than the $17 ______ because the stock price will reach $17 before it hits $18, making the option _____ valuable at $95 than $105.
put, put, less
Borrowing at a low interest rate in one currency to lend at a higher interest rate in another currency is sometimes called a "carry trade." An article in the New York Times describes an investment strategy of this type: "A speculative carry trade in which investors borrowed euros at low interest rates to buy the higher-yielding Hungarian currency." -The phrase "higher-yielding Hungarian currency" refers to:
relatively high returns on assets denominated in the Hungarian currency.
Dow Theory is considered technical analysis rather than fundamental analysis because it _____.
relies on patterns of past stock prices to predict future stock prices
Mean p = rf + beta(Mr - rf)
rf = risk free rate B= fraction of wealth in risky asset mr - rf = spread
short
right and obligation of seller to sell / deliver underlying asset on a specified date
futures contracts - short
right and obligation of seller to sell/deliver underlying asset on specified future date
long
right/obligation of buyer to receive / buy underlying asset on specified date
futures contract - long
right/obligation of the buyer to receive.buy the underlying asset on a soecified future date
A bubble is a situation in which the price of an asset _____ _____ its fundamental value.
rises above
Suppose that on January, 1, 2013, you purchased a coupon bond with the following characteristics: bullet Face value: $1000 bullet Coupon rate: 8 1/4 bullet Current yield: 7.6% bullet Maturity date: 2015 If the bond is selling for $870 on January 1, 2014, then the rate of return on this bond during the holding period of calendar year 2013 was
ror = coupon + cap gain/ purchase price coupon 1000 x 8.25% =82.50 inital price 82.50/7.6% =1085.526 ror = 82.5 + (870-1085.526) / 1085.526 82.5 - (-215.526)/ 1085.526 -133.026/ 1085.526 =-0.1225 or - 12.255%
Suppose that for a price of $900 you purchase a 7-year Treasury bond that has a face value of $1000 and a coupon rate of 3%. If you sell the bond one year later for $1140, what was your rate of return for that one-year holding period? The rate of return for the one-year holding period was
ror = coupon/ initial price + change in price/initial price 30/900 + 240/ 900 = 29.99 0r 30.00%
Suppose that you just bought a four-year $1000 coupon bond with a coupon rate of 6.7% when the market interest rate is 6.7%. One year later, the market interest rate falls to 4.7%. The rate of return earned on the bond during the year was
ror = coupon/ purchase price + change in price/ purchase price you paid $1000 one year later= 67x(1-(1/(1.047^3)))/0.047+(1000/1.047^3 1055.50 coupon 67 (add) one year ago 1000 (subtract) 115.5 115.5/ 1000 = 11.55
Suppose that you are a wheat farmer. Answer the following questions. It is September, and you intend to have 50,000 bushels of wheat harvested and ready to sell in November. The current spot market price of wheat is $2.67 per bushel, and the current December futures price of wheat is $2.92 per bushel. If each wheat futures contract is for 5,000 bushels, how many contracts will you buy or sell? You will (buy/sell) ___ contracts. The total value of these futures contracts is $_____. It is now November, and you sell 50,000 bushels of wheat at the spot price of $2.77 per bushel. If the futures price is $3.02 and you settle your position in the futures market, what was your gain or loss on your futures market position? The (gain/loss) on your futures market position was $_____. The (gain/loss) on your spot market position was $_____. Therefore, you (were/ were not) successful in completely hedging your risk from price fluctuations in the wheat market.
sell, 10 14600 2.92*10*5000=146000 loss, 5000 Profit (or loss)=Contract's value in September - Contract's value in November. That is: $146,000(10 * 5,000*$ 2.92)-$151,000(10 * 5,000*$ 3.02)=Loss of $5,000. gain, 5000 Profit (or loss) = Spot value in November - Spot value in September. That is: $138,500(10* 5,000 *$ 2.77)-$133,500(10*5,000*$ 2.67) = Gain of $5,000. were
An option writer is the _____ of an option and he/she has the _______ the underlying asset.
seller, obligation to sell
forward contracts tend to be illiquid because
selling contract is difficult because a buyer would have to accept the same terms
forward contracts tend to be ILLIQUID because...
selling contracts is diificult becasue buyer would have to accept the same terms
hedging
serves to reduce risk in financial markets
Futures contracts have a price that changes up until the ______ with _______
settlement date, standardized settlement dates
Hedging involves taking a ____ position in the futures market to offset a ____ position in the spot market.
short, long
the lower the volatility in the price of the underlying asset, the ______ the option premium, and thus _______ the option
smaller, cheaper
Homework 5 Question 10
solve the problem
what became of the large, standalone investment banks during the financial crisis of 2007-2009
some large investment banks were taken over, went bankrupt, and were converted to financial holding companies to get access to fed reserve lending to survive the financial meltdown
speculator
someone with no connection to an industry that places financial bets on futures contracts within the industry in an attempt to profit from changes in asset prices
Someone with no connection to an industry that places financial bets on futures contracts within the industry in an attempt to profit from changes in asset prices is called a _______ Suppose that you are a wealthy investor. Although you have no connection with the oil industry, you are convinced from studying the determinants of demand and supply in the oil market that the price of oil will decline sharply in the future. How might you use forward contracts to profit from your forecast?
speculator You could sell oil futures with the intention of buying them back at the lower price on or before the settlement date.
market functions much better with ...
speculators and not just hedgers!
profit to buyer:
spot price at settlement - futures price at purchase
futures contract, profit to buyer:
spot price at settlement date - future price at purchase
futures contracts:
standardized contract to buy/sell a specified amount of a commodity/asset on a specific future date - first evolved in commodity markets to keep risk sharing benefits of forward contracts while increasing liquidity and lowering counterparty risk and information costs
how do you calculate the intrinsic value of a put option?
strike price - underlying stock price
intrinsic value of a put option =
strike price - underlying stock price
A flight to safety is a ___ shift in investments where investors seek to ___assets perceived as risk and ___assets perceived as safe ___shifts ____
sudden, sell. buy, d shifts right
The disadvantage of speculation with options contracts
that their prices are higher than are the prices of forward contracts
expectations
the ______ theory states that interest rates on long-term bonds are an average of the interest rates investors expect on short-term bonds over the lifetime of the long-term bond
segmented markets
the _______ theory holds that the interest rate on a bond of a particular maturity is determined only by the demand and supply of bonds of that maturity
liquidity premium
the ________ theory holds that interest rates on long-term bonds are averages of the expected interest rates on short-term bonds plus a term premium
world real interest rate
the ______________ is the interest rate that is determined in the international capital market
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
The demand for US dollars represents
the demand by households and firms outside the US for US goods and financial assets
What would have to be true of a derivatives security if the security were to help you to hedge this risk?
the derivative would need to earn a profit if bond prices fall
A
the determinants of portfolio choice include all of the following except: A. current economic policy B. expected return C. risk D. wealth
To eliminate the possibility of arbitrage profits
the difference between the interest rates on a Japanese bond and a US bond must equal the expected change in the exchange rate between the yen and the dollar
Treasury yield curve
the most common way to analyze the term structure is by using a graph known as the ________
spot price
the price at which a commodity or financial asset can be sold at the current date
spot price:
the price at which a commodity or financial asset can be sold at the current date
Nominal exchange rate
the price of one currency in terms of another currency, also called the exchange rate
Suppose that an Apple iPhone costs $180 in the United States, £70 in the United Kingdom, and ¥30,000 in Japan. If the exchange rate between the pound and the dollar is $1.50 = £1, what's the exchange rate between the pound and dollar? If the exchange rate between the dollar and the yen is yen120 = $1, what is the exchange rate between the dollar and the yen?
the real exchange rate between the pound and the dollar is 0.58. the real exchange rate between the dollar and the yen is 0.72
If spot price > strike price
then intrinsic value = 0, out the money
If spot Price < strike price
then put is in the money and intrinsic value >0
Forward contracts have counterparty risk since _______
there is a chance that either the buyer or the seller may default on their obligations under the contract
Forward contracts have counterparty risk since _______.
there is a chance that either the buyer or the seller may default on their obligations under the contract one of the parties may go bankrupt after signing the contract and be unable to fulfill their obligation
in what ways are investment institutions similar to commercial banks?
they both short and lend long
Explain the effect on the demand for reserves or the supply of reserves of the following Fed policy action: A decrease in the required reserve ratio.
this would decrease the demand for reserves
Explain the effect on the demand for reserves or the supply of reserves of the following Fed policy action: An increase in the interest rate paid on reserves.
this would raise the interest rate at which the demand curve becomes horizontal.
derivatives were subject to lots of debate during the financial crisis of 2007-2009 ... buffet said they were ___
time bombs for parties dealing with them and the economic system
A shift of the AD curve
to the right is considered expansionary, and a shift to the left is considered contractionary.
Exchange rates quoted
units of domestic currency per unit of foreign currency are referred to as direct quotations.
effiecincy frontier
upward sloping, risk aversion, concave because of gains to diversification
relative price of foreign goods and services in terms of US goods and services
us goods / foreign goods - if real prices rise we can say we have a real appreciation of foreign currency if real prices fall, real appreciation of the $ - amount of US goods have to give up for foreign
A hedger
used derivates markets to reduce risk, while a speculator uses derivative markets to place a bet on the future value of a currency
Put option
want the strike price to be GREATER THAN the spot price to be "in the money" - because you have the right to sell and you want to sell it for more money
Call option
we want the strike price to be LESS THAN the spot price to be "in the money" - because you have the right to buy, you want to buy it for less money
D
what are the determinants of asset demand A. the liquidity of the investment compared to other investments B. the expected rate of return and the degree of risk for an investments compared to alternative investments C. the total amount of savings to be allocated among investments D. all of the above
B
what are the two types of income an investor can earn on a bond? A. tax-free interest income from coupon payments and realized capital gains B. interest income from coupon payments and capital gains from price changes C. realized capital gains and unrealized capital gains D. interest income from coupon payments and any increase in the principal of the bond
C
what is a bond rating? A. a system developed by the US Treasury to identify and rank the most profitable bonds B. a financial statistic ranking the popularity of bonds among investors C. a single statistic summarizing a rating agency's view of the bond issuer's likely creditworthiness D. an average determined by all rating agency's summarizing the bond issuer's likely creditworthiness
A
what is default risk? A. the risk that the bond issuer will fail to make payments of interest or principal B. the risk that investors will demand less of an asset C. the risk that the bond issuer will issue new bonds with a higher interest rate D. the risk that the buyer of a bond will sell the bond prior to maturity
C
what is meant by a bond issuer's creditworthiness? A. the ability of a bond issuer to issue new bonds B. the ability of a bond issuer to obtain credit C. the ability of a bond issuer to make the required payments on its bonds D. all of the above
A
what is the FIsher effect? A. an assertion by Irving Fisher that the nominal interest rate rises or falls point-for-point with changes in the expected inflation rate B. an assertion by irving fisher that the nominal interest rate rises or falls point-for-point with changes in the real interest rate C. a contradiction by irving fisher that the nominal interest rate rises or falls point-for-point with changes in the real interest rate
B
what is the risk structure of interest rates? A. the relationship among the interest rates on bonds and the bond ratings assigned to each bond B. the relationship among the interest rates on bonds that have different characteristics but the the same maturity C. the relationship among interest rates on bonds that have the same characteristics but a different maturity D. the relationship among the interest rates on bonds and the level of risk associated with each bond
C
what is the tax treatment of the coupons on a bond issued by the U.S. Treasury? A. the bond is subject to federal, state, and local taxes B. the bond is not subject to federal, state, or local taxes C. the bond is subject to federal tax only D. the bond is subject to state and local taxes only
Why should a recession connected with a financial crisis be more severe than a recession that did not involve a financial crisis?
when financial institutions fail, credit marekts can be damaged, and the amount of borrowing/economic activity, can decrease, further affecting real outout
The principal-agent problem occurs
when managers follow their own self interests rather than the interest of the shareholders.
A
which of the following is NOT a key fact about the term structure? A. interest rates on short-term bonds are usually higher than interest rates on long-term bonds B. interest rates on bonds of all maturities tend to rise and fall together C. interest rates on long-term bonds are usually higher than interest rates on short-term bonds D. interest rates on short-term bonds are occasionally higher than interest rates on long-term bonds
B C D
which of the following would shift the demand curve for bonds to the left? (check all correct answers) A. the liquidity of bonds increases B. expected inflation increases C. the expected return on stocks increases D. households' wealth decreases E. the expected return on bonds relative to other assets increases.
A D E
which of the following would shift the supply curve for bonds to the right (check all correct answers) A. government borrowing increases. B. corporate taxes increase C. expected inflation decreases D. subsidies to business increase E. firm's expected profitability increases
D
why do bonds that have the same maturities often have different interest rates? A. interest rates may vary due to risk B. interest rates may vary due to liquidity C. interest rates may vary due to information costs and costs from taxation D. all of the above
B
why does the demand curve for bonds slope down? why does the supply curve for bonds slope up? A. as the price of bonds increases, the interest rate on bonds increases, thus increasing the quantity of bonds demanded. likewise, as the price of bonds increases, the interest rates on the bonds will increase, thus holders of bonds will be less willing to sell them, decreasing the quantity supplied. B. as the price of bonds increases, the interest rates on the bonds will fall, thus reducing the quantity of bonds demanded. likewise, as the price of bonds increases, the interest rates on the bonds will fall, thus holders of bonds will be more willing to sell them, increasing the quantity supplied C. as wealth increases, all else constant, the demand for bonds will decrease as investors choose assets with higher returns, thus decreasing the quantity of bonds demanded. likewise, as wealth increases, all else constant, holders of bonds will be seeking assets with higher returns, thus increasing the quantity of bonds supplied.
"Speculative investors in oil cut their bullish bets on the price of crude ..." What does the article mean by a "cut their bullish bet"? Investors were betting oil prices _____________
would not continue to rise.
If the exchange rate between the dollar and the yen is yen 120 = $1, the real exchange rate between the dollar and the yen is . 62
yen120/yen35000 X $180
Someone with no connection to an industry that places financial bets on futures contracts within the industry in an attempt to profit from changes in asset prices is called a speculator. Suppose that you are a wealthy investor. Although you have no connection with the oil industry, you are convinced from studying the determinants of demand and supply in the oil market that the price of oil will decline sharply in the future. How might you use forward contracts to profit from your forecast?
you could sell oil futures with the intention of buying them back at a lower price on or before the settlement date
call option
you have the right to purchase the underlying asset at the strike price (buyer)
put option
you have the right to sell underlying asset at strike price (buyer)
if you think prices are going to fall
you want to SELL as a speculator and for each contract you sell, $ is credited to your margin account
Suppose that you are a wheat farmer. Answer the following questions. It is September, and you intend to have 40,000 bushels of wheat harvested and ready to sell in November. The current spot market price of wheat is $2.76 per bushel, and the current December futures price of wheat is $3.01 per bushel. If each wheat futures contract is for 5,000 bushels, how many contracts will you buy or sell? The total value of these futures contracts is $120,400
you will sell 8 contracts 40,000/5,000 = 8 you will SELL future contracts contracts to reduce risk of agricultural prices falling To get the total value of these future contract: multiply the number of contracts by the number of bushels included in the futures contract by the futures price of wheat per bushel
What are the main reasons that interest-rate parity may not hold exactly?
Exchange-rate risk. Transaction costs. Differences in default risk and liquidity.
How do banks manage interest-rate risk? (Check all that apply.)
Interest-rate swaps can reduce interest-rate risk exposure. Banks can reduce interest-rate risk by making more floating rate loans, or ARMs.
Would derivative markets be better off if the only people buying and selling derivative contracts were hedgers?
No, as in all markets, at least two parties are required for each transaction, and speculators help provide liquidity and efficiency in financial markets.
A student makes the following observation: It currently takes 80 yen to buy 1 U.S. dollar, which shows that the United States must be a much wealthier country than Japan. But it takes more than 1 U.S. dollar to buy 1 British pound, which shows that Great Britain must be a wealthier country than the United States. Do you agree with the student's reasoning? Why?
No, exchange rates do not measure the wealth of a country.
The most important bank liabilities are
Small-denomination time deposits and Checkable deposits.
A student makes the following observation: This month the euro depreciated sharply against the U.S. dollar. That was good news for attendance at Disneyland Paris and bad news for attendance at Walt Disney World in Orlando, Florida. Do you agree with the student?
Yes, as the euro depreciates, it becomes less expensive for U.S. citizens to travel to Disneyland Paris.
An article in the Wall Street Journal in 2016 noted that banks in China have been experiencing problems with business borrowers defaulting on loans and have had difficulty attracting enough deposits to fund new loans. Are these problems likely to matter for the future growth of the Chinese economy?
Yes; banks will have less funds available and will be hesitant to make loans to Chinese businesses.
In July 2010, Congress was considering having the federal government set up a "lending fund" for small banks. The U.S. Treasury would lend the funds to banks. The more of the funds the banks loaned to small businesses, the lower the interest rate the Treasury would charge the banks on the loans. Congressman Walt Minnick of Idaho was asked to comment on whether the bill would be helpful to small businesses. Here is part of his response: "The bank that's struggling to write down their commercial real estate assets is having to take a hit to capital, and this provides replacement capital on very, very favorable terms. So it deals with the left side of the balance sheet..." Source: Robb Mandelbaum, "Can Government Help Small Businesses?" New York Times, July 29, 2010. a. Would a loan from the Treasury be counted as part of a bank's capital? b. Does a bank's capital appear on the left side of the bank's balance sheet?
a. No, a loan from the treasury would not be counted as bank capital. b. Bank capital appears on the right side of the balance sheet, because it is the difference between assets and liabilities.
1.With respect to the theory of purchasing power parity, the statistics in this table are (homework 6 question 8) 2.If the purchasing power parity theory allowed us to exactly determine exchange rates in the short run, the exchange rate between the Brazilian real and the Israeli shekel would be ________________reals per shekel.
inconsistent, since purchasing power parity implies that $4.33, when converted into other currencies, should be sufficient to just purchase a Big Mac in the non-U.S. countries. inconsistent since the domestic currency prices of Big Macs (for the non-U.S. countries), when converted into dollars, differ markedly from $4.33. 2. 0.8470
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
store of value
A ______ is the accumulation of wealth by holding dollars or other assets that can be used to buy goods and services in the future.
medium of exchange
A _______ is something that is generally accepted as payment for goods and services.
B. Underwriting is an activity in which an investment bank guarantees to the issuing corporation the price of a new security and then resells the security for a profit.
A review of a biography of the British investment banker Siegmund Warburg states that Warburg believed: "Investment banking should not be about gambling but about ... financial intermediation built on client relationships, not speculative trading...Warburg was always queasy about profits made from [investing] the firm's own capital, preferring income from advisory and underwriting fees." Source: "Taking the Long View," Economist, July 24, 2010. What is underwriting? A. Underwriting is the first time a firm sells stock to the general public. B. Underwriting is an activity in which an investment bank guarantees to the issuing corporation the price of a new security and then resells the security for a profit. C. Underwriting is the signing of contract for buying or selling debt. D. Underwriting is the creation of sophisticated financial instruments.
Which of the following are components of aggregate expenditure? (Check all that apply.) A. Net exports (spending by foreign firms and households on goods and services produced in the U.S. minus spending by U.S. firms and households on goods and services produced in other countries). B. Consumption spending by households on goods and services. C. Government purchases on goods and services. D. Social Security payments.
A. Net exports (spending by foreign firms and households on goods and services produced in the U.S. minus spending by U.S. firms and households on goods and services produced in other countries). B. Consumption spending by households on goods and services. C. Government purchases on goods and services.
Why is the demand for real money balances downward sloping? A. The higher the interest rate on short-term assets, the more households and firms give up when they hold large money balances. B. As the short-term real interest rate increases, the opportunity cost of holding money increases, and households and firms hold more real money balances. C. As the short-term nominal interest rate increases, the opportunity cost of holding money decreases, and households and firms hold less real money balances. D. The higher the short-term nominal interest rate, the larger the quantity of real balances households and firms want to hold.
A. The higher the interest rate on short-term assets, the more households and firms give up when they hold large money balances.
What are real money balances? (Check all that apply.) A. The money supply, such as M1, divided by the price level. B. The value of money held by the government adjusted for changes in the price level. C. The value of consumer spending divided by the price level. D. The money supply adjusted for inflation.
A. The money supply, such as M1, divided by the price level. D. The money supply adjusted for inflation.
D. All answers are correct.
Adam Posen, a member of the Bank of England's Monetary Policy Committee, was quoted as arguing in a speech that: Central banks' purchases of government debt . . . far from undermining their independence . . . should enhance their credibility. . . . Mr. Posen said, . . . "What matters for our independence is our ability to say no and to mean it, and to be responsible about when we choose to say yes." Source: Natasha Brereton, "BOE's Posen Defends ECB's Actions," Wall Street Journal, June 15, 2010. Why might purchasing government debt be seen as undermining a central bank's independence? A. Purchasing government debt is almost like printing money. B. If the Bank of England starts purchasing government debt, it may be interpreted as a sign that the government is forcing the Bank of England to monetize the debt. C. When the central bank purchases government debt, it serves as a way for the government to spend money without having to pay for it. D. All answers are correct.
Are all business cycles the same in length and severity? A. Most business cycles have the same length but have various degrees of severity. B. Business cycles possess various lengths and degree of severity. C. All business cycles follow the same pattern of length and severity. D. Most business cycles have different lengths with equal degrees of severity.
B. Business cycles possess various
In 2015, the Chinese government announced that it would switch from relying on stimulating the economy through expansions in aggregate demand to relying on expansions in aggregate supply. According to a Chinese news site, the government had decided that "the best way to stimulate economic growth is to lower barriers to production, particularly through tax cuts." Source: open double quoteWhat Is China's Supply-Side Reform?close double quote news.xinhuanet.com, December 22, 2015. What kind of tax cuts did the government likely have in mind? A. Import taxes B. Business taxes C. Export taxes D. Real-estate transfer taxes
B. Business taxes
What problems does it pose for the economy? (Check all that apply.) A. It increases interest rates. B. It implies that negative shocks to aggregate demand can have long-lasting negative effects on unemployment. C. It raises the natural rate of unemployment. D. It leads to fiscal policy becoming ineffective.
B. It implies that negative shocks to aggregate demand can have long-lasting negative effects on unemployment. C. It raises the natural rate of unemployment.
How would the increase in stock prices and housing prices have affected aggregate demand? A. The aggregate demand curve would shift leftward. B. The aggregate demand curve would shift rightward. C. The aggregate demand curve would not change.
B. The aggregate demand curve would shift rightward.
How could the Fed's expansionary monetary policy hurt the economy given the lags in the impact of monetary policy actions? (Check all that apply.) A. The expansionary monetary policy, given the lags in the impact of monetary policy actions, could return the economy to recession. B. The amount of stimulus could be wrong by the time the policy fully impacts the economy. C. The expansionary monetary policy could hurt the economy by returning it to full employment. D. The expansionary monetary policy could be the wrong policy by the time the policy fully impacts the economy.
B. The amount of stimulus could be wrong by the time the policy fully impacts the economy. D. The expansionary monetary policy could be the wrong policy by the time the policy fully impacts the economy.
What is hysteresis? A. A temporary deviation from an economic equilibrium, especially after severe economic shocks. B. The idea that when high rates of unemployment persist, workers lose skills or are seen by employers as lacking current skills, and some of the long-term unemployed become discouraged and quit the labor force permanently. C. It refers to the extreme reaction (hysteria) savers and investors sometimes have to declining conditions in equity (stock) markets. D. The idea that when a country has a low interest rate for a long time, the natural rate of unemployment will increase.
B. The idea that when high rates of unemployment persist, workers lose skills or are seen by employers as lacking current skills, and some of the long-term unemployed become discouraged and quit the labor force permanently.
What is the primary reason that households and firms demand money? A. To feel rich. B. To facilitate buying and selling. C. To make investments. D. For speculative purposes.
B. To facilitate buying and selling.
Normally we think of the factors that cause the AD curve to shift as different from the factors that cause the LRAS curve to shift. Is this still true in the case of hysteresis? A. To the extent that hysteresis occurs, factors that decrease AD would increase LRAS. B. To the extent that hysteresis occurs, factors that decrease AD would decrease LRAS. C. Yes it is. Under no circumstances do the factors shifting AD have anything to do with shifts in LRAS. D. Hysteresis only involves simultaneous shifts in the SRAS and LRAS curves.
B. To the extent that hysteresis occurs, factors that decrease AD would decrease LRAS.
What is aggregate expenditure? A. Total spending on goods and services produced by firms owned by domestic residents. B. Total spending on the economy's output of goods and services. C. Total spending by domestic entities on an economy's output of goods and services. D. The sum of household and business purchases of domestically produced goods and services.
B. Total spending on the economy's output of goods and services.
In 2016, a columnist for the Wall Street Journal wrote that: For years, the world has looked to central banks to deploy whatever tools they had to prop up economic growth. Now, just as those tools reach their limits, governments are quietly stepping up. Fiscal policy across the developed world is collectively turning more stimulative ... Source: Greg Ip, "Fiscal Policy Makes a Quiet Turn Toward Stimulus," Wall Street Journal, September 14, 2016. All of the following are tools central banks were using to "prop up growth," except: A. lowering short-term interest rates. B. raising short-term interest rates. C. lowering long-term interest rates. D. increasing the monetary base.
B. raising short-term interest rates.
Stanley Fischer, vice-chair of the Federal Reserve, remarked that the exchange rate would affect aggregate demand in the United States: open double quoteSo that is the channel through which the exchange rate will affect our decisions.close double quote Source: Ben Leubsdorf, "Fischer Says Fed Officials Will Watch Dollar for Impact on Aggregate Demand," Wall Street Journal, October 9, 2014. The decisions Fischer would likely have been referring to include all of the following, except: A. target range for the federal funds rate. B. target range for the monetary base. C. asset purchases under quantitative easing. D. monetary policy decisions on interest rates.
B. target range for the monetary base.
Money, A stock, A bond, Foreign exchange, A securitized loan
Briefly define each of the five key financial assets.
fell, rose
Briefly explain what happened to the currency-to-deposit ratio (C/D) and the excess reserves-to-deposit ratio (ER/D) during the financial crisis of 2007-2009. The currency-to-deposit ratio (C/D) _______ , and the excess reserves-to-deposit ratio (ER/D) _____ during the financial crisis.
D. All of the above.
By the 2000s, what significant changes had taken place in the mortgage market? A. Investment banks began buying mortgages, bundling large numbers of them together as mortgage-backed securities, and reselling them to investors. B. Lenders loosened the standards for obtaining a mortgage loanlong dashoften lending to subprime borrowers and Alt-A borrowers. C. Lenders created new types of non-traditional loans, allowing borrowers to pay a very low interest rate for the first few years of the mortgage and then pay a higher rate in later years. D. All of the above.
Movements in the exchange rate affect all of the following, except: A. aggregate expenditures. B. aggregate demand. C. net exports. D. aggregate supply.
D. aggregate supply.
Given that the economy can correct itself and return to potential GDP, why would the Federal Reserve pursue expansionary monetary policy following a negative aggregate demand shock? How could the Fed pursuing expansionary monetary policy be preferable to the economy correcting itself? A. Self-adjusting methods of economic stabilization deny politicians the chance to show that they are in control of the situation. B. Self-adjusting methods of economic stabilization are more expensive for the government than is expansionary monetary policy. C. Expansionary monetary policy might more quickly return the economy to full employment than the adjustment of the economy by itself. D. Expansionary monetary policy has fewer negative effects on unemployment than self-adjustment does.
C. Expansionary monetary policy might more quickly return the economy to full employment than the adjustment of the economy by itself.
Does monetary neutrality mean that changes in the money supply can never affect real GDP? A. No, monetary neutrality only means that changes in the money supply will not affect real GDP in the short run. Changes in the money supply can and do affect real GDP in the long run. B. Yes, monetary neutrality means that money supply changes only affect one variable, the price level. Real GDP is never impacted. C. No, monetary neutrality only means that changes in the money supply will not affect real GDP in the long run. Changes in the money supply can and do affect real GDP in the short run. D. Yes, monetary neutrality means that money supply changes only affect one variable, the nominal interest rate. Real GDP is never impacted.
C. No, monetary neutrality only means that changes in the money supply will not affect real GDP in the long run. Changes in the money supply can and do affect real GDP in the short run.
In the early to mid-2000s, stock prices and housing prices rose substantially. What effect would these increases in household wealth have on the savings rate? A. The savings rate would not change. B. The savings rate would increase. C. The savings rate would decrease.
C. The savings rate would decrease.
Why is the AD curve downward sloping? A. The higher interest rate produced by a lower price level leads to more consumption spending, investment spending, and net exports. B. AD slopes downward for the same reasons the demand for an individual good slopes downward: because of income and substitution effects. C. If nothing else changes, a decrease in the price level reduces aggregate expenditure on goods and services. D. An increase in the price level decreases real money balances, which raises the interest rate. The higher interest rate decreases consumption spending, investment spending, and net exports.
D. An increase in the price level decreases real money balances, which raises the interest rate. The higher interest rate decreases consumption spending, investment spending, and net exports.
Why might some economists have believed that in 2016 those tools had reached their limits? A. The monetary base was beginning to expand. B. Interest rates were beginning to rise. C. The monetary base was beginning to contract. D. Interest rates were at historically low levels.
D. Interest rates were at historically low levels.
Why might attempts to fine-tune the economy be ineffective? A. The policy instruments which are used in short run are inefficient in the long run. B. The policy of fine-tuning does not take into account the fluctuations in aggregate supply. C. The policy of fine-tuning does not take into account the fluctuations in aggregate demand. D. There are potentially long lags in formulating and implementing stabilization policies. This is the correct answer.
D. There are potentially long lags in formulating and implementing stabilization policies. This is the correct answer.
These tax cuts would increase aggregate supply by: A. slowing down the pace of technological change. B lowering the return to entrepreneurship, encouraging the opening of new businesses. C. decrease the incentive for individuals to work, increasing the supply of labor. D. increasing the after-tax return to investment spending.
D. increasing the after-tax return to investment spending.
D. A and B only.
How does the creation of a secondary market in mortgages help to promote home ownership? A. By allowing banks to transfer the risk of holding a loan to firms that have economies of scale in risk assessment. B. By allowing banks to offer a lower interest rate than if they held the loan themselves. C. By allowing banks to offer non-securitized loans to high-risk borrowers. D. A and B only. E. All of the above.
win, win
During the 2007minus2009 recession, many people who had taken out mortgages to buy homes found that they were having trouble making the payments on their mortgage. Because housing prices were falling, many found that the amount they owed on their mortgage was greater than the price of their home. Significant numbers of people defaulted on their mortgages. The following appeared in an article discussing this issue in the Economist magazine: Since foreclosures are costly for lenders as well as painful for borrowers, both sides could be better off by renegotiating a mortgage. The sticking-point, according to conventional wisdom, is securitization. When mortgages are sliced into numerous pieces it is far harder to get lenders to agree on changing their terms. When a mortgage is renegotiated, lenders _____ and borrowers ______.
D. This is not necessarily correct. For instance, despite the apolitical setup of the Fed, each member of the Federal Reserve Board still has an incentive to maximize personal well-being, power, and influence, and may make decisions that promote those factors.
Evaluate the following statement: "Because the Fed does not have to ask Congress for money to fund its operations, the principal-agent view of the Fed's motivation cannot be correct." A. The principal-agent view of the Fed's motivation has no connection with Fed independence from Congress. B. This statement is accurate since the Fed's financial independence from the congressional budgeting process effectively means there is no principal for the agent to go against. C. Since the Fed is completely independent of Congress, there is no principal-agent relationship at all, so the principal-agent view of the Fed's motivation cannot be correct. D. This is not necessarily correct. For instance, despite the apolitical setup of the Fed, each member of the Federal Reserve Board still has an incentive to maximize personal well-being, power, and influence, and may make decisions that promote those factors.
B. Disagree: If the required reserve ratio equaled zero, the simple deposit multiplier would equal infinity, implying that multiple deposit expansion would go on forever. However, the realistic money multiplier, which includes currency and excess reserve holdings, would not equal infinity even if the required reserve ratio equaled zero.
Explain whether you agree with the following observation: "If the required reserve ratio were zero, the process of multiple deposit expansion would go on forever." A. Disagree: If the required reserve ratio was equal to zero, the simple deposit multiplier would be equal to zero, too. So, the multiple deposit expansion would not go on forever. B. Disagree: If the required reserve ratio equaled zero, the simple deposit multiplier would equal infinity, implying that multiple deposit expansion would go on forever. However, the realistic money multiplier, which includes currency and excess reserve holdings, would not equal infinity even if the required reserve ratio equaled zero. C. Agree: If the required reserve ratio equaled zero, the simple deposit multiplier would equal zero, implying that multiple deposit expansion would go on forever and the realistic money multiplier, which includes currency and excess reserve holdings, would also equal zero. D. Agree: If the required reserve ratio equaled zero, the simple deposit multiplier would equal infinity, implying that multiple deposit expansion would go on forever and the realistic money multiplier, which includes currency and excess reserve holdings, would also equal infinity.
D. It would be able to conduct monetary policy free from political interference.
Fed Chair Janet Yellen was quoted in an article in the Wall Street Journal as asserting that: "Academic studies establish beyond a shadow of a doubt that independent central banks perform better." Source: David Harrison, "Senate Defeats 'Audit the Fed' Bill," Wall Street Journal, January 12 2016. Why would a central bank that is independent be expected to perform better? A. It would be generate higher profits. B. It would be able to offer lower interest rates to borrowers. C. It would be able to offer higher interest rates to savers. D. It would be able to conduct monetary policy free from political interference.
B. The political business cycle would be more likely with the principal-agent view where the Fed lowers interest rates to stimulate the economy before an election to avoid conflict with groups that could limit its power and influence.
How are the principal-agent view and the public interest view connected to the theory of the political business cycle? A. These views are unrelated to the theory of the political business cycle. B. The political business cycle would be more likely with the principal-agent view where the Fed lowers interest rates to stimulate the economy before an election to avoid conflict with groups that could limit its power and influence. C. The political business cycle would be more likely with the public interest view where the Fed lowers interest rates to stimulate the economy before an election to avoid conflict with groups that could limit its power and influence. D. Under the both views the Fed lowers interest rates to stimulate the economy before an election to avoid conflict with groups that could limit its power and influence.
In addition to its original role as a lender of last resort, the modern Fed is now responsible for monetary policy.
How do the Fed's current responsibilities compare with its responsibilities when it was first created by Congress?
Because the loans have been bundled with other loans and resold to other investors.
How does securitization result in mortgages being "sliced into numerous pieces"?
D. The financing of investments by borrowing rather than using capital.
In referring to the collapse of the Long-Term Capital Management hedge fund in 1998, an article in the New York Times noted that: Starting with just $5 billion in capital, the fund was able to get $125 billion in additional funds. Using that leverage, it took on trading positions with an estimated potential value of $1.25 trillion. Despite the fund's seemingly brilliant strategy, the high leverage meant that it did not take much of a setback to wipe out the fund's underlying capital. And the potential freezing of $1 trillion of positions, even temporarily, was seen as a major risk to the system. Source: Anna Bernasek, "Hedge Funds" Heft Raises Increasing Concern About Their Risks," New York Times, July 5, 2005. What is leverage? A. The financing of investments by using capital rather than borrowing. B. The financing of investments by using equity rather than borrowing. C. The financing of investments by using financial assets. D. The financing of investments by borrowing rather than using capital.
A. The Congress can amend the Fed's charter and powers or even abolish it entirely. B. The president can exercise control over the membership of the Board of Governors and appoint a new chairman every four years.
In what ways is the Fed subject to external pressure? (Check all that apply.) A. The Congress can amend the Fed's charter and powers or even abolish it entirely. B. The president can exercise control over the membership of the Board of Governors and appoint a new chairman every four years. C. Through negative reporting journalists can rally public sentiment against Fed policies. D. The Congress scrutinizes Fed's budgetary requests and can reduce the amounts requested if the Fed has fallen out of favor with key members of the House or Senate.
D. It is often difficult for a central bank to act independently in a low-income country.
Is it easier for a central bank to be independent in a high-income country or in a low-income country? A. It is often difficult for a central bank to act independently in a high-income country. B. The independence of a central bank does not depend on the level of a country's income. C. Low-income countries rarely have central banks. D. It is often difficult for a central bank to act independently in a low-income country.
Since the 1960s, M2 has grown more rapidly.
Since the 1975, which measure of the money supply has grown more rapidly, M1 or M2?
B. The amendment would likely have little effect on the Fed and would simply quiet dissenters who don't believe the Fed is constitutional. D. The Fed already serves the role described in the hypothetical amendment.
Suppose that the U.S. Constitution were amended to include the following: "Congress shall establish a central bank that will be responsible for conducting the monetary policy of the United States." What effect would such an amendment be likely to have on the Fed? (Check all that apply.) A. The amendment would cause the making of monetary policy to be transferred from a private organization to a public agency. B. The amendment would likely have little effect on the Fed and would simply quiet dissenters who don't believe the Fed is constitutional. C. If such an amendment were enacted, the U.S. dollar would likely undergo a large depreciation. D. The Fed already serves the role described in the hypothetical amendment.
Suppose that in Year 1 the price level equals 103 and the output level equals $12 trillion and that in Year 2 the price level equals 104 and the output level equals $20 trillion. In the AD-AS model, what shift in the aggregate demand curve or the aggregate supply curve would explain the movement in the price level and the output level that occurred from Year 1 to Year 2? ___ curve must have ___.
The aggregate demand, increased
True
What a saver would consider a financial asset a borrower would consider a financial liability. Is this statement true or false?
D. All of the above.
What actions did the Federal Reserve and Treasury take in dealing with the financial crisis? A. The Fed aggressively lowered interest rates and created several new credit windows for distressed banks. B. The Federal Reserve and the Treasury worked together to find a buyout partner for Bear Stearns. C. Congress passed the Troubled Asset Relief Program (TARP) and the Treasury actively worked with the Fed to ensure financial stability. D. All of the above.
A. true.
What actions does a central bank need to have the independence to say "no" to? A central bank needs to be able to say no to actions that would harm the economy, like excessive inflation from buying government bonds. The statement above is A. true. B. false.
Transactions costs are almost always high. There is increased time and effort spent looking for trading partners. There is a lack of standardization. There is difficulty in accumulating wealth.
What are the costs and sources of inefficiency in a barter system? (Check all that apply.)
B. The increase in ER/D was significantly larger than the decrease in C/D, causing the value of the money multiplier to decline.
What impact did these changes have on the size of the money multiplier? A. The increase in ER/D was significantly larger than the decrease in C/D, causing the value of the money multiplier to increase. B. The increase in ER/D was significantly larger than the decrease in C/D, causing the value of the money multiplier to decline. C. The increase in C/D was significantly larger than the decrease in ER/D, causing the value of the money multiplier to increase. D. The decrease in C/D was significantly larger than the increase in ER/D, causing the value of the money multiplier to decline.
A. Research has shown that the more independent a central bank is, the lower the inflation rate will be. Thus, one would expect the average inflation rate in less-developed countries to be higher than in industrial countries.
What implications does your answer have for what the average inflation rate is likely to be in high-income countries as opposed to low-income countries? A. Research has shown that the more independent a central bank is, the lower the inflation rate will be. Thus, one would expect the average inflation rate in less-developed countries to be higher than in industrial countries. B. The average inflation rate will be higher in low-income countries, but only because of the limited ability of the economy to expand production. C. Research has shown that the more independent a central bank is, the lower the inflation rate will be. Thus, one would expect the average inflation rate in less-developed countries to be lower than in industrial countries. D. Research has shown that the rate of inflation does not depend on the level of the central bank's independence.
C. The article indicates that $5 billion in capital was leveraged to $125 billion.
What information from this excerpt indicates that Long-Term Capital Management was highly leveraged? A. The article indicates that $1.25 trillion in capital was leveraged to $1 trillion. B. The article indicates that $125 billion in capital was leveraged to $5 billion. C. The article indicates that $5 billion in capital was leveraged to $125 billion. D. The article indicates that $1.25 trillion in capital was leveraged to $5 billion.
Hyperinflation is inflation that exceeds 100% per year.
What is a hyperinflation?
The central bank of the United States.
What is the Federal Reserve?
A very high rate of growth in the money supply.
What is the cause of hyperinflation?
C. A theory of central bank decision making that holds that officials act in the best interests of the public.
What is the public interest view of the Fed's motivation? A. A theory of central banking that holds that officials maximize their personal well-being rather than that of the general public. B. A theory of central banking that holds that officials maximize the public's interest in (and attitude toward) the affairs of the monetary authority. C. A theory of central bank decision making that holds that officials act in the best interests of the public. D. A theory of central bank decision making that holds that officials act in the best interests of the shareholders.
B. the ratio of the amount of deposits created by banks to the amount of new reserves.
What is the simple deposit multiplier? The simple deposit multiplier is A. the ratio of the amount of new reserves to the amount of deposits created by banks. B. the ratio of the amount of deposits created by banks to the amount of new reserves. C. the percentage of checkable deposits that the Fed specifies that banks must hold as reserves. D. the ratio of the amount of deposits created by banks to the amount of already existing reserves.
A. A theory of central banking that holds that officials maximize their personal well-being rather than that of the general public.
What is the principal-agent view? A. A theory of central banking that holds that officials maximize their personal well-being rather than that of the general public. B. A theory of central bank decision making that holds that officials act in the best interest of the public. C. A theory of central banking that holds that officials maximize the general public's well-being rather than their personal well-being. D. A theory of central bank decision making that holds that officials act in the best interest of the shareholders.
D. All of the above.
What problems did the decline in housing prices that began in 2006 cause for the financial system? A. Banks began to restrict credit to all but the safest borrowers--limiting the flow of funds from savers to borrowers. B. Many subprime and Alt-A borrowers, borrowers with adjustable rate mortgages, and borrowers who had made only small down payments defaulted on their mortgages. C. The value of mortgage-backed securities declined sharply--causing heavy losses for the investment institutions owning these securities. D. All of the above.
B. Congress wanted the Federal Reserve to operate independently of external political pressures.
When Kentucky Senator Rand Paul was running for the 2016 Republican presidential nomination, an article in the New York Times noted that: "Mr. Paul opposes the Federal Reserve's control of the money supply and interest rates, suggesting that such powers should be exercised by Congress." Source: "Rand Paul on the Issues,"New York Times, April 7, 2015. Why does Congress directly control fiscal policy--the federal government's decisions with respect to spending and taxes--but delegate the authority over monetary policy to the Federal Reserve? A. Congress doesn't have the expertise to set monetary policy. B. Congress wanted the Federal Reserve to operate independently of external political pressures. C. Congress wasn't able to agree on a monetary policy. D. Member banks refused to join the Federal Reserve System unless they had authority over monetary policy.
They are appointed by the president and confirmed by the Senate.
Who appoints the members of the Federal Reserve's Board of Governors?
Because a house is likely to increase in price while automobiles and refrigerators are less likely to gain in value.
Why is a bubble more likely to occur in the housing market rather than in the market for automobiles or the market for refrigerators?
D. All answers are correct.
Why might a central bank sometimes want to say "yes" to the above actions? A. These actions may be positive in times of extreme economic circumstances. For instance, in the fall of 2010 the Federal Reserve undertook "quantitative easing," which was the purchase of government debt. The action flooded banks with excess liquidity. B. When these actions can put downward pressure on exchange rates, increasing exports to spur recovery. C. When these actions can lower the cost of government borrowing in bad economic times. D. All answers are correct.
To make it easier for families to borrow money to purchase a home.
Why might the federal government decide to intervene in the housing market to promote home ownership?
The cost of negotiation with every investor holding the security may be prohibitively costly.
Why would securitization make renegotiating a loan more difficult?
Can the economy be in a short-run macroeconomic equilibrium without being in a long-run macroeconomic equilibrium?
Yes
If the long-run aggregate supply curve shifts, does the short-run aggregate supply curve also have to shift? (Hint: Consider the factors that shift each curve and determine whether these factors also shift the other curve.)
Yes
Direct, indirect
______ finance is a transaction between two parties where one party lends directly to the other party, whereas ______ finance involves three parties: the borrower, the lender, and a third party -- such as a bank.
A subprime borrower, An Alt-A borrower
______ is a borrower with a flawed credit history and ______ is a borrower who states his or her income but does not document or prove the amount of income.
A securitized loan
______ is a collection of loans packaged together that pays an interest payment to the owner of the loan.
A bond
______ is a financial security issued by a corporation or government to borrow money in exchange for the rights to an interest payment.
Foreign exchange
______ is a unit of foreign currency.
Money
______ is anything that people are willing to accept in payment for goods and services or to pay off debts.
What policies might the Federal Reserve use to counteract an aggregate demand shock? The Fed would conduct a contractionary monetary policy to counteract a ___ demand shock, and it would implement this by ___ Treasury securities and ___ interest rates.
positive, selling, raising