Exam 1 Review

What are differences between a bond and a common stock?

- A bond is a debt instrument that entitles the owner to receive periodic amounts of money until its maturity​ date, whereas a common stock represents a share of ownership of the institution that has issued the stock. - A corporation has to pay all bondholders before paying stockholders.

Assume the bonds below have the same yield to maturity, face value and maturity date. Which has the lowest price? - A coupon bond with an annual coupon and coupon rate of 2% - A discount bond - Cannot be determined - A coupon bond with a semi-annual coupon and coupon rate of 5%

A discount bond

Which of the following is an example of financial​ intermediation? - A saver makes a deposit in a credit​ union, and the credit union makes a loan to a member for a new car. - IBM issues common stock that is sold to a college student. - IBM issues a bond that is sold to a retired person. - U.S. Treasury sells bonds to fund government spending.

A saver makes a deposit in a credit​ union, and the credit union makes a loan to a member for a new car.

​People, in​ general, do not lend money to one another to buy a house or a car​ because: - of information problems. - they do not know about the capacity of other people to repay their debts. - they do not know about the effort other people will provide to repay their debts. - All of the above.

All of the above.

Which of the following is correct about asymmetric information problems in financial markets? - Solutions to asymmetric information problems often rely on the government's ability to enforce contracts. - All of these are correct. - Solutions to asymmetric information problems are costly. - Asymmetric information problems never fully disappear.

All of these are correct.

Suppose demand for Treasury securities decreases and inflation expectations remain constant. Which of the following is correct? - The nominal interest rate rises and the real interest rate falls. - Both the nominal and real interest rate fall. - The nominal interest rate falls and the real interest rate rises. - Both the nominal and real interest rate rise.

Both the nominal and real interest rate rise.

Suppose the market for loans is made up of 75% low default risk borrowers and 25% percent high default risk borrowers. A financial intermediary must collect a 3% interest rate on a low-risk loan and 9% interest rate on a high risk loan in order to be profitable. Low-risk borrowers are willing to pay a 4% interest rate and high-risk borrowers are willing to pay a 10% interest rate. Assume the financial intermediary cannot verify whether a borrower is high-risk or low-risk. What is a potential solution to the problem and why might it work? - Charge all borrowers the average of the high-risk and low-risk rate. This would guarantee the lender at least breaks even. - Charge borrowers who can provide sufficient collateral the low-risk rate and charge those without collateral the high-risk rate. Providing collateral is low-cost to low-risk borrowers and too costly for high-risk borrowers. - Require all borrowers use the funds for approved purposes. This would allow lenders to guarantee funds are not misspent. - Require all borrowers provide collateral.

Charge borrowers who can provide sufficient collateral the low-risk rate and charge those without collateral the high-risk rate. Providing collateral is low-cost to low-risk borrowers and too costly for high-risk borrowers.

_____ securities most often specify dates and amount of payments in the contract. - Equity - Debt - Both debt and equity

Debt

Which of the following is an example of the moral hazard problem? - Equity holders of Fictional First bank persuade bank managers to borrow funds and make more loans. After some of the loans default, Fictional First risks insolvency. - Eddie the entrepreneur borrows $400,000 to start a business. He then goes to Las Vegas to gamble with some of the funds. - Al took out an adjustable rate mortgage in 2005. After the interest rate increased, he was no longer able to afford the payments and defaulted on the loan. - All of these answers are correct - Speedy auto insurance does not try to differentiate safe drivers from risky drivers. Speedy charges relatively high premiums and generally attracts the riskiest drivers.

Eddie the entrepreneur borrows $400,000 to start a business. He then goes to Las Vegas to gamble with some of the funds.

Emily plans on purchasing a car and can afford payments of $400 per month, a five year loan and a $20,000 car. While she contemplates her purchase, interest rates decrease. This means - Emily must purchase a cheaper car. - the value of the car Emily can afford does not change. - Emily can afford a more-expensive car.

Emily can afford a more-expensive car.

Firms expect the inflation rate to increase in the future. How does this impact a firm's decision to borrow funds today? - Expected inflation does not impact a firm's decision to borrow today. The firm will be collecting higher prices on goods produced and the dollar value of the debt does not change. - Firms are more likely to borrow funds today. The goods that a firm produces and sells are expected to sell at higher prices than previously expected, reducing the burden of the debt. - Firms are less likely to borrow funds today. Firms will collect dollars that have less purchasing power, increasing the burden of the debt. - Firms are less likely to borrow funds today. The goods that a firm produces and sells are expected to sell at higher prices than previously expected, increasing the burden of the debt.

Firms are more likely to borrow funds today. The goods that a firm produces and sells are expected to sell at higher prices than previously expected, reducing the burden of the debt.

How does a fall in the value of the pound sterling affect British​ consumers?

Foreign goods are now relatively more​ expensive; British consumers are hurt. This will also cause American businesses to be worse off.

Which of the following would cause an increase in demand for corporate bonds? - Investors perceive corporate bonds to be more risky. - Economic expansion results in corporations issuing more bonds. - Household income increases. - Investors expect interest rates to rise in the near future.

Household income increases.

Suppose the the yield curve is fairly flat. Which of the following is the best explanation for a flat yield curve? - Investors expect decline in economic activity and a decline in short-term interest rates. - Investors expect a decrease in inflation and that short-term yields will rise in the future. - Investors expect an increase in economic activity and that short-term yields will fall in the future. - Investors expect an increase in inflation and that short-term yields will fall in the future.

Investors expect decline in economic activity and a decline in short-term interest rates.

Is Bitcoin considered money in the United States? Select the correct answer and explanation. - Yes, it is acceptable as payment for goods and services. - Yes, it is a store of value. - No, it does not work as a medium of exchange. - No, goods and services are not priced in money and it is not legal tender.

No, goods and services are not priced in money and it is not legal tender.

Which of the following ratings granted by bond ratings agencies is associated with the lowest probability of default? - Highly Speculative - Speculative - Substantial Risk - Non-investment Grade

Non-investment Grade

_____ securities do not mature. - Bond - Stock (equity) - Loan

Stock (equity)

Which of the following is true? - Bonds have no maturity date. - Bonds are a share of ownership in the firm. - Stockholders generally receive nothing in the event of bankruptcy. - There is a specified amount that stocks will pay out while the investor owns the security.

Stockholders generally receive nothing in the event of bankruptcy.

What is a risk premium? - The extra yield investors require to hold a high risk asset relative to a low-risk asset. - The nominal interest rate minus the inflation rate. - The higher price that investors are willing to pay for safe assets.

The extra yield investors require to hold a high risk asset relative to a low-risk asset.

What is the typical relationship between interest rates on​ 6-month Treasury​ bills, 10-year Treasury​ notes, and Baa corporate​ bonds?

They tend to move together over time with the corporate bond having the highest rate of interest.

_____ are an example of a money market instrument. - Stocks (equity) - Treasury Bills - Long-term bonds

Treasury Bills

Which of the following is an example of a money market​ instrument? - a John Deere bond with 20 years to maturity - a mortgage - U.S. government treasury bill with six months to maturity - a share of stock in IBM

U.S. government treasury bill with six months to maturity.

Which of the following is a capital market instrument? - a AAA-rated corporate bond - commercial paper - Federal Funds - Treasury bills

a AAA-rated corporate bond

Which of the following is not considered money (M1 or M2) in the United States today? - a checking deposit in the amount of $100. - a $20 bill. - a savings deposit in the amount of $10,000. - None of these answers are correct - a retail money market account deposit in the amount of $30,000. - a U.S.Treasury security with $100,000 face value.

a U.S.Treasury security with $100,000 face value.

Which of the following assets is the most liquid? - a gold coin - a share of Apple stock - a checking account deposit

a checking account deposit

A pension fund is an example of - All of these answers are correct - a depository institution. - a contractional savings institution. - an investment intermediary.

a contractional savings institution.

Assume the Fisher Effect holds and the expected inflation rate decreases by one percentage point. This causes - a decrease in the real interest rate of one percentage point. - a decrease in the nominal interest rate of one percentage point. - an increase in the nominal interest rate of one percentage point. - no change in the nominal or real interest rate. - an increase in the real interest rate of one percentage point.

a decrease in the nominal interest rate of one percentage point. Fisher Equation i = r + inf r = i - inf

Which of the following is true about corporate bonds? - a greater value of corporate bonds is issued every year compared to new stock issuances. - the value of corporate bonds outstanding exceeds the value of the stock market. - corporate bonds are usually issued by firms with low credit ratings. - All of these answers are correct

a greater value of corporate bonds is issued every year compared to new stock issuances.

Which of the following is NOT considered money in the United States? - a $20 bill - a share of Apple stock - a savings account deposit

a share of Apple stock

The chief financial officer​ (CFO) of a large corporation that wishes to borrow​ $100 million to construct a factory in the United States should use the _____ market.

bond

A key assumption of the expectations theory of yield curves is that - bonds of all maturities are perfect substitutes. - investors are risk-averse. - investors prefer long-term bonds to short-term bonds. - investors prefer short-term bonds to long-term bonds.

bonds of all maturities are perfect substitutes.

The suppliers of bonds are - borrowers. - savers. - the government.

borrowers.

When individuals finance cars with car dealerships, they often get loans from finance companies. How do finance companies get the funds to make loans? - by issuing long-term bonds - by selling commercial paper - by taking deposits from households and firms - by selling Treasury bills, notes, and bonds

by selling commercial paper

Liquid assets are desirable because they - have relatively low yields. - are not very risky. - have relatively high yields. - are not traded very often. - can be turned into cash quickly and at low cost.

can be turned into cash quickly and at low cost.

Lenders attempt to solve the adverse selection problem by - carefully writing contracts that are specific about how loan funds can be used (covenants). - charging high interest rates on loans to cover losses in case of default. - making lots of loans to diversify risk of default. - carefully screening borrowers credit histories before lending.

carefully screening borrowers credit histories before lending.

Which of the following is money market instrument? - a 10-year Treasury security - a consumer loan - commercial paper - a share of Microsoft stock - a mortgage-backed security

commercial paper

Eddie the investor purchases a security issued by Coca-Cola that pays $20 every six months and $1000 in ten years. After that, the contract expires. This is an example of a - discount bond. - fixed-payment loan. - simple loan. - coupon bond.

coupon bond.

Suppose a coupon bond is trading at a premium, or price is greater than face value. This means that - coupon rate is equal to yield to maturity. - coupon rate is greater than yield to maturity. - yield to maturity must be negative. - coupon rate is less than yield to maturity.

coupon rate is greater than yield to maturity.

If expected inflation increases, households ____ demand for bonds, firms ____ the supply of bonds and the nominal interest rate _____ . - decrease; increase; increases - increase; decrease; decreases - decrease; increase; decreases - increase; increase; increases

decrease; increase; increases

According the the liquidity preference model (money supply/money demand), the quantity of money demanded by households ______ as the nominal interest rate increases. - increases - decreases - remains unchanged - is uncertain

decreases

Risky assets have higher yields than relatively safe assets because - demand for risky assets is higher than for save assets. - demand for risky assets is lower than for safe assets. - supply of risky assets is higher than safe assets. - investors seek high returns.

demand for risky assets is lower than for safe assets.

Risky assets have higher yields than relatively safe assets because - supply of risky assets is higher than safe assets. - demand for risky assets is higher than for save assets. - demand for risky assets is lower than for safe assets. - investors seek high returns.

demand for risky assets is lower than for safe assets.

Suppose investors change expectations and perceive Treasury securities to be safer than other assets. As a result, - supply decreases price rises. - demand increases and price rises. - supply increases price falls. - supply decreases and price falls. - demand decreases and price rises.

demand increases and price rises.

Eddie, an entrepreneur, raises funds by selling shares in his new firm to an old college buddy. This is an example of - indirect finance. - securitization. - direct finance. - financial intermediation.

direct finance.

A bond that pays only a payment at maturity is called a(n) - discount bond. - annuity. - perpetuity. - coupon bond.

discount bond.

Which of the following is not a solution to asymmetric information problems? - require collateral - diversification - detailed debt contracts

diversification

The periodic payments on an equity security are called - discount payments. - coupon payments. - dividends. - fixed payments.

dividends.

Lulu withdraws $100 cash from her deposit account at Mid First bank (assume Mid First had the funds in excess reserve). The immediate result is M1 _____ and M2 _____ . - decreases; increases - increases; decreases - decreases; does not change - increases; does not change - does not change; does not change

does not change; does not change

The cost per security to purchase a share of stock or a bond is greater for an individual than a financial intermediary. This statement illustrates the concept of - risk spreading. - asymmetric information. - expertise. - economies of scale.

economies of scale.

The term bank generally includes all of the following institutions except​: - finance companies. - commercial banks. - credit unions. - savings and loan associations.

finance companies.

Which of the following in the most important source of external funds to finances business? - sale of equity to the public - financial intermediaries like banks - bond issues

financial intermediaries like banks

Commodity money - does not function as a medium of exchange. - has never been used as money in the United States. - has value in addition to being money. - is otherwise valueless paper made money by law. - does not function as a store of value.

has value in addition to being money.

Money market instruments - are only issued by the U.S. Treasury. - include stocks and corporate bonds. - are riskier than capital market instruments. - have maturities less than one year.

have maturities less than one year.

According to the Consumer Financial Protection Bureau, millions of Americans do not have credit enough credit history to create a credit score. Lenders cannot tell if a borrower without a credit score is a high or low risk of default, so all of these borrowers are treated as _________ . This is an example of _____________ . - low risk; moral hazard - high risk; adverse selection - high risk; moral hazard - low risk; adverse selection

high risk; adverse selection

Owners of municipal bonds are allowed to exempt some earnings from income taxes. When compared to bonds with similar risk, liquidity, and contract terms municipal bonds likely have ____ prices and ____ yields. - higher; higher - higher; lower - lower; lower - lower; higher

higher; lower

According to the liquidity preference theory, - households earn interest on both non-monetary and monetary assets. - households earn interest on non-monetary assets. - households earn interest on monetary assets.

households earn interest on non-monetary assets.

Olga holds an ACME discount bond with face value of $1000 that matures in 10 years. This means - over the course of 10 years, Olga is entitled to periodic payments from ACME. - Olga holds a share of ownership in ACME for 10 years. - Olga holds a share of ownership in ACME until she sells the bond or the firm ceases to exist. - in 10 years, Olga receives $1000 from ACME and contract expires.

in 10 years, Olga receives $1000 from ACME and contract expires.

Granny withdraws $10,000 from her savings account in currency and purchases nine ounces of gold from Junior. Junior deposits the funds in his checking account. As a result M1 _______ and M2 ________ . - increases; decreases - increases; increases - decreases; does not change. - increases; does not change - decreases; decreases

increases; does not change

According to the liquidity preference (money supply/demand) model, if price level rises, money demand ______ and nominal interest rate ______. - increases; decreases - decreases; increases - increases; increases - decreases; decreases

increases; increases

When the size of the government budget deficit increases supply of Treasury securities _____ and yields ____. - decreases; rises - increases; falls - decreases; fall - increases; rise

increases; rise

Which of the following is NOT a function of financial intermediaries. - reducing transaction costs to saver. - increasing the return on assets. - reducing risk to the savers.

increasing the return on assets.

Al receives a bank loan to expand is auto dealership. This is an example of - indirect finance. - a secondary market transaction. - securitization. - direct finance.

indirect finance.

What shape of yield curve is uncommon? - inverted or downward sloping - both are equally common - upward sloping

inverted or downward sloping

The liquidity premium theory of yield curves includes the realistic assumption that - investors prefer long-term bonds to short-term bonds. - investors are risk-averse. - bonds of all maturities are perfect substitutes. - prices of short-term bonds are determined independently of long-term bonds.

investors are risk-averse.

The coupon rate of a conventional coupon bond - is the amount the investor collects when the security matures. - varies as yield to maturity changes. - is part of the security contract and does not change. - is the price the investor pays to purchase a security.

is part of the security contract and does not change.

An asset is considered liquid if - it has a low yield to maturity. - it can be bought or sold quickly with little cost. - it is not very risky. - it has a long maturity date. - it has a high yield to maturity.

it can be bought or sold quickly with little cost.

Which theory of yield curves is most realistic? - segmented markets theory - expectations theory - liquidity premium theory

liquidity premium theory

Suppose the market for loans is made up of 75% low default risk borrowers and 25% percent high default risk borrowers. A financial intermediary must collect a 3% interest rate on a low-risk loan and 9% interest rate on a high risk loan in order to be profitable. Low-risk borrowers are willing to pay a 4% interest rate and high-risk borrowers are willing to pay a 10% interest rate. Assume the financial intermediary cannot verify whether a borrower is high-risk or low-risk. What in the result of the intermediary's inability to distinguish high-risk and low-risk borrowers? - borrowers take on too much debt - loans do not get made to high-risk borrowers - loans do not get made to the low-risk borrowers - no loans are made

loans do not get made to the low-risk borrowers

According to the liquidity preference theory, - neither monetary nor non-monetary assets earn interest. - monetary assets do not earn interest. - non-monetary assets do not earn interest.

monetary assets do not earn interest.

Fiat money is - money with intrinsic value. - money made valuable by law. - expensive to create.

money made valuable by law.

Which type of investment intermediary offers services to customers that are very similar to savings accounts? - pension funds - money market mutual funds - finance companies - investment banks

money market mutual funds

Tess has borrowed funds to start a bicycle shop. She decides to keep the shop closed on weekends, reducing her chances of success. This is an illustration of the ____ problem. - agency - moral hazard - adverse selection - asymmetric

moral hazard

Harry gets a loan to purchase a house. After buying the house, he decides to knock the building down and build a grass hut in its place, reducing the value of the property. This is an example of the ______ problem the lender could solve this problem by ______. - moral hazard; including covenants in the loan contract about how the property can be used - adverse selection; including covenants in the loan contract about how the property can be used - moral hazard; requiring collateral - adverse selection; requiring a credit score

moral hazard; including covenants in the loan contract about how the property can be used

Bonds issued by state and local governments are called - Treasury bonds. - tax-free bonds. - municipal bonds. - common bonds.

municipal bonds.

Suppose the market for loans is made up of 75% low default risk borrowers and 25% percent high default risk borrowers. A financial intermediary must collect a 3% interest rate on a low-risk loan and 9% interest rate on a high risk loan in order to be profitable. Low-risk borrowers are willing to pay a 4% interest rate and high-risk borrowers are willing to pay a 10% interest rate. Assume the financial intermediary cannot verify whether a borrower is high-risk or low-risk. Suppose the intermediary offers an interest rate of 4.5%. Who will accept these terms? - only the low-risk borrowers - only the high-risk borrowers - neither type of borrowers - both types of borrowers

only the high-risk borrowers

Commercial banks reduce risk faced by savers by - charging low interest rates on loans. - pooling funds and diversifying types of loans. - specializing in one type of loan. - transferring long-term deposits into short-term loans.

pooling funds and diversifying types of loans.

Commercial banks reduce risk faced by savers by - pooling funds and diversifying types of loans. - charging low interest rates on loans. - transferring long-term deposits into short-term loans. - specializing in one type of loan.

pooling funds and diversifying types of loans.

What happens to present value (price) of a fixed-income security if yield to maturity rises? - present value remains the same - present value increases - present value decreases

present value decreases

Joel purchases collision insurance from an auto-insurance provider. What does the insurer likely do with Joel's premiums? - purchases relatively safe and liquid assets - holds cash - purchases speculative and high-yield assets - purchases common stock

purchases relatively safe and liquid assets

Barter can lead to efficiency gains over the use of money. results in an increase in economic activity. - requires the double coincidence of wants. was common in the United States prior to the establishment of the Federal Reserve.

requires the double coincidence of wants.

Sally gets a loan at 20% annual interest from a jewelry store to buy a bracelet, even though she can afford to pay cash, in order to build credit history and increase her credit score. Sally is _______ and in order to solve the _______ problem. - acting irrationally; adverse selection - sending a costly signal of creditworthiness; moral hazard - testing whether she can afford credit; moral hazard - sending a costly signal of creditworthiness; adverse selection

sending a costly signal of creditworthiness; adverse selection

When households get loans from financial intermediaries to purchase homes, cars, or other goods and services they are ____ of securities. The entities that hold the contracts and collect payments are the _____ of the securities. - suppliers; demanders - suppliers; suppliers - demanders; demanders - demanders; suppliers

suppliers; demanders

During periods of growth and expansion, both the supply of and demand for corporate bonds increase. Usually, the _____ effect dominates and yields _____. - supply; rise - demand; fall - supply; fall - demand; rise

supply; rise

Which of the following is NOT a financial intermediary? - the Arizona State Employee pension fund - life insurance company - the Federal Reserve - a consumer finance company that makes auto loans - Bank of America

the Federal Reserve

According to liquidity reference theory, what determines the money supply? - households and firms - the expected inflation rate - the central bank

the central bank

The real interest rate is - the difference between the expected inflation rate and nominal interest rate. - the difference between the nominal interest rate and expected inflation rate. - the sum of the nominal interest rate and expected inflation rate.

the difference between the nominal interest rate and expected inflation rate. Fisher Equation i = r + inf r = i - inf

Consider the liquidity premium theory of yield curves. The liquidity premium is best described as - the extra yield to compensate investors to hold bonds with higher default probabilities relative to low-default securities. - All of these answers are correct - the extra yield investors require to hold short-term bonds instead of long-term bonds. - the extra yield investors require to hold long-term bonds instead of short-term bonds.

the extra yield investors require to hold long-term bonds instead of short-term bonds. Investors are likely to prefer short-term bonds over long-term bonds

Adverse selection problems in lending markets can be solved by private parties producing information about borrowers risk. However, information is costly to collect. Once produced, it becomes a public good. What is the problem that occurs when people take advantage of public goods they have not paid for? - the moral hazard problem - the free rider problem - the adverse selection problem - the agency problem

the free rider problem

Which of the following does not change over contract period of a coupon bond? - current yield - the frequency of coupon payments - yield to maturity - return - price

the frequency of coupon payments

Normally, if investors expect a decline in economic activity, - the yield curve gets flatter or becomes inverted. - the yield curve shape is uncertain. - the yield curve shifts upward. - the yield curve gets steeper.

the yield curve gets flatter or becomes inverted.

Suppose the liquidity premium theory of yield curves is correct. If investors expect short-term yields to remain constant, - the yield curve is flat. - the yield curve is inverted. - the yield curve shape is uncertain. - the yield curve is slightly upward sloping.

the yield curve is slightly upward sloping.

The yield curve referred to in the text and videos is a graphical representation of - the yield to maturity of government bonds with different maturity dates. - the yield to maturity of long-term bonds with different risk profiles. - the yield to maturity of corporate bonds with different maturity dates.

the yield to maturity of government bonds with different maturity dates.

Banks exist​ because: - they are able to mitigate information problems. - they are able to lend money without requiring any collateral.

they are able to mitigate information problems.

Commercial banks provide a service to lenders and savers by - charging high interest rates. - specializing in one type of loan. - turning short-term deposits into long-term loans. - purchasing structured securities.

turning short-term deposits into long-term loans.

The most common shape of the yield curve for U.S. Treasury securities is - downward-sloping (inverted) - flat - upward-sloping - none. No shape is common.

upward-sloping

The coupon rate of a debt security is the - value of the annual coupon payments expressed as a percent of the face value. - percent of face value paid in coupon payments for the period of time the investor hold the security. - value of the annual coupon payments expressed as a percent of the price. - number of coupon payments made in a year. - the current yield.

value of the annual coupon payments expressed as a percent of the face value.

Suppose the expected return on a 1 year bond and a 10 year bond are the same. A risk averse investor - will purchase the 1 year bond. - will purchase the 10 year bond. - is indifferent between the two bonds since the expected return is the same.

will purchase the 1 year bond. Despite the same expected return, long-term bonds are still riskier than short-term bonds.

If expected inflation increases, - the yield curve gets flatter or becomes inverted. - the yield curve shifts downward. - yield curves get steeper. - short-term yields fall.

yield curves get steeper.

Under what conditions might a bond holder experience a loss? - yield to maturity falls sufficiently - yield to maturity increases sufficiently - none, bondholders do not experience losses. - face value increases

yield to maturity increases sufficiently

Which of the following is true of the link between​ well-performing financial markets and economic​ growth? - Financial markets promote economic efficiency by channeling funds from people who have a productive use for them to those who do not. - ​Well-performing financial markets reduce the efficiency of financing​ decisions, leading to an increase in economic growth. - ​Well-performing financial markets allocate funds to their more efficient​ use, thereby allowing the best investment opportunities to be undertaken.

​Well-performing financial markets allocate funds to their more efficient​ use, thereby allowing the best investment opportunities to be undertaken.