FIN 221 Chapter 2 & 6 Intro Exercises

Micro Gates bought Microsoft stock for $68 a year ago and has received $1.56 in dividends. Microsoft's current price is $75 a share. What is Mic's rate of return if he sells Intel at the current price? (Express your answer as a percentage 0.1 = 10% or 10)

12.6

You recently sold to your brother 200 shares of Disney stock, and the transfer was made through a broker. This is an example of:

A secondary market transaction.

Which of the following statements is CORRECT?

Capital market instruments include both long-term debt and common stocks.

Which of the following is correct?

Hedge funds are not as highly regulated as most other types of financial institutions. The justification for this light regulation is that only "sophisticated" investors (i.e., those with high net worths and high incomes) are permitted to invest in these funds, and such investors supposedly can do the necessary "due diligence" on their own rather than have it done by the SEC or some other regulator.

Which of the following are included in the nominal interest rate for a long-term US Treasury bond? a. Maturity risk premium b. Default risk premium c. Liquidity premium d. All of the above.

a. Maturity risk premium

Which of the following would be an example of a defined benefit pension plan? a. Social Security b. A 401K Plan c. An IRA d. None of the above

a. Social Security

Which of the following is an example of a primary market transaction? a. A bank sells a mortgage to another bank. b. An IPO. c. Dave Letterman buys Viacom stock from his Uncle Earl. d. None of the above.

b. An IPO.

Which of the following statements is CORRECT? a. Capital market transactions involve only preferred stock or common stock. b. Both Nasdaq dealers and "specialists" on the NYSE hold inventories of stocks. c. Money market transactions do not involve securities denominated in currencies other than the U.S. dollar. d. If General Electric were to issue new stock this year, it would be considered a secondary market transaction since the company already has stock outstanding. e. The most important difference between spot markets versus futures markets is the maturity of the instruments that are traded. Spot market transactions involve securities that have maturities of less than one year whereas futures markets transactions involve securities with maturities greater than one year.

b. Both Nasdaq dealers and "specialists" on the NYSE hold inventories of stocks.

Which of the following would be an example of a primary market transaction? a. Buying shares of a closed-end mutual fund b. Buying shares of an open-ended mutual fund c. Buying a share of Berkshire Hathaway from your grandma. d. None of the above

b. Buying shares of an open-ended mutual fund

Which of the following statements is CORRECT? a. Because of increased globalization, all of the world's stock markets are equally efficient as that term is defined in the text. b. If a market is semistrong-form efficient, this implies that above-average returns cannot be achieved by analyzing publicly available data because such information is already reflected in stock prices. c. If your uncle earned a higher return on his portfolio over a 10-year period than the return on the overall stock market, this would demonstrate that the stock market is inefficient. d. If a market is strong-form efficient, this implies that the returns on bonds and stocks should be identical. e. If a market is weak-form efficient, this implies that above-average returns can best be achieved by focusing on past movements of stock prices.

b. If a market is semistrong-form efficient, this implies that above-average returns cannot be achieved by analyzing publicly available data because such information is already reflected in stock prices.

Which of the following statements is CORRECT? Selected Answer:c. The maturity premiums embedded in the interest rates on U.S. Treasury securities are due primarily to the fact that the probability of default is higher on long-term bonds than on short-term bonds.Correct Answer:b. Reinvestment rate risk is lower, other things held constant, on long-term than on short-term bonds.

b. Reinvestment rate risk is lower, other things held constant, on long-term than on short-term bonds.

The real risk-free rate of interest is expected to remain constant at3% for the foreseeable future. However, inflation is expected to increase steadily over the next 30 years, so the Treasury yield curve has an upward slope. Assume that the pure expectations theory holds. You are also considering two corporate bonds, one with a 5-year maturity and one with a 10-year maturity. Both have the same default and liquidity risks. Given these assumptions, which of these statements is CORRECT? a. Since the pure expectations theory holds, 10-year corporate bonds must have the same yield as 10-year Treasury bonds. b. The 10-year corporate bond must have a higher yield than the 5-year corporate bond. c. Since the pure expectations theory holds, all 5-year Treasury bonds must have higher yields than all 10-year Treasury bonds. d. The 10-year Treasury bond must have a higher yield than the 5-year corporate bond. e. Since the pure expectations theory holds, the 10-year corporate bond must have the same yield as the 5-year corporate bond.

b. The 10-year corporate bond must have a higher yield than the 5-year corporate bond.

Inflation is expected to increase steadily over the next 10 years, there is a positive maturity risk premium on both Treasury and corporate bonds, and the real risk-free rate of interest is expected to remain constant. Which of the following statements is CORRECT? a. The yield on 7-year corporate bonds must exceed the yield on 10-year Treasury bonds. b. The yield on 10-year Treasury securities must exceed the yield on 7-year Treasury securities. c. The Treasury yield curve under the stated conditions would be humped rather than have a consistent positive or negative slope. d. The stated conditions cannot all be true-they are internally inconsistent. e. The yield on any corporate bond must exceed the yield on any Treasury bond.

b. The yield on 10-year Treasury securities must exceed the yield on 7-year Treasury securities.

What price would you pay if you were to buy a share of stock on the NASDAQ? a. the bid price b. the ask price c. the average of the bid and ask price d. None of the above

b. the ask price

Assume that the current corporate bond yield curve is upward sloping, or normal. Under this condition, we could be sure that a.Inflation is expected to decline in the future b.Maturity risk premiums could help to explain the yield curve's upward slope. c.Long-term interest rates are more volatile than short-term rates. d.Long-term bonds are a better buy than short-term bonds. .The economy is not in a recession.

b.Maturity risk premiums could help to explain the yield curve's upward slope.

Which of the following statements is CORRECT? a. Hedge funds are legal in Europe and Asia, but they are not permitted to operate in the United States. b. Hedge funds are legal in the United States, but they are not permitted to operate in Europe or Asia. c. Hedge funds are not as highly regulated as most other types of financial institutions. The justification for this light regulation is that only "sophisticated" investors (i.e., those with high net worths and high incomes) are permitted to invest in these funds, and such investors supposedly can do the necessary "due diligence" on their own rather than have it done by the SEC or some other regulator. d. Hedge funds have more in common with investment banks than with any other type of financial institution. e. Hedge funds have more in common with commercial banks than with any other type of financial institution.

c. Hedge funds are not as highly regulated as most other types of financial institutions. The justification for this light regulation is that only "sophisticated" investors (i.e., those with high net worths and high incomes) are permitted to invest in these funds, and such investors supposedly can do the necessary "due diligence" on their own rather than have it done by the SEC or some other regulator.

Which of the following is a primary market transaction? a. You buy 200 shares of IBM stock from your brother. The trade is not made through a broker-you just give him cash and he gives you the stock. b. IBM sells 2,000,000 to its employees when they exercise options granted in prior years. c. IBM issues 2,000,000 shares of new stock and sells them to the public. d. You sell 200 shares of IBM stock on the NYSE through your broker. e. One financial institution buys 200,000 shares of IBM stock from another institution. An investment banker arranges the transaction.

c. IBM issues 2,000,000 shares of new stock and sells them to the public.

What is the shape of the yield curve if 20-year treasury bond rates exceed 1-year treasury bond rates? a. Downward sloping b. Flat c. Upward sloping d. None of the above

c. Upward sloping

The real risk-free rate is expected to remain constant at 3% in the future, a 2% rate of inflation is expected for the next 2 years, after which inflation is expected to increase to 4%, and there is a positive maturity risk premium that increases with years to maturity. Given these conditions, which of the following statements is CORRECT? a.The yield on a 2-year T-bond must exceed that on a 5-year T-bond. b.The conditions in the problem cannot all be true-they are internally inconsistent. c.The yield on a 5-year Treasury bond must exceed that on a 2-year Treasury Bond d.The Treasury yield curve under the stated conditions would be humped rather than have a consistent positive or negative slope. e.The yield on a 7-year Treasury bond must exceed that of a 5-year corporate bond.

c.The yield on a 5-year Treasury bond must exceed that on a 2-year Treasury Bond

What does a downward sloping yield curve mean according to the pure expectations hypothesis? a. Investors expect the maturity risk premium to rise in the future. b. Investors expect interest rates to be higher in the future. c. Investors expect interest rates to remain the same in the future. d. Investors expect interest rates to be lower in the future.

d. Investors expect interest rates to be lower in the future.

Suppose the rate of return on a 10-year T-bond is 5.00% and that on a 10-year Treasury Inflation Protected Security (TIP) is 2.10%. Suppose further that the expected average rate of inflation over the next 10 years is 2.0%, that the MRP on a 10-year T-bond is 0.9%, that no MRP is required on TIPs, and that no liquidity premiums are required on any T-bonds. Given this data, what is the real risk free rate of return, r*? Disregard cross-product terms, i.e., if averaging is required, use the arithmetic average. a. 2.00% b. 1.90% c. 1.80% d. 1.70% e. 2.10%

e. 2.10%