final exam

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Will a U.S. Treasury bill have a risk premium that is higher​ than, lower​ than, or the same as that of a similar security​ (in terms of maturity and​ liquidity) issued by the government of​ Colombia?

A U.S. Treasury bill will have a lower risk premium since U.S. government issued securities are usually considered to be default free.

Which of the following does not describe an​ off-balance-sheet activity? A. A bank writes a mortgage and sells it to a life insurance company. B. A bank exchanges dollars for euros for a large corporate customer. C. A bank makes a loan to a large corporate customer. D. A bank guarantees a​ firm's debt by signing a​ banker's acceptance.

A bank makes a loan to a large corporate customer.

A bank almost always insists that the firms it lends to keep compensating balancesLOADING... at the bank.​ Why? ​(Check all that​ apply.)

A. Compensating balances help establish​ long-term customer​ relationships, which make it easier for the bank to collect information about prospective​ borrowers, thus reducing the adverse selection problem C. Compensating balances can act as collateral D. Compensating balances help the bank monitor the activities of a borrowing​ firm, which reduces the moral hazard problem

If a bank is falling short of meeting its capital requirements by​ $1 million, what three things can it do to rectify the​ situation? ​(Check all that​ apply.)

Call in existing loans in an attempt to decrease its asset holdings. Issue stock. Decrease dividend payments to increase retained earnings.

To pay for​ college, you have just taken out a​ $1,000 government loan that makes you pay​ $126 per year for 25 years.​ However, you​ don't have to start making these payments until you graduate from college two years from now. Why is the yield to maturity necessarily less than​ 12% (this is the yield to maturity on a normal​ $1,000 fixed-payment loan in which you pay​ $126 per year for 25​ years)?

D. This is the case because the first payment due begins at a future date.

The president of the United States can exert influence over the Federal Reserve in all of the following ways except​: A. influencing congressional decisions that might reduce the independence of the Fed. B. appointing new members to the Board of Governors. C. appointing a new chairman to the Board of Governors. D. reducing the​ Fed's net earnings.

D. reducing the​ Fed's net earnings.

Why are deposit insurance and other types of government safety nets important to the health of the​ economy?

Deposit insurance and other government safety nets help to eliminate a contagion effect.

When depositors withdraw funds from commercial banks to seek other more attractive​ assets, deposit losses in the banking system may restrict the amount of funds that banks can lend. Which of the following identifies this​ process?

Disintermediation

​"Bank managers should always seek the highest return possible on their​ assets." Is this statement​ true, false, or​ uncertain?

False. A bank must also consider an​ asset's risk and liquidity when deciding which assets to hold.

​"According to the expectations theory of the term​ structure, it is better to invest in​ one-year bonds, reinvested over two​ years, than to invest in a​ two-year bond, if interest rates on​ one-year bonds are expected to be the same in both​ years." Is this statement​ true, false, or​ uncertain

False: These investments are almost of the same profitability.

The bank panic of 1907 led to the passage of​ the:

Federal Reserve Act of 1913

Which of the following is not a difficulty in the regulation and supervision of​ banks?

Financial institutions are not required to follow the rules

People in the United States in the nineteenth century were sometimes willing to be paid by cheque rather than with​ gold, even though they knew that there was a possibility that the cheque might bounce. Which of the following would represent an advantage of gold over cheques as a form of​ money?

Gold has intrinsic value when compared to cheques

Why does the existence of deposit insurance increase the likelihood that depositors will need deposit​ protection?

Insured banks tend to pursue greater risks than they otherwise would

How might a sudden increase in​ people's expectations of future real estate prices affect interest​ rates?

Interest rates would increase because real estate would have a relatively higher rate of return compared to​ bonds, which would cause the demand for bonds to decrease.

If junk bonds are​ "junk," then why would investors buy​ them?

Junk bonds can provide high yields.

Why might the efficient market hypothesis be less likely to hold when fundamentals suggest stocks should be at a lower​ level?

Most investors are subject to loss​ aversion, so not enough short selling takes place in the market.

Which of the following is an argument in favor of the efficient market hypothesisLOADING...​?

Over the long​ term, stock prices follow a random walk and do resemble their underlying fundamental value.

Which of the following actions will reduce​ interest-rate risk faced by​ banks?

Purchase a financial​ future, option, or swap B. Shorten the duration of​ bank's assets C. Lengthen the duration of​ bank's liabilities D. All of the above

Short-term U.S. government securities are called secondary reserves because of their high liquidity.

Short-term U.S. government securities are called secondary reserves because of their high liquidity.

What are the costs and benefits of a​ too-big-to-fail policy?

The benefit is that it makes bank panics less​ likely; however, the cost is that it increases the incentive for moral hazard by big banks

Why might you be willing to make a loan to your neighbor by putting funds in a savings account earning a​ 5% interest rate at the bank and having the bank lend her the funds at a​ 10% interest rate rather than lend her the funds​ yourself?

The costs of writing up the loan contract might exceed the​ 5% difference between your deposit rate and the bank lending rate.

​Again, consider the effect of tight money policy on stock prices. Which of the following accurately describes the effects of tight money policy on stock​ prices, according to this​ model?

The economy would slow​ down, causing an increase in the denominator of the simplified Gordon growth model and a decrease in the price of stock ​(Upper P 0P0​).

Suppose after a few mergers and​ acquisitions, a single bank holds​ 70% of all the deposits in the United States. Which of the following statements is likely to be true in the event of the failure of the​ bank?

The failure of the bank will likely cause a financial​ catastrophe, prompting the FDIC to do everything to prevent the institution from going bankrupt.

Suppose that many big corporations decide not to issue​ bonds, since it is now too costly to comply with new financial market regulations. Can you describe the expected effect on interest​ rates?

The impact will translate into a shift to the left in the supply​ curve, increasing​ bond's prices​ (lowering interest​ rates) and lowering the quantity of bonds bought and sold in the market.

During​ 2008, the difference in yield​ (the yield spread​) between​ 3-month AA-rated financial commercial paper and​ 3-month AA-rated nonfinancial commercial paper steadily increased from its usual level of close to​ zero, spiking to over a full percentage point at its peak in October 2008. Which of the following explains this sudden​ increase?

The increase in the yield spread was a result of the decrease in demand for financial commercial paper due to the uncertainty and soundness of financial companies and banks.

The U.S. Treasury offers some of its debt as Treasury Inflation Protected​ Securities, or​ TIPS, in which the price of bonds is adjusted for inflation over the life of the debt instrument. TIPS bonds are traded on a much smaller scale than nominal U.S. Treasury bonds of equivalent maturity. What can you conclude about the liquidity premium between TIPS and nominal U.S.​ bonds?

The liquidity premium for a TIPS bond is usually smaller than inflation compensation in nominal U.S. bond yields of equal maturity.

During​ 2008, the difference in yield​ (the yield spread​) between​ 3-month AA-rated financial commercial paper and​ 3-month AA-rated nonfinancial commercial paper steadily increased from its usual level of close to​ zero, spiking to over a full percentage point at its peak in October 2008. Which of the following explains this sudden​ increase?

The liquidity premium for a TIPS bond is​ high, so it is more profitable than a nominal U.S. bond of equal maturity.

Consider tight money policy and its effects on stock prices via the simplified Gordon growth model equation ​(Equation 5LOADING...​). Which of the following accurately describes the effects of tight money policy on stock​ prices, according to this​ model?

The return on bonds and the required return on an equity investment ​(k Subscript eke​) would​ rise, while the price of stock ​(Upper P 0P0​) would fall.

Why is simply counting currency an inadequate measure of​ money?

There are other liquid assets similar to currency that can be used as money to purchase goods and services.

What is the main disadvantage of moving to e-money or moving to a cashless​ society?

There are problems with security and privacy

Why does the United States operate under a dual banking system​? ​(Check all that​ apply.)

There is skepticism of centralized power in the U.S. banking system. Federally chartered banks help to stabilize the banking system and are less prone to failure.

If stock prices did not follow a random walkLOADING...​, which of the following statements would be​ true?

There would be unexploited profit opportunities in the market and expectations would not be rational

How dofinancial intermediariesLOADING... benefit by providing​ risk-sharing services?

They are able to earn a profit on the spread between the returns they earn on risky assets and the payments they make on the assets they have sold

Which of the following statements regarding Federal Reserve independence is​ incorrect? A. In order to gain additional power to regulate the financial​ system, the governors need the support of Congress and the president to pass favourable legislation B. The Board of Governors knows that their bureaucratic power can be reined in by congressional legislation and so must still curry favour with both Congress and the president C. The Fed may feel pressure to support the​ president's policies since the president can veto legislation that might limit the​ Fed's discretionary power and authority D. The​ 14-year non-renewable terms for governors effectively insulate the Board of Governors from political pressure

The​ 14-year non-renewable terms for governors effectively insulate the Board of Governors from political pressure

M1 money growth in the U.S. was about​ 16% in​ 2008, 7% in​ 2009, and​ 9% in 2010. Over the same time​ period, the yield on​ 3-month Treasury bills fell from almost​ 3% to close to​ 0%. Given these high rates of money​ growth, why did interest rates​ fall, rather than​ increase?

The​ income, price-level, and​ expected-inflation effects were small relative to the liquidity effect.

the Federal Reserve System. resembles the U.S. Constitution in that it was designed with many checks and ​balances." Is this statement​ true, false, or​ uncertain? Explain your answer.

True. Because of public hostility and the centralization of​ power, the Federal Reserve System was created with many checks and balances to diffuse power.

Can a person with rational expectationsLOADING...​, given new information about the search technology​ industry, expect the price of a share of Google to rise by​ 10% in the next​ month?

Yes, if this information is such that expectations of growth prospects or desired yields justify such a change.

If no decent lending opportunity arises in the​ economy, and the central bank pays an interest rate on reserves that is similar to other​ low-risk investments, do you think banks will be willing to hold large amounts of excess​ reserves?

Yes. Banks will be willing to hold large amounts of excess reserves since these are safe investments.

The bank you own has the following balance sheetLOADING...​: Assets Liabilities Reserves ​$ 75 million Deposits ​$500 million Loans ​$525 million Bank capital ​$100 million If the bank suffers a deposit outflow of​ $50 million with a required reserve ratio on deposits of​ 10%, what actions can you take to keep your bank from​ failing?

You can borrow reserves in the federal funds market. B. You can call in or sell off loans. C. You can go to the discount window. D. Any of the above are appropriate actions to take.

The many regional Federal Reserve banksLOADING... resulted from a compromise between parties​ favoring:

a private central bank and those favoring a government institution.

If borrowers with the most risky investment projects are more likely to seek bank loans as compared to those borrowers with the safest investment​ projects, banks are said to face the problem​ of:

adverse selection

Transformation of assetsLOADING... can be accomplished​by

borrowing short and lending long

An asset with great liquidity is one that

can be converted into a medium of exchange with relative ease and speed.

Reserves, cash items in process of​ collection, and deposits at other banks are collectively called

cash items

Which of the following is not an asset on a​ bank's balance​ sheet? A. Reserves. B. Government securities. C. Loans. D. Checkable deposits

checkable deposit

Assets of value promised to the lender as compensation if the borrower defaults are​ called:

collateral

The volume of checkable deposits relative to total bank liabilitiesLOADING... ​has:

declined over time.

Identify the cash flowsLOADING... available to an investor in stock.

dividends and capital gains

Currency in circulation that cannot be redeemed for gold is​ called

fiat money

Regulators impose capital requirements on banks because a low​ capital-to-asset ratio dramatically

increases a​ bank's moral hazard.

Financial intermediariesLOADING... have a role to play in matching savers and borrowers for all of the following reasons except​:

information symmetries

A bank with excess reserves can economize on these reserves​ by:

lending reserves in the federal funds market.

A​ bank's capital-to-asset ratio is also known as its

leverage ratio .

We know that money is the most liquid store of value due to many reasons except that

money is exposed to the risks associated with hyperinflation.

If you read in the Wall Street Journal that the​ "smart money" on Wall Street expects stock prices to​ fall, you​ should:

not sell all of your stocks because this is publicly available information and is already reflected in stock prices.

Suppose the interest rates on​ one-, five-, and​ ten-year U.S. Treasury bonds are currently​ 3%, 6%, and​ 6%, respectively. Investor A chooses to hold only​ one-year bonds, and Investor B is indifferent with regard to holding​ five- and​ ten-year bonds. Which theories best explain the behavior of Investors A and​ B?

nvestor​ A's preferences are best explained by the segmented markets​ theory, while Investor​ B's preferences are more consistent with the expectations theory

Currency​ includes:

paper money and coins

What basic principle of finance can be applied to the valuation of any investment​ asset?

present value

The efficient market hypothesis implies​ that:

prices in markets like the stock market are unpredictable.

Increasing the independence of a central bankLOADING... would​ probably:

reduce pressures to pursue inflationary policies B. hinder the coordination of monetary and fiscal policy C. allow the central bank to more easily pursue monetary policies that directly oppose the​ government's fiscal policies D. All of the above are correct

The portion of checkable deposits that banks are required to hold is​ called:

required reserves.

Bank chartering reduces adverse selectionLOADING... problems​ by:

screening proposals for new institutions to prevent undesirable people from running the institution

Examples of off-balance-sheet activitiesLOADING... ​include:

selling loan portfolios

When an individual or institution buys a corporate bond in the primary​ market:

she is making a loan to the corporation issuing the bond.

Stock market analysts might prepare a forecast of the​ next-period stock price Upper P Subscript t plus 1Pt+1 as​ follows: Upper P Subscript t plus 1Pt+1 ​= StartFraction Upper P Subscript t plus Upper P Subscript t minus 1 Baseline plus Upper P Subscript t minus 2 Baseline plus Upper P Subscript t minus 3 Over 4 EndFractionPt + Pt−1 + Pt−2 + Pt−34​, a process known as a moving average. This technique is part of what is​ called:

technical analysis

The current yield is a good approximation to the yield to maturity​ when: ​(Check all that​ apply.)

the maturity of the bond occurs over a​ ten-year period. the bond price is very close to par.

Money may serve as an instrument that allows for comparison of the relative worth of various goods and services. What function of money does this​ describe?

unit of account

Interest rates were lower in the​ mid-1980s than in the late​ 1970s, yet many economists have commented that real interest rates were actually much higher in the​ mid- 1980s than in the late 1970s. Consider the diagram to the right that shows the nominal interest rateLOADING... and the inflation rate. The real interest rateLOADING...​:

was higher in 1985 than​ 2005, when the real interest rate was zero.

If your broker has been right in her five previous buy and sell​ recommendations, you should continue to listen to her advice. Is this statement true or​ false?

​False, although your broker has done well in the​ past, efficient market theory suggests that she has probably been lucky

If interest rates​ decline, which would you rather be​ holding, long-term bonds or​ short-term bonds?

​Long-term bonds because their price would increase more than the price of​ short-term bonds

Would fiscal policy makers ever have reason to worry about potentially inflationary​ conditions?

​Yes, higher inflation leads to a higher debt service burden and increases the costs of financing deficit spending.

In the aftermath of the global economic crisis that started to take hold in​ 2008, U.S. government budget deficits increased​ dramatically, yet interest rates on U.S. Treasury debt fell sharply and stayed low for quite some time. Does this make​ sense?

​Yes, the decrease in investment opportunities and known risk factors significantly offset the wealth effect on demand and the deficit effect on supply.

Is it better for bondholders when the yield to maturity increases or​ decreases? Bondholders are better off when the yield to​ maturity:

​decreases, since this represents an increase in the price of the bond and a decrease in potential capital losses

Risk that is related to the uncertainty about future​ interest-rate movements is​ called:

​interest-rate risk


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