financial markets

Money markets trade securities that I. mature in one year or less. II. have little chance of loss of principal. III. must be guaranteed by the federal government.

I and II only

If the Fed wishes to stimulate the economy, it could I. buy U.S. government securities. II. raise the discount rate. III. lower reserve requirements.

I and III only

Secondary markets help support primary markets because secondary markets I. offer primary market purchasers liquidity for their holdings. II. update the price or value of the primary market claims. III. reduce the cost of trading the primary market claims.

I, II, and III

The duration of a bond with a 5% coupon rate is ______ than the duration of a similar bond with a 10% coupon rate. If the yield to maturity increases the bond's duration ________.

Longer; decreases

The Fed offers three types of discount window loans. ______________ credit is offered to small institutions with demonstrable patterns of financing needs, _____________ credit is offered for short-term temporary funds outflows, and _____________ credit may be offered at a higher rate to troubled institutions with more severe liquidity problems.

Seasonal; primary; secondary

A particular security's equilibrium rate of return is 8 percent. For all securities, the inflation risk premium is 1.75 percent and the real risk-free rate is 3.5 percent. The security's liquidity risk premium is 0.25 percent and maturity risk premium is 0.85 percent. The security has no special covenants. Calculate the security's default risk premium. (Round your answer to 2 decimal places. (e.g., 32.16))

The fair interest rate on a financial security is calculated as i* = IP + RFR + DRP + LRP + SCP + MRP 8% = 1.75% + 3.5% + DRP + 0.25% + 0% + 0.85% Thus, DRP = 8% − 1.75% − 3.5% − 0.25% − 0% − 0.85% = 1.65%

T/F The real risk-free rate is the increment to purchasing power that the lender earns in order to induce him or her to forego current consumption.

True

A 10-year annual payment corporate bond has a market price of $1,050. It pays annual interest of $100 and its required rate of return is 9 percent. By how much is the bond mispriced?

Underpriced by $14.18 PV = 100 × PVIFA [9%, 10 yrs.] + 1,000 × PVIF (9%, 10 yrs.) = $1,064.18 Calculator Method: N = 10PMT = 100I/Y = 9FV = 1,000Solve for PV which is $1064.18; Market value is underpriced by $14.18.

Investment A pays 8 percent simple interest for 10 years. Investment B pays 7.75 percent compound interest for 10 years. Both require an initial $10,000 investment. The future value of A minus the future value of B is equal to ______________ (to the nearest penny).

[10,000 + (800 × 10)] − [10,000 × 1.077510] = -$3,094.67

a. What is the duration of a two-year bond that pays an annual coupon of 10 percent and has a current yield to maturity of 12 percent? Use $1,000 as the face value. (Do not round intermediate calculations. Round your answer to 4 decimal places. (e.g., 32.1616)) b. What is the duration of a two-year zero-coupon bond that is yielding 11.5 percent? Use $1,000 as the face value.

a. 1.9076 years b. 2 years

Consider the following. a. What is the duration of a four-year Treasury bond with a 10 percent semiannual coupon selling at par? b. What is the duration of a three-year Treasury bond with a 10 percent semiannual coupon selling at par? c. What is the duration of a two-year Treasury bond with a 10 percent semiannual coupon selling at par?

a. 3.39 years b. 2.66 years c. 1.86 years

a. What is the duration of a zero-coupon bond that has eight years to maturity? b. What is the duration if the maturity increases to 10 years? c. What is the duration if the maturity increases to 12 years?

a. 8 years b. 10 years c. 12 years

If interest rates are expected to drop, which of the following bonds would you rather hold? a. A 10-year, AAA rated zero-coupon bond b. A 5-year, AAA rated zero-coupon bond c. A 10-year, AAA rated 10% coupon bond d. A 5-year, AAA rated 10%-coupon bond

a. A 10-year, AAA rated zero-coupon bond explanation: If rates decline, bond prices increase. Thus, you would want to hold the bond with the longest duration (its price will be the most impacted the interest rate increase).

You go to the Wall Street Journal and notice that yields on almost all corporate and Treasury bonds have decreased. The yield decreases may be explained by which one of the following? a. A decrease in U.S. inflationary expectations b. Newly expected decline in the value of the dollar c. An increase in current and expected future returns of real corporate investments d. Decreased Japanese purchases of U.S. Treasury bills/bonds e. Increases in the U.S. government budget deficit

a. A decrease in U.S. inflationary expectations

Which of the following is the major monetary policy-making body of the U.S. Federal Reserve System? a. FOMC b. OCC c. FRB bank presidents d. U.S. Congress e. Group of Eight

a. FOMC

You are considering an investment in 30-year bonds issued by Moore Corporation. The bonds have no special covenants. The Wall Street Journal reports that 1-year T-bills are currently earning 3.25 percent. Your broker has determined the following information about economic activity and Moore Corporation bonds: -real risk-free rate =2.25% -default risk premium =1.15% -liquidity risk premium =0.50% -maturity risk premium =1.75% a. What is the inflation premium? b. What is the fair interest rate on Moore Corporation 30-year bonds?

a. IP = i* - RFR = 3.25% − 2.25% = 1.00% b. ij* = 1.00% + 2.25% + 1.15% + 0.50% + 1.75% = 6.65%

which of the following is/are money market instrument(s)? a. Negotiable CDs b. Common stock c. T-bonds d. 4-year maturity corporate bond e. Negotiable CDs, common stock, and T-bonds

a. Negotiable CDs

A corporation seeking to sell new equity securities to the public for the first time in order to raise cash for capital investment would most likely a. conduct an IPO with the assistance of an investment banker. b. engage in a secondary market sale of equity. c. conduct a private placement to a large number of potential buyers. d. place an ad in the Wall Street Journal soliciting retail suppliers of funds. e. issue bonds with the assistance of a dealer.

a. conduct an IPO with the assistance of an investment banker.

IBM creates and sells additional stock to the investment banker Morgan Stanley. Morgan Stanley then resells the issue to the U.S. public through its mutual funds. This transaction is an example of a(n) a. primary market transaction. b. asset transformation by Morgan Stanley. c. money market transaction. d. foreign exchange transaction. e. forward transaction.

a. primary market transaction.

The diagram below is a diagram of the user of funds <==> underwriter <==> suppliers of funds a. secondary markets b. primary markets c. money markets d. derivatives markets e. commodities markets

b. primary markets

The Fed funds rate is the rate that

banks charge each other on loans of excess reserves

The most diversified type of depository institutions is a. credit unions b. savings associations c. commercial banks d. finance companies e. mutual funds

c. commercial banks

Financial intermediaries (FIs) can offer savers a safer, more liquid investment than a capital market security, even though the intermediary invests in risky illiquid instruments because a. FIs can diversify away some of their risk b. FIs closely Monitor the riskiness of their assets c. the federal government them to do so d. FIs can diversity away some of their risk and closely monitor the riskiness of their assets e. FIs can diversify away some of their risk and the federal government requires them to do so

d. FIs can diversity away some of their risk and closely monitor the riskiness of their assets

Which of the following are capital market instruments? a. 10-year corporate bonds b. 30-year mortgages c. 20-year Treasury bonds d. 15-year U.S. government agency bonds e. all of these choices are correct

e. all of these choices are correct

The primary policy tool used by the Fed to meet its monetary policy goals is a. changing the discount rate. b. changing reserve requirements. c. devaluing the currency. d. changing bank regulations. e. open market operations.

e. open market operations

A decrease in reserve requirements could lead to an

increase in bank lending and an increase in the money supply.

The primary policy tool used by the Fed to meet its monetary policy goals is

open market operations

A security has an expected return less than its required return. This security is

selling for more than its PV.

If an N year security recovered the same percentage of its cost in PV terms each year, the duration would be

sum of the years/N

Duration is

the weighted average time to maturity of the bond's cash flows

T/F Primary markets are markets in which users of funds raise cash by selling securities to funds suppliers.

true

An annual payment bond with a $1,000 par has a 5 percent quoted coupon rate, a 6 percent promised YTM, and six years to maturity. What is the bond's duration?

Σ[(t × CFt/(1.06)t)]/$950.83 = 5.31 years

YIELD CURVE FOR ZERO COUPON BONDS RATED AA Maturity YTM Maturity YTM Maturity YTM1year 8.00% 7year 9.15% 13year 10.45% 2year 8.11% 8year 9.25% 14year 10.65% 3year 8.20% 9year 9.35% 15year 10.75% 4year 8.50% 10year 9.47% 16year 10.95% 5year 8.75% 11year 9.52% 17year 11.00% 6year 8.85% 12year 9.77% 18year 11.25% Assume that there are no liquidity premiums. To the nearest basis point, what is the expected interest rate on a four-year maturity AA zero coupon bond purchased six years from today?

((1.094710/1.08856))(1/4) − 1 = 10.41%

YIELD CURVE FOR ZERO COUPON BONDS RATED AA Maturity YTM Maturity YTM Maturity YTM1year 8.00% 7year 9.15% 13year 10.45% 2year 8.11% 8year 9.25% 14year 10.65% 3year 8.20% 9year 9.35% 15year 10.75% 4year 8.50% 10year 9.47% 16year 10.95% 5year 8.75% 11year 9.52% 17year 11.00% 6year 8.85% 12year 9.77% 18year 11.25% Assume that there are no liquidity premiums. You just bought a 15-year maturity Xerox corporate bond rated AA with a 0 percent coupon. You expect to sell the bond in eight years. Find the expected interest rate at the time of sale (watch out for rounding error).

((1.107515/1.09258))(1/7) − 1 = 12.49%

If you note the following yield curve in The Wall Street Journal, what is the one-year forward rate for the period beginning one year from today, 2f1 according to the unbiased expectations theory? (Do not round intermediate calculations. Round your answer to 2 decimal places. (e.g., 32.16)) one day = 2.00% one year = 5.50% two years = 6.50% three years = 9.00%

(1 + 1R2)2 = (1 + 1R1)(1 + 2f1) 1R2 = 0.065 = [(1 + 0.055)(1 + 2f1)]1/2 − 1 ⇒ [(1.065)2/(1.055)] − 1 = 2f1 = 7.51%

The Fed changes reserve requirements from 10 percent to 7 percent, thereby creating $900 million in excess reserves. The total change in deposits (with no drains) would be

(1/0.07) × $900 million = $12,857 million

Suppose we observe the following rates: 1R1 = 8%, 1R2 = 10%. If the unbiased expectations theory of the term structure of interest rates holds, what is the one-year interest rate expected one year from now, E(2r1)? (Do not round intermediate calculations. Round your answer to 2 decimal places. (e.g., 32.16))

1 + 1R2 = {(1 + 1R1)(1 + E(2r1))}1/2 1.10 = {1.08(1 + E(2r1))}1/2 1.21 = 1.08(1 + E(2r1)) 1.21/1.08 = 1 + E(2r1) 1 + E(2r1) = 1.1204 E(2r1) = 0.1204 = 12.04%

A recent edition of The Wall Street Journal reported interest rates of 2.25 percent, 2.60 percent, 2.98 percent, and 3.25 percent for three-year, four-year, five-year, and six-year Treasury notes, respectively. According to the unbiased expectations theory of the term structure of interest rates, what are the expected one-year rates during years 4, 5, and 6? (Do not round intermediate calculations. Round your answers to 2 decimal places. (e.g., 32.16))

1 + 1R4 = {(1 + 1R3)3(1 + E(4r1))}1/4 (1 + 1R4)4 = {(1 + 1R3)3(1 + E(4r1))} (1.026)4 = (1.0225)3(1 + E(4r1)) (1.026)4/(1.0225)3 = 1 + E(4r1 )1 + E(4r1) = 1.0366 E(4r1) = 3.66% 1 + 1R5 = {(1 + 1R4)4(1 + E(5r1))}1/5 (1 + 1R5)5 = {(1 + 1R4)4(1 + E(5r1))} (1.0298)5 = (1.026)4(1 + E(5r1)) (1.0298)5/(1.026)4 = 1 + E(5r1) 1 + E(5r1) = 1.0451 E(5r1) = 4.51% 1 + 1R6 = {(1 + 1R5)5(1 + E(6r1))}1/6 (1 + 1R6)6 = {(1 + 1R5)5(1 + E(6r1))} (1.0325)6 = (1.0298)5(1 + E(6r1))(1.0325)6/(1.0298)5 = 1 + E(6r1) 1 + E(6r1) = 1.0461 E(6r1) = 4.61%

The yields on a one-, two-, and three-year Treasury securities are: 1-year: 0.246% 2-year: 0.609% 3-year:0.900% What is the implied one-year forward rate in two years (i.e. what is the expected yield on a one-year security purchased in two years)?

1.485%. [1+0.009]^3/[1+0.00609]^2-1 =0.01485

You have just been offered a bond for $863.73. The coupon rate is 8 percent payable annually, and the yield to maturity on new issues with the same degree of risk are 10 percent. You want to know how many more interest payments you will receive, but the party selling the bond cannot remember. If the par value is $1,000, how many interest payments remain? (Do not round intermediate calculations. Round your answer to the nearest whole number.)

12 years

Suppose that the current one-year rate (one-year spot rate) and expected one-year T-bill rates over the following three years (i.e., years 2, 3, and 4, respectively) are as follows: 1R1 = 6%, E(2r1) = 7%, E(3r1) = 7.5%, E(4r1) = 7.85% Using the unbiased expectations theory, calculate the current (long-term) rates for one-, two-, three-, and four-year-maturity Treasury securities. (Round your answers to 2 decimal places. (e.g., 32.16))

1R1 = 6.00% 1R2 = [(1 + 0.06)(1 + 0.07)]1/2 − 1 = 6.50% 1R3 = [(1 + 0.06)(1 + 0.07)(1 + 0.075)]1/3 − 1 = 6.83% 1R4 = [(1 + 0.06)(1 + 0.07)(1 + 0.075)(1 + 0.0785)]1/4 − 1 = 7.09%

One-year T-bills currently earn 3.45 percent. You expect that one year from now, one-year T-bill rates will increase to 3.65 percent. If the unbiased expectations theory is correct, what should the current rate be on two-year Treasury securities? (Do not round intermediate calculations. Round your answer to 2 decimal places. (e.g., 32.16))

1R2 = [(1 + 0.0345)(1 + 0.0365)]1/2 − 1 = 3.55%

The current one-year T-bill rate is 5.2 percent and the expected one-year rate 12 months from now is 5.8 percent. According to the unbiased expectations theory, what should be the current rate for a two-year Treasury security? (Do not round intermediate calculations. Round your answer to 2 decimal places. (e.g., 32.16))

1R2 = [(1 + 0.052)(1 + 0.058)]1/2 − 1 = 5.50%

Bank A has an increase in deposits of $20 million dollars and all bank reserve requirements are 10 percent. Bank A loans out the full amount of the deposit increase that is allowed. This amount winds up deposited in Bank B. Bank B lends out the full amount possible as well and this amount winds up deposited in Bank C. What is the total increase in deposits resulting from these three banks?

20 + (20 × 0.90) + (18 × 0.90) = $54.20 million

A four-year maturity 0 percent coupon corporate bond with a required rate of return of 12 percent has an annual duration of _______________ years.

4.00 ~ Duration of zero coupon bond definition.

You bought a bond five years ago for $935 per bond. The bond is now selling for $980. It also paid $75 in interest per year, which you reinvested in the bond. Calculate the realized rate of return earned on this bond. (Do not round intermediate calculations. Round your answer to 2 decimal places. (e.g., 32.16))

8.83%

Calculate the yield to maturity on the following bonds: a. A 9 percent coupon (paid semiannually) bond, with a $1,000 face value and 15 years remaining to maturity. The bond is selling at $985. b. An 8 percent coupon (paid quarterly) bond, with a $1,000 face value and 10 years remaining to maturity. The bond is selling at $915. c. An 11 percent coupon (paid annually) bond, with a $1,000 face value and 6 years remaining to maturity. The bond is selling at $1,065.

9.190% 9.320% 9.530%