markets and financial intermediation exam 1

An insurance company is trying to sell you a retirement annuity. The annuity will give you 20 payments with the first payment in 12 years when you retire. The insurance firm is asking you to pay $50,000 today. If this is a fair deal, what must the payment amount be (to the dollar) if the interest rate is 8 percent?

$11,874

You want to have $5 million when you retire in 40 years. You believe you can earn 9 percent per year on your investment. How much must you invest each year to achieve your goal when you retire? (Ignore all taxes.)

$14,798

Suppose you can save $2,000 per year for the next ten years in an account earning 7 percent per year. How much will you have at the end of the tenth year if you make the first deposit today?

$29,567.20

A 15-payment annual annuity has its first payment in nine years. If the payment amount is $1,400 and the interest rate is 7 percent, what is the most you should be willing to pay today for this investment?

$7,421.24

You buy a car for $38,000. You agree to a 60-month loan with a monthly interest rate of 0.55 percent. What is your required monthly payment?

$745.29

An investment pays $400 in one year, X amount of dollars in two years, and $500 in three years. The total present value of all the cash flows (including X) is equal to $1,500. If i is 6 percent, what is X?

$789.70

Upon graduating from college this year, you expect to earn $25,000 per year. If you get your MBA, in one year you can expect to start at $35,000 per year. Over the year, inflation is expected to be 5 percent. In today's dollars, how much additional (less) money will you make from getting your MBA (to the nearest dollar) in your first year?

$8,333

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).

-$3094.67

An individual actually earned a 4 percent nominal return last year. Prices went up by 3 percent over the year. Given that the investment income was subject to a federal tax rate of 28 percent and a state and local tax rate of 6 percent, what was the investor's actual real after-tax rate of return?

-0.36 percent

The duration of a 180-day T-Bill is (in years)

0.493

Households are increasingly likely to both directly purchase securities (perhaps via a broker) and also place some money with a bank or thrift to meet different needs. Match up the given investor's desire with the appropriate intermediary or direct security. I. Money likely to be needed within six months II. Money to be set aside for college in 10 years III. Money to provide supplemental retirement income IV. Money to be used to provide for children in the event of death 1. Depository institutions 2. Insurer 3. Pension fund 4. Stocks or bonds

1,4,3,2

A common stock paid a dividend at the end of last year of $3.50. Dividends have grown at a constant rate of 6 percent per year over the last 20 years, and this constant growth rate is expected to continue into the future. The stock is currently selling at a price of $35 per share. What is the expected rate of return on this stock?

16.6 percent

Match the intermediary with the characteristic that best describes its function. I. Provide protection from adverse events. II. Pool funds of small savers and invest in either money or capital markets. III. Provide consumer loans and real estate loans funded by deposits. IV. Accumulate and transfer wealth from work period to retirement period. V. Underwrite and trade securities and provide brokerage services. 1. Thrifts 2. Insurers 3. Pension funds 4. Securities firms and investment banks 5. Mutual funds

2,5,1,3,4

Suppose you owned stock in a company for the last three years. You originally bought the stock three years ago for $30 and just sold it for $56. The stock paid an annual dividend of $1.35 on the last day of each of the past three years. What is your realized return on this investment?

26.85 percent

Suppose that the current one-year Treasury-bill rate is 3.15 percent and the expected one-year rate 12 months from now is 4.25 percent. According to the unbiased expectations theory, what should be the current rate for a two-year Treasury security?

3.70 percent

An investor requires a 3 percent increase in purchasing power in order to induce her to lend. She expects inflation to be 2 percent next year. The nominal rate she must charge is about

5 percent

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?

5.31 years

A semiannual payment bond with a $1,000 par has a 7 percent quoted coupon rate, a 7 percent promised YTM, and 10 years to maturity. What is the bond's duration?

7.35 years

The term structure of interest rates is upward sloping for all bond types. A certain AAA-rated non-callable 10-year corporate bond has been issued at a 6.15 percent promised yield. Which one of the following bonds probably has a higher promised yield?

A callable AAA-rated corporate bond with a 15-year maturity

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 decrease in U.S. inflationary expectations

Depository institutions (DIs) play an important role in the transmission of monetary policy from the Federal Reserve to the rest of the economy because

DI deposits are a major portion of the money supply.

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

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

Asset transformation by financial intermediaries involves increasing the risk attributes of securities such as mortgages, bonds, and stocks.

False

In the United States the SEC provides deposit insurance for $250,000 per person per bank.

False

There are three types of major financial markets today: primary, secondary, and derivatives markets. The NYSE and NASDAQ are both examples of derivatives markets.

False

As of 2016, which one of the following derivatives instruments had the greatest amount of notional principal outstanding?

Swaps

Enterprise Risk Management (ERM) system is responsible for managing the totality of a firm's risk exposures.

True

Money markets are the markets for securities with an original maturity of one year or less.

True

One of the factors responsible for globalization of financial markets and institutions is deregulation.

True

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

True

The NYSE is an example of a secondary market.

True

The Volcker Rule prohibits U.S. depository institutions from engaging in proprietary trading.

True

a negotiable CD is

a marketable bank-issued time deposit that specifies the interest rate earned and a fixed maturity date.

commercial paper is

a short-term unsecured promissory note issued by a company to raise funds for a short time period.

Of the following, the most likely effect of an increase in income tax rates would be to a. decrease the savings rate b. decrease the supply of loanable funds c. increase interest rates

all of these choices are correct

Which of the following are capital market instruments? 10-year corporate bonds 30-year mortgages 20-year treasury bonds 15-year US government agency bonds

all these choices are correct

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. Morgan Stanley is acting as an

asset transformer

Depository institutions include

banks and thrifts

The most diversified type of depository institutions is

commercial banks

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

conduct an IPO with the assistance of an investment banker.

The largest capital market security outstanding in 2016 measured by market value was

corporate stocks

The Securities Exchange Commission (SEC) does not

decide whether a public issue is fairly priced.

Financial intermediaries' ability to reduce the average cost of collecting information because of their efficient operations allows them to take advantage of

economies of scale

A 10-year maturity zero coupon bond will have lower price volatility than a 10-year bond with a 10 percent coupon.

false

A higher level of wealth causes the demand for loanable funds to increase and interest rates to fall.

false

According to the liquidity premium theory, investors preferring long-term bonds over short-term bonds would require lower liquidity premium.

false

An increase in interest rates increases the demand loanable funds.

false

An increase in the perceived riskiness of investments would cause a movement up along the supply curve.

false

As the liquidity of corporate bonds decrease, the risk premium required on those bonds decrease as well.

false

Corporate security issuers are always directly involved in funds transfers in the secondary market.

false

Earning a 5 percent interest rate with annual compounding is better than earning a 4.95 percent interest rate with semiannual compounding.

false

Everything else equal, the interest rate required on a callable bond will be less than the interest rate on a convertible bond.

false

Financial intermediation provides direct transfer of funds to the users.

false

If you earn 0.5 percent a month in your bank account, this would be the same as earning a 6 percent annual interest rate with annual compounding.

false

Secondary markets are markets used by corporations to raise cash by issuing securities for a short time period.

false

The average cost incurred by financial institutions to collect information is larger than that of individuals.

false

The coupon rate represents the most accurate measure of the bondholder's required return.

false

The longer the time to maturity, the lower the security's price sensitivity to an interest rate change, ceteris paribus.

false

The unbiased expectations hypothesis of the term structure posits that long-term interest rates are unrelated to expected future short-term rates.

false

We expect liquidity premiums to move inversely with interest rate volatility.

false

According to the liquidity premium theory of interest rates,

long-term spot rates are higher than the average of current and expected future short-term rates.

Which of the following bond types pays interest that is exempt from federal taxation?

municipal bonds

Classify each of the following in terms of their effect on interest rates (increase or decrease): I. Perceived risk of financial securities increases. II. Near term spending needs decrease. III. Future profitability of real investments increases. a. I increases: II increases: III increases b. I increases: II decreases: III decreases c. I decreases: II increases: III increases d. I decreases; II decreases; III decreases

none are correct

A 12-year annual payment corporate bond has a market price of $925. It pays annual interest of $60 and its required rate of return is 7 percent. By how much is the bond mispriced?

overpriced by $4.43

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)

primary market transaction

Inflation causes the demand curve for loanable funds to shift to the ________ and causes the supply curve to shift to the ________.

right;left

Insolvency risk at a financial intermediary (FI) is the risk

risk that an FI may not have enough capital to offset a sudden decline in the value of its assets.

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

selling for more than its PV

The relationship between maturity and yield to maturity is called the ________.

term structure

Liquidity risk at a financial intermediary (FI) is the risk

that a sudden surge in liability withdrawals may require an FI to liquidate assets quickly at fire sale prices.

An annuity and an annuity due with the same number of payments have the same future value if r = 10%. Which one has the higher payment?

the annuity has the higher payment

According to the unbiased expectations theory,

the long term spot rate is an average of the current and expected future short term interest rates

A bond with an 11 percent coupon and a 9 percent required return will sell at a premium to par.

true

A zero coupon bond has a duration equal to its maturity and a convexity equal to zero.

true

According to the market segmentation theory, short-term investors will not normally switch to intermediate- or long-term investments.

true

An improvement in economic conditions would likely shift the supply curve down and to the right and shift the demand curve for funds up and to the right.

true

An increase in the marginal tax rates for all U.S. taxpayers would probably result in reduced supply of funds by households.

true

An investor earned a 5 percent nominal risk-free rate over the year. However, over the year, prices increased by 2 percent. The investor's real risk-free rate was less than his nominal rate of return.

true

Central governments sometimes indirectly intervene in foreign exchange markets by affecting foreign exchange rates through raising or lowering interest rates.

true

Convertible bonds will normally have lower promised yields than straight bonds of similar terms and quality.

true

Financial intermediaries rather than financial systems are the most common agents to channel funds from the suppliers to the users of funds.

true

For any positive interest rate the present value of a given annuity will be less than the sum of the cash flows, and the future value of the same annuity will be greater than the sum of the cash flows.

true

Households generally supply more funds to the markets as their income and wealth increase, ceteris paribus.

true

One of the factors responsible for globalization of financial markets and institutions is deregulation.

true

Simple interest calculations assume that interest earned is never reinvested.

true

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

The risk that a security cannot be sold at a predictable price with low transaction costs at short notice is called liquidity risk.

true

The term structure of interest rates is the relationship between interest rates on bonds similar in terms except for maturity.

true

The traditional liquidity premium theory states that long-term interest rates are greater than the average of current and expected future short-term interest rates.

true

When the quantity of a financial security supplied or demanded changes at every given interest rate in response to a change in a factor, this causes a shift in the supply or demand curve.

true

With a zero interest rate both the present value and the future value of an N payment annuity would equal N × payment.

true

You would want to purchase a security if P ________ PV or E(r) ________ r.

≤; ≥

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

Which of the following would normally be expected to result in an increase in the supply of funds, all else equal? I. The perceived riskiness of all investments decreases. II. Expected inflation increases. III. Current income and wealth levels increase. IV. Near term spending needs of households increase as energy costs rise.

I and III only

Classify each of the following in terms of their effect on interest rates (increase or decrease): I. Covenants on borrowing become more restrictive. II. The Federal Reserve increases the money supply. III. Total household wealth increases.

I decreases; II decreases; III decreases

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

An investor wants to be able to buy 4 percent more goods and services in the future in order to induce her to invest today. During the investment period prices are expected to rise by 2 percent. Which statement(s) below is/are true? I. 4 percent is the desired real risk-free interest rate. II. 6 percent is the approximate nominal rate of interest required. III. 2 percent is the expected inflation rate over the period.

I, II, and III are true

What factors are encouraging financial institutions to offer overlapping financial services such as banking, investment banking, brokerage, etc.? I. Regulatory changes allowing institutions to offer more services II. Technological improvements reducing the cost of providing financial services III. Increasing competition from full-service global financial institutions IV. Reduction in the need to manage risk at financial institutions

I, II, and III only

________ and ________ allow a financial intermediary to offer safe liquid liabilities such as deposits while investing the depositors' money in riskier illiquid assets.

Monitoring; diversification

Which of the following is/are money market instrument(s)?

Negotiable CDs