Principles of Finance Chapter 6: Understanding Financial Markets and Institutions

Which one of these characteristics applies to money market securities? High level of risk Potentially large fluctuations in value Issued solely by the U. S. Treasury Short maturities

Short maturities

The United States government is a large borrower - partly to finance past deficits. The national debt, as of 2018, is $32.05 trillion $5.02 trillion $2.05 trillion $21.05 trillion

$21.05 trillion

The sale of which of these securities matches the definition of a money market transaction? Select all that apply. 90-day U. S. Treasury bill 2-year U. S. Treasury note 6-month U. S. Treasury security 5-year corporate bond

90-day U. S. Treasury bill 6-month U. S. Treasury security

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A money market is a market that trades securities that mature in one year or less.

What is the definition of a capital market? A capital market is a market that trades only securities issued by governmental entities. A capital market is a market that deals only with primary issues. A capital market is a market that trades securities with maturities in excess of one year. A capital market is a market that trades securities amongst financial institutions.

A capital market is a market that trades securities with maturities in excess of one year.

What is the definition of a capital market? A capital market is a market that trades securities with maturities in excess of one year. A capital market is a market that trades only securities issued by governmental entities. A capital market is a market that trades securities amongst financial institutions. A capital market is a market that deals only with primary issues.

A capital market is a market that trades securities with maturities in excess of one year.

The type of financial institution that obtains a large percentage of its funds from savers' deposits is called: A depository institution An insurance company A finance company An investment bank

A depository institution

Which one of these defines an asset transformer? A corporation that repurchases outstanding shares of stock A financial institution which issues secondary securities to investors An economic agent appointed to act on behalf of investors A financial institution that issues primary equity securities

A financial institution which issues secondary securities to investors

What is a forward rate? A forward rate is a rate on a security that will mature sometime in the future. A forward rate is a real rate that has been adjusted for all the risks associated with an individual security j. A forward rate is a real rate of interest that has been adjusted for inflation. A forward rate is an implied rate on a short-term security that will originate sometime in the future.

A forward rate is an implied rate on a short-term security that will originate sometime in the future.

What is a nominal interest rate? A nominal interest rate is the base rate excluding inflation, default risk, and liquidity risk. A nominal interest rate is the rate on a default-free loan minus the inflation premium. A nominal interest rate is the rate observed in the financial markets. A nominal interest rate is the market rate of interest minus the inflation premium.

A nominal interest rate is the rate observed in the financial markets.

Which one of these is the definition of a nominal interest rate? A nominal interest rate is the rate of interest that excludes all risk premiums. A nominal interest rate is the rate of interest that excludes the inflation premium. A nominal interest rate is the rate of interest that includes all risk premiums. A nominal interest rate is the rate of interest which excludes any special provisions.

A nominal interest rate is the rate of interest that includes all risk premiums.

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A primary market is a market in which corporations and other fund demanders obtain funds by issuing new securities.

What is the definition of a real interest rate? A real interest rate is the rate an investor actually earns on an investment. A real interest rate is the guaranteed rate that a bank pays on a certificate of deposit A real interest rate is the rate designated as (i) in the Fisher effect formula. A real interest rate is the rate that would exist on a default-free security if no inflation were expected.

A real interest rate is the rate that would exist on a default-free security if no inflation were expected.

Which of these defines a secondary market? Select all that apply. A secondary market is a market where previously issued securities are traded. The secondary market involves the resale of a stock by a shareholder. A secondary market is a market in which the seller is also the issuer. The secondary market refers to all security transactions that involve individual investors.

A secondary market is a market where previously issued securities are traded. The secondary market involves the resale of a stock by a shareholder.

What is the definition of an initial public offering (IPO)? An IPO is any sale of securities by a firm in the primary market. An IPO is the first offering of financial securities by a firm to the general public. An IPO is any sale of newly issued securities by a corporation. An IPO is any sale of newly issued securities by a firm to the general public.

An IPO is the first offering of financial securities by a firm to the general public.

If a large company wanted to take over a competitor, then they would likely approach which of the following for advice on how to do this? A superannuation fund An investment bank A depository institution A large finance company

An investment bank

The type of financial institution that is a specialist provider of advisory services is called: A finance company A depository institution An investment bank An insurance company

An investment bank

Anna withdrew funds from her bank and purchased 500 shares of ABC stock at the recommendation of her broker. Which one of these parties meets the definition of a delegated monitor? Anna's bank Anna ABC Company Anna's broker

Anna's broker

Default risk is the risk associated with either late or missed payments on which of these securities? Treasury bonds only Bonds only Bonds and preferred stock Preferred stock only

Bonds and preferred stock

Which of these is the special provision that grants an issuer the right to retire a security prior to maturity? Term structure Convertibility Exchange provision Call option

Call option

Which of the following affect the dollar-yuan exchange rate? Select all that apply. Chinese government intervention Demand for and supply of U. S. dollars Demand for and supply of Chinese yuan Demand for and supply of Mexican pesos

Chinese government intervention Demand for and supply of U. S. dollars Demand for and supply of Chinese yuan

A firm produces goods in the U. S. and receives euros in Germany when the goods are sold. Which particular aspect of this firm's operations exposes the firm to foreign exchange risk? Paying American suppliers in dollars Converting the euros into dollars Paying American workers in dollars Paying German salesmen in euros

Converting the euros into dollars

The Corner Bank packaged a pool of home mortgages and sold mortgage-backed securities to the Uptown Insurance Co. to fund the monies loaned to the home owners. Which party(ies) meet the definition of asset transformer? Uptown Insurance Co. Corner Bank and Uptown Insurance Co. Homeowners with Corner Bank mortgages Corner Bank only

Corner Bank only

Which one of the following best explains the concept of the unbiased expectations theory? The current yield curve is the market's expectations of current and future long-term rates. Current long-term interest rates are geometric averages of current and future expected short-term rates. The long term N-year rate is simply the current 1-year rate raised to the Nth power. Current long-term interest rates are arithmetic averages of current and future expected short-term rates.

Current long-term interest rates are geometric averages of current and future expected short-term rates.

What is the best definition of default risk? Default risk is the possibility that an issuer may pay late or miss an interest or principal payment. Default risk is defined as paying off a loan prior to maturity to avoid incurring future interest. Default risk is defined as non-repayment of the principal value of a loan. Default risk is the potential for an issuer to never pay the interest or principal payments on a debt security.

Default risk is the possibility that an issuer may pay late or miss an interest or principal payment.

Which term is used to designate an economic agent appointed to act on behalf of smaller investors in collecting information? Security issuer Asset transformer Delegated monitor Free agent

Delegated monitor

Which one of these terms best describes the relationship between the rate of inflation and the rate of interest? Direct relationship Exponential relationship No relationship Indirect relationship

Direct relationship

Which one of these statements correctly applies to the market segmentation theory? The maturity preferences of individual investors are directly offset by the maturity preferences of financial intermediaries (FIs). Each individual investor has a preferred maturity based on his or her own financial situation. Financial intermediaries (FIs) are neutral in respect to security maturities. Individual investors prefer longer-term securities and must be compensated to switch to shorter-term securities.

Each individual investor has a preferred maturity based on his or her own financial situation.

Capital markets are defined by the type of securities traded rather than the maturity of those securities. True False

False Capital markets are defined as markets trading securities with maturities in excess of one year.

In general, the quantity of loanable funds demanded drops as interest rates fall. True False

False In general, the quantity of loanable funds demanded is higher as interest rates fall.

Which money market security is defined as short-term funds transferred between financial institutions, often for no more than one day? Banker's acceptances Federal funds Negotiable certificates of deposit Commercial paper

Federal funds

According to the definition of a foreign exchange market, what good or commodity is exchanged in these markets? Foreign-produced goods Foreign currency only Foreign services Domestic-produced

Foreign currency only

Which one of these is the best definition of foreign exchange markets? Foreign exchange markets are markets in which agreements are made for goods to be imported from or exported to non-U. S. firms. Foreign exchange markets are markets in which foreign currency is traded for immediate delivery. Foreign exchange markets are markets in which foreign currency is traded for immediate or future delivery. Foreign exchange markets are markets outside of the U. S. in which financial transactions occur.

Foreign exchange markets are markets in which foreign currency is traded for immediate or future delivery.

What is the interest rate called that is derived from existing spot rates on similar securities with varying terms? Real rate Forward rate Effective annual rate Compounded rate

Forward rate

Which three of the following are key factors that limit direct investment in financial claims? Select three. Inflation risk Liquidity costs Monitoring costs Price risk

Liquidity costs Monitoring costs Price risk

Which one of these is a common feature of a secondary security as compared to the primary claim? Decreased marketability Less attractive to investors Less accessibility to funds Increased liquidity

Increased liquidity

Which of these parties are affected by foreign exchange risk? Select all that apply. New Englander exporter of fish to Iowa Individual who invests in overseas markets U. S. importer of clothing from Asia U. S. exporter of goods to Canada

Individual who invests in overseas markets U. S. importer of clothing from Asia U. S. exporter of goods to Canada

How will an expected increase in the rate of inflation affect interest rates? Interest rates will remain unchanged. Interest rates will change but the direction of the change is unpredictable. Interest rates will decrease. Interest rates will increase.

Interest rates will increase.

Which one of these best defines the role of investment banks? Investment banks are the primary demanders of funds. Investment banks are the primary suppliers of funds. Investment banks are the primary suppliers of mortgage funds. Investment banks are financial intermediaries between demanders and suppliers of funds.

Investment banks are financial intermediaries between demanders and suppliers of funds.

What key role does an investment bank play? Investment banks maintain a liquid secondary securities market. Investment banks serve as an intermediary between the issuer of a security and the underwriter of that security. Investment banks arrange primary market transactions for business entities. Investment banks purchase all private placements.

Investment banks arrange primary market transactions for business entities.

What is the key premise of the market segmentation theory? Investors do not consider securities with different maturities as perfect substitutes. The key premise is that a segmented market will yield a flat yield curve. Investors require a premium in direct relation to the term of a security. The key premise is that the yield curve must be upward-sloping in order for demand to equal supply in each segment.

Investors do not consider securities with different maturities as perfect substitutes.

What is the basic premise of the liquidity theory? Investors demand a premium that is inversely related to the term to maturity. Investors must be paid a premium to hold more liquid securities. Investors must be paid a premium to offset increased future uncertainty. Investors are indifferent to liquidity.

Investors must be paid a premium to offset increased future uncertainty.

Which one of these best defines liquidity risk? Liquidity risk is the risk that an issuer will repay a security prior to the original maturity date. Liquidity risk is the risk that a security issuer will have insufficient funds to make timely payments. Liquidity risk is the possibility that an asset's price must be lowered below fair market value in order to sell the asset on short notice. Liquidity risk is the possibility that an asset will sell immediately at fair market value.

Liquidity risk is the possibility that an asset's price must be lowered below fair market value in order to sell the asset on short notice.

Which one of these is a basic premise of the unbiased expectations theory? The current yield curve must be flat for the market to be in equilibrium. Long-term rates must exceed short-term rates to compensate for greater market risk. Long-term rates consist of a series of successive short-term rates. Interest rates balance the expected demand and supply for securities of varying maturities.

Long-term rates consist of a series of successive short-term rates.

What can you determine with certainty about an upward-sloping yield curve according to the liquidity premium theory? Longer-term rates are higher than shorter-term rates today Future 1-year rates will be the same as today's 1-year rate Future 1-year rates will be higher than today's 1-year rate Future 1-year rates will be lower than today's 1-year rate

Longer-term rates are higher than shorter-term rates today

Which one of these sets of characteristics applies to money market securities? High risk, high price volatility, long-term Low risk, low price volatility, short-term Short-term, low risk, high price volatility Short-term, low price volatility, high risk

Low risk, low price volatility, short-term

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Martha sold 100 shares of stock to her son. The Feel Good Co. sold 500 shares of ABC, Inc. to The Better Health Co.

Which one of the following is a key factor that makes direct investments unpopular with investors? Banker's fees Monitoring costs Costs of holding cash Financial intermediary costs

Monitoring costs

Which type of bond will generally pay the lowest rate of interest based on its taxability provision? U. S. Treasury bond Corporate bond U. S. Treasury note Municipal bond

Municipal bond

How many initial public offerings can a corporation issue? Maximum of ten Two; one for bonds and one for stocks Unlimited One

One Corporations can have multiple security issues but only the first issue to be offered to the general public is labeled as the IPO.

To minimize liquidity risk which three factors must exist? Select three. Predictable sale price Low transaction costs Sale on short notice Sale at a reasonable profit

Predictable sale price Low transaction costs Sale on short notice

The risk that an asset's value may be less than its purchase price is referred to as which type of risk? Price risk Default risk Liquidity risk Inflation risk

Price risk

Which one of these is the definition of a real risk-free rate? Interest rate that reflects annualizing with compounding figured in Interest rate actually observed in financial markets Rate that would exist on a default-free security if no inflation were expected Continual increase in the price level of a basket of goods

Rate that would exist on a default-free security if no inflation were expected

Which money market security involves a sale, generally at a discounted price, that includes a promise to reverse the sale at a specified price on a specified date? Treasury bill Negotiable certificate of deposit Repurchase agreement (repo) Banker's acceptance (BA)

Repurchase agreement (repo)

Which one of these statements is correct? Secondary securities are additional offerings of stock issued by corporations. Secondary securities are primarily owned by financial institutions. Secondary securities tend to be more liquid than primary securities. Secondary securities represent direct transfers of funds.

Secondary securities tend to be more liquid than primary securities.

Which set of characteristics best applies to a derivative security agreement? Variable quantity, specified price of exchanged asset,and specified exchange date, high degree of leverage Standardized quantity, predetermined price of exchanged asset, specified exchange date, high degree of leverage Variable quantity, predetermined price of exchanged asset, variable exchange date, low degree of leverage Standardized quantity, unspecified price of exchanged asset, and unspecified exchange date, low degree of leverage.

Standardized quantity, predetermined price of exchanged asset, specified exchange date, high degree of leverage

The largest securities market in the world in terms of trading volume is: The government treasury market The foreign exchange market The stock market The commodity market

The government treasury market

The largest supplier of loanable funds in the United States is Corporate investments The household sector U.S. banks

The household sector

The term structure of interest rates compares similar bonds based on which variable? Degree of liquidity Level of default risk Time to maturity Taxability provision

Time to maturity

The term structure of interest rates compares similar bonds based on which variable? Level of default risk Degree of liquidity Time to maturity Taxability provision

Time to maturity

The term structure of interest rates is derived from which one of these? Time value of money Fisher effect Default risk concept Consumer price index

Time value of money

U. S. interest rates can affect all exchange rates involving U. S. dollars. True False

True

True or false: The issuer of the security will receive the proceeds of a security's sale if that sale occurs in the primary market. True False

True The primary market refers to all sales of newly-issued securities by the issuing firms. Since the issuer is the seller, the issuer receives the sale proceeds.

The trading volume (measured in monetary terms) on bond markets typically exceeds that of equity markets. True False

True The trading volume (measured in monetary terms) in bonds on a typical day is many, many times larger than the trading volume in equities.

Which one of these is a characteristic of a derivative security? Price of asset exchanged determined when exchange occurs Informal agreement Value dependent on underlying security Risk-free security

Value dependent on underlying security

Which one of these price changes meets the definition of price risk? Theo purchased land for $539,000 and later sold it for $541,000. Jamie purchased a store for $389,000. That store is now worth $415,000. Willis purchased a lot for $120,000. That lot is now worth $89,000. Audry purchased a building for $267,000. That building is still worth $267,000.

Willis purchased a lot for $120,000. That lot is now worth $89,000.

What are bought and sold in a financial market? (Select all that apply.) real estate debt securities equity securities collectible coins

debt securities equity securities

A market where debt and equity securities are bought and sold is known as a ______ market. commodities corporate investment financial

financial

Generally, the quantity of loanable funds supplied increases as interest rates ______________________ (rise/fall).

rise or increase