Chapter 10: Financial Markets and Securities
Assume that Ford Motor Company issues a recall on all models built between 2010 and 2015 because of a major malfunction in driver-side airbags. Place the events below in the correct order.
1. Ford's default risk on bond payments increases. 2. The demand for Ford's corporate bonds decreases. 3. The price of Ford's bonds decreases. 4. The interest rate on Ford's bonds increases.
The existence of a secondary market for stocks and bonds results in which of the following?
Correct Answer(s) The cost of borrowing drops. Stocks and bonds become more desirable. Incorrect Answer(s) The risks involved in buying a stock increase. The demand for stocks and bonds drops.
Select all the events that could cause the price of a security to increase
Correct Answer(s) The stock price of this firm is expected to double. A secondary market exists for this security. The firm's bond rating increases. Incorrect Answer(s) A bond becomes a high-yield security.
What are some of the options the U.S. government has when it needs to raise funds?
Correct Answer(s) selling U.S. Treasury securities to domestic firms, households and governments selling U.S. Treasury securities to foreign firms, households and governments Incorrect Answer(s) selling stock in the U.S. government buying foreign securities from foreign firms, households, and governments
A stack of United States treasury security notes in $25, $100, and $500 incrementsWhat are some of the options the U.S. government has when it needs to raise funds?
Correct Answer(s) selling U.S. Treasury securities to foreign firms, households and governments selling U.S. Treasury securities to domestic firms, households and governments Incorrect Answer(s) buying foreign securities from foreign firms, households, and governments selling stock in the U.S. government
Identify each of the following scenarios as direct or indirect financing.
DIRECT FINANCE: Garry borrows money from his parents to buy a new computer. AMT Bank buys corporate bonds from the AT&T corporation. Indirect Finance: Sami receives a bank loan to buy a motorcycle. Carolyn buys shares of McDonald's stock from another McDonald's stock owner.
Identify each event as an example of indirect finance or direct finance.
Direct Finance Winston secures $10,000 from his parents to start a toy shop. Kiera's friend used her savings to finance the purchase of resources for Kiera's new business. Indirect Finance Marie acquires a business loan from the bank to open a floral boutique. A loan from the financial intermediary funded the building project of Lou's Fine Dining Restaurant.
Carla has $10,000 that she would like to save for retirement.
If she wants to earn a higher long-term rate of return, then she will likely choose to put her money into stocks. Carla also knows that stock prices fluctuate a lot over time; therefore, if she prefers to avoid risk, then she will probably choose to purchase bonds but will likely earn a lower rate of return.
Fill in the blanks to complete the passage below on congressional responses to the Great Recession and the COVID-19 recession
In April 2020, the U.S. government enacted the Paycheck Protection Program (PPP) just twelve years after the Troubled Asset Relief Program in 2008, which provided $700 billion to help stabilize the economy during the Great Recession. Both programs were funded by taxpayers.
Fill in the blanks to complete the passage about secondary markets.
Secondary markets act as a mediator between sellers and buyers of securities. The ease of resale is valuable to the potential buyer of the bond. Though the securities sold in this market are pre-owned, the market allows for the quick resale and therefore the securities are worth a higher price.
HOME MORTGAGES
Securitization is the creation of a new security by combining otherwise separate loan agreements. What is a common loan agreement that is often securitized?
Which of the following is an example of indirect financing?
Steven borrowed money through his credit union to purchase sneeze guards and partitions so he could keep his restaurant open for business.
Congress passed the Troubled Asset Relief Program (TARP) in 2008 to aid banks that had made bad loans. This program was highly controversial. Match each idea with either a reason to support TARP or a reason against the program.
TARP reduced bank failures, which prevented massive layoffs in the financial industry. 1 support TARP used funds from taxpayers to bail out banks that had contributed to the recession. 2 against TARP distorted the operations of private markets, which would have allowed poorly managed banks to fail. 3 against TARP helped to prevent many bankruptcies and to stabilize financial markets. 4 support
The figure below depicts the flow of loanable funds. Place the three participants in this process into their correct positions in the flow of funds, using the larger boxes. Also, place the two types of flow into their correct positions on the figure, using the smaller boxes.
TOP: 1. INDIRECT FINANCE 2. BANKS AND OTHER FINANCIAL INTERMEDIARIES (LEFT) 3. SAVERS/LENDERS (RIGHT) 4. BORROWERS/ INVESTERS 5. DIRECT FINANCE
One benefit of selling stocks over bonds is that the firm is able to get the financial capital it needs without having a large debt to pay back
TRUE
false
The Dow Jones Industrial Average tracks the average stock price of 500 different companies that are selected by the editors of the Wall Street JournaL
Countries like Japan and China purchase a lot of U.S. Treasury securities. Which of the following is true of foreign purchases of U.S. Treasury securities?
The United States benefits because the foreign purchases lower interest rates, increase private investment, and lead to greater GDP in the future.
Fill in the blanks to complete the passage about the relationship between bond prices and bond interest rates
When the dollar price on a bond rises, the effective interest rate goes down. This is because the face value remains the same, no matter what the bond sells for.
Match the type of financial tool with the correct description
a security contract where a corporation agrees to pay a specific amount on a determined date corporate bonds Correct label: corporate bonds bonds sold by the U.S. government to pay for the national debt treasury securities Correct label: treasury securities a security vehicle that gives shares of ownership in a firm stocks Correct label: stocks
Apply the correct label to each description of a financing agent, activity, setting, or instrument.
a security that represents a loan bond Correct label: bond Savers deposit funds into banks, which in turn make loans. indirect financing Correct label: indirect financing a type of financial intermediary that provides indirect financing bank Correct label: bank a security that represents part ownership stock Correct label: stock a forum where direct and indirect financing takes place financial market Correct label: financial market Borrowers and savers interact without middlemen. direct financing Correct label: direct financing
INTEREST RATE
face value minus dollar price, as a percent of dollar price interest rate
What are financial intermediaries?
firms that help channel funds from savers to borrowers
default risk
the risk that on the maturity date the borrower will not pay the face value default risk
This figure displays the United States home mortgage market's expansions and contractions from 1990-2018. During which time period did the greatest growth in home mortgages occur?
2005
Direct financing works in multiple ways. Put the following events in order to show how direct financing can strengthen an economy's GDP and financial standing.
Tom and Sally buy $10,000 worth of bonds from ABC Company. ABC Company uses the money from the sale of the bonds to hire two more workers. ABC Company increases its monthly production level. GDP increases. ABC Company repays its bond debt to Tom and Sally.
DOLLAR PRICE
the amount paid for a bond at purchase dollar price
FACE VALUE
the amount to be repaid at maturity face value
maturity date
the date on which the loan repayment is due maturity date
Taylor sells you a $10,000 bond. Match the dollar price with its corresponding interest rate.
$5,000 $7,500 $8,000 $9,000
Home mortgages are an important borrowing tool that allow people to buy a home without having to save the full amount of the home ahead of time.
A home loan is a contract between the bank and the homeowner. There are many variations on home loans, but the most common ones last for 30 years. Prior to the Great Recession, the home mortgage market had expanded to over $10 trillion.
The likelihood of a firm's repaying its debt is important for prospective bond buyers. Place the following bond ratings in order of the firm's creditworthiness, greatest to least.
AAAAABBBD
1146 BILLION
About 30% of the $20 trillion U.S. national debt is owed to foreigners. Many countries hold a significant amount of that debt. Choose the bar that represents China's approximately 6% share of U.S. national debt. The values on the graph are in billions of dollars
Fill in the blanks to complete the sentence about direct and indirect financing.
Firms need funding to build and buy the resources they use to produce their goods and services. Some firms must interact with the financial intermediaries such as banks to acquire financing for investment. Not all firms have the ability to avoid financial intermediaries and go directly to savers for investment funds.
Complete the following passage regarding the market for loanable funds
In the loanable funds market, savers supply funds to borrowers either directly or indirectly. A direct method is to buy stocks and bonds. The most common indirect method is to deposit money with banks, which, in turn, make loans to borrowers.
Drag the items to classify each event as a cause of increase or decrease in demand for the department store Dillard's $100,000 bond market.
LEFT: Dillard's closes 300 stores, which lessens its ability to repay debts. Dillard's is unable to repay bondholders. RIGHT: Dillard's bond rating rises to an A rating from a BB rating. Consumers now prefer Dillard's to any other department store causing financial gains for Dillard's
