ECIN 2221 Midterm
The fact that many companies employ supervisors to oversee the actions of workers is a way to treat: a. moral hazard. b. adverse selection. c. the law of diminishing returns. d. the free-rider problem.
a
The scandals involving Enron, World Com, Global Crossing and other large firms: a. are examples of asymmetric information and have led, at least temporarily, to a less well functioning stock market. b. is what should have been expected on the part of investors, that is why there is a risk premium. c. have resulted in a cry for less government regulation of public corporations. d. demonstrate that the government should be responsible for collecting and distributing financial information on firms.
a
The variance of a portfolio of assets: a. decreases as the number of assets increases. b. increases as the number of assets increase. c. approaches 0 as the number of assets decreases. d. approaches 1 as the number of assets increases.
a
U.S. monetary policy is best described as: a. aimed at keeping inflation low and stable and growth high and stable. b. determining the denominations of a country's currency. c. one of the most important functions of congress. d. attempting to keep inflation constant at zero percent.
a
Which best describes money as a means of payment? a. Money provides an immediate double coincidence of wants. b. Money makes sure a double coincidence of wants never occurs. c. Money requires at least two transactions to obtain the double coincidence of wants. d. To obtain a double coincidence of wants without money is impossible.
a
Which of the following is an example of a financial market? a. A local coffeehouse where people regularly buy and sell financial instruments. b. A bank that only accepts deposits and issues loans. c. An electronic network used for buying and selling textbooks. d. A central bank used for raising taxes and borrowing on behalf of the government.
a
Most of the buying and selling in primary markets: a. is in the public view. b. is highly transparent and closely monitored by the SEC. c. involve an investment bank. d. is done by the Federal Reserve.
c
One reason the government requires public corporations to disclose so much information is to: a. minimize the monopoly profits some corporations earn. b. give small corporations a better chance of competing against large corporations. c. address the potential harm from asymmetric information. d. discourage risk-taking by investors.
c
Specialization usually increases the output of a country; however effective specialization requires: a. everyone in the country producing the same thing. b. that workers have very similar skills. c. an effective low-cost means to exchange goods and services.
c
Systematic risk: a. is the risk eliminated through diversification. b. represents the risk affecting a specific company. c. cannot be eliminated through diversification. d. is another name for risk unique to an individual asset.
c
The New York Stock Exchange is an example of a: a. financial instrument. b. financial institution c. financial market. d. bank.
c
The function of providing liquidity by financial intermediaries: a. includes depositors withdrawing funds but not borrowers. b. only considers people who borrow on a short-term basis, but not depositors. c. affects people who need to borrow and depositors who withdraw their funds. d. only affects customers with savings accounts.
c
The risk premium for an investment: a. is negative for U.S. treasury securities. b. is a fixed amount added to the risk-free return, regardless of the level of risk. c. increases with risk. d. is zero (0) for risk-averse investors.
c
The statement "risk requires compensation" implies that people: a. do not take risk. b. only accept risk when they absolutely have to. c. will only accept risk when they are rewarded for doing so. d. avoid risk at all cost.
c
The ultimate role of the financial system of a country is to: a. provide a place for wealthy households to save. b. be a low-cost source of funds for government. c. facilitate production, employment, and consumption. d. provide jobs in the financial sector
c
The unit of account characteristic of money: a. makes it difficult to compare the relative prices of goods and services. b. refers to how we use money to transfer purchasing power over time. c. means prices are expressed in terms of money. d. means that money finalizes payments.
c
Tom obtains a car loan from Old Town Bank. a. The car loan is Tom's asset and the bank's liability. b. The car loan is Tom's asset, but the liability belongs to the bank's depositors. c. The car loan is Tom's liability and an asset for Old Town Bank. d. The car loan is Tom's liability and a liability of the bank until Tom pays it off.
c
Which of the following best expresses the proceeds a lender receives from a one-year simple loan when the annual interest rate equals i? a. PV + i b. FV/i c. PV(1 + i) d. PV/i
c
Which of the following statements best describes financial instruments? a. All financial instruments are a means of payment. b. Financial instruments can transfer resources between people but not risk. c. Financial instruments can transfer resources and risk between people. d. Financial instruments can transfer risk but not resources between people.
c
Which of the following would not be considered a characteristic of money? a. It is a store of value. b. It is a means of payment. c. It must have intrinsic value. d. It is a unit of account.
c
Without the use of money, workers in an economy would: a. become more specialized b. have to spend a lot less time trading c. probably specialize less d. be far more productive
c
When an individual obtains a car loan and makes all of the regular monthly payments, the sum of the payments made will exceed the purchase price of the car. This is due primarily to the core principle: a. risk requires compensation. b. information is the basis for decisions. c. markets determine prices and allocate resources. d. time has value.
d
Which of the following expresses 5.65%? a. 0.565 b. 0.00565 c. 5.65 d. 0.0565
d
Which of the following is necessarily true of coupon bonds? a. The price exceeds the face value. b. The coupon rate exceeds the interest rate. c. The price is equal to the coupon payments. d. The price is the sum of the present value of coupon payments and the face value.
d
The store of value characteristic of money refers to the fact that: a. people save most of their money. b. money allows people to shift purchasing power into the future. c. money is not valuable unless it is stored. d. money is the only way people have to store value.
b
Which of the following best expresses the payment a lender receives for lending money for three years? a. 3PV b. PV (1+i)3 c. PV/(1 + i)3 d. FV/ (1 + i)3
b
Which of the following would not be included in a definition of risk? a. Risk is a measure of uncertainty. b. Risk can always be avoided at no cost. c. Risk has a time horizon. d. Risk usually involves some future payoff.
b
What are the four characteristics of a financial instrument?
(1) A financial instrument is a written legal obligation; (2) A financial instrument transfers something of value to another party; (3) A financial instrument specifies some future date for this transfer to occur; and (4) A financial instrument specifies certain conditions under which payment will be made.
What are the five functions performed by financial intermediaries?
(1) Pooling the resources of small savers; (2) providing safekeeping and accounting services as well as access to the payments system; (3) supplying liquidity, converting savers' balances directly into a means of payment when needed; (4) providing ways to diversify risk; and (5) collecting and processing information in ways that reduce information costs.
What does it mean to say that an asset is "liquid"?
An asset is liquid when it can be converted into a means of payment, quickly without suffering a loss in value.
What distinguishes commodity money from fiat money?
Commodity money, such as gold or silver, has value even if it is not used as money. For example, gold coins could be melted down and converted to jewelry. Fiat money, such as U.S. paper currency really has no value other than its use as money. Its value derives from the fact that it is deemed to be legal tender by the U.S. government and along with people's willingness to accept it.
What is the difference between economies of scale and economies of scope? Provide an example of each that pertains to financial institutions.
Economies of scale are the lowering of average cost as output increases. For example, a lender can spread the cost of developing a single loan application and single lending contract over many loans. Economies of scale are the lowering of average cost as output increases. For example, as a lender learns and develops special skills in obtaining information on loan applicants the cost of processing these applications will fall. Economies of scale result from exploiting gains from specialization. Economies of scope imply, for example, that one firm producing two different products can do so at a lower total cost than two firms producing one product each. For example, a bank may find that it can issue both credit cards and installment loans at a lower total cost than one bank issuing only credit cards and another making only installment loans.
Explain how Federal Deposit Insurance (FDIC) could potentially create a moral hazard for the managers of deposit institutions.
FDIC insurance pays off depositors (up to a limit) if a bank or other insured depository institution fails. As a result, the managers or owners of the bank have the incentive to attract funds (offer higher interest rates to savers), and then earn as high a return as possible (take greater risk). If the high returns appear, all they have to return to the depositors is the principal and interest; everything else is theirs. This is one reason why many financial intermediaries are highly regulated and restricted in their use of funds.
Why is it that financial intermediaries are so important in most economies?
Financial intermediaries provide a variety of services that enhance growth. These include pooling savings, providing liquidity, diversifying risk and collecting and processing information. As a result, they help facilitate the low cost allocation of capital to its most productive uses, thereby enhancing growth.
Explain why the following statement is true, "money is an asset but not all assets are money."
Money is an asset because it represents something of value to the owner. But not all assets can be used as an immediate means of payment.
Standard & Poor's sells information to investors; this is their primary business. Is this an example of a financial intermediary? Explain.
No. A financial intermediary is involved indirectly in a financial transaction. It matches up the ultimate lenders (savers) with the ultimate spenders (borrowers). The funds flow through the intermediary which is acting as a "middleman." That is not the case with Standard & Poor's.
Convert each of the following basis points amounts to percents: a) 412.5 b) 10 c) 125.7 d) 1075 e) 1
Since 1 basis point equals .01 percent, we can determine that: a) 412.5 basis points is 4.125% b) 10 basis points is 0.1% c) 125.7 basis points is 1.257% d) 1075 basis points is 10.75% e) 1 basis point is 0.01%
Briefly explain the difference between idiosyncratic risk and systematic risk. Provide an example of each.
Systematic risk is risk resulting from something that will impact all firms, such as a general slowdown in the economy. Idiosyncratic risk will impact specific firms or industries, such as a harmful bacterium that is discovered in beef.
How are the decisions of government policy makers, such as the Federal Reserve, related to risk and an individual investor's portfolio?
The decisions of government policy makers, such as the Federal Reserve, affect macroeconomic conditions, which in turn, affect the degree of systematic risk in the financial system. When the economy has low GDP growth and/or high inflation, this creates systematic risk that cannot be eliminated through diversification
Calculate the expected value of an investment that has the following payoff frequency: a quarter of the time it will pay $2,000, half of the time it will pay $1,000 and the remaining time it will pay $0.
The expected value = ¼($2,000) + ½($1,000) + ¼($0) = $1,000
Is the obtaining of a car loan a primary or secondary market transaction?
The obtaining of a car loan is a primary market transaction since the loan represents a newly-issued instrument by the bank.
What would be the standard deviation for a $1,000 risk-free asset that returns $1,100?
The standard deviation for this asset would have to be $0. If it is truly risk-free the return is certain, and if the return is certain there is no variance in the return, therefore no standard deviation.
Identify the five core principles of Money and Banking.
Time has value, Risk requires compensation, Information is the basis for decisions, Markets determine prices and allocate resources, Stability improves welfare.
What is the primary function of U.S. regulatory agencies in the U.S. financial system?
To provide wide-ranging financial regulation—rules for the operation of financial institutions and markets—and supervision —oversight through examination and enforcement
Compute the future value of $1,000 at a 6 percent interest rate after three different lengths of time. Use 6, 10 and 20 years into the future.
We can use a calculator and the formula FV = PV(1 + i)n to solve this problem. To calculate the future value for six years the formula will be: FV = $1,000(1.06)6 which equals $1,418.52. Using a similar approach for 10 years: FV = $1,000(1.06)10 which equals $1790.85. And finally for 20 years: FV = $1,000(1.06)20 which equals $3207.14.
Another name for the expected value of an investment would be the: a. mean value. b. upper-end value. c. certain value. d. risk-free value.
a
Asymmetric information poses two important obstacles to the smooth flow of funds from savers to investors. They are: a. adverse selection, which arises before the transaction occurs, and moral hazard, which occurs after the transaction. b. moral hazard, which arises before the transaction occurs, and adverse selection, which occurs after the transaction. c. adverse selection and moral hazard, both of which occur after the transaction. d. adverse selection and moral hazard, both of which occur before the transaction.
a
Central banks can improve the welfare of a society by doing all of the following except: a. serving the interests of government rather than the public at large. b. helping to promote economic growth. c. focusing on keeping the overall level of prices stable. d. helping to reduce the volatility of business cycles.
a
Doubling the future value will cause the: a. present value to double. b. present value to decrease. c. present value to increase by less than 100%. d. interest rate, i, to decrease.
a
Financial instruments are used to channel funds from: a. savers to borrowers in financial markets and via financial institutions. b. savers to borrowers in financial markets but not through financial institutions. c. borrowers to savers in financial markets but not through financial institutions. d. borrowers to savers through financial institutions, but not in financial markets.
a
Financial instruments used primarily to transfer risk would not include: a. a bank loan. b. options. c. an insurance policy d. home mortgages
a
Financial intermediaries, through their ability to lower transaction costs: a. reduce the opportunity cost of specialization. b. decrease the efficiency of an economy. c. allow for people to be more self-sufficient. d. make collecting and processing information unprofitable.
a
If financial intermediaries did not have the ability to pool the resources of small savers: a. borrowers needing large amounts of money would find it more costly to obtain the funds. b. the economy would grow faster. c. people would likely save more. d. the risk associated with lending would decrease.
a
In 2010, regulators of many nations agreed on a major update of internationally active banks known as: a. Basel III. b. the Fred-Bob Act. c. the Gramm-Leach-Bliley Act. d. the Dodd-Frank Act.
a
Large companies seeking to raise funds often will use a well-known investment bank because: a. the investment bank's reputation identifies the company as being credit worthy. b. they are required to by government regulation. c. the investment bank is paying the company for the publicity and goodwill it will generate. d. this minimizes moral hazard.
a
Money eliminates the need for: a. a search for a double coincidence of wants. b. government regulation. c. specialization of labor. d. financial Intermediaries.
a
A coupon bond is a bond that: a. always sells at a price that is less than the face value. b. provides the owner with regular payments. c. pays the owner the sum of the coupons at the bond's maturity. d. pays a variable coupon rate depending on the bond's price.
b
A financial intermediary: a. is an agency that guarantees a loan. b. is a third-party that facilitates a transaction between a borrower and a lender. c. would be used in direct finance. d. must be a depository institution.
b
Credit: a. probably came into being at the same time as coinage. b. predates coinage by 2,000 years. c. did not exist until the middle ages. d. first became popular due to the writings of Aristotle.
b
Higher savings usually requires higher interest rates because: a. everyone prefers to save more instead of consuming. b. saving requires sacrifice and people must be compensated for this sacrifice. c. higher savings means we expect interest rates to decrease. d. of the rule of 72.
b
How do financial institutions evaluate the creditworthiness of potential borrowers? a. They offer high interest rates because only the best borrowers will be able to afford them. b. They gather information regarding the borrowers' finances. c. They do not evaluate creditworthiness because everyone is treated the same. d. They do not evaluate the creditworthiness because they know the borrower will honor his/her obligation to repay the loan.
b
In the United States, control of the quantity of money is given to the: a. President. b. Federal Reserve System. c. Bureau of Printing and Engraving. d. Department of the Treasury.
b
Loans made between borrowers and lenders are: a. liabilities to the lenders and assets to the borrowers since the borrower obtains the funds. b. assets to the lenders and liabilities of the borrowers since the promises are made to the lenders. c. not part of either parties' assets or liabilities until the loans are repaid. d. liabilities to both the lenders and the borrowers.
b
Mary purchases a U.S. Treasury bond; the bond is a(n): a. asset of the U.S. government as well as an asset for Mary. b. liability of the U.S. government and an asset for Mary. c. asset for Mary but not a liability of the U.S. Government. d. asset for the government but a liability for Mary.
b
More detailed financial instruments tend to be: a. less costly because all possible contingencies are covered. b. more costly because it will cost more to create. c. more desirable than less detailed ones, no matter what the price. d. less costly because they can be standardized more easily.
b
Most financial markets in the United States operate under a system: a. without any formal rules or regulation. b. with many rules and regulation to ensure a fair market. c. where it depends on which state where the financial market is located since some states do not have any regulations. d. that is totally controlled by the federal government.
b
Most individuals borrow: a. directly without the use of a financial intermediary. b. using a financial intermediary because it lowers the cost of borrowing. c. using a financial intermediary, but would save money if they financed directly. d. without using financial intermediaries, preferring credit cards.
b
Recent history has shown that the government regulations requiring the disclosure of information from public corporations have: a. all but eliminated the problems of asymmetric information. b. reduced but not eliminated the problems of asymmetric information. c. just about eliminated the market for information services. d. resulted in symmetric information.
b
Risk-free investments have rates of return: a. equal to zero. b. with a standard deviation equal to zero. c. that are uncertain, but have a certain time horizon. d. that exhibit a large spread of potential payoffs.
b
The amount of information an individual would seek before making a decision: a. is about the same across all individuals. b. varies directly with the importance of the decision. c. is the same across all decisions but varies across individuals. d. depends on how much time it will take to get the information regardless of the decision.
b
The central bank of the United States is: a. the Bank of America b. the Federal Reserve System c. the U.S. Treasury d. Citibank
b
The future value of $100 at a 5% per year interest rate at the end of one year is: a. $95.00 b. $105.00 c. $97.50 d. 107.50
b
The primary function of central banks is to: a. increase risk and volatility to increase compensation. b. control inflation, as well as help reduce the size and frequency of business cycle fluctuations. c. increase the uncertainty that firms face in making investment decisions. d. eliminate the need for banks to collect financial information.
b
Loans made between borrowers and lenders are: a. usually not taxable at the federal level. b. legal only in the state of origination. c. assets of the lenders. d. assets of the borrowers.
c
A financial instrument would include: a. only a written obligation and a transfer of value. b. only a written obligation and a specified date. c. a written obligation, a transfer of value, a future date, and certain conditions. d. a written obligation, a transfer of value, a specific date for payment, uncertain conditions.
c
A promise of a $100 payment to be received one year from today is: a. more valuable than receiving the payment today. b. less valuable than receiving the payment two years from now. c. equally valuable as a payment received today if the interest rate is zero. d. not enough information is provided to answer the question.
c
A society without any money: a. could never exchange goods and/or services. b. would find people doing everything for themselves. c. would have to rely on barter. d. would be more efficient since people would be more self-sufficient.
c
An investor deposits $400 into a bank account that earns an annual interest rate of 8%. Based on this information, how much interest will he earn during the second year alone? a. $25.60 b. $32 c. $34.56 d. $64
c
Diversification is the principle of: a. eliminating risk. b. reducing the risk we carry to just two. c. holding more than one asset to reduce risk. d. eliminating investments from our portfolio that have idiosyncratic risk.
c
Financial institutions, acting as financial intermediaries, perform all of the following, except: a. provide ways to diversify risk. b. pooling resources of small savers. c. increase transactions costs. d. provide safekeeping and accounting services.
c
Financial intermediation is: a. far less important than direct finance through stock and bond markets. b. only a little more important than direct finance in the United States. c. much more important than direct finance through stock and bond markets. d. the same thing as finance through stock and bond markets.
c
If a bond has a face value of $1,000 and a coupon rate of 4.25%, the bond owner will receive annual coupon payments of: a. $425.00 b. $4.25 c. $42.50 d. a value that cannot be determined from the information provided.
c
If the interest rate is zero, a promise to receive a $100 payment one year from now is: a. more valuable than receiving $100 today. b. less valuable than receiving $100 today. c. equal in value to receiving $100 today. d. equal in value to receiving $101 today.
c
In comparing money to a U.S. Treasury bond held by an individual, we can say: a. the treasury bond is an asset but money is not. b. money is an asset but the U.S. bond is a liability of the individual. c. both are stores of value. d. money is a store of value but the bond is not.
c
What is the present value of $200 promised two years from now at 5% annual interest? a. $190.00 b. $220.00 c. $180.00 d. $181.41
d
Rank the following assets from most liquid to least liquid. a) Common stock b) Houses c) currency d) Art e) Savings accounts f) Checking account deposits.
currency, checking account deposits, savings accounts, common stocks, houses, art
A lender usually knows less about the creditworthiness of a borrower than the borrower does. This is an example of: a. opportunistic behavior. b. economies of scale. c. diminishing marginal returns. d. information asymmetry.
d
A monthly growth rate of 0.6% is an annual growth rate of: a. 7.20% b. 6.00% c. 7.60% d. 7.44%
d
A risk-averse investor will: a. always accept a greater risk with a greater expected return. b. only invest in assets providing certain returns. c. never accept lower risk if it means accepting a lower expected return. d. sometimes accept a lower expected return if it means less risk.
d
A saver knows that if she put $95 in the bank today she will receive $100 from the bank one year from now, including the interest she will earn. What is the interest rate she is earning? a. 5.10% b. 6.00% c. 5.52% d. 5.26%
d
Identify which of the following is not one of the five core principles of money and banking. a. Risk requires compensation b. Time has value c. Information is the basis for decisions d. Stability creates risk
d
Inflation presents risk because: a. inflation is always present. b. inflation cannot be measured. c. there are different ways to measure it. d. there is no certainty regarding what inflation will be in the future.
d
Inflation refers to growth in the economy's: a. Gross Domestic Product (GDP). b. interest rates. c. money. d. prices.
d
Investing in financial instruments in today's economy: a. is an activity practiced only by the wealthy. b. involves costly transactions. c. requires a relatively large sum of money to invest (more than $100,000). d. is made easier by the use of mutual funds.
d
Over-the-counter (OTC) markets: a. employ specialists to minimize price volatility. b. are centralized exchanges but you must be a dealer to be part of an exchange. c. only deal in the stocks of companies with over $100 million in capital. d. are networks of security dealers linked electronically.
d
The better the information provided to financial markets the: a. less the amount of funds transferred between savers and borrowers. b. greater the amount of funds transferred between savers and borrowers, though risk increases. c. higher the return required by lenders. d. greater will be the flow of funds in these markets.
d
The largest regulatory change in U.S. financial markets since 1930 is known as: a. Basel III. b. the Fred-Bob Act. c. the Gramm-Leach-Bliley Act. d. the Dodd-Frank Act.
d
The measure of risk that focuses on the worst possible outcome is called: a. expected rate of return. b. risk-free rate of return. c. standard deviation of return. d. value at risk.
d
Identify the six parts of the financial system.
money, financial markets, financial instruments, financial institutions, government regulatory agencies, and central banks.