Econ 2035 Chapter 7, 8 & 9 study guide
what is the difference between a stock exchange and an over-the-counter market?
A stock exchange is a physical location where trading occurs face-to-face, while over-the-counter markets are virtual markets where dealers are linked by computers to buy and sell stocks.
What is the difference between adaptive expectations and rational expectations?
Adaptive expectations assume that investors' expectations are based on past values of a variable, whereas rational expectations assume that investors make forecasts of future values using all available information.
chapter 9 end of chapter 3.8 A column in the Wall Street Journal offered the opinion that "as a rule of thumb, the more complex a [financial] product is, the worse the deal." Do you agree? Why would a more complex financial product be likely to be a worse deal for an investor than a simpler product?
Agree. When investors buy simpler products, they typically have more information and can make more informed choices about the products.
chapter 9 end of chapter 3.6 Describe some of the information problems in the financial system that lead firms to rely more heavily on internal funds than external funds to finance their growth. Do these information problems imply that firms are able to spend less on expansion than is economically optimal?
Asymmetric information makes information costs for external funds higher than for internal funds, but these costs do not necessarily imply that firms are able to spend less on expansion than is economically optimal.
Which of the following might explain why a country without a strong financial system would struggle to achieve high rates of economic growth?
Firms are unable to acquire funds they need to expand.
Which of the following is not true regarding forward contracts and futures contracts?
Forward contracts have reduced counterparty risk and lower information costs
chapter 9 end of chapter 1.4 All of the following are reasons why these financial foundations were important in making possible the rapid growth of the U.S. economy during the nineteenth and twentieth centuries, except:
A central bank provided direct control over all interest rates, facilitating the control and direction of the overall economy.
what is a call option?
A derivative contract giving the buyer the right to buy the underlying asset at a set price during a set period of time.
what is a put option?
A derivative contract giving the buyer the right to sell the underlying asset at a set price during a set period of time.
What is a pricing anomaly?
A pricing anomaly is a strategy that investors might use to earn above-average returns.
Suppose that the euro rises in value relative to the dollar. What is the likely effect on European exports to the United States? What is the likely effect on U.S. exports to Europe? eruopean exports will _______ and U.S exports will ________
decrease, increase
chapter 8 end of chapter 3.7 Why did the reporter find it important to mention that the differential between U.S. interest rates and interest rates in other developed countries had declined? Foreign investment into a country decreases when the interest rate in that country___________________ given that the countries have _____________
decreases relative to other countries' rates, similar default risk
What risks were investors taking on by buying these bonds? By buying these bonds investors take on _________ associated with the investment. Buying Ball Corporation bonds in 2020 also exposes investors to __________-
default risk interest rate risk since rates will likely increase in the future
chapter 8 end of chapter 3.11 (solved problem 8.3) What does the article mean by the "stability of the peso"? In this situation when the article mentions the "stability of the peso" they are referring to the fact that the peso ______________________. This stability attracts investors to the carry trades described in the article since _______________-
does not have much volatility in its exchange rate. unexpected exchange rate changes could cause losses
chapter 7 end of chapter 3.8 What would happen to the prices of these derivatives if interest rates fell? If interest rates end up falling the value of the derivatives that they purchased to hedge risk would ______.
fall
chapter 7 end of chapter 4.6 In March 2020, the online trading app Robinhood had a service outage that left users unable to buy or sell stocks or options contracts through the app. An article in the New York Times described how one investor had bought put contracts on airline stocks. The article quoted the investor as saying, "Yesterday, I had plans to close out all of my options and take a profit. . . . Now I am in the red." What must have been happening to the prices of airlines stocks during these 2 days (the first day, "yesterday;" and the second day, "now")? the price of airlines stock must have _____________- the strike price on the first day and then had _____ the second day
fallen well below, risen
chapter 8 end of chapter 3.5 How can exchange-rate risk be hedged using forward, futures, and options contracts?
firms can buy forward contracts to hedge against a rise in exchange rate
Dollar price
foreign price divided by exchange rate
chapter 9 end of chapter 2.8 Decades ago, many bank records were written by hand in ledgers. The shift to keeping all records on computers has _______ the opportunities to achieve economies of scale by replacing ________ costs with ___________ costs
increased, labor, technology
chapter 9 end of chapter 13 RTDA data exercise 3 the networth of corporations __________ just after a recession
increases
chapter 9 end of chapter 2.8 Decades ago, many bank records were written by hand in ledgers. At the time, banks achieved ____________ economies of scale as the amount of labor required to maintain such records was ____________. for every transaction, _________ of the size of the bank.
little, the same, regardless
What is the most important source of external funds for these firms?
loans from financial intermediaries
chapter 8 end of chapter 2.4 ppp is a __________ theory that generally only holds over a _____ period of time
long run, long
chapter 7 end of chapter 4.8 Suppose you buy the January put with a strike price of $18 and the price of Facebook stock remains at $21.95. What will be your profit or loss?
loss is .80 loss will be equal to the option price
chapter 8 end of chapter 3.9 What does the article mean by Coca-Cola having a "more global business" than PepsiCo? It means that Coca-Cola has ____ foreign exports than Pepsi Co
more
becasue U.S goods are now _____ expensive this is _____ news for japanese consumers
more, bad
chapter 7 end of chapter 3.2 Is a firm likely to have a long position in both the spot market and the futures market?
no, this would imply the firm intends to both buy and sell the same asset in the future
If the trade war continued for the period that investors expected that it would, would stock prices fall further? ______ , since the trade war continued for the period that investors expected the stock prices _______--
no, will already reflect their fundamental values
When a newspaper article uses the term "the exchange rate," it is typically referring to the ______- exchange rate
nominal
chapter 9 end of chapter 2.13 Why would investors buy securities that contain bad commercial real estate loans? A.Investors might buy securities containing bad loans if securities are misrepresented. B.Investors might buy securities containing bad loans if they are risk "enthusiasts." C.Inaccurate rating agency judgments may cause investors to buy securities containing bad loans. D.All of the above. E.Only A and C are plausible.
only A and C are plausible
chapter 7 end of chapter 4.4 Which of the following is true of investors using options to manage risk?
options do not suffer a loss if the value of the asset moves in the opposite direction of that being hedged against
Stocks are called equities because
ownership of stocks represents partial ownership of a firm ownership fo a firm's stock represents ma legal claim on the firm's profits
chapter 8 end of chapter 2.7 Comparing GDP levels across countries using current nominal exchange rates ignores ___________
price differences for the same good across countries
chapter 9 end of chapter 2.6 What is the difference between venture capital firms and private equity firms? A _____________ firm raises equity capital to acquire shares in established firms with the intention of reducing ___________ problems. A ______________ firm is a firm that raises equity capital from investors to invest in startup firms.
private equity moral hazard ventrue capital
chapter 8 end of chapter 2.7 GDP's relative to other countries. Adjusting for PPP allows GDP comparisons to more accurately measure ______________ differences across countries
production
chapter 7 end of chapter 4.8 Suppose you buy the November call with a strike price of $18. If you exercise it when the price of Facebook is $22, what will be your profit or loss?
profit is -.44 22-18= 4 4-4.44 = -.44 profit
Someone with no connection to an industry that places financial bets on futures contracts within the industry in an attempt to profit from changes in asset prices is called a ______-
speculator
chapter 7 end of chapter 4.8 Why would a call with a $18 strike price sell for less than a call with a $17 strike price (for all expiration dates) while a put with a $18 strike price would sell for more than a put with a $17 strike price (for all expiration dates)?
the $18 call is cheaper than the $17 call because the stock price will reach $17 before it hits $18 making the option more valuable @ $17 than $18 the $18 put is more expensive than the $17 put because the stock price will reach $17 before it hits $18 making the option less valuable at $95 than $105
chapter 9 end of chapter 3.2 What is the most important method of debt financing for corporations?
the bond market
chapter 7 end of chapter 2.4 Suppose that oil prices decline by 50%. Which counterparty to a forward contract in oil has an incentive to default on the contract?
the buyer of the forward contract since the price they have committed to pay is now above the market price.
chapter 8 end of chapter 3.2 How does the interest-rate parity condition account for differences in interest rates in different countries on similar bonds?
the differences reflect expected changes in the exchange rate
A columnist in the Wall Street Journal writes, "Stocks are meant to be the discounted value of future profits." Briefly explain what he means. The value to an investor of holding a stock is based on _______ discounted by the ___________
the expected future cashflows the stock will generate risk or holding the stock
chapter 9 end of chapter 1.4 Economist Richard Sylla of New York University has argued that in the 1790s, Secretary of the Treasury Alexander Hamilton "established the financial foundations that would make the United States the most successful emerging market in the nineteenth century, and the economic colossus of the next that some would call the 'American century.'" Sylla would focus on all of the following "financial foundations" of the United States, except:
the issuance of currency
The principal-agent problem occurs
when managers follow their own self interests rather than the interest of the shareholders.
chapter 7 end of chapter 3.6 An article in the Wall Street Journal on the oil market observes that "money managers have been trimming their long trading positions." What is a long position in the futures market? if money managers are trimming their long trading positions they must be expecting that the price of oil ___________________-
will fall in the future
chapter 7 end of chapter 4.2 How do the rights and obligations of options buyers and sellers differ from the rights and obligations of futures buyers and sellers?
with futures contracts, buyers and sellers have symmetric rights and obligations; however, with options contracts, buyers have rights and sells have obligations
If everyone were perfectly honest, would there be a role for financial intermediaries?
yes
chapter 8 end of chapter 1.6 A student makes the following observation: This month the euro depreciated sharply against the U.S. dollar. That was good news for attendance at Disneyland Paris and bad news for attendance at Walt Disney World in Orlando, Florida. Do you agree with the student?
yes, as the euro depreciates, it becomes less expensive for U.S citizens to travel to Disney land Paris
chapter 7 end of chapter 3.11 How might you hedge against this risk you identified above?
you would sell treasury futures
Would derivative markets be better off if the only people buying and selling derivative contracts were hedgers?
No, as in all markets, at least two parties are required for each transaction, and speculators help provide liquidity and efficiency in financial markets.
A student makes the following observation: It currently takes 80 yen to buy 1 U.S. dollar, which shows that the United States must be a much wealthier country than Japan. But it takes more than 1 U.S. dollar to buy 1 British pound, which shows that Great Britain must be a wealthier country than the United States. Do you agree with the student's reasoning? Why?
No, exchange rates do not measure the wealth of a country.
A student makes the following observation: "The Dow Jones Industrial Average currently has a value of 26,000, while the S&P 500 has a value of 3,000. Therefore, the prices of the stocks in the DJIA are more than eight times as high as the prices of the stocks in the S&P 500." Do you agree with the student's reasoning?
No, these indexes are averages of stock prices and indicate the overall performance of the stock market.
Is it likely that an investor will be able to use a stock pricing anomaly to earn above-average returns in the stock market?
No, to earn above-average returns, investors would need to take on above-average risk.
If Biogen's decision to get FDA approval had not been a surprise, would the effect of the announcement on its stock price have been different?
Yes, if investors had known about the approval ahead of time the announcement would not have caused any change in the stock price since the news would have already been priced into the current stock price.
Is it possible for these buybacks to cause losses to investors?
Yes, if these buybacks are below the initial purchase price, then investors would suffer a loss.
An article on cnbc.com quotes a financial planner as saying that preferred stock "has some aspects similar to ordinary common stock. It also has some aspects of it that are more similar to a bond." In what sense is a share of preferred stock more like a bond than a share of common stock? (Check all that apply.)
If the corporation declares bankruptcy, preferred stockholders are paid off before common stockholders. Preferred stock receives fixed dividend payments that are set when the corporation issues the stock.
chapter 9 end of chapter 13 RTDA data exercise 3 which of the following best describes a non-financial corporation?
Institutions that are responsible for providing commercial goods or non-financial services
which of the following does NOT describe derivatives
Insurance is required when purchasing derivative securities.
Why might investors sometimes engage in herd behavior? Is this behavior consistent with the assumption of the efficient markets hypothesis?
Investors may fear missing out or believe in the greater fool theory. This behavior is not consistent with the efficient markets hypothesis.
Which of the following might explain why investors might expect to receive a higher return in the long run from buying index funds rather than actively managed funds?
It is extremely difficult to outperform the long-run average return on stocks.
An article on barrons.com discussing rapid increases in Amazon's stock price asks the question: "How risky might it be to follow the investing herd and jump in?" What does the article mean by "the investing herd"?
People who choose investments based on what others are doing
exchange rate formula
Real Exchange Rate = Nominal Exchange Rate * Ratio of prices in the two countries
Which of the following are examples of financial futures? (Check all that apply.)
Selling U.S. dollar futures contracts. Selling Treasury note futures contracts
Which of the following are examples of commodity futures? (Check all that apply.)
Selling oil futures to hedge against falling oil prices. Selling corn futures to hedge against falling corn prices.
chapter 9 end of chapter 2.13 What is securitization?
The process of converting loans and other financial assets that are not tradable into securities.
write the two components of the rate of return on a stock investment.
The rate of return is equal to the rate of return on the dividend plus the rate of return on the price change from the purchase price.
what key assumptions does the gordon growth model make?
The required rate of return is greater than the dividend growth rate of the stock. The growth rate of dividends is constant. Investors receive their first dividend immediately rather than at the end of the year
what is a random walk?
The unpredictable movements of stock prices—that is, on any given day, stock prices are as likely to rise as to fall.
chapter 7 end of chapter 1.4 Suppose you are a manufacture of cornbread. What risk do you face from price fluctuations? a. stable corn prices b. rising corn prices c. falling corn prices d. you face no risk from price fluctuations
b. rising corn prices
chapter 9 end of chapter 13 RTDA data exercise 3 which of the following are examples of non-financial corporations? berkshire hathaway fidelity goldman sachs apple chase
berkshire hathaway apple
index funds __________ whereas actively mangaged funds _______
buy a set portfolio of stocks frequrently buy and sell individual stocks
chapter 7 end of chapter 3.4 would general mills buy or sell futures contracts in wheat? what would general mills hope to gain by doing so? general mills would ______ futures contracts in wheat to reduce the risk of prices _______
buy, rising
chapter 7 end of chapter 3.6 An article in the Wall Street Journal on the oil market observes that "money managers have been trimming their long trading positions." What is a long position in the futures market? a long position in a futures contract, denotes the right and obligation of the _______________ the underlying asset ________________-
buyer to recieve or buy, on a specified future date
chapter 7 end of chapter 1.4 What would have to be true of a derivatives security if the security were to help you to hedge this risk? a. the derivative would need to go down in value if corn prices rose b. the derivative would need to go in value if corn prices fell c. the derivative would need to go up in value if corn prices rose d. derivatives would not help you hedge this risk
c. the derivative would need to go up in vale if corn prices rose
chapter 9 end of chapter 13 RTDA data exercise 3 the net worth of corporations ______________ just before a recession
can either be increasing or stable
chapter 9 end of chapter 13 RTDA data exercise 3 the net worth of corporations __________________ during a recession
can either be increasing or stable
chapter 8 end of chapter 3.9 Why would having a more global business hurt Coca-Cola during a period in which the U.S. dollar was strong? A strong U.S. dollar in general will make imports into the U.S. ________________ while exports out of the U.S. ______________. Therefore, the strong U.s dollar will result in _________________
cheaper for U.S consumers are more expensive for foreign consumers a drop in exports for coca cola
chapter 7 end of chapter 5.2 credit swaps are
contracts in which interest-rate payments are exchanged, with the intention of reducing default risk.
chapter 8 end of chapter 2.4 According to a survey of professional foreign-exchange traders, the theory of purchasing power parity is considered to be "academic jargon." Which of the following are reasons why foreign-exchange traders might not find PPP to be useful as they trade currencies day-to-day? check all that apply
- Day-to-day movements in currencies are driven by the news. Day-to-day movements in currencies are driven by short-term economic events. Day-to-day movements in currencies can be driven by a large degree of random movements.
chapter 7 end of chapter 4.8 What is the intrinsic value of the put option that expires in January and has a $18 strike price? The intrinsic value on a put option is the strike price minus the underlying stock price. The put option is out of the money (strike price is below the market price), so the intrinsic value is
.00 18-18= 0.00
chapter 8 end of chapter 1.8 Suppose that an Apple iPhone costs $240 in the United States, £70 in the United Kingdom, and ¥40,000 in Japan. If the exchange rate between the pound and the dollar is $1.50 = £1, the real exchange rate between the pound and the dollar is _____
.43 1.50*(70/240) = .43
chapter 8 end of chapter 1.8 If the exchange rate between the dollar and the yen is ¥120 = $1, the real exchange rate between the dollar and the yen is _____
.72 120*(240/40000) = .72
chapter 7 end of chapter 3.10 The open interest on the contract expiring in March 2021 is ________
118,718 (from the chart provided)
chapter 7 end of chapter 3.10 Consider the hypothetical listing in the following table for 10-year Treasury note futures on the Chicago Board of Trade. One futures contract for Treasury notes = $100,000 face value of 10-year 6% notes. If today you bought two contracts expiring in December 2020, you would pay ___________ (Remember there are 1,000 $100s of face value in a $100,000 contract.)
261,100 (130.510 x 1,000 x 2) = 261,100
chapter 7 end of chapter 4.8 The intrinsic value on a call option is the underlying stock price minus the strike price: The intrinsic value of the call option that expires in April and has a$17 strike price is
4.95 21.95-17 = 4.95 (from graph provided)
chapter 9 end of chapter 2.13 Is it likely that the interest rates on these securities were high enough to compensate investors for the additional risk involved with these securities? Briefly explain. A.The interest rates would have been high enough to compensate investors for the additional risk if the rating agencies had accurately assessed the risks; unfortunately, the agencies underperformed. B.It is not likely that the interest rates on these securities were high enough given the financial meltdown that ensued; hindsight is, of course, 20-20. C.The interest rates were "spot on" given the risks involved. Investors just got too greedy. D.A and B are correct.
A and B are correct
chapter 9 end of chapter 2.13 Why would banks make bad commercial real estate loans? Don't banks lose money if these loans default?
Banks might make bad loans if potential losses on the loans are borne by entities other than the banks
How does the lemons problem lead many firms to borrow from banks rather than from individual investors? (Check all that apply.)
Because potential investors have difficulty in distinguishing good borrowers from bad borrowers, they offer good borrowers terms they are reluctant to accept. C. Because banks specialize in gathering information, they are able to overcome the problem of distinguishing good borrowers from bad borrowers.
What is behavioral finance, and how is it related to behavioral economics?
Behavioral finance studies how people make choices in the markets by applying concepts from behavioral economics
In the adjacent figure, countries that are above the upward sloping line have relatively high levels of real GDP per capita for their levels of financial development and countries that are below the line have relatively low levels of real GDP per capita for their levels of financial development. Holding constant all other factors that might affect a country's rate of economic growth, would we expect future growth rates to be higher for countries above the line or for countries below the line?
Below the line because these countries have underperformed so far given the strength of their financial system.
chapter 7 end of chapter 5.2 in what way is a credit swap different from an interest rate swap?
Credit swaps reduce default risk, or credit risk, rather than interest-rate risk.
chapter 8 end of chapter 3.11 (solved problem 8.3) Borrowing at a low interest rate in one currency to lend at a higher interest in another currency is sometimes called a "carry trade." In early 2020, an article on bloomberg.com observed that: "Lured by both the stability of the peso and Mexico's high interest rates, investors keep piling in to the [carry] trade." How were investors making a profit in this carry trade?
By borrowing at a low interest rate in one currency and lending at a higher interest rate in another currency using assets with similar default risks.
How can herd behavior lead to a bubble in a financial market?
By carrying a stock price higher than its fundamental value, even leading to a speculative bubble.
What is the difference between a commodity future and a financial future?
Commodity futures take a long or short position in the commodity market, while financial futures take a long or short position on a financial asset.
chapter 9 end of chapter 13 RTDA data exercise 3 Why did corporate net worth decline by so much during the recession of 2007-2009?
Corporate net worth declined significantly during the 2007-2009 recession because corporations lost revenue due to a large decline in household net worth and spending.
what are the 3 most important stock market indexes?
Dow Jones Industrial Average. S&P 500. NASDAQ Composite.
The website of the CME Group, a market for trading derivatives contracts, includes the following observation: "A Eurodollar and a euro are not the same thing." What is the difference between Eurodollars and euros?
Eurodollars are dollar deposits in banks outside the U.S. while euros are the European Union's currency.
chapter 8 end of chapter 3.5 How might an investor use forward, futures, and options contracts to speculate on the future value of a currency? (Check all that apply.)
For options, if the value of the currency falls below the strike price, the firm could exercise the option and sell at the (above-market) strike price. For forward contracts, if an investor becomes convinced that the future value of the euro will be lower than other people in the foreign-exchange market currently believe, the investor can sell euros in the forward market.
Which financial instruments can oil companies use to protect themselves from swings in the price of oil?
Futures contracts, they can sell oil futures contracts protect themselves against price changes.
chapter 7 end of chapter 1.2 what is the difference between hedging and speculating? __________ serves to reduce risk in financial markets, while _____________ may increase risk in the market
Hedging, Speculating
In early 2020, an article on barrons.com was titled "Tesla Stock Jumped 20%. It Makes No Sense." The article mentioned that the increase in Tesla's stock price "baffled investment pros." Under what circumstances would an "investment pro" expect the price of a firm's stock to increase?
If new information is released that impacts the firm's profitability today or in the future
A column on bloomberg.com notes that "once academics discover and publish an anomaly - some pattern in stock prices that can be used to get predictable superior risk-adjusted returns - the anomaly tends to go away." Why does the columnist refer to "risk-adjusted returns"? Is earning an above-average return on an investment that has greater-than-average risk inconsistent with the efficient markets hypothesis?
It is not inconsistent, the hypothesis predicts that all stock investments should have the same return only after adjustment for differences in risk, liquidity, and information costs.
Can an increase in a stock's price continue indefinitely for the reason you found above? If not, what would cause the increase to stop?
No it cannot, informed investors will recognize the stock price does not match its fundamental value and arbitrage away the price anomaly.
What is the difference between the nominal exchange rate and the real exchange rate?
Nominal exchange rates tell you how many, say, euros you will receive in exchange for a U.S. dollar, but they do not tell you how much of another country's goods and services you can buy with that U.S. dollar.
During 2018 and 2019, the United States and China were engaged in a trade war, with each country imposing tariffs on the other country's imports. As a result, some U.S. firms had to pay higher prices for inputs, and some experienced declining sales in China. An article in the Wall Street Journal wondered whether the decline in future profits would cause stock prices to fall further. The article quoted a stock analyst who did not believe that stock prices would decline further, arguing, "The market, I think, is saying all this bad news is already priced in." What does the analyst mean when he says that news about the trade war is already "priced in"?
That the current stock prices in the market already reflect the bad news on expected profits
chapter 9 end of chapter 2.4 What effect has the SEC had on the level of asymmetric information in the U.S. financial system?
The SEC has been successful in reducing the cost of asymmetric information, but it has not eliminated it completely.
chapter 9 end of chapter 2.4 Which of the following is true regarding the Securities and Exchange Commission (SEC)?
The SEC is a federal government agency that regulates U.S. stock and bond markets.
An article in the Wall Street Journal discussing State Street Bank's preferred stock noted that it was "currently yielding 6% after its price declined from $26.55 in July to $25.07 in early December." What "yield" is the article referring to?
The dividend yield for this preferred stock.
Which of the following is not a reason why savers with small amounts to invest rarely make loans directly to individuals or firms?
The interest rate that savers would earn from making these loans is too low.
How is it related to the theory of purchasing power parity (PPP)?
The law of one price is the basis for PPP.
An article in the Wall Street Journal discussed the decision of pharmaceutical company Biogen to try to get approval from the Food and Drug Administration (FDA) for a drug to treat Alzheimer's disease. Previously, Biogen had stopped studying the drug because it appeared to be ineffective. The article described Biogen's decision as a "surprising about-face" and noted "shares in Biogen surged 26% to $281.87." Even if Biogen received FDA approval for the drug, it would take years before the drug would be available for sale and Biogen could earn profits from it. Why then would the price of Biogen's stock increase by 26% in one day?
The value of the stock today reflects the present value of the increased earnings that investors expect to receive into the indefinite future as a result of the approval.
What services do forward contracts provide in the financial system? (Check all that apply)
They allow an agreement in the present to exchange a given amount of a commodity or a financial asset at a particular date in the future for a set price. C. They allow transactions to be agreed to in the present but to be settled in the future. D. They give firms and investors an opportunity to hedge the risk on transactions that depend on future prices
chapter 7 end of chapter 5.6 Is the analyst's firm likely to be buying or selling credit default swaps on a distressed firm?
They are most likely buying so they can earn a payoff if the distressed company ends up defaulting on their bonds.
An article in the Wall Street Journal noted: "Oil companies expect to produce a certain amount of crude at future dates and want to protect themselves from swings in the price of oil. They do so by buying financial instruments." Would oil companies be worried about prices rising or falling?
They are worried about prices falling since they would earn less per unit when it came time to sell.
chapter 9 end of chapter 2.2 Why are financial intermediaries important to the financial system?
They reduce transaction and information costs that often drive a wedge between savers and borrowers.
Many companies issue preferred stock with a provision that allows the company to buy it back at its original price after five years. When would companies be likely to buy back their preferred stock?
They would be more likely to buy back their preferred shares if the stock price has risen.
The dividend on preferred stock is fixed, so how can the yield the article refers to change?
This yield is found by dividing the dividend by the current price of the stock, therefore the yield can change as the stock price changes.
chapter 7 end of chapter 5.6 An article on bloomberg.com quoted an analyst at a financial firm as stating, "When a company is in distress, CDS is one of the best ways to trade the risk." What does the analyst mean by "trade the risk"?
To pass the risk of losing money due to a default to the seller of the CDS.
Why don't these firms rely on external funds to the same extent as large firms do?
Transactions costs and information costs are much higher for smaller firms.
Columnist Noah Smith, writing on bloomberg.com, notes that some academic research on pricing anomalies in the stock market "implies that many are real, and can be used to beat the market - at least, until enough traders catch on that the mispricing gets traded away." Is a finding that pricing anomalies allow some traders to make an above-average return for a period of time inconsistent with the efficient markets hypothesis?
Yes it is consistent, for the hypothesis to hold true it requires investors to take advantage of arbitrage opportunities during pricing anomalies to push stock prices to their new fundamental values.
Suppose that you are a wealthy investor. Although you have no connection with the oil industry, you are convinced from studying the determinants of demand and supply in the oil market that the price of oil will decline sharply in the future. How might you use forward contracts to profit from your forecast?
You could sell oil futures with the intention of buying them back at the lower price on or before the settlement date
chapter 7 end of chapter 5.4 how might you use swaps to reduce your risk?
You would swap some of the fixed-interest rate loans for variable interest-rate payments.
chapter 8 end of chapter 3.11 (solved problem 8.3) In the seven months following the publication of this article, the economic effects of the Covid-19 pandemic resulted in the exchange rate between the peso and the dollar changing from 18.7 pesos to the dollar to 22.4 pesos to the dollar. How does this movement in the value of the peso affect the profits investors make from this carry trade? this is __________ of the peso relative to the dollar that will __________ from the carry trade when investors convert back into dollars.
a depreciation, cause a lower return
chapter 8 end of chapter 3.13 Suppose that the U.S. firm Alcoa sells $2 million worth of aluminum to a British firm. If the exchange rate is currently $1.53=£1 and the British firm will pay Alcoa £1,307,189.54 in 90 days, answer the following questions. What exchange-rate risk does Alcoa face in this transaction?
a falling British pound
Chapter 9 end of chapter 2.10 An article in the Economist magazine observes: "Insurance companies often suspect the only people who buy insurance are the ones most likely to collect." What do economists call the problem being described here?
adverse selction
What is the difference between moral hazard and adverse selection? __________ occurs when bad risks are more likely to seek/accept a financial contract than are good risks. ____________ occurs in financial markets when borrowers use borrowed funds differently than they would have used their own funds.
adverse selection moral hazard
Why are supporters of the efficient markets hypothesis unconvinced that differences between the theoretical and actual behavior of financial markets actually invalidate the hypothesis? A. They fail to take into account how risk affects the returns of alternative strategies. B. They fail to take into account the costs of the tax implications of alternative strategies. C. They fail to take into account the costs of transaction costs of alternative strategies. d. all of the above
all of the above
Why might bubbles be difficult to identify? A. For every overvalued asset, there is always an investor willing to buy the asset at an even higher price. B. Investors may not exhibit rational behavior when purchasing an overvalued stock. Your answer is not correct. C. Poor investor psychology, such as herd behavior, may not allow investors to see an asset as overvalued. D. All of the above.
all of the above
chapter 7 end of chapter 4.12 The CBOE Web site quotes the CEO of an investment advisory firm as saying: "The VIX Index is an important and popular tool for measuring investor sentiment...." In what sense is the VIX a measure of investor sentiment? a. It is a measure of volatility and thus has become a measure of general market turbulence. B.It gauges how much volatility investors are anticipating in the market and helps to hedge against that volatility. C.It is a measure of volatility and thus has become a measure of investor panic. d. all of the above
all of the above
chapter 8 end of chapter 3.2 What are the main reasons that interest-rate parity may not hold exactly? a. Exchange-rate risk. B.Transaction costs. C.Differences in default risk and liquidity. D.All of the above.
all of the above
chapter 8 end of chapter 3.13 What alternatives does Alcoa have to hedge this exchange-rate risk? a. Alcoa can sell currency futures. B.Alcoa can buy options contracts. C.Alcoa can enter into a forward contract. D.All of the above.
all of the above
Why might a stock rapidly increase in price even if the reason baffles investment pros? a. It can be caused by herd behavior where uninformed investors imitate the buying of stocks of other investors. B. It can be caused by some investors overreacting to good news released by the company. C. It can be caused by investors buying the overpriced stock believing they can sell it to others at an even higher price than they paid. d. all of the above could be true
all of the above could be true
According to the theory of purchasing power parity, if the inflation rate in Japan is lower than the inflation rate in Canada, what should happen to the exchange rate between the Japanese yen and the Canadian dollar in the long run? In the long run, the Japanese yen will _______ relative tot he canadian dollar becaus e of ________ inflation in japan
appreciate, lower
chapter 8 end of chapter 1.2 If the exchange rate between the yen and the dollar changes from ¥94 = $1 to ¥75= $1, the yen has ________ against the dollar, and the dollar has ___________ against the yen
appreciated, depreciated
According to the efficient markets hypothesis, stock prices _____ predictable
are not
BOnds _____ equities because they represent ________
are not, debt for a firm
chapter 9 end of chapter 13 RTDA data exercise 3 what is corporate net worth
assets minus liabilities
chapter 7 end of chapter 3.8 An article on bloomberg.com in early 2020 discussed a fund manager who believed that interest rates, which had been falling, would soon begin increasing. Therefore, his fund was "buying derivatives that will pay off if rates go back up." Which derivatives would his fund likely be buying? How might these derivatives pay off if interest rates rose? This fund would likely use __________. For example, the firm could __________________. Treasury note futures contracts. if interest rates do end up rising they can then _______________ than they initially paid to offset their initial position in treasury notes.
futures contracts go short in the futures market by selling buy futures contracts at a lower price
If the exchange rate between the yen and the dollar changes from ¥92 = $1 to ¥95 = $1, is this good news for Sony? a yen depreciation is _____ news for sony
good
this is ____ news for U.S consumers, as japanese goods become ______ expensive and ______ news for U.S firms as the dollar has appreciated against the yen
good less bad appreciated
chapter 7 end of chapter 4.6 In March 2020, the online trading app Robinhood had a service outage that left users unable to buy or sell stocks or options contracts through the app. An article in the New York Times described how one investor had bought put contracts on airline stocks. The article quoted the investor as saying, "Yesterday, I had plans to close out all of my options and take a profit. . . . Now I am in the red." What must have been happening to the prices of airlines stocks during these 2 days (the first day, "yesterday;" and the second day, "now")? How far "in the red" could this investor be? That is, how much is it possible for him to lose on his investment in the options contracts?
he could only lose up to the initial cost of the options
chapter 8 end of chapter 2.7 Without adjusting for PPP, countries suffering from high inflation rates would have misleadingly ____
high
What is a junk bond? A junk bond is a bond with ___________. Investors have been willing to buy these bonds despite their low yields since they ________-
high defualt risk and low credit rating offer hgiher interest rates than higher rated bonds
chapter 9 end of chapter 1.2 The World Bank's data tells us that countries with higher levels of financial development tend to have _____ levels of real GDP per capita, which indicates they are _____
higher, better
The law of one price states that:
identical products should sell for the same price everywhere
chapter 7 end of chapter 4.10 Under what circumstances might an investor want to buy both call options and put options on a stock at the same time?
if the investor expects a large change in a stock price but is uncertain which direction it will be
chapter 9 end of chapter 2.4 the SEC was founded
in 1934 in an attempt to alleviate the asymmetric information problem that became apparent following the stock market crash of 1929.
chapter 8 end of chapter 2.2 Is PPP a theory of exchange rate determination in the long run or in the short run?
in the long run
Chapter 9 end of chapter 2.10 An article in the Economist magazine observes: "Insurance companies often suspect the only people who buy insurance are the ones most likely to collect." If insurance companies are correct in their suspicion, it will ________ the price of insurance
increase
chapter 8 end of chapter 3.9 In late 2019, before the Covid-19 pandemic began to significantly affect the global economy, an article in the Wall Street Journal noted that: "Coca-Cola is . . . suffering a drag from the strong dollar . . . . This helps explain why Coca-Cola, with a more global business than that of rival PepsiCo, has underperformed lately." What does the article mean by a "strong dollar"? That the indirect exchange rate for the dollar (foreign currency per dollar) is______________________
increasing or at an above average level
chapter 8 end of chapter 1.2 What is the difference between a direct quotation of an exchange rate and an indirect quotation? ________ quotations express exchange rates as units of foreign currency per unit of domestic currency, whereas _________ quotations are exchange rates as units of domestic currency per unit of foreign currency
indirect, direct
Chapter 7 end of chapter 3.11 Suppose that you are an investor who owns $10,000 in U.S. Treasury notes. Will you be more worried about market interest rates rising or falling?
interest rate rising, as that forces bond prices down
chapter 7 end of chapter 3.10 Suppose you sell the December futures contract, and 1 day later, the Chicago Board of Trade informs you that it has credited funds to your margin account. What happened to interest rates during that day?
interest rates increased, treasury note prices decreased, and the value of the contract increased
Is the fact that investors can earn an above-average return using a trading strategy that relies on a pricing anomaly inconsistent with the efficient markets hypothesis? Is it still inconsistent if the above-average return disappears once academics have discussed the pricing anomaly in a published article? Earning above-average returns _____ inconsistent with the hypothesis ________The hypothesis assumes that once new information is published regarding an anomaly investors will ________-
is not unless it occurs over a long period of time adjust their behavior and the anomaly will disappear
chapter 9 end of chapter 13 RTDA data exercise 3 How might the decline in corporate net worth have affected the severity of the 2007-2009 recession?
it exacerbated the severity of the 2007 - 2009 recession
what does the "open interest" on a future contract mean?
it reports the volume of contracts outstanding
The "lemons problem"
refers to the adverse selection problem that arises from asymmetric information
Each year the Wall Street Journal holds a stock-picking contest in which columnists for the newspaper pick 24 stocks, and Wall Street fund managers also pick 24 stocks. In a recent year, of the columnists' stock picks "more picks lost money than made money." But the columnists' picks still performed better than the picks of the fund managers. Shouldn't well-informed financial journalists and highly paid fund managers be able to choose more stocks that will increase in price than decrease in price? The efficient market hypothesis assumes that stock prices ________ This means that changes in the stock price will be __________ it is therefore ___________ that well-informed financial journalists and highly paid fund managers happened to pick individual stocks that decreased in value in a given year.
reflect all known information regarding the current and furture profitability of the firms the result of unforeseen events not surprising
Former Federal Reserve Chairman Alan Greenspan once argued that it is very difficult to identify bubbles until after they pop. What is a bubble, and why might they be difficult to identify? A bubble is a situation in which the price of an asset ______ its fundamental value
rise above
chapter 8 end of chapter 3.13 To hedge this exchange-rate risk, Alcoa can _________ pounds for dollars at the forward rate to hedge the risk of the pound _________
sell 1,307,189.54, falling
chapter 8 end of chapter 3.15 suppose you are convinced that the value of the Canadian dollar will rise relative to the U.S. dollar. An investor might make a profit based on this conviction in all of the following ways, except:
sell put contracts on the U.S dollar
chapter 7 end of chapter 3.4 would a farmer buy or sell futures contracts? what would a farmer hope to gain by doing so? a farmer would _____ futures contracts to reduce the risk of agricultural prices _________
sell, falling
chapter 7 end of chapter 3.2 Hedging involves taking a long position in the futures market to offset a _________ position in the spot market
short
chapter 8 end of chapter 3.7 An article in the Wall Street Journal in July 2020 discussed the falling value of the U.S. dollar in exchange for other currencies. The article noted that the decline in the value of the dollar "has been accelerated by the Fed's decision to slash interest rates to near zero, removing much of the differential between the U.S. and other developed countries." Why would the Fed reducing interest rates lead to a decline in the value of the dollar?
the lower interest rate makes U.S financial assets less attractive causing a decrease in demand for dollar
chapter 8 end of chapter 1.4 What does it mean to describe the foreign-exchange market as an "over-the-counter market"?
the market consists of market makers linked together by computers
What is the most important source of funds for small to medium-sized firms?
the owners personal funds and profits
what is an options intrinsic value?
the payoff to the buyer of the option from exercising it immediately
chapter 8 end of chapter 2.9 According to the theory of purchasing power parity, what should happen to the value of the U.S. dollar relative to the Mexican peso if the following occurs? the U.S puts quotas and tariffs on many imported goods.
the peso depreciates relative to the dollar
chapter 9 end of chapter 3.4 Consider the possibility of income insurance. With income insurance, if a person loses his job or doesn't get as big a raise as anticipated, he would be compensated under his insurance coverage. Why don't insurance companies offer income insurance of this type? (Check all that apply.)
the problem is a moral hazard (once insured, you won't work as hard) The problem is adverse selection (people who are more likely to be fired or get low raises would be more likely to buy such insurance)
chapter 7 end of chapter 5.4 Suppose that you manage a bank that has made many loans at a fixed interest rate. You are worried that inflation might rise and the value of the loans will decline Why would an increase in inflation cause the value of your fixed-rate loans to decline?
the real return of fixed rate loans will be lower
counterparty risk is
the risk of the other party to the transaction defaulting.
chapter 7 end of chapter 3.2 Why did futures markets originate in agricultural markets?
the supply of agricultural products depends on the weather and can be subject to wide price fluctuations
chapter 9 end of chapter 1.2 The World Bank measures financial development by:
the total amount of credit banks and financial markets extend to households and firms as a percentage of GDP.
Counterparty risk is greater for trading in derivatives because:
the transaction is only completed after the underlying asset has matured
chapter 7 end of chapter 2.2 forward contracts have counter party risk since_________
there is a chance that either the buyer or the seller may default on their obligations under the contract
chapter 7 end of chapter 3.8 If this fund manager was correct and interest rates rose, would that have been good news or bad news for investors who owned bonds?
this would be bad news for those that already owned bonds, the value of their bonds would decrease since they are set at a lower rate
Just before the Covid-19 pandemic began to significantly affect the Chinese economy, two articles in the Wall Street Journal noted problems in the Chinese banking system. One article noted that large "Chinese banks also prefer to make safe loans to large, state-owned companies instead of helping the kind of small, private companies that are truly in need." Another article noted that smaller Chinese banks were having difficulty attracting deposits and were also experiencing rising levels of debt defaults. Are these problems likely to matter for the future growth of the Chinese economy?
Yes, small private businesses provide a lot of the jobs, innovation, and capital accumulation needed for a country to grow long-term. Only lending to large state-owned firms will limit growth.
