ECON330 HW1-4 Exam 1
3.7) Monetary policy affects stock prices through the following except A.) the changes in the return on bonds. B.) the changes in the growth rate of the dividends. C.) the changes in the price level. D.) the changes in the required rate of return. Suppose that the Fed engages in an contractionary monetary policy, which raises interest rates. Which of the following statements best describes the impact of this event on the stock market?
the changes in the price level. There will be an increase in the required rate of return on equities, a decrease in the growth rate on dividends, and stock prices will fall.
4.16) For a given return on assets, the lower is bank capital,
the higher is the return for the owners of the bank.
2.12) The opportunity cost of holding money is
the interest rate.
3.6) In the generalized dividend model, the current stock price is the sum of
the present value of the future dividend stream.
4.12) When you deposit $50 in your account at First National Bank and a $100 check you have written on this account is cashed at Chemical Bank, then
the reserves at First National fall by $50.
1.14) A discount bond is also called a ________ because the owner does not receive periodic payments.
zero-coupon bond
2.9) Everything else held constant, an increase in the riskiness of bonds relative to alternative assets causes the demand for bonds to ________ and the demand curve to shift to the ________.
fall; left
2.6) Everything else held constant, when bonds become less widely traded, and as a consequence the market becomes less liquid, the demand curve for bonds shifts to the ________ and the interest rate ________.
left; rises
2.8) During business cycle expansions when income and wealth are rising, the demand for bonds ________ and the demand curve shifts to the ________, everything else held constant.
rises; right
3.1) Using the one−period valuation model, assuming a year−end dividend of $0.11, an expected sales price of $110, and a required rate of return of 10%, the current price of the stock would be
$100.10
1.4) Calculate the present value of a $1,200 discount bond with 6 years to maturity if the yield to maturity is 3%. The present value is $________
$1004.98
1.16) Consider a bond with a 6% annual coupon and a face value of $1,100. Complete the following table. (Enter your responses rounded to two decimal places.) Years to Maturity | Yield to Maturity | Current Price 3 | 4% | $______ 3 | 6% | $______ 4 | 6% | $______ 6 | 4% | $______ 6 | 8% | $______ Part 2 When the yield to maturity is ______ the coupon rate, the bond's current price is below its face value. For a given maturity, the bond's current price ______ as the yield to maturity rises. For a given yield to maturity, a bond's value ______ as its maturity increases. When the yield to maturity is ______ the coupon rate, a bond's current price equals its face value regardless of the number of years to maturity.
$1161.05 $1100 $1100 $1215.33 $998.30 greater than falls rises equal to
3.2) Suppose that the price a stock is bought for is $125. Based on the one-period valuation model of stock prices, if the stock is sold a year later at the price $131 and the required rate of return on the equity investments is 15%, then the dividend paid out for the stock is $______. (Round your response to the nearest penny.) Suppose that the price a stock was bought for was higher than the one above. Holding every other variable the same, this implies that the dividend paid out for the stock is ______.
$12.75 also higher
3.4) The current price of a stock is $102.16. If dividends are expected to be $1.20 per share for the next five years, and the required return is 9%, then what should the price of the stock be in 5 years when you plan to sell it? The price 5 years from now will be $______. (Round your response to the nearest dollar.) If the dividend and required return remain the same, and the stock price is expected to increase by $1 five years from now, does the current stock price also increase by $1?
$150 No, the current stock price will not increase by $1 because the future stock price is discounted by the required return.
4.9) If a bank has $100,000 of checkable deposits, a required reserve ratio of 20 percent, and it holds $40,000 in reserves, then the maximum deposit outflow it can sustain without altering its balance sheet is
$25,000.
4.17) Angus Bank holds no excess reserves but complies with the reserve requirement. The required reserves ratio is 8%, and reserves are currently $25 million. The amount of deposits is $______ million. (Round your response to one decimal place.) The reserve shortage created by a deposit outflow of $4 million is $______ million. (Round your response to two decimal places.) The cost of the reserve shortage if Angus Bank borrows in the federal funds market (assume the federal funds rate is 0.30%) is $______.
$312.5 million $-3.68 million $11,040
1.12) If the nominal rate of interest is 2 percent, and the expected inflation rate is −10 percent, the real rate of interest is
12 percent.
1.15) What is the yield to maturity on a bond that has a price of $4,000 and pays $500 of interest annually forever? Yield to maturity = _____ percent
12.5
4.18) Suppose that a bank finances itself purely with deposits. Its bank capital is 50 USD. The reserve requirement is 10%. The bank holds 20 USD in reserves, out of which 10 USD are excess reserves. The bank has lend 85 USD to its customers. It also holds some financial securities and owns a building. We know that the financial securities are worth double value of the building. How much is the bank's building worth?
15 USD
Rank the following bank assets from most liquid (1) to least liquid (4). (Enter a numerical value between 1 and 4.) Asset | Rank Commercial loans | ____ Securities | ____ Reserves | ____ Physical capital | ____
3 2 1 4
2.17) The demand curve and supply curve for one-year discount bonds with a face value of $1,030 are represented by the following equations: Bd: Price = −0.6Quantity+1,160 Bs: Price = Quantity+680 The expected equilibrium quantity of bonds is _____. (Round your response to the nearest whole number.) The expected equilibrium price of bonds is $_____. (Round your response to the nearest whole number.) The expected interest rate in this market is _____%. (Round your response to two decimal places.)
300 $980 5.1%
2.2) Using the numbers 1, 2, 3, and 4, rank the following four assets from most liquid (1) to least liquid (4). A 10,000-square-foot office building $2,000 in cash A $10,000 Treasury bill 100 shares of Google stock
4 1 2 3
1.10) I purchase a 10 percent coupon bond. Based on my purchase, I calculate a yield to maturity of 8 percent. If I hold this bond to maturity, then my return on this asset is
8 percent.
3.8) A share of stock in Bodah Corporation pays an annual dividend of $5. The current market price is $50. From the list of individuals below, identify who is likely to be a buyer or a seller of this stock. (Each person currently owns 100 shares.) Individual | Required Return | Expected Growth in Dividends | Buy or Sell? Kate | 5% | 0% | ____ Keith | 8% | 0% | ____ Kyle | 15% | 0% | ____
Buy Buy Sell
3.9) For bonds, the current price depends on the discounted stream of coupon payments (C) and the face value (F). For stocks, the current price depends on the discounted stream of dividends (D). Which of the following statements is true:
C and F are known today, D is not.
1.9) Which of the following are generally true of bonds? A.) The longer a bond's maturity, the smaller is the size of the price change associated with an interest rate change. B.) Prices and returns for short-term bonds are more volatile than those for longer-term bonds. C.) A bond's return equals the yield to maturity when the time to maturity is the same as the holding period. D.) A rise in interest rates is associated with a fall in bond prices, resulting in capital gains on bonds whose terms to maturity are longer than the holding periods.
C.) A bond's return equals the yield to maturity when the time to maturity is the same as the holding period.
4.11) TerpBank holds 9 mio USD in reserves. The reserve requirement is 10%. Which of the following statements is false? A.) None of these statements is false. B.) If TerpBank has 90 mio USD of its liabilities in deposits it fulfills the reserve requirement. C.) If TerpBank holds 90 mio USD in loans it fulfills the reserve requirement. D.) If TerpBank has 9 mio USD of its liabilities in deposits its excess reserves amount to 8.1 mio USD. E.) If TerpBank has 999 mio USD of its liabilities in deposits it does not fulfill the reserve requirement. F.) If TerpBank has 99 mio USD of its liabilities in deposits it does not fulfill the reserve requirement.
C.) If TerpBank holds 90 mio USD in loans it fulfills the reserve requirement.
4.3) Which of the following is not an asset on a bank's balance sheet?
Checkable deposits.
1.6) Which of the following are true of fixed payment loans? A.) The borrower repays both the principal and interest at the maturity date. B.) The borrower pays interest periodically and the principal at the maturity date. C.) Commercial loans to businesses are often of this type. D.) Installment loans and mortgages are frequently of the fixed payment type.
D.) Installment loans and mortgages are frequently of the fixed payment type.
1.8) The yield to maturity on a 10-year Treasury note (with face value = $100 and annual coupon rate = 2.625%) is 3.37%. If the price of this Treasury note goes up, its: I. coupon rate drops below 2.625%. II. coupon rate rises above 2.625%. III. yield to maturity drops below 3.37%. IV. yield to maturity rises above 3.37%.
III.
2.7) Given the business cycle contraction has resulted in a lack of profitable investment opportunities in the private sector, which of the following would potentially be a stimulus to the Japanese economy and would raise interest rates?
If the government runs large deficits to fund new infrastructure projects, it would issue debt to finance these deficits. This would increase the supply of bonds, which would raise interest rates.
2.11) What will happen in the bond market if the government imposes a limit on the amount of daily transactions? Which characteristic of an asset would be affected?
Liquidity of bonds relative to other assets will decrease, increasing the interest rate and lowering bond's prices.
2.15) For every $1,000 of annual income, households maintain average cash balances (their demand for money) of $200. How will growth in GDP affect interest rates, holding the money supply constant? Use the liquidity preference framework 1.) Using the line drawing tool, show the effect of growth in GDP using the liquidity preference framework. Properly label your line. 2.) Using the point drawing tool, indicate the new equilibrium interest rate and quantity of money. Label the point '2'.
Md shifts to the right The new equilibrium interest rate and quantity of money is where Md2 intersects Ms
2.13) Suppose you are in charge of the financial department of your company and you have to decide whether to borrow short or long term. Checking the news, you realize that the government is about to engage in a major infrastructure plan in the near future. Predict what will happen to interest rates. Will you advise borrowing short or long term?
Since the government is a major player in the market for bonds, this will most likely result in a shift to the right in the supply curve, lowering the price of bonds and increasing interest rates. You would recommend locking in a long-term loan at the current interest rate.
4.14) It is important for banks to manage interest rate risk because:
Some assets are sensitive to interest rate changes, and some liabilities are.
3.10) Suppose that you are asked to forecast future stock prices of ABC Corporation, so you proceed to collect all available information. The day you announce your forecast, competitors of ABC Corporation announce a brand new plan to merge and reshape the structure of the industry. Would your forecast still be considered optimal? (Select all that apply.)
Your forecast is considered optimal, but for a short period of time. Your answer is correct. Your forecast is still considered to be optimal, since it was made with all available information at the time.
4.7) A deposit outflow results in equal reductions in
assets and liabilities.
3.11) If the public expects a corporation to lose $5 per share this quarter and it actually loses $4, which is still the largest loss in the history of the company, what does the efficient market hypothesis say will happen to the price of the stock when the $4 loss is announced? The stock price will ______
be revised upward
3.12) If the public expects a corporation to lose $5 per share this quarter and it actually loses $4, which is still the largest loss in the history of the company, what does the efficient market hypothesis say will happen to the price of the stock when the $4 loss is announced? The stock price will ______
be revised upward
3.14) Sometimes one observes that the price of a company's stock falls after the announcement of favorable earnings. This phenomenon is
consistent with the efficient markets hypothesis if the earnings were not as high as anticipated.
1.5) A credit market instrument that pays the owner a fixed coupon payment every year until the maturity date and then repays the face value is called a
coupon bond.
1.1) The dollar amount of the yearly coupon payment expressed as a percentage of the face value of the bond is called the bond's
coupon rate.
1.2) An increase in the time to the promised future payment ________ the present value of the payment.
decreases
2.4) Along the supply curve for bonds, an increase in the price of bonds If the price of bonds is below the equilibrium price, there occurs an excess
decreases the interest rate and increases the quantity of bonds supplied. demand for bonds, the price will rise, and the interest rate will fall.
1.13) Since the early 1950s, nominal interest rates and real interest rates in the United States
do not always move in the same direction.
2.5) When the price of a bond decreases, all else equal, the bond demand curve ________.
does not shift
2.16) The president of the United States announces in a press conference that he will fight the higher inflation rate with a new anti-inflation program. Predict what will happen to interest rates if the public believes him. As a result of the president's announcement, people's expectations of inflation will _____, which causes the demand for bonds to shift to the _____. However, the lower expected inflation rate causes the cost of borrowing to _____, so the supply of bonds will _____, which causes the supply curve for bonds to shift to the _____. The impact of this change in bond demand and supply will cause equilibrium interest rates to _____.
fall right rise decrease left decrease
1.3) A credit market instrument that requires the borrower to make the same payment every period until the maturity date is known as a
fixed − payment loan.
2.14) graph Using the diagram to the right, representative of a primary bond market, show the effects of an increase in household wealth and an increase in expected profitability of investments. Given how interests typically behave during a business cycle expansion, the effect of this shock is likely to
increase bond yields
4.6) When a new depositor opens a checking account at the First National Bank, the bank's assets ________ and its liabilities ________.
increase; increase
2.1) If wealth increases, the demand for stocks ________ and that of long−term bonds ________, everything else held constant.
increases; increases
4.15) Holding large amounts of bank capital helps prevent bank failures because
it can be used to absorb the losses resulting from bad loans.
3.15) The efficient markets hypothesis suggests that if an unexploited profit opportunity arises in an efficient market,
it will be quickly eliminated.
4.2) The most important category of assets on a bank's balance sheet is
loans.
3.13) If you read in the Wall Street Journal that the "smart money" on Wall Street expects stock prices to fall, you should:
not sell all of your stocks because this is publicly available information and is already reflected in stock prices.
4.13) A $5 million deposit outflow from a bank has the immediate effect of
reducing deposits and reserves by $5 million.
4.8) A $100 deposit into my checking account at My Bank increases my checkable deposits by $100, and the bank's ________ by $100.
reserves
4.4) The sum of a bank's vault cash plus its deposits at the Fed is the bank's Required reserves are a fixed percentage of a bank' If a bank has $1000 in deposits and the required reserve ratio is 10%, then the amount required as the bank's reserves is $_____.
reserves. checkable deposits. $100
3.3) According to the Gordon Growth Model, the price of stocks depend on the following except A.) the most recent dividend paid B.) required return on investments C.) return on Treasure bills D.) expected constant growth rate in dividends When your required return on an equity investment increases, then according to the Gordon Growth Model you will be willing to pay ______ for the investment. Suppose that a stock is expected to pay a $1 dividend next year, that the dividend is expected to grow at 5% per year, and that your required return on this equity investment is 6%. Using the Gordon growth model, the price you would be willing to pay for the stock is $______. (Round your response to the nearest two decimal place.)
return on Treasure bills less $100
2.10) In a business cycle expansion, the ________ of bonds increases and the ________ curve shifts to the ________ as business investments are expected to be more profitable, everything else held constant.
supply; supply; right
4.1) Which of the following are reported as assets on a bank's balance sheet?
Reserves
3.5) Suppose that a stock paid a dividend of $2 this year and that your required return on equity investments is 11%. Using the Gordon growth model, if you expect the dividends to grow at 5%, you will be willing to pay for the stock the amount $_____. (Round your response to the nearest two decimal places.) Using the Gordon growth model of stock price determination, if a share of stock will pay a $1 dividend next year, dividends are expected to grow 2%, and people require an 11% return on equity investments, then the price of the stock is $_____. (Round your response to the nearest two decimal places.) According to the Gordon growth model of stock price determination, at what price should a stock sell for if the required return on equity investments is 12%, the stock will pay a dividend of $1.80 next year, and dividends are expected to grow at a constant rate of 3%?
$35 $11.11 $20
4.10) Suppose $50,000 is deposited at the Bank Of UMD. The required reserve ratio is 10 percent, and the Bank Of UMD chooses not to hold any excess reserves but makes loans instead. What are the Bank Of UMD's total loans? Total loans are equal to $______.
$45,000
1.11) A three-year bond with $1,000 face value and 10% coupon rate is sold for $1,000 today. If one year later the market interest rate increases to 15%, then this bond will have a market price of _______ next year.
$918.71
1.7) If a $5,000 face−value discount bond maturing in one year is selling for $5,000, then its yield to maturity is
0 percent.
3.16) Consider each of the following situations and answer the questions that follow. Situation One: Many of your fellow investors are shocked when great news for TerpCorp—strong sales and large profits for the quarter—are met with a decrease in the price of TerpCorp stock. Does this indicate a failure of the efficient market hypothesis? Why or why not? Situation Two: "I'm going to put all my savings into EconMart," a classmate tells you. "I subscribe to a 'hot tips' investment newsletter that says they're about to put a product on the market that nearly everyone needs. The price of their stock is sure to skyrocket!" Do you agree with your classmate? Why or why not? Situation Three: "I'm so confused," your brother tells you. "I want to maximize the money available to me after retirement, but I just have no clue what to do with my small savings. I'm thinking about buying shares in a mutual fund. You've taken some economics and finance classes—what do you suggest I do?" What's your advice for your brother?
No, the most likely explanation is that investors had expected TerpCorp sales and profits to be even higher than those reported. No, because information from an investment newsletter is already public and is therefore already reflected in stock prices. Buy shares in a no-load mutual fund and make sure that management fees are low.
3.17) Which of the following is an argument in favor of the efficient market hypothesis?
Over the long term, stock prices follow a random walk and do resemble their underlying fundamental value.
2.3) Raphael observes that at the current level of interest rates there is an excess supply of bonds, and therefore he anticipates an increase in the price of bonds. Is Raphael correct?
Raphael is incorrect. The supply and demand analysis tells us that interest rates will increase, creating a movement along both the demand curve (in the southeast direction) and the supply curve (in the southwest direction) in order to reach the equilibrium interest rate (and price). The bond's price will therefore fall.
