Exam 3 Study Guide

Which of the following is not a general characteristic of money markets? A. Good marketability. B. Competitive market with many brokers and dealers. C. Payments in immediately available funds. D. All of the above are general characteristics of money markets.

All of the above are general characteristics of money markets.

Money market mutual funds invest in the following securities: A. Federal agency securities. B. Commercial paper. C. Banker's acceptances. D. Negotiable certificates of deposit. E. All of the above.

All of the above.

Which of the following is not an important secondary market characteristic? A. All of them are important secondary market characteristics. B. Resilience - ability to attract buyers (sellers) when the stock price decreases (increases). C. Breadth - number of traders trading that stock. D. Depth - the size of conditional orders to buy and sell.

All of them are important secondary market characteristics

Which of the following statements about preferred stock is incorrect? A. Usually, no voting. B. Cannot force unprofitable company to bankruptcy when dividend is not paid. C. Always pays fixed-rate dividend; cannot pay adjustable-rate like some bonds. D. Has characteristics of both common stocks and bonds.

Always pays fixed-rate dividend; cannot pay adjustable-rate like bonds

Which of the following statements is incorrect? A. T-bills are sold through auctions using competitive and noncompetitive bids. B. Noncompetitive bids do not require specifying the price at which one wants to buy securities. C. Competitive bids do not require specifying the quantity one wants to acquire. D. The maximum quantity that can be specified in noncompetitive bids is $5,000,000.

Competitive bids do not require specifying the quantity one wants to acquire.

Which of the following statements is incorrect? A. Interest is tax deductible. B. Convertible stock is stock that can be exchanged for a predetermined number of common shares at the discretion of the issuer. C. Convertible preferred stock is preferred stock that can be exchanged for a predetermined number of common shares at the discretion of the owner. D. Convertible bonds are bonds that can be exchanged for a predetermined number of common shares at the discretion of the owner.

Convertible stock is stock that can be exchange for a predetermined number of common shares at the discretion of the issuer

Which of the following statements about commercial paper is incorrect? A. Sold at a discount from par value. B. Major investors include commercial banks, insurance companies, and state and local pension funds. C. Banks can provide backup lines of credit, reducing the risk of commercial papers. D. Corporations always sell commercial paper through their own sales force.

Corporations always sell commercial paper through their own sales force

Which of the following statements is incorrect? A. Corporate bonds typically make coupon payments and have a face value of $1,000. B. Bearer bonds are coupon bonds owned by bearer, while owners of registered bonds are only noted by records. C. In the case of term bonds, all bonds in the issue mature on the same date. D. In the case of serial bonds, bonds in the issue mature on different dates. E. Municipal bonds are never serial bonds.

Municipal bonds are never serial bonds

Which of the following statements about bid-ask spread is incorrect? A. Wider for low priced stocks. B. Narrower for very small trades (few shares). C. Wider for large block trades.

Narrower for very small trades (few shares)

Which of the following statements about construction-to-permanent mortgages is incorrect? A. Used by homebuyers who want to build their homes. B. The borrower does not receive all money at once. C. During the construction phase, only interest is paid; after the construction phase the balance is rolled over into FRM, ARM, or other type of mortgage. D. None.

None

Which of the following statements are incorrect? A. Comparing net financial assets and financial liabilities in 2005 and 2010 we can see that the deficit of federal and local governments approximately doubled. B. Notes have maturity of one to ten years. C. Bonds have maturity over ten years. D. None.

None

Which of the following statements is incorrect? A. Foreign bonds are issued by foreign companies and denominated in the currency of a country where they are issued. B. Foreign bonds have to comply with the regulations of the country where they are issued. C. Eurobonds are bonds denominated in a currency other than that of the country where they are issued. D. None.

None

Which of the following statements is incorrect? A. In case of bankruptcy, senior debt has priority against subordinated debt. B. Sinking fund in bond indenture refers to a requirement to accumulate funds to retire the firm's debt. C. Call provision allows the borrower to retire bonds before their maturity if the borrower wants to do so. D. None.

None

Which of the following statements is incorrect? A. Stock exchanges are physical places or electronically connected markets where listed stocks are traded by the members of exchange. B. None. C. Stocks not listed on organized exchanges are traded in the over-the-counter market which is organized as dealer market. D. Examples of stock exchanges include New York Stock Exchange and Chicago Stock Exchange.

None

Which of the following statements about repurchase agreements is incorrect? A. Sale of securities with an agreement to buy them back later at a higher price. B. Essentially it is borrowing with collateral. C. Value of securities used as collateral usually exceeds the sale and the repurchase prices. D. None of the above.

None of the above.

Which of the following statements about interest-only mortgages is incorrect? A. Borrower makes only interest payment during the initial years (e.g., 3 to 10 years). B. After the initial period the payments increase to include repayments of loan. C. Offer a good opportunity for people who do not have much money to improve the quality of their life without increasing their risk. D. These types of mortgages are risky for borrowers because borrowers may be unable to afford making payments once those payments increase and borrowers do not reduce their loan while paying only interest.

Offer a good opportunity for people who do not have much money to improve the quality of their life without increasing their risk.

Which of the following statements is incorrect? A. DJIA is a market value-weighted index. B. DJIA includes leading companies in their industries. C. Market value-weighted indexes are better at reflecting the market performance than price-weighted indexes. D. Dow Jones Industrial Average is the oldest stock market index.

DJIA is a market value-weighted index

Which of the following is not an example of bond with collateral? A. Mortgage bond - land or buildings pledged. B. Equipment trust certificates - specific, titled, or identifiable equipment pledged. C. Collateral bonds - financial assets pledged D. Debentures - company assets pledged.

Debentures

Which of the following statements is incorrect? A. The number of government regulations tends to increase with time, increasing the costs to financial industry. B. Government regulations create systematic risk. C. Government regulations are better than private regulations since there is no conflict of interest between the government and the people. D. Regulations by private sector have an advantage over government regulations since private regulators face competition and have to bear the costs of wrong decisions.

Government regulations are better than private regulations since there is no conflict of interest between the government and the people

Which of the following statements about mortgage-backed securities is incorrect? A. Differently from mortgages they are issued in standardized denominations. B. Issued or insured by large, well-known private or government institutions. C. Gained bad reputation during the last financial crisis in the U.S. D. Have lower liquidity than mortgages.

Have lower liquidity than mortgages

Which of the following statements about mortgage-backed securities is incorrect? A. Have worse secondary market than mortgages. B. Make it easier for banks who originated mortgages not to hold them on their balance sheets. C. Allow smaller investors indirectly invest in mortgages. D. None.

Have worse secondary market than mortgages

Which of the following statements is incorrect? A. Caps on ARMs limit interest rate risk by limiting how much interest rate can increase during one year and through the life of the loan. B. Adjustable interest rate is often defined as treasury security rate, fixed-rate mortgage index, the prime rate, or the LIBOR rate plus certain fixed percentage. C. Initial interest rates on ARMs are lower than interest rates on FRMs. D. ARMs are safer for borrowers than FRMs.

ARMs are safer for borrowers than FRMs

Which of the following statements is incorrect? A. In a typical 30-year fixed-rate mortgage most of the money in the first payments go towards paying interest rather than repaying the loan. B. The longer the maturity of a fixed-rate mortgage, the larger percentage of the first payments goes towards paying interest. C. Adjustable rate mortgages (ARMs) reduce the interest rate risk to borrowers. D. Adjustable rate mortgages usually have a fixed rate for the first few years with the rate later adjusting according to a formula disclosed when the loan is originated.

Adjustable rate mortgages (ARMs) reduce the interest rate risk to borrowers

Which of the following statements is incorrect? A. The U.S. Treasury bills are sold on discount basis. B. Individual investors can invest smaller amounts in T-bills through the Treasury Direct Program. C. All federal debt is completely risk free. D. T-bill yields estimated as bank discount rates are lower than the actual yields received on these investments.

All federal debt is completely risk free.

Which of the following make it easier and cheaper to secure a mortgage loan? A. Good credit history. B. Higher income. C. Larger down payment. D. a and b. E. All of the above.

All of the above

Which of the following statements about securitized credit instruments are correct? A. Securitization is packaging loans and selling claims to future cash flows of the loans. B. Value of new securities is expected to exceed the value of loan cash flows, providing incentives to securitize. C. A variety of asset backed securities have been created, beginning in the mortgage market and now extending to other types of loans. D. All of the above.

All of the above

Which of the following statements about securitized credit instruments are correct? A. Tranches from one pool of loans can vary from very high to very low risk. B. Financial guarantees can reduce the risk of the tranches. C. The residual or non-guaranteed tranches have a higher risk/return profile. D. All of the above.

All of the above

Which of the following statements does describe financial guarantees? A. Provided for a fee by commercial banks and insurance companies. B. Cover the payment of principal and interest in the event of default. C. Substitutes the credit standing of the guarantor for that of the issuer. D. All of the above.

All of the above

Which of the following statements about reverse annuity mortgages is incorrect? A. More popular among older people. B. Allow homeowners to borrow against the equity in their home and receive monthly payments, often lifetime annuities. C. At the end the house is owned by the borrower. D. At the end the house is owned by the provider of the annuity.

At the end the house if owned by the borrower

Which of the following statements is incorrect? A. Trading as a dealer is riskier than trading as a broker. B. Direct search is seldom used to bring buyers and sellers together in secondary markets. C. Auctions are never used for selling equity. D. Brokers trade other people securities while dealers trade on their own account.

Auctions are never used for selling equity

Which of the following statements is incorrect? A. Bonds bought in private placements cannot be traded in secondary markets. B. Private placements increase when interest rates are high or market conditions are unstable. C. Junk bonds are less risky (considering default risk) than common stock of the same firm. D. None.

Bonds bought in private placements cannot be traded in secondary markets

Which of the following statements about rollover and renegotiable rate mortgages is incorrect? A. They are similar to ARMs. B. Interest rates are reset to prevailing rates at predetermined periods. C. Periods between adjustments are longer than in traditional ARMs. D. Borrower is not affected by the interest rate risk.

Borrower is not affected by the interest rate risk

Which of the following statements about home equity loans and lines of credit is incorrect? A. Allow homeowners to borrow against equity in their homes at relatively low interest rates. B. Cannot be used as a second mortgage if the borrower has not fully repaid the first mortgage. C. They sometimes are used for down payment on the first mortgage to avoid paying for mortgage insurance. D. Cannot be used when homeowners do not have any equity in their home.

Cannot be used as a second mortgage if the borrower has not fully repaid the first mortgage

Which money market instruments are issued by nonfinancial corporations? A. T-bills. B. Commercial paper. C. Negotiable CDs. D. Repurchase agreements.

Commercial paper.

Which of the following statements is incorrect? A. Households are both major issuers and investors in capital market securities. B. Businesses are major issuers of rather than investors in capital market securities. C. Federal and local governments are major investors in rather than major issuers of capital market securities. D. Foreign investors are a major group of investors in the U.S. capital markets.

Federal and local governments are major investors in rather than major issuers of capital market securities.

Which of the following statements is incorrect? A. Federal agency securities have lower marketability than T-bills, since the market for each agency security is smaller than that for T-bills and some agency securities do not have explicit guarantees of the federal government. B. Federal funds refer to short-term lending and borrowing between banks. C. Federal funds are traded in immediately available funds. D. Federal government is obligated to bail out all government-sponsored agencies.

Federal government is obligated to bail out all government-sponsored agencies.

Which of the following statements is incorrect? A. Traditionally mortgages were held by lenders until repaid; now, qualifying mortgages are often sold to government agencies. B. The best choice for a typical home buyer among different types of mortgages is the fixed-rate mortgage. C. The lien is removed and the borrower obtains a clear title to the property when the mortgage is fully paid. D. Fixed-rate mortgage (FRM) means that investor will pay fixed rate on principal, however, principal and thus monthly payments change through time.

Fixed-rate mortgage (FRM) means that investor will pay fixed rate on principal, however, principal and thus monthly payments change through time.

You have a choice of an AAA-rated corporate bond with a yield of 7% or an AAA-rated municipal bond with a yield of 5.9%. If your marginal tax rate is 20%, which bond should you prefer to buy? A. Corporate bond. B. Municipal bond.

Municipal Bond

Which of the following statements is incorrect? A. TIPS provide protection from inflation. B. The face value on inflation-indexed notes and bonds pay changes with inflation. C. Inflation-indexed notes and bonds pay variable coupon rates which change with inflation. D. The principal of inflation-indexed notes and bonds adjusts for inflation while coupon rate remains fixed.

Inflation-indexed notes and bonds pay variable coupon rates which change with inflation

Which of the following statements about federal funds is incorrect? A. Originally, the market for excess reserves held at the Fed. B. Interest rates on federal funds are fully controlled by the Fed. C. Bookkeeping entry. D. Short-term lending and borrowing between banks.

Interest rates on federal funds are fully controlled by the Fed.

Which of the following statements about bid-ask spread is incorrect? A. Represent transaction costs to sellers and buyers. B. Investors who engage in frequent trading suffer less from bid-ask spreads. C. Wider for trades where one side has inside information. D. Wider for less frequently traded stocks.

Investors who engage in frequent trading suffer less from bid-ask spreads

Which of the following statements about common stock is incorrect? A. Usually one share - one vote. B. Minority shareholders are more likely to get representation on the board of directors with the straight rather than cumulative voting. C. In case of dual class shares, one class share can provide more votes than the other class share even when both are entitled to the same cash flows. D. Allows voting on some major issues.

Minority shareholders are more likely to get representation on the board of directors with the straight rather than cumulative voting

Which of the following statements is incorrect? A. If the Fed wants to increase short-term interest rates, it can sell debt securities with short-term maturities, reducing their prices and thus increasing their rates of return. B. Money market is convenient for investors who temporarily have extra cash but cannot afford forgoing liquidity. C. Money market securities have low default risk. D. Money market securities have low liquidity.

Money market securities have low liquidity.

Which of the following statements is incorrect? A. Good secondary markets make it easier for firms to raise money in primary markets. B. Primary markets provide liquidity to investors who bought securities. C. Secondary markets provide liquidity to investors who bought securities. D. Secondary markets allow investors and managers to see the current market value of the firm's equity.

Primary markets provide liquidity to investors who bought securities

Which of the following statements is incorrect? A. Private institutions can issue only one type of securities on the same pool of mortgages. B. The risk of securities issued on the same pool of mortgages can be very different, with riskier securities providing insurance for the less risky securities in the pool. C. The fact that borrowers can prepay mortgage loans makes it harder for banks to manage interest rate risk. D. Homeowners tend to prepay mortgage loans when interest rates decline.

Private institutions can issue only one type of securities on the same pool of mortgages

Which of the following statements about common stock is incorrect? A. Residual claim against the firm's cash flows or assets. B. Return is derived from dividends and share appreciation. C. Profitable corporations have a responsibility to pay dividend. D. Represent ownership in corporation.

Profitable corporations have a responsibility to pay dividend

Which of the following statements is incorrect? A. Investors in corporate bonds typically have long-term horizon and are not concerned with liquidity. B. Public sale of corporate bonds is open to all interested buyers; private placements, while open to all interested buyers, are limited to fewer than 35 investors. C. Most secondary trading of corporate bonds is characterized by low trading volume and wide bid-ask spreads. D. On average, issuers of corporate bonds are riskier than issuers of commercial papers.

Public sale of corporate bonds is open to all interested buyers, private placements, while open to all interested buyers are limited to fewer than 35 investors

Which of the following is not a general characteristic of money markets? A. Securities with up to one-year maturities. B. Risky borrowers. C. Low transaction costs. D. Standardized securities.

Risky borrowers.

Which of the following statements is incorrect? A. Mortgage loans are secured by the pledge of real property. B. Mortgage loans do not have a standard denomination. C. Mortgage markets are highly regulated and supported by federal government policies. D. Secondary market for mortgages is weaker than for money market securities but stronger than for bonds.

Secondary market for mortgages is weaker than for money market securities but stronger than for bonds

Which of the following statements is incorrect? A. Public offerings are sold to general public while private placements are sold to a small number of sophisticated investors. B. Shelf registration give a right to current shareholders to buy new shares at a predetermined price. C. Shelf registration allows firms to sell shares for two years without additional registration. D. Rights offerings give a right to current shareholders to buy new shares at a predetermined price.

Shelf registration give a right to current shareholders to buy new shares at a predetermined price

Which of the following statements about commercial paper is not correct?

Small investors can buy much smaller denominations through the Direct Purchase Program offered by the Fed.

Which of the following statements is incorrect? A. State and local government bonds (munis) are backed by the federal government. B. Some municipal bonds are backed by the taxing power of a political entity that issued them. C. Some municipal bonds are paid back with cash from a specific project. D. State and local governments sometimes use public financing to finance private business.

State and local government bonds (munis) are backed by the federal government

Which of the following statements is incorrect? A. S&P 500 index includes 500 largest companies. B. The percentage change in DJIA or S&P 500 value shows the percentage change in the value of the portfolio that is represented by the index. C. Stock market prices do not reflect investor expectations about future performance of companies. D. There are stock indexes for small and medium firms, specific industries, different countries, and different regions.

Stock market prices do not reflect investor expectations about future performance of companies

Which securities commercial banks do not use to obtain financing? A. T-bills. B. Federal funds. C. Commercial paper. D. Repurchase agreements.

T-bills.

Which securities does the U.S. Treasury use to obtain financing? A. T-bills. B. Federal funds. C. Commercial paper. D. Repurchase agreements.

T-bills.

Which of the following statements is incorrect? A. The Securities and Exchange Commission is the principal regulator of financial markets. B. The SEC has a strong motivation to have good regulations as otherwise the SEC will not survive competition. C. Private exchanges have motivation to use good regulations as otherwise these exchanges will not survive competition. D. States also have regulations about security issues and trading.

The SEC has a strong motivation to have good regulations as otherwise the SEC will not survive competition

Which of the following statements is incorrect? A. The vast majority of commercial paper issues are in the top two credit rating categories. B. Negotiable certificates of deposit make time deposits in the bank more liquid by allowing the depositor to sell the right to the deposit in the bank to somebody else at any time. C. The interest rate on negotiable certificates of deposit depends on the credit risk of the depositor rather than on the credit risk of the issuing bank. D. Bankers' acceptances facilitate the trade between sellers and buyers who do not know each other well.

The interest rate on negotiable certificates of deposit depends on the credit risk of the depositor rather than on the credit risk of the issuing bank.

Which of the following is not a characteristic of bankers' acceptances? A. Time draft - order to pay in future. B. Mostly related to international trade. C. The interest they pay depend on the credit worthiness of the bank that accepted them. D. The interest they pay depend on the credit worthiness of the buyer in the business transaction.

The interest they pay depend on the credit worthiness of the buyer in the business transaction.

Which of the following statements about balloon payment mortgages is incorrect? A. These mortgages became very popular recently. B. They offer relatively low fixed interest rate for predetermined period (e.g., 7 years). C. Monthly payments are determined using 15- or 30-year period like estimating monthly payments for FRM. D. After the initial fixed-rate period, the loan is repaid or the loan is refinanced at prevailing interest rates.

These mortgages became very popular recently

Which of the following statements is incorrect? A. Higher systematic risk is associated with higher required return. B. Total risk can be measured by standard deviation, variance, and beta. C. Diversification works well for people engaged in passive investing but can cause problems for active investors. D. Unsystematic risk is diversifiable and thus can be avoided without reducing the expected return on a portfolio.

Total risk can be measured by standard deviation, variance, and beta

The market reacts to the difference between the information in the announcement and the market expectation about the announcement. A. True. B. False.

True

A money market mutual fund takes money from many investors and forms one investment portfolio, investing in securities with less than one-year maturity.

True.

It is easier for individuals to invest in money market mutual funds than to buy money market securities like commercial paper or certificates of deposit.

True.

Which of the following statements is incorrect? A. Firms sell new securities and raise money for projects in primary markets. B. Investment bankers underwrite equity offerings often guaranteeing proceeds to the firm. C. Investment bankers receive underwriter's spread - difference between gross and net proceeds. D. Typically, initial public offerings are made in primary markets while seasoned equity offerings are made in secondary markets.

Typically, initial public offerings are made in primary markets while seasoned equity offerings are made in secondary markets

Which of the following statements is incorrect? A. Outstanding U.S. Treasury bills increased significantly from 2005 to 2010. B. Outstanding money markets securities issued by corporations decreased from 2005 to 2010. C. When a firm needs money for a long-term, short-term borrowing is less risky than long-term borrowing. Thus, it makes sense to increase short-term borrowing when economic situation is very uncertain. D. When economic situation is very uncertain, many companies find that it is hard or impossible to issue commercial paper.

When a firm needs money for a long-term, short-term borrowing is less risky than long-term borrowing. Thus, it makes sense to increase short-term borrowing when economic situation is very uncertain.

Which of the following statements is incorrect? A. With book entry securities, investors do not receive the physical security they buy, instead the physical security is held at some financial institution. B. Most of marketable Treasury debt is in book-entry form. C. The largest federal agencies can issue their own debt securities, while smaller federal agencies are more likely to obtain financing through Federal Financing Bank. D. Government-sponsored agencies, differently from government-owned agencies, do not have an explicit guarantee of the government.

With book entry securities, investors do not receive the physical security they buy, instead the physical security is held at some financial institution.

Which of the following statements is incorrect? A. Separate trading of registered interest and principal refers to making each interest payment and principal payment into separate securities that are zero-coupon bonds. B. STRIPs are created by financial institution when investors value these securities more highly than the original securities. C. Zero coupon bonds are much easier to use when managing interest rate risk than coupon paying bonds. D. Zero coupon bonds usually pay higher coupon rate than other bonds.

Zero coupon bonds usually pay higher coupon rates than other bonds