Finance 510 Test 2
31) (I) Most corporate bonds have a face value of $1,000, pay interest semiannually, and can be redeemed anytime the issuer wishes. (II) Registered bonds have now been largely replaced by bearer bonds, which do not have coupons. A) (I) is true, (II) false. B) (I) is false, (II) true. C) Both are true. D) Both are false.
A) (I) is true, (II) false.
21) Suppose that you purchase a 182-day Treasury bill for $9,850 that is worth $10,000 when it matures. The security's annualized yield if held to maturity is about
A) 1.5%. B) 2%. C) 3%. D) 6%. Answer: C
20) Suppose that you purchase a 91-day Treasury bill for $9,850 that is worth $10,000 when it matures. The security's annualized yield if held to maturity is about
A) 4 percent. B) 5 percent. C) 6 percent. D) 7 percent. Answer: C
9) Which of the following are true statements about participants in the money markets?
A) Large banks participate in the money markets by selling large negotiable CDs. B) The U.S. government and corporations borrow in the money markets because cash inflows and outflows are rarely synchronized. C) The Federal Reserve is the single most influential participant in the U.S. money market. D) All of the above are true. E) Only A and B of the above are true. Answer: D
8) Which of the following statements about the money markets are true?
A) Most money market securities do not pay interest. Instead, the investor pays less for the security than it will be worth when it matures. B) Pension funds invest a portion of their assets in the money market to have sufficient liquidity to meet their obligations. C) Unlike most participants in the money market, the U.S. Treasury Department is always a demander of money market funds and never a supplier. D) All of the above are true. E) Only A and B of the above are true. Answer: D
7) Which of the following statements about the money markets are true?
A) Not all commercial banks deal for their customers in the secondary market. B) Money markets are used extensively by businesses both to warehouse surplus funds and to raise short-term funds. C) The single most influential participant in the U.S. money market is the U.S. Treasury Department. D) All of the above are true. E) Only A and B of the above are true. Answer: E
45) Which of the following are true for the current yield? A) The current yield is defined as the yearly coupon payment divided by the price of the security. B) The formula for the current yield is identical to the formula describing the yield to maturity for a discount bond. C) The current yield is always a poor approximation for the yield to maturity. D) All of the above are true. E) Only A and B of the above are true.
A) The current yield is defined as the yearly coupon payment divided by the price of the security.
19) Which of the following statements are true of Treasury bills?
A) The market for Treasury bills is extremely deep and liquid. B) Occasionally, investors find that earnings on T-bills do not compensate them for changes in purchasing power due to inflation. C) By volume, most Treasury bills are sold to individuals who submit noncompetitive bids. D) All of the above are true. E) Only A and B of the above are true. Answer: E
29) Which of the following statements about Treasury inflation-indexed bonds is not true? A) The principal amount used to compute the interest payment varies with the consumer price index. B) The interest payment rises when inflation occurs. C) The interest rate rises when inflation occurs. D) At maturity, the securities pay the greater of face value or inflation-adjusted principal.
A) The principal amount used to compute the interest payment varies with the consumer price index.
18) Money market instruments issued by the U.S. Treasury are called
A) Treasury bills. B) Treasury notes. C) Treasury bonds. D) Treasury strips. Answer: A
38) A requirement in the bond indenture that the firm pay off a portion of the bond issue each year is called A) a sinking fund. B) a call provision. C) a restrictive covenant. D) a shelf registration.
A) a sinking fund.
26) Most of the time, the interest rate on Treasury notes and bonds is ________ that on money market securities because of ________ risk. A) above; interest-rate B) above; default C) below; interest-rate D) below; default
A) above; interest-rate
54) Bonds A) are securities that represent a debt owed by the issuer to the investor. B) obligate the issuer to pay a specified amount at a given date, generally without periodic interest payments. C) both A and B of the above. D) none of the above.
A) are securities that represent a debt owed by the issuer to the investor.
3) Money market instruments
A) are usually sold in large denominations. B) have low default risk. C) mature in one year or less. D) are characterized by all of the above. E) are characterized by only A and B of the above. Answer: D
17) Which of the following is the largest borrower in the money markets?
A) commercial banks B) large corporations C) the U.S. Treasury D) U.S. firms engaged in foreign trade Answer: C
14) Finance companies raise funds in the money market by selling
A) commercial paper. B) federal funds. C) negotiable certificates of deposit. D) Eurodollars. Answer: A
16) When inflation rose in the late 1970s,
A) consumers moved money out of money market mutual funds because their returns did not keep pace with inflation. B) banks solidified their advantage over money markets by offering higher deposit rates. C) brokerage houses introduced highly popular money market mutual funds, which drew significant amounts of money out of bank deposits. D) consumers were unable to take advantage of higher rates in money markets because of the requirement of large transaction sizes. Answer: C
46) The nearer a bond's price is to its par value and the longer the maturity of the bond, the more closely the ________ approximates the ________. A) current yield; yield to maturity B) current yield; coupon rate C) yield to maturity; current yield D) yield to maturity; coupon rate
A) current yield; yield to maturity
15) Finance companies play a unique role in money markets by
A) giving consumers indirect access to money markets. B) combining consumers' investments to purchase money market securities on their behalf. C) borrowing in capital markets to finance purchases of money market securities. D) assisting the government in its sales of U.S. Treasury securities. Answer: A
13) The largest purchasers of capital market securities are A) households. B) corporations. C) governments. D) central banks.
A) households.
7) A firm will borrow long-term A) if the extra interest cost of borrowing long-term is less than the expected cost of rising interest rates before it retires its debt. B) if the extra interest cost of borrowing short-term due to rising interest rates does not exceed the expected premium that is paid for borrowing long-term. C) if short-term interest rates are expected to decline during the term of the debt. D) if long-term interest rates are expected to decline during the term of the debt.
A) if the extra interest cost of borrowing long-term is less than the expected cost of rising interest rates before it retires its debt.
43) In its simplest form, a credit default swap provides A) insurance against default in the principle and interest payments of a credit instrument. B) an alternative method for bond issuers to pay principle and interest payments via a swap. C) bond investors with a method to swap interest payments for principle payments during a "credit event." D) the government with a guarantee that certain bond issues will not run into credit problems.
A) insurance against default in the principle and interest payments of a credit instrument.
37) Unlike most money market securities, commercial paper A) is not generally traded in a secondary market. B) usually has a term to maturity that is longer than a year. C) is not popular with most money market investors because of the high default risk. D) all of the above. E) only A and B of the above.
A) is not generally traded in a secondary market.
10) The most influential participant(s) in the U.S. money market
A) is the Federal Reserve. B) is the U.S. Treasury Department. C) are the large money center banks. D) are the investment banks that underwrite securities. Answer: A
47) Asset-backed commercial paper differs from conventional commercial paper in that A) it is backed (secured) by some bundle of assets. B) its maturity usually extends well beyond 1 year. C) both A and B of the above. D) neither A nor B of the above.
A) it is backed (secured) by some bundle of assets.
11) The Fed is an active participant in money markets mainly because of its responsibility to
A) lower borrowing costs to encourage capital investment. B) control the money supply. C) increase the interest income of retirees holding money market instruments. D) assist the Securities and Exchange Commission in regulating the behavior of other money market participants. Answer: B
12) Commercial banks are large holders of ________ and are the major issuer of ________.
A) negotiable certificates of deposit; U.S. government securities B) U.S. government securities; negotiable certificates of deposit C) commercial paper; Eurodollars D) Eurodollars; commercial paper Answer: B
59) By the time the subprime financial crisis hit in force, Fannie and Freddie had ________ subprime and Alt-A assets on their books. A) over $1 trillion of B) very few C) been prohibited from holding D) none of the above
A) over $1 trillion of
22) Treasury bills do not
A) pay interest. B) have a maturity date. C) have a face amount. D) have an active secondary market. Answer: A
33) Policies that limit the discretion of managers as a way of protecting bondholders' interests are called A) restrictive covenants. B) debentures. C) sinking funds. D) bond indentures.
A) restrictive covenants.
5) The primary reason that individuals and firms choose to borrow long-term is to reduce the risk that interest rates will ________ before they pay off their debt. A) rise B) fall C) become more volatile D) become more stable
A) rise
13) The primary function of large diversified brokerage firms in the money market is to
A) sell money market securities to the Federal Reserve for its open market operations. B) make a market for money market securities by maintaining an inventory from which to buy or sell. C) buy money market securities from corporations that need liquidity. D) buy T-bills from the U.S. Treasury Department. Answer B
2) Money market securities have all the following characteristics except they are not
A) short term. B) money. C) low risk. D) very liquid. Answer: B
4) The banking industry
A) should have an efficiency advantage in gathering information that would eliminate the need for the money markets. B) exists primarily to mediate the asymmetric information problem between saver-lenders and borrower-spenders. C) is subject to more regulations and governmental costs than the money markets. D) all of the above are true. E) only A and B of the above are true. Answer: D
45) In a direct placement A) the issuer bypasses the dealer and sells indirectly to the end investor. B) the dealer sells directly to the end investor. C) the issuer bypasses the dealer and sells directly to the end investor. D) none of the above.
A) the issuer bypasses the dealer and sells indirectly to the end investor.
5) In situations where asymmetric information problems are not severe,
A) the money markets have a distinct cost advantage over banks in providing short-term funds. B) the money markets have a distinct cost advantage over banks in providing long-term funds. C) banks have a distinct cost advantage over the money markets in providing short-term funds. D) the money markets cannot allocate short-term funds as efficiently as banks can. Answer: A
9) Governments never issue stock because A) they cannot sell ownership claims. B) the Constitution expressly forbids it. C) both A and B of the above. D) neither A nor B of the above.
A) they cannot sell ownership claims.
52) Corporations may enter the capital markets because A) they do not have sufficient capital to fund their investment opportunities. B) they want to preserve their capital to protect against expected needs. C) it is required by the Securities and Exchange Commission (SEC). D) none of the above.
A) they do not have sufficient capital to fund their investment opportunities.
44) The main role of investment companies in the money market is to A) trade on behalf of commercial accounts. B) mediate the symmetric information problem between server-lender and borrower-spenders. C) both A and B of the above. D) neither A nor B of the above.
A) trade on behalf of commercial accounts.
6) Brokerage firms that offered money market security accounts in the 1970s had a cost advantage over banks in attracting funds because the brokerage firms
A) were not subject to deposit reserve requirements. B) were not subject to the deposit interest rate ceilings. C) were not limited in how much they could borrow from depositors. D) had the advantage of all the above. E) had the advantage of only A and B of the above. Answer: E
28) (I) Because interest rates on Treasury bills are more volatile than rates on long-term securities, the return on short-term Treasury securities is usually above that on longer-term Treasury securities. (II) A Treasury STRIP separates the periodic interest payments from the final principal repayment. A) (I) is true, (II) false. B) (I) is false, (II) true. C) Both are true. D) Both are false.
B) (I) is false, (II) true
16) (I) Capital market securities fall into two categories: bonds and stocks. (II) Long-term bonds include government bonds and long-term notes, municipal bonds, and corporate bonds. A) (I) is true, (II) false. B) (I) is false, (II) true. C) Both are true. D) Both are false.
B) (I) is false, (II) true.
30) If the Fed wants to lower the federal funds interest rate, it will ________ the banking system by ________ securities. A) add reserves to; selling B) add reserves to; buying C) remove reserves from; selling D) remove reserves from; buying
B) add reserves to; buying
23) The security with the longest maturity is a Treasury A) note. B) bond. C) acceptance. D) bill.
B) bond.
18) The ________ rate is the rate of interest that the issuer must pay. A) market B) coupon C) discount D) funds
B) coupon
37) Call provisions will be exercised when interest rates ________ and bond values ________. A) rise; rise B) fall; rise C) rise; fall D) fall; fall
B) fall; rise
46) The advantage of mutual funds is that they A) require no cash up front. B) give investors with relatively small amounts of cash to invest access to large-denomination securities. C) always yield the highest returns. D) both A and B of the above.
B) give investors with relatively small amounts of cash to invest access to large-denomination securities.
57) The first step in finding the value of a bond is to A) discount back the cash flows using an interest rate that represents the yield available on other bonds of like risk and maturity. B) identify the cash flows the holder of the bond will receive. C) contact the holder of the bond. D) none of the above.
B) identify the cash flows the holder of the bond will receive
43) Two important characteristics of any financial market are flexibility and A) risk. B) innovation. C) tolerance. D) capital.
B) innovation.
1) Compared to money market securities, capital market securities have A) more liquidity. B) longer maturities. C) lower yields. D) less risk.
B) longer maturities.
51) When an old bond's market value is above its par value, the bond is selling at a ________. This occurs because the old bond's coupon rate is ________ the coupon rates of new bonds with similar risk. A) premium; below B) premium; above C) discount; below D) discount; above
B) premium; above
23) If your competitive bid for a Treasury bill is successful, then you will A) certainly pay less than if you had submitted a noncompetitive bid. B) probably pay more than if you had submitted a noncompetitive bid. C) pay the average of prices offered in other successful competitive bids. D) pay the same as other successful competitive bidders.
B) probably pay more than if you had submitted a noncompetitive bid.
44) Corporate bonds are less risky if they are ________ bonds and municipal bonds are less risky if they are ________ bonds. A) secured; revenue B) secured; general obligation C) unsecured; revenue D) unsecured; general obligation
B) secured; general obligation
31) If the Fed wants to raise the federal funds interest rate, it will ________ securities to ________ the banking system. A) sell; add reserves to B) sell; remove reserves from C) buy; add reserves to D) buy; remove reserves from
B) sell; remove reserves from
48) The current yield is a less accurate approximation of the yield to maturity the ________ the time to maturity of the bond and the ________ the price is from/to the par value. A) shorter; closer B) shorter; farther C) longer; closer D) longer; farther
B) shorter; farther
8) The primary issuers of capital market securities include A) the federal and local governments. B) the federal and local governments, and corporations. C) the federal and local governments, corporations, and financial institutions. D) local governments and corporations.
B) the federal and local governments, and corporations.
55) STRIPS (Separate Trading of Registered Interest and Principal Securities) are also called A) interest-based securities. B) zero-coupon securities. C) leveraged securities. D) covenant securities.
B) zero-coupon securities.
Explain why banks, which would seem to have a comparative advantage in gathering information, have not eliminated the need for the money markets.
Banks have higher costs than the money market owing to the need to maintain reserve requirements. The lower cost structure of the money markets, coupled with the economies of scale resulting from high volume and large-denomination securities, allows for higher interest rates.
50) The current yield on a $5,000, 8 percent coupon bond selling for $4,000 is A) 5%. B) 8%. C) 10%. D) 20%. E) none of the above.
C) 10%.
49) The current yield on a $6,000, 10 percent coupon bond selling for $5,000 is A) 5%. B) 10%. C) 12%. D) 15%.
C) 12%.
10) (I) The primary issuers of capital market securities are federal and local governments, and corporations. (II) Governments never issue stock because they cannot sell ownership claims. A) (I) is true, (II) false. B) (I) is false, (II) true. C) Both are true. D) Both are false.
C) Both are true.
15) (I) There are two types of exchanges in the secondary market for capital securities: organized exchanges and over-the-counter exchanges. (II) When firms sell securities for the very first time, the issue is an initial public offering. A) (I) is true, (II) false. B) (I) is false, (II) true. C) Both are true. D) Both are false.
C) Both are true.
19) (I) The coupon rate is the rate of interest that the issuer of the bond must pay. (II) The coupon rate is usually fixed for the duration of the bond and does not fluctuate with market interest rates. A) (I) is true, (II) false. B) (I) is false, (II) true. C) Both are true. D) Both are false.
C) Both are true.
2) (I) Securities that have an original maturity greater than one year are traded in capital markets. (II) The best known capital market securities are stocks and bonds. A) (I) is true, (II) false. B) (I) is false, (II) true. C) Both are true. D) Both are false.
C) Both are true.
24) (I) To sell an old bond when interest rates have risen, the holder will have to discount the bond until the yield to the buyer is the same as the market rate. (II) The risk that the value of a bond will fall when market interest rates rise is called interest-rate risk. A) (I) is true, (II) false. B) (I) is false, (II) true. C) Both are true. D) Both are false.
C) Both are true.
27) (I) In most years, the rate of return on short-term Treasury bills is below that on the 20-year Treasury bond. (II) Interest rates on Treasury bills are more volatile than rates on long-term Treasury securities. A) (I) is true, (II) false. B) (I) is false, (II) true. C) Both are true. D) Both are false.
C) Both are true.
30) (I) Municipal bonds that are issued to pay for essential public projects are exempt from federal taxation. (II) General obligation bonds do not have specific assets pledged as security or a specific source of revenue allocated for their repayment. A) (I) is true, (II) false. B) (I) is false, (II) true. C) Both are true. D) Both are false.
C) Both are true.
36) (I) Restrictive covenants often limit the amount of dividends that firms can pay the stockholders. (II) Most corporate indentures include a call provision, which states that the issuer has the right to force the holder to sell the bond back. A) (I) is true, (II) false. B) (I) is false, (II) true. C) Both are true. D) Both are false.
C) Both are true.
39) (I) Callable bonds usually have a higher yield than comparable noncallable bonds. (II) Convertible bonds are attractive to bondholders and sell for a higher price than comparable nonconvertible bonds. A) (I) is true, (II) false. B) (I) is false, (II) true. C) Both are true. D) Both are false.
C) Both are true.
4) (I) Firms and individuals use the capital markets for long-term investments. (II) Capital markets provide an alternative to investment in assets such as real estate and gold. A) (I) is true, (II) false. B) (I) is false, (II) true. C) Both are true. D) Both are false.
C) Both are true.
28) The Federal Reserve can influence the federal funds interest rate by buying securities, which ________ reserves, thereby ________ the federal funds rate. A) adds; raising B) removes; lowering C) adds; lowering D) removes; raising
C) adds; lowering
58) A change in the current yield ________ signals a change in the same direction of the yield to maturity. A) never B) rarely C) always D) often
C) always
42) Money market transactions A) do not take place in any one particular location or building. B) are usually arranged purchases and sales between participants over the phone by traders and completed electronically. C) are both A and B of the above. D) are none the the above.
C) are both A and B of the above.
22) The prices of Treasury notes, bonds, and bills are quoted A) as a percentage of the coupon rate. B) as a percentage of the previous day's closing value. C) as a percentage of $100 face value. D) as a multiple of the annual interest paid.
C) as a percentage of $100 face value.
53) Capital market trading occurs in A) the primary market. B) the secondary market. C) both A and B of the above. D) none of the above.
C) both A and B of the above.
29) The Fed can lower the federal funds interest rate by ________ securities, thereby ________ reserves. A) selling; adding B) selling; lowering C) buying; adding D) buying; lowering
C) buying; adding
21) Treasury bonds are subject to ________ risk but are free of ________ risk. A) default; interest-rate B) default; underwriting C) interest-rate; default D) interest-rate; underwriting
C) interest-rate; default
34) Typically, the interest rate on corporate bonds will be ________ the more restrictions are placed on management through restrictive covenants, because ________. A) higher; corporate earnings will be limited by the restrictions B) higher; the bonds will be considered safer by bondholders C) lower; the bonds will be considered safer by buyers D) lower; corporate earnings will be higher with more restrictions in place
C) lower; the bonds will be considered safer by buyers
41) Which of the following statements about money market securities are true? A) The interest rates on all money market instruments move very closely together over time. B) The secondary market for Treasury bills is extensive and well developed. C) There is no well-developed secondary market for commercial paper. D) All of the above are true. E) Only A and B of the above are true.
D) All of the above are true.
26) Federal funds are A) usually overnight investments. B) borrowed by banks that have a deficit of reserves. C) lent by banks that have an excess of reserves. D) all of the above. E) only A and B of the above.
D) all of the above.
33) Repos are A) usually low-risk loans. B) usually collateralized with Treasury securities. C) low interest rate loans. D) all of the above. E) only A and B of the above.
D) all of the above.
34) A negotiable certificate of deposit A) is a term security because it has a specified maturity date. B) is a bearer instrument, meaning whoever holds the certificate at maturity receives the principal and interest. C) can be bought and sold until maturity. D) all of the above. E) only A and B of the above.
D) all of the above.
36) Commercial paper securities A) are issued only by the largest and most creditworthy corporations, as they are unsecured. B) carry an interest rate that varies according to the firm's level of risk. C) never have a term to maturity that exceeds 270 days. D) all of the above. E) only A and B of the above.
D) all of the above.
25) Federal funds A) are short-term funds transferred between financial institutions, usually for a period of one day. B) actually have nothing to do with the federal government. C) provide banks with an immediate infusion of reserves. D) are all of the above. E) are only A and B of the above.
D) are all of the above.
39) Banker's acceptances A) can be bought and sold until they mature. B) are issued only by large money center banks. C) carry low interest rates because of the very low default risk. D) are all of the above. E) are only A and B of the above.
D) are all of the above.
32) The bond contract that states the lender's rights and privileges and the borrower's obligations is called the A) bond syndicate. B) restrictive covenant. C) bond covenant. D) bond indenture.
D) bond indenture.
12) The distribution of a firm's capital between debt and equity is its A) current ratio. B) liability structure. C) acid ratio. D) capital structure.
D) capital structure.
40) Long-term unsecured bonds that are backed only by the general creditworthiness of the issuer are called A) junk bonds. B) callable bonds. C) convertible bonds. D) debentures.
D) debentures
27) The Fed can influence the federal funds interest rate by adjusting the level of reserves available to banks. The Fed can A) lower the federal funds interest rate by adding reserves. B) raise the federal funds interest rate by removing reserves. C) remove reserves by selling securities. D) do all of the above. E) do only A and B of the above.
D) do all of the above.
32) Government securities dealers frequently engage in repos to A) manage liquidity. B) take advantage of anticipated changes in interest rates. C) lend or borrow for a day or two with what is essentially a collateralized loan. D) do all of the above. E) do only A and B of the above.
D) do all of the above.
35) Restrictive covenants can A) limit the amount of dividends the firm can pay. B) limit the ability of the firm to issue additional debt. C) restrict the ability of the firm to enter into a merger agreement. D) do all of the above. E) do only A and B of the above.
D) do all of the above.
42) Financial guarantees A) are insurance policies to back bond issues. B) are purchased by financially weaker security issuers. C) lower the risk of the bonds covered by the guarantee. D) do all of the above. E) do only A and B of the above.
D) do all of the above.
17) The ________ value of a bond is the amount that the issuer must pay at maturity. A) market B) present C) discounted D) face
D) face
56) The risk on an agency bond is A) high. B) zero. C) moderate. D) low.
D) low.
24) If your noncompetitive bid for a Treasury bill is successful, then you will A) certainly pay less than if you had submitted a competitive bid. B) certainly pay more than if you had submitted a competitive bid. C) pay the average of prices offered in other noncompetitive bids. D) pay the same as other successful noncompetitive bidders.
D) pay the same as other successful noncompetitive bidders.
41) A secured bond is backed by A) the general creditworthiness of the borrower. B) an insurance company's financial guarantee. C) the expected future earnings of the borrower. D) specific collateral.
D) specific collateral.
47) Which of the following are true for the current yield? A) The current yield is defined as the yearly coupon payment divided by the price of the security. B) The current yield and the yield to maturity always move together. C) The formula for the current yield is identical to the formula describing the yield to maturity for a discount bond. D) All of the above are true. E) Only A and B of the above are true.
E) Only A and B of the above are true.
35) Negotiable certificates of deposit A) are bearer instruments because their holders earn the interest and principal at maturity. B) typically have a maturity of one to four months. C) are usually denominated at $100,000. D) are all of the above. E) are only A and B of the above.
E) are only A and B of the above.
40) Eurodollars A) are time deposits with fixed maturities and are, therefore, somewhat illiquid. B) may offer the borrower a lower interest rate than can be received in the domestic market. C) are limited to London banks. D) are all of the above. E) are only A and B of the above.
E) are only A and B of the above.
14) Individuals and households frequently purchase capital market securities through financial institutions such as A) mutual funds. B) pension funds. C) money market mutual funds. D) all of the above. E) only A and B of the above.
E) only A and B of the above.
38) A banker's acceptance is A) used to finance goods that have not yet been transferred from the seller to the buyer. B) an order to pay a specified amount of money to the bearer on a given date. C) a relatively new money market security that arose in the 1960s as international trade expanded. D) all of the above. E) only A and B of the above.
E) only A and B of the above.
How are Treasury bills sold? How do competitive and noncompetitive bids differ?
In competitive bidding for securities, buyers submit bids. A noncompetitive bidder accepts the average of the rate paid by the competitive bidders.
Explain how the Federal Reserve can influence the federal funds interest rate.
The Federal Reserve cannot directly set the federal funds rate of interest. It can influence the interest rate by adding funds to or withdrawing reserves from the economy.