MASTER FINAL EXAM STUDY GUIDE - FIN 3636 Chapter 9, BUS322 Final Exam Practice Question - Chapter 22, BUS 322 Final Exam, Chapter 9 Questions, Chapter 10, Chapter 11, CHAPTER 12, Fin Exam 2 Ch. 6, 9, 11, 12, 13, 17, 20, 22, Chapter 6, Ch 7, Chapter 1...

41) The oldest central bank, founded in 1694, is the A) Bank of England. B) Deutsche Bundesbank. C) Bank of Japan. D) Federal Reserve System

A) Bank of England.

38) Although it enjoys a high degree of autonomy, the Fed is still subject to the influence of Congress because A) Congress can pass legislation that would restrict the Fed's independence. B) Congress can withhold the Fed's budget requests. C) Congress can remove members of the Board of Governors whose views on policy differ from those of key members of Congress. D) All of the above.

A) Congress can pass legislation that would restrict the Fed's independence.

42) The newest central bank, which began operations in January 1999, is the A) European Central Bank. B) Bank of Argentina. C) Bank of Korea. D) Bank of New Zealand.

A) European Central Bank.

21) Which of the following are duties of the Board of Governors of the Federal Reserve System? A) Setting margin requirements, the fraction of the purchase price of securities that has to be paid for with cash. B) Setting the maximum interest rates payable on certain types of time deposits under Regulation Q. C) Regulating credit with the approval of the President under the Credit Control Act of 1969. D) None of the above has been a duty of the Board since the mid-1980s.

A) Setting margin requirements, the fraction of the purchase price of securities that has to be paid for with cash.

51) The strongest argument for an independent Federal Reserve rests on the view that subjecting the Fed to more political pressures would impart A) an inflationary bias to monetary policy. B) a deflationary bias to monetary policy. C) a disinflationary bias to monetary policy. D) a countercyclical bias to monetary policy.

A) an inflationary bias to monetary policy.

Finance companies raise funds in the money market by selling

A) commercial paper. ( p. 256 top)

20) The Fed's support of the Depository Institutions Deregulation and Monetary Control Act of 1980 stemmed in part from its A) concern over declining Fed membership. B) belief that all banking regulations should be eliminated. C) belief that interest rate ceilings were too low. D) belief that depositors had to become more knowledgeable about banking operations.

A) concern over declining Fed membership.

Finance companies play a unique role in money markets by

A) giving consumers indirect access to money markets.

44) A trend in recent years is that more and more governments A) have been granting greater independence to their central banks. B) have been reducing the independence of their central banks to make them more accountable for poor economic performance. C) have mandated that their central banks give up multiple policy goals to focus strictly on inflation. D) have required their central banks to coordinate policies with their ministers of finance.

A) have been granting greater independence to their central banks.

Unlike most money market securities, commercial paper

A) is not generally traded in a secondary market.(p. 264 first full paragraph. A strong secondary market for commercial paper does not exist)

The most influential participant(s) in the U.S. money market

A) is the Federal Reserve.

Asset-backed commercial paper differs from conventional commercial paper in that

A) it is backed (secured) by some bundle of assets.

Treasury bills do not

A) pay interest.

33) The designers of the Federal Reserve Act meant to create a central bank characterized by its A) system of checks and balances and decentralization of power. B) strong concentration of power in the hands of a few people. C) inability to function as a lender of last resort. D) responsiveness to the electorate.

A) system of checks and balances and decentralization of power.

34) The power within the Federal Reserve was effectively transferred to the Board of Governors by A) the banking legislation of the Great Depression. B) Supreme Court decisions in the 1950s. C) the Depository Institutions Deregulation and Monetary Control Act of 1980. D) the Treasury-Federal Reserve Accord of 1951.

A) the banking legislation of the Great Depression.

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.

47) According to the theory of bureaucratic behavior, the objective of bureaucracy is A) to maximize its own welfare, meaning that it seeks additional power and prestige. B) to maximize consumers' surplus, meaning that it seeks additional regulatory powers. C) to protect the industry it regulates, meaning that it seeks additional regulatory powers. D) none of the above.

A) to maximize its own welfare, meaning that it seeks additional power and prestige.

The main role of investment companies in the money market is to

A) trade on behalf of commercial accounts. see chart p.254

2) Bank panics in 1819, 1837, 1857, 1873, 1884, 1893, and 1907 convinced many that A) the Federal Reserve needed greater control over the banking system. B) the Federal Reserve needed greater authority to deal with problem banks. C) a central bank was needed to prevent future financial panics. D) both A and B of the above.

C) a central bank was needed to prevent future financial panics.

When inflation rose in the late 1970s,

C) brokerage houses introduced highly popular money market mutual funds, which drew significant amounts of money out of bank deposits.

The Fed can lower the federal funds interest rate by ________ securities, thereby ________ reserves.

C) buying; adding

36) Federal Reserve independence is thought to A) introduce a short-term bias to monetary policymaking. B) lead to better fiscal and monetary policy coordination. C) introduce longer-run considerations to monetary policymaking. D) do both A and B of the above.

C) introduce longer-run considerations to monetary policymaking.

37) Members of Congress are able to influence monetary policy, albeit indirectly, through their ability to A) withhold appropriations from the Board of Governors. B) withhold appropriations from the Federal Open Market Committee. C) propose legislation that would force the Fed to submit budget requests to Congress, as must other government agencies. D) do all of the above.

C) propose legislation that would force the Fed to submit budget requests to Congress, as must other government agencies.

28) Although the Federal Open Market Committee does not have formal authority to set ________ and the ________, it does possess the authority in practice. A) margin requirements; discount rate B) margin requirements; federal funds rate C) reserve requirements; discount rate D) reserve requirements; federal funds rate

C) reserve requirements; discount rate

15) Member commercial banks have purchased stock in their district Fed banks; the dividend paid by that stock is limited to A) four percent annually. B) five percent annually. C) six percent annually. D) eight percent annually.

C) six percent annually.

30) The Federal Open Market Committee consists of A) the five senior members of the seven-member Board of Governors. B) the seven members of the Board of Governors and seven presidents of the regional Fed banks. C) the seven members of the Board of Governors and five presidents of the regional Fed banks. D) the twelve regional Fed bank presidents and the chairman of the Board of Governors.

C) the seven members of the Board of Governors and five presidents of the regional Fed banks.

The usual maturity range for fed funds is ________.

D) 1 to 7 days

1) Americans' fear of centralized power and their distrust of moneyed interests explain why the U.S. did not have a central bank until the A) 17th century. B) 18th century. C) 19th century. D) 20th century.

D) 20th century.

9) Which of the following is an element of the Federal Reserve System? A) The Federal Reserve banks B) The Board of Governors C) The FOMC D) All of the above

D) All of the above

29) Which of the following are true statements? A) The FOMC usually meets every six weeks to set monetary policy. B) The FOMC issues directives to the trading desk at the New York Fed. C) Designers of the Federal Reserve Act did not envision the use of open market operations as a monetary policy tool. D) All of the above are true statements. E) Only A and B of the above are true statements.

D) All of the above are true statements. see chart on p.185

17) Which of the following banks are required to be members of the Federal Reserve System? A) State-chartered banks B) Insured banks C) Banks having over $500 million in assets D) None of the above

D) None of the above

5) The financial panic of 1907 resulted in such widespread bank failures and substantial losses to depositors that the American public finally became convinced that A) the First Bank of the United States had failed to serve as a lender of last resort. B) the Second Bank of the United States had failed to serve as a lender of last resort. C) the Federal Reserve System had failed to serve as a lender of last resort. D) a central bank was needed to prevent future panics.

D) a central bank was needed to prevent future panics.

48) According to the theory of bureaucratic behavior, A) the objective of a bureaucracy is to maximize its own welfare, meaning that it seeks additional power and prestige. B) the bureaucracy will fight vigorously to preserve its autonomy; thus, it will attempt to avoid conflict with the president and Congress. C) the bureaucracy will support legislation that gives it additional regulatory power. D) all of the above describe bureaucratic behavior.

D) all of the above describe bureaucratic behavior.

4) The traditional American distrust of moneyed interests and the fear of centralized power help to explain A) the failures of the first two experiments in central banking in the United States. B) the decentralized structure of the Federal Reserve System. C) why the Board of Governors of the Federal Reserve System is not located in New York. D) all of the above. E) only A and B of the above.

D) all of the above.

40) According to the textbook authors, A) the Fed appears to be remarkably free of the political pressures that influence other government agencies. B) since the president can protect the Fed from Congress, the Fed may be responsive to the president's policy preferences. C) the Fed appears to be more responsive to the political pressures that influence other government agencies. D) both A and B of the above. E) both B and C of the above.

D) both A and B of the above.

39) According to the textbook authors, the Fed is A) remarkably free of the political pressures that influence other government agencies. B) more responsive to the political pressures that influence other government agencies. C) probably somewhat constrained in its policymaking by the congressional threat to reduce Fed independence. D) both A and C of the above.

D) both A and C of the above.

46) The theory of bureaucratic behavior suggests that the Federal Reserve will A) try to avoid a conflict with the president and Congress over increases in interest rates. B) try to gain regulatory power over more banks. C) devise clever strategies in an effort to avoid blame for poor economic performance. D) do all of the above.

D) do all of the above.

26) The Board of Governors A) establishes, within limits, reserve requirements. B) effectively sets the discount rate. C) sets margin requirements. D) does all of the above. E) does only A and B of the above.

D) does all of the above.

13) Each Fed bank president attends FOMC meetings; although only ________ Fed bank presidents vote on policy, all ________ provide input. A) three; ten B) five; ten C) three; twelve D) five; twelve

D) five; twelve

If your noncompetitive bid for a Treasury bill is successful, then you will

D) pay the same as other successful noncompetitive bidders.

8) Which of the following is an element of the Federal Reserve System? A) The Federal Reserve banks B) The Board of Governors C) The FDIC D) All of the above E) Only A and B of the above

E) Only A and B of the above

32) Which of the following are true statements? A) The FOMC usually meets every six weeks to set monetary policy. B) The FOMC issues directives to the trading desk at the New York Fed. C) Designers of the Federal Reserve Act did not envision the use of discount lending as a monetary policy tool. D) All of the above are true statements. E) Only A and B of the above are true statements.

E) Only A and B of the above are true statements. see chart on p.185

19) Banks subject to reserve requirements set by the Federal Reserve System include A) only state-chartered banks. B) only nationally chartered banks. C) only banks with less than $100 million in assets. D) only banks with less than $500 million in assets. E) all banks whether or not they are members of the Federal Reserve System.

E) all banks whether or not they are members of the Federal Reserve System.

23) The chairman of the Board of Governors of the Federal Reserve System exercises a high degree of control over the board A) through his ability to set the agenda of the Board and the FOMC. B) through his role as spokesperson for the Fed with the President and before Congress. C) because he can veto decisions made by a majority of the other Board members. D) because of all of the above. E) because of only A and B of the above.

E) because of only A and B of the above.

3) The unusual structure of the Federal Reserve System is perhaps best explained by A) Americans' fear of centralized power. B) the traditional American distrust of moneyed interests. C) Americans' desire to remove control of the money supply from the U.S. Treasury. D) all of the above. E) only A and B of the above.

E) only A and B of the above.

35) Factors that provide the Federal Reserve with a high degree of independence include A) 14-year terms for members of the Board of Governors. B) a four-year term for the chairman of the Board of Governors that is not coincident with the president's term of office. C) constitutional independence from Congress and the president. D) all of the above. E) only A and B of the above.

E) only A and B of the above.

49) The theory of bureaucratic behavior when applied to the Fed helps to explain why the Fed A) resists so vigorously congressional attempts to limit the central bank's autonomy. B) is secretive about the conduct of future monetary policy. C) sought less control over banks in the 1980s. D) all of the above. E) only A and B of the above.

E) only A and B of the above.

43) Which of the following central banks has the greatest degree of independence? A) Bank of England B) European Central Bank C) Bank of Japan D) Federal Reserve System

B) European Central Bank

31) The Federal Reserve entity that determines monetary policy strategy is the A) Board of Governors. B) Federal Open Market Committee. C) Chairman of the Board of Governors. D) Shadow Open Market Committee.

B) Federal Open Market Committee.

12) Which Federal Reserve Bank president always has a vote in the Federal Open Market Committee? A) Philadelphia B) New York C) Boston D) San Francisco

B) New York

22) Which of the following are not duties of the Board of Governors of the Federal Reserve System? A) Setting margin requirements, the fraction of the purchase price of securities that has to be paid for with cash. B) Setting the maximum interest rates payable on certain types of time deposits under Regulation Q. C) Approving the discount rate "established" by the Federal Reserve banks. D) Representing the United States in negotiations with foreign governments on economic matters.

B) Setting the maximum interest rates payable on certain types of time deposits under Regulation Q.

10) Which of the following is not an entity of the Federal Reserve System? A) Federal Reserve banks B) The FDIC C) The Board of Governors D) The Federal Advisory Council E) Member commercial banks

B) The FDIC

Commercial banks are large holders of ________ and are the major issuer of ________.

B) U.S. government securities; negotiable certificates of deposit

7) The many regional Federal Reserve banks resulted from a compromise between parties favoring A) the establishment of a central bank and those opposed to its establishment. B) a private central bank and those favoring a government institution. C) the establishment of the Board of Governors in Washington, D.C., and those preferring its establishment in New York City. D) none of the above.

B) a private central bank and those favoring a government institution.

If the Fed wants to lower the federal funds interest rate, it will ________ the banking system by ________ securities.

B) add reserves to; buying

The advantage of mutual funds is that they

B) give investors with relatively small amounts of cash to invest access to large-denomination securities.

Two important characteristics of any financial market are flexibility and

B) innovation.

50) The theory of bureaucratic behavior when applied to the Fed helps to explain why the Fed A) is supportive of congressional attempts to limit the central bank's autonomy. B) is secretive about the conduct of future monetary policy. C) sought less control over banks in the 1980s. D) is willing to take on powerful groups that may threaten its autonomy.

B) is secretive about the conduct of future monetary policy.

45) The theory of bureaucratic behavior suggests that the objective of a bureaucracy is to maximize A) the public's welfare. B) its own welfare. C) profits. D) conflict between the executive and legislative branches of government.

B) its own welfare.

The primary function of large diversified brokerage firms in the money market is to

B) make a market for money market securities by maintaining an inventory from which to buy or sell.

Money market securities have all the following characteristics except they are not

B) money.

16) All ________ are required to be members of the Fed. A) state-chartered banks B) nationally chartered banks C) banks with more than $100 million in assets D) banks with more than $500 million in assets

B) nationally chartered banks

If your competitive bid for a Treasury bill is successful, then you will

B) probably pay more than if you had submitted a noncompetitive bid.

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

C) 6 percent.

11) Which of the following functions are not performed by any of the twelve regional Federal Reserve banks? A) Check clearing B) Conducting economic research C) Setting interest rates payable on time deposits D) Issuing new currency

C) Setting interest rates payable on time deposits

Which of the following is the largest borrower in the money markets?

C) The U.S. Treasury

"Foreign exchange rates, like stock prices, should follow a random walk." Is this statement true, false, or uncertain? Explain your answer.

"Foreign exchange rates, like stock prices, should follow a random walk." Is this statement true, false, or uncertain? Explain your answer. True in principle. Foreign exchange rates are a random walk over a short interval such as a week because changes in the exchange rate are unpredictable. If a change were predictable, large unexploited profit opportunities would exist in the foreign exchange market. If the foreign exchange market is efficient, these unexploited profit opportunities cannot exist, and so the foreign exchange rate will approximately follow a random walk.

100 asset 4 years 90 liabilities 6 year 2 percentage

(100 x(-2%) x 4 years) 8 assets fall in value (90 x(-2%) x 6 years) 10.8 liabilities Net worth increases by 2.8

8. What are Fed Funds? Does the Federal Reserve directly set the Fed funds rate? How does the Fed influence this rate?

- Are short-term funds transferred between financial institutions at the US interbank market, usually for a period of one day and can have maturities to 7 days. - Banks often use fed funds to meet the reserve requirements imposed by the government. They keep a certain percentage of their total deposits with the Federal Reserve - The Central Banks cannot directly control fed funds rates. The influence is indirect, i.e., by buying or selling securities (e.g. T-bills).

6. A bond makes an annual $80 interest payment (8% coupon). The bond has 5 years before it matures, at which time it will pay $1,000. Assuming a discount rate of 10%, what should be the price of the bond?

- Bond with 8% annual coupon, Face or Par Value = $1,000, n = 5 years, Discount rate: 10% - Price = 80/(1+0.1) + 80/(1.1)²...+ 80/1.1^4 + (1,000 + (1,000x0.08))/1.1^5 = $924.18

13. What kinds of risk is an investor exposed to when she buys a corporate bond?

- Corporate bonds are issued by corporations and usually pay interest semi-annually. - The degree of risk varies with each bond, even from the same issuer. The degree of risk ranges from low-risk (AAA) to higher risk (BBB). Any bond rated below BBB is considered sub-investment grade debt.

10. Explain what is a bond and what are the main characteristics of a simple bond, namely the par value, the coupon interest rate, and the maturity.

- Definition: Long term debt security, with maturity greater than one year. It is used by issuers as a way to borrow funds for long-term financing or investments. They are issued by US Treasury, Federal and local governments, corporations and bought by Institutional investors (most often has they are expensive). Characteristics: - Annual or semi-annual interest payments in the form of coupons - At maturity, the issuer pays the par value to the bond holder - Both the par value and coupons are specified when the bond is issued - Very often, the coupon of a bond is constant and the bond holder receives the same coupon every year (or every six months) Frequency of coupon payments - However, some bonds have coupons which are variable-rate coupons (floating-rate bond) or indexed to inflation. - Issued to the primary capital market (Investors), Secondary market private transaction from investor who bought the bond from the primary market to another investor - Some bond contracts can include: Protective covenants (on dividend policy), A call provision: the issuer has the right to force the buyer to sell back the bond before maturity, Convertibility: the bond holder has the right, under certain conditions, to convert the bond into shares of the corporation

3. Why does the U.S. government use money markets?

- For example, to do Cash Management with Treasury Bills. For instance, debt securities are issued by the US Treasury to cover government budget shortfalls (deficits) Cash Management. - Moreover, Fed Funds which are a market for lending and borrowing between banks are ruled by the government. The US government manipulates them for monetary policy purposes. The Federal Reserves (like the European Central Bank in Europe) has set minimum reserves requirements that all banks must maintain Because many clients may withdraw their money at the same time and they must, of course, fulfil the clients' demands

11. How are bonds different from money market securities? Discuss the difference between money markets and capital markets.

- From the issuer or seller's standpoint, both markets provide a necessary business function: maintaining adequate levels of funding. - The goal for which sellers access each market varies depending on their liquidity needs (money market securities more liquid) and time horizon (money market shorter maturities). - Capital markets offer higher-risk investments, while money markets offer safer assets - Money market returns are often low but steady, while capital markets offer higher returns. The magnitude of capital market returns often has a direct correlation to the level of risk, but that is not always the case.

5. Suppose the Pound sterling overnight LIBOR rate today is 0.22574%. Bank A borrows $50,000,000 from Bank B for a period of one day at this rate. What is the amount of interest owed (assume 365 days convention)?

- Interest = 50,000,000 x 0.0022574 x 1/365 = 309.23

1. What characteristics define the money markets?

- Is the market for short-term debt (less than one year maturity) - The securities traded in the money markets have high liquidity, low default risk and low expected returns Can easily be bought and sold and are considered as money - Benefit: Invest excess cash, Cash outflows (payments) and cash inflows (income) are not perfectly synchronized which can lead to cash shortages "a-synchronization problem" (eg. When I have to produce goods first (cost for inputs and employees) and get paid after a couple of weeks) Money markets provide a way to solve these cash timing problems.

7. Who are the major parties issuing and investing in money market securities?

- Issuers are mainly U.S. government, banks, businesses and finance companies - Investors are mainly consumers, companies, banks, governments and businesses

5. What is meant by the Eurodollar market? Why is it an important source of funding?

- It is an active interbank market in Eurodollars. This market is used by banks around the world as a source of overnight funding, therefore, it is an alternative to fed funds - It is an important market because it allows to benefit from exchange rate fluctuations

9. What is a LIBOR rate? What is the market convention to quote LIBOR rates?

- LIBOR is the abbreviation for London Interbank Offer Rate, a type of Eurodollars. - It is the rate at which a bank is prepared to lend to another one (eg. Loans Libor + charge) - It is quoted every day for different maturities ranging for one day to one year. - Bank must satisfy certain creditworthiness criteria to qualify for receiving LIBOR (time) deposits. - It must typically be rated (at least) AA, AAA being the best rating - It turns out that LIBOR is quoted for various, currencies and not only for the dollar - ICE LIBOR (formerly known as BBA LIBOR) is a benchmark rate produced for five currencies with seven maturities quoted for each - ranging from overnight to 12 months; All ICE LIBOR rates are quoted as an annualized interest rate. This is a market convention - The US Dollar LIBOR interest rate is the average interbank interest rate at which a large number of banks on the London money market are prepared to lend one another (unsecured) funds denominated in US Dollars. - The Euro LIBOR interest rate is the average interbank interest rate at which a large number of banks on the London money market are prepared to lend one another (unsecured) funds denominated in European euros. - LIBOR provides an indication of the average rate at which a LIBOR contributor bank can obtain (unsecured) funding in the London interbank market for a given period in a given currency

2. If a 15-year bond is supposed to mature in 3 months, is it considered to be a money market instrument?

- No, it remains a capital market instrument due to its characteristics (higher interest rates, often tax exempt, higher risk...)

3. Suppose you want to earn an annualized discount rate of 2.5%. What would be the most you would be willing to pay for a 182-day Treasury bill that pays $10,000 at maturity?

- P = F (1 - iDisc x n / 360) = 10,000 x (1 - 0.025 x 182/360) = 9873.61

4. Calculate the price of a 180-day T-bill purchased at a 5% discount rate if the T-bill has a face value of $5,000.

- P = F (1 - iDisc x n / 360) = 5,000 x (1 - 0.05 x 180/360) =

14. What is the yield to maturity of a bond, and what are the main factors that affect it?

- Since the cash flows of a bond are known in advance, the valuation of a bond is simple: The present value of a bond is equal to the present value of all its future cash flows. - The future cash flows are discounted at the required rate of return/yield. ++++++

Which of the following statements are true of Treasury bills?

- The market for Treasury bills is extremely deep and liquid. - Occasionally, investors find that earnings on T-bills do not compensate them for changes in purchasing power due to inflation.

4. Why do businesses use money markets?

- To invest excess cash or borrow money for a relatively short period with high liquidity. - Securities they buy issue are Repurchase Agreements and Commercial papers - Securities they buy are Repurchase Agreements, Negotiable certificates of deposit, Commercial papers, Banker's acceptance and Eurodollar deposits

6. Which of the money market securities is the most liquid and considered to be the most risk-free? Why?

- Treasury Bills that are used by the government. They are very liquid (issued for terms of 4, 13, 26, and 52 weeks and are auctioned on a regular schedule) and are Virtually default-risk free (because it is short term and very liquid Risk that government can't pay back after 4 weeks is minor)

2. What would be your annualized discount rate % and your annualized investment rate % if a Treasury bill was purchased for $9,360 maturing in 270 days for $10,000?

- i Disc = ((F-P) / F) x 360/n = ((10,000-9,360) / 10,000) x 360/270 = 0.0853 = 8.53% Discount rate gives me the price of the treasury bill - I Inv = ((F-P) / P) x 365/n = ((10,000-9,360) / 10,000) x 365/270 = 0.0866 = 8.66% Annualized interest rates is around 8.6%

1. What would be your annualized discount rate % and your annualized investment rate % on the purchase of a 182-day Treasury bill for $4,925 that pays $5,000 at maturity?

- i Disc = ((F-P) / F) x 360/n = ((5000-4925) / 5000) x 360/182 = 0.0297 = 2.96% Discount rate gives me the price of the treasury bill - I Inv = ((F-P) / P) x 365/n = ((5000-4925) / 4925) x 360/182 = 0.0305 = 3.05% Annualized interest rates is around 3%

Government securities dealers frequently engage in repos to

- manage liquidity. - take advantage of anticipated changes in interest rates. - lend or borrow for a day or two with what is essentially a collateralized loan.

Activity in money markets increased significantly in the late 1970s and early 1980s because of

- rising short-term interest rates. - regulations that limited what banks could pay for deposits.

If the bank you own has no excess reserves and a sound customer comes in asking for a loan, should you automatically turn the customer down, explaining that you don't have any excess reserves to loan out? Why or why not? What options are available for you to provide the funds your customer needs?

-No. When you turn a customer down, you may lose that customer's business forever, which is extremely costly. Instead, you might go out and borrow from other banks, corporations, or the Fed to obtain funds so that you can make the customer's loan. Alternatively, you might sell negotiable CDs or some of your securities to acquire the necessary funds.

What does it mean if a bank has never incurred costs due to a deposit outflow? Should you invest stock?

-The fact that the bank has never incurred costs as a result of a deposit outflow means that the bank is holding a lot of reserves that do not earn any interest. Thus the bank's profits are low, and stock in the bank is not a good investment.

Suppose that you are the manager of a bank 30 rate-asset 20rate-liabilities 5 percent

.5

Rank the following bank assets from most liquid to least liquid

1. Reserves 2.Securities 3.Commercial loans 4.Physical capital

What five categories of regulation does the Dodd-Frank Bill and Future Regulation address?

1.Consumer Protection 2.Resolution Authority 3.Systemic Risk Regulation 4.Volker Rule 5.Derivatives

What are the four advantages of open market operations?

1.Fed has complete control 2.Flexible and precise 3.Easily Reversed 4.Implemented quickly

What are five goals of monetary policy?

1.High employment 2.Economic Growth 3.Stability of financial markets 4.Interest Rate Stability 5.Foreign exchange market stability

What are the five principal benefits of mutual funds?

1.Liquidity Intermediation 2.Denomination Intermediation 3.Diversification 4.Cost Advantages 5.Managerial Expertise

What are the four general principles of bank management?

1.Liquidity Management 2.Asset Management 3.Liability Management 4.Managing capital adequacy

What are the three policy tools for the Fed?

1.Open Market Operations 2.Discount Rate 3.Reserve Requirement

Rank the following bank assets from most to least liquid: Commercial Paper, Securities, Reserves, Physical Capital

1.Reserves 2.Securities 3.Commercial Paper 4.Physical Capital

What are the four primary classes of mutual funds available for investors?

1.Stock Funds 2.Bond Funds 3.Hybrid Fund 4.Money Market Funds

A bank has 200,000 of checkable deposts, a required reserve ratio of 20 percent. The bank currently hold 160,000 in reserves. How much of these reserves are excess reserves

120,000

A bank has 25,000 checkable 25 percent 18750 reserve

12500

What do 12b-1 fees pay, and what is the maximum amount these fees can be?

12b-1 fees pay the mutual fund for marketing and advertising; they are limited to 1% of the funds average net assets per year

100 asset 4 year 85 liablities 3 year 2 pervent

2.9

When 25,000 is deposited at a bank the required reserve ratio is 10 percent, and the bank chooses not to hold any excess recerives

22500

Suppose that you purchase a 182 day Treasury bill for $9850 that is worth $10,000 when it matures. The security's annualized yield if held to maturity is about

3%

When 50,000 10 percent

45,000

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

6 percent

100 million asset 4 years 90 lil 3 years 5 percentage

6.5

100 asset 5 years 85 liabilities 2 years 2 percentage

6.6 percent

Suppose First National hold 100 million in assets with an average duration of 4 years, it holds 90 million liabilities 2 year. 3 percent A 3- percentage-point increase in interest rates decreases First National's net worth by 6.6 percent

6.6percent

When 150000 is deposited at a bank, the required reserve ration is 5 percent, and the bank chooses not to hold any excess reserves makes loans instead, total reserves are equal to

7500

Suppose that you are the manager of a bank whose 100 billion

8billion 10.8 billion 2.8 billion

In a _____, new issues of security are sold to buyers by the corporation or government agency ultimately using the funds. a.) primary market b.) secondary market c.) capital market d.) money market

A

In security sales, the ______ price is the price that the broker pays for securities they buy for their inventory. a.) bid b.) ask c.) midpoint d.) transaction

A

Investment banks advertise upcoming securities offerings with block ads in the wall street journal. such an ad is called a _______ a.) tombstone b.) marker c.) prospectus d.) registration statement

A

Investment banks sell______ securities to the public, and brokerage firms sell ________ securities to the public a.) new, existing b.) new and existing, existing c.) existing, new d.) existing, new and existing

A

Which of the following best explains the difference between brokers and dealers? A) Brokers are pure middlemen; dealers make markets by standing ready to buy and sell at given prices. B) Dealers are pure middlemen; brokers make markets by standing ready to buy and sell at given prices. C) Dealers link up buyers and sellers, but do not stand ready to buy and sell from their inventories of securities; brokers stand ready to buy and sell from their inventories of securities. D) There is no difference between brokers and dealers.

A

________ perform their main function in the primary market for securities and ________ perform their main function in the secondary market. A) Investment banks; securities brokers and dealers B) Securities brokers and dealers; investment banks C) Securities brokers; securities dealers D) Securities dealers; securities brokers

A

by law, investors must be given a portion of the registration statement before they can invest in a new security. this document is called a______ a.) prospectus b.) proxy statement c.) fiduciary warrant d.) debenture

A

in a _________ agreement, the investment banker make no guarantee regarding the price the issuing firm will receive, but agrees to sell the securities on a commission basis. a.) best efforts b.) brokered c.) private-placement d.) jump start

A

How are deferred loads structured?

A deferred load is a fee charged when money is withdrawn from a fund; they are usually 5% and fall by 1% for each year the investment

Close End Fund

A fixed number of nonredeemable shares are sold through an initial offering and are then traded in the OTC market

Hedge Funds

A special type of mutual fund that received considerable attention following the collapse of long term capital management; high minimum investment, high fee, highly levered, long term commitment of funds is required

Distinguish a term security and demand deposits.

A term security has a specific maturity date (6 month negotiable CD). A demand security can be withdrawn at any time (checking account).

21) According to the Gordon growth model, what is an investor's valuation of a stock whose current dividend is $1.00 per year if dividends are expected to grow at a constant rate of 10 percent over a long period of time and the investor's required return is 11 percent? A) $110 B) $100 C) $11 D) $10 E) $5.24

A) $110 (1x1.1)/.11-10)

20) (I) The coupon rate is the rate of interest that the issuer of the bond must pay. (II) The coupon rate on old bonds fluctuates with market interest rates so they will remain attractive to investors. 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.

3) (I) Preferred stockholders hold a claim on assets that has priority over the claims of common stockholders, but after that of bondholders. (II) Firms issue preferred stock in far greater amounts than common stock. 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.

7) (I) In the United States, nonbank loans are the most important source of external funds for nonfinancial businesses. (II) In Germany and Japan, issuing stocks and bonds is the most important source of external for nonfinancial businesses. 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.

7) (I) The largest of the organized stock exchanges in the United States is the New York Stock Exchange. (II) To be listed on the NYSE, a firm must have a minimum of $100 million in market value or $10 million in revenues. 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.

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. (actually can't be redeemed "anytime" but after a specified time, go with it.)

The usual maturity range for commercial paper is ________.

A) 1 to 270 days

4) Of the sources of external funds for nonfinancial businesses in the United States, stocks account for approximately ________ of the total. A) 10% B) 20% C) 30% D) 40%

A) 10%

23) Holding other things constant, a stock's value will be highest if its dividend growth rate is A) 15%. B) 10%. C) 5%. D) 2%.

A) 15%.

37) In 2010, the NYSE traded ________ shares on an average trading day. A) 4 billion B) 7 billion C) 10 billion D) 12 billion

A) 4 billion

Although it enjoys a high degree of autonomy, the Fed is still subject to the influence of Congress because A) Congress can pass legislation that would restrict the Fed's independence. B) Congress can withhold the Fed's budget requests. C) Congress can remove members of the Board of Governors whose views on policy differ from those of key members of Congress. D) All of the above.

A) Congress can pass legislation that would restrict the Fed's independence.

27) Which of the following is true regarding the Gordon growth model? A) Dividends are assumed to grow at a constant rate forever. B) The dividend growth rate is assumed to be greater than the required return on equity. C) Both A and B of the above. D) Neither A nor B of the above.

A) Dividends are assumed to grow at a constant rate forever.

10) The most active stock exchange in the world is the A) Nikkei Stock Exchange. B) London Stock Exchange. C) Shanghai Stock Exchange. D) New York Stock Exchange.

A) Nikkei Stock Exchange.

Which of the following are duties of the Board of Governors of the Federal Reserve System? A) Setting margin requirements, the fraction of the purchase price of securities that has to be paid for with cash. B) Setting the maximum interest rates payable on certain types of time deposits under Regulation Q. C) Regulating credit with the approval of the President under the Credit Control Act of 1969. D) None of the above has been a duty of the Board since the mid-1980s.

A) Setting margin requirements, the fraction of the purchase price of securities that has to be paid for with cash.

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.

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. (just know this is correct answer...does not make sense based on text p.278)

Money market instruments issued by the U.S. Treasury are called

A) Treasury bills.

23) Although the verdict is not yet in, the available evidence indicates that, for many purposes, the efficient market hypothesis is A) a good starting point for analyzing expectations. B) not a good starting point for analyzing expectations. C) too general to be a useful tool for analyzing expectations. D) none of the above.

A) a good starting point for analyzing expectations.

52) A clause in a mortgage loan contract requiring the borrower to purchase homeowner's insurance is an example of A) a restrictive covenant. B) a collusive agreement between mortgage lenders and insurance companies. C) both A and B of the above. D) neither A nor B of the above.

A) a restrictive covenant.

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.

15) Rules used to predict movements in stock prices based on past patterns are, according to the efficient markets theory, A) a waste of time. B) profitably employed by all financial analysts. C) the most efficient rules to employ. D) consistent with the random walk hypothesis.

A) a waste of time.

Rules used to predict movements in stock prices based on past patterns are, according to the efficient markets theory, A) a waste of time. B) profitably employed by all financial analysts. C) the most efficient rules to employ. D) consistent with the random walk hypothesis.

A) a waste of time.

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

17) The problem created by asymmetric information before the transaction occurs is called ________, while the problem created after the transaction occurs is called ________. A) adverse selection; moral hazard B) moral hazard; adverse selection C) costly state verification; free-riding D) free-riding; costly state verification

A) adverse selection; moral hazard

The problem created by asymmetric information before the transaction occurs is called ________, while the problem created after the transaction occurs is called ________. A) adverse selection; moral hazard B) moral hazard; adverse selection C) costly state verification; free-riding D) free-riding; costly state verification

A) adverse selection; moral hazard

42) The subprime financial crisis led to one of the worst bear markets in the last 50 years. Stock prices likely fell due to A) an increase in required returns on equity investments. B) a decline in growth prospects for U.S. companies. C) Both A and B are likely reasons. D) None of the above are correct.

A) an increase in required returns on equity investments.

66) The Board of Governors of the Federal Reserve System A) appoint three directors to each Federal Reserve Bank. B) elect six members to member commercial banks. C) both of the above. D) none of the above.

A) appoint three directors to each Federal Reserve Bank.

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.

25) The efficient market hypothesis applies to A) both the stock market and the foreign exchange market. B) the stock market but not the foreign exchange market. C) the foreign exchange market but not the stock market. D) neither the stock market nor the foreign exchange market.

A) both the stock market and the foreign exchange market.

The efficient market hypothesis applies to A) both the stock market and the foreign exchange market. B) the stock market but not the foreign exchange market. C) the foreign exchange market but not the stock market. D) neither the stock market nor the foreign exchange market.

A) both the stock market and the foreign exchange market.

71) The ________ of the Board of Governors is the spokesperson for the Fed. A) chairman B) president C) either of the above can be the spokesperson D) neither of the above

A) chairman

78) Conflicts of interest in the Arthur Andersen accounting firm intensified when ________ became the firm's largest source of profits and large clients pressured ________ office managers to give favorable audits. A) consulting; regional B) consulting; national C) auditing; regional D) auditing; national

A) consulting; regional

Conflicts of interest in the Arthur Andersen accounting firm intensified when ________ became the firm's largest source of profits and large clients pressured ________ office managers to give favorable audits. A) consulting; regional B) consulting; national C) auditing; regional D) auditing; national

A) consulting; regional

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

34) The 2001 terrorist attacks and the Enron financial scandal caused anticipated dividend growth to ________, investors' required return on equity to ________, and stock prices to ________. A) decrease; increase; decrease B) decrease; increase; increase C) increase; decrease; decrease D) increase; decrease; increase

A) decrease; increase; decrease

26) According to the January effect, stock prices A) experience an abnormal price rise from December to January. B) experience an abnormal price decline from December to January. C) follow a random walk during January. D) set the pattern for the entire year in January.

A) experience an abnormal price rise from December to January.

According to the January effect, stock prices A) experience an abnormal price rise from December to January. B) experience an abnormal price decline from December to January. C) follow a random walk during January. D) set the pattern for the entire year in January.

A) experience an abnormal price rise from December to January.

31) An important lesson from the Black Monday Crash of 1987 and the tech crash of 2000 is that A) factors other than market fundamentals affect stock prices. B) the strong version of the efficient market hypothesis, that stock prices reflect the true fundamental value of securities, is correct. C) market psychology has little if any effect on stock prices. D) there is no such thing as a rational bubble.

A) factors other than market fundamentals affect stock prices.

Corporate bonds are not as liquid as government bonds because A) fewer bonds for any one corporation are traded, making them more costly to sell. B) the corporate bond rating must be calculated each time they are traded. C) corporate bonds are not callable. D) all of the above. E) only A and B of the above.

A) fewer bonds for any one corporation are traded, making them more costly to sell.

22) The ________ problem occurs when people who do not pay for information take advantage of the information that other people have paid for. A) free-rider B) moral hazard C) adverse selection D) lemons

A) free-rider

Typically, yield curves are A) gently upward-sloping. B) gently downward-sloping. C) flat. D) bowl shaped. E) mound shaped.

A) gently upward-sloping.

82) Since firms issuing new securities pay to have these securities rated, the credit-rating agencies have incentive to ________ to attract more business. A) give favorable ratings B) give impartial ratings C) lower the fees they charge D) practice spinning

A) give favorable ratings

Since firms issuing new securities pay to have these securities rated, the credit-rating agencies have incentive to ________ to attract more business. A) give favorable ratings B) give impartial ratings C) lower the fees they charge D) practice spinning

A) give favorable ratings

A trend in recent years is that more and more governments A) have been granting greater independence to their central banks. B) have been reducing the independence of their central banks to make them more accountable for poor economic performance. C) have mandated that their central banks give up multiple policy goals to focus strictly on inflation. D) have required their central banks to coordinate policies with their ministers of finance.

A) have been granting greater independence to their central banks.

41) A ________ PE may indicate that the market feels the firm's earnings are very ________ risk and is therefore willing to pay a ________ for them. A) high; low; premium B) high; high; discount C) low; low; discount D) high; high; premium

A) high; low; premium

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.

72) A conflict of interest between providing impartial research about companies issuing securities and selling those same securities arises in A) investment banking. B) commercial banking. C) accounting firms. D) mutual funds.

A) investment banking.

A conflict of interest between providing impartial research about companies issuing securities and selling those same securities arises in A) investment banking. B) commercial banking. C) accounting firms. D) mutual funds.

A) investment banking.

74) Spinning is the practice of A) investment banks allowing executives of potential client companies to buy underpriced initial public offerings of other companies' securities. B) investment bank analysts providing misleading information about a company to encourage more investors to purchase the company's securities. C) accounting firms encouraging its audit clients to also purchase its management advisory services. D) credit rating agencies providing higher ratings on a company's securities in order to develop a long-term relationship with the company.

A) investment banks allowing executives of potential client companies to buy underpriced initial public offerings of other companies' securities.

24) The efficient market hypothesis suggests that A) investors should purchase no-load mutual funds, which have low management fees. B) investors can use the advice of technical analysts to outperform the market. C) investors let too many unexploited profit opportunities go by if they adopt a "buy and hold" strategy. D) only A and B of the above are sensible strategies.

A) investors should purchase no-load mutual funds, which have low management fees.

When yield curves are steeply upward-sloping, A) long-term interest rates are above short-term interest rates. B) short-term interest rates are above long-term interest rates. C) short-term interest rates are about the same as long-term interest rates. D) medium-term interest rates are above both short-term and long-term interest rates. E) medium-term interest rates are below both short-term and long-term interest rates.

A) long-term interest rates are above short-term interest rates.

58) Liquidity services are services that A) make it easier for customers to conduct transactions. B) conducts transactions for the customer. C) increase transaction costs. D) all of the above.

A) make it easier for customers to conduct transactions.

36) Financial intermediaries (banks in particular) have the ability to avoid the free-rider problem as long as they primarily A) make private loans. B) acquire a diversified portfolio of stocks. C) buy junk bonds. D) do a balanced combination of A and B of the above.

A) make private loans.

Financial intermediaries (banks in particular) have the ability to avoid the free-rider problem as long as they primarily A) make private loans. B) acquire a diversified portfolio of stocks. C) buy junk bonds. D) do a balanced combination of A and B of the above.

A) make private loans.

40) According to the strong view of the efficient markets hypothesis, security prices reflect ________ and so financial markets are efficient. A) market fundamentals B) rational expectations C) momentum effects D) current market trends

A) market fundamentals

A moderately upward-sloping yield curve indicates that short-term interest rates are expected to A) neither rise nor fall in the near future. B) remain relatively unchanged, but that long-term rates are expected to fall. C) neither rise nor fall, but that long-term rates are expected to rise moderately. D) rise moderately in the near future.

A) neither rise nor fall in the near future.

19) The advantage of a "buy and hold strategy" is that A) net profits will tend to be higher because there will be fewer brokerage commissions. B) losses will eventually be eliminated. C) the longer a stock is held, the higher its price will be. D) only B and C of the above are true.

A) net profits will tend to be higher because there will be fewer brokerage commissions.

The advantage of a "buy and hold strategy" is that A) net profits will tend to be higher because there will be fewer brokerage commissions. B) losses will eventually be eliminated. C) the longer a stock is held, the higher its price will be. D) only B and C of the above are true.

A) net profits will tend to be higher because there will be fewer brokerage commissions.

67) The Federal Advisory Council has ________ member(s) from each district. A) one B) two C) three D) can have any number of

A) one

40) Commercial and farm mortgages, in which property is pledged as collateral, account for A) one-quarter of borrowing by nonfinancial businesses. B) one-half of borrowing by nonfinancial businesses. C) one-twentieth of borrowing by nonfinancial businesses. D) two-thirds of borrowing by nonfinancial businesses.

A) one-quarter of borrowing by nonfinancial businesses.

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

34) The authors' analysis of adverse selection indicates that financial intermediaries A) overcome free-rider problems by holding nontraded loans. B) must buy securities from corporations to diversify the risk that results from holding nontradable loans. C) have not been very successful in dealing with adverse selection problems in financial markets. D) do all of the above. E) do only A and B of the above.

A) overcome free-rider problems by holding nontraded loans.

63) Instrument independence means the central bank is free from A) political pressure regarding how it uses the tools of monetary policy. B) political pressure regarding the goals it pursues. C) both A and B of the above. D) neither A nor B of the above.

A) political pressure regarding how it uses the tools of monetary policy.

41) When a market bubble occurs, ________. A) prices of assets rise well above their fundamental values B) a "thin layer" of trading masks true market movements C) market fundamentals and actual security prices converge D) prices of assets fluctuate rapidly above and below market fundamentals

A) prices of assets rise well above their fundamental values

42) Moral hazard in equity contracts is known as the ________ problem because the manager of the firm has fewer incentives to maximize profits than the stockholders might ideally prefer. A) principal-agent B) adverse selection C) free-rider D) debt deflation

A) principal-agent

65) The problem with monitoring as a tool to solve the ________ problem is that it can be expensive in terms of time and money, as reflected in the name economists give it,costly state verification. A) principal-agent B) adverse selection C) audit D) regulation

A) principal-agent

Moral hazard in equity contracts is known as the ________ problem because the manager of the firm has fewer incentives to maximize profits than the stockholders might ideally prefer. A) principal-agent B) adverse selection C) free-rider D) debt deflation

A) principal-agent

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

25) To sell an old bond when interest rates have ________, the holder will have to ________ the price of the bond until the yield to the buyer is the same as the market rate. A) risen; lower B) risen; raise C) fallen; lower D) risen; inflate

A) risen; lower

66) A financial institution can achieve cost savings by engaging in multiple activities. These are called economies of A) scope. B) scale. C) complexity. D) information.

A) scope.

61) Critics of Fed independence argue A) that it is undemocratic to have monetary policy controlled by an elite group responsible to no one. B) that an independent Fed conducts monetary policy with a consistent inflationary bias. C) that the Fed, since it does not face a binding budget constraint, spends too much of its earnings. D) only A and B of the above.

A) that it is undemocratic to have monetary policy controlled by an elite group responsible to no one.

50) A debt contract is said to be incentive compatible if A) the borrower's net worth reduces the probability of moral hazard. B) restrictive covenants limit the type of activities that can be undertaken by the borrower. C) both A and B of the above occur. D) neither A nor B of the above occur.

A) the borrower's net worth reduces the probability of moral hazard.

60) Critics of the current system of Fed independence contend that A) the current system is undemocratic. B) voters have too much say about monetary policy. C) the president has too much control over monetary policy on a day-to-day basis. D) all of the above are true.

A) the current system is undemocratic.

30) A key finding of the economic analysis of financial structure is that A) the existence of the free-rider problem for traded securities helps to explain why banks play a predominant role in financing the activities of businesses. B) while free-rider problems limit the extent to which securities markets finance some business activities, the majority of funds going to businesses are channeled through securities markets. C) given the great extent to which securities markets are regulated, free-rider problems are not of significant economic consequence in these markets. D) economists do not have a very good explanation for why securities markets are so heavily regulated

A) the existence of the free-rider problem for traded securities helps to explain why banks play a predominant role in financing the activities of businesses.

26) When an accounting firm conducts an independent audit, the accounting firms certify that A) the firm is adhering to standard accounting principles and disclosing accurate information about sales, assets, and earnings. B) the firm is adhering to federal regulations with regard to product safety, hiring practices, and environmental regulations. C) the firm's management is qualified to conduct the firm's business in the best interest of share holders. D) All of the above are correct answers.

A) the firm is adhering to standard accounting principles and disclosing accurate information about sales, assets, and earnings.

17) In the one-period valuation model, a stock's value will be higher A) the higher its expected future price is. B) the lower its dividend is. C) the higher the required return on investments in equity is. D) all of the above.

A) the higher its expected future price is.

19) Adverse selection is a problem associated with equity and debt contracts arising from A) the lender's relative lack of information about the borrower's potential returns and risks of his investment activities. B) the lender's inability to legally require sufficient collateral to cover a 100 percent loss if the borrower defaults. C) the borrower's lack of incentive to seek a loan for highly risky investments. D) none of the above.

A) the lender's relative lack of information about the borrower's potential returns and risks of his investment activities.

Adverse selection is a problem associated with equity and debt contracts arising from A) the lender's relative lack of information about the borrower's potential returns and risks of his investment activities. B) the lender's inability to legally require sufficient collateral to cover a 100 percent loss if the borrower defaults. C) the borrower's lack of incentive to seek a loan for highly risky investments. D) none of the above.

A) the lender's relative lack of information about the borrower's potential returns and risks of his investment activities.

14) A basic principle of finance is that the value of any investment is A) the present value of all future net cash flows generated by the investment. B) the undiscounted sum of all future net cash flows generated by the investment. C) unrelated to the future net cash flows generated by the investment. D) unrelated to the degree of risk associated with the future net cash flows generated by the investment.

A) the present value of all future net cash flows generated by the investment.

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.

6) Another way to state the efficient market condition is that in an efficient market, A) unexploited profit opportunities will be quickly eliminated. B) unexploited profit opportunities will never exist. C) arbitrageurs guarantee that unexploited profit opportunities never exist. D) both A and C of the above occur.

A) unexploited profit opportunities will be quickly eliminated.

Another way to state the efficient market condition is that in an efficient market, A) unexploited profit opportunities will be quickly eliminated. B) unexploited profit opportunities will never exist. C) arbitrageurs guarantee that unexploited profit opportunities never exist. D) both A and C of the above occur.

A) unexploited profit opportunities will be quickly eliminated.

46) One financial intermediary in our financial structure that helps to reduce the moral hazard arising from the principal-agent problem is the A) venture capital firm. B) money market mutual fund. C) pawn broker. D) savings and loan association.

A) venture capital firm.

According to the expectations theory of the term structure, A) when the yield curve is steeply upward-sloping, short-term interest rates are expected to rise in the future. B) when the yield curve is downward-sloping, short-term interest rates are expected to remain relatively stable in the future. C) investors have strong preferences for short-term relative to long-term bonds, explaining why yield curves typically slope upward. D) all of the above. E) only A and B of the above.

A) when the yield curve is steeply upward-sloping, short-term interest rates are expected to rise in the future.

25) The problem of adverse selection helps to explain A) which firms are more likely to obtain funds from banks and other financial intermediaries, rather than from securities markets. B) why collateral is an important feature of consumer, but not business, debt contracts. C) why direct finance is more important than indirect finance as a source of business finance. D) only A and B of the above.

A) which firms are more likely to obtain funds from banks and other financial intermediaries, rather than from securities markets.

The problem of adverse selection helps to explain A) which firms are more likely to obtain funds from banks and other financial intermediaries, rather than from securities markets. B) why collateral is an important feature of consumer, but not business, debt contracts. C) why direct finance is more important than indirect finance as a source of business finance. D) only A and B of the above.

A) which firms are more likely to obtain funds from banks and other financial intermediaries, rather than from securities markets.

The Federal Reserve can influence the federal funds interest rate by buying securities, which ________ reserves, thereby ________ the federal funds rate.

Adds; Lowering

If borrowers with the most risky investment projects are more likely to seek bank loans as compared to those borrowers with the safest investment projects, banks are said to face the problem of

Adverse selction

Why was the United States one of the last of the major industrialized countries to have a central bank?

Agriculture and other interests in the US were quite suspicious of centralized power and thus opposed the creation of a central bank.

Which of the following actions will reduce interest-rate risk faced by banks

All of the above

Why is being nosy a desirable trait for a banker

All of the above

Fully Subscribed

All shares are spoken for

Money Market Mutual Funds MMMFs

Allow investors similar access to their funds as a bank savings account, but offered higher rates

What is meant by liquidity intermediation?

Allowing investors to redeem there shares at any time, despite long term holdings

6) What is a rational bubble?

Although prices may not follow market fundamentals and are driven up by irrational exuberance ( irrational bubble), if the price is driven up by the expectation that prices will rise, this is a rational bubble.

Best Efforts

An alternative to a firm commitment, the underwriter does not buy the issue, but rather makes its "best effort" to sell the entire issue

Private Equity Investments

An alternative to investing via public securities; a limited partnership raises funds to invest in new companies, to buyout existing divisions

Distinguish between an open and closed end mutual fund.

An open end mutual fund is continuously issuing new shares as new funds are received. A closed end fund only issue shares once.

Banker Acceptances

An order to pay a specified amount to the bearer on a given date if specified conditions have been meet; often used when buyers/sellers of expensive goods live in different countries

1) American businesses get more funds from direct financing than from indirect financing.

Answer: FALSE

1) Evidence that stock prices sometimes fall when a firm announces good news contradicts the efficient market hypothesis.

Answer: FALSE

10) It is probably a good use of an investor's time to watch as many shows featuring technical analysts as possible.

Answer: FALSE

11) Economies of scale means that the percentage return on a financial transaction rises as the size of the transaction rises.

Answer: FALSE

11) Having performed well in the past indicates that an investment adviser or a mutual fund will perform well in the future.

Answer: FALSE

12) Agency theory focuses on how government agencies regulate financial intermediaries and markets.

Answer: FALSE

13) The principal-agent problem is an example of the adverse selection problem that can result from asymmetric information.

Answer: FALSE

16) The current yield on a bond is a good approximation of the bond's yield to maturity when the bond matures in five years or less and its price differs from its par value by a large amount.

Answer: FALSE

17) The Sarbanes-Oxley Act of 2002 was passed in response to scandals in the investment banking industry.

Answer: FALSE

17) The secondary market is where new issues of stocks and bonds are introduced.

Answer: FALSE

18) General obligation bonds have specific assets pledged as security or specific sources of revenue allocated for their repayment.

Answer: FALSE

18) The Sarbanes-Oxley Act of 2002 provides for oversight of accounting firms but makes no provisions for increasing the flow of information to financial markets.

Answer: FALSE

3) Evidence that a mutual fund has performed extraordinarily well in the past contradicts the efficient market hypothesis.

Answer: FALSE

4) Issuing marketable securities is the primary way businesses finance their operations.

Answer: FALSE

7) In an efficient market, abnormal returns are not possible, even using inside information.

Answer: FALSE

7) The problem of adverse selection helps to explain why direct finance is more important than indirect finance as a source of business finance.

Answer: FALSE

8) "Short selling" refers to the practice of buying a stock and holding it for only a short time before selling it.

Answer: FALSE

9) Most corporate bonds have a face value of $1,000, are sold at a discount, and can only be redeemed at the maturity date.

Answer: FALSE

2) The primary issuers of capital market securities are local governments and corporations.

Answer: FALSE (Federal and local governments and corporations)

10) Registered bonds have now been largely replaced by bearer bonds, which do not have coupons.

Answer: FALSE (bearer bonds have largely been replaced by registered bonds with no coupons)

6) Most of the time, the interest rate on Treasury notes is below that on money market securities because of their low default risk.

Answer: FALSE (treasury notes are 1-10 maturity. They require higher interest rates because of their interest rate risk)

1) Firms and individuals use the money markets primarily to warehouse funds for short periods of time until a more important need or a more productive use for the funds arises.

Answer: TRUE

10) Net worth is the difference between a firm's assets and its liabilities.

Answer: TRUE

11) A sinking fund is a requirement in the bond indenture that the firm pay off a portion of the bond issue each year.

Answer: TRUE

12) Debentures are long-term unsecured bonds that are backed only by the general creditworthiness of the issuer.

Answer: TRUE

12) Technical analysis is a popular technique used to predict stock prices by studying past stock price data and searching for patterns such as trends and regular cycles.

Answer: TRUE

13) In a leveraged buy-out, a firm greatly increases its debt level by issuing junk bonds to finance the purchase of another firm's stock.

Answer: TRUE

13) The efficient market hypothesis does not have to imply that financial markets are efficient.

Answer: TRUE

14) A financial guarantee ensures that the lender (bond purchaser) will be paid both principal and interest in the event the issuer defaults.

Answer: TRUE

14) The financial system is one of the most heavily regulated sectors of the economy.

Answer: TRUE

15) Collateralized debt is also called secured debt.

Answer: TRUE

15) The Commodity Futures Modernization Act (2000) removed derivative securities, such as credit default swaps, from regulatory oversight.

Answer: TRUE

16) Most legal work in the U.S. involves the writing and enforcement of contracts, not ambulance chasing, criminal law, and frivolous lawsuits.

Answer: TRUE

19) The Sarbanes-Oxley Act of 2002 and the Global Legal Settlement of 2002 both have the potential to reduce economies of scope.

Answer: TRUE

2) American businesses use stock to finance about 10 percent of their external financing.

Answer: TRUE

2) If the security markets are truly efficient, there is no need to pay for help selecting securities.

Answer: TRUE

20) The Global Legal Settlement of 2002 arose out of a lawsuit brought by New York Attorney General Eliot Spitzer against the ten largest investment banks.

Answer: TRUE

21) The Sarbanes-Oxley Act of 2002 established a Public Company Accounting Oversight Board (PCAOB), overseen by the SEC, to supervise accounting firms and ensure that audits are independent and controlled for quality.

Answer: TRUE

22) Due to criticisms of rating agencies following the default of many subprime products, the SEC prohibited credit rating agencies from structuring the same products that they rate.

Answer: TRUE

23) China is in an early state of development, with a per capita income that is still less than $10,000, one-fifth of the per capita income in the United States.

Answer: TRUE

3) Capital market securities are less liquid and have longer maturities than money market securities.

Answer: TRUE

3) One reason why indirect financing is used is to minimize adverse selection problems.

Answer: TRUE

4) Governments never issue stock because they cannot sell ownership claims.

Answer: TRUE

5) Because of the adverse selection problem, lenders may refuse loans to individuals with low net worth.

Answer: TRUE

5) The evidence suggests technical analysts are not superior stock pickers.

Answer: TRUE

5) To sell an old bond when rates have risen, the holder will have to discount the bond until the yield to the buyer is the same as the market rate.

Answer: TRUE

6) If the markets are efficient, the optimal investment strategy will be to buy and hold so as to minimize transaction costs.

Answer: TRUE

6) The concept of adverse selection helps to explain why indirect finance is more important than direct finance as a source of business finance.

Answer: TRUE

7) Municipal bonds that are issued to pay for essential public projects are exempt from federal taxation.

Answer: TRUE

8) Most municipal bonds are revenue bonds rather than general obligation bonds.

Answer: TRUE

8) The concept of adverse selection helps explain why collateral is an important feature of many debt contracts.

Answer: TRUE

9) Loss aversion means the unhappiness a person feels when he or she suffers a monetary loss exceeds the happiness the same person experiences from receiving a monetary gain of the same amount.

Answer: TRUE

9) One way of describing the solution that high net worth provides to the moral hazard problem is to say that it makes debt contracts incentive compatible.

Answer: TRUE

If the bank suffers a deposit outflow of 50 million with a requrid reserve ratio on deposits of 10 percent. Reserves 75, Loans 525, Deposits 500, Bank capital 100

Any combination of the above

Money market instruments:

Are characterized by all of the above: usually sold in large denominations, have low default risk, and mature in one year or less.

What assets and liabilities are listed on the Federal Reserve Balance Sheet?

Assets:Government Securities and Discount Loans Liabilities: Currency in Circulation and Reserves

An investment bank is a financial institution that a.) bundles small deposits into larger loans b.) helps corporations raise funds c.) holds most of its assets in commercial paper d.) does all of the above e.) does A and B of above

B

From an investment bankers prospective, the best outcome occurs when a new issue is ___________ a.) undersubscribed b.) fully subscribed c.) oversubscribed d.) syndicated

B

In securities sales, the ________ price is the price that the broker receive when they sell the securities. A) bid B) ask C) midpoint D) transaction

B

Most investment banks are attached to a.)large commercial banks b.) large brokerage houses c.) finance companies d.) large non-financial corporations

B

Often investment bankers will form a group, each one buying only a portion of the new securities to be issued. Such a group is called and underwriting________ a.) alliance b.) syndicate c.) association d.) guild

B

The best known investment banker involved in mergers and acquisitions, credited with inventing the junk bond market, is ________. A) Ivan Boesky B) Michael Milken C) James Garner D) Michael Douglas

B

The largest US underwriter of global debt and equity issues, as of 2009, was _______ a.) merrill lynch b.) JP morgan c.) morgan stanley d.) Goldman sachs

B

Under best efforts underwriting, the underwriter a.) pays for the entire security issued b.) sells the security on a commission basis c.) spread the risk among different brokerage houses d.) make a special appeal to the SEC to delay the issue

B

in a ________, a security is sold between investors, and does not (necessarily) involve the corporation or government agency ultimately using the funds a.) primary market b.) secondary market c.) capital market d.) money market

B

investment baks find it less difficult to price securities if the firm has prior issues currently selling in the market, called _____ a.) secondary issues b.) seasoned issues c.) outstanding issues d.) experienced issues

B

87) China is in an early state of development, with a per capita income that is still less than ________, one-fifth of the per capita income in the United States. A) $5,000 B) $10,000 C) $25,000 D) $50,000

B) $10,000

15) A stock currently sells for $25 per share and pays $0.24 per year in dividends. What is an investor's valuation of this stock if she expects it to be selling for $30 in one year and requires a 15 percent return on equity investments? A) $30.24 B) $26.30 C) $26.09 D) $27.74

B) $26.30 ((.24/1+.15) + 30/1+.15)

26) Suppose the average industry PE ratio for auto parts retailers is 20. What is the current price of Auto Zone stock if the retailer's earnings per share is projected to be $1.85? A) $21.85 B) $37 C) $10.81 D) $9.25

B) $37

24) Holding other things constant, a stock's value will be highest if its most recent dividend is A) $2.00. B) $5.00. C) $0.50. D) $1.00.

B) $5.00.

31) (I) The market price of a security at a given time is the highest value any investor puts on the security. (II) Superior information about a security increases its value by reducing its risk. A) (I) is true, (II) is false. B) (I) is false, (II) is true. C) Both are true. D) Both are false.

B) (I) is false, (II) is true.

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. (capital markets include bonds, stock and mortgages p. 273 introduction)

12) (I) The total cost of carrying out a transaction in financial markets increases proportionally with the size of the transaction. (II) Financial intermediaries facilitate diversification when an investor has only a small sum to invest. A) (I) is true; (II) false. B) (I) is false; (II) true. C) Both (I) and (II) are true. D) Both (I) and (II) are false.

B) (I) is false; (II) true.

72) Currently, there are ________ countries that are members of the European Monetary Union. A) 10 B) 17 C) 15 D) 20

B) 17

The Federal Reserve entity that determines monetary policy strategy is the A) Board of Governors. B) Federal Open Market Committee. C) Chairman of the Board of Governors. D) Shadow Open Market Committee.

B) Federal Open Market Committee.

11) Which of the following statements about trading operations in an organized exchange is correct? A) Floor traders all deal in a wide variety of stocks. B) In most trades, specialists match buy and sell orders. C) In most trades, specialists buy for or sell from their own inventories. D) The SuperDOT system is used to expedite large trades of over 100,000 shares.

B) In most trades, specialists match buy and sell orders.

33) Which of the following is an insight from behavioral finance? A) The price of securities fully reflects all available information. B) Investor overconfidence leads to high trading volumes. C) The optimal forecast of a security's return equals the security's equilibrium return. D) Investment advisers cannot consistently beat the market.

B) Investor overconfidence leads to high trading volumes.

9) Which of the following is not one of the eight basic facts about financial structure? A) The financial system is among the most heavily regulated sectors of the economy. B) Issuing marketable securities is the primary way businesses finance their operations. C) Indirect finance, which involves the activities of financial intermediaries, is many times more important than direct finance in which businesses raise funds directly from lenders in financial markets. D) Financial intermediaries is the most important source of external funds to finance businesses.

B) Issuing marketable securities is the primary way businesses finance their operations.

Which Federal Reserve Bank president always has a vote in the Federal Open Market Committee? A) Philadelphia B) New York C) Boston D) San Francisco

B) New York

30) Which of the following does not weaken the efficient markets hypothesis? A) Mean reversion B) Success of buy-and-hold strategy C) January effect D) Excessive volatility

B) Success of buy-and-hold strategy

8) A situation in which the price of an asset differs from its fundamental market value is called A) an unexploited profit opportunity. B) a bubble. C) a correction. D) a mean reversion.

B) a bubble.

A situation in which the price of an asset differs from its fundamental market value is called A) an unexploited profit opportunity. B) a bubble. C) a correction. D) a mean reversion.

B) a bubble.

83) The Sarbanes-Oxley Act of 2002 dealt with conflicts of interest in A) investment banks. B) accounting firms. C) credit-rating agencies. D) all of the above.

B) accounting firms.

The Sarbanes-Oxley Act of 2002 dealt with conflicts of interest in A) investment banks. B) accounting firms. C) credit-rating agencies. D) all of the above.

B) accounting firms.

13) If bad credit risks are the ones who most actively seek loans and, therefore, receive them from financial intermediaries, then financial intermediaries face the problem of A) moral hazard. B) adverse selection. C) free-riding. D) costly state verification

B) adverse selection.

If bad credit risks are the ones who most actively seek loans and, therefore, receive them from financial intermediaries, then financial intermediaries face the problem of A) moral hazard. B) adverse selection. C) free-riding. D) costly state verification.

B) adverse selection.

35) Which of the following is not an objective of the Securities and Exchange Commission? A) maintain integrity of the securities markets B) advise investors about which particular stocks are good buys C) require firms to provide specific information to investors D) regulate major participants in securities markets

B) advise investors about which particular stocks are good buys

28) That most used cars are sold by intermediaries (i.e., used car dealers) provides evidence that these intermediaries A) have been afforded special government treatment, since used car dealers do not provide information that is valued by consumers of used cars. B) are able to prevent potential competitors from free-riding off the information that they provide. C) have failed to solve adverse selection problems in this market because "lemons" continue to be traded. D) do all of the above.

B) are able to prevent potential competitors from free-riding off the information that they provide.

18) A borrower who takes out a loan usually has better information about the potential returns and risks of the investment projects he plans to undertake than the lender does. This inequality of information is called A) moral hazard. B) asymmetric information. C) noncollateralized risk. D) adverse selection.

B) asymmetric information.

23) The security with the longest maturity is a Treasury A) note. B) bond. C) acceptance. D) bill.

B) bond.

59) Adverse selection A) is a problem created by asymmetrical information after the transaction. B) can be solved by eliminating asymmetrical information. C) occurs when people who do not pay for information take advantage of the information other people have to pay for. D) all of the above.

B) can be solved by eliminating asymmetrical information.

Adverse selection A) is a problem created by asymmetrical information after the transaction. B) can be solved by eliminating asymmetrical information. C) occurs when people who do not pay for information take advantage of the information other people have to pay for. D) all of the above.

B) can be solved by eliminating asymmetrical information.

57) Economies of scale A) in the financial markets does not explain why financial intermediaries developed and have become such an important part of our financial structure. B) can be used to an advantage by reducing transaction cost. C) both A and B of the above. D) neither A nor B of the above.

B) can be used to an advantage by reducing transaction cost.

6) The riskiest capital market security is A) preferred stock. B) common stock. C) corporate bonds. D) Treasury bonds.

B) common stock.

21) Sometimes one observes that the price of a company's stock falls after the announcement of favorable earnings. This phenomenon is A) clearly inconsistent with the efficient market hypothesis. B) consistent with the efficient market hypothesis if the earnings were not as high as anticipated. C) consistent with the efficient market hypothesis if the earnings were not as low as anticipated. D) the result of none of the above.

B) consistent with the efficient market hypothesis if the earnings were not as high as anticipated.

53) A debt contract that specifies that the company can only use the funds to finance certain activities A) is a private loan. B) contains a restrictive covenant. C) increases the problem of adverse selection. D) all of the above. E) only A and B of the above.

B) contains a restrictive covenant.

The Fed is an active participant in money markets mainly because of its responsibility to

B) control the money supply.

18) The ________ rate is the rate of interest that the issuer must pay. A) market B) coupon C) discount D) funds

B) coupon

As a result of the subprime collapse, the demand for low -quality corporate bonds ________, the demand for high-quality Treasury bonds ________, and the risk spread ________. A) increased; decreased; was unchanged B) decreased; increased; increased C) increased; decreased; decreased D) decreased; increased; was unchanged

B) decreased; increased; increased

If Moody's or Standard and Poor's downgrades its rating on a corporate bond, the demand for the bond ________ and its yield ________. A) increases; decreases B) decreases; increases C) increases; increases D) decreases; decreases

B) decreases; increases

In actual practice, short-term interest rates are just as likely to fall as to rise; this is the major shortcoming of the A) market segmentation theory. B) expectations theory. C) liquidity premium theory. D) separable markets theory.

B) expectations theory.

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 (if market rates fall, your bond, having a higher rate, would sell at a premium)

64) Suppose legislation requiring the Fed to keep the inflation rate between 1.5% and 2.5% per year is passed by Congress. This law restricts the Fed's A) instrument independence. B) goal independence. C) both A and B of the above. D) neither A nor B of the above.

B) goal independence.

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.

84) The Global Legal Settlement of 2002 dealt with conflicts of interest in A) accounting firms. B) investment banks. C) credit-rating agencies. D) all of the above.

B) investment banks.

63) Net worth A) is the difference between current assets and current liabilities. B) is the difference between assets and liabilities. C) is total assets divided by total liabilities. D) is total assets plus total liabilities.

B) is the difference between assets and liabilities.

19) In the generalized dividend valuation model, a stock's value depends only on A) its future dividend payments and its future price. B) its future dividend payments and the required return on equity. C) its future price and the required return on investments on equity. D) its future dividend payments.

B) its future dividend payments and the required return on equity.

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.

15) Because of the lemons problem in the used car market, the average quality of the used cars offered for sale will be ________, which gives rise to the problem of ________. A) low; moral hazard B) low; adverse selection C) high; moral hazard D) high; adverse selection

B) low; adverse selection

Because of the lemons problem in the used car market, the average quality of the used cars offered for sale will be ________, which gives rise to the problem of ________. A) low; moral hazard B) low; adverse selection C) high; moral hazard D) high; adverse selection

B) low; adverse selection

65) Cross-country evidence suggests that an increase in central bank independence results in a ________ inflation rate and ________ unemployment. A) lower; higher B) lower; no worse C) higher; lower D) higher; higher

B) lower; no worse

77) Auditors attempt to reduce information asymmetry between a firm's managers and its A) customers. B) owners. C) employees. D) competitors.

B) owners.

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

69) The directors of a district bank are classified into three categories: A, B, and C. The three B directors are A) professional bankers. B) prominent leaders from industry, labor, agriculture, or the consumer sector. C) elected by the board of governors to represent the public interest. D) all of the above.

B) prominent leaders from industry, labor, agriculture, or the consumer sector.

A corporation suffering big losses might be more likely to suspend interest payments on its bonds, thereby A) raising the default risk and causing the demand for its bonds to rise. B) raising the default risk and causing the demand for its bonds to fall. C) lowering the default risk and causing the demand for its bonds to rise. D) lowering the default risk and causing the demand for its bonds to fall.

B) raising the default risk and causing the demand for its bonds to fall.

6) The primary reason that individuals and firms choose to borrow long-term is to A) reduce the risk that interest rates will fall before they pay off their debt. B) reduce the risk that interest rates will rise before they pay off their debt. C) reduce monthly interest payments, as interest rates tend to be higher on short-term than long-term debt instruments. D) reduce total interest payments over the life of the debt.

B) reduce the risk that interest rates will rise before they pay off their debt.

When the default risk on corporate bonds decreases, other things equal, the demand curve for corporate bonds shifts to the ________ and the demand curve for Treasury bonds shifts to the ________. A) right; right B) right; left C) left; left D) left; right

B) right; left

67) A financial institution can achieve cost savings in its credit card operations if it increases the number of cardholders. This is an example of economies of A) scope. B) scale. C) complexity. D) information.

B) scale.

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 (revenue bonds based on the revenue stream of a project, could default...G.O.s are based on the full faith and credit of the issuer)

80) The conflict of interest in credit-rating agencies arises because ________ pay to have securities rated and, as a result, the agencies' ratings may be biased ________. A) security issuers; downward B) security issuers; upward C) investors; downward D) regulators; upward

B) security issuers; upward

The conflict of interest in credit-rating agencies arises because ________ pay to have securities rated and, as a result, the agencies' ratings may be biased ________. A) security issuers; downward B) security issuers; upward C) investors; downward D) regulators; upward

B) security issuers; upward

If the Fed wants to raise the federal funds interest rate, it will ________ securities to ________ the banking system.

B) sell; remove reserves from

32) An investor gains from short selling by ________ and then later ________. A) buying a stock; selling it at a higher price B) selling a stock; buying it back at a lower price C) buying a stock; selling it at a lower price D) selling a stock; buying it back at a higher price

B) selling a stock; buying it back at a lower price

35) An arrangement with a broker to borrow stocks from them and then sell it in the market, with the hope that they earn a profit by buying the stock back again after it has fallen in price is called A) behavioral finance. B) short sales. C) smart money. D) random walk.

B) short sales.

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

28) The efficient markets hypothesis is weakened by evidence that A) stock prices tend to follow a random walk. B) stock prices are more volatile than fluctuations in their fundamental values can explain. C) technical analysis does not outperform the overall market. D) an investment adviser's past success or failure at picking stocks does not predict his or her future performance.

B) stock prices are more volatile than fluctuations in their fundamental values can explain.

1) Of the following sources of external finance for American nonfinancial businesses, the least important is A) loans from banks. B) stocks. C) bonds and commercial paper. D) nonbank loans.

B) stocks.

73) If potential revenues from underwriting greatly exceed brokerage commissions, there is ________ incentive for investment bank analysts to report ________ information about firms issuing securities. A) stronger; unbiased B) stronger; favorable C) weaker; unbiased D) weaker; favorable

B) stronger; favorable

37) Evidence against market efficiency does not include A) the small-firm effect. B) technical analysis. C) excessive volatility. D) mean reversion.

B) technical analysis.

Evidence against market efficiency does not include A) the small-firm effect. B) technical analysis. C) excessive volatility. D) mean reversion.

B) technical analysis.

6) Nationwide financial panics in 1873, 1884, 1893, and 1907 might have been avoided had A) the First Bank of the United States served its intended role of lender of last resort. B) the Second Bank of the United States not been abolished in 1836 by President Andrew Jackson. C) the Second Bank of the United States served its intended role of lender of last resort. D) the Federal Reserve served its intended role of lender of last resort.

B) the Second Bank of the United States not been abolished in 1836 by President Andrew Jackson.

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.

According to the liquidity premium theory of the term structure, A) because buyers of bonds may prefer bonds of one maturity over another, interest rates on bonds of different maturities do not move together over time. B) the interest rate on long-term bonds will equal an average of short-term interest rates that people expect to occur over the life of the long-term bonds plus a term premium. C) because of the positive term premium, the yield curve cannot be downward-sloping. D) all of the above. E) only A and B of the above.

B) the interest rate on long-term bonds will equal an average of short-term interest rates that people expect to occur over the life of the long-term bonds plus a term premium.

56) The case for Federal Reserve independence does not include the idea that A) political pressure would impart an inflationary bias to monetary policy. B) the principal-agent problem is perhaps worse for the Fed than for congressmen since the former does not answer to the voters on election day. C) a politically insulated Fed would be more concerned with long-run objectives and thus be a defender of a sound dollar and a stable price level. D) a Federal Reserve under the control of Congress or the president might make the so-called political business cycle more pronounced.

B) the principal-agent problem is perhaps worse for the Fed than for congressmen since the former does not answer to the voters on election day.

The risk structure of interest rates is A) the structure of how interest rates move over time. B) the relationship among interest rates of different bonds with the same maturity. C) the relationship among the terms to maturity of different bonds. D) the relationship among interest rates on bonds with different maturities.

B) the relationship among interest rates of different bonds with the same maturity.

7) Another way to state the efficient market hypothesis is that in an efficient market, A) unexploited profit opportunities will never exist as market participants, such as arbitrageurs, ensure that they are instantaneously dissipated. B) unexploited profit opportunities will not exist for long, as market participants will act quickly to eliminate them. C) every financial market participant must be well informed about securities. D) only A and C of the above.

B) unexploited profit opportunities will not exist for long, as market participants will act quickly to eliminate them.

61) Bad firms A) do not have an incentive to make themselves look good. B) will slant the information they are required to transmit to the public. C) both A and B of the above. D) neither A nor B of the above.

B) will slant the information they are required to transmit to the public.

44) The principal-agent problem A) occurs when managers have more incentive to maximize profits than the stockholders-owners do. B) would not arise if the owners of the firm had complete information about the activities of the managers. C) in financial markets helps to explain why equity is a relatively important source of finance for American businesses. D) all of the above. E) only A and B of the above.

B) would not arise if the owners of the firm had complete information about the activities of the managers.

The principal-agent problem A) occurs when managers have more incentive to maximize profits than the stockholders-owners do. B) would not arise if the owners of the firm had complete information about the activities of the managers. C) in financial markets helps to explain why equity is a relatively important source of finance for American businesses. D) all of the above. E) only A and B of the above.

B) would not arise if the owners of the firm had complete information about the activities of the managers.

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. (each interest and principle payment becomes a zero coupon bond)

Banks Sheet A Reserves75, Loans 535 Deposits 500, BC 100 Bank Sheet B Reserves 100, Loans 500 Depostis 500, BC 100

Balance Sheet B because the excess reserves are adequate to cover the depost outflow without habing to alter its balnace sheet

Why has there been such a dramatic increase in bank holding companies?

Bank Holding Company allows a bank to 1. circumvent branching restrictions since it can own a controlling interest in several banks and 2 engage in other activities related to banking that can be highly profitable

What forms does bank supervision take, and how does it help promote a safe and sound banking system?

Bank supervision involves bank examinations in which bank examiners assess six areas of the banks represented in the CAMELS ratings(Capital Adequacy, Asset Quality, Management, Earnings, Liquidity, and Sensitivity to market risk)

Dual Banking System

Banks supervised by the federal government and banks supervised by the states operate side by side

Measuring the sensitivity of bank profits to changes in interest rates by calculating the product of the gap and the change in the interest rate is caled

Basic gap analysis

10. Why do equity holders care more about ROE than ROA?

Because ROE, the return on equity, tells stock holders how much they are earning on their equity investment, while ROA, the return on assets, only provides an indication how well the bank's assets are being managed.

3) Explain how the "lemons" problem could cause financial markets to fail.

Because of asymmetric information and adverse selection, investors cannot distinguish between good and bad firms. Unwilling to pay more than average price. Good companies unwilling to sell at that price, market functions poorly if at all.

Why has noninterest income been growing as a source of bank operating income?

Because the off-balance sheet activities that generate fees have become a more important part of a bank's business.

Why has the development of overnight loan markets made it more likely that banks will hold fewer excess reserves?

Because when a deposit outflow occurs a banks can borrow reserves in overnight loan markets and does not need to acquire reserves at high cost by calling in or selling off loans. Reduces the costs associated with deposit outflows, so banks will hold fewer excess reserves.

Why does imposing bank capital requirements on banks help limit risk taking?

Because with higher amounts of capital, banks have more to lose if they take on too much risk. Thus it makes it less likely banks will take on excessive risk.

What are the costs and benefits of a too-big-to-fail policy?

Benefits are that is makes bank panics less likely. Costs are that it increases the incentives of moral hazard by big banks and it discriminates against small banks

9) Discuss why Black Monday, the day when the DJIA declined more than 20%, is not evidence against the efficient market hypothesis.

Black Monday is not evidence against the efficient market hypothesis as long as the crash could not have been predicted.

Why might a bank be more willing to borrow funds from other banks rather than borrow from the Fed

Borrowing from the Fed might invite greater supervisory scrutiny from the central bank

3) What is the optimal investment strategy according to the efficient market hypothesis? Why?

Buy and hold. less transaction costs.

Which of the following management strategies will reduce bank capital relative to assets and rasise the equity multiplier

Buy back bank stock

Market Order

Buy or sell security at current price

The fed can lower the federal funds interest rate by ____ securities, thereby ______ reserves.

Buying; adding

Investment banks may lose ________ if new securities issues are ___________ a.) large amounts of money, undersubscribed b.) large amounts of money, fully subscribed c.) future business, oversubscribed d.) future business, undersubscribed

C

SEC registration is a.) required for all securities b.) rehired if less than 1.5 million in securities are issued per year c.) not required for securities that are sold though a private placement d.) required if the securities mature in less than one year E.) required if securities are underwritten by a reputable investment bank

C

The most active investment banking firm in the private placement market is ______ a.) merrill lynch b.) leham brothers c.) goldman saches d.) morgan stanely

C

The primary function of investment banks is a.) the budding of deposits into loans b.) extending long-term credit to other financial institutions c.) helping corporations raise funds d.) providing credit to firms engaged in international trade

C

The process of underwriting a stock or bond issue requires that the investment bank A) assure investors that the issue will provide them a high return. B) purchase the entire issue at a predetermined price if the quantity demanded by consumers is insufficient at the predetermined price. C) purchase the entire issue at a predetermined price and then resell it in the market. D) do both A and B of the above.

C

Which of the following is not a service securities brokers offer their clients? a.) holding customer stock for safekeeping b.) providing insurance against loss of the securities c.) providing insurance against loss of value of the securities d.) extending margin credit

C

22) According to the Gordon growth model, what is an investor's valuation of a stock whose current dividend is $1.00 per year if dividends are expected to grow at a constant rate of 10 percent over a long period of time and the investor's required return is 15 percent? A) $20 B) $11 C) $22 D) $7.33 E) $4.40

C) $22

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%.

25) Each member of the seven-member Board of Governors is appointed by the president and confirmed by the Senate to serve A) 4-year terms. B) 6-year terms. C) 14-year terms. D) as long as the appointing president remains in office.

C) 14-year terms.

Each member of the seven-member Board of Governors is appointed by the president and confirmed by the Senate to serve A) 4-year terms. B) 6-year terms. C) 14-year terms. D) as long as the appointing president remains in office.

C) 14-year terms.

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

C) 3%.

3) Of the sources of external funds for nonfinancial businesses in the United States, bonds account for approximately ________ of the total. A) 10% B) 20% C) 30% D) 50%

C) 30%

18) Of all commercial banks, about ________ percent belong to the Federal Reserve System. A) 10 B) 25 C) 33 D) 50

C) 33

1) (I) A share of common stock in a firm represents an ownership interest in that firm. (II) A share of preferred stock is as much like a bond as it is like common stock. A) (I) is true, (II) false. B) (I) is false, (II) true. C) Both are true. D) Both are false.

C) Both are true.

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.

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.

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.

4) (I) Preferred stockholders hold a claim on assets that has priority over the claims of common stockholders. (II) Bondholders hold a claim on assets that has priority over the claims of preferred stockholders. A) (I) is true, (II) false. B) (I) is false, (II) true. C) Both are true. D) Both are false.

C) Both are true.

5) (I) Firms issue common stock in far greater amounts than preferred stock. (II) In a given year, the total volume of stock issued is much less than the volume of bonds issued. 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. (the indenture is the contract associated with a corporate bond. Corporate bonds usually contain call provision)

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.(short term rates are more volatile than long term rates p.277)

11) Which of the following best explains the recent decline in the role of financial intermediaries? A) Private production and sale of information B) Government regulation to increase information C) Improvements in information technology D) None of the above can explain the recent decline

C) Improvements in information technology

39) What is the primary disadvantage of an ETF? A) ETFs tend to have lower management fees than comparable index mutual bonds. B) ETFs usually have no minimum investment amount. C) Investors have to pay a broker commission each time they buy or sell shares. D) None of the above are disadvantages of an ETF.

C) Investors have to pay a broker commission each time they buy or sell shares.

81) During the 2007-2009 financial crisis, housing prices began to fall and subprime mortgages began to default. Which of the following statements is true about the rating of subprime mortgage products? A) The rating agencies were way ahead of the market, giving many of the subprime products junk ratings from the start. B) Rating agencies were not involved. Subprime mortgages could not be structured, by law. C) Many AAA-rated subprime products had to be downgraded over and over again until they reached junk status. D) None of the above are true.

C) Many AAA-rated subprime products had to be downgraded over and over again until they reached junk status.

31) In the United States, the government agency requiring that firms, which sell securities in public markets, adhere to standard accounting principles and disclose information about their sales, assets, and earnings is the A) Federal Corporate Securities Commission. B) Federal Trade Commission. C) Securities and Exchange Commission. D) U.S. Treasury Department. E) Federal Reserve System.

C) Securities and Exchange Commission.

In the United States, the government agency requiring that firms, which sell securities in public markets, adhere to standard accounting principles and disclose information about their sales, assets, and earnings is the A) Federal Corporate Securities Commission. B) Federal Trade Commission. C) Securities and Exchange Commission. D) U.S. Treasury Department. E) Federal Reserve System.

C) Securities and Exchange Commission.

Which of the following functions are not performed by any of the twelve regional Federal Reserve banks? A) Check clearing B) Conducting economic research C) Setting interest rates payable on time deposits D) Issuing new currency

C) Setting interest rates payable on time deposits

40) A high price earnings ratio (PE) gives what interpretation? A) The market expects earnings to fall in the future. B) The market feels the firm's earnings are very high risk and are willing to pay a premium for them. C) The market expects the earnings to rise in the future. D) The firm is not paying a dividend.

C) The market expects the earnings to rise in the future.

32) An audit certifies that A) a firm's loans will be repaid. B) a firm's securities are safe investments. C) a firm abides by standard accounting principles. D) the information reported in a firm's accounting statements is correct.

C) a firm abides by standard accounting principles.

If the yield curve slope is flat, the liquidity premium theory indicates that the market is predicting A) a mild rise in short-term interest rates in the near future and a mild decline further out in the future. B) constant short-term interest rates in the near future and further out in the future. C) a mild decline in short-term interest rates in the near future and a continuing mild decline further out in the future. D) constant short-term interest rates in the near future and a mild decline further out in the future.

C) a mild decline in short-term interest rates in the near future and a continuing mild decline further out in the future.

The Federal Reserve can influence the federal funds interest rate by buying securities, which ________ reserves, thereby ________ the federal funds rate.

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

24) Members of the Board of Governors are A) chosen by the Federal Reserve Bank presidents. B) appointed by the newly elected president of the United States, as are cabinet positions. C) appointed by the president of the United States and confirmed by the Senate as members resign. D) never allowed to serve more than seven-year terms.

C) appointed by the president of the United States and confirmed by the Senate as members resign.

Members of the Board of Governors are A) chosen by the Federal Reserve Bank presidents. B) appointed by the newly elected president of the United States, as are cabinet positions. C) appointed by the president of the United States and confirmed by the Senate as members resign. D) never allowed to serve more than seven-year terms.

C) appointed by the president of the United States and confirmed by the Senate as members resign.

39) The elimination of a riskless profit opportunity in a market is called A) the efficient market hypothesis. B) random walk. C) arbitrage. D) market fundamentals.

C) arbitrage.

The elimination of a riskless profit opportunity in a market is called A) the efficient market hypothesis. B) random walk. C) arbitrage. D) market fundamentals.

C) arbitrage.

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.

28) The PE ratio approach to valuing stock is especially useful for valuing A) privately held firms. B) firms that don't pay dividends. C) both A and B of the above. D) neither A nor B of the above.

C) both A and B of the above.

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.

70) An advantage of providing multiple financial services within one financial institution is that it A) lowers information costs. B) develops broader long-term relationships with customers. C) both A and B of the above. D) none of the above.

C) both A and B of the above.

3) The efficient market hypothesis A) is based on the assumption that prices of securities fully reflect all available information. B) holds that the expected return on a security equals the equilibrium return. C) both A and B. D) neither A nor B.

C) both A and B.

The efficient market hypothesis A) is based on the assumption that prices of securities fully reflect all available information. B) holds that the expected return on a security equals the equilibrium return. C) both A and B. D) neither A nor B.

C) both A and B.

37) Property that is pledged to the lender in the event that a borrower cannot make his or her debt payment is called A) points. B) interest. C) collateral. D) good faith money.

C) collateral.

39) The majority of household debt in the United States consists of A) credit card debt. B) consumer installment debt. C) collateralized loans. D) unsecured loans, such as student loans.

C) collateralized loans.

The majority of household debt in the United States consists of A) credit card debt. B) consumer installment debt. C) collateralized loans. D) unsecured loans, such as student loans.

C) collateralized loans.

2) Preferred stockholders hold a claim on assets that has priority over the claims of A) both common stockholders and bondholders. B) neither common stockholders nor bondholders. C) common stockholders, but after that of bondholders. D) bondholders, but after that of common stockholders.

C) common stockholders, but after that of bondholders

9) Securities not listed on one of the exchanges trade in the over-the-counter market. In this exchange, dealers "make a market" by A) buying stocks for inventory when investors want to sell. B) selling stocks from inventory when investors want to buy. C) doing both of the above. D) doing neither of the above.

C) doing both of the above.

2) According to the efficient market hypothesis, the current price of a financial security A) is the discounted net present value of future interest payments. B) is determined by the highest successful bidder. C) fully reflects all available relevant information. D) is a result of none of the above.

C) fully reflects all available relevant information.

According to the efficient market hypothesis, the current price of a financial security A) is the discounted net present value of future interest payments. B) is determined by the highest successful bidder. C) fully reflects all available relevant information. D) is a result of none of the above.

C) fully reflects all available relevant information.

27) The small-firm effect refers to the observation that small firms' stocks A) follow a random walk but large firms' stocks do not. B) have earned abnormally low returns given their greater risk. C) have earned abnormally high returns even taking into account their greater risk. D) sell for lower prices than do large firms' stocks.

C) have earned abnormally high returns even taking into account their greater risk.

The small-firm effect refers to the observation that small firms' stocks A) follow a random walk but large firms' stocks do not. B) have earned abnormally low returns given their greater risk. C) have earned abnormally high returns even taking into account their greater risk. D) sell for lower prices than do large firms' stocks.

C) have earned abnormally high returns even taking into account their greater risk.

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

Federal Reserve independence is thought to A) introduce a short-term bias to monetary policymaking. B) lead to better fiscal and monetary policy coordination. C) introduce longer-run considerations to monetary policymaking. D) do both A and B of the above.

C) introduce longer-run considerations to monetary policymaking.

Bonds with relatively low risk of default are called A) zero coupon bonds. B) junk bonds. C) investment-grade bonds. D) none of the above.

C) investment-grade bonds.

12) Raj Rajaratnam, a successful investor in the 2000s who consistently beat the market, was able to outperform the market on a consistent basis, indicating that A) securities markets are not efficient. B) unexploited profit opportunities were abundant. C) investors can outperform the market with inside information. D) only B and C of the above.

C) investors can outperform the market with inside information.

11) The efficient market hypothesis suggests that allocating your funds in the financial markets on the advice of a financial analyst A) will certainly mean higher returns than if you had made selections by throwing darts at the financial page. B) will always mean lower returns than if you had made selections by throwing darts at the financial page. C) is not likely to prove superior to a strategy of making selections by throwing darts at the financial page. D) is good for the economy.

C) is not likely to prove superior to a strategy of making selections by throwing darts at the financial page.

The efficient market hypothesis suggests that allocating your funds in the financial markets on the advice of a financial analyst A) will certainly mean higher returns than if you had made selections by throwing darts at the financial page. B) will always mean lower returns than if you had made selections by throwing darts at the financial page. C) is not likely to prove superior to a strategy of making selections by throwing darts at the financial page. D) is good for the economy.

C) is not likely to prove superior to a strategy of making selections by throwing darts at the financial page.

76) Investment banks serve two client groups, A) home buyers and mortgage lenders. B) people saving for retirement and pension funds. C) issuers of securities and investors in those securities. D) mutual funds and investors with relatively small amounts to invest.

C) issuers of securities and investors in those securities.

35) The pecking order hypothesis predicts that the ________ a corporation is, the more likely it will be to ________. A) smaller and less well known; issue securities B) larger and more well known; borrow from financial intermediaries C) larger and more well known; issue securities D) smaller and less well known; need external financing

C) larger and more well known; issue securities

23) Because of the adverse selection problem, A) good credit risks are more likely to seek loans, causing lenders to make a disproportionate amount of loans to good credit risks. B) lenders may refuse loans to individuals with high net worth, because of their greater proclivity to "skip town." C) lenders are reluctant to make loans that are not secured by collateral. D) all of the above.

C) lenders are reluctant to make loans that are not secured by collateral.

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

14) If borrowers take on big risks after obtaining a loan, then lenders face the problem of A) free-riding. B) adverse selection. C) moral hazard. D) costly state verification.

C) moral hazard.

If borrowers take on big risks after obtaining a loan, then lenders face the problem of A) free-riding. B) adverse selection. C) moral hazard. D) costly state verification.

C) moral hazard.

9) A situation in which the price of an asset differs from its fundamental market value A) indicates that unexploited profit opportunities exist. B) indicates that unexploited profit opportunities do not exist. C) need not indicate that unexploited profit opportunities exist. D) indicates that the efficient market hypothesis is fundamentally flawed.

C) need not indicate that unexploited profit opportunities exist.

64) Economies of scope refer to cost savings that arise when the A) size of financial transactions increase. B) size of financial transactions decrease. C) number of different activities undertaken increases.

C) number of different activities undertaken increases.

51) A debt contract is more likely to be incentive compatible if A) the company must follow standard accounting principles. B) the funds are provided by a venture capital firm. C) owners of the firm have more of their own money in the business. D) all of the above. E) only B and C.

C) owners of the firm have more of their own money in the business.

55) The case for Federal Reserve independence does not include the idea that A) political pressure would impart an inflationary bias to monetary policy. B) a politically insulated Fed would be more concerned with long-run objectives and thus be a defender of a sound dollar and a stable price level. C) policy is always performed better by an elite group such as the Fed. D) a Federal Reserve under the control of Congress or the president might make the so-called political business cycle more pronounced.

C) policy is always performed better by an elite group such as the Fed.

Moody's and Standard and Poor's are agencies that A) help investors collect when corporations default on their bonds. B) advise municipal bond issuers on the tax exempt status of their bonds. C) produce information about the probability of default on corporate bonds. D) maintain liquid markets for corporate bonds.

C) produce information about the probability of default on corporate bonds.

79) The potential conflict of interest when a single accounting firm provides both auditing and consulting services is that the firm can A) charge higher fees to its audit clients and lower fees for its consulting services so it can expand its consulting business. B) charge higher fees to its consulting clients and lower fees for its audit services so it can expand its auditing business. C) provide unjustifiably favorable audit reviews for firms that are large clients for its consulting services. D) pressure its clients into paying high fees for both auditing and consulting services.

C) provide unjustifiably favorable audit reviews for firms that are large clients for its consulting services.

16) In the used car market, asymmetric information leads to the lemons problem because the price that buyers are willing to pay will A) reflect the highest quality of used cars in the market. B) reflect the lowest quality of used cars in the market. C) reflect the average quality of used cars in the market. D) none of the above.

C) reflect the average quality of used cars in the market.

In the used car market, asymmetric information leads to the lemons problem because the price that buyers are willing to pay will A) reflect the highest quality of used cars in the market. B) reflect the lowest quality of used cars in the market. C) reflect the average quality of used cars in the market. D) none of the above.

C) reflect the average quality of used cars in the market.

18) In the one-period valuation model, a stock's value falls if the ________ rises. A) dividend B) expected future price C) required return on equity D) current price

C) required return on equity

27) Although neither ________ nor the ________ is officially set by the Federal Open Market Committee, decisions concerning these policy tools are effectively made by the committee. A) margin requirements; discount rate B) margin requirements; federal funds rate C) reserve requirements; discount rate D) reserve requirements; federal funds rate

C) reserve requirements; discount rate

According to the liquidity premium theory of the term structure, when the yield curve has its usual slope, the market expects A) short-term interest rates to rise sharply. B) short-term interest rates to drop sharply. C) short-term interest rates to stay near their current levels. D) none of the above.

C) short-term interest rates to stay near their current levels.

29) Mean reversion refers to the observation that A) stock prices overact to news announcements. B) stocks prices are more volatile than fluctuations in their fundamental value would predict. C) stocks with low returns are likely to have high returns in the future. D) stocks with low returns are likely to have even lower returns in the future.

C) stocks with low returns are likely to have high returns in the future.

Mean reversion refers to the observation that A) stock prices overact to news announcements. B) stocks prices are more volatile than fluctuations in their fundamental value would predict. C) stocks with low returns are likely to have high returns in the future. D) stocks with low returns are likely to have even lower returns in the future.

C) stocks with low returns are likely to have high returns in the future.

16) Tests used to rate the performance of rules developed in technical analysis conclude that A) technical analysis outperforms the overall market. B) technical analysis far outperforms the overall market, suggesting that stockbrokers provide valuable services. C) technical analysis does not outperform the overall market. D) technical analysis does not outperform the overall market, suggesting that stockbrokers do not provide services of any value.

C) technical analysis does not outperform the overall market.

Tests used to rate the performance of rules developed in technical analysis conclude that A) technical analysis outperforms the overall market. B) technical analysis far outperforms the overall market, suggesting that stockbrokers provide valuable services. C) technical analysis does not outperform the overall market. D) technical analysis does not outperform the overall market, suggesting that stockbrokers do not provide services of any value.

C) technical analysis does not outperform the overall market.

If income tax rates were lowered, then A) the interest rate on municipal bonds would fall. B) the interest rate on Treasury bonds would rise. C) the interest rate on municipal bonds would rise. D) the price of Treasury bonds would fall.

C) the interest rate on municipal bonds would rise.

In a direct placement

C) the issuer bypasses the dealer and sells directly to the end investor. (this is the correct answer. The answer key incorrectly list the answer as A)

27) The concept of adverse selection helps to explain A) why collateral is not a common feature of many debt contracts. B) why large, well-established corporations find it so difficult to borrow funds in securities markets. C) why financial markets are among the most heavily regulated sectors of the economy. D) all of the above.

C) why financial markets are among the most heavily regulated sectors of the economy.

The spread between interest rates on low-quality corporate bonds and U.S. government bonds ________ during the Great Depression. A) was reversed B) narrowed significantly C) widened significantly D) did not change

C) widened significantly

The relationship among interest rates on bonds with identical default risk but different maturities is called the A) time-risk structure of interest rates. B) liquidity structure of interest rates. C) yield curve. D) bond demand curve.

C) yield curve.

Thrift Industry:Savings and Loan Associations (S&L)

Can be charted by federal government or by the states; Office of the Comptroller of Currency regulates federally insured S&Ls by setting minimum capital requirements, requiring periodic reports and examinations

5) What facts about financial structure can be explained by adverse selection?

Can lead to failure of markets. Good companies unwilling to sell at average market price, bad companies are only to happy to sell for more than they are worth. Investors wind up not investing.

Load Funds (class A shares)

Charge an upfront fee for buying the shares

What is a load fund?

Charges a fee for accepting investments; this fee may be at the beginning of the investment or may be charged when the funds are withdrawn

What bank regulation is designed to reduce adverse selection problems for deposit insurance? Will it always work?

Chartering banks helps reduce adverse selection problem because it attempts to screen proposals for new banks to prevent risk prone entrepreneurs from controlling them. It will not always work because entrepreneurs and crooks have incentive to hide their true nature.

What four liabilities are on a banks balance sheet?

Checkable Deposits, Non-Transaction Deposits, Borrowings, Bank Capital

Which of the following is not an asset on a banks balnace sheet

Checkable deposits

Assets of value promised to the lender as compensation if the borrower defaults are called ---

Collateral

Hybrid Funds

Combine stocks and bonds into a single fund

What is the riskiest capital market security?

Common Stock

A bank almost always insists that the firms it lends to keep compensating balances at the bank. Why?

Compensating balances can act as collateral. They also help establish long-term customer relationships, which make it easier for the bank to collect information about prospective borrowers, thus reducing the adverse selection problem. Compensating balances help the bank monitor the activities of a borrowing firm so that it can prevent the firm from taking on too much risk, thereby not acting in the interest of the bank

A bank almost always insists that the firms it lends to keep compensating balances

Compensating balances help establish Compensating balnces help the bank Compensating balnces can act as collateral

Distinguish between competitive and non competitive bidding.

Competitive bidding buyer submits price and noncompetitive bidders accept the average of the rate paid by competitive bidders.

13) What conflicts of interest can arise in investment banking?

Conflicts with underwriting and research for bank selling securities and what they will be willing to reveal to buyers. Bank doesn't want research department to say that bond issue is crap.

The fed is an active participant in money markets mainly because of its responsibility to:

Control the money supply

During the depression, about ______ banks failed (about 40% of all commercial banks) a.) 500 b.) 1000 c.) 500 d.) 10000

D

Investment bankers have been active in the mergers and acquisitions market since the 1960s. their contributions include a.) helping firms that want to acquire another firm locate a firm to pursue b.) helping would-be acquirers solicit shareholders through a tender offer c.) helping target firms ward off undesired takeover attempts d.) all the above e.) only A and B of above

D

Securities dealers A) sell securities out of their inventories to customers who want to buy. B) buy securities, which they add to their inventories, from customers who want to sell. C) are largely responsible for the health and growth of small businesses in the United States. D) do all of the above. E) do only A and B of the above.

D

The buyers of private placement securities are most likely to be ________. A) insurance companies B) pension funds and mutual funds C) commercial banks D) all of the above E) only A and B of the above

D

The primary function of investment banks is to A) extend credit to stock brokers and dealers. B) extend credit to investors. C) extend credit to corporations. D) help corporations issue new securities.

D

The registration statement that securities underwrite files with the SEC contains information about a.) the firms financial condition, management, competition, industry, and experience b.) how the funds will be used c.) managements assessment of the risk of the securities d.) all the above e.) only A and B of the above

D

Which is not an activity of an investment bank a.) underwriting new issues of corporate stocks and bonds b.) acting as deal makers in mergers c.) acting as intermediaries in the buying and selling of businesses or parted of businesses d.) underwriting new issues of federal government bonds

D

Which of the following is not a step in the process by which an investment bank assists in the sale of a company or corporate division? A) Preparation of a confidential memorandum B) Negotiation of a letter of intent C) Preparation of a definitive agreement D) Forming a syndicate of purchasers

D

tasks that investment bankers perform when acting as underwriters to sell securities to the public include a.) pricing and security b.) preparing the filings required by the SEC c.) arranging for the securities to be rated d.) all the above e.) only A and B of the above

D

16) A stock currently sells for $30 per share and pays $1.00 per year in dividends. What is an investor's valuation of this stock if he expects it to be selling for $37 in one year and requires a 12 percent return on equity investments? A) $38 B) $33.50 C) $34.50 D) $33.93

D) $33.93

25) Holding other things constant, a stock's value will be highest if the investor's required return on investments in equity is A) 20%. B) 15%. C) 10%. D) 5%.

D) 5%.

34) Which of the following is empirical evidence indicating that the efficient market hypothesis may not always be generally applicable? A) Small-firm effect B) January effect C) Market overreaction D) All of the above

D) All of the above

Which of the following statements are true? A) Because coupon payments on municipal bonds are exempt from federal income tax, the expected after-tax return on them will be higher for individuals in higher income tax brackets. B) An increase in tax rates will increase the demand for municipal bonds, lowering their interest rates. C) Interest rates on municipal bonds will be lower than on comparable bonds without the tax exemption. D) All of the above are true statements. E) Only A and B are true statements.

D) All of the above are true statements.

22) Important implications of the efficient market hypothesis include which of the following? A) Future changes in stock prices should, for all practical purposes, be unpredictable. B) Stock prices will respond to announcements only when the information in these announcements is new. C) Sometimes a stock price declines when good news is announced. D) All of the above. E) Only A and B of the above.

D) All of the above.

38) Exchange traded funds (ETFs) have which of the following features? A) They are listed and traded as individual stocks on a stock exchange. B) They are indexed rather than actively managed. C) Their value is based on the underlying net asset value of the stocks held in the index basket. D) All of the above.

D) All of the above.

54) Which of the following are accurate statements concerning the role that restrictive covenants play in reducing moral hazard in financial markets? A) Covenants reduce moral hazard by restricting borrowers' undesirable behavior. B) Covenants require that borrowers keep collateral in good condition. C) Covenants require periodic accounting statements and income reports. D) All of the above. E) Only A and B of the above.

D) All of the above.

6) With regard to external sources of financing for nonfinancial businesses in the United States, which of the following are accurate statements? A) Direct finance is used in less than 5% of the external financing of American businesses. B) Only large, well-established corporations have access to securities markets to finance their activities. C) Loans from banks and other financial intermediaries in the United States provide five times more financing of corporate activities than do stock markets. D) All of the above. E) Only A and B of the above.

D) All of the above.

86) The Global Legal Settlement includes what key element? A) It directly reduces conflicts of interest. B) It provides incentives for investment banks to not exploit conflicts of interest. C) It has measures to improve the quality for information in financial markets. D) All of the above.

D) All of the above.

11) (I) The primary issuers of capital market securities are financial institutions. (II) The largest purchasers of capital market securities are corporations. A) (I) is true, (II) false. B) (I) is false, (II) true. C) Both are true. D) Both are false.

D) Both are false.

3) (I) Securities that have an original maturity greater than one year are traded in money markets. (II) The best known money 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.

D) Both are false.

68) Which combination of activities within a single financial institution is least likely to lead to conflicts of interest? A) Auditing and management advisory services B) Commercial banking and investment banking C) Assessment of credit quality and consulting D) Consumer lending and business lending

D) Consumer lending and business lending

13) Which of the following statements is false regarding Electronic Communications Networks (ECNs)? A) Archipelago and Instinet are two examples of ECNs. B) Competition from ECNs has forced NASDAQ to cut its fees. C) Traders benefit from lower trading costs and faster service. D) ECNs allow institutional investors, but not individuals, to trade after hours.

D) ECNs allow institutional investors, but not individuals, to trade after hours.

12) Which of the following is not an advantage of Electronic Communications Networks (ECNs)? A) All unfilled orders are available for review by ECN traders. B) Transactions costs are lower for ECN trades. C) Trades are made and confirmed faster. D) ECNs work well for thinly traded stocks.

D) ECNs work well for thinly traded stocks.

85) Which of the following provisions of legislation to deal with conflicts of interest does not increase the flow of information in financial markets? A) Requiring a firm's chief officers to certify its financial statements and other disclosures B) Requiring investment banks to make their analysts' recommendations public C) Requiring disclosure of off-balance-sheet transactions D) Increasing resources available to the Securities and Exchange Commission to supervise financial markets

D) Increasing resources available to the Securities and Exchange Commission to supervise financial markets

17) Which of the following types of information will most likely enable the exploitation of a profit opportunity? A) Financial analysts' published recommendations B) Technical analysis C) Hot tips from a stockbroker D) Insider information

D) Insider information

47) A venture capital firm protects its equity investment from moral hazard through which of the following means? A) It places people on the board of directors to better monitor the borrowing firm's activities. B) It writes contracts that prohibit the sale of an equity investment to anyone but the venture capital firm. C) It prohibits the borrowing firm from replacing its management. D) It does both A and B of the above. E) It does both A and C of the above.

D) It does both A and B of the above.

________ bonds are exempt from federal income taxes. A) Corporate Aaa B) U.S. Treasury C) Corporate Baa D) Municipal

D) Municipal

14) The ________ Fed bank, with about 25 percent of the system's assets, is the most important of the Federal Reserve banks. A) Chicago B) Los Angeles C) Miami D) New York E) Washington, D.C.

D) New York

8) Which of the following is not one of the eight basic facts about financial structure? A) Debt contracts are typically extremely complicated legal documents that place substantial restrictions on the behavior of the borrower. B) Indirect finance, which involves the activities of financial intermediaries, is many times more important than direct finance in which businesses raise funds directly from lenders in financial markets. C) Collateral is a prevalent feature of debt contracts for both households and businesses. D) New security issues is the most important source of external funds to finance businesses.

D) New security issues is the most important source of external funds to finance businesses.

18) Which of the following types of information will most likely enable the exploitation of a profit opportunity? A) Financial analysts' published recommendations B) Technical analysis C) Hot tips from a stockbroker D) None of the above

D) None of the above

68) The three largest Federal Reserve banks in terms of assets are those of New York, Chicago, and A) Atlanta. B) Los Angeles. C) Baltimore. D) San Francisco.

D) San Francisco.

43) Because managers (________) have less incentive to maximize profits than the stockholders-owners (________) do, stockholders find it costly to monitor managers; thus, stockholders are reluctant to purchase equities. A) principals; agents B) principals; principals C) agents; agents D) agents; principals

D) agents; principals

Because managers (________) have less incentive to maximize profits than the stockholders-owners (________) do, stockholders find it costly to monitor managers; thus, stockholders are reluctant to purchase equities. A) principals; agents B) principals; principals C) agents; agents D) agents; principals

D) agents; principals

75) Investment banks are guilty of conflict of interest when they A) pressure their analysts to produce research favorable to their client firms. B) permit executives of client firms to alter analysts' research on their firms. C) prohibit analysts from making negative or controversial comments about client firms. D) all of the above

D) all of the above

20) The efficient market hypothesis suggests that A) investors should not try to outguess the market by constantly buying and selling securities. B) investors do better on average if they adopt a "buy and hold" strategy. C) buying into a mutual fund is a sensible strategy for a small investor. D) all of the above are sensible strategies. E) only A and B of the above are sensible strategies.

D) all of the above are sensible strategies.

33) Stock values computed by valuation models may differ from actual market prices because it is difficult to A) estimate future dividend growth rates. B) estimate the risk of a stock. C) forecast a stock's future dividends. D) all of the above are true.

D) all of the above are true.

21) Because of the adverse selection problem, A) lenders may make a disproportionate amount of loans to bad credit risks. B) lenders may refuse loans to individuals with low net worth. C) lenders are reluctant to make loans that are not secured by collateral. D) all of the above.

D) all of the above.

24) The problem of adverse selection helps to explain A) why banks prefer to make loans secured by collateral. B) why banks have a comparative advantage in raising funds for American businesses. C) why borrowers are willing to offer collateral to secure their promises to repay loans. D) all of the above. E) only A and B of the above.

D) all of the above.

36) Evidence in favor of market efficiency includes A) performance of investment analysts and mutual funds. B) whether stock prices reflect publicly available information. C) the random-walk behavior of stock prices. D) all of the above.

D) all of the above.

38) Collateral is A) property that is pledged to the lender if a borrower cannot make his or her debt payments. B) a prevalent feature of debt contracts for households. C) a prevalent feature of debt contracts for businesses. D) all of the above. E) only A and C of the above.

D) all of the above.

48) Debt contracts A) are agreements by the borrowers to pay the lenders fixed dollar amounts at periodic intervals. B) have an advantage over equity contracts in that they have a lower cost of state verification. C) are used much more frequently to raise capital than equity contracts. D) all of the above. E) only A and B of the above.

D) all of the above.

53) The case for Federal Reserve independence includes the idea that A) political pressure would impart an inflationary bias to monetary policy. B) a politically insulated Fed would be more concerned with long-run objectives and thus be a defender of a sound dollar and a stable price level. C) a Federal Reserve under the control of Congress or the president might make the so-called political business cycle more pronounced. D) all of the above.

D) all of the above.

60) The free-rider problem A) occurs when people who do not pay for information take advantage of the information other people have to pay for. B) suggests that the private sale of information will only be a partial solution to the lemons problem. C) prevents the private market from producing enough information to eliminate all the asymmetric information that leads to adverse selection. D) all of the above.

D) all of the above.

62) A bank A) has the ability to profit from the information it produces. B) avoids the free-rider problem by primarily making private loans rather than by purchasing securities that are traded in the open market. C) becomes an expert in determining good firms from bad firms. D) all of the above.

D) all of the above.

62) Critics of Fed independence argue A) that it is undemocratic to have monetary policy controlled by an elite group responsible to no one. B) that independence seemingly does little to guarantee good monetary policy. C) that its independence may encourage the Fed to pursue a course of narrow self-interest rather than the public interest. D) all of the above.

D) all of the above.

70) The 12 Federal Reserve banks are involved in monetary policy in which of the following ways? A) Their directors establish the discount rate. B) They decide which banks can obtain discount loans from the Federal Reserve Bank. C) Their directors select one commercial banker from each bank's district to serve on the Federal Advisory Council. D) all of the above.

D) all of the above.

According to the market segmentation theory of the term structure, A) the interest rate for bonds of one maturity is determined by the supply and demand for bonds of that maturity. B) bonds of one maturity are not substitutes for bonds of other maturities; therefore, interest rates on bonds of different maturities do not move together over time. C) investors' strong preference for short-term relative to long-term bonds explains why yield curves typically slope upward. D) all of the above. E) none of the above.

D) all of the above.

The free-rider problem A) occurs when people who do not pay for information take advantage of the information other people have to pay for. B) suggests that the private sale of information will only be a partial solution to the lemons problem. C) prevents the private market from producing enough information to eliminate all the asymmetric information that leads to adverse selection. D) all of the above.

D) all of the above.

30) A weakness of the PE approach to valuing stock is that it is A) difficult to estimate the constant growth rate of a firm's dividends. B) difficult to estimate the required return on equity. C) difficult to predict how much a firm will pay in dividends. D) based on industry averages rather than firm-specific factors.

D) based on industry averages rather than firm-specific factors.

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.

52) Politicians in a democratic society may be shortsighted because of their desire to win reelection; thus, the political process can A) impart an inflationary bias to monetary policy. B) impart a deflationary bias to monetary policy. C) generate a political business cycle in which, just before an election, expansionary policies are pursued to lower unemployment and interest rates. D) cause both A and C of the above to occur.

D) cause both A and C of the above to occur.

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.

Holding everything else the same, if a corporation's earnings rise, then the default risk on its bonds will ________ and the expected return on those bonds will ________. A) increase; decrease B) decrease; decrease C) increase; increase D) decrease; increase

D) decrease; increase

29) That most used cars are sold by intermediaries (i.e., used car dealers) provides evidence that these intermediaries A) provide information that is valued by consumers of used cars. B) are able to prevent others from free-riding off the information that they provide. C) can profit by becoming experts in determining whether an automobile is a good car or a lemon. D) do all 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.

56) Governments in developing countries sometimes adopt policies that retard the efficient operation of their financial systems. These actions include policies that A) prevent lenders from foreclosing on borrowers with political clout. B) nationalize banks and direct credit to politically favored borrowers. C) make it costly to collect payments and collateral from defaulting debtors. D) do all of the above. E) do only A and B of the above.

D) do all of the above.

57) Advocates of Fed independence fear that subjecting the Fed to direct presidential or congressional control would A) impart an inflationary bias to monetary policy. B) force monetary authorities to sacrifice the long-run objective of price stability. C) make the so-called political business cycle even more pronounced. D) do all of the above. E) do only A and B of the above.

D) do all of the above.

69) Conflicts of interest pose a problem because they A) lower the quality of information. B) increase problems of asymmetric information. C) make the financial system less efficient. D) do all of the above.

D) do all of the above.

That most used cars are sold by intermediaries (i.e., used car dealers) provides evidence that these intermediaries A) provide information that is valued by consumers of used cars. B) are able to prevent others from free-riding off the information that they provide. C) can profit by becoming experts in determining whether an automobile is a good car or a lemon. D) do all of the above.

D) do all of the above.

59) Supporters of the current system of Fed independence believe that a less autonomous Fed would A) adopt a long-run bias toward policymaking. B) pursue overly expansionary monetary policies. C) be more likely to create a political business cycle. D) do only B and C of the above.

D) do only B and C of the above.

The liquidity premium theory of the term structure A) indicates that today's long-term interest rate equals the average of short-term interest rates that people expect to occur over the life of the long-term bond. B) assumes that bonds of different maturities are perfect substitutes. C) suggests that markets for bonds of different maturities are completely separate because people have different preferences. D) does none of the above.

D) does none 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

32) The main cause of fluctuations in stock prices is changes in A) tax laws. B) errors in technical stock analysis. C) daily trading volume in stock markets. D) information available to investors. E) total household wealth in the economy.

D) information available to investors.

The Bush tax cut passed in 2001 reduces the top income tax bracket from 39 percent to 35 percent over the next ten years. As a result of this tax cut, the demand for municipal bonds should shift to the ________ and the interest rate on municipal bonds should ________. A) right; decline B) right; increase C) left; decline D) left; increase

D) left; increase

When the corporate bond market becomes less liquid, other things equal, the demand curve for corporate bonds shifts to the ________ and the demand curve for Treasury bonds shifts to the ________. A) right; right B) right; left C) left; left D) left; right

D) left; right

56) The risk on an agency bond is A) high. B) zero. C) moderate. D) low.

D) low.

29) The PE ratio approach to valuing stock is especially useful for valuing A) publicly held corporations. B) firms that regularly pay dividends. C) both A and B of the above. D) neither A nor B of the above.

D) neither A nor B of the above.

2) Of the following sources of external finance for American nonfinancial businesses, the most important is A) loans from banks. B) stocks. C) bonds and commercial paper. D) nonbank loans.

D) nonbank loans.

If the expected path of one-year interest rates over the next four years is 5 percent, 4 percent, 2 percent, and 1 percent, then the pure expectations theory predicts that today's interest rate on the four-year bond is A) 1 percent. B) 2 percent. C) 4 percent. D) none of the above.

D) none of the above.

4) If the optimal forecast of the return on a security exceeds the equilibrium return, then A) the market is inefficient. B) an unexploited profit opportunity exists. C) the market is in equilibrium. D) only A and B of the above are true. E) only B and C of the above are true.

D) only A and B of the above are true.

If the optimal forecast of the return on a security exceeds the equilibrium return, then A) the market is inefficient. B) an unexploited profit opportunity exists. C) the market is in equilibrium. D) only A and B of the above are true. E) only B and C of the above are true.

D) only A and B of the above are true.

36) A share of common stock in a firm represents an ownership interest in that firm and allows stockholders to A) vote. B) receive dividends. C) receive interest payments. D) only A and B of the above.

D) only A and B of the above.

54) The case for Federal Reserve independence includes the idea that A) a politically insulated Fed would be more concerned with long-run objectives and thus be a defender of a sound dollar and a stable price level. B) a Federal Reserve under the control of Congress or the president might make the so-called political business cycle more pronounced. C) the principal-agent problem is perhaps worse for the Fed than for congressmen since the former does not answer to the voters on election day. D) only A and B of the above.

D) only A and B of the above.

71) A conflict of interest occurs when A) a financial firm sells a service to its customers for a price that exceeds the cost of producing the service. B) lenders prefer higher interest rates and borrowers prefer lower interest rates. C) riskier borrowers are the ones who are more likely to apply for loans. D) people expected to provide reliable information to the public have incentives not to do so.

D) people expected to provide reliable information to the public have incentives not to do so.

A conflict of interest occurs when A) a financial firm sells a service to its customers for a price that exceeds the cost of producing the service. B) lenders prefer higher interest rates and borrowers prefer lower interest rates. C) riskier borrowers are the ones who are more likely to apply for loans. D) people expected to provide reliable information to the public have incentives not to do so.

D) people expected to provide reliable information to the public have incentives not to do so.

When a municipal bond is given tax-free status, the demand for municipal bonds shifts ________, causing the interest rate on the bond to ________. A) leftward; rise B) leftward; fall C) rightward; rise D) rightward; fall

D) rightward; fall

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.

13) To say that stock prices follow a "random walk" is to argue that A) stock prices rise, then fall. B) stock prices rise, then fall in a predictable fashion. C) stock prices tend to follow trends. D) stock prices are, for all practical purposes, unpredictable.

D) stock prices are, for all practical purposes, unpredictable.

To say that stock prices follow a "random walk" is to argue that A) stock prices rise, then fall. B) stock prices rise, then fall in a predictable fashion. C) stock prices tend to follow trends. D) stock prices are, for all practical purposes, unpredictable.

D) stock prices are, for all practical purposes, unpredictable.

14) To say that stock prices follow a "random walk" is to argue that A) stock prices rise, then fall, then rise again. B) stock prices rise, then fall in a predictable fashion. C) stock prices tend to follow trends. D) stock prices cannot be predicted based on past trends.

D) stock prices cannot be predicted based on past trends.

38) Evidence in favor of market efficiency does not include A) random-walk behavior. B) technical analysis. C) performance of investment analysts and mutual funds. D) the January effect.

D) the January effect.

Evidence in favor of market efficiency does not include A) random-walk behavior. B) technical analysis. C) performance of investment analysts and mutual funds. D) the January effect.

D) the January effect.

The term structure of interest rates is A) the relationship among interest rates of different bonds with the same risk and maturity. B) the structure of how interest rates move over time. C) the relationship among the terms to maturity of different bonds from different issuers. D) the relationship among interest rates on bonds with different maturities but similar risk.

D) the relationship among interest rates on bonds with different maturities but similar risk.

20) Which of the following is not an element of the Gordon growth model of stock valuation? A) the stock's most recent dividend paid B) the expected constant growth rate of dividends C) the required return on investments in equity D) the stock's expected future price

D) the stock's expected future price

10) Studies of mutual fund performance indicate that mutual funds that outperformed the market in one time period A) usually beat the market in the next time period. B) usually beat the market in the next two subsequent time periods. C) usually beat the market in the next three subsequent time periods. D) usually do not beat the market in the next time period.

D) usually do not beat the market in the next time period.

Studies of mutual fund performance indicate that mutual funds that outperformed the market in one time period A) usually beat the market in the next time period. B) usually beat the market in the next two subsequent time periods. C) usually beat the market in the next three subsequent time periods. D) usually do not beat the market in the next time period.

D) usually do not beat the market in the next time period.

The volume of checkable deposits relative to total bank liabilities has

Declined over time

Treasury STRIPS

Developed in early 1980s to help investors avoid reinvestment risk associated with coupon bonds

Bank loans from the Federal Reserve are called ----- and represent a source of new funds for financial intermediaries

Discount loans

Private placements a.) do not require the services of the investment bankers b.) don't need to be registered with the SEC c.) are more common in the sale of stock than for bonds d.) all the above e.) only A and B of the above

E

Security dealers a.) hold inventories of securities, which they sell to customers who want to buy b.) hold securities that they have purchased from customers who want to sell c.) are called market takers, as they have significantly cut into the market that brokers used to dominate d.)all the above E. Only A and B of the above

E

The Glass-Steagall Act a.) separated commercial and investment banking b.) made it illegal for a commercial banks to buy or sell securities on behalf of its customers c.) made it illegal for investment banks to engage in the underwriting of corporate securities d.) did all the above e.) did only A and B of above

E

The buyers of private placement issues are most likely to be ______ a.) insurance companies b.) pension funds c.) investment banks d.) all the above e.) only A and B of the above

E

Which of the following is an element of the Federal Reserve System? A) The Federal Reserve banks B) The Board of Governors C) The FDIC D) All of the above E) Only A and B of the above

E) Only A and B of the above

Which of the following are true statements? A) The FOMC usually meets every six weeks to set monetary policy. B) The FOMC issues directives to the trading desk at the New York Fed. C) Designers of the Federal Reserve Act did not envision the use of discount lending as a monetary policy tool. D) All of the above are true statements. E) Only A and B of the above are true statements.

E) Only A and B of the above are true statements.

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.

5) With regard to external sources of financing for nonfinancial businesses in the United States, which of the following are accurate statements? A) Marketable securities account for a larger share of external business financing in the United States than in most other countries. B) Since 1970, less than 5% of newly issued corporate bonds and commercial paper have been sold directly to American households. C) The stock market accounted for the largest share of the financing of American businesses in the 1970-2000 period. D) All of the above. E) Only A and B of the above.

E) Only A and B of the above.

1) How expectations are formed is important because expectations influence A) the demand for assets. B) bond prices. C) the risk structure of interest rates. D) the term structure of interest rates. E) all of the above.

E) all of the above.

49) Equity contracts account for a small fraction of external funds raised by American businesses because A) costly state verification makes the equity contract less desirable than the debt contract. B) there is greater scope for moral hazard problems under equity contracts, as compared to debt contracts. C) equity contracts do not permit borrowing firms to raise additional funds by issuing debt. D) all of the above. E) both A and B of the above.

E) both A and B of the above.

Since yield curves are usually upward sloping, the ________ indicates that, on average, people tend to prefer holding short-term bonds to long-term bonds. A) market segmentation theory B) expectations theory C) liquidity premium theory D) both A and B of the above E) both A and C of the above

E) both A and C of the above

58) Advocates of Fed independence fear that subjecting the Fed to direct presidential or congressional control would A) impart an inflationary bias to monetary policy. B) force monetary authorities to sacrifice the long-run objective of price stability. C) make the so-called political business cycle less pronounced. D) do all of the above. E) do only A and B of the above.

E) do only A and B of the above.

The risk premium on corporate bonds becomes smaller if A) the riskiness of corporate bonds increases. B) the liquidity of corporate bonds increases. C) the liquidity of corporate bonds decreases. D) the riskiness of corporate bonds decreases. E) either B or D of the above occur.

E) either B or D of the above occur.

If the expected path of one-year interest rates over the next five years is 1 percent, 2 percent, 3 percent, 4 percent, and 5 percent, then the pure expectations theory predicts that the bond with the highest interest rate today is the one with a maturity of A) one year. B) two years. C) three years. D) four years. E) five years.

E) five years.

8) To list on the NYSE, a firm must A) have earnings of at least $10 million per year. B) have at least $500 million in outstanding debt. C) have a total of $100 million in market value. D) meet all of the above requirements. E) meet A and C of the above requirements.

E) meet A and C of the above requirements.

5) According to the efficient market hypothesis A) one cannot expect to earn an abnormally high return by purchasing a security. B) information in newspapers and in the published reports of financial analysts is already reflected in market prices. C) unexploited profit opportunities abound, thereby explaining why so many people get rich by trading securities. 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.

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.

20) Moral hazard is a problem associated with debt and equity contracts arising from A) the borrower's incentive to undertake highly risky investments. B) the owners' inability to ensure that managers will act in the owners' interest. C) the difficulty lenders have in sorting out good credit risks from bad credit risks. D) all of the above. E) only A and B of the above.

E) only A and B of the above.

33) The authors' analysis of adverse selection indicates that financial intermediaries in general, and banks in particular (because they hold a large fraction of nontraded loans), A) have advantages in overcoming the free-rider problem, helping to explain why indirect finance is a more important source of business finance than direct finance. B) play a greater role in moving funds to corporations than do securities markets as a result of their ability to overcome the free-rider problem. C) provide better-known and larger corporations a higher percentage of their external funds than they do to newer and smaller corporations, which rely to a greater extent on the new issues market for funds. D) all of the above. E) only A and B of the above.

E) only A and B of the above.

41) Because of the moral hazard problem, A) lenders will write debt contracts that restrict certain activities of borrowers. B) lenders will more readily lend to borrowers with high net worth. C) debt contracts are used less frequently to raise capital than equity contracts. D) all of the above. E) only A and B of the above.

E) only A and B of the above.

45) Solutions to the moral hazard problem include A) high net worth. B) monitoring and enforcement of restrictive covenants. C) greater reliance on equity contracts and less on debt contracts. D) all of the above. E) only A and B of the above.

E) only A and B of the above.

55) Although restrictive covenants can potentially reduce moral hazard, a problem with restrictive covenants is that A) borrowers may find loopholes that make the covenants ineffective. B) they are costly to monitor and enforce. C) too many resources may be devoted to monitoring and enforcing them, as debtholders duplicate others' monitoring and enforcement efforts. D) all of the above. E) only A and B of the above.

E) only A and B of the above.

Because of the moral hazard problem, A) lenders will write debt contracts that restrict certain activities of borrowers. B) lenders will more readily lend to borrowers with high net worth. C) debt contracts are used less frequently to raise capital than equity contracts. D) all of the above. E) only A and B of the above.

E) only A and B of the above.

Factors that provide the Federal Reserve with a high degree of independence include A) 14-year terms for members of the Board of Governors. B) a four-year term for the chairman of the Board of Governors that is not coincident with the president's term of office. C) constitutional independence from Congress and the president. D) all of the above. E) only A and B of the above.

E) only A and B of the above.

Moral hazard is a problem associated with debt and equity contracts arising from A) the borrower's incentive to undertake highly risky investments. B) the owners' inability to ensure that managers will act in the owners' interest. C) the difficulty lenders have in sorting out good credit risks from bad credit risks. D) all of the above. E) only A and B of the above.

E) only A and B of the above.

The unusual structure of the Federal Reserve System is perhaps best explained by A) Americans' fear of centralized power. B) the traditional American distrust of moneyed interests. C) Americans' desire to remove control of the money supply from the U.S. Treasury. D) all of the above. E) only A and B of the above.

E) only A and B of the above.

10) Because information is scarce, A) equity contracts are used much more frequently to raise capital than are debt contracts. B) monitoring managers gives rise to costly state verification. C) government regulations, such as standard accounting principles, can help reduce moral hazard. D) all of the above are true. E) only B and C of the above are true.

E) only B and C of the above are true.

1) What are economies of scale in financial transactions? How can financial intermediaries achieve these economies?

Economies of scale is the reduction of transaction costs per $ invested as the size of transactions increases. Financial intermediaries can reduce costs by bundling investors funds together. Example- The cost of arranging the purchasing 10K shares is not much greater than cost of arranging purchase of 50 shares.

Why did new technology make it harder to enforce limitations on bank branching?

Electronic Banking facilities are frequently shared by several banks, so these facilities are not classified as branches.

Why might eliminating the Fed's independence lead to a more pronounced political business cycle?

Eliminating the Fed's independence might make it more shortsighted and subject to political influence. Thus, when political gains could be achieved by expansionary policy before an election, the Fed might be more likely to engage in this activity. As a result, more pronounced political business cycles might result.

Financial Guarantee

Ensures that the lender will be paid both principal and interest in event issuer defaults

How does the Federal Reserve affect monetary policy?

Establish discount rate, elect one member to FAC, determine which bank receives loan, and five of 12 bank presidents vote of BOG

1) Why are expectations important in understanding how financial instruments are valued?

Expectations of risk, returns, and liquidity affect pricing in an efficient market

What are some advantages of banker acceptances?

Exporter paid immediately and shielded from foreign exchange risk, importers bank guarantees payment, crucial to international trade

1) More stock trading in the U.S. occurs in over-the-counter markets rather than on organized exchanges.

FALSE

12) A stock's market value will be higher the higher the investor's required rate of return is, all else being equal.

FALSE

14) The Wall Street Journal reports on 23 different indexes in its "Markets Lineup" column.

FALSE

15) A lower than average PE may mean that the market expects earnings to rise in the future.

FALSE

3) Electronic Communications Networks apply technology to make organized exchanges more efficient and speedy.

FALSE

4) All stocks pay dividends, as that is the only way an investor can profit from holding stock.

FALSE

7) The Dow Jones Industrial Average is the broadest and best indicator of the stock market's day-to-day performance.

FALSE

9) About half of new equity issues are preferred stock.

FALSE

When faced with capital shortfall, banks can raise new capital or restrict lending. In 2008

False Make fewer loans

Because diversification is a desirable strategy for aboiding risk, it never makes sense for a bank to specialize in making specific types of loans

False because a bank may have developed expertise in screening and monitoring a particular kind of loan, thus improving its ability to handle problems of adverse selection and moral hazard

"Bank managers should always seek the highest return possible on their assets." Is this true, false, or uncertain? Explain.

False, If an asset has a lot of risk a bank manager might not want to hold it even if it has a higher return than other assets.

"Because diversification is a desirable strategy for avoiding risk, it never makes sense for a bank to specialize in making specific types of loans." Is this statement true, false, or uncertain? Explain your answer.

False. Although diversification is a desirable strategy for a bank, it may still make sense for a bank to specialize in certain types of lending. For example, a bank may have developed expertise in screening and monitoring borrowers for a particular kind of loan, thus improving its ability to handle problems of adverse selection and moral hazard

Bank managers should always seek the highest return possible on their assets." Is this statement true, false or uncertain? Explain your answer.

False. If an asset has a lot of risk, a bank manager might not want to hold it even if it has a higher return than other assets. Thus a bank manager has to consider risk as well as the expected return when deciding to hold an asset.

"An efficient market is one in which no one ever profits from having better information than the rest." Is this statement true, false, or uncertain? Explain your answer.

False. The people with better information are exactly those who make the market more efficient by eliminating unexploited profit opportunities. These people can profit from their better information.

What are the four regulatory agencies?

Federal Reserve, FDIC, Office of the Comptroller of the Currency, State Banking Authorities

Using the T-account of the First National Bank and the Second National Bank, describe what happens when Jane Brown writes a 95 check on her account at the First National Bank to pay her friend Joe Green

First National -95. -95 Second National 95, 95

7) Give evidence both for and against market efficiency.

For - random walk, markets unpredictable, no benefit from tech analysis or stock pickers. Against - January effect, volatility, small firm effect.

What is the goal of underwriting?

For all the shares in an offering to be spoken for

Regulatory Arbitrage

For any given category, they seek assets that are riskiest

10) What is the free-rider problem? Describe some situations that this problem creates.

Free rider problem is people using information that others have paid for. Discourages the production and sale of information. You cannot benefit from the information you purchased if everyone else is following your lead (free riders)

Sweep Accounts

Funds are "swept" out of checking accounts nightly and invested at overnight rates

Deferred Loan (class B shares)

Funds charge a fee when the shares are redeemed

Sinking Fund

Funds set aside by the issuer of a bond to pay for redemption of bond when it matures.

in addition to treasury securities, some agencies of the government issue bonds. list 3 such agencies, and state what the funds raised by the bond issues are used for.

Ginny Mae (Government National Mortgage Association), Federal Housing Administration, the Veteran Administration, the Fannie Mae (Federal National Mortgage Association), and Sallie Mae (Student Loan Marketing Association). The first 4 fund mortgage loans and the last funds college student loans.

What distinguishes a hedge fund from other types of mutual funds?

Hedge funds typically require very large investments, do not allow withdrawals, and charge very high fees

How can the existence of asymmetric information provide a rationale for government regulation of financial markets?

How can the existence of asymmetric information provide a rationale for government regulation of financial markets? Because there is asymmetric information and the free-rider problem, there is not enough information available in financial markets. This provides a rationale for government to regulate to markets to encourage information production to better screen out good and bad borrowers. They can also reduce morale hazard and improve performance of markets by enforcing standard accounting principles and prosecuting fraud.

How does the free-rider problem aggravate adverse selection and moral hazard problems in financial markets?

How does the free-rider problem aggravate adverse selection and moral hazard problems in financial markets? The free-rider problem means that private producers of information will not obtain the full benefit of their information producing activities, and so less information will be produced. This means that there will be less information collected to screen out good from bad risks, making adverse selection problems worse, and that there will be less monitoring of borrowers, increasing the moral hazard problem.

If I read the Wall Street Journal that the "smart money" on Wall Street expects stock prices to fall, should I follow that lead and sell all my stocks?

If I read the Wall Street Journal that the "smart money" on Wall Street expects stock prices to fall, should I follow that lead and sell all my stocks? No, because this is publicly available information and is already reflected in stock prices. The optimal forecast of stock returns will equal the equilibrium return, so there is no benefit from selling your stocks.

4) Explain what the market reaction will be in an efficient market if a firm announces a fully anticipated filing for bankruptcy.

If the filing for bankruptcy is full anticipated, it will be priced in to the market in an efficient market. No drastic price changes expected.

If the public expects a corporation to lose $5 a 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?

If the public expects a corporation to lose $5 a 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 rise. Even though the company is suffering a loss, the price of the stock reflects an even larger expected loss. When the loss is less than expected, efficient markets theory then indicates that the stock price will rise.

If yield curves, on average, were flat, what would this say about the liquidity premiums in the term structure? Would you be more or less willing to accept the pure expectations theory?

If yield curves, on average, were flat, what would this say about the liquidity premiums in the term structure? Would you be more or less willing to accept the pure expectations theory? If yield curves on average were flat, this would suggest that the risk premium on long-term relative to short-term bonds would equal zero and we would be more willing to accept the pure expectations theory.

What is the difference between a hostile takeover and a merger

In a hostile takeover, the target firm does not want control to pass to the acquiring firm, and so its management makes every effort to prevent the takeover from happening. In a merger both sides work together to expedite the union of the firms.

Do you think that removing the impediments to a nationwide banking system will be beneficial to the economy?

In general yes. A national banking system will enable banks to diversify their loan portfolios better, thus decreasing likelihood of bank failures. Also increase a banks profitability.

Why is being nosy a good trait for a banker?

In order for a banker to reduce adverse selection she must screen out good from bad credit risks by learning all she can about potential borrowers. Similarly in order to minimize moral hazard, she must continually monitor borrowers to ensure that they are complying with restrictive loan covenants. Hence it pays for the banker to be nosy

Checkable Deposits (Liability)

Includes all accounts that allow the owner (depositor) to write checks to third parties. Checkable deposits are banks lowest cost funds.

How does an index fund differ from an actively managed fund?

Index funds are not actively managed. They simply hold the stocks in the index and usually have significantly lower fees than actively managed funds

Oversubscribed

Interest in more shares than are available

Risk that is related to the uncertainty about future interest rate movemtns is called

Interest-rate risk

What are the primary services an investment banker will provide to a firm issuing securities

Investment bankers offer advice, help with filing documents, and assistance with marketing the issue.

Denomination Intermediation

Investors can participate in equity and debt offerings that, individually, require more capital than they possess

Liquidity Intermediation

Investors can quickly convert investments into cash while still allowing the fund to invest for the long term

Diversification

Investors immediately realize the benefits of diversification even for small investments

Open End Fund

Investors may buy or redeem shares at any point where the price is determined by the net asset value of the fund

If a bank is falling short of meeting its capital requirements by 1 million

Issure stock Decrease dividend payments to increase retained earnings Call in existing loans in an attempt to decrease

15. If a bank is falling shore of meeting its capital requirements by $1m, what three things can it do to rectify the situation?

It can raise $1 million of capital by issuing new stock. It can cut its dividend payments by $1 million, thereby increasing its retained earnings by $1 million. It can decrease the amount of its assets so that the amount of its capital relative to its assets increases, thereby meeting the capital requirements.

A bank finds that its ROE is too low because it has too much bank capital.

It can sell part of its holdings of securitites and hold more excess reserves

If reserve requirements were eliminated in the future, what effects would this have on the size of money market mutual funds?

It would decrease the size of MMMFs because banks could then offer higher interest rates on their deposits; funds would flow out of MMMFs into banks

Do you think that eliminating or limiting the amount of deposit insurance would be a good idea? Explain.

It would help reduce the moral hazard of excessive risk taking on the part of banks, but would make bank failures and panics more likely so may not be a very good idea.

How could market value accounting for bank capital requirements benefit the economy? How difficult would it be to implement?

It would let the deposit insurance agency know quickly if a bank was falling below its capital requirement so it could be closed down before substantial losses.

Thrift Industry:Mutual Savings Bank

Jointly owned by the depositors and subject to many of the FDICs regulations for state chartered banks

Who issues commercial paper and why?

Large businesses with very good credit standings sell commercial paper to raise short term funds

11) The U.S. has more lawyers per capita than any other country in the world. It is also among the richest countries in the world. Explain why these two facts may not be mere coincidence.

Legal system involves writing and enforcing contracts and protecting property rights. Anglo Saxon legas system is and advantage of the U.S. Economy.

Shadow Banking System

Lending has been replaced by lending via the securities market

Restrictive Covenants

Limit the amount of dividends the firm can pay and ability of firm to issue additional debt

What features of mutual funds and the investment environment have led to mutual funds rapid growth in the last two decades?

Liquidity Intermediation, Denomination Intermediation, Diversification, Cost Advantages, and the growth of defined contribution pension plans

What are three off balance sheet activities?

Loan Sales, Fee Income, Trading Activities and Risk Management Techniques

2) How is it possible that a firm can announce a record-breaking loss, yet its stock price rises when the announcement is made?

Loss could be less than expected

Which of the following is a main responsibility of the bank manager

Mainting reserves at a level to minimize the cost to the bank of deposit outflow

Liability Management

Managing the source of funds, from deposits, to CDs, to other debt

Managerial Expertise

Many investors prefer to rely on professional money managers to select their investments

what purpose initially motivated Merrill Lynch to offer money market mutual funds to its customers?

Merrill Lynch initially felt is could better service its regular customers by making it easier to buy and sell securities from an account held at the brokerage house. The brokerage could offer a market interest rate on these funds by investing them in the money markets.

In order to reduce the ----- problem in loan markets, bankers often insist on collateral from potential borrowers

Moral hazard

How do disclosure requirements help limit excessive risk taking by banks?

More public information about the risks incurred by the banks and the quality of their portfolio helps stockholders evaluate and monitor banks and pull funds out if they are taking on too much risk

Which of the following may not be used as a backup line of credit

Mortgages

Mutual Funds

Mutual Funds pool together resources of many small investors by selling them shares and using the proceeds to buy securities

8) Does the efficient market hypothesis imply that financial markets are efficient? Explain.

No - markets can be inefficient when influenced by insider trading and behavioral factors outside of market fundamentals that drive trades.

Does the fact that a security has passed an SEC review mean that investors can buy the security without having to worry about taking a loss on the investment?

No, and SEC review simply determines if the proper documents have been filed.

If the president of a bank told you that the bank was so well run it has never had to call in loans, sell securities, or borrow as a result of a deposit outflow, would you be willing to buy stock in that bank?

No, because bank president is not managing bank well. Since the bank has never incurred costs as result of deposit outflow means the bank is holding a lot of reserves, earning no interest. Profits are low, hence would not but stock.

Can we expect the value of the dollar to rise by 2% next week if our expectations are optimal?

No, because this expected change in the value of the dollar would imply that there is a huge unexploited profit opportunity (over a 100% expected return at an annual rate). Since the rational expectations theory rules out unexploited profit opportunities, such a big expected change in the exchange rate could not exist.

If the bank you own has no excess reserves and a sound customer comes in asking for a loan, should you automatically turn the customer down? Why and what other options are available?

No, you may lose that customer's business forever, which is extremely costly. You may go out and borrow from other banks, corporations, or Fed to obtain funds.

If the bank you own has no excess reserves and a sound customer comes in asking for a loan should you automatically turn the customer down

No. There are several ways that reserves

What special problem do off-balance sheet activities present to bank regulators, and what have they done about it?

Not showing up on the balance sheets, so they cannot be dealt with by simple bank capital requirements, which are based on bank assets, such as a leverage ratio. Bank regulators dealt with this by requiring banks to set aside additional bank capital for different off balance sheet activities

Full Service Brokers

Offer clients research and investment advice, but usually charge higher commission rates

Which of the following statements are true of Treasury Bills?

Only A and B of the above are true; The market for Treasury Bills is extremely deep and liquid, and Occasionally, investors find that earnings on T-bills do not compensate them for changes in purchasing power due to inflation.

Eurodollars

Only A and B of the above; Are time deposits with fixed maturities and are, therefore, somewhat illiquid. May offer the borrower a lower interest rate that can be received in the domestic market.

Money Market Funds

Open end funds that invest only in money market securities; offer check writing privileges

Thrift Industry:Credit Unions

Organized around a particular group of individuals with a common bond; regulatory changes allow individual credit unions to cater to a more diverse group of people

How does the FDIC handle failed banks? (Two Ways)

Payoff Method- where the bank is permitted to fail Purchase and Assumption Method- where the bank is folded into another banking organization

Predict what will happen to interest rates on a corporation's bonds if the federal government guarantees today that it will pay creditors if the corporation goes bankrupt in the future. What will happen to the interest rates on Treasury securities?

Predict what will happen to interest rates on a corporation's bonds if the federal government guarantees today that it will pay creditors if the corporation goes bankrupt in the future. What will happen to the interest rates on Treasury securities? The government guarantee will reduce the default risk on corporate bonds, making them more desirable relative to Treasury securities. The increased demand for corporate bonds and decreased demand for Treasury securities will lower interest rates on corporate bonds and raise them on Treasury bonds.

Venture Capital Firms

Provide fund for start up companies; often become very involved with firm management and provide expertise

Discount Broker

Provides facilities to buy/sell securities but offers no advice; many online discount brokerage firms do have research available

"Too big to Fail"

Regulators are reluctant to let the largest banks fail because of the potential impact on the entire system

What was the motivation behind legislation separating commercial baking from investment banking

Regulators felt that investment banking was riskier and had led to bank failures during the great depression.

Eurodollars

Represent dollar denominated deposits held in foreign banks

The portion of checkable deposits that banks are required to hold is called

Required Reserves

What happens to reserves at the First National Bank if one person withdraws 900 of cash and another person deposits 600 of cash

Reserves -300 Checkable -300

What are the assets on a banks balance sheet?

Reserves, Reserve Requirement, Cash items in process of collection, Securities, Loans, Deposit at other bank

Provisions in loan contracts designed to mmitigate the moral hazard problem are called

Restrictive covenants

6) What facts about financial structure can be explained by moral hazard?

Risk of moral hazard leads lenders to require complex contracts with restrictive and prescriptive covenants.

Risk premiums on corporate bonds are usually anti-cyclical; that is, they decrease during business cycle expansions and increase during recessions. Why is this so?

Risk premiums on corporate bonds are usually anti-cyclical; that is, they decrease during business cycle expansions and increase during recessions. Why is this so? During business cycle booms, fewer corporations go bankrupt and there is less default risk on corporate bonds, which lowers their risk premium. Similarly, during recessions, default risk on corporate bonds increases and their risk premium increases. The risk premium on corporate bonds is thus anticyclical, rising during recessions and falling during booms.

Short Sales

Sell a security you dont own with the intent of buying it back at a later date

Examples of off balance sheet activities include

Selling loan portfolios

Glass-Steagall Act

Separated the activities of commercial banks from those of the securities industry; allowed commercial banks to sell on the run government securities, but prohibited underwriting

If you are a banker and expect interest rates to rise in the future, would you want to make short term or long term loans?

Short term so when these loans mature, you will be able to make loans at higher interest rates, generating more income.

The share of checkable deposits in toatl bank liabilities has

Shrunk over time

When investors are involved in trading activities in an attempt to outguess markets they are

Speculating

10) A stock's market value will be higher the higher its expected dividend stream is, all else being equal.

TRUE

11) The Gordon growth model assumes that a stock's dividend grows at a constant rate forever.

TRUE

13) About 95% of orders to buy or sell on the NYSE are executed using SuperDOT.

TRUE

2) In over-the-counter markets, dealers increase the liquidity of thinly traded securities.

TRUE

5) Common stock is the riskiest corporate security, followed by preferred stock and then bonds.

TRUE

6) The Enron financial scandal increased uncertainty about the quality of accounting information and as a result, increased required return on investment in stocks.

TRUE

8) The Securities and Exchange Commission requires firms to submit various documents to increase the flow of information to investors but does not verify the accuracy of that information.

TRUE

The Fed is the most independent of all U.S. government agencies. What is the main difference between it and other government agencies that explains the Fed's greater independence?

The Fed is the most independent of all U.S. government agencies. What is the main difference between it and other government agencies that explains the Fed's greater independence? The Fed is more independent because its substantial revenue from securities and discount loans allows it to control its own budget.

The Fed promotes secrecy by not releasing the minutes of the FOMC meetings to Congress or the public immediately. Discuss the pros and cons of this policy.

The Fed promotes secrecy by not releasing the minutes of the FOMC meetings to Congress or the public immediately. Discuss the pros and cons of this policy. The argument for not releasing the FOMC directives immediately is that it keeps Congress off the Fed's back, thus enabling the Fed to pursue an independent monetary policy that is less subject to inflation and political business cycles. The argument for releasing the directive immediately is that it would make the Fed more accountable.

Explain the behavior of the Fed.

The Fed serves in the interest of the public and seek to maximize their own welfare

What law separated investment banking from commercial banking

The Glass Steagall Act (1933)

Asset Management

The attempt to earn the highest possible return on asset while minimizing the risk

How could higher deposit insurance premiums for banks with riskier assets benefit the economy?

The economy would benefit from reduced moral hazard, Banks would not want to take on too much risk because it would increase their deposit insurance premiums.

Private Placements

The entire issue is sold to a small, select group of investors

Which goals of the Fed frequently conflict?

The goal of price stability often conflicts with the goal of high economic growth, unemployment, and interest rate stability

Federal Fund Rate

The interest rate on overnight loans of reserves from one bank to another, an open market purchase will cause rate to fall (more money in system)

Why would an investment banker advise a firm to issue a security using best efforts rather than overwriting

The investment banker and the firm may not be able to agree on a price or the issue may be too small for the investment banker to want to invest the time and effort needed to arrive at the price.

Do you think the lemons problem would be more sever for stocks traded on the New York Stock Exchange or those traded over the counter? Explain.

The lemons problem would be less severe for firms listed on the New York Stock Exchange because they are typically larger corporations which are better known in the marketplace. Therefore it is easier for investors to get information about them and figure out whether the firm is of good quality or is a lemon. This makes the adverse selection-lemons problem less severe.

Cost Advantages

The mutual fund can negotiate lower transaction fees than would be available to the individual investor

Non-Transaction Deposits (Liability)

The overall primary source of bank liabilities and are accounts from which the depositor cannot write checks; savings accounts and CDs

The principal agent problem that exists for bank trading activities can be reduced through

The physical separation of trading activities from bookkeeping activites

Why has the developement of overnight loan markets made it more likely that banks will hold fewer excess reserves

The presence of overnight loan markets thus reduces the costs associated with deposit outflows

Why have banks been losing cost advantages in acquiring funds in recent years?

The rise of inflation and the resulting higher interest rates on alternatives to CDs meant banks had a big shrinkage in this low cost way of raising funds.

What is interest rate risk?

The risk that a bonds price will change die to changes in market interest rates.

Bank Capital (Liability)

The source of funds supplied by the bank owners, either directly through purchase of ownership shares or indirectly through retention of earnings

Securitization

The transformation of illiquid assets into marketable capital market instruments

5) How do loss aversion, overconfidence of investors, and social contagion affect market efficiency?

These are all behavioral reactions that do not follow market fundamentals. As such they make markets less efficient.

What are three characteristics of Money Market securities?

They are usually sold in large denomination, have low default risk, and mature in one year or less

Does the Federal Reserve directly set the federal funds interest rate? How do they influence rate?

They cannot directly set federal funds rate, but can influence it by adding funds or withdrawing reserves from the economy.

What valuable services do dealers provide that facilitates transaction trading and keeping the markets liquid.

They make a market by standing ready to buy or sell securities

13. If a bank finds its ROE is too low because it has too much bank capital, what can it do to raise its ROE?

To lower capital and raise ROE, holding its assets constant, it can pay out more dividends or buy back some of its shares. Alternatively, it can keep its capital constant but increase the amount of its assets by acquiring new funds and then seeking out new loan business or purchasing more securities with these new funds.

Why does the government use money markets?

To sell large volumes of securities to support government spending; the government has spent more each year than it has made from tax revenue.

Money market instruments issued by the U.S. treasury are called:

Treasury Bills

What are some money market instruments?

Treasury Bills, Negotiable CDs, Banker Acceptances, Repurchase Agreements, Commercial Paper, Eurodollars, and Federal Funds

"If stock prices did not follow a random walk, there would be unexploited profit opportunities in the market." Is this statement true, false, or uncertain? Explain your answer.

True, as an approximation. If large changes in a stock price could be predicted, then the optimal forecast of the stock return would not equal the equilibrium return for that stock. In this case, there would be unexploited profit opportunities in the market and expectations would not be rational. Very small changes in stock prices could be predictable, however, and the optimal forecast of returns would equal the equilibrium return. In this case, an unexploited profit opportunity would not exist.

"Banking has become a more dynamic industry because of more active liability management." Is this true, false, or uncertain? Explain.

True, banks can now pursue new loan business much more aggressively because when they see profitable loan opportunities, they can use liability management to acquire new funds and expand banks business.

"Banking has become a more dynamic industry because of more active liability management." Is this statement true, false or uncertain?

True. Banks can now pursue new loan business much more aggressively than in the past because when they see profitable loan opportunities, they can use liability management to acquire new funds and expand the bank's business.

What does the structure of the Federal Reserve include?

Twelve federal reserve banks, Board of Governors, Federal Open Market Committee, Federal Advisory Council, Member Banks

2) How does the U.S. differ from other countries with respect to the source of funding for nonfinancial business?

US is lowest in bank loans, highest in Non-bank loans, bonds and stocks in that order. Germany, Japan, and Canada highest in bank loans, 76%, 78%, 56%

Undersubscribed

Unable to generate interest in all of the available shares

What four crucial functions do investment banks perform in financial markets?

Underwrite the initial sale of stocks/bonds; deal maker in merger and acquisitions, middleman in purchase or sale of companies , private broker to the very wealthy

Commercial Paper

Unsecured debt issued by corporations with short original maturity

What effect would reducing income tax rates have on the interest rates of municipal bonds? Would interest rates of Treasury securities be affected and, if so, how?

What effect would reducing income tax rates have on the interest rates of municipal bonds? Would interest rates of Treasury securities be affected and, if so, how? The reduction in income tax rates would make the tax-exempt privilege for municipal bonds less valuable, and they would be less desirable than taxable Treasury bonds. The resulting decline in the demand for municipal bonds and increase in demand for Treasury bonds would raise interest rates on municipal bonds while causing interest rates on Treasury bonds to fall.

Asset Transformation

When a bank takes your savings deposits and uses the funds to make, say, a mortgage loan

Equity Sales

When a firm sells an entire division, enlisting the aid of an investment banker; assists in determining the value of division or firm; develop confidential financial statements for prospective buyer

Securities Orders

When you call a brokerage house to buy or sell a security

Which entities in the Federal Reserve System control the discount rate? Reserve requirement? Open market operations?

Which entities in the Federal Reserve System control the discount rate? Reserve requirement? Open market operations? The Board of Governors sets reserve requirements and the discount rate; the FOMC directs open market operations. In practice, however, the FOMC helps make decisions about reserve requirements and the discount rate.

If you are a banker and expect interest rates to rise in the future, would you want to make short-term or long-term loans?

You should want to make short-term loans. Then, when these loans mature, you will be able to make loans at higher interest rates, which will generate more income for the bank.

Limit Order

You specify the most you are willing to pay or the least you are willing to accept for a security

what is a sinking fund? do investors like bonds that contain this feature?

a sinking fund contains funds set aside by the issuer of the bond to pay for the redemption of the bond when it matures. because a sinking fund increases the likelihood that a firm will have the funds to pay off the bonds as required, investors like the feature. as a result, interest rates are lower on securities with sinking funds.

distinguish between competitive bidding and non-competitive bidding for treasury securities

a treasury auction will sell a certain face amount of securities. the non-competitive bids will all settle at the yield dictated by the auction. thus, the face amount of non-competitive bids are removed from the total amount to be auctioned by competitive bid. the competitive bids are ranked according to yield and the auction is settled at the lowest yield for which there are enough bids at a lower yield to clear the remaining auction amount. winning competitive and non-competitive bids are settled at this yield.

Describe two conflicts of interest that occur when underwriting and research are provided by a single investment firm.

a. Research analysts in investment banks might distort their research to please issuers of securities so underwriters in the investment bank can get their business. b. Investment banks might engage in spinning, a form of kickback in which they allocate hot, but underpriced, IPOs to executives in return for their companies' future business.

If the fed wants to lower the federal funds interest rate, it will _________ the banking system by _________ securities.

add reserves to; buying

4) Distinguish between adverse selection and moral hazard.

adverse selection before the transaction, moral hazard after

Commercial paper securities

all of the above; are issued only by the largest and most creditworthy corporations, as they are unsecured. Carry an interest rate that varies according to the firm's level of risk. Never have a term to maturity that exceeds 270 days.

federal funds are

all of the above; usually overnight investments, borrowed by banks that have a deficit of reserves, and lent by banks that have an excess of reserves.

Negotiable certificates of deposit

are only A and B of the above; are bearer instruments because their holders earn the interest and principal at maturity, and typically have a maturity of one to four months

7) What factors usually cause an increase in moral hazard?

asymmetric information

8) What factors usually cause an increase in adverse selection?

asymmetric information

14) What conflicts of interest can arise in accounting firms?

auditing and consulting. Auditors may skew their opinions to win consulting contracts. Arthur Andersen auditors did not want to unfavorable audits to big clients.

why are banker;s acceptances so popular for international transactions?

banker's acceptances substitute the credit worthiness of a bank for that of a business. when a company sells a product to a company it is unfamiliar with, it often prefers to have the promise of a bank that payment will be made.

why do banks not eliminate the need for 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.

what is the document called that lists the terms of a bond?

bond indenture

Transformation of assets can be accomplished by

borrowing short and lending long

why do businesses use the money market?

businesses both invest and borrow in the money markets. they borrow to meet short-term cash flow needs, often by issuing commercial paper. they invest in all types of money market securities as an alternative to holding idle cash balances

Why do investment banking firms often form syndicates for selling securities to the public

by forming a syndicate the risk of the issue is spread among many different firms and more brokers will be attempting to sell the securities

what characteristics define the money markets?

can be characterized as having securities that trade in one year or less, are one of large denomination, and are very liquid

describe the two ways whereby capital market securities pass from the issuer to the public?

capital market securities may be sold in a public offering or in a private placement. in a public offering, investment bankers register the security with the SEC and market it through a network of brokerage houses. in a private placement, the firm or an investment bankers sells the securities to a very large number of investors, who each buy a large quantity.

who issues federal funds, and what is the usual purpose of these funds?

federal funds are sold by banks to other banks. they're used to invest excess reserves and to raise reserves is a bank is short

a call provision on a bond allows the issuer to redeem the bond at will. investors don't like call provisions and so require higher interest on callable bonds. who do issuers continue to issue callable bonds anyway?

firms like having the flexibility to adjust their capital structure by paying off debt they no longer need. they also need to pay off debt to remove restrictive covenants. call provisions permit both these actions at the issuers discretion.

what motivates regulators to impose interest ceilings on bank savings accounts? what effect did this eventually have on the money markets?

following the great depression, regulators were primarily concerned with stopping banks from failing. by removing interest-rate competition, bank risk was substantially reduced. the problem with these regulations was that when market interest rates rose above the established interest-rate ceiling, investors withdrew their funds from banks.

The advantage of mutual funds is that they

give investors with relatively small amounts of cash to invest access to large-denomination securities.

contrast investors use of capital markets with their use of money markets

investors use capital markets for long-term investment purposes. they use money markets, which have lower yields, primarily for temporary or transaction purposes.

Asset-backed commercial paper differs from conventional commercial paper in that

it is backed (secured) by some bundle of assets.

is it better for a security issue to be fully subscribed or oversubscribed?

it is better to be fully subscribed because oversubscription indicated that the investment bankers priced the securities too low.

who issues commercial paper and for what purpose?

large businesses with very good credit standings sell commercial paper to raise short term funds. the most common use of these funds is to extend short term funds. the most common use of these funds is to extend short-term loans to customers for the purchase of the firm;s products.

A bank with excess reserves can economize on these reserves by

lending reserves in the federal funds market

why are more funds from property and casualty insurance companies than funds from life insurance companies invested in the money markets?

life insurance companies can invest for the long term because the timing for their liabilities is known with reasonable accuracy. property and casualty insurance companies cannot predict the natural disasters that cause large payouts on policies.

Banks generate profits by earning higher returns on their ----- than the pay in interest on -----

loans, deposits

Large-denomination CDs are ------, so that like a bond, they have a ------- degree of liquidity and can be sold in secondary markets

negotibale, greater

A banker's acceptance is

only A and B of the above; used to finance goods that have not yet been transferred from the seller to the buyer. an order to pay a specified amount of money to the bearer on a given date.

9) What is the principal-agent problem?

particular type of moral hazard. Stock holders, "the principals" are not the managers. Managers are "agents" of the principles. Problem is that without close supervision by principles, managers (agents) do not always act in the best interest of the principals.

Treasury bills do not

pay interest

Gap analysis measures the difference between a banks

rate-sensitive

If the fed wants to raise the federal funds interest rate, it will _________ the banking system by _________ securities.

sell; remove reserves from

what are primary capital market securities, and who are the primary purchasers of these securities?

stocks and bonds. most of these are purchased by and owned by households

distinguish between a term security and a demand security.

term securities have a specific maturity date. demand securities can be redeemed at any time. a six-month certificate of deposit is a term security. a checking account is a demand security.

Which of the following is the largest borrower in the money markets?

the U.S. treasury

why does the US government use the money market?

the US government sells large numbers of securities in the money markets to support government spending. over the past several decades, the government has spent more each year than it has received in tax revenues. it makes up the difference by borrowing. part of what it borrows comes from the money markets.

14. What are the benefits and costs for a bank when it decides to increase the amount of its bank capital?

the benefit is that the bank now has a larger cushion of bank capital and so is less likely to go broke if there are losses on its loans or other assets. The cost is that for the same ROA, it will have a lower ROE, return on equity.

is a treasury bond issued 29 years ago with 6 months remaining before it matures a money market instrument?

the bond would not be considered a money market security because money market securities have an original maturity of less than a year.

does the federal reserve directly set the federal funds interest rate? how does the fed influence this 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.

a bond provides info abut its par value, coupon interest rate, and maturity date. define each of these.

the par value is the amount the issuer will pay the holder when the bond matures. the coupon interest rate is multiplied times the the par value to determine the interest payment the issuer must make each year. the maturity date is when the issuer must bay the holder the par value.

distinguish between the primary market and the secondary market for securities

the primary market is for securities being issued for the very first time, and the issuer receives the funds paid for the security. the secondary market is for securities that have been issued previously but are being traded smong investors.

as interest rates in the market change over time, the market price of bonds rises and falls. the change in the value of bonds due to change in interest rates is a risk incurred by bond investors. what is this risk called?

the risk that a bond's price will change due to changes in market interest rates is called INTEREST RISK RATE.

which of the money market securities is the most liquid and considered the most risk-free? why?

treasury bills are usually viewed as the most liquid and least risky of securities because they're backed by the strength of the US government and trade in extremely large volumes

the US treasury issues bills, notes, and bonds. how do these three securities differ?

treasury bills mature in less than 1 year, treasury notes mature in 1 to 10 years, and treasury bonds mature in 10 to 30 years.

What does it mean to say that investment bankers underwrite a security offering? how is this different from a best-efforts offering?

when an offering is underwritten, the investment banker purchases the issue at a pre-specified price. in a best efforts issue, the investment banker does not need to take ownership.

Which of the following are true statements about participants in the money markets?

- Large banks participate in the money markets by selling large negotiable CDs. - The U.S. government and corporations borrow in the money markets because cash inflows and outflows are rarely synchronized. - The Federal Reserve is the single most influential participant in the U.S. money market.

Which of the following statements about the money markets are true?

- Most money market securities do not pay interest. Instead, the investor pays less for the security than it will be worth when it matures. - Pension funds invest a portion of their assets in the money market to have sufficient liquidity to meet their obligations. - Unlike most participants in the money market, the U.S. Treasury Department is always a demander of money market funds and never a supplier.

Which of the following statements about the money markets are true?

- Not all commercial banks deal for their customers in the secondary market. - Money markets are used extensively by businesses both to warehouse surplus funds and to raise short-term funds.

Which of the following statements about money market securities are true?

- The interest rates on all money market instruments move very closely together over time. - The secondary market for Treasury bills is extensive and well developed. - There is no well-developed secondary market for commercial paper.

Negotiable certificates of deposit

- are bearer instruments because their holders earn the interest and principal at maturity. - typically have a maturity of one to four months.

Commercial paper securities

- are issued only by the largest and most creditworthy corporations, as they are unsecured. - carry an interest rate that varies according to the firm's level of risk. - never have a term to maturity that exceeds 270 days.

Federal funds

- are short-term funds transferred between financial institutions, usually for a period of one day. - actually have nothing to do with the federal government. - provide banks with an immediate infusion of reserves.

Eurodollars

- are time deposits with fixed maturities and are, therefore, somewhat illiquid. - may offer the borrower a lower interest rate than can be received in the domestic market.

Money market instruments

- are usually sold in large denominations. - have low default risk. - mature in one year or less.

Banker's acceptances

- can be bought and sold until they mature - are issued only by large money center banks - carry low interest rates because of the very low default risk

Money market transactions

- do not take place in any one particular location or building. - are usually arranged purchases and sales between participants over the phone by traders and completed electronically.

A negotiable certificate of deposit

- is a term security because it has a specified maturity date. - is a bearer instrument, meaning whoever holds the certificate at maturity receives the principal and interest. - can be bought and sold until maturity.

The Fed can influence the federal funds interest rate by adjusting the level of reserves available to banks. The Fed can

- lower the federal funds interest rate by adding reserves. - raise the federal funds interest rate by removing reserves. - remove reserves by selling securities.

The banking industry

- should have an efficiency advantage in gathering information that would eliminate the need for the money markets. - exists primarily to mediate the asymmetric information problem between saver-lenders and borrower-spenders. - is subject to more regulations and governmental costs than the money markets.

A banker's acceptance is

- used to finance goods that have not yet been transferred from the seller to the buyer. - an order to pay a specified amount of money to the bearer on a given date.

Repos are

- usually low-risk loans. - usually collateralized with Treasury securities. - low interest rate loans.

Federal funds are

- usually overnight investments. - borrowed by banks that have a deficit of reserves. - lent by banks that have an excess of reserves.

Brokerage firms that offered money market security accounts in the 1970s had a cost advantage over banks in attracting funds because the brokerage firms

- were not subject to deposit reserve requirements. - were not subject to the deposit interest rate ceilings.