Exam 1: MONEY, BANKING, & CREDIT In Tutorial Library

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TITLE: Exam 1: MONEY, BANKING, & CREDIT

CLASS / COURSE: Finance

QUESTION DESCRIPTION:

Money, Banking, & Credit

Exam 1 Summer II 2007

1.      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.

2.      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.

3.      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

4.      Federal funds are

(a)   usually overnight investments.

(b)   borrowed by banks that have a deficit of reserves.

(c)   lent by banks that have an excess of reserves.

(d)   all of the above.

(e)   only (a) and (b) of the above.

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

(a)   adds; raising

(b)   removes; lowering

(c)   adds; lowering

(d)   removes; raising

6.      An open market purchase of Treasuries by the Fed

(a)   shifts the supply curve for reserves to the right and causes the federal funds rate to fall.

(b)   shifts the demand curve for reserves to the right and causes the federal funds rate to rise.

(c)   shifts the supply curve for reserves to the left and causes the federal funds rate to rise.

(d)   shifts the demand curve for reserves to the left and causes the federal funds rate to fall.

7.      If the Fed increases reserve requirements, the demand for reserves _________ and the equilibrium federal funds rate _________.

(a)   increases; drops

(b)   decreases; rises

(c)   decreases; drops

(d)   increases; rises

8.      (I) The main objective of the Federal Reserve in its conduct of monetary policy is to maintain price stability.                                                                                           (II) Money markets are used extensively by businesses both to warehouse surplus funds and to raise short-term funds.

(a)   (I) is true, (II) false.

(b)   (I) is false, (II) true.

(c)   Both are true.

(d)   Both are false.

9.      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.

 

10.   The term structure of interest rates is

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

(b)   the structure of how interest rates move over time.

(c)   the relationship among the terms to maturity of different bonds.

(d)   the relationship among interest rates on bonds with different maturities.

11.   Which of the following long-term bonds should have the lowest interest rate?

(a)   Corporate Baa bonds

(b)   U.S. Treasury bonds

(c)   Corporate Aaa bonds

(d)   Municipal bonds

12.   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.

13.   When the expected inflation rate increases, the demand for bonds _________, the supply of bonds _________, and the interest rate _________.

(a)   increases; increases; rises

(b)   decreases; decreases; falls

(c)   increases; decreases; falls

(d)   decreases; increases; rises

14.   (I) If a corporate bond becomes less liquid, the interest rate on the bond will fall.                                                                                                               (II) If a corporate bond becomes less liquid, the interest rate on Treasury bonds will fall.

(a)   (I) is true, (II) false.

(b)   (I) is false, (II) true.

(c)   Both are true.

(d)   Both are false.

15.   During business cycle expansions when income and wealth are rising, the demand for bonds _________ and the demand curve shifts to the _________.

(a)   falls; right

(b)   falls; left

(c)   rises; right

(d)   rises; left

16.   Which of the following are true of coupon bonds?

(a)   The owner of a coupon bond receives a fixed interest payment every year until the maturity date, when the face or par value is repaid.

(b)   U.S. Treasury bonds and notes are examples of coupon bonds.

(c)   Corporate bonds are examples of coupon bonds.

(d)   All of the above.

(e)   Only (a) and (b) of the above.

17.   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)   Investors can earn abnormal profits by using past trading patterns of stocks.

(d)   all of the above are sensible strategies.

(e)   only (a) and (b) of the above are sensible strategies.

18.   If you expect the inflation rate to be 15 percent next year and a one-year bond has a yield to maturity of 7 percent, then the real interest rate on this bond is

(a)   7 percent.

(b)   22 percent.

(c)   –15 percent.

(d)   –8 percent.

(e)   none of the above.

19.   (I)  Prices of longer-maturity bonds respond more dramatically to changes in interest rates.                                                                                                                                   (II) Prices and yields for long-term bonds are less volatile than those for short-term bonds.

(a)   (I) is true, (II) false.

(b)   (I) is false, (II) true.

(c)   Both are true.

(d)   Both are false.

20.   (I)  Once agency conflicts arise there are no significant measures to minimize these conflicts.                                                                                                                                   (II) The value of a firm increases with the dispersion of ownership of the firm (positive relationship

(a)   (I) is true, (II) false.

(b)   (I) is false, (II) true.

(c)   Both are true.

(d)   Both are false.

21.   Which if the following is NOT a solution to moral hazard in a firm

(a)   the threat of takeover

(b)   Disclosure of financial information through regulation 

(c)   Loans that are contingent upon the behavior of the firm

(d)   Fines and the threat of going to jail

 

22.   Assume that interest rates on 20-year Treasury and corporate bonds are as follows: T-bond = 7.72%; A = 9.64%; AAA = 8.72%; BBB = 10.18% The differences in rates among these issues were caused primarily by

(a)   differences in default risk

(b)   differences in maturity risk

(c)   tax effects

(d)   differences in inflation expectations

(e)   differences in real rates

 

 

 

23.   You notice that the price of a 4.0% coupon, 12-year Treasury Note is priced at 90:16 in the Wall Street Journal.  What is the bonds yield to maturity?

(a)   2.56%

(b)   2.865%

(c)   5.07%

(d)   5.13%

 

24.   Reinvestment risk is the risk that

(a)   a bond’s value may fall in the future.

(b)   a bond’s future coupon payments may have to be invested at a rate lower than the bond’s yield to maturity.

(c)   an investor’s holding period will be short and equal in length to the maturity of the bonds he or she holds.

(d)   a bond’s issuer may fail to make the future coupon payments and an investor will have no cash to reinvest.

25.   Financial markets are necessary because

(a)   they allow a more efficient allocation of resources and capital in the economy

(b)   they allow consumption and investing decisions to be made separable.

(c)   markets save the search costs associated with finding counterparties to lend or borrow capital  

(d)   Both A & B are correct

(e)   All of the above are correct

26.   Which of the following are subject to adverse selection

(a)   Ebay bidders AND Ebay sellers

(b)   The admissions committee at Texas Tech

(c)   Person applying for life insurance

(d)   Both A & B are correct

(e)   All of the above are correct

 

 

27.   Suppose the real risk-free rate is 3.50%, the average future inflation rate is 2.25%, a maturity premium of 0.08% per year to maturity applies, i.e., MRP = 0.08%(t), where t is the years to maturity. Suppose also that a liquidity premium of 0.5% and a default risk premium of 0.85 applies to A-rated corporate bonds. How much higher would the rate of return be on a 5-year A-rated corporate bond than on a 5-year Treasury bond? Here we assume that the pure expectations theory is NOT valid, and disregard any cross-product terms, i.e., if averaging is required, use the arithmetic average.
   (a)   1.05%

(b)   1.25%

(c)   1.45%

(d)   1.65%

(e)   None  of the above

 

28.   Suppose you bought a five-year, 10% coupon rate security for $1000. Suppose one year later investors require an 8% return for a comparable bond.  If you decide to sell the bond, what would your total rate of return be for this one-year investment? (2 points)

(a)   10%

(b)   12.45%

(c)   14.55%

(d)   16.62%

(e)    None of the above

 

29.   Assume that a Treasury note that matures in 4 years has a yield to maturity of 8%.  If the yield on a 3-year Treasury note is 6%, what is the one year forward rate, three years from today?

(a)   11.67%

(b)   13.88%

(c)   14.23%

(d)   None of the above

 

30.   For at least the next 10 years, the real risk-free rate of interest, r*, is expected to remain at 3%, inflation is expected to steadily increase steadily, and the maturity risk premium is expected to be 0.1(t )%, where t is the number of years until the bond matures. Given this information, which of the following statements is correct?

(a)   the yield on 2-year Treasury securities must exceed the yield on 5-year Treasury securities.

(b)   the yield on 5-year Treasury securities must exceed the yield on 10-year corporate bonds.

(c)    the yield on 5-year corporate bonds must exceed the yield on 8-year Treasury bonds.

(d)    the yield curve must be "humped."

(e)    the yield curve must be upward sloping.

31.   When the riskiness of all corporate bonds decrease, the demand for corporate bonds _________ and the demand Treasury bonds _________.

(a)   increases; decreases

(b)   decreases; increases

(c)   decreases; decreases

(d)   increases; increases

 

32.   What does the January 15, 1981 yield curve tell you about the direction of interest rates

(a)   Interest rates are expected to remain fairly constant over the next 5 years

(b)   Interest rates are expected to increase over the next 5 years

(c)   Interest rates are expected to decline substantially over the next 10 years

(d)   None of the above

33.    (I)  Financial intermediaries are not necessary today because financial markets allow firms to issue equity and raise debt                                                                                                                                                                                 (II) Unless a bond defaults, an investor cannot lose money investing in bonds.

 (a)  (I) is true, (II) false.

(b)   (I) is false, (II) true.

(c)   Both are true.

(d)   Both are false.

 

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SUBJECTS / CATEGORIES:
1. Finance
2. Financial Management
3. Accounting
4. Corporate Finance
5. Business Economics
6. Economics

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