Key Concepts in Financial Markets and Interest Rates
Key Concepts in Financial Markets
1) Every financial market performs the following function:
D) It channels funds from lenders-savers to borrowers-spenders.
4) Which of the following can be described as involving direct finance?
B) A corporation buys commercial paper issued by another corporation.
5) Which of the following can be described as involving indirect finance?
A) A corporation takes out loans from a bank.
B) People buy shares in a mutual fund.
C) A corporation buys commercial paper in a secondary market.
D) All of the above.
E) Only A and B of the above.
15) A corporation acquires new funds only when its securities are sold in the:
A) secondary market by an investment bank.
B) primary market by an investment bank.
30) An investor who puts all her funds into one asset ________ her portfolio’s ________.
B) decreases; diversification
The correct answer is increases risk. Diversification reduces risk.
32) The presence of ________ in financial markets leads to adverse selection and moral hazard problems that interfere with the efficient functioning of financial markets.
A) noncollateralized risk
C) asymmetric information
34) When the potential borrowers who are the most likely to default are the ones most actively seeking a loan, ________ is said to exist.
B) adverse selection
39) Successful financial intermediaries have higher earnings on their investments because they are better equipped than individuals to screen out good from bad risks, thereby reducing losses due to:
B) adverse selection.
40) In financial markets, lenders typically have inferior information about potential returns and risks associated with any investment project. This difference in information is called:
B) asymmetric information.
43) Which of the following are not investment intermediaries?
A) A life insurance company
B) A pension fund
C) A mutual fund
D) Only A and B of the above
46) Asymmetric information can lead to widespread collapse of financial intermediaries, referred to as a:
B) financial panic.
47) Which of the following is not a regulator of part of the U.S. financial system?
A) National Credit Union Administration
B) Securities and Exchange Commission
C) Federal Reserve System
D) Federal Deposit Insurance Corporation
E) All of the above are regulators.
48) Asymmetric information can lead to the widespread collapse of financial intermediaries, referred as financial ________.
A) panic
49) The SEC restricts trading by the largest stockholders (known as ________) in corporations issuing securities.
A) insiders
50) The Federal Deposit Insurance Corporation (FDIC) insures each depositor at a commercial bank, savings and loan association, or mutual savings bank up to a loss of ________ per account.
B) $250,000
51) The major differences between financial regulation in the United States and abroad relate to bank regulation. Specifically, in the past, the U.S. was the only industrialized country to subject banks to restrictions on ________.
A) branching
56) Fire and casualty insurance companies are what type of intermediary?
A) Contractual savings institution
58) The largest depository institution (value of assets) at the end of 2012 was:
A) commercial banks.
59) At the end of 2012, the value of debt instruments in the U.S. was around ________ trillion, and the value of equities was around ________ trillion.
A) $38; $19
60) The DAX (Germany) and the FTSE 100 (London) are examples of ________.
C) foreign stock price indexes
Understanding Bond Pricing and Interest Rates
1) A loan that requires the borrower to make the same payment every period until the maturity date is called a:
B) fixed-payment loan.
2) A coupon bond pays the owner of the bond:
B) a fixed interest payment every period, plus the face value of the bond at the maturity date.
3) A bond’s future payments are called its:
A) cash flows.
4) A credit market instrument that pays the owner the face value of the security at the maturity date and nothing prior to then is called a:
D) discount bond.
9) If a $5,000 coupon bond has a coupon rate of 13 percent, then the coupon payment every year is:
A) $650.
10) An $8,000 coupon bond with a $400 annual coupon payment has a coupon rate of:
A) 5 percent.
11) The concept of ________ is based on the notion that a dollar paid to you in the future is less valuable to you than a dollar today.
A) present value
13) The process of calculating what dollars received in the future are worth today is called:
B) discounting the future.
14) With an interest rate of 5 percent, the present value of $100 received one year from now is approximately:
C) $95.
15) With an interest rate of 10 percent, the present value of a security that pays $1,100 next year and $1,460 four years from now is approximately:
B) $2,000.
16) With an interest rate of 8 percent, the present value of $100 received one year from now is approximately:
A) $93.
17) With an interest rate of 6 percent, the present value of $100 received one year from now is approximately:
C) $94.
21) For a simple loan, the simple interest rate equals the:
D) yield to maturity.
24) The yield to maturity of a one-year, simple loan of $400 that requires an interest payment of $50 is:
D) 12.5 percent.
26) A $10,000, 8 percent coupon bond that sells for $10,100 has a yield to maturity ________.
C) less than 8 percent
35) The yield to maturity on a consol bond that pays $200 yearly and sells for $1000 is:
C) 20 percent.
39) The yield to maturity for a one-year discount bond equals:
A) the increase in price over the year, divided by the initial price.
40) If a $10,000 face value discount bond maturing in one year is selling for $8,000, then its yield to maturity is:
C) 25 percent.
41) If a $10,000 face value discount bond maturing in one year is selling for $9,000, then its yield to maturity is approximately:
C) 11 percent.
42) If a $10,000 face value discount bond maturing in one year is selling for $5,000, then its yield to maturity is:
D) 100 percent.
45) 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:
D) -8 percent.
47) The nominal interest rate minus the expected rate of inflation:
A) defines the real interest rate.
B) is a better measure of the incentives to borrow and lend than the nominal interest rate.
C) is a more accurate indicator of the tightness of credit market conditions than the nominal interest rate.
D) all of the above.
E) only A and B of the above.
48) The nominal interest rate minus the expected rate of inflation:
A) defines the real interest rate.
51) What is the return on a 5 percent coupon bond that initially sells for $1,000 and sells for $1,200 one year later?
D) 25 percent
53) The return on a 5 percent coupon bond that initially sells for $1,000 and sells for $1,100 one year later is:
D) 15 percent.
54) The return on a 10 percent coupon bond that initially sells for $1,000 and sells for $900 one year later is:
C) 0 percent.
62) If an investor’s holding period is longer than the term to maturity of a bond, he or she is exposed to:
A) interest-rate risk.
B) reinvestment risk.
While reinvestment risk exists, interest rate risk is the primary concern when the holding period exceeds the term to maturity.
66) When the lender provides the borrower with an amount of funds that must be repaid to the lender at the maturity date, along with an additional payment for the interest, it is called a ________.
C) simple loan
67) A discount bond:
B) is also called a zero-coupon bond.
68) The interest rate that is adjusted for actual changes in the price level is called the:
A) ex-post real interest rate.
73) The real interest rate is actually the ex-ante real interest rate because it is adjusted for ________ changes in the price level.
B) expected
74) An ex-post real interest rate is adjusted for ________ changes in the price level.
A) actual
Supply and Demand in the Bond Market
1) As the price of a bond ________ and the expected return ________, bonds become more attractive to investors and the quantity demanded rises.
A) falls; rises
2) The supply curve for bonds has the usual upward slope, indicating that as the price ________, ceteris paribus, the ________ increases.
D) rises; quantity supplied
3) When the price of a bond is above the equilibrium price, there is excess ________ in the bond market and the price will ________.
C) supply; fall
4) When the price of a bond is below the equilibrium price, there is excess ________ in the bond market and the price will ________.
A) demand; rise
5) When the price of a bond is ________ the equilibrium price, there is an excess supply of bonds and the price will ________.
B) above; fall
6) When the price of a bond is ________ the equilibrium price, there is an excess demand for bonds and the price will ________.
D) below; rise
7) When the interest rate on a bond is above the equilibrium interest rate, there is excess ________ in the bond market and the interest rate will ________.
B) demand; fall
8) When the interest rate on a bond is below the equilibrium interest rate, there is excess ________ in the bond market and the interest rate will ________.
D) supply; rise
9) When the interest rate on a bond is ________ the equilibrium interest rate, there is excess ________ in the bond market and the interest rate will ________.
A) above; demand; fall
10) When the interest rate on a bond is ________ the equilibrium interest rate, there is excess ________ in the bond market and the interest rate will ________.
C) below; supply; rise
11) When the demand for bonds ________ or the supply of bonds ________, interest rates rise.
D) decreases; increases
12) When the demand for bonds ________ or the supply of bonds ________, interest rates fall.
B) increases; decreases
13) When the demand for bonds ________ or the supply of bonds ________, bond prices rise.
A) increases; decreases
14) When the demand for bonds ________ or the supply of bonds ________, bond prices fall.
D) decreases; increases
15) Factors that determine the demand for an asset include changes in the:
E) all of the above.
16) The demand for an asset rises if ________ falls.
A) risk relative to other assets
17) The higher the standard deviation of returns on an asset, the ________ the asset’s ________.
A) greater; risk
18) Diversification benefits an investor by:
C) reducing risk.
19) In a recession when income and wealth are falling, the demand for bonds ________ and the demand curve shifts to the ________.
B) falls; left
20) During business cycle expansions when income and wealth are rising, the demand for bonds ________ and the demand curve shifts to the ________.
C) rises; right
21) Higher expected interest rates in the future ________ the demand for long-term bonds and shift the demand curve to the ________.
C) decrease; left
22) Lower expected interest rates in the future ________ the demand for long-term bonds and shift the demand curve to the ________.
B) increase; right.
23) When people begin to expect a large stock market decline, the demand curve for bonds shifts to the ________ and the interest rate ________.
A) right; falls
24) When people begin to expect a large run up in stock prices, the demand curve for bonds shifts to the ________ and the interest rate ________.
D) left; rises