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Midterm Exam (Ch.1 ~ Ch.6)

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Started on Sunday, May 15, 2011, 04:01 PM

Completed on Sunday, May 15, 2011, 05:40 PM

Time taken 1 hour 39 mins

Marks 53/70

Grade 15.14 out of a maximum of 20 (76%)

1

Marks: 1

An increase in the riskiness of corporate bonds will ________ the yield on corporate bonds and ________ the yield on Treasury securities, everything else held constant.

Correct Marks for this submission: 1/1.

Choose one answer.

a. increase; reduce

b. reduce; reduce

c. reduce; increase

d. increase; increase

2

Marks: 1

When a company whose ability to repay its obligations in full is uncertain,

Choose one answer.

a. it must do so through financial markets rather than through financial intermediaries.

b. it will have to issue debt with longer maturities than would a company with a lower probability of default.

c. it must offer investors higher yields to compensate them for the risk they take in buying their bonds or making loans.

d. its bonds will sell for higher prices than would the bonds of a company with a lower probability of default.

Page 1 of 22FINA500-1900-SP11: Midterm Exam (Ch.1 ~ Ch.6)

5/15/2011http://moodle.unva.edu/moodle/mod/quiz/review.php?attempt=60395&showall=true


3

Marks: 1

The expectations theory


Choose one answer.

a. has difficulty explaining why yields on bonds of different maturities move together.

b. has difficulty explaining why U.S. Treasury securities have lower yields than corporate bonds.

c. has difficulty explaining why yield curves usually slope upward.

d. accounts well for the fact that yield curves usually slope upward.

4

Marks: 1

________ is the relative ease and speed with which an asset can be converted into a medium of exchange.


Choose one answer.

a. Specialization

b. Deflation

c. Efficiency

d. Liquidity

5

Marks: 1

In the figure above, the price of bonds would fall from P1 to P2



Incorrect Marks for this submission: 0/1.

Choose one answer.

a. the riskiness of bonds falls relative to other assets.

b. inflation is expected to increase in the future.

c. interest rates are expected to fall in the future.

d. the expected return on bonds relative to other assets is expected to increase in the future.

6

Marks: 1

As a result of higher expected inflation,

Incorrect Marks for this submission: 0/1.

Choose one answer.

a. the demand and supply curves for loanable funds both shift to the right and the equilibrium interest rate usually rises.

b. the demand and supply curves for loanable funds both shift to the left and the equilibrium interest rate usually falls.

c. the demand curve for loanable funds shifts to the left, the supply curve for loanable funds shifts to the right, and the equilibrium interest rate usually rises.

d. the demand curve for loanable funds shifts to the right, the supply curve for loanable funds shifts to the left, and the equilibrium interest rate usually rises.

7

Marks: 1

The price of a consol equals the coupon payment


Choose one answer.

a. plus the interest rate.

b. minus the interest rate.

c. times the interest rate.

d. divided by the interest rate.

8

Marks: 1

It is true that inflation is a

Choose one answer.

a. continually rising price level.

b. continuous fall in prices.




c. continuous increase in the money supply.

d. decline in interest rates.

9

Marks: 1

When the ________ interest rate is low, there are greater incentives to ________ and fewer incentives to ________.


Choose one answer.

a. market; lend; borrow

b. real; borrow; lend

c. nominal; lend; borrow

d. real; lend; borrow

10

Marks: 10

Last month, corporations supplied $250 billion in bonds to investors at an average market rate of 11.8%. This month, an additional $25 billion in bonds became available, and market rates increased to 12.2%. Assuming a Loanable Funds Framework for interest rates, and that the demand curve remained constant, derive a linear equation for the demand for bonds, using prices instead of interest rates.

Answer:

The supply and demand of corporate bonds determine the quantity of loanable funds in the market. The price of a bond is negatively associated with a particular level of interest rate. In other words, when the bond price rises the interest rate falls and vice a versa. The loanable funds framework also suggests that the supply and demand are stock variables and not flow variables. Based on these we can determine a relationship between the quantity of bonds demanded and the price of the bond at any point in time assuming all other variables are held constant.

We also know that the interest rate is related to the price of the bond based on following equation

Interest Rate on Bond = i = (F – P)/ P

Where P is the current price of the bond and the F is the face value of the bond



The question provides following details:

Last month :

Quantity of bonds in market = Q1 = $250B worth

Market Interest rate = i1 = 11.80%

Assuming the Face value of corporation Bond = F

Then price of bond last month = P1 = F/ (1 + i1) = F (1/ (1+ 0.118)) = 0.894454F ----- [1]

This month :

Quantity of bonds in market this month = Q2 = $250B + $25B worth = $275 B worth

Market Interest rate = i2 = 12.20%

Then price of bond this month = P2 = F/ (1 + i2) = F (1/ (1+ 0.122)) = 0.891265F ----- [2]

Also it is given that the demand curve has not shifted and has remained constant. We have two coordinates on the demand curve -

Coordinate 1: (Q1, P1) = (250, 0.894454F)

Coordinate 2: (Q2, P2) = (275, 0.891265F)

This enables us to determine the slope of the demand curve, assuming a straight line demand curve:

Slope = m = (P2-P1)/ (Q2-Q1) = (0.891265F - 0.894454F) / (275 –

250) = -1.2756 x 10-4 F

Thus the linear equation of the Demand curve becomes

Price = (-1.2756 x 10-4 F) x Quantity + Constant

Employing first coordinate to determine the constant we get

0.894454F = (-1.2756 x 10-4 F) x 250 +Constant

This implies that,

Constant = 0.926344F ----- [3]



Thus the linear equation for the demand for bonds using price can be written as,

Price = (-1.2756 x 10-4 F) x Quantity + 0.926344F ----- [4]

Where F is the Face value of the bond.

Usually the face value of the bond is $1,000, if we assume this then the equation [4] can be written as

Price = -0.12756 x Quantity + 926.344 ----- [5]

The equation [5] is the linear equation for the demand for bonds using bond prices.

11

Marks: 1

If money is declared to be legal tender, it must be


Choose one answer.

a. possible to exchange it for an equivalent amount of precious metal.

b. accepted to settle private transactions and it must be used in paying taxes.

c. minted from a precious metal.

d. acceptable to citizens of foreign countries.

12

Marks: 1

Under the expectations theory, an upward-sloping yield curve indicates that investors expect future short-term rates to


Choose one answer.

a. either rise or remain constant.

b. rise.

c. remain constant.

d. fall.

13

Marks: 1

During an economic recession,

Choose




one answer.

a. the demand curve for loanable funds shifts to the right, the supply curve for loanable funds shifts to the left, and the equilibrium interest rate usually falls.

b. the demand and supply curves for loanable funds both shift to the left and the equilibrium interest rate usually falls.

c. the demand curve for loanable funds shifts to the left, the supply curve for loanable funds shifts to the right, and the equilibrium interest rate usually rises.

d. the demand and supply curves for loanable funds both shift to the right and the equilibrium interest rate usually rises.

14

Marks: 1

In which of the following situations would you prefer to be the lender?


Choose one answer.

a. The interest rate is 4 percent and the expected inflation rate is 1 percent.

b. The interest rate is 13 percent and the expected inflation rate is 15 percent.

c. The interest rate is 9 percent and the expected inflation rate is 7 percent.

d. The interest rate is 25 percent and the expected inflation rate is 50 percent.

15

Marks: 1

Under the liquidity premium theory, the expectation that future short-term rates will be constant results in a yield curve that


Choose one answer.

a. is flat.

b. slopes downward.

c. slopes upward.

d. is flat, slopes upward, or slopes downward, depending on the size of the term premium at each maturity.

Evidence from business cycle fluctuations in the United States indicates that



16

Marks: 1


Choose one answer.

a. recessions have been preceded by dollar depreciation.

b. a negative relationship between money growth and general economic activity exists.

c. recessions have been preceded by a decline in the growth rate of money.

d. recessions have been preceded by declines in share prices on the stock exchange.

17

Marks: 5 You have paid $980.30 for an 8% coupon bond with a face value of $1,000 that mature in five years. You plan on holding the bond for one year. If you want to earn a 9% rate of return on this investment, what price must you sell the bond for? Is this realistic?

Answer: It is given in the question that

� Face Value of Coupon Bond = F = $1,000

� Coupon Rate = r = 8% per annum

� Maturity Term = n = 5 Years

� Expected Return after 1 year = 9%

We know,

Rate of Return = Current Yield + Capital Gain

= (Coupon Payment + P1 – P0) / P0

9% = (1000 * 8% + P1 – 980.30)/ 980.30

Solving for P1 we have:

P1 = 980.30 * (1+ 0.09) – 1000*0.08

P1 = 1068.53 – 80 = $988.53

Thus the bond should sell for $988.53 in 1 year’s time.

To answer the second part of the question viz. whether this is realistic, we determine that since the coupon was purchased at a discount at $980.30; the current interest rate in the market is



approximately 8.5%. One year from now, when the coupon is being sold, its price is determined based on the remaining term to maturity, which would be 4 years and the prevailing interest rates at that time.

Thus one year from now, for a coupon bond of face value $1,000 and 8% coupon rate maturing in next 4 years, to sell at $988.53 the prevailing interest rates at that time should be approximately 8.349%. A change from 8.50% to 8.349% in the market interest rates or YTM will determine whether or not the price of the bond will be $988.53. The market interest rates do fluctuate due to several macroeconomic conditions and business cycles and a drop of 0.1% in 1 year is reasonable and realistic.

18

Marks: 1

The risk structure of interest rates refers to


Choose one answer.

a. the amount of additional interest necessary to compensate savers for the greater risk of default on some bonds.

b. the relationship among the interest rates on bonds with the same maturity.

c. the relationship among the interest rates on similar bonds with different maturities.

d. the amount of additional yield necessary to compensate savers for the lesser liquidity of some bonds.

19

Marks: 1

An investment intermediary that lends funds to consumers is


Choose one answer.

a. a finance fund.

b. a consumer company.

c. an investment bank.

d. a finance company.

20

Marks: 1

Equity holders are a corporation's ________. That means the corporation must pay all of its debt holders before it pays its equity holders.




Choose one answer.

a. debtors

b. underwriters

c. residual claimants

d. brokers

21

Marks: 1

The supply curve for bonds has the usual upward slope, indicating that as the price ________, ceteris paribus, the ________ increases.


Choose one answer.

a. falls; quantity supplied

b. falls; supply

c. rises; supply

d. rises; quantity supplied

22

Marks: 1

If the expected path of 1-year interest rates over the next five years is 1 percent, 2 percent, 3 percent, 4 percent, and 5 percent, the expectations theory predicts that the bond with the highest interest rate today is the one with a maturity of


Choose one answer.

a. two years.

b. three years.

c. four years.

d. five years.

23

Marks: 1



The mound-shaped yield curve in the figure above indicates that short-term interest rates are expected to


Choose one answer.

a. rise in the near-term and fall later on.

b. remain unchanged in the near-term and fall later on.

c. fall moderately in the near-term and rise later on.

d. fall sharply in the near-term and rise later on.

24

Marks: 1

If a one-year bond currently yields 5% and is expected to yield 7% next year, the liquidity premium theory predicts that the yield today on a two-year bond should be


Choose one answer.

a. 5%.

b. 6%.

c. less than 6%, but more than 5%.

d. more than 6%.

25

Marks: 1

In which of the following situations would you prefer to be the borrower?

Choose a. The interest rate is 13 percent and the expected inflation




one answer.

rate is 15 percent.

b. The interest rate is 25 percent and the expected inflation rate is 50 percent.

c. The interest rate is 4 percent and the expected inflation rate is 1 percent.

d. The interest rate is 9 percent and the expected inflation rate is 7 percent.

26

Marks: 1

________ are financial intermediaries that acquire funds by selling shares to many individuals and using the proceeds to purchase diversified portfolios of stocks and bonds.


Choose one answer.

a. Mutual funds

b. Credit unions

c. Finance companies

d. Investment banks

27

Marks: 1

Everything else held constant, when real estate prices are expected to decrease


Choose one answer.

a. the demand curve for bonds shifts to the left and the interest rate falls.

b. the supply curve for bonds shifts to the right and the interest rate falls.

c. the demand curve for bonds shifts to the left and the interest rate rises.

d. the demand curve for bonds shifts to the right and the interest rate falls.

28

Marks: 1

Which of the following bonds would have the highest default risk?

Choose a. Junk bonds




one answer.

b. U.S. Treasury bonds

c. Municipal bonds

d. Investment-grade bonds

29

Marks: 1

Stock prices are


Choose one answer.

a. extremely volatile.

b. relatively stable trending downward at a moderate rate.

c. relatively stable trending upward at a steady pace.

d. unstable trending downward at a moderate rate.

30

Marks: 1

When yield curves are flat,


Choose one answer.

a. medium-term interest rates are above both short-term and long-term interest rates.

b. long-term interest rates are above short-term interest rates.

c. short-term interest rates are about the same as long-term interest rates.

d. short-term interest rates are above long-term interest rates.

31

Marks: 1

Thrift institutions include

Choose one answer.

a. finance companies, mutual funds, and money market funds.

b. pension funds, mutual funds, and banks.

c. banks, mutual funds, and insurance companies.

d. savings and loan associations, mutual savings banks, and credit unions.




32

Marks: 1

As wealth increases in the economy, savers are willing to


Choose one answer.

a. lend more at any given interest rate.

b. hold more cash relative to their holdings of bonds.

c. buy fewer bonds at any given price.

d. lend less at any given interest rate.

33

Marks: 1

In a barter economy the number of prices in an economy with N goods is


Choose one answer.

a. N(N/2).

b. [N(N - 1)]/2.

c. 2N.

d. N(N/2) - 1.

34

Marks: 1

In the United States, loans from ________ are far ________ important for corporate finance than are securities markets.


Choose one answer.

a. government agencies; more

b. government agencies; less

c. financial intermediaries; less

d. financial intermediaries; more

35

Marks: 1

If people expect real estate prices to increase significantly, the ________ curve for bonds will shift to the ________, everything else held constant.

Choose




one answer.

a. supply; left

b. demand; left

c. demand; right

d. supply; right

36

Marks: 1

The nominal interest rate minus the expected rate of inflation


Choose one answer.

a. defines the discount rate.

b. is a less accurate indicator of the tightness of credit market conditions than is the nominal interest rate.

c. defines the real interest rate.

d. is a less accurate measure of the incentives to borrow and lend than is the nominal interest rate.

37

Marks: 1

Banks, savings and loan associations, mutual savings banks, and credit unions


Choose one answer.

a. since deregulation now provide services only to small depositors.

b. produce nothing of value and are therefore a drain on society's resources.

c. have been adept at innovating in response to changes in the regulatory environment.

d. are no longer important players in financial intermediation.

38

Marks: 1

In explaining the evolution of money

Choose one answer.

a. new forms of money evolve to lower transaction costs.

b. commodity money, because it is valued more highly, tends to drive out paper money.




c. paper money is always backed by gold and therefore more desirable than checks.

d. government regulation is the most important factor.

39

Marks: 1

Economists' attempts to explain the term structure of interest rates


Choose one answer.

a. have proved entirely unsatisfactory to date.

b. illustrate how economists modify theories to improve them when they are inconsistent with the empirical evidence.

c. illustrate how economists continue to accept theories that fail to explain observed behavior of interest rate movements.

d. prove that the real world is a special case that tends to get short shrift in theoretical models.

40

Marks: 1

The upward and downward movement of aggregate output produced in the economy is referred to as the ________.


Choose one answer.

a. roller coaster

b. business cycle

c. shock wave

d. see saw

41

Marks: 1

A decrease in the liquidity of corporate bonds, other things being equal, shifts the demand curve for corporate bonds to the ________ and the demand curve for Treasury bonds shifts to the ________.

Choose one answer.

a. left; left

b. left; right

c. right; right




d. right; left

42

Marks: 1

Which of the following is not a form of e-money?


Choose one answer.

a. a credit card

b. a smart card

c. a stored-value card

d. a debit card

43

Marks: 1

All of the following are examples of coupon bonds except


Choose one answer.

a. U.S. Treasury bills

b. Corporate bonds

c. U.S. Treasury bonds

d. U.S. Treasury notes

44

Marks: 1

According to the segmented markets theory of the term structure


Choose one answer.

a. because of the positive term premium, the yield curve will not be observed to be downward-sloping.

b. investors' strong preferences for short-term relative to long-term bonds explains why yield curves typically slope downward.

c. bonds of one maturity are close substitutes for bonds of other maturities, therefore, interest rates on bonds of different maturities move together over time.

d. the interest rate for each maturity bond is determined by supply and demand for that maturity bond.



45

Marks: 1

If a $5,000 coupon bond has a coupon rate of 13 percent, then the coupon payment every year is


Choose one answer.

a. $650.

b. $13.

c. $130.

d. $1,300.

46

Marks: 1

The term structure of interest rates is


Choose one answer.

a. the relationship among the term to maturity of different bonds.

b. the relationship among interest rates on bonds with different maturities.

c. the structure of how interest rates move over time.

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

47

Marks: 1

The distinguishing feature of a well-functioning financial market is the


Choose one answer.

a. increased ease of converting common stocks into bonds.

b. incorporation of available information into asset prices.

c. continual increase in the liquidity of most assets.

d. continual reduction in the riskiness of most assets.

48

Marks: 1

Generally, the initial money supply data reported by the Fed

Choose one answer.

a. usually underestimate the revised statistics.

b. is not a reliable guide to the long-run behavior of the money supply.




c. is a reliable guide to the short-run behavior of the money supply.

d. is not a reliable guide to the short-run behavior of the money supply.

49

Marks: 1

Of the four effects on interest rates from an increase in the money supply, the one that works in the opposite direction of the other three is the


Choose one answer.

a. liquidity effect.

b. price level effect.

c. income effect.

d. expected inflation effect.

50

Marks: 1

When short-term interest rates are expected to fall sharply in the future, the yield curve will


Choose one answer.

a. be an inverted U shape.

b. be flat.

c. be inverted.

d. slope up.

51

Marks: 1

Unlike the segmented markets theory, the expectations theory attributes the slope of the yield curve to

Choose one answer.

a. tax considerations.

b. the variance in the inflation rates over the business cycle.

c. the fact that short-term bonds are not perfect substitutes for long-term bonds.

d. the market's view of future short-term interest rates.




52

Marks: 1

Which of the following is included in both M1 and M2?


Choose one answer.

a. Savings deposits

b. Currency

c. Money market deposit accounts

d. Small-denomination time deposits

53

Marks: 1

If the price of a euro (the European currency) increases from $1.00 to $1.10, then, everything else held constant,


Choose one answer.

a. a European vacation becomes less expensive.

b. foreign travel becomes impossible.

c. the cost of a European vacation is not affected.

d. a European vacation becomes more expensive.

54

Marks: 1

The duration of a coupon bond increases


Choose one answer.

a. the higher the coupon rate on the bond.

b. the higher the bond price.

c. when interest rates increase.

d. the longer is the bond's term to maturity.

55

Marks: 1

Which of the following are not traded in a capital market?

Choose one

a. U.S. government agency securities.




answer. b. State and local government bonds.

c. Corporate bonds.

d. Repurchase agreements.

56

Marks: 1

The U-shaped yield curve in the figure above indicates that short-term interest rates are expected to


Choose one answer.

a. remain unchanged in the near-term and rise later on.

b. rise in the near-term and fall later on.

c. fall sharply in the near-term and rise later on.

d. fall moderately in the near-term and rise later on.

57

Marks: 1

Three factors explain the risk structure of interest rates:

Choose one answer.

a. maturity, liquidity, and the income tax treatment of a security.

b. maturity, default risk, and the income tax treatment of a security.

c. maturity, default risk, and the liquidity of a security.



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FINA500-1900-SP11


d. liquidity, default risk, and the income tax treatment of a security.

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