TEST BANK for financial markets and institutions. 13th Edition Jeff Mandura

TEST BANK for financial markets and institutions. 13th Edition Jeff Mandura.

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Chapter 01: Role of Financial Markets and Institutions 1. Financial market participants who provide funds are called a. deficit units. b. surplus units. c. primary units. d. secondary units.

ANSWER:

b

2. Which of the following is NOT an issuer of bonds? a. households b. corporations c. the U.S. Treasury d. government agencies ANSWER:

a

3. Behavioral finance a applies concepts from sociology and anthropology to the behavior of market participants. b. studies the behavior of financial markets in response to changes in Federal Reserve policy. c. applies psychology to financial decision making. d. explains why markets are efficient.

ANSWER:

c

4. The financial markets that facilitate the flow of short-term funds are known as a. money markets. b. capital markets. c. primary markets. d. secondary markets.

ANSWER:

a

5. Funds are provided to the initial issuer of securities in the a. secondary market. b. primary market. c. deficit market. d. surplus market.

ANSWER:

b

6. Which of the following is a capital market instrument? a a six-month certificate of deposit b. a three-month Treasury bill c. a ten-year bond d. an agreement for a bank to loan funds directly to a company for nine months ANSWER:

c

7. Which of the following is a money market security?

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Chapter 01: Role of Financial Markets and Institutions a. b. c. d.

Treasury note municipal bond mortgage commercial paper

ANSWER:

d

8. The creditors in the federal funds market are a. households. b. depository institutions. c. firms. d. government agencies.

ANSWER:

b

9. Investors in equity securities may earn a return from a coupon payments and the return of principal at the maturity date. b. coupon payments and a capital gain when they sell the securities. c. quarterly dividends (if paid) and a capital gain when they sell the securities. d. quarterly dividends (if paid) and the return of principal at the maturity date.

ANSWER:

c

10. Money market securities generally have ____. a relatively low liquidity, low expected return, and a high degree of credit risk b. relatively high liquidity, high expected return, and a high degree of credit risk c. relatively low liquidity, high expected return, and a low degree of credit risk d. relatively high liquidity, low expected return, and a low degree of credit risk ANSWER:

d

11. If security prices fully reflect all available information, the markets for these securities are a. efficient. b. primary. c. overvalued. d. undervalued.

ANSWER:

a

12. If markets are ____, investors could use available information ignored by the market to earn abnormally high returns. a. perfect b. active c. inefficient d. in equilibrium ANSWER: c 13. If financial markets are efficient, this implies that all securities should earn the same return. a.

True Copyright Cengage Learning. Powered by Cognero.

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Chapter 01: Role of Financial Markets and Institutions b.

False

ANSWER:

False

14. The Securities Act of 1933 a required complete disclosure of relevant financial information for publicly offered securities in the primary market. b. declared trading strategies to manipulate the prices of public secondary securities illegal. c. imposed heavy penalties for insider trading. d. required complete disclosure of relevant financial information for securities traded in the secondary market. e. All of these are correct.

ANSWER: a 15. The Securities and Exchange Commission (SEC) was established by the a.

Federal Reserve Act. b.

McFadden Act. c.

Securities Exchange Act of 1934. d.

Glass-Steagall Act. e.

None of these are correct.

ANSWER:

c

16. Stock issued by a corporation is an example of a(n) a debt security. . b. money market security. c. equity security. d. debt security AND money market security.

ANSWER:

c

17. If financial markets were ____, all information about any securities for sale in primary and secondary markets would be continuously and freely available to investors. a. efficient b. inefficient c. perfect d. imperfect ANSWER: c 18. Which of the following is NOT a typical function of securities firms? a provide brokerage services b. provide underwriting services c. accept deposits that are insured by the federal government and use the funds to provide loans to corporations d. offer advice on mergers and other corporate restructurings ANSWER: c 19. Without the participation of financial intermediaries in financial market transactions, Copyright Cengage Learning. Powered by Cognero.

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Chapter 01: Role of Financial Markets and Institutions a information and transaction costs would be lower. b. transaction costs would be higher but information costs would be unchanged. c. information costs would be higher but transaction costs would be unchanged. d. information and transaction costs would be higher.

ANSWER:

d

20. Which of the following is most likely to be described as a depository institution? a. finance companies b. securities firms c. credit unions d. pension funds e. insurance companies ANSWER:

c

21. In aggregate, ____ are the most dominant depository institution, with more total assets than other depository institutions. a. commercial banks b. savings banks c. credit unions d.

S&Ls ANSWER: a 22. Which of the following is a nondepository financial institution? a. savings bank b. commercial bank c. savings and loan association d. mutual fund ANSWER:

d

23. Which of the following distinguishes credit unions from commercial banks and savings institutions? a Credit unions are nonprofit. b. Credit unions accept deposits but do not make loans. c. Credit unions make loans but do not accept deposits. d. Savings institutions restrict their business to members who share a common bond.

ANSWER:

a

24. When a securities firm acts as a broker, it a guarantees the issuer a specific price for newly issued securities. b. makes a market in specific securities by adjusting its own inventory. c. executes securities transactions between two parties. d. purchases securities for its own account.

ANSWER:

c

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Chapter 01: Role of Financial Markets and Institutions 25. When a securities firm acts as a(n) ____, it makes a market in specific securities by maintaining an inventory of those securities. a. adviser b. dealer c. broker d.

None of these are correct.

ANSWER: b 26. ____ obtain funds by issuing securities and then lend the funds to individuals and small businesses. a.

Finance companies b.

Securities firms c.

Mutual funds d.

Insurance companies ANSWER:

a

27. Households with ____ are served by ____. a deficient funds; depository institutions and finance companies b. deficient funds; finance companies only c. savings; finance companies only d. savings; pension funds and finance companies ANSWER:

a

28. ____ concentrate on mortgage loans. a.

Finance companies b.

Commercial banks c.

Savings institutions d.

Credit unions ANSWER:

c

29. ____ securities have a maturity of one year or less; ____ securities generally have relatively high liquidity. a.

Money market; capital market b.

Money market; money market c.

Capital market; money market d.

Capital market; capital market ANSWER: b 30. Which of the following are NOT major investors in stocks? a. commercial banks b. insurance companies c. mutual funds d. pension funds ANSWER: Copyright Cengage Learning. Powered by Cognero.

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Chapter 01: Role of Financial Markets and Institutions 31. Which of the following financial intermediaries commonly invest in stocks and bonds? a. pension funds b. insurance companies c. mutual funds d.

All of these are correct.

ANSWER: 32. Securities represent a claim on the issuer. a. b.

ANSWER:

d

True False

33. Debt securities represent debt (borrowed funds) incurred by the issuer. a.

True b.

False ANSWER:

True

True

34. A five-year security was purchased two years ago by an investor who plans to resell it. The investor will sell the security in the a. secondary market. b. primary market. c. deficit market. d. surplus market.

ANSWER: a 35. When security prices fully reflect all available information, the markets for these securities are said to be efficient. a.

True b.

False ANSWER: True 36. If markets are perfect, securities buyers and sellers do not have full access to information and cannot always break down securities to the precise size they desire. a.

True b.

False ANSWER: False 37. A broker executes securities transactions between two parties and charges a commission for the transaction. a.

True b.

False ANSWER: True 38. The adoption of the euro by 19 European countries has increased business between those countries and created a more competitive environment in Europe. a.

True Copyright Cengage Learning. Powered by Cognero.

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Chapter 01: Role of Financial Markets and Institutions b.

False

ANSWER:

True

39. In recent years, financial institutions have consolidated to capitalize on economies of scale and on economies of scope. a.

True b.

False ANSWER: True 40. Securities represent a claim on the provider of funds. a.

True b.

False ANSWER:

False

41. Debt securities include commercial paper, Treasury bonds, and corporate bonds. a.

True b.

False ANSWER:

True

42. Common types of capital market securities include Treasury bills and commercial paper. a.

True b.

False ANSWER: False 43. Common types of money market securities include negotiable certificates of deposit and Treasury bills. a.

True b.

False ANSWER: True 44. Money market securities are commonly issued to finance the purchase of assets such as buildings, equipment, or machinery. a.

True b.

False ANSWER: False 45. The total asset value of savings institutions is larger than that of commercial banks. a.

True b.

False ANSWER: False 46. Financial markets facilitating the flow of short-term debt securities with maturities of one year or less are known as a. secondary markets. b. capital markets. c. primary markets. d. money markets.

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Chapter 01: Role of Financial Markets and Institutions e.

None of these are correct.

ANSWER:

d

47. Which of the following transactions would NOT be considered a secondary market transaction? a An individual investor purchases some existing shares of stock in Apple through her broker. b. An institutional investor sells some Disney stock through its broker. c. A firm that was privately held engages in an offering of stock to the public. d. All of these are correct.

ANSWER:

c

48. If investors speculate in the underlying asset rather than in derivative contracts on the underlying asset, they will probably achieve ____ returns, and they are exposed to relatively ____ risk. a. lower; lower b. lower; higher c. higher; lower d. higher; higher ANSWER: a 49. ____ maintain a larger amount of assets in aggregate than the other types of nondepository institutions. a.

Finance companies b.

Mutual funds c.

Life insurance companies d.

Securities firms ANSWER:

b

50. An asymmetric information problem arises when one party to a transaction has information that is not available to the other party, as when a corporation fails to tell investors the full extent of its losses. a.

True b.

False ANSWER: True 51. Bonds issued by corporations have a ____ expected return and ____ risk than Treasury bonds. a. lower; lower b. lower; higher c. higher; lower d. higher; higher ANSWER:

d

52. Systemic risk is the risk that a large decline in one stock’s price could cause investors to sell their stock in other companies. a.

True b.

False ANSWER: False Copyright Cengage Learning. Powered by Cognero.

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Chapter 01: Role of Financial Markets and Institutions 53. The Sarbanes-Oxley Act requires firms to provide complete and accurate financial information and imposes penalties on key executives of the firm if financial fraud is detected. a.

True b.

False ANSWER: True 54. Capital market securities are commonly issued in order to finance the purchase of assets such as buildings, equipment, or machinery. a.

True b.

False ANSWER: True 55. Commercial banks in aggregate have more assets than credit unions. a.

True b.

False ANSWER:

True

56. Those participants who receive more money than they spend are referred to as a. deficit units. b. surplus units. c. borrowing units. d. government units.

ANSWER:

b

57. Equity securities a have a maturity. . b. pay interest on a periodic basis. c. represent ownership in the issuer. d. repay the principal amount at maturity.

ANSWER:

c

58. ____ involve(s) decisions such as how much funding to obtain and what types of securities to issue when financing operations. a.

Corporate finance b.

Investment management c.

Financial markets and institutions d.

None of these are correct.

ANSWER: a 59. There is a ____ relationship between the risk of a security and the expected return from investing in the security. a. positive b. negative c. indeterminable Copyright Cengage Learning. Powered by Cognero.

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Chapter 01: Role of Financial Markets and Institutions d.

None of these are correct.

ANSWER:

a

60. If a security is undervalued, some investors will capitalize on this by purchasing that security. As a result, the security's price will ____, resulting in a ____ return for those investors. a. rise; lower b. fall; higher c. fall; lower d. rise; higher ANSWER: d 61. The credit crisis in the 2008–2009 period was caused by weak economies in Asia. a.

True b.

False ANSWER: False 62. ____ are classified as depository institutions. a.

Credit unions b.

Pension funds c.

Finance companies d.

Securities firms ANSWER:

a

63. The main reason that depository institutions experienced financial problems during the credit crisis was their investment in a. mortgages. b. money market securities. c. stocks. d.

Treasury bonds.

ANSWER: a 64. Those financial markets that facilitate the flow of short-term funds (with maturities of less than one year) are known as capital markets, while those that facilitate the flow of long-term funds are known as money markets. a.

True b.

False ANSWER: False 65. Bonds commonly have maturities of one to three years. a.

True b.

False ANSWER:

False

66. Since markets are efficient, institutional and individual investors should ignore the various investment instruments available.

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Chapter 01: Role of Financial Markets and Institutions a. b.

True False

ANSWER:

False

67. Speculating with derivative contracts on an underlying asset typically results in both higher risk and higher returns than speculating in the underlying asset itself. a.

True b.

False ANSWER: True 68. When security prices fully reflect all available information, the markets for these securities are said to be perfect. a.

True b.

False ANSWER: False 69. Securities that are not as safe and liquid as other securities are never considered for investment by anyone. a.

True b.

False ANSWER: False 70. By requiring full disclosure of information, securities laws prevent investors from making poor investment decisions. a.

True b.

False ANSWER: False 71. When a depository institution offers a loan, it is acting as a creditor. a.

True b.

False ANSWER: 72. Savings institutions are a type of nondepository institution. a.

True b.

False ANSWER:

True

False

73. Most mutual funds raise funds by issuing securities and then lend the funds to individuals and small businesses. a.

True b.

False ANSWER: False 74. Institutional investors not only provide financial support to companies but also exercise some degree of corporate control over them. a.

True b.

False Copyright Cengage Learning. Powered by Cognero.

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Chapter 01: Role of Financial Markets and Institutions ANSWER:

True

75. Which of the following is NOT a reason why depository financial institutions are popular? a They offer deposit accounts that can accommodate the amount and liquidity characteristics desired by most surplus units. b. They repackage funds received from deposits to provide loans of the size and maturity desired by deficit units. c. They accept the risk on loans that they provide. d. They use their information resources to act as brokers, executing securities transactions between two parties. e. They have more expertise than individual surplus units in evaluating the creditworthiness of deficit units.

ANSWER: d 76. Which of the following are NOT considered money market securities? a.

Treasury bills b. mortgage-backed securities c. negotiable certificates of deposit d. commercial paper ANSWER:

b

77. ____ are not considered capital market securities. a.

Derivative securities b.

Treasury bonds c.

Corporate bonds d.

Equity securities e.

Mortgages ANSWER:

a

78. ____ are long-term debt obligations issued by corporations and government agencies to support their operations. a.

Common stock b.

Derivative securities c.

Bonds d.

None of these are correct.

ANSWER: c 79. Which of the following is an example of an asymmetric information problem? a A corporation releases toxic wastes into a river. b. A corporation relocates to Ireland to take advantage of lower corporate tax rates. c. A stock analyst rates a stock higher than it deserves because the securities firm she works for wants to obtain business from the corporation that issued the stock. d. A corporation manipulates its financial information to avoid disclosing a large loss from its operations in China.

ANSWER: d 80. If investors speculate in derivative contracts rather than in the underlying asset, they will probably achieve ____ Copyright Cengage Learning. Powered by Cognero.

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Chapter 01: Role of Financial Markets and Institutions returns, and they are exposed to relatively ____ risk. a. lower; lower b. lower; higher c. higher; lower d. higher; higher ANSWER:

d

81. When particular securities are perceived to be ____ by the market, their prices decrease when they are sold by investors. a. undervalued b. overvalued c. fairly priced d. efficient e.

None of these are correct.

ANSWER: b 82. Which of the following are NOT considered depository financial institutions? a finance companies . b. c. d. e.

ANSWER:

commercial banks savings institutions credit unions All of these are depository financial institutions. a

83. The main source of funds for ____ is proceeds from selling securities to households and businesses, while their main use of funds is providing loans to households and businesses. a. savings institutions b. commercial banks c. mutual funds d. finance companies e. pension funds ANSWER: d 84. Which of the following statements is incorrect? a Financial markets attract funds from investors and channel the funds to corporations. b. Money markets enable corporations to borrow funds on a short-term basis so that they can support their existing operations. c. Financial institutions serve solely as intermediaries with the financial markets and never serve as investors. d. Investors seek to invest their funds in the stock of firms that are presently undervalued and have much potential to improve.

ANSWER: c Copyright Cengage Learning. Powered by Cognero.

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Chapter 01: Role of Financial Markets and Institutions 85. Which of the following facilitates the exchange of currencies? a. money market b. foreign exchange market c.

New York Stock Exchange d. federal funds market ANSWER:

b

86. Debt securities issued by a small firm may be ________, meaning that _______ investors want to invest in those securities. a. liquid; many b. liquid; not many c. illiquid; not many d. illiquid; many ANSWER: c 87. Valuing stocks is easier than valuing debt securities because stocks promise to provide investors with specific payments at regular intervals. a.

True b.

False ANSWER: False 88. ____________ applies psychology to financial decisions and offers an explanation for why markets are not always efficient. a.

Psychological marketing b.

Behavioral finance c.

Inefficient markets theory d.

Financial psychology ANSWER: b 89. International integration of securities markets allows a governments and corporations to have easier access to funding from creditors and investors in other countries. b. investors and creditors to benefit from investment opportunities in other countries. c. one country’s financial problems to adversely affect other countries. d. All of these are correct.

ANSWER:

d

90. The foreign exchange market facilitates the exchange of a information between investors in different countries. . b. c. d.

debt securities. equity securities. currencies.

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Chapter 01: Role of Financial Markets and Institutions ANSWER:

d

91. If a depository institution is experiencing more deposits than it needs to make loans or invest in securities, it can lend its excess funds to another depository institution through the a.

Federal Reserve’s trading desk. b. options market. c. federal funds market. d. federal exchange market.

ANSWER: c 92. Most of the funds that insurance companies receive from premiums are invested in short-run money market securities. a.

True b.

False ANSWER: False 93. The risk that financial problems could spread among financial institutions and across financial markets, causing a collapse of the financial system, is known as a. systemic risk. b. leverage risk. c. financial meltdown risk. d. credit risk.

ANSWER: a 94. Systemic risk exists because a there is no government regulation of financial markets. b. financial institutions invest in similar securities and therefore are similarly exposed to large declines in prices of those securities. c. financial institutions borrow using long-term debt securities but lend their funds for short-term periods. d. financial institutions invest heavily in Treasury securities and therefore are exposed to the possibility that the government will default on its debts.

ANSWER: b

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Chapter 02: Determination of Interest Rates 1. The level of installment debt as a percentage of disposable income is generally ____ during recessionary periods. a. higher b. lower c. zero d. negative ANSWER: b 2. At any given point in time, households would demand a ____ quantity of loanable funds at ____ rates of interest. a. greater; higher b. greater; lower c. smaller; lower d.

None of these are correct.

ANSWER: b 3. Businesses demand loanable funds to a. finance installment debt. b. subsidize other companies. c. invest in long-term (fixed) assets. d.

None of these are correct.

ANSWER:

c

4. The required return to implement a given business project will be ____ if interest rates are lower. This implies that businesses will demand a ____ quantity of loanable funds when interest rates are lower. a. greater; lower b. lower; greater c. lower; lower d. greater; greater ANSWER: b 5. If interest rates are ____, ____ projects will have expected returns that exceed a business’s particular required rate of return. a. higher; more b. lower; more c. lower; no d.

None of these are correct.

ANSWER: b 6. The demand for funds resulting from business investment in new projects is ____ related to the number of projects implemented, and is therefore ____ related to the interest rate. a. inversely; positively b. positively; inversely c. inversely; inversely d. positively; positively Copyright Cengage Learning. Powered by Cognero.

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Chapter 02: Determination of Interest Rates ANSWER:

b

7. If economic conditions become less favorable, then a expected cash flows on various projects will increase. b. the required rate of return on projects will increase. c. there will be additional acceptable business projects. d. there will be a decreased demand by business for loanable funds.

ANSWER:

d

8. As a result of more favorable economic conditions, there is a(n) ____ demand for loanable funds, causing an ____ shift in the demand curve. a. decreased; inward b. decreased; outward c. increased; outward d. increased; inward ANSWER: c 9. The federal government’s demand for loanable funds is ____. If the budget deficit is expected to increase, the federal government’s demand for loanable funds will ____. a. interest-elastic; decrease b. interest-elastic; increase c. interest-inelastic; increase d. interest-inelastic; decrease ANSWER: c 10. Other things being equal, foreign governments and corporations would demand ____ U.S. funds if their local interest rates were lower than U.S. rates. Therefore, for a given set of foreign interest rates, foreign demand for U.S. funds is ____ related to U.S. interest rates. a. less; inversely b. more; positively c. less; positively d. more; inversely ANSWER: a 11. For a given set of foreign interest rates, the quantity of U.S. loanable funds demanded by foreign governments or firms will be ____ U.S. interest rates. a. positively related to b. inversely related to c. unrelated to d.

None of these are correct.

ANSWER: b 12. The quantity of loanable funds supplied is normally a highly interest-elastic.

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Chapter 02: Determination of Interest Rates b. more interest-elastic than the demand for loanable funds. c. less interest-elastic than the demand for loanable funds. d. equally as interest-elastic as the demand for loanable funds. e. highly interest-elastic AND more interest-elastic than the demand for loanable funds.

ANSWER:

c

13. The ____ sector is the largest supplier of loanable funds. a. household b. government c. business d.

None of these are correct.

ANSWER:

a

14. If a strong economy allows for a large ____ in households’ income, the supply curve will shift ____. a. decrease; outward b. increase; inward c. increase; outward d.

None of these are correct.

ANSWER:

c

15. The equilibrium interest rate a equates the aggregate demand for loanable funds with the aggregate supply of loanable funds. b. equates the elasticity of the aggregate demand for and supply of loanable funds. c. decreases as the aggregate supply of loanable funds decreases. d. increases as the aggregate demand for loanable funds decreases.

ANSWER:

a

16. The equilibrium interest rate should a fall when the aggregate supply of funds exceeds the aggregate demand for funds. b. rise when the aggregate supply of funds exceeds the aggregate demand for funds. c. fall when the aggregate demand for funds exceeds the aggregate supply of funds. d. rise when the aggregate demand for funds equals the aggregate supply of funds. e. rise when the aggregate supply of funds exceeds the aggregate demand for funds AND fall when the aggregate demand for funds exceeds the aggregate supply of funds.

ANSWER:

a

17. Which of the following is likely to cause a decrease in the equilibrium U.S. interest rate, other things being equal? a a decrease in saving by foreign savers b. an increase in inflation c. pessimistic economic projections that cause businesses to reduce expansion plans d. a decrease in saving by U.S. households ANSWER: c Copyright Cengage Learning. Powered by Cognero.

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Chapter 02: Determination of Interest Rates 18. The Fisher effect states that the a nominal interest rate equals the expected inflation rate plus the real rate of interest. b. nominal interest rate equals the real rate of interest minus the expected inflation rate. c. real rate of interest equals the nominal interest rate plus the expected inflation rate. d. expected inflation rate equals the nominal interest rate plus the real rate of interest.

ANSWER:

a

19. If the real interest rate was negative for a period of time, then a inflation is expected to exceed the nominal interest rate in the future. b. inflation is expected to be less than the nominal interest rate in the future. c. actual inflation was less than the nominal interest rate during that period of time. d. actual inflation was greater than the nominal interest rate during that period of time.

ANSWER:

d

20. If inflation is expected to decrease, then a savers will provide less funds at the existing equilibrium interest rate. b. the equilibrium interest rate will increase. c. the equilibrium interest rate will decrease. d. borrowers will demand more funds at the existing equilibrium interest rate.

ANSWER:

c

21. If inflation turns out to be lower than expected a savers benefit. . b. borrowers benefit while savers are not affected. c. savers and borrowers are equally affected. d. savers are adversely affected but borrowers benefit.

ANSWER:

a

22. If the economy weakens, there is ____ pressure on interest rates. If the Federal Reserve increases the money supply there is ____ pressure on interest rates (assume that inflationary expectations are not affected). a. upward; upward b. upward; downward c. downward; upward d. downward; downward ANSWER: d 23. What is the basis of the relationship between the Fisher effect and the loanable funds theory? a savers' desire to maintain the existing real rate of interest b. borrowers' desire to achieve a positive real rate of interest c. savers' desire to achieve a negative real rate of interest d. borrowers' desire to achieve a positive real rate of interest AND savers' desire to achieve a negative real rate of interest Copyright Cengage Learning. Powered by Cognero.

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Chapter 02: Determination of Interest Rates ANSWER:

a

24. Assume that foreign investors who have invested in U.S. securities decide to decrease their holdings of U.S. securities and increase their holdings of securities in their own countries. This should cause the supply of loanable funds in the United States to______ and should place ____ pressure on U.S. interest rates. a. decrease; upward b. decrease; downward c. increase; downward d. increase; upward ANSWER: a 25. Assume that foreign investors who have invested in U.S. securities decide to increase their holdings of U.S. securities.

This should cause the supply of loanable funds in the United States to ____ and should place ____ pressure on U.S. interest rates. a. decrease; upward b. decrease; downward c. increase; downward d. increase; upward ANSWER: c 26. If the federal government needs to borrow additional funds, this borrowing reflects a(n) ____ in the supply of loanable funds and a(n) ____ in the demand for loanable funds. a. increase; no change b. decrease; no change c. no change; increase d. no change; decrease ANSWER: c 27. If the federal government reduces its budget deficit, this causes a(n) ____ in the supply of loanable funds and a(n) ____ in the demand for loanable funds. a. increase; no change b. decrease; no change c. no change; increase d. no change; decrease ANSWER: d 28. When there are expectations of higher inflation in the future, we would typically expect the supply of loanable funds to ____ and the demand for loanable funds to ____. a. increase; decrease b. increase; increase c. decrease; increase d. decrease; decrease ANSWER: c Copyright Cengage Learning. Powered by Cognero.

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Chapter 02: Determination of Interest Rates 29. If the real interest rate is expected to become negative, then the purchasing power of savings would be ____, as the inflation rate is expected to be ____ the existing nominal interest rate. a. decreasing; less than b. decreasing; greater than c. increasing; greater than d. increasing; less than ANSWER: b 30. If economic expansion is expected to decrease, the demand for loanable funds should ____ and interest rates should ____. a. increase; increase b. increase; decrease c. decrease; decrease d. decrease; increase ANSWER: c 31. The federal government’s spending policies are generally thought to be _________ interest rates, but municipal governments’ spending is somewhat ________ interest rates. a independent of; sensitive to . b. sensitive to; independent of c. inversely rated to; positively related to d. positively related to; inversely related to ANSWER: a 32. The federal government’s _________ determines the budget deficit and therefore determines the government’s demand for loanable funds. a. monetary policy b. fiscal policy c. congressional policy d. economic policy ANSWER: b 33. Canada and the United States are major trading partners. If Canada experiences a major increase in economic growth, that could place ____ pressure on Canadian interest rates and ____ pressure on U.S. interest rates. a. upward; upward b. upward; downward c. downward; downward d. downward; upward ANSWER: a 34. If investors shift funds from stocks into bank deposits, this ____ the supply of loanable funds and places ____ pressure on interest rates. a. increases; upward Copyright Cengage Learning. Powered by Cognero.

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Chapter 02: Determination of Interest Rates b. c. d.

increases; downward decreases; downward decreases; upward

ANSWER:

b

35. When Japanese interest rates rise, and exchange rate expectations remain unchanged, the most likely effect is that the supply of loanable funds provided by Japanese investors to the United States will ____, and U.S. interest rates will ____. a. increase; increase b. increase; decrease c. decrease; decrease d. decrease; increase ANSWER: d 36. Which of the following will probably NOT result in an increase in the business demand for loanable funds? a an increase in economic growth . b. a reduction in interest rates on business loans c. a recession d. None of these are correct.

ANSWER: c 37. If the aggregate demand for loanable funds increases without a corresponding ____ in aggregate supply, there will be a ____ of loanable funds. a. increase; surplus b. increase; shortage c. decrease; surplus d. decrease; shortage ANSWER: b 38. A ____ federal government deficit increases the quantity of loanable funds demanded at any prevailing interest rate, causing an ____ shift in the demand schedule. a. higher; inward b. higher; outward c. lower; outward d.

None of these are correct.

ANSWER: b 39. Which of the following is NOT true regarding foreign interest rates? a The large flow of funds between countries causes interest rates in any given country to become more susceptible to interest rate movements in other countries. b. If a foreign country is experiencing high inflation, its equilibrium interest rate is likely to be higher than the U.S. equilibrium interest rate. c. An increase in a foreign country's interest rates will likely decrease demand for U.S. loanable funds by businesses in that country.

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Chapter 02: Determination of Interest Rates d. All of these are true regarding foreign interest rates.

ANSWER:

c

40. Which of the following is least likely to affect household demand for loanable funds? a a decrease in tax rates b. an increase in interest rates c. a reduction in available projects with an expected high rate of return d. All of these are equally likely to affect household demand for loanable funds.

ANSWER:

c

41. Which of the following statements is incorrect? a The Fed's monetary policy is intended to influence U.S. economic conditions. b. The Fed's monetary policy affects the supply of loanable funds, which affects interest rates. c. By influencing interest rates, the Fed is able to influence the amount of money that corporations and households are willing to borrow and spend. d. All of these are true.

ANSWER:

d

42. The ____ suggests that the market interest rate is determined by factors that control the supply of and demand for loanable funds. a.

Fisher effect b. loanable funds theory c. real interest rate d.

None of these are correct.

ANSWER: b 43. When forecasting future interest rates, if the net demand for funds (ND) becomes _____, there will be ______ adjustment in interest rates. a. negative; an upward b. negative; no c. positive; an upward d. positive; a downward ANSWER: c 44. Other things being equal, a ____ quantity of U.S. funds would be demanded by foreign governments and corporations if their domestic interest rates were ____ relative to U.S. rates. a. smaller; high b. larger; high c. larger; low d.

None of these are correct.

ANSWER: b 45. The federal government's demand for funds is said to be interest-inelastic, or ____ to interest rates.

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Chapter 02: Determination of Interest Rates a . b. c. d.

ANSWER:

sensitive

insensitive relatively sensitive as compared to other sectors None of these are correct. b

46. The required rate of return to implement a proposed project will be ______ if interest rates are ________. a. lower; higher b. lower; lower c. higher; lower d. higher; unchanged ANSWER: b 47. The expected impact of an increased expansion by businesses is an ____ shift in the demand schedule and ____ in the supply schedule. a. inward; an inward shift b. inward; an outward shift c. outward; an inward shift d. outward; no obvious change ANSWER: d 48. Which of the following is a valid representation of the Fisher effect? a. i = E(INF) + iR b.

iR = E(INF) + i

c.

E(INF) = i + iR None of these are correct.

d.

ANSWER:

a

49. The real interest rate can be forecasted by subtracting the ___ from the ____ for that period. a nominal interest rate; expected inflation rate . b. prime rate; nominal interest rate c. expected inflation rate; nominal interest rate d. prime rate; expected inflation rate ANSWER:

c

50. According to the Fisher effect, expectations of higher inflation cause savers to require a ____ on savings. a. higher nominal interest rate b. higher real interest rate c. lower nominal interest rate d. lower real interest rate Copyright Cengage Learning. Powered by Cognero.

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Chapter 02: Determination of Interest Rates ANSWER:

a

51. The federal government’s demand for funds is ________, and municipal governments’ demand for funds is ____________. a interest-inelastic; very interest-inelastic . b. interest-elastic; interest-elastic c. interest-inelastic; somewhat interest-elastic d. interest-elastic; somewhat interest-inelastic ANSWER: c 52. Assume that a credit crisis causes a weak economy, and the Fed increases money supply. These conditions should cause a an increase in both the supply of and the demand for loanable funds. b. a decrease in both the supply of and the demand for loanable funds. c. a decrease in the supply of loanable funds and an increase in the demand for loanable funds. d. an increase in the supply of loanable funds and a decrease in the demand for loanable funds.

ANSWER: d 53. The crowding-out effect occurs when a foreign investors crowd out U.S. investors in the market for loanable funds. b. the federal government’s demand for loanable funds due to a higher budget deficit crowds out the private demand in the market for loanable funds. c. institutional investors crowd out individual investors in the market for loanable funds. d. firms and municipal governments crowd out households in the market for loanable funds.

ANSWER: b 54. According to the loanable funds theory, market interest rates are determined by the factors that control the supply of and demand for loanable funds. a.

True b.

False ANSWER: True 55. The supply of loanable funds in the United States is partly determined by the monetary policy implemented by the Federal Reserve System. a.

True b.

False ANSWER: True 56. At any point in time, households and businesses demand a greater quantity of loanable funds at lower rates of interest. a.

True b.

False ANSWER: True 57. The business demand for loanable funds is inversely related to the number of proposed projects implemented and Copyright Cengage Learning. Powered by Cognero.

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Chapter 02: Determination of Interest Rates inversely related to the interest rate. a. b.

ANSWER:

True False False

58. Other things being equal, a smaller quantity of U.S. funds would be demanded by foreign governments and corporations if their domestic interest rates were high relative to U.S. rates. a.

True b.

False ANSWER: False 59. If foreign interest rates fall, foreign firms and governments would likely reduce their demand for U.S. funds. a.

True b.

False ANSWER: True 60. Since the aggregate demand for loanable funds is the sum of the quantities demanded by the separate sectors, and since most of these sectors are likely to demand a larger quantity of funds at lower interest rates (other things being equal), the aggregate demand for loanable funds is positively related to interest rates at any point in time. a.

True b.

False ANSWER: False 61. In general, suppliers of loanable funds are willing to supply more funds if the interest rate is higher. a.

True b.

False ANSWER: True 62. If the aggregate demand for loanable funds increases without a corresponding increase in aggregate supply, there will be a surplus of loanable funds. a.

True b.

False ANSWER: False 63. The relationship between interest rates and expected inflation is often referred to as the loanable funds theory. a.

True b.

False ANSWER: False 64. According to the Fisher effect, if the real interest rate is zero, the nominal interest rate must be equal to the expected inflation rate. a.

True b.

False ANSWER: True Copyright Cengage Learning. Powered by Cognero.

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Chapter 02: Determination of Interest Rates 65. To forecast the real interest rate for an upcoming period using the Fisher effect, the expected inflation rate over that period is subtracted from the nominal interest rate quoted for that period. a.

True b.

False ANSWER: True 66. According to the Fisher effect, when the inflation rate is lower than anticipated, the real interest rate is relatively low. a.

True b.

False ANSWER: False 67. Forecasters should consider future plans for corporate expansion and the future state of the economy when forecasting business demand for loanable funds. a.

True b.

False ANSWER: True

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Chapter 03: Structure of Interest Rates 1. In general, securities with ____ characteristics will offer ____ yields. a. favorable; higher b. favorable; lower c. unfavorable; lower d.

None of these are correct.

ANSWER:

b

2. Credit (default) risk is likely to be highest for a. short-term Treasury securities. b.

AAA corporate securities. c. long-term Treasury securities. d.

BBB corporate securities.

ANSWER:

d

3. Some financial institutions such as commercial banks typically invest only in a. junk bonds. b. corporate bonds rated B or higher. c.

Treasury securities. d. investment-grade bonds.

ANSWER:

d

4. Credit ratings are most commonly used to indicate which financial institutions have available funds that they can lend to borrowers. a.

True b.

False ANSWER: False 5. If a security can easily be converted to cash without a loss in value, it a. is liquid. b. has a high after-tax yield. c. has high credit risk. d. is illiquid.

ANSWER:

a

6. Interest rate movements across countries tend to be _________ correlated as a result of ____________ financial markets. a. positively; internationally integrated b. positively; fully segmented c. negatively; partially segmented d. negatively; internationally integrated ANSWER: a 7. If all other characteristics are similar, ____ would have to offer ____. a taxable securities; a higher after-tax yield than tax-exempt securities Copyright Cengage Learning. Powered by Cognero.

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Chapter 03: Structure of Interest Rates b. taxable securities; a higher before-tax yield than tax-exempt securities c. tax-exempt securities; a higher after-tax yield than taxable securities d. tax-exempt securities; a higher before-tax yield than taxable securities ANSWER:

b

8. Assume an investor's tax rate is 25 percent. The before-tax yield on a security is 12 percent. What is the after-tax yield? a.

16.00 percent b.

9.25 percent c.

9.00 percent d.

3.00 percent e.

None of these are correct.

ANSWER: c 9. According to the segmented markets theory, if most investors suddenly preferred to invest in long-term securities and most borrowers suddenly preferred to issue short-term securities, there would be a upward pressure on the yield of long-term securities. b. downward pressure on the yield of short-term securities. c. downward pressure on the yield of long-term securities. d. no change in the yield of short-term securities.

ANSWER: c 10. A firm in the 20 percent tax bracket is aware of a tax-exempt security that is paying a yield of 7 percent. To match this yield, taxable securities must offer a before-tax yield of a.

8.75 percent. b.

10.8 percent. c.

20.0 percent. d.

None of these are correct.

ANSWER: a 11. Holding other factors such as risk constant, the relationship between the maturity and the annualized yield of debt securities is called the a. term structure of interest rates. b. default structure of interest rates. c. liquidity structure of interest rates. d. tax structure of interest rates. e.

None of these are correct.

ANSWER: a 12. The term structure of interest rates defines the relationship a between risk and return. . b. between risk and maturity. c. between maturity and yield.

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Chapter 03: Structure of Interest Rates d.

ANSWER:

between default risk ratings and maturity. c

13. If shorter-term securities have higher annualized yields than longer-term securities, the yield curve a is horizontal. b. is upward sloping. c. is downward sloping. d. cannot be determined unless we know additional information (such as the level of market interest rates).

ANSWER: c 14. Assume that annualized yields of short-term and long-term securities are equal. If investors suddenly believe interest rates will increase, their actions may cause the yield curve to a. become inverted. b. become flat. c. become upward sloping. d. be unaffected.

ANSWER: c 15. If issuers of securities (borrowers) and investors suddenly expect interest rates to decrease, their actions to benefit from their expectations should cause a long-term yields to rise. b. short-term yields to decrease. c. prices of long-term securities to decrease. d. long-term yields to rise AND short-term yields to decrease. e. None of these are correct.

ANSWER: e 16. Within the category of capital market securities, municipal bonds have the before-tax yield, and their after-tax yield is typically of Treasury bonds from the perspective of investors in high tax brackets. a. highest; below that b. lowest; above that c. highest; above that d. lowest; below that ANSWER: b 17. The yield offered on a debt security is to the security's risk premium. a. negatively; negatively b. positively; positively c. negatively; positively d. positively; negatively ANSWER:

related to the prevailing risk-free rate and

related

b

18. The theory for the term structure of interest rates that says the shape of the yield curve is determined solely by Copyright Cengage Learning. Powered by Cognero.

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Chapter 03: Structure of Interest Rates expectations of future interest rates is called the a. segmented markets theory. b. liquidity premium theory. c. pure expectations theory. d. theory of rational expectations.

ANSWER:

c

19. Assume investors are indifferent among security maturities. Today, the annualized two-year interest rate is 12 percent, and the one-year interest rate is 9 percent. What is the forward rate according to the pure expectations theory? a.

15.08 percent b.

3.00 percent c.

12.00 percent d.

12.62 percent e.

11.41 percent ANSWER: a 20. Assume the yield curve is flat. If investors flood the short-term market and avoid the long-term market, they may cause the yield curve to a. remain flat. b. become upward sloping. c. become downward sloping. d.

None of these are correct.

ANSWER: b 21. According to pure expectations theory, if interest rates are expected to decrease, there will be ____ pressure on the demand for short-term funds by borrowers and ____ pressure on the demand for long-term funds issued by borrowers. a. upward; upward b. downward; downward c. upward; downward d. downward; upward ANSWER: c 22. Investors may attempt to benefit from the higher yields on longer-term securities even though they have only shortterm funds to invest by using a strategy called ________ the yield curve. a. extending b. holding c. riding d. exploiting ANSWER: c 23. According to the pure expectations theory of the term structure of interest rates, the ____ the difference between the implied one-year forward rate and today's one-year interest rate, the ____ is the expected change in the one-year interest rate. a. greater; less Copyright Cengage Learning. Powered by Cognero.

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Chapter 03: Structure of Interest Rates b. c. d.

less; greater greater; greater less; less

ANSWER:

c

24. Assume that today, the annualized two-year interest rate is 12 percent, and the one-year interest rate is 9 percent. A three-year security has an annualized interest rate of 14 percent. What is the one-year forward rate two years from now? a.

12.67 percent b.

113 percent c.

195 percent d.

15.67 percent e.

None of these are correct.

ANSWER: e 25. Assume that a yield curve is influenced by interest rate expectations and a liquidity premium. Assume the yield curve is initially flat. If liquidity suddenly was no longer important, the yield curve would now have a ____ (assuming no other changes). a. slight downward slope b. slight upward slope c. steep upward slope d. steep downward slope ANSWER: a 26. According to the liquidity premium theory, the expected yield on a two-year security will ____ the expected yield from consecutive investments in one-year securities. a equal b. be less than c. be greater than d. be less than or greater than, depending on the size of the liquidity premium ANSWER: c 27. Assume that the current yield on one-year securities is 6 percent, and that the yield on a two-year security is 7 percent.

If the liquidity premium on a two-year security is 0.4 percent, then the one-year forward rate is a.

8.0 percent. b.

7.6 percent. c.

3.0 percent. d.

7.0 percent.

ANSWER: b 28. If liquidity influences the yield curve, but is not considered when deriving the forward interest rate, the forward interest rate ____ the market's expectation of the future interest rate. a overestimates b. accurately estimates c. underestimates Copyright Cengage Learning. Powered by Cognero.

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Chapter 03: Structure of Interest Rates d. is an unbiased forecast of (it has an equal chance of overestimating or underestimating) ANSWER:

a

29. If the liquidity premium exists, a flat yield curve would be interpreted as the market expecting ____ in interest rates. a. no changes b. a slight decrease c. a slight increase d. a large increase ANSWER: b 30. The theory of the term structure of interest rates, which states that investors and borrowers choose securities with maturities that satisfy their forecasted cash needs, is the a. pure expectations theory. b. liquidity premium theory. c. segmented markets theory. d. liquidity habitat theory.

ANSWER: c 31. According to the segmented markets theory, if most investors suddenly preferred to invest in short-term securities and most borrowers suddenly preferred to issue long-term securities, there would be a upward pressure on the yields of both short-term and long-term securities. b. downward pressure on the yield of short-term securities. c. downward pressure on the yield of long-term securities. d. upward pressure on the yield of short-term securities.

ANSWER: b 32. A theory states that while investors and borrowers may normally concentrate on a particular natural maturity market, conditions may cause them to change maturity markets. This theory is called the a. liquidity premium theory. b. efficient markets theory. c. pure expectations theory. d. preferred habitat theory.

ANSWER: d 33. According to segmented markets theory, if investors have mostly short-term funds available and borrowers want longterm funds, there would be ____ pressure on the supply of short-term funds provided by investors and ____ pressure on the yield of long-term securities. a. upward; upward b. downward; downward c. upward; downward d. downward; upward ANSWER: a 34. If a yield curve is upward sloping, the investment strategy of buying long-term securities, then selling them after a Copyright Cengage Learning. Powered by Cognero.

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Chapter 03: Structure of Interest Rates short period (say, one year) is called a. riding the yield curve. b. liquidating the yield curve. c. segmenting the yield curve. d. a forward roll. e.

None of these are correct.

ANSWER:

a

35. Other things being equal, the yield required on A-rated bonds should be ____ the yield required on B-rated bonds whose other characteristics are exactly the same. a greater than b. equal to c. less than d. All of these are possible, depending on the size of the bond offering.

ANSWER: c 36. Assume that the Treasury bond yield today is 2 percentage points higher than it was one year ago. Also assume that the credit (default) risk premium of an A-rated bond declined by 0.4 percentage point since one year ago. A newly issued A-rated bond will likely offer a yield today that is ____ the yield that was offered on an A-rated bond issued one year ago. a. greater than b. equal to c. less than d.

A or B are both common ANSWER: a 37. In some time periods, there is evidence that corporations initially financed long-term projects with short-term funds.

They planned to borrow long-term funds once interest rates were lower. This specifically supports the ____ for explaining the term structure of interest rates. a liquidity premium theory b. expectations theory c. segmented markets theory d. liquidity premium theory AND segmented markets theory ANSWER: b 38. According to expectations theory, the sudden expectation of lower interest rates in the future will cause investors to provide a ____ supply of short-term funds and a ____ supply of long-term funds. a. large; large b. large; small c. small; small d. small; large ANSWER: d 39. The yield curve in a foreign country is Copyright Cengage Learning. Powered by Cognero.

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Chapter 03: Structure of Interest Rates a .

always downward sloping.

b. nonexistent. c. the same as in the United States at any point in time. d. None of these are correct.

ANSWER:

d

40. If research showed that anticipation about future interest rates was the only important factor for all investors in choosing short-term or long-term securities, this would support the argument made by the a liquidity premium theory. . b. expectations theory. c. segmented markets theory. d. liquidity premium theory AND expectations theory.

ANSWER:

b

41. If research showed that all investors attempt to purchase securities that perfectly match the time for which they will have available funds, this would specifically support the argument made by the a. liquidity premium theory. b. real interest rate theory. c. expectations theory. d. segmented markets theory.

ANSWER: d 42. Which of the following established the Office of Credit Ratings and mandated that credit rating agencies establish internal controls to make their ratings process more transparent? a Financial Reform Act of 2010 . b.

Consumer Protection Act of 2008 c.

Federal Ratings Commission Act of 2014 d.

None of the above is correct.

ANSWER: a 43. You are considering the purchase of a tax-exempt security that is paying a yield of 10.08 percent. You are in the 28 percent tax bracket. To match this after-tax yield, you would consider taxable securities that pay a.

31.1 percent. b.

19 percent. c.

12.5 percent. d.

14 percent.

ANSWER: d 44. The annualized yield on a three-year security is 13 percent; the annualized two-year interest rate is 12 percent, while the one-year interest rate is 9 percent. The forward rate one year ahead is ____ percent.

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Chapter 03: Structure of Interest Rates a. b. c. d.

ANSWER:

2.8 115 103 15.1 d

45. The annualized yield on a two-year security is below the annualized one-year interest rate. The one-year forward rate as of one year ahead is ______________. zero b. negative c. positive, but below the annualized one-year interest rate d. None of these are correct ANSWER: c 46. According to segmented markets theory, if investors have mostly long-term funds available and borrowers want shortterm funds, this will place ____ pressure on the demand for long-term funds issued by borrowers and the yield curve will be ____ sloping. a. upward; downward b. downward; upward c. upward; upward d. downward; downward ANSWER: d 47. An upward-sloping yield curve indicates that Treasury securities with ____ maturities offer ____ annualized yields. a longer; lower b. longer; higher c. shorter; similar (short-term and long-term annualized yields are the same) d. shorter; higher ANSWER: b 48. Assume that the Treasury experiences a large decrease in the budget deficit and purchases a large number of shortterm Treasury securities (Treasury bills or T-bills). This action will ____ the supply of T-bills in the market and place ____ pressure on the yield of T-bills. a. decrease; downward b. decrease; upward c. increase; upward d. increase; downward ANSWER: b 49. Vaughn Corporation is considering the issue of commercial paper and would like to know the yield it should offer on its commercial paper. The corporation believes that a 0.2 percent credit risk premium, a 0.1 percent liquidity premium, and a 0.3 percent tax adjustment are necessary to sell its commercial paper to investors. Furthermore, annualized rates on short-term Treasury securities (T-bills) are 7 percent. Based on this information, Vaughn should offer ____ percent on its commercial paper.

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Chapter 03: Structure of Interest Rates a. b. c. d. e.

8.0 7.6 7.5 7.9 None of these are correct.

ANSWER:

b

50. If liquidity influences the yield curve, the forward rate underestimates the market's expectation of the future interest rate. a.

True b.

False ANSWER: False 51. According to the text, research on the term structure of interest rates has found that maturity markets are not even partially segmented, because investors view various maturities as adequate substitutes for each other. a.

True b.

False ANSWER: False 52. Some types of debt securities always offer a higher yield than others. a.

True b.

False ANSWER:

True

53. Investors will always prefer the purchase of risk-free Treasury securities, since other securities have a higher level of risk. a.

True b.

False ANSWER: False 54. The higher a bond rating, the lower the perceived credit risk. a.

True b.

False ANSWER: 55. Treasury securities are exempt from federal and state income taxes. a.

True b.

False ANSWER:

True

False

56. The term structure of interest rates defines the relationship between maturity and annualized yield, holding other factors such as risk constant. a.

True b.

False Copyright Cengage Learning. Powered by Cognero.

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Chapter 03: Structure of Interest Rates ANSWER:

True

57. The graphic comparison of maturities and annualized yields is known as the interest rate curve. a.

True b.

False ANSWER: False 58. According to the segmented markets theory, the term structure of interest rates is determined solely by expectations of future interest rates. a.

True b.

False ANSWER: False 59. The forward rate is commonly used to represent the market's forecast of the future interest rate. a.

True b.

False ANSWER: True 60. Other things being equal, an expected decrease in interest rates will increase the demand for long-term funds by borrowers. a.

True b.

False ANSWER: False 61. The preference for more liquid short-term securities places downward pressure on the slope of the yield curve. a.

True b.

False ANSWER: False 62. When expectations theory is combined with the liquidity theory, the yield on a security will always be equal to the yield from consecutive investments in shorter-term securities over the same investment horizon. a. b.

ANSWER:

True False False

63. The segmented markets theory suggests that although investors and borrowers may normally concentrate on a particular natural maturity market, certain events may cause them to wander from it. a.

True b.

False ANSWER: False 64. If the yield curve is upward sloping, some investors may attempt to benefit from the higher yields on longer-term securities, even when they have funds for only a short period of time. This strategy is known as riding the yield curve. a.

True Copyright Cengage Learning. Powered by Cognero.

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Chapter 03: Structure of Interest Rates b.

False

ANSWER: 65. Yield curves are always upward sloping. a. b.

ANSWER:

True

True False False

66. Which of the following statements is NOT true with respect to debt securities? a Some types of debt securities always offer a higher yield than others. b. Debt securities offer different yields because they exhibit different characteristics that influence the offered yield. c. In general, securities with favorable characteristics will offer higher yields to entice investors. d. All of these are correct with respect to debt securities.

ANSWER: c 67. Which of the following is NOT a characteristic affecting the yields on debt securities? a credit (default) risk b. liquidity c. tax status d. term to maturity e. All of these are correct and affect yields on debt securities.

ANSWER:

e

68. All other characteristics being equal, securities with ____ liquidity would have to offer a ____ yield to be preferred. a. lower; higher b. higher; higher c. lower; lower d.

None of these are correct.

ANSWER: a 69. A downward-sloping yield curve indicates that Treasury securities with ____ maturities offer ____ annualized yields. a longer; lower b. longer; higher c. shorter; lower d. shorter; the same (short-term and long-term annualized yields are the same) ANSWER: a 70. Assume that the Treasury experiences a large increase in the budget deficit and issues a large number of short-term securities (Treasury bills or T-bills). This action will ____ the supply of T-bills in the market and place ____ pressure on the yield of T-bills. a. decrease; downward b. decrease; upward c. increase; upward Copyright Cengage Learning. Powered by Cognero.

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Chapter 03: Structure of Interest Rates d.

increase; downward

ANSWER:

c

71. If the liquidity premium theory completely describes the term structure of interest rates, then, on the average, the yield curve should be a. flat. b. downward sloping. c. upward sloping. d.

None of these are correct.

ANSWER: c 72. If interest rates are expected to decrease, the yield on new short-term securities may be expected to ____, and the yield curve should be ____ sloping. a. increase; upward b. increase; downward c. decrease; upward d. decrease; downward ANSWER: b 73. According to segmented markets theory, if investors have mostly long-term funds available and borrowers want shortterm funds, this will place ____ pressure on the demand for short-term funds by borrowers and the yield curve will be ____ sloping. a. upward; downward b. downward; upward c. upward; upward d. downward; downward ANSWER: a 74. The ____ theory suggests that although investors and borrowers may normally concentrate on a particular natural maturity market, certain events may cause them to wander from it. a. pure expectations b. liquidity premium c. segmented markets d. preferred habitat ANSWER: d 75. Assume that maturity markets are completely segmented. If the Treasury issues a large amount of long-term Treasury bonds to finance the budget deficit, this would place ____ pressure on _________-term yields. a. upward; short b. downward; short c. upward; long d. downward; long ANSWER: c Copyright Cengage Learning. Powered by Cognero.

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Chapter 03: Structure of Interest Rates 76. Bonds issued at different times by the same corporation may not receive the same rating from a rating agency. a.

True b.

False ANSWER: True 77. Investment-grade bonds are bonds that are rated as Caa or better by Moody’s and as CCC or better by Standard & Poor’s. a.

True b.

False ANSWER: False 78. Based on the expectations theory of the term structure of interest rates, a flat or inverted yield curve is most commonly interpreted to signal that that the economy will strengthen in the near future. a.

True b.

False ANSWER: False 79. The yields of securities commonly move in the same direction over time. a.

True b.

False ANSWER:

True

80. Because interest rates may vary significantly across countries at a given point in time, investors do not monitor the term structures of interest rates in foreign countries unless they are interested in investing in a particular foreign country. a.

True b.

False ANSWER: False

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Chapter 04: Functions of the Fed 1. Which of the following is NOT a major component of the Federal Reserve System? a member banks . b.

Federal Open Market Committee c.

Securities and Exchange Commission d.

Board of Governors ANSWER:

c

2. As a result of the Financial Reform Act of 2010, the ____ was established to regulate financial products and services. a Federal Advisory Committee . b.

Federal Open Market Committee c.

Consumer Financial Protection Bureau d.

Board of Governors ANSWER: c 3. Which of the following is NOT an activity of Fed district banks? a clearing checks b. replacing old currency c. providing loans to depository institutions d. acting as an intermediary to match up lenders and borrowers in the stock market ANSWER:

d

4. All ____ are required to be members of the Federal Reserve System. a. state banks b. national banks c. savings and loan associations d. finance companies e. state banks AND national banks ANSWER:

b

5. The ____ is made up of seven individual members, and each member is appointed by the President of the United States. a Board of Governors . b.

Federal Reserve district bank c.

Federal Open Market Committee (FOMC) d.

Securities and Exchange Commission ANSWER: a 6. Which of the following is currently a main role of the Federal Reserve's Board of Governors? a regulating commercial banks b. regulating foreign trade c. controlling monetary policy Copyright Cengage Learning. Powered by Cognero.

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Chapter 04: Functions of the Fed d. regulating commercial banks AND controlling monetary policy ANSWER:

d

7. Members of the Board of Governors serve 14-year nonrenewable terms. a.

True b.

False ANSWER:

True

8. With regard to monetary policy, which of the following is under the direct control of the Federal Reserve's Board of Governors? a revising reserve requirements for depository institutions b. authorizing changes in the amount of borrowing by the Treasury c. monitoring the stock market for insider trading d. monitoring the derivatives market for illegal trading strategies ANSWER: a 9. The ____ rate is the interest rate charged on the Fed’s short-term loans to depository institutions. a. federal funds b. prime c. primary credit d. real ANSWER:

c

10. Which of the following is an action that the Fed uses to increase or decrease the money supply? a buying or selling Treasury securities in the secondary market b. adjusting the tax rate imposed on income earned on Treasury securities c. adjusting the coupon rate on Treasury bonds d. selling Treasury securities in the primary market ANSWER:

a

11. The policy directive is provided by the Board of Governors to the FOMC. a.

True b.

False ANSWER:

False

12. Total funds of commercial banks will initially ____ by the dollar amount of securities ____ by the Fed. a increase; purchased . b. increase; sold c. decrease; purchased d. increase; purchased AND increase; sold ANSWER:

a

13. The purchase of government securities by someone other than the Fed results in Copyright Cengage Learning. Powered by Cognero.

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Chapter 04: Functions of the Fed a .

an overall increase in funds among commercial banks.

b. an overall decrease in funds among commercial banks. c. offsetting changes in funds at commercial banks. d. an increase in securities maintained by the Fed. ANSWER:

c

14. As the supply of funds in the banking system ____, the federal funds rate ____. a. increases; declines b. increases; increases c. declines, declines d.

None of these are correct.

ANSWER:

a

15. Repurchase agreements are purchased by the Fed to _________ the aggregate level of bank funds. a. temporarily decrease b. permanently increase c. permanently decrease d. temporarily increase ANSWER:

d

16. When open market operations are used to ____ bank funds, the yield on debt instruments ____. a. reduce; decreases b. reduce; increases c. increase; increases d.

None of these are correct.

ANSWER:

b

17. ____ open market operations offset the impact of other conditions that affect the level of funds. a.

Active b.

Passive c.

Dynamic d.

Defensive ANSWER:

d

18. The main monetary policy goal of most central banks is to stabilize the value of the local currency against foreign currencies. a.

True b.

False ANSWER: False 19. The primary credit rate is the interest rate that the Fed charges the most creditworthy depository institutions for shortterm loans.

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Chapter 04: Functions of the Fed a. b.

True False

ANSWER:

True

20. The main purpose of the Fed’s lending facility is to control the money supply. a.

True b.

False ANSWER: False 21. To decrease the money supply, the Fed could a. increase b. stabilize c. reduce d. eliminate ANSWER:

the reserve requirement ratio.

22. The

the ultimate effect of any initial increase in the money supply.

a. b. c. d.

the reserve requirement ratio, the lower; less lower; greater greater; less lower; greater AND greater; less

a

ANSWER:

d

23. The a. b. c. d.

is directly responsible for controlling money supply growth.

Federal Advisory Council FOMC Board of Governors President of the United States

ANSWER:

b

24. Which of the following is the most likely effect when the Fed increases the supply of funds to the banking system? a higher interest rates offered on bank deposits . b. lower yields on debt securities c. higher interest rates on home mortgages d. higher interest rates on loans to businesses ANSWER: b 25. The form of money consisting of currency held by the public and checking deposits at depository institutions is called a.

M1. b.

M2. c.

M3. d.

MMDA. Copyright Cengage Learning. Powered by Cognero.

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Chapter 04: Functions of the Fed ANSWER:

a

26. Currently, about 90 percent of all banks in the United States are members of the Fed. a.

True b.

False ANSWER: False 27. The purpose of the Trading Desk of the Federal Reserve Bank of New York is to buy stocks for member commercial banks. a. b.

True False

ANSWER:

False

28. The voting members of the Federal Open Market Committee consist of the Board of Governors plus the a President of the United States. . b. presidents of the 12 Fed district banks. c. presidents of 5 Fed district banks. d.

Federal Advisory Council.

ANSWER:

c

29. The Board of Governors is composed of a seven members appointed by the President of the United States. b. the 12 presidents of Fed district banks. c. the Federal Open Market Committee, plus the Federal Advisory Council. d. the Federal Open Market Committee, plus the President of the United States.

ANSWER:

a

30. The ____ is directly responsible for setting reserve requirements. a.

Federal Advisory Council b.

FOMC c.

Board of Governors d.

President of the United States ANSWER:

c

31. The ____ is directly responsible for conducting monetary policy. a.

Federal Advisory Council b.

FOMC c.

Senate d.

President of the United States ANSWER:

b

32. The Trading Desk’s open market operations to either reduce or increase the federal funds rate are classified as Copyright Cengage Learning. Powered by Cognero.

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Chapter 04: Functions of the Fed ________ because they are intended to have a lasting impact on economic conditions. a. defensive b. stimulative c. substantive d. dynamic ANSWER:

d

33. If the Trading Desk is instructed to increase the federal funds rate, its traders _________ securities dealers, and those dealers’ bank account balances are __________. a sell Treasury securities to; reduced . b. sell Treasury securities to; increased c. buy Treasury securities from; reduced d. buy Treasury securities from; increased ANSWER: a 34. The chief objective of the European Central Bank is ____ in the countries of the eurozone. a maintaining low unemployment b. ensuring that budget deficits do not exceed certain limits c. maintaining price and currency stability d. None of these are correct.

ANSWER:

c

35. Which of the following were purchased by the Fed as part of its quantitative easing during the credit crisis? a mortgage-backed securities b. commercial paper c. bonds backed by consumer loans, automobile loans, and credit card loans d. All of the above were purchased as part of quantitative easing.

ANSWER: d 36. The federal funds rate is the rate at which the Fed lends money directly to member banks. a. b.

ANSWER:

True False False

37. When the Fed purchases securities, the total funds of commercial banks ____ by the market value of the securities purchased by the Fed. This activity initiated by the FOMC's policy directive is referred to as a ____ of money supply growth. a. increase; loosening b. decrease; tightening c. decrease; loosening d. increase; tightening e.

None of these are correct.

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Chapter 04: Functions of the Fed ANSWER:

a

38. The Trading Desk is sometimes directed to ____ a sufficient amount of Treasury securities to ____ the federal funds rate to a new targeted level set by the FOMC. a. buy; lower b. sell; increase c. buy; increase d. sell; lower e. buy; lower AND sell; increase ANSWER: e 39. Which of the following statements is incorrect with respect to a single European monetary policy? a It prevents any participating European country from solving local economic problems with its own unique monetary policy. b. It allows each country in Europe to use its own currency. c. Each participating country is still able to apply its own fiscal policy (tax and government expenditure decisions). d. All of these are true with respect to a single European monetary policy.

ANSWER: b 40. During the credit crisis, the Fed provided funding that allowed Bear Stearns, a large securities firm, to avoid bankruptcy even though Bear Stearns was not a depository institution. a.

True b.

False ANSWER: True 41. The euro has been adopted by all of the major countries of Western Europe, including Switzerland and the United Kingdom. a.

True b.

False ANSWER: False 42. The FOMC’s decisions on monetary policy are rarely unanimous as one or more members usually dissent. a.

True b.

False ANSWER: False 43. All commercial banks are required to be members of the Fed. a.

True b.

False ANSWER:

False

44. During the credit crisis, the Fed took the unprecedented step of intervening in the stock markets to prevent the stock prices of major commercial banks from declining by more than 10 percent from the previous quarter. a.

True Copyright Cengage Learning. Powered by Cognero.

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Chapter 04: Functions of the Fed b.

False

ANSWER:

False

45. Each Federal Reserve district bank is responsible for reporting its regional conditions, and all of these reports are consolidated to compose the Beige Book. a.

True b.

False ANSWER: True 46. When the Trading Desk sells a sufficient amount of Treasury securities, it creates a surplus of funds in the banking system. Consequently, the federal funds rate decreases along with other interest rates. a.

True b.

False ANSWER: False 47. Adjustment of the primary credit rate is the most common means by which the Fed controls the money supply. a.

True b.

False ANSWER: False 48. To increase the money supply, the Trading Desk would be instructed to sell government securities. a.

True b.

False ANSWER: False 49. To increase the money supply, the Fed may increase the reserve requirement ratio. a.

True b.

False ANSWER: False 50. In December 2008, during the credit crisis, the Fed raised the target for the federal funds rate as a range between 2.5 and 3.5 percent and maintained the federal funds rate within this range until the end of 2015 in order to stimulate the economy. a.

True b.

False ANSWER: False 51. The advisory committee making recommendations to the Fed about economic and banking issues is the a Community Advisory Council. . b. Community Depository Institutions Advisory Council. c. Federal Advisory Council. d. None of these are correct.

ANSWER: Copyright Cengage Learning. Powered by Cognero.

c Page 8

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Chapter 04: Functions of the Fed 52. The advisory committee offering views on issues related to credit unions is the a Community Advisory Council. . b. Community Depository Institutions Advisory Council. c. Federal Advisory Council. d. Federal Open Market Committee.

ANSWER:

b

53. When the Fed buys Treasury bills as a means of increasing the money supply, it places ____ pressure on their prices and ____ pressure on their yields. a. upward; upward b. downward; downward c. upward; downward d. downward; upward ANSWER: c 54. To increase money supply growth, the Fed could a sell government securities in the secondary market. . b. c. d. e.

ANSWER:

increase the primary credit rate. increase the reserve requirement ratio.

All of these are correct.

None of these are correct. e

55. When the Fed sells securities, the total funds of commercial banks ____ by the market value of the securities sold by the Fed. This activity initiated by the FOMC's policy directive is referred to as a ____ of money supply growth. a. increase; loosening b. decrease; loosening c. increase; tightening d. decrease; tightening e.

None of these are correct.

ANSWER: d 56. ____ includes currency held by the public and checking deposits as well as savings accounts and small time deposits, money market deposit accounts, and some other items. a.

M1 b.

M2 c.

M3 d.

None of these are correct.

ANSWER: b Copyright Cengage Learning. Powered by Cognero.

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Chapter 04: Functions of the Fed 57. The ____ meets with the Board of Governors twice a year and offers views on the economic circumstances and financial services needs of consumers and communities. a Consumer Financial Protection Bureau . b.

Federal Advisory Council c.

Community Advisory Council d.

Federal Trade Commission ANSWER: c 58. The Fed’s primary goal has historically been to add liquidity to the mortgage market by continuously purchasing mortgage-backed securities. a.

True b.

False ANSWER: False 59. When the Fed purchases _______, it is attempting to directly stimulate the housing market. a. commercial paper b. short-term Treasury securities c. mortgage-backed securities d. consumer loans ANSWER:

c

60. The Fed’s purchases of long-term Treasury securities during the credit crisis were intended to a reduce long-term interest rates. b. reduce interest rates on credit cards and consumer loans. c. increase the federal funds rate. d. restore confidence in the market for Treasury securities.

ANSWER:

a

61. Which of the following did the Fed NOT do during the credit crisis? a. purchase mortgage-backed securities b. purchase commercial paper c. reduce the targeted federal funds rate d. raise the primary credit rate ANSWER:

d

62. The term “quantitative easing” refers to the Fed’s a purchases of only short-term Treasury securities. b. sales of only short-term Treasury securities. c. purchases of various types of debt securities, including risky debt securities. d. purchases of only commodities such as gold.

ANSWER:

c

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Chapter 04: Functions of the Fed 63. When the Fed initiated a program to purchase commercial paper, one of its primary goals was to a prevent financial institutions from holding commercial paper. b. require that financial institutions increase their holdings of commercial paper. c. increase activity in the market for commercial paper and boost the confidence of investors in commercial paper. d. prevent financial institutions from issuing commercial paper in the future.

ANSWER: c 64. If the Fed initiates a program to purchase long-term Treasury securities, it is most likely attempting to a reduce the rate on short-term Treasury securities. . b. c. d.

ANSWER:

reduce the rate on commercial paper. reduce inflation. reduce long-term interest rates.

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d

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Chapter 05: Monetary Policy 1. The Fed can affect the interaction between the demand for money and the supply of money to influence interest rates, the aggregate level of spending, and therefore economic growth. a.

True b.

False ANSWER: True 2. The Fed can ____ the level of spending as a means of stimulating the economy by ____ the money supply. a. increase; decreasing b. decrease; increasing c. decrease; decreasing d. increase; increasing ANSWER: d 3. A credit crunch occurs when a interest rates decline. b. interest rates rise. c. creditors restrict the amount of loans they are willing to provide. d. the economy is strong.

ANSWER:

c

4. According to the theory of rational expectations, higher inflationary expectations encourage businesses and households to reduce their demand for loanable funds. a.

True b.

False ANSWER: False 5. A passive monetary policy adjusts the money supply automatically in response to economic conditions. a.

True b.

False ANSWER: False 6. If the Fed implemented a policy of inflation targeting, and if the U.S. inflation rate deviated substantially from the Fed's target inflation rate, the Fed could lose credibility. a.

True b.

False ANSWER: True 7. In general, there is a a positive relationship between unemployment and inflation. b. an inverse relationship between unemployment and inflation. c. an inverse relationship between GDP and inflation. d. a positive relationship between GDP and unemployment.

ANSWER: Copyright Cengage Learning. Powered by Cognero.

b Page 1

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Chapter 05: Monetary Policy 8. A ____-money policy can reduce unemployment, and a ____-money policy can reduce inflation. a. tight; loose b. loose; tight c. tight; tight d. loose; loose ANSWER:

b

9. A loose-money policy tends to ____ economic growth and ____ the inflation rate. a stimulate; place downward pressure on . b. stimulate; place upward pressure on c. dampen; place upward pressure on d. dampen; place downward pressure on ANSWER:

b

10. When both inflation and unemployment are relatively high, there is more disagreement among FOMC members about the proper monetary policy to implement. a.

True b.

False ANSWER: True 11. ____ serves as the most direct indicator of economic growth in the United States. a.

Gross domestic product (GDP) b.

Technology c.

The Treasury bond rate d.

The industrial production index ANSWER:

a

12. Which of the following is NOT an indicator of inflation? a. housing price indexes b. wage rates c. oil prices d. consumer confidence surveys ANSWER:

d

13. The ____ indicators tend to rise or fall after a business cycle. a. leading b. lagging c. coincident d.

None of these are correct.

ANSWER:

b

14. The ____ indicators tend to rise or fall at the same time as a business cycle. a. leading Copyright Cengage Learning. Powered by Cognero.

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Chapter 05: Monetary Policy b. c. d.

lagging coincident None of these are correct.

ANSWER:

c

15. The time lag between when an economic problem arises and when it is reported in economic statistics is the a. recognition lag. b. implementation lag. c. impact lag. d. open-market lag.

ANSWER: a 16. The time between when the Fed adjusts the money supply and when the adjustment has an effect on the economy is the a. recognition lag. b. implementation lag. c. impact lag. d. open-market lag.

ANSWER: c 17. If the Fed attempts to reduce inflation, it would likely increase money supply growth. a.

True b.

False ANSWER: False 18. Which of the following best describes the relationship between the Fed and the presidential administration? a The Fed must receive the administration’s approval before conducting monetary policy. b. The Fed must implement a monetary policy specifically to support the administration's policy. c. The administration must receive approval from the Fed before implementing fiscal policy. d. The Fed must receive the administration’s approval before conducting monetary policy AND the administration must receive approval from the Fed before implementing fiscal policy. e. None of these are correct.

ANSWER: e 19. A high budget deficit tends to place ____ pressure on interest rates; the Fed's tightening of the money supply tends to place ____ pressure on interest rates. a. upward; upward b. upward; downward c. downward; downward d. downward; upward ANSWER: a 20. The Fed is usually more willing to maintain a stimulative monetary policy when inflation is relatively high. a.

True Copyright Cengage Learning. Powered by Cognero.

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Chapter 05: Monetary Policy b.

False

ANSWER:

False

21. Costner National, a commercial bank, obtains short-term deposits and makes long-term fixed-rate loans. It should be adversely affected when the Fed a. purchases Treasury securities. b. maintains a stable money supply. c. uses a tight-money policy. d. uses a loose-money policy.

ANSWER: c 22. The ____ lag is the time from when an economic problem arises until it is recognized. a. recognition b. adjustment c. implementation d.

None of these are correct.

ANSWER:

a

23. A ____ dollar tends to exert inflationary pressure in the United States. a. stable b. strong c. weak d. stable AND strong ANSWER:

c

24. There is some evidence that high money supply growth may lead to _______ U.S. inflation over time, which in turn places ____ pressure on U.S. interest rates. a. higher; upward b. higher; downward c. lower; downward d. lower; upward ANSWER: a 25. If the Fed uses a passive monetary policy during weak economic conditions, a it increases the money supply substantially. b. it reduces the money supply substantially. c. it allows the economy to fix itself. d. it purchases commercial paper and mortgage-backed securities.

ANSWER:

c

26. Which of the following is true about an increase in the U.S. government’s budget deficit? a It will lead to global crowding out if U.S. interest rates fall below the level of interest rates in other countries. b. It will cause outflows of foreign funds from the United States as foreign investors move their funds to other countries.

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Chapter 05: Monetary Policy c. It will cause an inward shift in the aggregate demand for loanable funds curve. d. None of these are correct.

ANSWER:

d

27. Inflation is commonly the result of a a. large budget deficit. b. high level of interest rates. c. high level of unemployment. d. high level of aggregate demand.

ANSWER:

d

28. According to the theory of rational expectations, if the Fed uses open market operations to increase the supply of loanable funds, the ultimate effect on interest rates a is a reduction in interest rates. b. is an increase in interest rates. c. is no effect on interest rates. d. cannot be determined because the effects may be offsetting.

ANSWER: d 29. The Federal Reserve would be most inclined to use a stimulative monetary policy to cure a recession if oil prices are a. low and steady. b. low, but rising. c. very high, but declining slightly. d. very high and rising.

ANSWER: a 30. Global crowding out refers to the impact that a excessive U.S. population growth can have on interest rates. b. excessive global population growth can have on interest rates. c. an excessive budget deficit in one country can have on interest rates of other countries. d. an excessive budget deficit in one country can have on exchange rates.

ANSWER:

c

31. Which of the following is NOT an effect of a stimulative monetary policy? a The risk-free rate and the credit risk premium increase. b. A firm’s cost of debt decreases. c. A firm’s cost of equity decreases. d. Depository institutions experience an increase in their supply of funds.

ANSWER:

a

32. When the Fed uses open market operations to sell some of its Treasury securities, there will be a an outward shift in the supply schedule of loanable funds. b. an inward shift in the supply schedule of loanable funds.

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Chapter 05: Monetary Policy c. no shift in the supply schedule of loanable funds. d. an outward shift in the demand schedule for loanable funds.

ANSWER:

b

33. Which of the following is NOT a disadvantage of inflation targeting? a If the U.S. inflation rate deviates substantially from the Fed's target inflation rate, the Fed could lose credibility. b. The Fed's focus on inflation could result in a much higher unemployment level. c. The Fed's focus on inflation will likely lead to a higher government budget deficit. d. All of these are disadvantages of inflation targeting.

ANSWER:

c

34. Financial institutions such as commercial banks, bond mutual funds, insurance companies, and pension funds maintain large portfolios of bonds, so their portfolios are ____ affected when the Fed ____ interest rates. a adversely; decreases . b. adversely; increases c. favorably; increases d. adversely; decreases AND favorably; increase ANSWER: b 35. One reason that a stimulative monetary policy might fail is that savers such as retirees who rely on interest income to meet their expenses may have to reduce their spending. a.

True b.

False ANSWER: True 36. During the 2008–2015 period, the Fed increased the federal funds rate in an effort to stimulate the economy. a.

True b.

False ANSWER: False 37. In recent years, the Fed has made an effort to be more transparent in its communications to financial markets about its future policy. a.

True b.

False ANSWER: True 38. The Fed faces a trade-off in monetary policy between reducing unemployment and reducing the federal government’s budget deficit. a.

True b.

False ANSWER: False 39. The relationship between the interest rate on loanable funds and the level of business investment is positive.

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Chapter 05: Monetary Policy a. b.

True False

ANSWER:

False

40. The supply schedule of loanable funds indicates the quantity of funds that would be demanded at various possible interest rates. a.

True b.

False ANSWER: False 41. To correct excessive inflation, the Fed could use open market operations by buying Treasury securities in the secondary market. a.

True b.

False ANSWER: False 42. When the Fed wants to encourage businesses to increase their spending on long-term projects, it may use a stimulative policy focused on reducing long-term Treasury yields. a.

True b.

False ANSWER: True 43. Economists who work at the Fed recognize that a stimulative monetary policy will not always reduce a high unemployment rate and could even ignite inflation. a.

True b.

False ANSWER: True 44. An attempt by the Fed to stimulate the economy by reducing short-term interest rates may have a limited effect if long-term interest rates remain unaffected. a.

True b.

False ANSWER: True 45. The Fed needs the approval of the presidential administration to make decisions. a.

True b.

False ANSWER: False 46. The Fed is more likely to use a stimulative policy during a strong-dollar period. a.

True b.

False ANSWER:

True

47. A purchase of Treasury securities by the Fed leads to a(n) ____ in interest rates and a(n) ____ in the level of business Copyright Cengage Learning. Powered by Cognero.

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Chapter 05: Monetary Policy investment. a. b. c. d.

increase; decrease decrease; decrease increase; increase decrease; increase

ANSWER:

d

48. Which of the following is true with respect to inflation targeting? a Inflation targeting would allow the Fed more control over inflation caused by excessive aggregate demand. b. Inflation targeting would require the Fed to maintain very strong economic growth. c. Inflation targeting could control the inflation caused by higher oil prices. d. Inflation targeting would allow the Fed to have more control over the unemployment rate.

ANSWER: a 49. A ____ economic indicator tends to rise or fall a few months after business-cycle expansions and contractions. a. leading b. coincident c. lagging d.

None of these are correct.

ANSWER: c 50. A weak dollar can stimulate ____, discourage ____, and ____ the U.S. economy. a.

U.S. exports; U.S. imports; weaken b.

U.S. exports; U.S. imports; stimulate c.

U.S. imports; U.S. exports; stimulate d.

None of these are correct.

ANSWER:

b

51. The interest rate that the Fed targets for its monetary policy is the a. commercial paper rate. b. federal funds rate. c.

Treasury bond coupon rate. d. one-year certificate of deposit rate.

ANSWER:

b

52. Which of the following might be monitored as an indicator of inflation? a consumer price index . b. gold prices c. oil prices d.

All of these may be indicators of inflation.

ANSWER:

d

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Chapter 05: Monetary Policy 53. The Fed’s monetary policy is commonly intended to alter the supply of funds in the banking system in order to achieve a specific targeted a. discount rate. b. required reserve requirement. c. federal funds rate. d. prime rate.

ANSWER: c 54. If a firm has a credit risk premium of 3 percent and the Treasury security rate is 4 percent, the firm will be able to borrow at ________. If the Fed implements a monetary policy that raises the Treasury security rate to 6 percent, the cost of borrowing for the firm will be ________. a.

7 percent; 10 percent b.

4 percent; 6 percent c.

7 percent; 9 percent d.

1 percent; 3 percent ANSWER: c 55. The Fed normally controls the money supply by buying and selling ________. a.

Federal Reserve notes b.

Treasury securities c. certificates of deposit d. federal fund notes ANSWER:

b

56. The intent of the Fed’s strategy to resolve the credit crisis in 2008–2009 was to a increase long-term interest rates. b. require corporations to issue more commercial paper. c. require bond rating agencies to impose higher standards on their ratings. d. reduce interest rates.

ANSWER:

d

57. Which of the following is NOT a reason that a stimulative monetary policy may be ineffective? a The effects of a stimulative policy may be disrupted by expectations of inflation. b. Retirees who rely on interest income may restrict their spending. c. Lending institutions may increase their standards for borrowers, so some potential borrowers may not qualify for loans. d. Higher interest rates caused by the stimulative policy might reduce economic growth.

ANSWER: d 58. The Fed’s monetary policy is primarily intended to regulate commercial loans. a.

True b.

False ANSWER: False Copyright Cengage Learning. Powered by Cognero.

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Chapter 05: Monetary Policy

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Chapter 06: Money Markets 1. Securities with maturities of one year or less are classified as a. capital market instruments. b. money market instruments. c. preferred stock. d.

None of these are correct.

ANSWER:

b

2. Which of the following is NOT a money market security? a.

Treasury bill b. negotiable certificate of deposit c. common stock d. federal funds ANSWER:

c

3. ____ is/are sold at an auction at a discount from par value. a.

Treasury bills b.

Repurchase agreements c.

Banker's acceptances d.

Commercial paper ANSWER:

a

4. Jarrod King, a private investor, purchases a Treasury bill with a $10,000 par value for $9,645. One hundred days later, Jarrod sells the T-bill for $9,719. What is Jarrod's expected annualized yield from this transaction? a.

13.43 percent b.

2.25 percent c.

10.55 percent d.

2.80 percent e.

None of these are correct.

ANSWER: d 5. Assume investors require a 5 percent annualized return on a six-month T-bill with a par value of $10,000. The price investors would be willing to pay is $____. a.

10,000 b.

9,524 c.

9,756 d.

None of these are correct.

ANSWER: c 6. A newly issued T-bill with a $10,000 par value sells for $9,750, and has a 90-day maturity. What is the discount? a.

10.26 percent b.

0.26 percent c. $2,500 d.

10.00 percent Copyright Cengage Learning. Powered by Cognero.

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Chapter 06: Money Markets e.

11.00 percent

ANSWER:

d

7. Large corporations typically make ____ bids for T-bills so they can purchase larger amounts. a. competitive b. noncompetitive c. very small d. none of the above ANSWER:

a

8. At any given time, the yield on commercial paper is ____ the yield on a T-bill with the same maturity. a. slightly less than b. slightly higher than c. equal to d. much less than ANSWER:

b

9. T-bills and commercial paper are sold a with a stated coupon rate. b. at a discount from par value. c. at a premium above par value. d. with a stated coupon rate AND at a premium above par value. e. None of these are correct.

ANSWER:

b

10. Commercial paper has a maximum maturity of ____ days. a.

45 b.

270 c.

360 d.

None of these are correct.

ANSWER:

b

11. An investor buys commercial paper with a 60-day maturity for $985,000. Par value is $1,000,000, and the investor holds it to maturity. What is the annualized yield? a.

8.62 percent b.

8.78 percent c.

8.90 percent d.

9.14 percent e.

9.00 percent ANSWER: d 12. A firm plans to issue 30-day commercial paper for $9,900,000. Par value is $10,000,000. What is the firm's cost of borrowing?

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Chapter 06: Money Markets a. b. c. d. e.

12.12 percent 11.11 percent 13.00 percent 14.08 percent 15.25 percent

ANSWER:

a

13. Which of the following is NOT a money market instrument? a banker's acceptance . b. commercial paper c. negotiable CD d. repurchase agreement e.

All of these are money market instruments.

ANSWER:

e

14. A repurchase agreement calls for an investor to buy securities for $4,925,000 and sell them back in 60 days for $5,000,000. What is the yield? a.

9.43 percent b.

9.28 percent c.

9.14 percent d.

9.00 percent ANSWER: c 15. The federal funds market allows depository institutions to borrow a short-term funds from each other. b. short-term funds from the Treasury. c. long-term funds from each other. d. long-term funds from the Federal Reserve. e. short-term funds from the Treasury AND long-term funds from the Federal Reserve.

ANSWER:

a

16. When a bank guarantees a future payment to a firm, the financial instrument used is called a. a repurchase agreement. b. a negotiable CD. c. a banker's acceptance. d. commercial paper.

ANSWER:

c

17. Which of the following is true of money market instruments? a Their yields are highly correlated over time. b. They typically sell for par value when they are initially issued (especially T-bills and commercial paper). c. Treasury bills have the highest yield.

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Chapter 06: Money Markets d. They all make periodic coupon (interest) payments. e. They typically sell for par value when they are initially issued (especially T-bills and commercial paper) AND treasury bills have the highest yield.

ANSWER: a 18. An investor purchased an NCD a year ago in the secondary market for $980,000. She redeems it today and receives $1,000,000. She also receives interest of $30,000. The investor's annualized yield on this investment is a.

2.0 percent. b.

5.10 percent. c.

5.00 percent. d.

2.04 percent.

ANSWER: b 19. An investor initially purchased securities at a price of $9,923,418, with an agreement to sell them back at a price of $10,000,000 at the end of a 90-day period. The repo rate is ____ percent. a.

3.10 b.

0.77 c.

1.00 d.

None of these are correct.

ANSWER: a 20. The rate at which depository institutions effectively lend or borrow funds from each other is the ____. a. federal funds rate b. discount rate c. prime rate d. repo rate ANSWER:

a

21. ____ are the most active participants in the federal funds market. a.

Savings and loan associations b.

Securities firms c.

Credit unions d.

Commercial banks ANSWER:

d

22. Which of the following is NOT true about Eurodollar securities? a Eurodollars are U.S. dollars deposited in the United States by European investors. b. The interest rate on Eurodollar floating-rate CDs adjusts periodically to the LIBOR. c. Eurodollar securities include Euronotes and Euro-commercial paper. d. The volume of Eurodollar CDs has grown because the U.S. dollar is used in a significant number of international transactions.

ANSWER:

a

23. Which money market transaction is most likely to represent a loan from one commercial bank to another?

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Chapter 06: Money Markets a. b. c. d.

banker's acceptance negotiable CD federal funds commercial paper

ANSWER:

c

24. The rate on Eurodollar floating-rate CDs is based on a a weighted average of European prime rates. . b. the London Interbank Offer Rate. c. the U.S. prime rate. d. a weighted average of European discount rates.

ANSWER:

b

25. Treasury bills a. have a maturity of up to five years. b. have an active secondary market. c. are commonly sold at par value. d. commonly offer coupon payments.

ANSWER:

b

26. The yield on commercial paper is ____ the yield of Treasury bills of the same maturity. The difference between their yields would be especially large during a ____ period. a. higher than; recessionary b. higher than; boom economy c. less than; boom economy d. less than; recessionary ANSWER: a 27. The yield on NCDs is ____ the yield of Treasury bills of the same maturity. The difference between their yields would be especially large during a ____ period. a. higher than; recessionary b. higher than; boom economy c. less than; boom economy d. less than; recessionary ANSWER: a 28. Which of the following may be issued in the primary market by well-known creditworthy firms to borrow funds? a. banker’s acceptances b. retail CDs c. commercial paper d. federal funds ANSWER: c Copyright Cengage Learning. Powered by Cognero.

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Chapter 06: Money Markets 29. An increase in an indicator of inflation such as the consumer price index may create expectations of ________ interest rates and place _______ pressure on the prices of money market securities. a. lower; downward b. lower; upward c. higher; downward d. higher; upward ANSWER: c 30. The effective yield of a foreign money market security is ____ when the foreign currency strengthens against the dollar. a. increased b. reduced c. always negative d. unaffected ANSWER: a 31. The effective yield of a foreign money market security is ____ when the foreign currency weakens against the dollar. a. increased b. reduced c. always negative d. unaffected ANSWER: b 32. Treasury bills are sold through ____ when initially issued. a. insurance companies b. commercial paper dealers c. auction d. finance companies ANSWER:

c

33. At a given point in time, the actual price paid for a three-month Treasury bill is a usually equal to the par value. . b. more than the price paid for a six-month Treasury bill. c. equal to the price paid for a six-month Treasury bill. d. None of these are correct.

ANSWER:

b

34. The minimum denomination of commercial paper is a. $25,000. b. $100,000. c. $150,000. d. $200,000.

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Chapter 06: Money Markets ANSWER:

b

35. Commercial paper is a always directly placed with investors. b. always placed with the help of commercial paper dealers. c. placed either directly or with the help of commercial paper dealers. d. always placed by bank holding companies.

ANSWER:

c

36. An investor, purchases a six-month (182-day) T-bill with a $10,000 par value for $9,700. If the Treasury bill is held to maturity, the annualized yield is ____ percent. a.

6.52 b.

1.54 c.

1.50 d.

6.20 e.

None of these are correct.

ANSWER: d 37. When an investor purchases a six-month (182-day) T-bill with a $10,000 par value for $9,700, the Treasury bill discount is ____ percent. a.

5.93 b.

6.12 c.

6.20 d.

6.02 e.

None of these are correct.

ANSWER: a 38. Robbins Corp. frequently invests excess funds in the Mexican money market. One year ago, Robbins invested in a one-year Mexican money market security that provided a yield of 25 percent. At the end of the year, when Robbins converted the Mexican pesos to dollars, the peso had depreciated from $.12 to $.11. What is the effective yield earned by Robbins? a.

25.00 percent b.

35.41 percent c.

14.59 percent d.

None of these are correct.

ANSWER: c 39. Which of the following statements is incorrect with respect to the federal funds rate? a It is the rate charged by financial institutions on loans they extend to each other. b. It is the interest rate in which the Federal Reserve charges on loans that it provides to commercial banks. c. Commercial banks are the most active participants in the federal funds market. d. Financial market participants view changes in the federal funds rate as an indicator of potential changes in other money market rates.

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Chapter 06: Money Markets e. The Federal Reserve adjusts the amount of funds in depository institutions in order to influence the federal funds rate.

ANSWER: b 40. The yields offered on asset-backed commercial paper are often ______ the yields offered on unsecured commercial paper. a. equal to b. lower than c. higher than d. more variable ANSWER: c 41. If economic conditions cause investors to sell stocks because they want to invest in safer securities with much liquidity, this should cause a ____ demand for money market securities, which would place ____ pressure on the yields of money market securities. a. weak; downward b. weak; upward c. strong; upward d.

None of these are correct.

ANSWER: d 42. The amount of commercial paper outstanding today is approximately twice as large as it was before the credit crisis that began in 2008. a.

True b.

False ANSWER: False 43. Money market securities must have a maturity of three months or less. a.

True b.

False ANSWER:

False

44. Money market securities are issued in the primary market through a telecommunications network by the Treasury, corporations, and financial intermediaries that wish to obtain short-term financing. a.

True b.

False ANSWER: True 45. An international interbank market facilitates the transfer of funds from banks with excess funds to those with deficient funds. a.

True b.

False ANSWER: True 46. The interest rate charged for a short-term loan from a bank to a corporation is referred to as the London Interbank Copyright Cengage Learning. Powered by Cognero.

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Chapter 06: Money Markets Offer Rate (LIBOR). a. b.

True False

ANSWER:

False

47. Money markets are used to facilitate the transfer of short-term funds from individuals, corporations, or governments with excess funds to those with deficient funds. a.

True b.

False ANSWER: True 48. Because money market securities have a short-term maturity and typically cannot be sold easily, they provide investors with a low degree of liquidity. a.

True b.

False ANSWER: False 49. There is no limit to the amount of T-bills that can be purchased by noncompetitive bidders in a T-bill auction. a.

True b.

False ANSWER: False 50. T-bills do not offer coupon payments but are sold at a discount from par value. a.

True b.

False ANSWER:

True

51. Junk commercial paper is commercial paper that is not rated or has a low rating. a.

True b.

False ANSWER:

True

52. A line of credit provided by a commercial bank gives a company the right (but not the obligation) to borrow a specified maximum amount of funds over a specified period of time. a.

True b.

False ANSWER: True 53. T-bills must offer a premium above negotiable certificates of deposit (NCDs) to compensate for less liquidity and safety. a.

True b.

False ANSWER: False 54. Most repo transactions use government securities.

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Chapter 06: Money Markets a. b.

ANSWER:

True False True

55. Exporters can hold a banker's acceptance until the date at which payment is to be made, but they frequently sell the acceptance before then at a discount to obtain cash immediately. a.

True b.

False ANSWER: True 56. Money market security values are less sensitive to interest rate movements than bonds. a.

True b.

False ANSWER: True 57. During periods of uncertainty about the economy, there is a shift from risky money market securities to Treasury securities. a.

True b.

False ANSWER: True 58. The price that competitive and noncompetitive bidders will pay at a Treasury bill auction is the a highest price entered by a competitive bidder. b. highest price entered by a noncompetitive bidder. c. lowest accepted bid price entered by a competitive bidder. d. equally weighted average price paid by all competitive bidders whose bids were accepted. e. None of these are correct.

ANSWER:

c

59. A private investor purchases a six-month (182-day) T-bill with a $10,000 par value for $9,800. If she holds the Treasury bill to maturity, her annualized yield is ____ percent. a.

3.96 b.

4.54 c.

1.50 d.

4.09 e.

None of these are correct.

ANSWER: d 60. You purchase a six-month (182-day) T-bill with a $10,000 par value for $9,800. The Treasury bill discount is ____ percent. a.

3.96 b.

4.09 c.

6.20 d.

3.56 Copyright Cengage Learning. Powered by Cognero.

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Chapter 06: Money Markets e.

None of these are correct.

ANSWER:

a

61. A ____ is not a money market security. a Treasury bill . b. negotiable certificate of deposit c. bond d. banker's acceptance e.

All of these are money market securities.

ANSWER:

c

62. Freeman Corp., a large corporation, plans to issue 45-day commercial paper with a par value of $3,000,000. Freeman expects to sell the commercial paper for $2,947,000. Freeman's annualized cost of borrowing is estimated to be ____ percent. a.

14.39 b.

14.13 c.

14.59 d.

14.33 e.

None of these are correct.

ANSWER: a 63. When a firm sells its commercial paper at a ____ price than projected, its cost of raising funds will be ____ than what it initially anticipated. a. higher; higher b. lower; lower c. higher; lower d. lower; higher e. higher; lower AND lower; higher ANSWER: e 64. Which of the following securities is most likely to be used in a repo transaction? a commercial paper b. certificate of deposit c. Treasury bill d. common stock e. All of these are equally likely to be used in a repo transaction.

ANSWER:

c

65. A major drawback to investing in Treasury bills is that they cannot easily be liquidated. a.

True b.

False ANSWER: False Copyright Cengage Learning. Powered by Cognero.

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Chapter 06: Money Markets 66. At each T-bill auction, the prices paid for three-month T-bills are significantly lower than the prices paid for sixmonth bills. a.

True b.

False ANSWER: False 67. Ignoring transaction costs, the cost of borrowing with commercial paper is equal to a the yield on T-bills of the same maturity. b. the yield earned by investors holding the paper until maturity. c. the federal funds rate. d. the par value of the paper.

ANSWER:

b

68. LIBOR is a the interest rate charged on international interbank loans. b. the average rate charged on commercial loans in Europe c. the rate charged by the Federal Reserve for loans to banks. d. the rate charged by the European Central Bank for loans to banks.

ANSWER:

a

69. The LIBOR scandal in 2012 involved a banks reporting inflated earnings from their loans. b. hackers breaking into the loan documentation files. c. banks falsely reporting the interest rates they offered in the interbank market. d. collusion among the banks when setting the commercial paper rate.

ANSWER:

c

70. Credit guarantees for commercial paper a ensure that the issuer of commercial paper will use the funds obtained to provide credit. b. are issued by the Federal Reserve Bank of New York. c. are only as good as the credit of the guarantor. d. ensure that the issuer of commercial paper will use the funds obtained to provide credit AND are only as good as the credit of the guarantor.

ANSWER: c 71. The money market interest rate paid by corporations that borrow short-term funds in a particular country is typically a equal to the rate paid by that country’s government. b. slightly higher than the rate paid by that country’s government. c. mostly influenced by the demand for and supply of long-term funds in that country. d. set by the country’s central bank.

ANSWER: b

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Chapter 07: Bond Markets 1. ____ commonly have maturities of 10 years or longer. a.

Commercial paper certificates b.

Treasury bills c.

Federal fund notes d.

Bonds ANSWER:

d

2. The yield to maturity is the annualized discount rate that equates the future coupon and principal payments to the initial proceeds received from the bond offering. a.

True b.

False ANSWER: True 3. Note maturities are usually ____, while bond maturities are ____. a. less than 10 years; 10 years or more b.

10 years or more; less than 10 years c. less than 5 years; 5 years or more d.

5 years or more; less than 5 years ANSWER:

a

4. Investors in Treasury notes and bonds receive ____ interest payments from the Treasury. a. annual b. semiannual c. quarterly d. monthly ANSWER:

b

5. The Treasury has relied heavily on ____-year bonds to finance the U.S. budget deficit. a.

50 b.

70 c.

10 d.

5 ANSWER:

c

6. Interest earned from Treasury bonds is a. exempt from all income tax. b. exempt from federal income tax. c. exempt from state and local taxes. d. subject to all income taxes.

ANSWER:

c

7. Treasury bond auctions are normally conducted only at the beginning of each year. a.

True Copyright Cengage Learning. Powered by Cognero.

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Chapter 07: Bond Markets b.

False

ANSWER:

False

8. ____ bids for Treasury bonds specify a price that the bidder is willing to pay and a dollar amount of securities to be purchased. a.

Competitive b.

Noncompetitive c.

Negotiable d.

Non-negotiable ANSWER: a 9. Treasury bond dealers a quote an ask price for customers who want to sell existing Treasury bonds to the dealers. b. profit from a very wide spread between bid and ask prices in the Treasury securities market. c. may trade Treasury bonds among themselves. d. make a primary market for Treasury bonds.

ANSWER:

c

10. Under the STRIP program created by the Treasury, stripped securities are created and sold by the Treasury. a.

True b.

False ANSWER: False 11. A 10-year, inflation-indexed bond has a par value of $10,000 and a coupon rate of 5 percent. During the first six months since the bond was issued, the inflation rate was 2 percent. Based on this information, the coupon payment after six months will be $____. a.

250 b.

255 c.

500 d.

510 ANSWER: b 12. Bonds issued by ____ are backed by the federal government. a. the Treasury b.

AAA-rated corporations c. state governments d. city governments ANSWER:

a

13. Municipal general obligation bonds are ____. Municipal revenue bonds are ____. a supported by the municipal government's ability to tax; supported by the municipal government's ability to tax b. supported by the municipal government's ability to tax; supported by revenue generated from the project c. always subject to federal taxes; always exempt from state and local taxes Copyright Cengage Learning. Powered by Cognero.

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Chapter 07: Bond Markets d. typically zero-coupon bonds; typically zero-coupon bonds ANSWER:

b

14. In general, variable-rate municipal bonds are desirable to investors who expect that interest rates will ______. a. remain unchanged b. fall c. rise d.

None of these are correct.

ANSWER: c 15. A variable-rate bond allows a investors to benefit from declining rates over time. b. issuers to benefit from rising market interest rates over time. c. investors to benefit from rising market interest rates over time. d. None of these are correct.

ANSWER:

c

16. Corporate bonds that receive a ____ rating from credit rating agencies are normally placed at ____ yields. a. higher; lower b. lower; lower c. higher; higher d.

None of these are correct.

ANSWER: a 17. A private bond placement has to be registered with the SEC. a.

True b.

False ANSWER:

False

18. Which of the following institutions is most likely to purchase a private bond placement? a. commercial bank b. finance company c. insurance company d. savings institution ANSWER:

c

19. A call provision on bonds normally allows the firm to a sell new bonds at par value. . b. sell new bonds above market value. c. sell bonds to the Treasury. d. buy back bonds that it previously issued.

ANSWER:

d

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Chapter 07: Bond Markets 20. A corporate restructuring in which the corporation seeks to reduce its debt by issuing stock and using the proceeds to retire its existing bonds is known as a(n) a. debt-for-equity swap. b. leveraged buyout. c. equity-for-debt swap. d. collateralized debt retirement.

ANSWER: c 21. Many bonds have different call prices: a higher price for calling the bonds to meet sinking-fund requirements and a lower price if the bonds are called for any other reason. a.

True b.

False ANSWER: False 22. Bonds that are not secured by specific property are called a. chattel mortgage bonds. b. open-end mortgage bonds. c. debentures. d. blanket mortgage bonds.

ANSWER:

c

23. The coupon rate of most variable-rate bonds is tied to a. the prime rate. b. the discount rate. c.

LIBOR. d. the federal funds rate.

ANSWER:

c

24. Assume that one year ago you purchased corporate bonds that have no protective covenants. Today, it is announced that the firm that issued the bonds plans a leveraged buyout. The market value of your bonds will likely ____ as a result. a. rise b. decline c. be zero d. be unaffected ANSWER: b 25. During weak economic periods, newly issued junk bonds require lower risk premiums than in strong economic periods. a.

True b.

False ANSWER: False 26. ____ bonds have the most active secondary market. a.

Treasury Copyright Cengage Learning. Powered by Cognero.

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Chapter 07: Bond Markets b. c. d.

Zero-coupon corporate Junk Municipal

ANSWER:

a

27. ____ are not primary purchasers of bonds. a.

Insurance companies b.

Finance companies c.

Mutual funds d.

Pension funds ANSWER:

b

28. Leveraged buyouts are commonly financed by the issuance of a. money market securities. b.

Treasury bonds. c. corporate bonds. d. municipal bonds.

ANSWER:

c

29. When firms issue ____, the amount of interest and principal to be paid is based on specified market conditions. The amount of the repayment may be tied to a Treasury bond price index or even to a stock index. a. auction-rate securities b. structured notes c. leveraged notes d. stripped securities ANSWER: b 30. Which of the following statements is true regarding STRIPS? a They are issued by the Treasury. b. They are created and sold by various financial institutions. c. They are not backed by the U.S. government. d. They have to be held until maturity. e. All of these are true regarding STRIPS. ANSWER:

b

31. (Financial calculator required.) Erin, a private investor, can purchase $1,000 par value bonds for $980. The bonds have a 10 percent coupon rate, pay interest annually, and have 20 years remaining until maturity. Erin's yield to maturity is ____ percent. a.

9.96 b.

10.00 c.

10.33 d.

10.24 e.

None of these are correct.

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Chapter 07: Bond Markets ANSWER:

d

32. Devin, a private investor, purchases $1,000 par value bonds with a 12 percent coupon rate and a 9 percent yield to maturity. Devin will hold the bonds until maturity. Thus, he will earn a return of ____ percent. a 12 . b. 9 c. 10.5 d. More information is needed to answer this question ANSWER:

b

33. Which of the following is NOT true regarding zero-coupon bonds? a They are issued at a deep discount from par value. b. Investors are taxed annually on the amount of interest earned, even though they will not receive the interest until maturity. c. The issuing firm is permitted to deduct the amortized discount as interest expense, even though it does not pay interest. d. Zero-coupon bonds pay dividends instead of coupons. e. All of these are correct.

ANSWER: d 34. Which of the following is NOT true regarding the call provision? a It typically requires a firm to pay a price above par value when it calls its bonds. b. The difference between the market value of the bond and the par value is called the call premium. c. A principal use of the call provision is to lower future interest payments. d. A principal use of the call provision is to retire bonds as required by a sinking-fund provision. e. A call provision is normally viewed as a disadvantage to bondholders.

ANSWER:

b

35. If interest rates suddenly ____, those existing bonds that have a call feature are ____ likely to be called. a. decline; more b. decline; less c. increase; more d.

None of these are correct.

ANSWER:

a

36. Which of the following is NOT likely to be an example of a protective covenant provision? a limit on the amount of dividends a firm can pay b. a limit on the corporate officers' salaries a firm can pay c. a limit on the amount of additional debt a firm can issue d. a call feature ANSWER:

d

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Chapter 07: Bond Markets 37. Bonds are issued in the primary market through a telecommunications network. a.

True b.

False ANSWER:

True

38. Corporate bonds can be placed with investors through a public offering or a private placement. a.

True b.

False ANSWER: True 39. When a corporation issues bonds, it normally hires a securities firm that targets large institutional investors such as pension funds, bond mutual funds, and insurance companies. a.

True b.

False ANSWER: True 40. Rule 144A allows small individual investors to trade privately placed bonds with each other without requiring the firms that issued the securities to register them with the SEC. a.

True b.

False ANSWER: False 41. Rule 144A creates liquidity for securities that are privately placed. a.

True b.

False ANSWER: 42. Most corporate bonds have a maturity between 2 and 7 years. a.

True b.

False ANSWER:

True

False

43. Structured notes are issued by firms to borrow funds, and the amount of interest and principal to be paid is based on specified market conditions. a.

True b.

False ANSWER: True 44. Bonds issued by large well-known corporations in large volume are illiquid because most buyers hold these bonds until maturity. a.

True b.

False ANSWER: False 45. The bond market is served by bond dealers, who can play a broker role by matching up buyers and sellers.

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Chapter 07: Bond Markets a. b.

True False

ANSWER: 46. Bond dealers do not have an inventory of bonds. a.

True b.

False ANSWER:

True

False

47. Bond dealers specialize in small transactions (less than $100,000) in order to enable small investors to trade bonds. a.

True b.

False ANSWER: False 48. Many bonds are listed on the New York Stock Exchange (NYSE). a.

True b.

False ANSWER:

True

49. The primary investors in bond markets are institutional investors such as commercial banks, bond mutual funds, pension funds, and insurance companies. a.

True b.

False ANSWER: True 50. The key difference between a note and a bond is that note maturities are usually less than one year, while bond maturities are one year or more. a.

True b.

False ANSWER: False 51. Treasury bonds are issued by state and local governments. a.

True b.

False ANSWER:

False

52. Stripped bonds are bonds whose cash flows have been transformed into a security representing the principal payment only and a security representing interest payments only. a.

True b.

False ANSWER: True 53. Inflation-indexed Treasury bonds are intended for investors who wish to ensure that the returns on their investments keep up with the increase in prices over time.

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Chapter 07: Bond Markets a. b.

True False

ANSWER:

True

54. Savings bonds are bonds issued by the Federal Reserve. a.

True b.

False ANSWER:

False

55. Corporate bonds usually pay interest on an annual basis. a.

True b.

False ANSWER:

False

56. The bond debenture is a legal document specifying the rights and obligations of both the issuing firm and the bondholders. a.

True b.

False ANSWER: False 57. A sinking-fund provision is a requirement that the issuing firm retire a certain amount of the bond issue each year. a.

True b.

False ANSWER: True 58. Subordinated indentures have claims against the firm's assets that are junior to the claims of both mortgage bonds and regular indentures. a.

True b.

False ANSWER: False 59. High-risk bonds are called trash bonds. a. b.

ANSWER:

True False False

60. Zero-coupon bonds do not pay interest. Instead, they are issued at a discount from par value. a.

True b.

False ANSWER: True 61. If interest rates suddenly decline, those existing bonds that have a call feature are less likely to be called. a.

True b.

False Copyright Cengage Learning. Powered by Cognero.

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Chapter 07: Bond Markets ANSWER:

False

62. Which of the following statements is NOT true regarding STRIPS? a They are not issued by the Treasury. b. They are created and sold by various financial institutions. c. They are backed by the U.S. government. d. They have to be held until maturity. e. All of these are true regarding STRIPS. ANSWER:

d

63. Which of the following is NOT an advantage of online bond brokerage services? a Pricing is more transparent because investors can easily compare bid and ask spreads. b. Some services charge commissions, which may be more easily understood than bid and ask spreads. c. Some brokers have narrowed their spreads so that they do not lose business to competitors. d. All of these are advantages of online bond brokerage services.

ANSWER: d 64. Jim purchases $10,000 par value bonds with a 10 percent coupon rate and a 7 percent yield to maturity. Jim will hold the bonds until maturity. Thus, he will earn a return of ____ percent. a 8 . b. 7 c. 10 d. More information is needed to answer this question.

ANSWER:

b

65. Which of the following statements is incorrect? a A municipal bond must pay a risk premium to compensate for the possibility of default risk. b. A Treasury bond must pay a slight premium to compensate for being less liquid than municipal bonds. c. The income earned from municipal bonds is exempt from federal taxes. d. All of these are correct.

ANSWER: b 66. A(n) __________ allows investors to exchange a bond for a stated number of shares of the firm’s _________. a. equity-for-debt swap; common stock b. debt-for-equity swap; preferred stock c. call provision; common stock d. convertible bond; common stock ANSWER: d 67. Everything else being equal, which of the following bond ratings is associated with the highest yield? a.

Baa b.

A Copyright Cengage Learning. Powered by Cognero.

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Chapter 07: Bond Markets c. d.

Aa Aaa

ANSWER:

a

68. A _____ has first claim on specified real property assets, while a _____ is a debenture that has claims against a firm's assets that are junior to the claims of mortgage bonds and regular debentures. a first mortgage bond; second mortgage bond . b. first mortgage bond; debenture c. first mortgage bond; subordinated debenture d. chattel mortgage bond; subordinated debenture e. None of these are correct.

ANSWER: c 69. If a firm believes that it will have sufficient cash flows to cover interest payments, it may consider using ____ debt and ____ equity, which implies a ____ degree of financial leverage. a. more; less; lower b. more; less; higher c. less; more; higher d.

None of these are correct.

ANSWER: b 70. The yield to investors on Treasury bonds reflects the risk-free rate because these bonds are virtually free from credit (default) risk. a.

True b.

False ANSWER: True 71. The issuance of municipal securities is regulated by a the Securities and Exchange Commission. . b. the Consumer Financial Protection Bureau. c. the respective state governments. d. the Federal Reserve.

ANSWER:

c

72. For bonds issued under a _______ arrangement, the underwriter guarantees the issuer that the bonds will be sold at a specified price. a. specific value b. fixed proceeds c. best efforts d. firm commitment ANSWER: d Copyright Cengage Learning. Powered by Cognero.

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Chapter 07: Bond Markets 73. For bonds issued under a _______ arrangement, the underwriter attempts to sell the bonds at a specified price but makes no guarantee to the issuer. a. floating value b. variable proceeds c. best efforts d. firm commitment ANSWER: c 74. Most newly issued municipal bonds are insured because investors are unwilling to purchase uninsured municipal bonds out of fear that the issuer may default. a.

True b.

False ANSWER: False 75. The Financial Reform Act of 2010 established the __________ to provide oversight for credit rating agencies. a.

Federal Ratings Bureau b.

Office of Credit Ratings c.

Office of Agency Supervision d.

Ratings Oversight Commission ANSWER: b 76. A credit rating agency is paid by a the purchasers of the bonds that the agency rates. b. the issuers of the bonds that the agency rates. c. the taxpayers, because the rating agencies are government agencies. d. the New York Stock Exchange or the over-the-counter market where the bonds are listed.

ANSWER:

b

77. All of the bonds issued by a particular company will have the same maturity, price, and credit rating. a.

True b.

False ANSWER: False 78. Corporate bonds are sometimes packaged by commercial banks into ___________, in which investors receive the interest or principal payments generated by the debt securities. a collateralized debt obligations (CDOs) . b. credit default swaps c. reverse loans d. inverted bonds ANSWER: a

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Chapter 08: Bond Valuation and Risk 1. The appropriate discount rate for valuing any bond is the bond's coupon rate. b. bond's coupon rate adjusted for the expected inflation rate over the life of the bond. c. Treasury bill rate with an adjustment to include a risk premium if one exists. d. yield that could be earned on alternative investments with similar risk and maturity.

ANSWER:

d

2. The valuation of bonds is generally perceived to be ____ the valuation of equity securities. a. more difficult than b. easier than c. just as difficult as d.

None of these are correct.

ANSWER:

b

3. A bond with a $1,000 par value has an 8 percent annual coupon rate. It will mature in 4 years, and annual coupon payments are made at the end of each year. Present annual yields on similar bonds are 6 percent. What should be the current price? a. $1,069.31 b. $1,000.00 c. $971.20 d. $927.66 e.

None of these are correct.

ANSWER: a 4. A bond with a 12 percent quarterly coupon rate has a yield to maturity of 16 percent. The bond has a par value of $1,000 and matures in 20 years. Based on this information, a fair price of this bond is $____. a.

1,302 b.

963 c.

761 d.

1,299 ANSWER: c 5. From the perspective of investing institutions, the most attractive foreign bonds offer a ____ and are denominated in a currency that ____ over the investment horizon. a. high yield; appreciates b. high yield; remains stable c. low yield; appreciates d. low yield; depreciates ANSWER: a 6. The value of ____-risk securities will be relatively ____. a. high; high b. high; low c. low; low Copyright Cengage Learning. Powered by Cognero.

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Chapter 08: Bond Valuation and Risk d.

None of these are correct.

ANSWER:

b

7. If the coupon rate equals the required rate of return, the price of the bond a. should be above its par value. b. should be below its par value. c. should be equal to its par value. d. is negligible.

ANSWER:

c

8. When financial institutions expect interest rates to ____, they may ____. a increase; sell bonds and buy short-term securities b. increase; sell short-term securities and buy bonds c. decrease; sell bonds and buy short-term securities d. increase; sell short-term securities and buy bonds AND decrease; sell bonds and buy short-term securities ANSWER: a 9. For a bond of a given par value, the higher the investor's required rate of return is above the coupon rate, the a. greater is the premium on the price. b. greater is the discount on the price. c. smaller is the premium on the price. d. smaller is the discount on the price.

ANSWER: b 10. Zero-coupon bonds with a par value of $1,000,000 have a maturity of 10 years and a required rate of return of 9 percent. What is the current price? a. $363,212 b. $385,500 c. $422,400 d. $424,100 e. $525,400 ANSWER: c 11. If the coupon rate ____ the required rate of return, the price of a bond ____ par value. a equals; equals . b. exceeds; is less than c. is less than; is greater than d. exceeds; is less than AND is less than; is greater than e. None of these are correct.

ANSWER:

a

12. The prices of bonds with ____ are most sensitive to interest rate movements.

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Chapter 08: Bond Valuation and Risk a high coupon payments b. zero coupon payments c. small coupon payments d. None of these are correct because the size of the coupon payment does not affect the sensitivity of bond prices to interest rate movements.

ANSWER: b 13. A(n) ____ in the expected level of inflation results in ____ pressure on bond prices. a. increase; upward b. increase; downward c. decrease; downward d.

None of these are correct.

ANSWER:

b

14. Other things held constant, bond prices should increase when inflationary expectations rise. a.

True b.

False ANSWER: False 15. Assume that the price of a $1,000 zero-coupon bond with five years to maturity is $567 when the required rate of return is 12 percent. If the required rate of return suddenly changes to 15 percent, what is the price elasticity of the bond? a.

-.980 b. +.980 c.

-.494 d. +.494 e.

None of these are correct.

ANSWER: c 16. If a financial institution's bond portfolio contains a relatively large portion of ____, it will be ____. a high-coupon bonds; more favorably affected by declining interest rates b. zero- or low-coupon bonds; more favorably affected by declining interest rates c. zero- or low-coupon bonds; more favorably affected by rising interest rates d. high-coupon bonds; completely insulated from rising interest rates ANSWER:

b

17. The prices of ____-coupon bonds and bonds with ____ maturities are most sensitive to changes in the required rate of return. a. low; short b. low; long c. high; short d. high; long ANSWER: b 18. A $1,000 par bond with five years to maturity is currently priced at $892. Annual interest payments are $90. What is Copyright Cengage Learning. Powered by Cognero.

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Chapter 08: Bond Valuation and Risk the yield to maturity? a. b. c. d.

13 percent 12 percent 11 percent 10 percent

ANSWER:

b

19. A bank buys bonds with a par value of $25 million for $24,040,000. The coupon rate is 10 percent, and the bonds make annual payments. The bonds mature in four years. The bank wants to sell them in two years and estimates the required rate of return in two years will be 8 percent. What will the market value of the bonds be in two years? a. $24,113,418 b. $24,667,230 c. $25,000,000 d. $25,891,632 ANSWER: d 20. The prices of short-term bonds are commonly ____ those of long-term bonds. a more volatile than b. equally as volatile as c. less volatile than d. More volatile and less volatile occur with about equal frequency.

ANSWER:

c

21. If interest rates consistently rise over a specific period, the market price of a bond you own would likely ____ over this period. (Assume no major change in the bond's credit risk.) a consistently increase b. consistently decrease c. remain unchanged d. change in a direction that cannot be determined with the above information ANSWER: b 22. If interest rates consistently decline over a specific period, the market price of a bond you own would likely ____ over this period. (Assume no major change in the bond's credit risk.) a consistently increase b. consistently decrease c. remain unchanged d. change in a direction that cannot be determined with the above information ANSWER: a 23. If analysts expect that the demand for loanable funds will increase and the supply of loanable funds will decrease, they would most likely expect interest rates to ____ and prices of existing bonds to ____. a. increase; increase b. increase; decrease c. decrease; decrease Copyright Cengage Learning. Powered by Cognero.

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Chapter 08: Bond Valuation and Risk d.

decrease; increase

ANSWER:

b

24. Consider a coupon bond that sold at par value two years ago. If interest rates are much lower now than when this bond was issued, the coupon rate of that bond will likely be ____ the prevailing interest rates, and the present value of the bond will be ____ its par value. a. above; above b. above; below c. below; below d. below; above ANSWER: a 25. If bond portfolio managers expect interest rates to increase in the future, they would likely ____ their holdings of bonds now, which could cause the prices of bonds to ____ as a result of their actions. a. increase; increase b. increase; decrease c. decrease; decrease d. decrease; increase ANSWER: c 26. Which of the following will most likely cause bond prices to increase? (Assume no possibility of higher inflation in the future.) a reduced Treasury borrowing along with anticipation that money supply growth will decrease b. reduced Treasury borrowing along with anticipation that money supply growth will increase c. an anticipated drop in money supply growth along with increasing Treasury borrowing d. higher levels of Treasury borrowing and corporate borrowing ANSWER: b 27. If the U.S. government announces that it will borrow an additional $400 billion, this announcement will normally cause bond traders to expect a higher interest rates in the future, and they will buy bonds now. b. higher interest rates in the future, and they will sell bonds now. c. stable interest rates in the future, and they will buy bonds now. d. lower interest rates in the future, and they will buy bonds now. e. lower interest rates in the future, and they will sell bonds now.

ANSWER: b 28. The market value of long-term bonds is ____ sensitive to interest rate movements; as interest rates fall, the market value of long-term bonds ____. a. slightly; rises b. very; rises c. very; declines d. slightly; declines ANSWER: b Copyright Cengage Learning. Powered by Cognero.

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Chapter 08: Bond Valuation and Risk 29. The bonds that are most sensitive to interest rate movements have a no coupon and a short-term maturity. . b. high coupons and a short-term maturity. c. high coupons and a long-term maturity. d. no coupon and a long-term maturity.

ANSWER:

d

30. When two securities have the same expected cash flows, the value of the high-risk security will be higher than the value of the low-risk security. a.

True b.

False ANSWER: False 31. Morgan would like to purchase a bond that has a par value of $1,000, pays $80 at the end of each year in coupon payments, and has 10 years remaining until maturity. If the prevailing annualized yield on other bonds with similar characteristics is 6 percent, how much will Morgan pay for the bond? a. $1,000.00 b. $1,147.20 c. $856.80 d.

None of these are correct.

ANSWER: b 32. Sioux Financial Corp. has forecasted its bond portfolio value for one year ahead to be $105 million. In one year, it expects to receive $10,000,000 in coupon payments. The bond portfolio today is worth $101 million. What is the forecasted return of this bond portfolio? a.

10 percent b.

8.82 percent c.

4.32 percent d.

13.86 percent e.

None of these are correct.

ANSWER: d 33. Hurricane Corp. recently purchased corporate bonds in the secondary market with a par value of $11 million, a coupon rate of 12 percent (with annual coupon payments), and four years until maturity. If Hurricane intends to sell the bonds in two years and expects investors' required rate of return on similar investments to be 14 percent at that time, what is the expected market value of the bonds in two years? a. $9.33 million b. $11.00 million c. $10.64 million d. $9.82 million e.

None of these are correct.

ANSWER: c Copyright Cengage Learning. Powered by Cognero.

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Chapter 08: Bond Valuation and Risk 34. Assume a bond with a $1,000 par value and an 11 percent coupon rate, two years remaining to maturity, and a 10 percent yield to maturity. The duration of this bond is a.

1.90 years. b.

1.50 years. c.

1.72 years. d.

None of these are correct.

ANSWER: a 35. Assume a bond with a $1,000 par value and an 11 percent coupon rate, two years remaining to maturity, and a 10 percent yield to maturity. The modified duration of this bond is a.

1.73 years. b.

1.81 years. c.

1.90 years. d.

None of these are correct.

ANSWER: a 36. The actual relationship reflecting the response of a bond's price to a change in bond yields is a. concave. b. convex. c. linear. d. quadratic.

ANSWER:

b

37. If the level of inflation is expected to ____, there will be ____ pressure on interest rates and ____ pressure on the required rate of return on bonds. a. increase; upward; downward b. decrease; upward; downward c. decrease; upward; upward d. increase; downward; upward e. increase; upward; upward ANSWER: e 38. Using a(n) ____ strategy, investors allocate funds evenly to bonds in each of several different maturity classes. a. matching b. laddered c. barbell d. interest rate e.

None of these are correct.

ANSWER: b 39. With a(n) ____ strategy, funds are allocated to bonds with a short term to maturity and bonds with a long term to maturity. Thus, this strategy allocates some funds to achieving a relatively high return and other funds to covering liquidity needs. a. matching Copyright Cengage Learning. Powered by Cognero.

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Chapter 08: Bond Valuation and Risk b. c. d. e.

laddered barbell interest rate None of these are correct.

ANSWER:

c

40. Which of the following bonds is most susceptible to interest rate risk from an investor's perspective? a. short-term, high-coupon b. short-term, low-coupon c. long-term, high-coupon d. long-term, zero-coupon ANSWER:

d

41. Which of the following is most likely to cause a decrease in bond prices? a a decrease in money supply growth and an increase in the demand for loanable funds b. a forecast of decreasing oil prices c. a forecast of a stronger dollar d. an increase in money supply growth and no change in the demand for loanable funds ANSWER:

a

42. If the Treasury issues an unusually large amount of bonds in the primary market, it places ____ pressure on bond prices and ____ pressure on yields to be earned by investors that purchase bonds and plan to hold them to maturity. a. downward; downward b. downward; upward c. upward; upward d. upward; downward ANSWER: b 43. Assume bond portfolio managers actively manage their portfolios. If they expect interest rates to ____, they would shift toward ____. a increase; long-maturity bonds with zero-coupon rates . b. decrease; short-maturity bonds with high-coupon rates c. increase; high-coupon bonds with long maturities d. decrease; long-maturity bonds with zero-coupon rates ANSWER:

d

44. The market price of a bond is partly determined by the timing of the payments made to bondholders. a.

True b.

False ANSWER: True 45. The appropriate price of a bond is simply the sum of the cash flows to be received.

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Chapter 08: Bond Valuation and Risk a. b.

True False

ANSWER:

False

46. The valuation of bonds is generally perceived to be more difficult than the valuation of equity securities. a.

True b.

False ANSWER: False 47. Bonds that sell below their par value are called premium bonds. a.

True b.

False ANSWER: 48. A zero-coupon bond makes no coupon payments. a.

True b.

False ANSWER:

False

True

49. If the coupon rate of a bond is above the investor's required rate of return, the price of the bond should be below its par value. a.

True b.

False ANSWER: False 50. An increase in either the risk-free rate or the general level of the risk premium on bonds results in a higher required rate of return and therefore causes bond prices to increase. a.

True b.

False ANSWER: False 51. The long-term, risk-free interest rate is driven by inflationary expectations, economic growth, the money supply, and the budget deficit. a.

True b.

False ANSWER: True 52. If the level of inflation is expected to decrease, there will be upward pressure on interest rates and on the required rate of return on bonds. a.

True b.

False ANSWER: False 53. Foreign investors anticipating dollar depreciation are less willing to hold U.S. bonds because the coupon payments will convert to less of their home currency.

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Chapter 08: Bond Valuation and Risk a. b.

True False

ANSWER:

True

54. Any announcement that signals stronger than expected economic growth tends to increase bond prices. a.

True b.

False ANSWER: False 55. Bond price elasticity is the percentage change in bond prices divided by the percentage change in the required rate of return. a.

True b.

False ANSWER: True 56. As interest rates increase, prices of short-term bonds will decline by a greater degree than prices of long-term bonds. a.

True b.

False ANSWER: False 57. Duration is a measure of the life of a bond on a present value basis. a.

True b.

False ANSWER:

True

58. A bond portfolio containing a large portion of zero-coupon bonds will be more favorably affected by declining interest rates than a bond portfolio containing no zero-coupon bonds. a.

True b.

False ANSWER: True 59. International diversification of bonds reduces the sensitivity of a bond portfolio to any single country's interest rate movements. a.

True b.

False ANSWER: True 60. In a laddered strategy, investors create a bond portfolio that will generate periodic income that can match their expected periodic expenses. a.

True b.

False ANSWER: False 61. The credit crisis of 2008–2009 had substantial effects on the credit risk premiums of bonds issued by U.S. corporations, but bonds issued by corporations based in other countries were largely unaffected.

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Chapter 08: Bond Valuation and Risk a. b.

True False

ANSWER:

False

62. Stephanie would like to purchase a bond that has a par value of $1,000, pays $100 at the end of each year in coupon payments, and has three years remaining until maturity. If the prevailing annualized yield on other bonds with similar characteristics is 12 percent, how much will Stephanie pay for the bond? a. $1,000.00 b. $951.97 c. $856.80 d.

None of these are correct.

ANSWER: b 63. Julia just purchased a $1,000 par value bond with a 10 percent annual coupon rate and a life of 20 years. The bond has four years remaining until maturity, and the yield to maturity is 12 percent. How much did Julia pay for the bond? a. $1,063.40 b. $1,000 c. $939.25 d.

None of these are correct.

ANSWER: c 64. To determine the present value of a bond that pays semiannual interest, which of the following adjustments should not be made to compute the price of the bond? a The annualized coupon should be split in half. . b. c. d. e.

ANSWER:

The annual discount rate should be divided by 2.

The number of annual periods should be doubled.

The par value should be split in half.

All of these adjustments have to be made. d

65. A $1,000 par value bond, paying $50 semiannually, with an 8 percent yield to maturity and five years remaining to maturity should sell for a. $1,000.00. b. $1,081.11. c. $798.70. d. $880.22. e.

None of these are correct.

ANSWER: b 66. An economic announcement signaling ____ economic growth in the future will probably cause bond prices to ____. a weak; decrease .

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Chapter 08: Bond Valuation and Risk b. c. d. e.

ANSWER:

strong; increase weak; increase strong; decrease weak; increase AND strong; decrease e

67. Because of a change in the required rate of return from 11 percent to 13 percent, the bond price of a zero-coupon bond will fall from $1,000 to $860. Thus, the bond price elasticity for this bond is a.

0.77. b.

-0.77. c.

-0.90. d.

-1.06. e.

None of these are correct.

ANSWER: b 68. The required rate of return on a certain bond changes from 12 percent to 8 percent, causing the price of the bond to change from $900 to $1,100. The bond price elasticity of this bond is a.

-0.36. b.

-0.44. c.

-0.55. d.

-0.67. e.

0.67.

ANSWER: d 69. Assume a bond with a $1,000 par value and a 7 percent coupon rate, three years remaining to maturity, and a 9 percent yield to maturity. The duration of this bond is ____ years. a.

1.92 b.

2.5 c.

2.8 d.

None of these are correct.

ANSWER: c 70. A bond has a $1,000 par value and an 8 percent coupon rate. The bond has four years remaining to maturity and a 10 percent yield to maturity. This bond's modified duration is ____ years. a.

1.33 b.

1.27 c.

3.24 d.

1.31 e.

None of these are correct.

ANSWER: c 71. If investors rely strictly on modified duration to estimate the percentage change in the price of a bond, they will tend to ____ the price decline associated with an increase in rates and ____ the price increase associated with a decrease in rates.

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Chapter 08: Bond Valuation and Risk a. b. c. d.

underestimate; underestimate overestimate; overestimate underestimate; overestimate overestimate; underestimate

ANSWER:

d

72. The process by which higher credit risk in one country is transmitted to another country is known as a. credit epidemic. b. credit expansion. c. credit contagion. d.

None of these are correct.

ANSWER:

c

73. Systemic risk could be avoided if all financial institutions would use derivative securities as a means of insuring against the default of the debt securities that they hold. a.

True b.

False ANSWER: False 74. Which of the following is NOT a factor affecting the market price of a foreign bond held by a U.S. investor? a foreign interest rate movements b. credit risk c. exchange rate fluctuations d. All of these are factors affecting the market price of a foreign bond.

ANSWER: d 75. When holding other factors constant, increased borrowing by the Treasury can result in a _______ required return and therefore _______ prices on existing bonds. a. higher; lower b. higher; higher c. lower; higher d. lower; lower ANSWER: a 76. Holding other factors constant, a higher budget deficit leads to ______ interest rates, and higher inflationary expectations lead to _______ interest rates. a. higher; lower b. higher; higher c. lower; higher d. lower; lower ANSWER: b 77. The credit risk premium tends to be larger for bonds that have longer terms to maturity. a.

True Copyright Cengage Learning. Powered by Cognero.

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Chapter 08: Bond Valuation and Risk b.

False

ANSWER:

True

78. The ____________ was established to identify risks in the U.S. financial system and make regulatory recommendations that could reduce such risks. a Financial Risk Assessment Commission . b.

Financial Markets Protection Agency c.

Financial Stability Oversight Council d.

Federal Bureau of Financial Markets ANSWER:

c

79. Which of the following are common methods of assessing the sensitivity of bonds to a change in the required rate of return on bonds? a duration and convexity . b. bond yield elasticity and durability c. bond price elasticity and return sensitivity analysis d. bond price elasticity and duration ANSWER:

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d

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Chapter 09: Mortgage Markets 1. Mortgage-backed securities are commonly contained within collateralized debt obligations. a.

True b.

False ANSWER: True 2. Federally insured mortgages guarantee a loan repayment to the lending financial institution. b. that the interest rate will not increase during the life of the mortgage. c. the lending financial institution a selling price for the mortgage in the secondary market. d. All of these are correct.

ANSWER:

a

3. At a given point in time, the interest rate offered on a new fixed-rate mortgage is typically ____ the initial interest rate offered on a new adjustable-rate mortgage. a. below b. above c. equal to d.

All of these are very common.

ANSWER: b 4. An institution that originates and holds a fixed-rate mortgage is adversely affected by ____ interest rates; the borrower who was provided the mortgage is adversely affected by ____ interest rates. a. stable; decreasing b. increasing; stable c. increasing; decreasing d. decreasing; increasing ANSWER: c 5. Rates for adjustable-rate mortgages are commonly tied to the a average prime rate over the previous year. . b. Fed's discount rate over the previous year. c. average Treasury bill rate over the previous year. d. average Treasury bond rate over the previous year.

ANSWER:

c

6. Caps on mortgage rate fluctuations with adjustable-rate mortgages (ARMs) are typically a 2 percent per year and 5 percent for the mortgage lifetime. b. 5 percent per year and 15 percent for the mortgage lifetime. c. 0 percent per year and 10 percent for the mortgage lifetime. d. 3 percent per year and 8 percent for the mortgage lifetime.

ANSWER:

a

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Chapter 09: Mortgage Markets 7. From the perspective of the lending financial institution, interest rate risk is a lower on a 30-year fixed-rate mortgage than on a 15-year fixed-rate mortgage. b. lower on a 15-year fixed-rate mortgage than on a 30-year fixed-rate mortgage. c. higher on a 15-year fixed-rate mortgage than on a 30-year fixed-rate mortgage. d. higher on a 15-year adjustable-rate mortgage than on a 30-year adjustable-rate mortgage.

ANSWER:

b

8. Mortgage companies specialize in a purchasing mortgages originated by other financial institutions. b. investing and maintaining mortgages that they create. c. originating mortgages and selling those mortgages. d. borrowing money through the creation of mortgages that is used to invest in real estate.

ANSWER:

c

9. For any given interest rate, the shorter the life of the mortgage, the ____ the monthly payment and the ____ the total payments over the life of the mortgage. a. greater; greater b. greater; lower c. lower; greater d. lower; lower ANSWER: b 10. A financial institution has a higher degree of interest rate risk on a ____ than a ____. a 30-year fixed-rate mortgage; 15-year fixed-rate mortgage b. 30-year variable-rate mortgage; 30-year fixed-rate mortgage c. 15-year fixed-rate mortgage; 30-year fixed-rate mortgage d. 15-year variable-rate mortgage; 15-year fixed-rate mortgage ANSWER:

a

11. A balloon-payment mortgage requires interest payments for a 10- to 20-year period, at the end of which the borrower must pay the full amount of the principal. a.

True b.

False ANSWER: False 12. Which of the following was part of the U.S. government’s response to the credit crisis? a Troubled Asset Relief Program (TARP) b. Housing and Economic Recovery Act c. Homeowners’ Mortgage Guarantee Act d. Troubled Asset Relief Program (TARP) AND Housing and Economic Recovery Act ANSWER:

d

13. A mortgage that requires interest payments for a three- to five-year period, then full payment of principal, is a(n) a. chattel mortgage.

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Chapter 09: Mortgage Markets b. c. d.

balloon-payment mortgage. variable-rate mortgage. open-ended mortgage bond.

ANSWER:

b

14. A mortgage with low initial payments that increase over time without ever leveling off is a a. graduated payment mortgage. b. growing-equity mortgage. c. second mortgage. d. shared-appreciation mortgage.

ANSWER:

b

15. The interest rate on a second mortgage is ____ the rate on a first mortgage created at the same time, because the second mortgage is ____ the existing first mortgage in priority claim against the property in the event of default. a. higher than; behind b. equal to that; equal to c. lower than; ahead of d. higher than; ahead of e. lower than; behind ANSWER: a 16. Which of the following mortgages allows the home purchaser to obtain a mortgage at a below-market interest rate throughout the life of the mortgage? a. second mortgage b. growing-equity mortgage c. graduated-payment mortgage d. shared-appreciation mortgage ANSWER: d 17. A ____ mortgage allows the borrower to initially make small payments on the mortgage. The payments then increase over the first 5 to 10 years and then level off. a. graduated-payment mortgage b. growing-equity mortgage c. second mortgage d. shared-appreciation mortgage ANSWER: a 18. Mortgage companies, commercial banks, and savings institutions are the primary originators of mortgages. a.

True b.

False ANSWER: True 19. ____ was created in 1968 as a corporation that is wholly owned by the federal government. It guarantees payment on FHA and VA mortgages that meet specific criteria.

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Chapter 09: Mortgage Markets a. b. c. d.

Freddie Mac Ginnie Mae Fannie Mae None of these are correct.

ANSWER: 20. "Securitization" refers to the private insurance of conventional mortgages. a.

True b.

False ANSWER: 21. A financial institution may service a mortgage even after selling it. a.

True b.

False ANSWER:

b

False

True

22. The difference between the 30-year mortgage rate and the 30-year Treasury bond rate is primarily attributable to a. interest rate risk. b. reinvestment rate risk. c. credit risk. d. insurance risk.

ANSWER: c 23. Which of the following is NOT a guarantor of federally insured mortgages? a Federal Housing Administration (FHA) b. Veterans Administration (VA) c. Federal Deposit Insurance Corporation (FDIC) d. All of these are guarantors of federally insured mortgages.

ANSWER:

c

24. ___ economic growth will probably ____ the risk premium on mortgages and cause the price of mortgages in the secondary market to _____. a.

Strong; increase; decrease b.

Strong; increase; increase c.

Weak; increase; decrease d.

Weak; increase; increase e.

Weak; decrease; decrease ANSWER: c 25. Which of the following are important criteria that financial institutions consider when assessing the creditworthiness of a prospective borrower for a mortgage? a the down payment the borrower will make . b. the borrower’s debt-to-income ratio Copyright Cengage Learning. Powered by Cognero.

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Chapter 09: Mortgage Markets c. d.

ANSWER:

the borrower’s credit score all of the above d

26. An adjustable-rate mortgage increases interest rate risk for the ____, but reduces interest rate risk for the ____. a. originator; borrower b. borrower; originator c. government; originator d.

None of these are correct.

ANSWER: b 27. A mortgage contract specifies a the interest rate. . b. the collateral backing the loan. c. whether the interest rate is fixed or adjustable. d. the maturity. e. all of the above.

ANSWER:

e

28. Which of the following is NOT a common type of mortgage-backed security according to your text? a FHLMA (Freddie Mac) participation certificates (PCs) b. collateralized mortgage obligations (CMOs) c. balloon-payment mortgage certificates d. private-label pass-through securities e. All of these are common types of mortgage pass-through securities.

ANSWER:

c

29. ____ risk is the risk that a borrower may prepay the mortgage in response to a decline in interest rates. a.

Interest rate b.

Credit c.

Prepayment d.

Reinvestment rate ANSWER:

c

30. Mortgage-backed securities are assigned ratings by a. rating agencies. b. the U.S. Treasury c. the Federal Reserve. d. the mortgage originator.

ANSWER:

a

31. In a collateralized mortgage obligation (CMO), mortgages are segmented into ____ (or classes).

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Chapter 09: Mortgage Markets a. b. c. d.

balloon payments caps tranches strips

ANSWER:

c

32. Which of the following was a major contributor to the credit crisis? a strict criteria applied by mortgage originators b. liberal criteria applied by mortgage originators c. very strict credit ratings applied to mortgage-backed securities d. fixed-rate mortgages with long terms to maturity ANSWER:

b

33. Fannie Mae and Freddie Mac experienced financial problems during the credit crisis because they a were unwilling to finance new mortgages. b. invested heavily in balloon-payment mortgages. c. invested only in prime mortgages that offered very low returns. d. invested heavily in subprime mortgages.

ANSWER:

d

34. ____ mortgages enable more people with relatively lower income, or high existing debt, or a small down payment to purchase homes. a.

Prime b.

Balloon c.

Amortized d.

Subprime ANSWER: d 35. The secondary mortgage market accommodates originators of mortgages who desire to sell their mortgages before maturity. a.

True b.

False ANSWER: True 36. Regardless of what happens to market interest rates, most adjustable-rate mortgages (ARMs) specify a maximum allowable fluctuation in the mortgage rate per year and over the mortgage life. a.

True b.

False ANSWER: True 37. Some adjustable-rate mortgages (ARMs) contain an option clause that allows mortgage holders to switch to a fixedrate mortgage within a specified period. a.

True b.

False Copyright Cengage Learning. Powered by Cognero.

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Chapter 09: Mortgage Markets ANSWER:

True

38. Mortgage lenders normally charge a higher initial interest rate on adjustable-rate mortgages than on fixed-rate mortgages. a.

True b.

False ANSWER: False 39. A balloon-payment mortgage requires only interest payments for a three- to five-year period. At the end of this period, full payment of the principal (the balloon payment) is required. a.

True b.

False ANSWER: True 40. During the early years of a mortgage, most of the monthly payment reflects principal. a.

True b.

False ANSWER: False 41. Mortgages are rarely sold in the secondary market. a.

True b.

False ANSWER:

False

42. An increase in either the risk-free rate or the risk premium on a fixed-rate mortgage results in a higher required rate of return when investing in the mortgage and therefore causes the mortgage price to decrease. a.

True b.

False ANSWER: True 43. Strong economic growth tends to reduce the probability that borrowers will default on their mortgage payments and therefore tends to decrease mortgage prices. a.

True b.

False ANSWER: False 44. The higher the level of equity invested by the borrower, the higher the probability that the loan will default. a.

True b.

False ANSWER: False 45. Borrowers who have a lower level of income relative to their periodic loan payments are more likely to default on their mortgages. a.

True b.

False Copyright Cengage Learning. Powered by Cognero.

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Chapter 09: Mortgage Markets ANSWER: 46. Non-U.S. financial institutions never hold mortgages on U.S. property. a.

True b.

False ANSWER:

True

False

47. The ____ market accommodates originators of mortgages that desire to sell their mortgages prior to maturity. a. primary b. secondary c. money d.

None of these are correct.

ANSWER: b 48. Financial institutions that hold fixed-rate mortgages in their asset portfolios are exposed to ____ risk, because they commonly use funds obtained from short-term customer deposits to make long-term mortgage loans. a. exchange rate b. prepayment c. reinvestment rate d. interest rate e. exchange rate ANSWER: d 49. From the perspective of the lending financial institution, there is a ____ degree of interest rate risk for ____-maturity mortgages. a. higher; shorter b. higher; longer c. lower; shorter d. higher; longer AND lower; shorter ANSWER: d 50. In the earlier years of a mortgage, a most of the monthly payment reflects principal reduction. b. most of the monthly payment reflects interest. c. about half of the monthly payment reflects interest. d. all of the monthly payment reflects principal reduction.

ANSWER:

b

51. Which of the following will typically require the borrower to ultimately request a new mortgage? a. graduated-payment mortgage (GPM) b. growing-equity mortgage c. balloon-payment mortgage d. shared-appreciation mortgage Copyright Cengage Learning. Powered by Cognero.

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Chapter 09: Mortgage Markets ANSWER:

c

52. Which of the following is NOT true with respect to a growing-equity mortgage? a It is similar to a graduated-payment mortgage. b. The monthly payments on the mortgage are initially small. c. The monthly payments increase throughout the life of the mortgage. d. The monthly payments increase for the first 5 to 10 years of the mortgage and then level off.

ANSWER:

d

53. American International Group (AIG) was a huge _______ of credit default swaps (CDS) that offered protection against mortgage defaults, so when many mortgages defaulted during the credit crisis, AIG was obliged to _______. a seller; repurchase the CDS contracts it had sold b. buyer; sell its CDS contracts to raise capital c. buyer; surrender its CDS contracts to the Federal Reserve d. seller; make large payments to the buyers of the CDS contracts ANSWER: d 54. The probability that a borrower will default (credit risk) is influenced by all of the following EXCEPT a economic conditions. . b. the level of equity invested by the borrower. c. the borrower's debt-to-income level. d. the borrower's credit score. e.

Credit risk is affected by all of these.

ANSWER:

e

55. In a short sale of a home a the lender forecloses and then sells the home for less than what is owed on the mortgage. b. the lender allows the homeowner to sell the home for less than what is owed on the mortgage. c. the lender does not recover the full amount of the mortgage. d. the lender allows the homeowner to sell the home for less than what is owed on the mortgage AND the lender does not recover the full amount of the mortgage. e. the lender forecloses and then sells the home for less than what is owed on the mortgage AND the lender does not recover the full amount of the mortgage.

ANSWER: d 56. An investor in interest-only collateralized mortgage obligations (CMOs) would not be concerned that homeowners will prepay the underlying mortgages. a.

True b.

False ANSWER: False 57. The valuation of mortgage-backed securities is difficult because of limited transparency. a.

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Chapter 09: Mortgage Markets b.

ANSWER:

False True

58. A(n) _________ problem occurs when a person or institution does not have to bear the full consequences of its behavior and therefore assumes more risk than it otherwise would. a. asymmetric information b. moral hazard c. risk adjustment d. specific hazard ANSWER: b 59. A __________ is a privately negotiated contract that protects investors against the risk of default on particular debt securities such as mortgage-backed securities. a. default insurance contract b. default risk swap c. credit default swap d. collateralized debt obligation ANSWER: c 60. Speculators sell credit default swaps to benefit from the default of specific subprime mortgages. a.

True b.

False ANSWER: False 61. Financial institutions may purchase credit default swaps on mortgages if they expect defaults on many mortgages. a.

True b.

False ANSWER: True 62. Financial institutions may sell credit default swaps on mortgages if they expect defaults on many mortgages. a.

True b.

False ANSWER: False 63. At a given point in time, the price of a credit default swap contract should be ________ related to the default risk of the securities covered by the contract. For a given set of securities that are covered by a credit default swap, the price of the contract should be _______ related to the default risk as it changes over time. a. positively; positively b. positively; inversely c.

Inversely; positively d. inversely; inversely ANSWER: a 64. Bear Stearns commonly used __________ as collateral when borrowing short-term funds, but its funding was cut off Copyright Cengage Learning. Powered by Cognero.

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Chapter 09: Mortgage Markets because prospective creditors questioned the quality of the collateral. a. commercial paper b.

Treasury securities c. its stock d. mortgages ANSWER:

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d

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Chapter 10: Stock Offerings and Investor Monitoring 1. Which of the following statements is incorrect?

A stock represents partial ownership in a corporation. b. Like debt securities, common stock is issued by firms to obtain funds. c. Stocks are issued by corporations to raise short-term funds. d. The secondary stock market enables investors to sell stocks that they had previously purchased.

ANSWER:

c

2. Preferred shareholders a typically have the same voting rights as common shareholders. b. do not share the ownership of the firm with common shareholders. c. typically participate in the profits of the firm beyond the stated fixed annual dividend. d. may not receive a dividend every year.

ANSWER:

d

3. From a cost perspective, preferred stock is a less desirable source of capital for a firm than bonds. a.

True b.

False ANSWER: True 4. A ____ prevents dividends from being paid on common stock until all current and previously omitted dividends are paid on preferred stock. a. residual claim b. preferred margin c. cumulative provision d. liquidation claim ANSWER: c 5. Firms assume ____ risk when they issue preferred stock than when they issue bonds. The payment of dividends on preferred stock ____ be omitted without the firm being forced into bankruptcy. a. more; can b. less; can c. more; cannot d. less; cannot ANSWER: b 6. When a corporation first decides to issue stock to the public, it engages in a(n) a. secondary offering. b. initial public offering. c. seasoned equity offering. d.

None of these are correct.

ANSWER:

b

7. A firm can avoid the time lag between registering new securities with the SEC and actually selling them by using a. a proxy.

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Chapter 10: Stock Offerings and Investor Monitoring b. c. d.

shelf registration. a margin call. preemptive rights.

ANSWER:

b

8. To the extent that shares sold during an IPO are discounted from their appropriate price, the proceeds that the issuing firm receives from the IPO are less than it deserves. a.

True b.

False ANSWER: True 9. The transaction costs to the issuing firm in an IPO are usually ____ percent of the funds raised. a.

1 b.

3 c.

7 d.

25 ANSWER:

c

10. If many investors quickly sell an IPO stock in the secondary market, there will be ____ on the stock's price. a. upward pressure b. downward pressure c. no additional pressure d.

None of these are correct.

ANSWER: b 11. The purpose of a lockup provision is to a keep individual investors from buying and selling stock. b. prevent downward pressure on the stock's price. c. increase the number of outstanding shares. d. allocate a larger proportion of stock to institutional investors.

ANSWER: 12. IPOs tend to occur more frequently during recessions. a.

True b.

False ANSWER:

b

False

13. A road show is a way to a promote a secondary offering of stock. b. arouse interest in an IPO. c. obtain funding from a venture capital fund. d. gain support for a shareholders’ lawsuit against a firm’s board of directors.

ANSWER: Copyright Cengage Learning. Powered by Cognero.

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Chapter 10: Stock Offerings and Investor Monitoring 14. The practice of purchasing IPO stock at the offer price and selling the stock shortly afterward is called a. flipping. b. skiing. c. flopping. d.

None of these are correct.

ANSWER:

a

15. When brokers encourage investors to place first-day bids for IPO shares that are above the offer price, this is referred to as a. flipping. b. spinning. c. laddering. d.

None of these are correct.

ANSWER: c 16. On average, firms that have had IPOs tend to perform ____ over a period of a year or longer. a. well b. poorly c. about the same as the S&P 500 index d.

None of these are correct.

ANSWER:

b

17. A firm that wants to engage in a secondary stock offering does not need to file the offering with the SEC. a.

True b.

False ANSWER: False 18. A firm will typically attempt to sell shares from a secondary offering a far below the prevailing market price. . b. far above the prevailing market price. c. at the prevailing market price. d. at the offer price of the IPO. ANSWER:

c

19. A(n) ____ represents ownership of a foreign stock. a.

ADR b.

SEAQ c.

Nasdaq d.

AMEX ANSWER:

a

20. The first-time issuance of shares by a specific firm to the public is referred to as a(n) a. stock repurchase.

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Chapter 10: Stock Offerings and Investor Monitoring b. c. d.

secondary stock offering. initial rights issue. initial public offering (IPO).

ANSWER:

d

21. A new stock issuance by a specific firm that already has stock outstanding is referred to as a(n) a. stock repurchase. b. secondary stock offering. c. initial rights issue. d. initial public offering (IPO).

ANSWER:

b

22. The largest organized exchange in the United States, with the largest market capitalization, is the a.

New York Stock Exchange. b.

American Stock Exchange. c.

Midwest Stock Exchange. d.

Pacific Stock Exchange.

ANSWER:

a

23. ____ are employed by brokerage firms and execute orders for clients on the NYSE. a.

Specialists b.

Commission brokers c.

Venture managers d.

Dealers ANSWER:

b

24. The OTC market does not have a trading floor. a.

True b.

False ANSWER:

True

25. Firms listed on the OTC Pink market a are typically very large. b. satisfy the Nasdaq's listing requirements. c. are typically owned by major institutional and individual investors. d. do not have to register with the Securities and Exchange Commission.

ANSWER:

d

26. The prevailing price per share divided by the firm's earnings per share is known as the a. dividend yield. b. price-earnings ratio. c. fully diluted earnings per share. d. annual dividend.

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Chapter 10: Stock Offerings and Investor Monitoring ANSWER:

b

27. The ____ is a value-weighted average of stock prices of 30 large U.S. firms. a.

Dow Jones Industrial Average b.

Standard and Poor's 500 c.

New York Stock Exchange Index d.

Nasdaq ANSWER:

a

28. The ____ is a value-weighted index of stock prices of 500 large U.S. firms. a.

Dow Jones Industrial Average b.

Standard and Poor's 500 c.

New York Stock Exchange Index d.

Nasdaq ANSWER:

b

29. Sudden favorable news about the performance of a firm will make investors believe that the firm's stock is ____ at its prevailing price. a. overvalued b. fixed c. appropriate d. undervalued ANSWER: d 30. Analysts periodically communicate with high-level managers of the firms whose stock they rate. a.

True b.

False ANSWER: True 31. Shareholders can most easily measure a firm's performance by monitoring changes in its ____ over time. a. share price b. employee job descriptions c. board of directors d. asset size ANSWER: a 32. Which of the following is NOT true regarding the Sarbanes-Oxley Act? a It requires firms to establish an internal control process for their financial reporting. b. It requires a firm’s CEO and CFO to certify that the audited financial statements are accurate. c. It allows a public accounting firm to audit a client firm whose CEO was employed by the accounting firm six months earlier. d. It prevents a firm from providing excessive compensation to members of its audit committee so that they will not closely oversee the audit.

ANSWER: c Copyright Cengage Learning. Powered by Cognero.

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Chapter 10: Stock Offerings and Investor Monitoring 33. An example of shareholder activism is a. communication with the firm. b. engaging in a proxy contest. c. filing a lawsuit against the board. d.

All of these are correct.

ANSWER:

d

34. ____ are acquisitions that require substantial amounts of borrowed funds. a.

Stock repurchases b.

Corporate controls c.

Leveraged buyouts d.

Stock splits ANSWER:

c

35. ____ are not barriers to corporate control to eliminate agency problems. a.

Leveraged buyouts b.

Antitakeover amendments c.

Poison pills d.

Golden parachutes ANSWER:

a

36. Listing stock on a foreign stock exchange a may increase the stock's liquidity. b. may enhance the firm's global image. c. may increase the pool of potential investors, making it easier to place an entire issue of stock. d. All of these are correct.

ANSWER:

d

37. American depository receipts (ADRs) are similar to a. stock options. b. bank deposits. c. stocks. d. bonds.

ANSWER:

c

38. ____ are portfolios of international stocks created and managed by various financial institutions. a.

International mutual funds b.

American depository receipts c.

Exchange rate options d.

Initial public offerings ANSWER:

a

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Chapter 10: Stock Offerings and Investor Monitoring 39. ____ sell shares to investors and use the proceeds to invest in portfolios of international stocks created and managed by portfolio managers. a.

International mutual funds b.

American depository receipts c.

World equity depository receipts d.

Initial public depository receipts ANSWER: a 40. When a firm buys some of its shares that it had previously issued, this is referred to as a a. reverse IPO. b. leveraged buyout. c. ladder spin. d. stock repurchase.

ANSWER:

d

41. Whenever _____ the stock price will be driven up. a. supply exceeds demand b. demand exceeds supply c. demand is reduced d.

None of these are correct.

ANSWER:

b

42. Which of the following is NOT a form of shareholder activism? a. proxy contests b. poison pills c. shareholder lawsuits d.

None of these are correct.

ANSWER:

b

43. Initial public offerings (IPOs) tend to occur more frequently during bearish (weak) stock markets. a.

True b.

False ANSWER: False 44. Initial public offerings (IPOs) typically perform ____ on the day of the IPO and ____ for periods of a year or longer after the IPO. a. well; poorly b. poorly; well c. well; well d. poorly; poorly ANSWER: a 45. Which of the following is NOT a part of the over-the-counter market? a. the OTCQB Copyright Cengage Learning. Powered by Cognero.

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Chapter 10: Stock Offerings and Investor Monitoring b. c. d.

the OTC Pink the OTC Bulletin Board the New York Stock Exchange

ANSWER:

d

46. A firm has a current stock price of $15.32. The firm's annual dividend is $1.14 per share. The firm's dividend yield is a. .74 percent. b.

1.34 percent. c.

7.44 percent. d.

1.14 percent.

ANSWER: c 47. If the secondary market for a stock is inactive, then the shares are illiquid. a.

True b.

False ANSWER:

True

48. Private firms that need a large equity investment but are not yet in a position to go public may attempt to obtain funding from a venture capital (VC) fund. a.

True b.

False ANSWER: True 49. Venture capital (VC) funds receive money from wealth investors and from pension funds that need to receive their money back in one year or less. a.

True b.

False ANSWER: False 50. Venture capital (VC) funds commonly serve as advisers to the businesses in which they invest. a.

True b.

False ANSWER: True 51. Venture capital (VC) funds usually invest in publicly traded businesses. a.

True b.

False ANSWER:

False

52. Venture capital (VC) funds typically plan to exit from their original investment within about one year. a.

True b.

False ANSWER: False Copyright Cengage Learning. Powered by Cognero.

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Chapter 10: Stock Offerings and Investor Monitoring 53. The phrase "leaving money on the table" refers to investors paying more for a stock in the secondary market than was paid by those investors who were able to buy shares at the initial (offer) price on the IPO date. a.

True b.

False ANSWER: False 54. Underwriters sell most or all of the shares of an IPO to institutional investors. a.

True b.

False ANSWER:

True

55. The total cost of engaging in an IPO is usually about 1 percent of the total proceeds. a.

True b.

False ANSWER: False 56. Crowdfunding is a way that small businesses can raise funds from a number of investors over the Internet. a.

True b.

False ANSWER: True 57. In general, secondary offerings cause an immediate increase in the market price of the stock. a.

True b.

False ANSWER: False 58. In addition to extended sessions offered by the stock exchanges, some electronic communications networks (ECNs) allow for trading at any time. a.

True b.

False ANSWER: True 59. As a result of the Sarbanes-Oxley Act, firms were able to reduce their costs of compiling and reporting financial information. a.

True b.

False ANSWER: False 60. The Sarbanes-Oxley Act has improved transparency, but investors may still have limited information about publicly traded firms. a.

True b.

False ANSWER: True 61. The legal protection of shareholders varies substantially among countries.

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Chapter 10: Stock Offerings and Investor Monitoring a. b.

True False

ANSWER:

True

62. Common law countries such as the United States, Canada, and the United Kingdom allow for more legal protections for shareholders than civil law countries such as France or Italy. a.

True b.

False ANSWER: True 63. The government enforcement of securities laws varies among countries. a.

True b.

False ANSWER:

True

64. All countries that have stock markets have similar laws regarding the financial information that must be provided by public companies. a.

True b.

False ANSWER: False 65. Index-traded funds are passive funds that track a specific index. a.

True b.

False ANSWER:

False

66. A venture capital fund typically plans to exit from its original investment within about four to seven years. a.

True b.

False ANSWER: True 67. Venture capital funds typically take over businesses and manage them. a.

True b.

False ANSWER:

False

68. Normally, only the owners of preferred stock are permitted to vote on certain key matters concerning the firm, such as the election of the board of directors. a.

True b.

False ANSWER: False 69. If shareholders become dissatisfied with a firm's performance, they may engage in a proxy contest in an attempt to change the composition of the board of directors.

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Chapter 10: Stock Offerings and Investor Monitoring a. b.

ANSWER:

True False True

70. Initial public offerings (IPOs) tend to occur more frequently during bullish stock markets. a.

True b.

False ANSWER: True 71. According to financial research, there is evidence that the stock price associated with an IPO typically rises on the first day but then declines over time. a.

True b.

False ANSWER: True 72. Shelf-registration allows firms quick access to funds without repeatedly being slowed by the registration process. a.

True b.

False ANSWER: True 73. The OTC market has several segments including the OTCQX and OTC Pink, where smaller stocks are traded. a.

True b.

False ANSWER: True 74. The Dow Jones Industrial Average (DJIA) is a price-weighted average of stock prices of 30 large U.S. firms. a.

True b.

False ANSWER: True 75. Research studies have found that the share prices of both target firms and acquiring firms react very positively to announcements of an acquisition. a.

True b.

False ANSWER: False 76. If managers believe that their firm's stock price is weak because it is undervalued by the market, they may consider repurchasing a portion of the shares that are outstanding. a.

True b.

False ANSWER: True 77. International exchange-traded funds (ETFs) represent international stock indexes and thus enable investors to invest in a specific index representing a particular country’s stock market.

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Chapter 10: Stock Offerings and Investor Monitoring a. b.

True False

ANSWER:

True

78. Which of the following is NOT true with respect to venture capital (VC) funds? a When a VC fund decides to invest in a business, it will set out clear requirements that the business must meet to receive the funding. b. A VC fund commonly sells its equity stake in a firm to the public before the firm engages in an IPO. c. VC funds receive money from wealthy investors and pension funds that are willing to maintain the investment for a long-term period. d. All of these are true with respect to VC funds.

ANSWER: b 79. Assume that a firm is valued at $800 million and has 6 million shares of stock outstanding. This firm's stock should have a price of $____ per share. a.

6.00 b.

80.00 c.

133.33 d.

None of these are correct.

ANSWER: c 80. The owners of common stock are permitted to vote on the a election of the board of directors. . b. c. d. e.

ANSWER:

authorization to issue new shares of common stock. approval of amendments to the corporate charter. adoption of bylaws.

All of these are correct. e

81. Which of the following is NOT true with respect to preferred stock? a Preferred stock usually does not allow for significant voting rights. b. If the firm does not have sufficient earnings to pay the preferred stock dividends, the preferred shareholders may force the firm into bankruptcy. c. Normally, the owners of preferred stock do not participate in the profits of the firm beyond the stated fixed annual dividend. d. Payment of preferred dividends is not a tax-deductible expense. e. All of these are correct.

ANSWER: b 82. Which of the following is NOT true with respect to initial public offerings (IPOs)? a IPOs are first-time offerings of shares by a specific firm to the public.

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Chapter 10: Stock Offerings and Investor Monitoring b. Normally, a firm planning an IPO will hire a securities firm to recommend the amount of stock to issue and the asking price for the stock. c. Owners of firms that engage in IPOs are normally required to retain their shares for at least three years before selling them in the secondary market. d. IPOs are typically intended to raise funds so the corporation can expand.

ANSWER: c 83. To discourage flipping, some securities firms make ____ shares of future IPOs available to institutional investors that retain shares for a ____ period of time. a. fewer; long b. more; short c. more; long d. fewer; long AND more; short ANSWER: c 84. When Facebook engaged in its IPO, there was much uncertainty about its proper valuation, as is typical for stocks whose valuations are based on expectations of aggressive earnings growth. a.

True b.

False ANSWER: True 85. Firms are more willing to issue new stock in a secondary stock offering when the market price of their outstanding shares is relatively a high. . b. low. c. either high or low, depending on the overall market. d. None of these are correct.

ANSWER:

a

86. Designated market movers create liquidity and maintain an orderly market at the a.

New York Stock Exchange. b.

American Stock Exchange. c. over-the-counter market. d.

Nasdaq.

ANSWER:

a

87. Which of the following is NOT true regarding overallotment options? a They are rarely used in IPOs. b. They allow the underwriter to allocate an additional 15 percent of the shares of the firm engaging in an IPO. c. They allow the underwriter to purchase additional shares at the IPO offer price. d. They can be used to help stabilize the stock price in the days after an IPO. ANSWER: a Copyright Cengage Learning. Powered by Cognero.

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Chapter 10: Stock Offerings and Investor Monitoring 88. In preparing for an IPO, a prospectus must be filed with the a stock market where the firm will be listed. . b.

Securities and Exchange Commission. c.

Consumer Financial Protection Bureau. d.

Federal Trade Commission.

ANSWER:

b

89. Which of the following is NOT a barrier to corporate control? a antitakeover amendments . b. proxy contests c. poison pills d. golden parachutes e.

All of these are barriers to corporate control.

ANSWER:

b

90. Possible disadvantages of private stock exchanges to investors include a only large institutional investors may purchase shares in privately listed stocks. b. required disclosures may be less than those required when a firm goes public. c. trading volume is limited. d. required disclosures may be less than those required when a firm goes public AND trading volume is limited.

ANSWER: d 91. After an IPO, firms commonly list their shares on a private stock exchange. a.

True b.

False ANSWER:

False

92. Managers protected by golden parachutes may be more willing to make decisions that increase the company’s earnings in the long run, even though the decisions adversely affect the stock price in the short run. a.

True b.

False ANSWER: True 93. A firm whose stock price has risen a will not have to pay a premium if it acquires another firm. b. has an incentive to use its stock as currency to acquire the shares of a target firm. c. is likely to be a candidate for a leveraged buyout. d. is likely to repurchase some of its shares.

ANSWER:

b

94. Most individual investors attend road shows of firms that are about to go public before they purchase shares at the Copyright Cengage Learning. Powered by Cognero.

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Chapter 10: Stock Offerings and Investor Monitoring time of an IPO. a. b.

True False

ANSWER:

False

95. When a corporation makes a secondary offering, it may direct sales of the stock to its existing shareholders by giving them a. preemptive rights. b. limit orders. c. subscription rights. d. presumptive rights.

ANSWER: a 96. Which of the following is NOT likely to be included in a stock quotation? a the stock’s 52-week price range . b. the stock’s dividend yield c. the stock’s average price over the previous year d. the stock’s price-earnings ratio ANSWER:

c

97. The investment by a private equity fund in a business is normally much larger than the typical investment by a venture capital fund. a.

True b.

False ANSWER: True 98. Private equity funds tend to use mostly _________ when acquiring stakes in businesses. a their equity from issuing common stock . b. their equity from retaining earnings c. their equity from issuing preferred stock d. borrowed funds ANSWER:

d

99. Private equity funds may exit their investment in a business by a selling their stake to another company. b. engaging in a credit default swap with the business. c. investing in shares of the business when the business engages in an IPO. d. repurchasing shares of their own stock in the secondary market.

ANSWER:

a

100. Venture capital funds commonly exit their investment in a business by a receiving dividends from the business.

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Chapter 10: Stock Offerings and Investor Monitoring b. engaging in a credit default swap with the business. c. selling shares of the business when the business engages in an IPO. d. repurchasing shares of their own stock in the secondary market.

ANSWER:

c

101. The phrase “__________” implies that the company engaged in an IPO could have received a larger amount of funds had the offer price been set at a higher level. a. synchronizing the order b. covering the spread c. offsetting the flow d. leaving money on the table ANSWER: d 102. For many IPOs, the lead underwriter has a(an) _______ option, which allows it to allocate an additional 15 percent of the firm’s shares for a period of up to 30 days after the IPO. a. credit default b. quantitative c. overallotment d. lockup ANSWER: c

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Chapter 11: Stock Valuation and Risk 1. The price-earnings valuation method applies the ____ price-earnings ratio to the ____ earnings per share in order to value the firm's stock. a. firm's; industry b. firm's; firm's c. average industry; industry d. average industry; firm's ANSWER: d 2. The PE method to stock valuation may result in an inaccurate valuation for a firm if errors are made in forecasting the firm's future earnings or in choosing the industry composite used to derive the PE ratio. a.

True b.

False ANSWER: True 3. Bolwork Inc. is expected to pay a dividend of $5 per share next year. Bolwork's dividends are expected to grow by 3 percent annually. The required rate of return for Bolwork stock is 15 percent. Based on the dividend discount model, a fair value for Bolwork stock is $____ per share. a.

33.33 b.

166.67 c.

41.67 d.

60.00 ANSWER: c 4. The limitations of the dividend discount model are more pronounced when valuing stocks a that pay most of their earnings as dividends. . b. that retain most of their earnings. c. that have a long history of dividends. d. that have constant earnings growth ANSWER:

b

5. Vansel Inc. retains most of its earnings. The company currently has earnings per share of $11. Vansel expects its earnings to grow at a constant rate of 2 percent per year. Furthermore, the average PE ratio of all other firms in Vansel's industry is 12. Vansel is expected to pay dividends per share of $3.50 during each of the next three years. If investors require a 10 percent rate of return on Vansel stock, a fair price for Vansel stock today is $____. a.

113.95 b.

111.32 c.

105.25 d.

130.72 ANSWER: a 6. When evaluating stock performance, ____ measures variability that is systematically related to market returns; ____ measures total variability of a stock's returns. a. beta; standard deviation b. standard deviation; beta Copyright Cengage Learning. Powered by Cognero.

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Chapter 11: Stock Valuation and Risk c. d.

intercept; beta beta; error term

ANSWER:

a

7. The ____ is commonly used as a proxy for the risk-free rate in the capital asset pricing model. a.

Treasury bond rate b. prime rate c. discount rate d. federal funds rate ANSWER:

a

8. A beta of 1.8 implies that the stock has a risk premium of 1.8 percent. a.

True b.

False ANSWER:

False

9. Stock prices of U.S. firms primarily involved in exporting are likely to be ____ affected by a weak dollar and ____ affected by a strong dollar. a. favorably; adversely b. adversely; adversely c. favorably; favorably d. adversely; favorably ANSWER: a 10. A weak dollar may enhance the value of a U.S. firm whose sales are dependent on the U.S. economy. a.

True b.

False ANSWER: True 11. The January effect refers to the ____ pressure on ____ stocks in January of every year. a. downward; large b. upward; large c. downward; small d. upward; small ANSWER:

d

12. The expected acquisition of a firm typically results in ____ in the target's stock price. a. an increase b. a decrease c. no change d.

None of these are correct.

ANSWER:

a

13. The ____ index uses the standard deviation of a stock’s return to measure the stock’s risk-adjusted performance.

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Chapter 11: Stock Valuation and Risk a. b. c. d.

Sharpe Treynor arbitrage margin

ANSWER:

a

14. The ____ index can be used to measure risk-adjusted performance of a stock while controlling for the stock's beta. a.

Sharpe b.

Treynor c. arbitrage d. margin ANSWER: b 15. Stock price volatility increased during the credit crisis. a.

True b.

False ANSWER:

True

16. The Sharpe index measures the a average return on a stock. . b. variability of stock returns per unit of return. c. stock's beta adjusted for risk. d. excess return above the risk-free rate per unit of risk.

ANSWER:

d

17. A stock's average return is 11 percent. The average risk-free rate is 9 percent. The stock's beta is 1, and the standard deviation of its returns is 10 percent. What is the Sharpe index? a. .05 b. .5 c. .1 d. .02 e. .2 ANSWER: e 18. A stock's average return is 10 percent. The average risk-free rate is 7 percent. The standard deviation of the stock's return is 4 percent, and the stock's beta is 1.5. What is the Treynor index for the stock? a. .03 b. .75 c.

1.33 d. .02 e.

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Chapter 11: Stock Valuation and Risk ANSWER:

d

19. If security prices fully reflect all market-related information (such as historical price patterns) but do not fully reflect all other public information, security markets are a weak-form efficient. . b. semistrong-form efficient. c. strong-form efficient. d. semistrong-form efficient AND strong-form efficient. e. None of these are correct.

ANSWER:

a

20. If security markets are semistrong-form efficient, investors cannot solely use ____ to earn excess returns. a previous price movements b. insider information c. publicly available information d. previous price movements AND publicly available information ANSWER: d 21. The ____ is often used to estimate the required rate of return for any firm with public traded stock. a. capital asset pricing model b.

Treynor index c.

Sharpe index d.

Treynor index AND Sharpe index ANSWER:

a

22. According to the text, other things being equal, stock prices of U.S. firms primarily involved in exporting could be ____ affected by a weak dollar. Stock prices of U.S. importing firms could be ____ affected by a weak dollar. a. adversely; favorably b. favorably; adversely c. favorably; favorably d. adversely; adversely ANSWER: b 23. The demand by foreign investors for the stock of a U.S. firm sold on a U.S. exchange may be higher when the dollar is expected to ____, other things being equal. (Assume the firm's operations are unaffected by the value of the dollar.) a. strengthen b. weaken c. stabilize d. weaken and then stabilize ANSWER: a 24. A higher beta for an asset reflects Copyright Cengage Learning. Powered by Cognero.

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Chapter 11: Stock Valuation and Risk a lower risk. b. lower covariance between the asset's returns and market returns. c. higher covariance between the asset's returns and the market returns. d. None of these are correct.

ANSWER:

c

25. The "January effect" refers to a large a rise in the price of small stocks in January. . b. decline in the price of small stocks in January. c. decline in the price of large stocks in January. d. rise in the price of large stocks in January.

ANSWER:

a

26. Technical analysis relies on the use of ____ to make investment decisions. a. interest rates b. inflationary expectations c. industry conditions d. recent stock price trends ANSWER:

d

27. The capital asset pricing model (CAPM) suggests that the required rate of return on a stock is directly influenced by the stock's a prevailing level of industry competition. . b. beta. c. liquidity. d. size (market capitalization).

ANSWER: b 28. According to the capital asset pricing model, the required return by investors on a security is a inversely related to the risk-free rate. . b. inversely related to the firm's beta. c. inversely related to the market return. d.

None of these are correct.

ANSWER:

d

29. Boris stock has an average return of 15 percent. Its beta is 1.5. Its standard deviation of returns is 25 percent. The average risk-free rate is 6 percent. The Sharpe index for Boris stock is a.

0.35. b.

0.36. c.

0.45. d.

0.28.

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Chapter 11: Stock Valuation and Risk e.

None of these are correct.

ANSWER:

b

30. Morgan stock has an average return minus the average risk-free rate of 12.5 percent, a beta of 2.5, and a standard deviation of returns of 20 percent. The Treynor index of Morgan stock is a.

0.0625. b.

0.05. c.

0.35. d.

0.03. e.

None of these are correct.

ANSWER: b 31. Zilo stock has an average return minus the average risk-free rate of 5 percent, a beta of 1, and a standard deviation of returns of 20 percent. The Sharpe index of Zilo stock is a.

0.05. b.

0.35. c.

0.25. d.

0.45. e.

None of these are correct.

ANSWER: c 32. Sorvino Company is expected to offer a dividend of $3.20 per share per year forever. The required rate of return on Sorvino stock is 13 percent. Thus, the price of a share of Sorvino stock, according to the dividend discount model, is $____. a.

4.06 b.

4.16 c.

40.63 d.

24.62 e.

None of these are correct.

ANSWER: d 33. Kandle Company paid a dividend of $4.76 per share this year and plans to pay a dividend of $5 per share next year, which is expected to increase by 3 percent per year subsequently. The required rate of return is 15 percent. The value of Kandle stock, according to the dividend discount model, is $____. a.

39.67 b.

41.67 c.

33.33 d.

31.73 e.

None of these are correct.

ANSWER: b 34. LeBlanc Inc. currently has earnings of $10 per share, and investors expect that the earnings per share will grow by 3 percent per year. Furthermore, the mean PE ratio of all other firms in the same industry as LeBlanc Inc. is 15. LeBlanc is expected to pay a dividend of $3 per share over the next four years, and an investor in LeBlanc requires a return of 12 Copyright Cengage Learning. Powered by Cognero.

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Chapter 11: Stock Valuation and Risk percent. What is the forecasted stock price of LeBlanc in four years, using the adjusted dividend discount model? a. $150.00 b. $163.91 c. $45.00 d. $168.83 e.

None of these are correct.

ANSWER: d 35. Tarzak Inc. has earnings of $10 per share, and investors expect that the earnings per share will grow by 3 percent per year. Furthermore, the mean PE ratio of all other firms in the same industry as Tarzak is 15. Tarzak is expected to pay a dividend of $3 per share over the next four years, and an investor in Tarzak requires a return of 12 percent. The estimated stock price of Tarzak today should be ____ using the adjusted dividend discount model. a. $116.41 b. $104.91 c. $161.15 d. $128.64 ANSWER: a 36. The standard deviation of a stock's returns is used to measure the stock's a. volatility. b. beta. c.

Treynor index. d. risk-free rate.

ANSWER:

a

37. If the returns of two stocks are perfectly correlated, then a their betas should each equal 1.0. . b. the sum of their betas should equal 1.0. c. their correlation coefficient should equal 1.0. d. their portfolio standard deviation should equal 1.0.

ANSWER:

c

38. A stock's beta can be measured from the estimate of the ________ using regression analysis. a. intercept b. market return c. risk-free rate d. slope coefficient ANSWER:

d

39. A beta of 1.1 means that for a given 1 percent change in the value of the market, the _______ is expected to change by 1.1 percent in the same direction. a. risk-free rate Copyright Cengage Learning. Powered by Cognero.

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Chapter 11: Stock Valuation and Risk b. c. d.

stock's value stock's standard deviation correlation coefficient

ANSWER:

b

40. The beta of a stock portfolio is equal to a weighted average of the a betas of stocks in the portfolio. b. betas of stocks in the portfolio, plus their correlation coefficients. c. standard deviations of stocks in the portfolio. d. correlation coefficients between stocks in the portfolio.

ANSWER:

a

41. Value at risk estimates the ____ a particular investment for a specified confidence level. a. beta of b. risk-free rate of c. largest expected loss to d. standard deviation of ANSWER:

c

42. A stock has a standard deviation of daily returns of 1 percent. It wants to determine the lower boundary of its probability distribution of returns, based on 1.65 standard deviations from the expected outcome. The stock's expected daily return is .2 percent. The lower boundary is a.

-1.45 percent. b.

-1.85 percent c.

0 percent. d.

-1.65 percent.

ANSWER: a 43. A stock has a standard deviation of daily returns of 3 percent. It wants to determine the lower boundary of its probability distribution of returns, based on 1.65 standard deviations from the expected outcome. The stock's expected daily return is .1 percent. The lower boundary is a.

-1.65 percent. b.

-3.00 percent c.

-4.85 percent. d.

-5.05 percent.

ANSWER: c 44. Which of the following is NOT commonly used as an estimate of a stock's volatility? a an estimate of its standard deviation of returns over a recent period b. a time-series trend of historical standard deviations of returns over recent periods c. the implied volatility derived from the stock option pricing model d. an estimate of its option premium derived from the stock option pricing model ANSWER: Copyright Cengage Learning. Powered by Cognero.

d Page 8

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Chapter 11: Stock Valuation and Risk 45. The credit crisis caused major problems in the mortgage market but had no impact on the stock market. a.

True b.

False ANSWER: False 46. When a firm’s announced earnings are lower than expected, investors will increase their valuation of the firm’s future cash flows and its stock. a.

True b.

False ANSWER: False 47. A relatively simple method of valuing a stock is to apply the mean price-earnings (PE) ratio of all publicly traded competitors in the respective industry to the firm's expected earnings for the year. a.

True b.

False ANSWER: True 48. While the previous year's earnings are often used as a base for forecasting future earnings, the recent year's earnings do not always provide an accurate forecast of the future. a.

True b.

False ANSWER: True 49. If investors agree on a firm's forecasted earnings, they will derive the same value for that firm using the PE method to value the firm's stock. a.

True b.

False ANSWER: False 50. The dividend discount model states that the price of a stock should reflect the present value of the stock's future dividends. a.

True b.

False ANSWER: True 51. The dividend discount model can be adapted to assess the value of any firm, even those that retain most or all of their earnings. a.

True b.

False ANSWER: True 52. For firms that do not pay dividends, the free cash flow model may be more suitable than the dividend discount model. a.

True b.

False ANSWER: True Copyright Cengage Learning. Powered by Cognero.

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Chapter 11: Stock Valuation and Risk 53. The capital asset pricing model (CAPM) is based on the premise that the only important risk of a firm is unsystematic risk. a.

True b.

False ANSWER: False 54. The prime rate is commonly used as a proxy for the risk-free rate in the capital asset pricing model (CAPM). a.

True b.

False ANSWER: False 55. A stock with a beta of 2.3 means that for every 1 percent change in the market overall, the stock tends to change by 2.3 percent in the same direction. a.

True b.

False ANSWER: True 56. When there is a sharp decline in the CBOE Volatility Index (VIX), stock prices also tend to decline. a.

True b.

False ANSWER: False 57. A firm's stock price is affected not only by macroeconomic and market conditions but also by firm-specific conditions. a.

True b.

False ANSWER: True 58. If an investor has a $50,000 investment in a stock and has used beta to measure the maximum daily percentage loss as −5 percent, the maximum daily loss in dollars would be $10,000. a.

True b.

False ANSWER: False 59. The main source of uncertainty in computing the return of a stock is the dividend to be received next year. a.

True b.

False ANSWER: False 60. A stock portfolio has more volatility when its individual stock returns are uncorrelated. a.

True b.

False ANSWER: False Copyright Cengage Learning. Powered by Cognero.

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Chapter 11: Stock Valuation and Risk 61. Beta serves as a measure of risk because it can be used to derive a probability distribution of returns based on a set of market returns. a.

True b.

False ANSWER: True 62. The value-at-risk method is intended to warn investors about the potential maximum loss that could occur. a.

True b.

False ANSWER: True 63. Regarding the value-at-risk method, the same methods used to derive the maximum expected loss of one stock can be applied to derive the maximum expected loss of a stock portfolio for a given confidence level. a.

True b.

False ANSWER: True 64. Portfolio managers who monitor systematic risk rather than total risk are more concerned about stock volatility than about beta. a.

True b.

False ANSWER: False 65. Regarding the implied standard deviation, by plugging in the actual option premium paid by investors for a specific stock in the option pricing model, it is possible to derive the anticipated volatility level. a.

True b.

False ANSWER: True 66. A portfolio's beta is the sum of the individual forecasted betas, weighted by the market value of each stock. a.

True b.

False ANSWER: False 67. If beta is thought to be the appropriate measure of risk, a stock's risk-adjusted returns should be determined by the Sharpe index. a.

True b.

False ANSWER: False 68. The Treynor index is similar to the Sharpe index, except that is uses beta rather than standard deviation to measure the stock's risk. a.

True b.

False ANSWER: True Copyright Cengage Learning. Powered by Cognero.

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Chapter 11: Stock Valuation and Risk 69. Fabrizio, Inc. is expected to generate earnings of $1.50 per share this year. If the mean price-earnings ratio of competitors in the same industry is 20, then the valuation of Fabrizio’s shares is $____. a.

13.33 b.

3.00 c.

20.00 d.

30.00 e.

None of these are correct.

ANSWER: d 70. Which of the following is NOT used to measure a stock's risk? a the stock's price volatility . b. the stock's return c. the stock's beta d. the value-at-risk method e.

All of these are used to measure risk.

ANSWER:

b

71. If the standard deviation of a stock's returns over the last 12 quarters is 4 percent, and if there is no perceived change in volatility, there is a ____ percent probability that the stock's returns will be within ____ percentage points of the expected outcome. a.

68; 4 b.

68; 8 c.

95; 8 d.

95; 6 e.

None of these are correct.

ANSWER: a 72. Which of the following is NOT a limitation of the PE method of valuing stocks? a Stock buybacks can distort a firm’s earnings. b. Using previous earnings may not be useful for a firm that is restructuring. c. The earnings of firms in a cyclical industry may vary dramatically depending on whether the economy is strong or weak. d. Creative accounting may distort a firm’s reported earnings. e. All of the above are limitations of the PE method.

ANSWER: e 73. Which of the following is NOT correct regarding the capital asset pricing model (CAPM)? a It is sometimes used to estimate the required rate of return for any firm with publicly traded stock. b. It is based on the premise that the only important risk of a firm is systematic risk. c. It is concerned with unsystematic risk. d. All of these are correct.

ANSWER: Copyright Cengage Learning. Powered by Cognero.

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Chapter 11: Stock Valuation and Risk 74. The ____ is not a factor used in the capital asset pricing model (CAPM) to derive the return of an asset. a prevailing risk-free rate b. dividend growth rate c. market return d. covariance between the asset's return and the market return e. All of these are factors used in the CAPM. ANSWER:

b

75. Steam Corp. has a beta of 1.5. The prevailing risk-free rate is 5 percent, and the annual market return in recent years has been 11 percent. Based on this information, the required rate of return on Steam Corp. stock is ____ percent. a.

21.5 b.

6.5 c.

16.5 d.

14.0 e.

None of these are correct.

ANSWER: d 76. Which of the following is not a type of factor that drives stock prices, according to your text? a economic factors . b. market-related factors c. firm-specific factors d. All of the above are factors that affect stock prices.

ANSWER:

d

77. The general mood of investors represents a. investor sentiment. b. beta. c. systematic risk. d. unsystematic risk.

ANSWER:

a

78. ____ are not a firm-specific factor that affect stock prices. a Exchange rates b. Dividend policy changes c. Acquisitions d. Earnings surprises e. All of these are firm-specific factors that affect stock prices.

ANSWER:

a

79. The U.S. government’s budget deficit has a significant impact on the bond market but does not affect the stock market.

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Chapter 11: Stock Valuation and Risk a. b.

True False

ANSWER:

False

80. Investors can avoid unsystematic risk by a using the capital asset pricing model. . b. investing in stocks with low PE ratios. c. holding diversified portfolios. d. using the free cash flow model.

ANSWER:

c

81. The market risk premium is a the yield on newly issued Treasury bonds. b. the return of the market in excess of the risk-free rate. c. the covariance between the risk-free rate and the return of the market. d. the return of the market in excess of expected cash flows.

ANSWER:

b

82. The market risk premium is stable over time and is not affected by stock market conditions. a.

True b.

False ANSWER: False 83. Holding other factors constant, an increase in the capital gains tax rate will have a more effect on the valuation of dividend-paying stocks than on stocks with high growth prospects. b. less effect on the valuation of dividend-paying stocks than on stocks with high growth prospects. c. no effect on the valuations of stocks. d. the same effect on the valuation of dividend-paying stocks and stocks with high growth prospects.

ANSWER:

b

84. The CBOE Volatility Index (VIX) indicates the volatility of the bond market in general. a.

True b.

False ANSWER: False 85. Holding other factors constant, a stock portfolio has more volatility when its individual stock volatilities are ________ and its individual stock returns have _______ correlations. a. high; low b. low; high c. low; low d. high; high ANSWER: d Copyright Cengage Learning. Powered by Cognero.

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Chapter 11: Stock Valuation and Risk 86. Even though a foreign stock appears to be undervalued in its own country, the stock may not generate a reasonable return for a U.S. investor if the currency of that country depreciates against the U.S. dollar. a.

True b.

False ANSWER: True 87. As a result of market integration, stock markets in emerging markets are likely to be as efficient as U.S. stock markets. a.

True b.

False ANSWER: False

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Chapter 12: Market Microstructure and Strategies 1. A ____ order to buy or sell a stock means to execute the transaction at the best possible price. a. market b. limit c. stop-loss d. stop-buy ANSWER:

a

2. With a ____ order, the investor specifies a purchase price that is above the current market price. a. market b. limit c. stop-loss d. stop-buy ANSWER:

d

3. When investors buy stock with borrowed funds, this is sometimes referred to as a. use of proxy. b. purchasing stock on margin. c. a margin call. d. a margin residual claim.

ANSWER:

b

4. The maintenance margin is the minimum amount of the margin that investors must maintain as a percentage of the stock's initial purchase price. a.

True b.

False ANSWER: False 5. Assume a stock is initially priced at $50, and pays an annual $2 dividend. An investor uses cash to pay $25 a share and borrows the remaining funds at a 12 percent annual interest. What is the return if the investor sells the stock for $55 at the end of one year? a.

50 percent b.

30 percent c.

10 percent d.

16 percent e.

8 percent ANSWER: d 6. When a brokerage firm demands more collateral from investors who have borrowed from the brokerage firm to buy stocks, it is making a a. margin call. b. short sale. c. proxy fight. d. hedge.

ANSWER: a Copyright Cengage Learning. Powered by Cognero.

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Chapter 12: Market Microstructure and Strategies 7. Which of the following statements is incorrect? a In a short sale, investors place an order to sell a stock that they do not own. b. Investors sell a stock short when they anticipate that its price will rise. c. When investors sell short, they will ultimately have to provide the stock back to the investor from whom they borrowed it. d. Short-sellers must make payments to the investor from whom the stock was borrowed to cover the dividend payments that the investor would have received if the stock had not been borrowed.

ANSWER: b 8. Which of the following statements about program trading is incorrect? a It represents a computerized response by institutional investors to either buy or sell a large basket of stocks in response to movements in a particular stock index. b. It may involve the purchase of stocks that have become "underpriced." c. It may involve the sale of stocks that have become "overpriced." d. It is designed to capitalize on Federal Reserve monetary policy announcements. e. None of these are correct.

ANSWER: d 9. You purchase a stock with cash, and you earn a negative return on the stock. If you had purchased the stock with 60 percent cash and 40 percent borrowed funds, your return on your investment would have been a positive. b. more negative than if you had covered the entire investment with cash. c. negative, but more favorable than if you had covered the entire investment with cash. d. zero.

ANSWER: b 10. Mark uses his own funds to purchase a stock priced at $70. He thinks he can sell the stock for $100 after one year.

What is Mark’s estimated return on the stock? a.

30.00 percent b.

-42.86 percent c.

-30.00 percent d.

42.86 percent e.

None of these are correct.

ANSWER: d 11. Mark purchases a stock priced at $70. The stock is not expected to pay any dividends in the coming year. Mark thinks he can sell the stock for $100 after one year. If Mark uses his own funds for half of the investment amount and borrows the remainder from his brokerage firm at an annual interest rate of 12 percent, his estimated return on the stock would be ____ percent. a.

42.86 b.

85.71 c.

73.71 d.

30.00 Copyright Cengage Learning. Powered by Cognero.

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Chapter 12: Market Microstructure and Strategies ANSWER:

c

12. Karen purchased a stock priced at $33 on margin, paying $23 and borrowing the remainder from a brokerage firm at 15 percent annual interest. The stock pays an annual dividend of $2. If Karen sells the stock after one year at a price of $50, what is her return on the stock? a.

27.60 percent b.

82.61 percent c.

76.09 percent d.

58.70 percent e.

None of these are correct.

ANSWER: c 13. Under the present margin requirements, at least ____ percent of an investor's invested funds must be paid in cash. a.

20 b.

30 c.

40 d.

50 e.

None of these are correct.

ANSWER: d 14. The short interest ratio is commonly measured as the number of shares sold short divided by the number of shares that the firm has repurchased in the last quarter. a.

True b.

False ANSWER: False 15. Investors can reduce their risk by purchasing a stock on margin instead of using all cash to buy the stock. a.

True b.

False ANSWER: False 16. A short-seller a anticipates that the price of the stock sold short will increase. b. earns the difference between what was initially paid for the stock versus what the stock is later sold for. c. makes a profit equal to the difference between the original selling price and the price paid for the stock, after subtracting any dividend payments made. d. is essentially lending the stock to another investor and will ultimately receive that stock back from that investor. e. None of these are correct.

ANSWER: c 17. ____ are enforced to restrict the amount of credit extended to customers by stockbrokers. a.

Limit orders b.

Margin requirements Copyright Cengage Learning. Powered by Cognero.

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Chapter 12: Market Microstructure and Strategies c. d.

Maintenance margins Initial margins

ANSWER:

b

18. Assume that a stock is priced at $50 and pays an annual dividend of $2 per share. An investor purchases the stock on margin, paying $25 per share and borrowing the remainder from the brokerage firm at 9 percent annual interest. If, after one year, the stock is sold at a price of $65.25 per share, the return on the stock is a.

60 percent. b.

44 percent. c.

30 percent. d.

69 percent.

ANSWER: a 19. Assume that a stock is priced at $50 and pays an annual dividend of $2 per share. An investor purchases the stock, using only personal funds and not borrowing from the brokerage firm. If, after one year, the stock is sold at a price of $65.25 per share, the return on the stock is a.

26.5 percent. b.

28.5 percent. c.

30.5 percent. d.

34.5 percent.

ANSWER: d 20. The risk of a short sale is that the stock price a. may decrease over time. b. will remain the same. c. may increase over time. d.

None of these are correct.

ANSWER:

c

21. ____ may facilitate stock transactions by taking positions in specific stocks. a.

Board members b.

Capstone members c.

Market makers d.

None of these are correct.

ANSWER:

c

22. ____ may execute transactions on a stock exchange for their clients. a.

Board members b.

Capstone members c.

Floor brokers d.

None of these are correct.

ANSWER:

c

23. The short interest represents the amount of interest that borrowers owe on loans used to purchase stock.

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Chapter 12: Market Microstructure and Strategies a. b.

True False

ANSWER:

False

24. A short interest ratio of 20 or higher indicates that many investors a believe that the stock price is currently overvalued. b. believe that the stock price is currently undervalued. c. are selling the stock short. d. believe that the stock price is currently overvalued AND are selling the stock short.

ANSWER:

d

25. Short selling a stock refers to a poor performance from purchasing an overvalued stock. b. the new issuance of low-priced stocks by firms. c. the new issuance of stocks by financially weak firms. d. the borrowing of stock owned by someone else and selling it in the market.

ANSWER:

d

26. Trading halts are imposed by a. the SEC. b. brokers. c. stock exchanges. d. the Treasury.

ANSWER:

c

27. Kayla would like to purchase a stock priced at $30. The stock is not expected to pay any dividends in the coming year.

She thinks she can sell the stock for $36 after one year. Her estimated return on the stock would be ____ percent. a.

6 b.

10 c.

15 d.

20 ANSWER: d 28. The ____ the trading volume of a stock, the ____ the spread. a. larger; wider b. larger; narrower c. lower; narrower d.

None of these are correct.

ANSWER:

b

29. Electronic communications networks are primarily intended to prevent executives from using inside information when trading stocks. a.

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Chapter 12: Market Microstructure and Strategies b.

False

ANSWER:

False

30. A ____ is a trading platform on a computer website that allows investors to trade stocks without the use of a broker. a. direct access broker b. program trader c. market maker d. communication network ANSWER: a 31. ____ is defined as a computerized response by institutional investors to either buy or sell a large basket of stocks in response to movements in a particular stock index. a Direct access brokering . b.

Electronic communication networking c.

Program trading d.

High-volume stock trading ANSWER: c 32. Trading halts are intended to ensure that the market has complete information before trading on news. a.

True b.

False ANSWER: True 33. The Division of ____ of the SEC requires the orderly disclosure of securities trades by various organizations that facilitate the trading of securities. a.

Corporation Finance b.

Enforcement c.

Administration d.

Trading and Markets ANSWER: d 34. The Division of ____ of the SEC assesses possible violations of SEC regulations and can take action against individuals or firms. a.

Corporation Finance b.

Enforcement c.

Administration d.

Trading and Markets ANSWER: b 35. International trading of stocks has been facilitated by reductions in a transaction costs. . b. information costs.

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Chapter 12: Market Microstructure and Strategies c. d.

ANSWER:

exchange rate risk. transaction costs AND information costs. d

36. The transaction costs associated with international trading of stocks have been reduced by a the consolidation of stock exchanges. . b. extensive computerization of stock exchanges. c. the Eurolist system. d. All of these are correct.

ANSWER:

d

37. The strategy of combining the use of futures or options contracts on a stock index with program trading is known as a. trading with algorithms. b. downside insurance. c. portfolio insurance. d. spread the risk trading.

ANSWER: c 38. A market order is an order to buy or sell a stock at the best possible price. a.

True b.

False ANSWER:

True

39. A stop-loss order is a particular type of limit order whereby the investor specifies a selling price that is below the current market price of the stock. a.

True b.

False ANSWER: True 40. When investors place a limit order, they can place it for the day only. a.

True b.

False ANSWER:

False

41. The initial margin is the minimum amount of margin that investors must maintain as a percentage of the stock's value without receiving a margin call. a.

True b.

False ANSWER: False 42. A margin call from a broker means that the investor is required to provide more collateral (cash or stocks) or sell the stock. a.

True Copyright Cengage Learning. Powered by Cognero.

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Chapter 12: Market Microstructure and Strategies b.

False

ANSWER:

True

43. When investors sell short, they are essentially lending the stock to another investor and will ultimately receive that stock back from the investor to whom they lent it. a.

True b.

False ANSWER: False 44. When the ratio of the number of shares of a stock sold short divided by the total number of shares outstanding is 3 percent or higher, this suggests a large amount of short positions in the market, which implies that a relatively large number of investors expect the stock's price to decline. a.

True b.

False ANSWER: True 45. Trading halts are intended to prevent insider trading. a.

True b.

False ANSWER:

False

46. A trading halt prevents a stock from experiencing a loss in response to news. a.

True b.

False ANSWER:

False

47. The SEC's Division of Trading and Markets assesses possible violations of the SEC's regulations and can take action against individuals or firms. a.

True b.

False ANSWER: False 48. Regulation Fair Disclosure (FD) requires firms to disclose relevant information first to their most important clients. a.

True b.

False ANSWER: False 49. ____ offer advice to customers on stocks to buy or sell. a.

Full-service brokers b.

Discount brokers c.

Floor brokers d.

Specialists e.

Market makers ANSWER: Copyright Cengage Learning. Powered by Cognero.

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Chapter 12: Market Microstructure and Strategies 50. Which of the following statements is incorrect with respect to Regulation Fair Disclosure (FD)? a It requires firms to disclose relevant information broadly to investors at the same time. b. It requires firms to file all relevant information with the SEC before disclosing it to analysts. c. Some critics suggest that the regulation has caused firms to disclose less information than before to ensure that they do not violate the regulation. d. It prohibits firms from communicating with analysts after a news announcement is made to all investors. e. It requires firms to file all relevant information with the SEC before disclosing it to analysts AND it prohibits firms from communicating with analysts after a news announcement is made to all investors.

ANSWER: e 51. A(n) ____ from a broker requires the investor to put up additional collateral. a. maintenance margin b. initial margin c. margin call d. trading halt ANSWER:

c

52. Which of the following is incorrect in regard to short selling? a Naked short selling involves selling a stock short without first borrowing the stock. b. During the credit crisis, the SEC temporarily protected more than 800 firms from short selling. c. The SEC’s uptick rule prevents speculators from taking a short position in stocks that have declined at least 30 percent for the day, except when the most recent trade resulted in an increase in the stock price. d. During the credit crisis, some short-sellers focused particularly on the stocks of financial institutions. e. None of these are correct.

ANSWER: c 53. The bid-ask spread is negatively related to a. order costs b. inventory costs c. risk d. trading volume ANSWER:

d

54. Which of the following statements is incorrect with respect to the structure of the SEC? a It is composed of seven commissioners appointed by the president of the United States. b. The president selects one commissioner to chair the commission. c. Each commissioner serves a five-year term. d. Commissioners' terms are staggered. e. Commissioners meet to assess whether existing regulations are successfully preventing abuses and to revise the regulations as needed.

ANSWER: a 55. Which of the following is incorrect with regard to taxes imposed on stock transactions?

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Chapter 12: Market Microstructure and Strategies a Stock transactions are subject to dividend and capital gains tax at the federal level and may be subject to state income tax as well. b. Stocks have to be held for at least one year to qualify for the long-term capital gains tax. c. The maximum federal tax on dividends and long-term capital gains is 14 percent. d. Higher tax rates are imposed on the dividends and capital gains of individuals in high tax brackets.

ANSWER: c 56. The SEC's ____ reviews the registration statement filed when a firm goes public, corporate filings for annual and quarterly reports, and proxy statements that involve voting for board members or other corporate issues. a.

Division of Corporation Finance b.

Division of Trading and Markets c.

Division of Enforcement d.

None of these are correct.

ANSWER: a 57. Under the SEC’s uptick rule, speculators are prohibited from taking a short position in stocks that have experienced a decline of at least 10 percent for the day, unless the most recent trade resulted in a decrease in the stock price. a.

True b.

False ANSWER: False 58. In naked short selling, short-sellers sell a stock short that they currently own. a.

True b.

False ANSWER:

False

59. Dark pools a are computerized platforms used by institutional investors that operate like private stock markets. b. are stocks issued by firms that have disclosed very limited financial information. c. are stock option contracts that cover positions in stocks. d. are contracts used to bet against the default of a debt instrument.

ANSWER:

a

60. It is not illegal for investors to take positions in a stock based on inside information that they received from an insider at the company, although it would be illegal for the insider to take a position based on that information. a.

True b.

False ANSWER: False 61. When the price of a company’s stock increases or decreases significantly in advance of a public announcement of an event affecting the company, there are suspicions that __________ may have occurred. a. bid rigging b. default inversion c. insider trading Copyright Cengage Learning. Powered by Cognero.

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Chapter 12: Market Microstructure and Strategies d.

an increase in margin requirements

ANSWER:

c

62. A criticism of dark pools is that they a reduce transparency. . b. are more expensive than the public stock exchanges. c. are not accessible to institutional investors. d. cannot be used to trade large blocks of stock.

ANSWER:

a

63. Expert networks consisting of managers or executives of a publicly traded company who are hired as consultants (“experts”) by a hedge fund to provide insight about the company a are illegal under Regulation FD. b. are legitimate if the consultants divulge only information that is already public. c. have raised concerns that the consultants provide inside information. d. are legitimate if the consultants divulge only information that is already public AND have raised concerns that the consultants provide inside information.

ANSWER: d 64. To prosecute defendants connected with the Galleon Fund for __________, the government effectively used wiretap evidence. a. dark pool trading b. naked short selling c. insider trading d. accounting fraud ANSWER: c 65. ______________ represents the use of electronic platforms to execute orders based on an algorithm with programmed instructions. a.

High frequency trading b.

Mechanical analysis c.

Liquidity trading d.

Technical analysis ANSWER: a 66. Traders that engage in high frequency trading commonly close out their positions in a. one day. b. one month. c. three months. d. one year.

ANSWER: Copyright Cengage Learning. Powered by Cognero.

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Chapter 12: Market Microstructure and Strategies 67. High frequency traders set up their own _________ that specify the conditions under which a specific stock should be purchased or sold, the size of the transaction, and the price that should be paid. a. algorithms b. inverse programs c. circuit breakers d. nextron networks ANSWER: a 68. On May 6, 2010, the “__________” occurred, when stocks on the New York Stock Exchange declined by more than 9 percent on average before reversing and recovering most of those losses on that same day. Much of the trading occurred within a half hour. a. credit default crisis b. swap crisis c. specialist crash d. flash crash ANSWER: d 69. While an investor’s ability to simultaneously consider multiple markets to accommodate orders was perceived to allow for more competitive pricing (lower transactions costs), it also led to a form of “_______________” whereby traders with relatively faster access to specific markets can use another trader’s planned orders and move ahead of that order. a. randomized algo b. front running c. circuit breaking d. specialist surfing ANSWER: b 70. Many high frequency traders are willing to serve as intermediaries (similar to market makers) by accommodating orders that they believe will ultimately result in profits. a.

True b.

False ANSWER: True

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Chapter 13: Financial Futures Markets 1. A(n) ____ is a standardized agreement to deliver or receive a specified amount of a specified financial instrument at a specified price and date. a. option contract b. brokerage contract c. financial futures contract d. margin call ANSWER: c 2. Interest rate futures are not available on a.

Treasury bonds. b.

Treasury notes. c.

Eurodollar CDs. d. the S&P 500 index.

ANSWER:

d

3. ____ take positions in futures to reduce their exposure to future movements in interest rates or stock prices. a.

Hedgers b.

Day traders c.

Position traders d.

None of these are correct.

ANSWER: a 4. The initial margin of a futures contract is typically between ____ percent of a futures contract's full value. a.

0 and 2 b.

5 and 18 c.

25 and 40 d.

45 and 60 ANSWER:

b

5. The main role of a futures exchange is to initiate buy positions on any futures contracts that it believes will increase in value over time. a.

True b.

False ANSWER: False 6. Assume that a T-bill futures contract with a face value of $1 million is purchased at a price of $95.00 per $100 face value. At settlement, the price of T-bills is $95.50. What is the difference between the selling and purchase price of the futures contract? a. $.50 b. $50 c. $500 d. $5,000 e.

None of these are correct.

ANSWER: d Copyright Cengage Learning. Powered by Cognero.

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Chapter 13: Financial Futures Markets 7. If speculators believe interest rates will ____, they would consider ____ a T-bill futures contract today. a. increase; selling b. increase; buying c. decrease, selling d. decrease; purchasing a call option on ANSWER:

a

8. Financial futures contracts on U.S. securities are ____ by non-U.S. financial institutions. a. not allowed to be traded b. rarely desired c. commonly traded d. only allowed to be traded ANSWER:

c

9. Assume that speculators purchased a futures contract at the beginning of the year. If the price of the security represented by the futures contract ____ over the year, then these speculators would likely have purchased the futures contract for ____ than they can sell it for. a. increases; more b. decreases; less c. remains the same; more d. increases; less ANSWER: d 10. Assume that a futures contract on Treasury bonds with a face value of $100,000 is purchased at 93-00. If the same contract is later sold at 94-18, what is the gain, ignoring transaction costs? a. $1,180,000 b. $118 c. $11,800 d. $15,625 e. $1,562.50 ANSWER: e 11. The use of financial leverage a reduces gains on futures contracts. b. reduces losses on futures contracts. c. magnifies both gains and losses on futures contracts. d. magnifies losses on futures contracts but has no effect on gains.

ANSWER:

c

12. According to the text, when a financial institution sells futures contracts on debt securities in order to hedge against an increase in interest rates, this is referred to as a. a long hedge. b. a short hedge.

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Chapter 13: Financial Futures Markets c. d.

a closed out position. basis trading.

ANSWER:

b

13. A financial institution that maintains some Treasury bond holdings sells Treasury bond futures contracts. If interest rates increase, the market value of the bond holdings will ____, and the position in futures contracts will result in a ____. a. increase; gain b. increase; loss c. decrease; gain d. decrease; loss ANSWER: c 14. As applied to the futures markets, the basis is the a difference between the price of a security and the price of a futures contract on the security. b. gain or loss from hedging with futures contracts. c. difference between a futures contract price and the initial deposit required. d. price paid for a futures contract after accounting for transaction costs. e. price paid for an option contract.

ANSWER:

a

15. Assume that a bank obtains most of its funds from large CDs with a five-year maturity. Its assets are in the form of loans with rates that adjust every six months. The bank would be ____ affected if interest rates decline. To partially hedge its position, it could ____ interest rate futures contracts. a. adversely; purchase b. favorably; sell c. favorably; purchase d. adversely; sell ANSWER: a 16. According to the text, using a futures contract on one financial instrument to hedge securities not identical to the instrument represented by the futures contract is known as _______ hedging. a. cross b. ratio c. beta d. liquid ANSWER: a 17. Cross-hedging with Treasury bond futures is primarily intended to protect against credit (default) risk of securities. a.

True b.

False ANSWER: False 18. A bank has $500 million in long-term assets and $400 million in long-term fixed-rate liabilities. If interest rates rise, the bank’s net exposure will be ________, assuming that the long-term assets and liabilities are similarly affected.

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Chapter 13: Financial Futures Markets Therefore the bank should focus on hedging the net exposure amount by creating a ______. a. $100 million; short hedge b. $100 million; long hedge c. $900 million; short hedge d. $900 million; long hedge ANSWER:

a

19. __________ occurs when a firm does not have adequate controls to monitor the employees responsible for its futures positions and those employees take more speculative positions than the firm desires. a.

Credit risk b.

Control risk c.

Operational risk d.

Management risk ANSWER: c 20. Systemic risk reflects the risk that a particular event could a cause losses at a firm due to inadequate management control. b. spread adverse effects among several firms or among financial markets. c. cause a loss in value due to market conditions. d. have a larger effect on the futures position than on the position being hedged.

ANSWER:

b

21. If a financial institution expects that the market value of its municipal bonds will decline because of economic conditions, it could hedge its position by ____ futures contracts on ____. a purchasing; Treasury bonds . b. purchasing; the S&P 500 Index c. purchasing; the Municipal Bond Index d. selling; the Municipal Bond Index ANSWER: d 22. The net gain or loss on a futures contract for a stock index that is not closed out is the difference between the futures price when the initial position was created and the futures price at a the settlement date. b. the date at which the futures price reaches its maximum. c. the date at which the futures price reaches its minimum. d. the date three months beyond the date when the initial position was taken.

ANSWER: a 23. The value of an S&P 500 futures contract is $250 times the index. Assume the futures price on the S&P 500 index is 2400 at the time of purchase. If the index price is 2560 when the position is closed out, the gain is a. $40,000. b. $20,000. c. $33,190.

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Chapter 13: Financial Futures Markets d. e.

$25,000. $35,500.

ANSWER:

a

24. Assume that a stock mutual fund uses stock index futures as it conducts dynamic asset allocation. This means that the mutual fund a liquidates all of its stock holdings whenever it expects a market downturn. b. maintains a constant buy position in stock index futures. c. maintains a constant sell position in stock index futures. d. None of these are correct.

ANSWER: d 25. Companies with international trade can hedge ____ by ____ currency futures. a payables; selling . b. receivables; buying c. payables; buying d. payables; selling AND receivables; buying e. receivables; buying AND payables; buying ANSWER:

c

26. Assume that corporate bond portfolio managers are concerned about the possibility of many bond defaults resulting from a future recession. A short position in Treasury bond futures ____ an effective hedge against the credit (default) risk.

A short position in Treasury bill futures ____ an effective hedge against the credit (default) risk. a. would be; would be b. would be; would not be c. would not be; would not be d. would not be; would be ANSWER: c 27. The cost of carry, or net financing cost, to the purchaser of stock index futures refers to the brokerage commissions paid to the broker as a result of the purchase. a.

True b.

False ANSWER: False 28. ____ risk is the risk that the position being hedged by a futures contract is not affected in the same manner as the instrument underlying the futures contract. a.

Market b.

Liquidity c.

Credit d.

Basis e.

None of these are correct.

ANSWER: d Copyright Cengage Learning. Powered by Cognero.

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Chapter 13: Financial Futures Markets 29. Trading restrictions imposed on specific stocks or stock indexes are referred to as a. index busters. b. index options. c. circuit breakers. d. protective covenants.

ANSWER:

c

30. Currency futures may be purchased to hedge ____ or to capitalize on the expected ____ of that currency against the dollar. a. receivables; appreciation b. receivables; depreciation c. payables; depreciation d. payables; appreciation ANSWER: d 31. The values of stock index futures contracts are insulated from market risk. a.

True b.

False ANSWER:

False

32. Dynamic asset allocation involves the switching between risky and low-risk investments by institutional investors over time in response to changing expectations. a.

True b.

False ANSWER: True 33. The prices of stock index futures a are always the same as the prices of the stocks representing the index. b. are always a little above the prices of the stocks representing the index. c. are always a little below the prices of the stocks representing the index. d. None of these are correct.

ANSWER:

d

34. The actions of numerous institutional investors to sell stock index futures instead of selling stocks to prepare for a market decline would likely cause the index futures price to be a. equal to the prevailing stock prices. b. below the prevailing stock prices. c. above the prevailing stock prices. d. negative.

ANSWER: b 35. Speculators who normally close out their futures positions on the same day that the positions were initiated are referred to as Copyright Cengage Learning. Powered by Cognero.

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Chapter 13: Financial Futures Markets a. b. c. d.

day traders. hedgers. closed-end traders. position traders.

ANSWER:

a

36. Speculators in futures contracts that normally maintain their futures positions for extended periods of time (such as weeks or months) are referred to as a. day traders. b. hedgers. c. closed-end traders. d. position traders.

ANSWER: d 37. Which of the following is NOT true regarding the futures exchanges? a They provide an organized marketplace where standardized futures contracts can be traded. b. They facilitate the trading of specialized futures contracts that are tailored to the preferences of the parties involved. c. They facilitate the trading process by clearing, settling, and guaranteeing all transactions. d. They are regulated by the Commodity Futures Trading Commission (CFTC). e. All of these are correct.

ANSWER: b 38. An S&P 500 index futures contract is valued at $250 times its index level. Laura sells an S&P 500 futures contract with a September settlement date when the index is 2550. By the settlement date, the S&P 500 index falls to 2450. The profit (or loss) on Laura's position in the S&P 500 futures contract is a. $15,000. b.

-$15,000. c. $25,000. d. −$25,000. e.

0 ANSWER: c 39. Assume a corporation is receiving a large amount of funds in the near future. The company plans to use the funds to purchase municipal bonds. Also assume that the company is concerned that interest rates will decrease before the purchase date, which would make the municipal bonds more expensive. In order to hedge against this possibility, the company should ____ MBI futures contracts. If interest rates decrease, the futures contract will generate a ____. a. sell; loss b. purchase; gain c. purchase; loss d. sell; gain e.

None of these are correct.

ANSWER: b Copyright Cengage Learning. Powered by Cognero.

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Chapter 13: Financial Futures Markets 40. If there are ____ traders with buy offers than sell offers for a particular contract, the futures price will ____ until this imbalance is removed. a. more; decrease b. more; rise c. fewer; rise d.

None of these are correct.

ANSWER: b 41. Which of the following statements is incorrect? a Circuit breakers are trading restrictions imposed on specific stocks or stock indexes. b. Circuit breakers guarantee that prices will turn upward. c. Circuit breakers may be able to prevent large declines in prices that would be attributed to panic selling rather than to fundamental forces. d. Circuit breakers may allow investors to determine whether circulating rumors are true.

ANSWER: b 42. Financial futures contracts on stock indexes are referred to as interest rate futures. a.

True b.

False ANSWER: False 43. Financial futures contracts are normally sold on a futures exchange, not over the counter. a.

True b.

False ANSWER: True 44. Brokers commonly require margin deposits from their customers above those required by the exchanges. a.

True b.

False ANSWER: True 45. Purchasers of financial futures contracts traded on an exchange know who the sellers are, and send a check directly to the seller at the time of the purchase. a.

True b.

False ANSWER: False 46. The futures price is mainly a function of the prevailing price of the underlying security plus an expected adjustment in that price by the settlement date. a.

True b.

False ANSWER: True 47. The earnings of a financial institution that hedges with interest rate futures are less sensitive to economic events than the earnings of an institution that does not hedge.

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Chapter 13: Financial Futures Markets a. b.

True False

ANSWER:

True

48. A bond index futures contract allows for the buying, but not the selling, of a bond index for a specified price at a specified date. a.

True b.

False ANSWER: False 49. Market participants who expect the stock market to perform poorly before the settlement date may consider selling S&P 500 index futures. a.

True b.

False ANSWER: True 50. Stock index futures cannot be closed out before the settlement date. a.

True b.

False ANSWER:

False

51. The value of a stock index futures contract has little correlation with the value of the underlying stock index. a.

True b.

False ANSWER: False 52. Since stock index futures prices are primarily driven by movements in the corresponding stock indexes, participants in stock index futures monitor indicators that may signal changes in the stock indexes. a.

True b.

False ANSWER: True 53. The price of stock index futures may reflect investor expectations about the market more rapidly than stock prices. a.

True b.

False ANSWER: True 54. Financial futures contracts on U.S. securities are commonly traded by non-U.S. financial institutions that maintain holdings of U.S. securities. a.

True b.

False ANSWER: True 55. Purchasers of currency futures contracts are required to hold the contract until the settlement date and accept delivery of the foreign currency at that time.

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Chapter 13: Financial Futures Markets a. b.

True False

ANSWER:

False

56. Which of the following statements is incorrect regarding single stock futures? a Investors who expect a particular stock’s price to decline over time can sell futures contracts on that stock, or they can sell the stock short. b. Single stock futures are available only on stocks of companies that are in the S&P 500 index. c. Single stock futures are traded in the United States at OneChicago. d. Single stock futures are regulated by the Commodity Futures Trading Commission (CFTC) and the Securities and Exchange Commission. e. All of these are correct.

ANSWER: b 57. Stock index futures are commonly priced ____ than the stock index itself. a. higher b. lower c. either higher or lower d.

None of these are correct.

ANSWER:

c

58. An unexpected ____ in the consumer price index tends to create expectations of ____ interest rates and places ____ pressure on Treasury bond futures prices. a. increase; higher; downward b. increase; lower; downward c. increase; higher; upward d. decrease; higher; downward e. none of the above ANSWER: a 59. Evan purchased a futures contract on Treasury bonds at a price of 102-12. Two months later, Evan sells the same futures contract in order to close out the position. At that time, the futures contract specifies 103-15. What is Evan's nominal profit? The par value of the futures contract is $100,000. a. $1,030.00; profit b. $1,030.00; loss c. $1,093.75; profit d. $1,093.75; loss e.

None of these are correct.

ANSWER: c 60. Clarke Company plans to satisfy cash needs in nine months by selling its Treasury bond holdings for $4 million.

However, Clarke is concerned that interest rates might increase over the next three months. To hedge against this possibility, Clarke plans to sell Treasury bond futures. Thus, Clarke sells ____ futures contract for a price of 99-12.

Assuming that the actual price of the futures contract declines to 97-20, Clarke would make a ____ of $____ from closing Copyright Cengage Learning. Powered by Cognero.

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Chapter 13: Financial Futures Markets out the futures position. a.

40; profit; $76,800 b.

40; loss; $76,800 c.

50; profit; $70,000 d.

40; profit; $70,000 e.

None of these are correct.

ANSWER:

d

61. _________ take positions in financial futures to reduce their exposure to future movements in interest rates or stock prices; ________ commonly take the opposite position and thus serve as counterparties on many transactions. a.

Speculators; hedgers b.

Hedgers; speculators c.

Arbitrageurs; speculators d.

Hedgers; arbitrageurs ANSWER: b 62. Some specialized futures contracts are sold over the counter, whereas standardized financial futures contracts are traded on exchanges. a.

True b.

False ANSWER: True 63. A financial institution that wishes to reduce its exposure to the possibility of declining interest rates might use a. a long hedge. b. a short hedge. c. a day hedge. d. index arbitrage.

ANSWER: a 64. Settlement of stock index futures contracts occurs through delivery of the underlying securities. a.

True b.

False ANSWER: False 65. ___________ involves the buying or selling of stock index futures with a simultaneous opposite position in the stocks that the index comprises. a.

Dynamic asset allocation b.

Cross-hedging c.

Index arbitrage d.

Net hedging ANSWER: c 66. Which of the following is NOT a type of risk associated with futures contracts? a. basis risk Copyright Cengage Learning. Powered by Cognero.

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Chapter 13: Financial Futures Markets b. c. d.

liquidity risk market risk postpayment risk

ANSWER:

d

67. Credit risk exists for futures contracts traded on exchanges, but it is normally not a concern for over-the-counter futures transactions. a.

True b.

False ANSWER: False

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Chapter 14: Options Markets 1. A ____ grants the owner the right to purchase a specified financial instrument for a specified price within a specified period of time. a. call option b. put option c. sale of a futures contract d. purchase of a futures contract ANSWER: a 2. A ____ requires a premium above and beyond the price to be paid for the financial instrument. a. futures contract b. call option c. put option d. call option AND put option ANSWER:

d

3. A put option is "out of the money" when the a market price of the security exceeds the exercise price. b. market price of the security equals the exercise price. c. market price of the security is less than the exercise price. d. premium on the option is less than the exercise price.

ANSWER:

a

4. When the market price of the underlying security exceeds the exercise price, a a. call option is in the money. b. put option is in the money. c. call option is at the money. d. call option is out of the money.

ANSWER:

a

5. Sellers (writers) of call options can close out their position at any point in time by a selling a put option on the same stock. b. buying identical call options. c. selling additional call options on the same stock. d. selling a put option on the same stock AND buying identical call options.

ANSWER:

b

6. The ____ is the most important exchange for trading options. a New York Stock Exchange (NYSE) . b.

Chicago Board Options Exchange (CBOE) c.

Boston Options Exchange d.

Nasdaq ANSWER:

b

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Chapter 14: Options Markets 7. The Options Clearing Corporation (OCC) serves as a guarantor on option contracts traded in the United States. a.

True b.

False ANSWER: True 8. ____ can execute transactions desired by investors and trade stock options for their own account. a.

Maintenance brokers b.

Discount brokers c.

Market makers d.

None of these are correct.

ANSWER:

c

9. A speculator buys a call option for $3, with an exercise price of $50. The stock is currently priced at $49, and rises to $55 on the expiration date. What is the stock price at which the speculator would break even? a. $50 b. $58 c. $52 d. $53 e. $49 ANSWER: d 10. A speculator purchases a put option for a premium of $4, with an exercise price of $30. The stock is presently priced at $29 and rises to $32 before the expiration date. What is the maximum profit per unit to the speculator who owned the put option assuming he or she exercises the option at the ideal time? a.

-$4 b.

-$3 c.

-$2 d. $2 e. $3 ANSWER: b 11. A speculator purchases a put option for a premium of $4, with an exercise price of $30. The stock is presently priced at $29 and rises to $32 before the expiration date. What is the stock price at which the speculator would break even? a. $26 b. $34 c. $28 d. $29 e. $32 ANSWER: a 12. The ____, the higher the call option premium, other things being equal. a lower the existing price of the underlying security relative to the exercise price b. lower the volatility of the underlying security's market price c. longer the time to maturity of the option Copyright Cengage Learning. Powered by Cognero.

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Chapter 14: Options Markets d. lower the existing price of the underlying security relative to the exercise price AND lower the volatility of the underlying security's market price ANSWER: c 13. The longer the time to maturity, the ____ the call option premium and the ____ the put option premium. a. higher; lower b. lower; higher c. higher; higher d. lower; lower ANSWER:

c

14. The greater the volatility of the underlying stock, the ____ the call option premium and the ____ the put option premium. a. higher; lower b. lower; higher c. higher; higher d. lower; lower ANSWER: c 15. The sale of a call option on a stock the seller already owns is referred to as a. a covered call. b. a naked call. c. a call on futures. d. futures on options.

ANSWER:

a

16. Assume a pension fund purchased stock at $53. Call options at a $50 exercise price presently have a $4 premium per share. The pension fund sells a call option on the stock it owns. If the call option is exercised when the price of the stock is $56, what is the gain or loss per share to the pension fund (including its gain from holding the stock as well)? a. $4 gain b. $6 loss c. $2 loss d. $1 gain e. $0 ANSWER: d 17. Covered call writing ____ the upside potential return and ____ the risk of an investment in stock. a. increases; increases b. increases; decreases c. limits; increases d. limits; decreases ANSWER:

d

18. Put options are typically used to hedge when portfolio managers are mainly concerned about Copyright Cengage Learning. Powered by Cognero.

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Chapter 14: Options Markets a . b. c. d.

ANSWER:

a permanent decline in a stock's value. a permanent increase in a stock's value. a temporary decline in a stock's value. a temporary increase in a stock's value. c

19. A speculator purchases a put option on Treasury bond futures with a September delivery date with an exercise price of 85-00. The option has a premium of 2-00. Assume that the price of the futures contract decreases to 82-00 on the expiration date and the option is exercised at that point (if it is feasible). What is the net gain? a. $1,968.75 b. $3,750.00 c. $3,000.00 d.

-$2,000.00 e. $1,000.00 ANSWER: e 20. Assume an insurance company purchases a call option on a stock index futures contract for a premium of 14, with an exercise price of 1800. The value of a stock index futures contract is 250 times the index. If the stock index on the futures contract increases to 1830, what is the gain on the sale of the futures contract? a. $15,000 b. $7,500 c. $3,300 d. $4,000 e. $1,500 ANSWER: d 21. Corporations involved in international business transactions can ____ to hedge future ____. a sell currency call options; payables b. purchase currency put options; receivables c. purchase currency call options, receivables d. purchase currency put options, payables e. sell currency call options; payables AND purchase currency put options; receivables ANSWER:

b

22. If a corporation hedges payables with currency call options, it will ____ if the value of the foreign currency is ____ than the exercise price when the payables are due. a exercise the option; greater b. exercise the option; lower c. let the option expire; greater d. let the option expire; lower e. exercise the option; greater AND let the option expire; lower ANSWER: e Copyright Cengage Learning. Powered by Cognero.

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Chapter 14: Options Markets 23. Speculators purchase currency ____ on currencies they expect to ____ against the dollar. a. call options; weaken b. put options; strengthen c. futures; weaken d. put options; weaken ANSWER:

d

24. Speculators may be willing to write ____ options on foreign currencies they expect to ____ against the dollar. a. put; strengthen b. put; weaken c. call; strengthen d. call; weaken e. put; strengthen AND call; weaken ANSWER: e 25. European-style stock options a are long-term options (at least one year until expiration at the time they are created). b. can be exercised after the expiration date. c. can be exercised any time until the expiration date. d. None of these are correct.

ANSWER:

d

26. A speculator purchased a call option with an exercise price of $31 for a premium of $4. The option was exercised a few days later when the stock price was $34. What was the return to the speculator? a.

25 percent b.

-25 percent c.

-3.2 percent d.

-2.9 percent ANSWER: b 27. The premium on an existing call option should ____ when the price of the underlying stock decreases. a. be negative b. decline c. increase d. be unaffected e. be negative AND decline ANSWER:

b

28. The premium on an existing put option should ____ when the price of the underlying stock increases. a. be negative b. decline c. increase d. be unaffected Copyright Cengage Learning. Powered by Cognero.

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Chapter 14: Options Markets e.

be negative AND decline

ANSWER:

b

29. The premium on an existing put option should ____ when there is an increase in the volatility of the underlying stock. a. be negative b. decline c. increase d. be unaffected e. be negative AND decline ANSWER: c 30. The premium on an existing call option should ____ when there is a reduction in the volatility of the underlying stock. a. be negative b. decline c. increase d. be unaffected e. be negative AND decline ANSWER: b 31. The premium on an existing put option should ____ when there is a reduction in the volatility of the underlying stock. a. be negative b. decline c. increase d. be unaffected e. be negative AND decline ANSWER: b 32. The premium on an existing call option should ____ when there is an increase in the volatility of the underlying stock. a. be negative b. decline c. increase d. be unaffected e. be negative AND decline ANSWER: c 33. When a stock index option is exercised, the cash payment is equal to a specified dollar amount multiplied by a the index level. b. the exercise price. c. the difference between the index level and the exercise price. d. the sum of the index level and the exercise price.

ANSWER: c 34. When stock portfolio managers use dynamic asset allocation by purchasing call options on a stock index, they ____ Copyright Cengage Learning. Powered by Cognero.

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Chapter 14: Options Markets their exposure to stock market conditions. a. reduce b. completely eliminate c. have no effect on d. increase ANSWER:

d

35. Options on stock indexes representing non-U.S. stocks are ____; options exchanges have been established ____. a available; in numerous non-U.S. countries . b. not available; in numerous non-U.S. countries c. available; only in the United States d. not available; only in the United States ANSWER: a 36. Which of the following is NOT true regarding options and options on futures contracts? a The purchaser of both an option and an option on futures must pay a premium. b. Options are available on stock indexes, but not on stock index futures. c. The fulfillment of options on futures contracts is regulated by exchanges, while the fulfillment of options is not. d. Options are available on stock indexes, but not on stock index futures AND the fulfillment of options on futures contracts is regulated by exchanges, while the fulfillment of options is not.

ANSWER: d 37. Marcie purchases a call option on interest rate futures with an exercise price of 92-10. The premium on the call option is 2-24. Just before the expiration date, the price of Treasury bond futures (which will have a face value of $100,000 at maturity) is 97-14. At this time, Marcie decides to exercise the option and closes out the position by selling an identical futures contract. Marcie's net gain from this strategy is $____. a.

-2,687.50 b.

2,687.50 c.

2,375.00 d.

7,437.50 e.

None of these are correct.

ANSWER: b 38. Reese Insurance company sold a call option on interest rate futures with an exercise price of 92-10. The premium on the call option is 2-24. Just before the expiration date, the price of Treasury bond futures (which will have a face value at maturity of $100,000) is 97-14. At this time, the option was exercised as the buyer closed out the position by selling an identical futures contract. Reese's net gain from selling the call option is $____. a.

2,687.50 b.

-2,687.50 c.

2,375.00 d.

7,437.50 e.

None of these are correct.

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Chapter 14: Options Markets ANSWER:

b

39. Vince, a speculator, expects interest rates to increase and purchases a put option on Treasury bond futures with an exercise price of 95-32. The premium paid for the put option is 2-36. Just prior to the expiration date, the price of the Treasury bond futures contract is valued at 93-22. Vince exercises the option and closes out the position by purchasing an identical futures contract. Vince's net gain from this speculative strategy is $____. a.

-406.25 b.

4,718.75 c.

-4,718.75 d.

-812.50 e.

None of these are correct.

ANSWER: a 40. Which of the following is NOT an assumption underlying the Black-Scholes option-pricing model? a The risk-free rate is known and constant over the life of the option. b. The probability distribution of stock prices is lognormal. c. Investors are risk averse and will always choose the option that involves the least risk. d. The variability of a stock's return is constant. e. There are no transaction costs involved in trading options.

ANSWER:

c

41. Which of the following is NOT true with respect to market makers? a They benefit from the spread. b. They may earn profits when they take positions in options. c. They are not subject to a risk of loss on their positions in options. d. All of these are true with respect to market makers.

ANSWER:

c

42. Options trading is regulated by the a Options Clearing Corporation. . b.

International Securities Exchange. c.

Securities and Exchange Commission. d.

Federal Reserve.

ANSWER:

c

43. On an options exchange, most option trades are executed a. electronically. b. on the trading floor. c. by personal phone call. d.

None of the above.

ANSWER:

a

44. When investors purchase an option that does not hedge their existing investments, the option can be referred to as Copyright Cengage Learning. Powered by Cognero.

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Chapter 14: Options Markets "naked." a. b.

True False

ANSWER:

True

45. Options on small stocks normally have higher premiums than options on large stocks because small stocks typically are more volatile. a.

True b.

False ANSWER: True 46. Which of the following can normally be found in quotations for stock options? a exercise price, expiration date, and implied volatility b. exercise price, expiration date, and most recently quoted premium c. expiration date, implied volatility, and trading volume d. expiration date, most recently quoted premium, and implied volatility ANSWER:

b

47. Stock options can be used by speculators to benefit from their expectations and by financial institutions to reduce their risk. a.

True b.

False ANSWER: True 48. The writer of a put option is obligated to provide the specified financial instrument at the price specified by the option contract if the owner exercises the option. a.

True b.

False ANSWER: False 49. A call option is said to be at the money when the market price of the underlying security exceeds the exercise price. a.

True b.

False ANSWER: False 50. Market makers can execute stock option transactions for customers but do not trade stock options for their own account. a.

True b.

False ANSWER: False 51. American-style stock options can be exercised only just before expiration. a.

True b.

False Copyright Cengage Learning. Powered by Cognero.

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Chapter 14: Options Markets ANSWER:

False

52. An option with a higher exercise price has a higher call option premium and a lower put option premium. a.

True b.

False ANSWER: False 53. Several call options are available for a given stock, and the risk-return potential will vary among them a.

True b.

False ANSWER: True 54. The higher the existing market price of the underlying financial instrument relative to the exercise price, the higher the put option premium, other things being equal. a.

True b.

False ANSWER: False 55. The longer a call option's time to maturity, the lower the call option premium, other things being equal. a.

True b.

False ANSWER: False 56. The results with covered call writing are better than the results without covered call writing both when the stock performs poorly and when it performs well. a.

True b.

False ANSWER: False 57. Put options are more typically used to hedge when portfolio managers are mainly concerned about a temporary decline in a stock's value. a.

True b.

False ANSWER: True 58. An increase in uncertainty results in a higher implied standard deviation for the stock, which means that the writer of an option requires a higher premium to compensate for the anticipated increase in the stock's volatility. a.

True b.

False ANSWER: True 59. Speculators who anticipate a sharp increase in stock market prices overall may consider purchasing put options on one of the market indexes. a.

True b.

False Copyright Cengage Learning. Powered by Cognero.

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Chapter 14: Options Markets ANSWER:

False

60. Speculators who anticipate a decline in interest rates may consider writing a call option on Treasury bond futures. a.

True b.

False ANSWER: False 61. Speculators sell call options on currencies that they expect to strengthen against the dollar. a.

True b.

False ANSWER: False 62. A key requirement for listing stock options on an exchange is that the trading volume of the underlying stock must reach a certain minimum level. a.

True b.

False ANSWER: True 63. Assuming the same expiration date, an option with a ____ exercise price has a ____ call option premium and a ____ put option premium. a. higher; higher; higher b. higher; higher; lower c. higher; lower; higher d. lower; lower; higher e.

None of these are correct.

ANSWER: c 64. Corporations involved in international business transactions may purchase ________ to hedge __________ denominated in a foreign currency. a currency put options; future receivables b. currency call options; future payables c. currency call options; future receivables d. currency put options; future receivables AND currency call options; future payables ANSWER: d 65. The ____ is not a factor affecting the call option premium. a market price of the underlying instrument (relative to the option's exercise price) b. volatility of the underlying instrument c. current price of futures contracts on the underlying instrument d. time to maturity of the call option ANSWER:

c

66. Speculators who anticipate a decline in interest rates may consider ________ option on Treasury bond futures. a. purchasing a put option Copyright Cengage Learning. Powered by Cognero.

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Chapter 14: Options Markets b. c. d.

selling a call option purchasing a call option None of these are correct.

ANSWER:

c

67. Brad expects interest rates to increase and purchases a put option on Treasury bond futures with an exercise price of 97-00. The premium paid for the put option is 3-00. Just prior to the expiration date, the price of the Treasury bond futures contract is valued at 89-00. Brad exercises the option and closes out the position by purchasing an identical futures contract. Brad's net gain from this speculative strategy is $____, and his return on his investment is about _______ percent.

5,300; 366 a. b.

11,000; 27 c.

-5,000; −167 5,000; 167 d. e.

None of these are correct.

ANSWER: d 68. The purchaser of an American-style put option is always better off exercising the option at the expiration date than before that date. a.

True b.

False ANSWER: False 69. Which of the following does NOT directly affect a call option premium? a volatility of the underlying instrument . b. market price of the underlying instrument c. analyst rating of the underlying instrument d. time to maturity of the option ANSWER:

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c

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Chapter 15: Swap Markets 1. Financial institutions with ____ interest rate–sensitive liabilities than assets are ____ affected by rising interest rates. a. more; adversely b. fewer; adversely c. more; favorably d.

None of these are correct.

ANSWER: a 2. Which of the following statements is incorrect? a Interest rate swaps are sometimes used by financial institutions and other firms for speculative purposes. b. A primary reason for the popularity of interest rate swaps is the existence of market imperfections. c. Swaps are necessary for some financial institutions to obtain the maturities or rate sensitivities on funds that they desire. d. Most financial institutions that anticipate that interest rates will move in an unfavorable direction do not hedge their positions.

ANSWER: d 3. Savings institutions participate in the swap market primarily to a serve as an intermediary by matching up two parties in a swap. b. serve as a dealer by taking the counterparty position in a swap. c. reduce interest rate risk. d. None of these are correct.

ANSWER:

c

4. In a swap arrangement, the most common index used for floating-rate payments is the a coupon rate on existing bonds. . b. c. d.

ANSWER:

stock dividend rate based on a U.S. stock index.

London Interbank Offer Rate (LIBOR).

Treasury bond yield. c

5. The most likely users of plain vanilla swaps would be a commercial banks that focus on short-term consumer loans. b. savings institutions. c. manufacturing companies. d. municipal governments.

ANSWER:

b

6. Swap transactions are only used to a hedge against upward interest rate movements. . b.

hedge against downward interest rate movements.

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Chapter 15: Swap Markets c. speculate. d. None of these are correct.

ANSWER:

d

7. If a firm negotiates a plain vanilla swap, it will provide ____ payments in exchange for ____ payments. a. fixed-rate; floating-rate b. fixed-rate euro; fixed-rate dollar c. stock dividend; fixed-rate d. stock dividend; floating-rate ANSWER:

a

8. A(n) ____ swap allows the party making fixed payments to extend the swap period. a. forward b. extendable c. callable d. putable ANSWER:

b

9. A(n) ____ swap allows the party making fixed-rate payments to terminate the swap prior to maturity. a. forward b. extendable c. callable d. putable ANSWER:

c

10. A ____ swap involves the exchange of fixed-rate payments for floating-rate payments that are capped. a. rate-capped b. zero-coupon-for-floating c. callable d. putable ANSWER:

a

11. The option on a callable swap would most likely be exercised if interest rates a. rise. b. fall. c. remain constant. d. remain somewhat stable.

ANSWER:

b

12. The option on a putable swap would most likely be exercised if interest rates a. rise. b. fall. c. remain constant.

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Chapter 15: Swap Markets d.

remain somewhat stable.

ANSWER:

a

13. A(n) ____ swap involves an exchange of interest payments over a swap period that does not begin until a specified future point in time. a. forward b. extendable c. callable d. putable ANSWER: a 14. If a financial institution that has more rate-sensitive liabilities than assets negotiates a rate-capped swap, its ____ payments will be capped, and it will ____ an up-front premium in exchange for the cap. a. outflow; receive b. outflow; pay c. inflow; pay d. inflow; receive ANSWER: d 15. An equity swap involves the exchange of interest payments for payments linked to the degree of change in a bond index. a.

True b.

False ANSWER: False 16. Assume a U.S. savings institution funds its fixed-rate mortgages by attracting short-term deposits. If it engages in an interest rate swap, but the index on the swap does not move in perfect tandem with its cost of deposits, this reflects a. sovereign risk. b. basis risk. c. credit risk. d.

None of these are correct.

ANSWER: b 17. ____ risk prevents an interest rate swap from completely eliminating a financial institution's exposure to interest rate risk. a.

Credit b.

Basis c.

Sovereign d.

None of these are correct.

ANSWER: b 18. ____ risk in a swap is typically not overwhelming because the affected party can simply discontinue its payments to the other party. a.

Basis Copyright Cengage Learning. Powered by Cognero.

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Chapter 15: Swap Markets b. c. d.

Credit Sovereign None of these are correct.

ANSWER:

b

19. Sovereign risk differs from credit risk because it is dependent on the financial status of the government rather than the counterparty itself. a.

True b.

False ANSWER: True 20. In a period when interest rates are expected to rise, ____ institutions will want a fixed-for-floating swap, and the fixed rate specified on interest rate swaps will be ____ under these conditions. a. many; lower b. many; higher c. few; lower d. few; higher ANSWER: b 21. An interest rate swap agreement indicates the ____ value, which represents the principal amount to which interest rates are applied to determine the interest payments involved. a. vanilla b.

LIBOR c. programmed d. notional ANSWER: d 22. Financial institutions primarily use interest rate swaps in a way that will ____ exposure to interest rate risk and ____ potential returns. a. increase; increase b. increase; reduce c. reduce; increase d. reduce; reduce ANSWER: d 23. An advantage of a ____ over other interest rate swaps is that the fixed-rate payer has the flexibility to avoid exchanging future interest payments. a. callable swap b. putable swap c. zero-coupon-for-floating swap d. forward swap ANSWER: a 24. The advantage of a rate-capped interest rate swap (relative to a plain vanilla swap) to the party exchanging fixed Copyright Cengage Learning. Powered by Cognero.

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Chapter 15: Swap Markets payments for floating payments is that a there is a minimum limit set on the interest rate payments received. b. there is a maximum limit set on the interest payments it will provide. c. it receives an up-front fee. d. None of these are correct.

ANSWER:

c

25. A plain vanilla swap enables firms to exchange ____ for ____. a fixed-rate payments; floating-rate payments b. a high interest rate foreign currency; a low interest rate foreign currency c. a low interest rate foreign currency; a high interest rate foreign currency d. bonds; stocks that pay dividends ANSWER:

a

26. An arrangement that enables firms to exchange currencies at periodic intervals is called a(n) a. currency swap. b. interest rate swap. c. swap exchange. d.

Eurobond swap.

ANSWER:

a

27. When a bank participates in a swap of fixed interest rate payments for floating-rate payments, or a swap of currencies, it a can match up two parties but cannot take a position in the swap. b. can match up two parties or can take a position in the swap. c. cannot match up two parties and cannot take a position in the swap. d. cannot match up two parties but can take a position in the swap.

ANSWER: b 28. An equity swap involves the exchange of a preferred stock for common stock. b. interest payments for an equity position in the counterparty's firm. c. interest payments for payments linked to the degree of change in a stock index. d. interest payments for newly issued stock by financial institutions.

ANSWER:

c

29. A firm is involved in an agreement whereby it receives payments in periods when a market interest rate falls below an interest rate level specified in the agreement. This means that the firm has a. purchased an interest rate cap. b. sold an interest rate cap. c. purchased an interest rate floor. d. sold an interest rate floor.

ANSWER: c Copyright Cengage Learning. Powered by Cognero.

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Chapter 15: Swap Markets 30. The typical purchaser of an interest rate cap is a financial institution that is ____ affected by ____ interest rates. a. favorably; rising b. favorably; falling c. adversely; rising d. adversely; falling ANSWER: c 31. A firm is involved in an agreement whereby it makes payments in periods when a market interest rate rises above an interest rate level specified in the agreement. This means that the firm has a. purchased an interest rate cap. b. sold an interest rate cap. c. purchased an interest rate floor. d. sold an interest rate floor.

ANSWER: b 32. A firm is involved in an agreement whereby it receives payments in periods when a market interest rate rises above an interest rate level specified in the agreement. This means that the firm has a. purchased an interest rate cap. b. sold an interest rate cap. c. purchased an interest rate floor. d. sold an interest rate floor.

ANSWER: a 33. An interest rate collar involves the ____ of an interest rate cap and the simultaneous ____ of an interest rate floor. a. sale; sale b. sale; purchase c. purchase; purchase d. purchase; sale ANSWER: d 34. Financial institutions such as U.S. savings institutions and commercial banks traditionally had fewer interest rate– sensitive ____ than ____ and therefore were adversely affected by ____ interest rates. a. assets; liabilities; increasing b. liabilities; assets; decreasing c. liabilities; assets; increasing d.

None of these are correct.

ANSWER: a 35. The Bank of Moronto has negotiated a plain vanilla swap whereby it will exchange fixed payments of 10 percent for floating payments equal to LIBOR plus 0.5 percent at the end of each of the next three years. In the first year, LIBOR is 8 percent; in the second year, 9 percent; in the third year, LIBOR is 7 percent. What is the total net payment the Bank of Moronto makes over the three-year period if the notional principal is $10 million? a.

-$600,000 b. $600,000 Copyright Cengage Learning. Powered by Cognero.

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Chapter 15: Swap Markets c. d. e.

$450,000 -$450,000 None of these are correct.

ANSWER:

d

36. Hewitt Inc. has entered into an equity swap arrangement that allows it to swap a fixed interest rate of 8 percent in exchange for the rate of appreciation on the Dow Jones Industrial Average each year over a three-year period. The notional principal is $1 million. If the Dow depreciates by 1 percent over the year, Hewitt will a. have to make a payment of $70,000. b. have to make a payment of $90,000. c. receive a payment of $70,000. d. receive a payment of $90,000. e.

None of these are correct.

ANSWER: b 37. Lizard National Bank purchases a three-year interest rate cap for a fee of 2 percent of notional principal valued at $50 million, with an interest rate ceiling of 11 percent and LIBOR as the index representing the market interest rate. LIBOR is 9 percent, 12 percent, and 13 percent at the end of each of the next three years, respectively. The total payments received (or paid) by Lizard, including the initial fee, are $____. a.

500,000 b.

-500,000 c.

-1,500,000 d.

1,500,000 e.

None of these are correct.

ANSWER: a 38. In a ____, a buyer makes periodic payments to a seller in exchange for protection against the possible default of debt securities specified in the contract. a. default option contract b. default futures contract c. bankruptcy contract d. credit default swap ANSWER: d 39. A common maturity of a credit default swap contract is a. one month. b. three months. c. five years. d.

25 years.

ANSWER:

c

40. AIG's financial problems during the credit crisis were attributed to a its purchases of credit default swaps. b. its position as a counterparty in numerous interest rate swaps.

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Chapter 15: Swap Markets c. its sales of mortgage-backed securities. d. its sales of credit default swaps.

ANSWER: 41. The primary purpose of interest rate swaps is to reduce exchange rate risk. a.

True b.

False ANSWER:

d

False

42. A forward swap allows an institution to lock in the terms of the arrangement today, and the swap period begins immediately. a.

True b.

False ANSWER: False 43. A putable swap gives the party making the fixed-rate payments the right to terminate the swap. a.

True b.

False ANSWER: False 44. A rate-capped swap may limit the fixed-rate payer's ability to effectively hedge against interest rate risk. a.

True b.

False ANSWER: True 45. An equity swap involves the exchange of dividend payments for payments linked to the degree of change in a stock index. a.

True b.

False ANSWER: False 46. Systemic risk is the risk that a firm involved in an interest rate swap may not meet its payment obligations. a.

True b.

False ANSWER: False 47. If a large bank that has taken numerous swap positions and guaranteed many other swap positions fails, there could be several defaults on swap payments. a.

True b.

False ANSWER: True 48. The most common proxy for the benchmark rate from which a floating-rate payment is determined is the prime rate. a.

True Copyright Cengage Learning. Powered by Cognero.

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Chapter 15: Swap Markets b.

False

ANSWER:

False

49. Interest rate swaps are rarely used by companies that issue bonds. a.

True b.

False ANSWER:

False

50. An interest rate cap offers payments in periods when a specified interest rate index exceeds a specified floor interest rate. a.

True b.

False ANSWER: False 51. Interest rate floors are commonly used to hedge against lower interest rates. a.

True b.

False ANSWER:

True

52. An interest rate collar involves the purchase of an interest rate cap and the simultaneously sale of an interest rate floor. a.

True b.

False ANSWER: True 53. Which of the following is NOT a typical provision of an interest rate swap? a the notional principal value to which the interest rates are applied to determine the interest payments involved b. the fixed interest rate c. the formula and type of index used to determine the floating interest rate d. the underwriter of the bond e. All of these are provisions of an interest rate swap.

ANSWER: d 54. A ____ swap involves an exchange of interest rate payments that does not begin until a specified future point in time. a. plain vanilla b. zero-coupon-for-floating c. forward d. seasoned vanilla e. putable ANSWER: c 55. If a U.S. institution in a forward swap would like to lock in the fixed rate that it will pay when the swap period begins, it is probably concerned that interest rates will ____; the counterparty is likely adversely affected by ____ interest rates. a. increase; increasing b. increase; declining Copyright Cengage Learning. Powered by Cognero.

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Chapter 15: Swap Markets c. d. e.

decrease; declining decrease; increasing None of these are correct.

ANSWER:

b

56. A(n) ____ swap provides the party making the floating-rate payments with a right to terminate the swap. a. callable b. extendable c. plain vanilla d. putable e.

None of these are correct.

ANSWER:

d

57. Interest rate ____ are interest rate derivative instruments that are normally classified separately from interest rate swaps. a. caps b. floors c. collars d.

All of these are correct.

ANSWER: d 58. Which of the following is a reason why financial institutions engage in interest rate swaps? a to reduce interest rate risk b. to act as an intermediary c. to act as a dealer in swaps d. All of these are reasons why financial institutions engage in swaps.

ANSWER:

d

59. A financial institution may participate in the swaps markets by a serving as an intermediary by matching up parties that wish to engage in a swap. b. engaging in swaps to reduce interest rate risk. c. assuming the credit risk involved in a swap by guaranteeing that the payments will be made. d. serving as an intermediary by matching up parties that wish to engage in a swap AND engaging in swaps to reduce interest rate risk.

ANSWER: d 60. The London Interbank Offer Rate (LIBOR) varies among currencies. a.

True b.

False ANSWER:

True

61. During the credit crisis, many mortgage-backed securities defaulted, generating large profits for sellers of credit default swaps and large losses for buyers of the swaps. a.

True Copyright Cengage Learning. Powered by Cognero.

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Chapter 15: Swap Markets b.

ANSWER:

False False

62. After the credit crisis, new rules and regulations were issued to reform the swap markets. Which of the following is NOT one of the requirements of these new rules and regulations? a Dealers and major participants in swaps must register with the Commodities Futures Trading Commission or the Securities and Exchange Commission. b. To make the market more transparent, the majority of swaps are to be traded on electronic platforms called swap execution facilities. c. Credit default swaps can no longer be created for mortgage-backed securities. d. Information about all swaps must be reported to a swap data repository.

ANSWER: c 63. The same types of risks that apply to interest rate swaps may also apply to currency swaps, except that currency swaps are not subject to basis risk. a.

True b.

False ANSWER: False

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Chapter 16: Foreign Exchange Derivative Markets 1. At any given point in time, the price at which banks will buy a currency is ____ the price at which they sell it. a. higher than b. lower than c. the same as d.

None of these are correct.

ANSWER: b 2. Which of the following are most likely to provide currency forward contracts to their customers? a. commercial banks b. international mutual funds c. brokerage firms d. insurance companies ANSWER:

a

3. The Bretton Woods era was the era a of free-floating exchange rates. b. of floating rates without boundaries, but subject to government intervention. c. in which governments maintained exchange rates within 1 percent of a specified rate. d. in which exchange rates were maintained within 10 percent of a specified rate.

ANSWER:

c

4. A system whereby exchange rates are market determined without boundaries but subject to government intervention is called a. a dirty float. b. a free float. c. the gold standard. d. the Bretton Woods era.

ANSWER: a 5. A country that pegs its currency is still able to maintain complete control over its local interest rates. a.

True b.

False ANSWER: False 6. If the demand for British pounds ____, the pound will ____, other things being equal. a increases; appreciate . b. c. d.

ANSWER:

decreases; appreciate increases; depreciate decreases; appreciate AND increases; depreciate a

7. A(n) ____ in the supply of euros for sale will cause the euro to ____.

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Chapter 16: Foreign Exchange Derivative Markets a. b. c. d.

increase; appreciate increase; depreciate decrease; depreciate None of these are correct.

ANSWER:

b

8. Purchasing power parity suggests that the exchange rate will on average change by a percentage that reflects the ____ differential between two countries. a. income b. interest rate c. inflation d. tax ANSWER: c 9. In reality, exchange rates do not always change as suggested by purchasing power parity. a.

True b.

False ANSWER: True 10. If U.S. interest rates suddenly become much higher than European interest rates (and if this does not cause concern about higher inflation in the United States), the U.S. demand for euros would ____, and the supply of euros to be exchanged for dollars would ____, other factors held constant. a. increase; increase b. increase; decrease c. decrease; increase d. decrease; decrease ANSWER: c 11. When a government influences factors, such as inflation, interest rates, or income, in order to affect currency's value, this is an example of a. direct intervention. b. indirect intervention. c. a freely floating system. d. a pegged system.

ANSWER: b 12. Which of the following statements is NOT correct? a Central banks often consider adjusting a currency's value to influence economic conditions. b. If the U.S. central bank wishes to stimulate the economy, it could weaken the dollar. c. A weaker dollar could cause U.S. inflation by reducing foreign competition. d. Direct intervention occurs when the central bank influences the factors that determine the dollar's value.

ANSWER: d 13. Direct intervention is always extremely effective.

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Chapter 16: Foreign Exchange Derivative Markets a. b.

True False

ANSWER:

False

14. If the U.S. government imposed trade restrictions on U.S. imports, this would ____ the U.S. demand for foreign currencies and would place ____ pressure on the values of foreign currencies (with respect to the dollar). a. increase; upward b. increase, downward c. limit; upward d. limit; downward ANSWER: d 15. If a commercial bank expects the euro to appreciate against the dollar, it may take a ____ position in euros and a ____ position in dollars. a. short; short b. long; short c. short; long d. long; long ANSWER: b 16. Generally, a ____ home currency can ____ domestic economic growth. a weak; dampen . b. strong; stimulate c. strong; dampen d. weak; dampen AND strong; stimulate ANSWER:

c

17. If the forward rate of a foreign currency ____ the existing spot rate, the forward rate will exhibit a ____. a exceeds; discount . b. is below; premium c. is below; discount d. exceeds; discount AND is below; premium ANSWER:

c

18. ____ forecasting involves the use of historical exchange rate data to predict future values. a.

Technical b.

Fundamental c.

Market-based d.

Mixed ANSWER:

a

19. Fundamental forecasting has been found to be consistently superior to the other forecasting techniques.

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Chapter 16: Foreign Exchange Derivative Markets a. b.

True False

ANSWER:

False

20. Which of the following is NOT a method of forecasting exchange rates? a using the forward rate for a currency to predict the future spot rate b. using a time-series model that examines moving averages and allows the forecaster to identify patterns in a currency’s movements c. using the volatility of future exchange rate movements d. examining current values for economic variables along with their historical impact on a currency’s value ANSWER: c 21. A speculator who expects the euro to appreciate might a purchase euros forward, and when they are received, sell them in the spot market. b. sell euros forward, and then purchase them in the spot market just before fulfilling the forward obligation. c. sell futures contracts on euros, and then purchase euros in the spot market just before fulfilling the futures obligation. d. All of these are correct.

ANSWER: a 22. Which of the following statements is NOT correct regarding forward contracts? a They are typically negotiated with a commercial bank b. They are standardized contracts that represent a standard number of units and have a specific maturity date. c. They are sometimes referred to in terms of their percentage premium or discount. d. They can be used to hedge a corporation's risk that a currency's value may appreciate or depreciate over time.

ANSWER: b 23. If the spot rate of the British pound is $2, and the 180-day forward rate is $2.05, what is the annualized premium or discount? a.

2.5 percent discount b.

2.5 percent premium c.

10 percent premium d.

5 percent discount e.

5 percent premium ANSWER: e 24. Currency futures contracts differ from forward contracts in that they a are an obligation. . b. are not an obligation. c. are standardized. d. can specify any amount and maturity date.

ANSWER: Copyright Cengage Learning. Powered by Cognero.

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Chapter 16: Foreign Exchange Derivative Markets 25. If the spot rate ____ the exercise price, a currency ____ option will not be exercised. a remains below; call . b. remains below; put c. remains above; call d. remains below; call AND remains below; put ANSWER: 26. A pegged exchange rate system is no longer used by any countries. a.

True b.

False ANSWER:

a

False

27. Assume that a British pound put option has a premium of $.03 per unit and an exercise price of $1.60. The present spot rate is $1.61. The expected future spot rate on the expiration date is $1.52. The option will be exercised on this date, if at all. What is the expected per unit net gain (or loss) resulting from purchasing the put option? a. $.01 loss b. $.09 loss c. $.09 gain d. $.05 gain ANSWER: d 28. The speculative risk of purchasing a ____ is that the foreign currency’s value ____ over time. a. put option; increases b. put option; decreases c. call option; increases d. futures contract; increases ANSWER:

a

29. According to interest rate parity, if the interest rate in a foreign country is ____ than in the home country, the forward rate of the foreign currency will have a ____. a higher; discount . b. lower; premium c. higher; premium d. higher; discount AND lower; premium ANSWER: d 30. ____ serve as financial intermediaries in the foreign exchange market by buying or selling currencies to accommodate customers. a.

Pension funds b.

International mutual funds c.

Insurance companies d.

Commercial banks Copyright Cengage Learning. Powered by Cognero.

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Chapter 16: Foreign Exchange Derivative Markets e.

None of these are correct.

ANSWER:

d

31. In the Wall Street Journal, you observe that the British pound (£) is quoted at $1.65. The Australian dollar (A$) is quoted at $0.60. What is the value of the Australian dollar in British pounds? a.

A$2.75 b.

A$0.36 c. £2.75 d. £0.36 e.

None of these are correct.

ANSWER: d 32. If European inflation suddenly becomes much higher than U.S. inflation, the U.S. demand for European goods will ____. In addition, the supply of euros to be sold for dollars will ____; both forces will place ____ pressure on the value of the euro. a. increase; decline; upward b. increase; decline; downward c. decrease; increase; upward d. decrease; increase; downward e.

None of these are correct.

ANSWER: d 33. Assume the following information. · · · · ·

Interest rate on borrowed euros is 5 percent annualized.

Interest rate on dollars loaned out is 6 percent annualized.

Spot rate is 1.10 euros per dollar (one euro = $0.909).

Expected spot rate in five days is 1.15 euros per dollar.

Fabrizio Bank can borrow 10 million euros.

If Fabrizio Bank attempts to capitalize on the above information, its profit over the five-day period is a.

2,653,597.22 euros. b.

455,266.81 euros. c.

452,426.04 euros. d.

None of these are correct.

ANSWER:

b

34. A country that pegs its exchange rate to another exchange rate does not have complete control over its interest rates. a.

True b.

False ANSWER: True 35. The Swiss franc is presently pegged to the euro. a.

True b.

False Copyright Cengage Learning. Powered by Cognero.

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Chapter 16: Foreign Exchange Derivative Markets ANSWER:

False

36. Financial institutions rarely use the forward market. a.

True b.

False ANSWER:

False

37. If the quoted cross-exchange rate between two foreign currencies is not aligned with the two corresponding exchange rates, investors can profit from triangular arbitrage. a.

True b.

False ANSWER: True 38. The indirect exchange rate specifies the value of the currency in U.S. dollars. a.

True b.

False ANSWER:

False

39. The forward rate premium is dictated by the national income differential of the two currencies. a.

True b.

False ANSWER: False 40. The potential benefits from using foreign exchange derivatives are independent of the expected exchange rate movements. a.

True b.

False ANSWER: False 41. The forward rate is the exchange rate for immediate delivery. a.

True b.

False ANSWER:

False

42. The Smithsonian Agreement allowed for a devaluation of the dollar and for a widening of the boundaries within which currencies were allowed to fluctuate. a.

True b.

False ANSWER: True 43. The European Central Bank is responsible for setting fiscal policy for all countries in the eurozone. a.

True b.

False ANSWER: False Copyright Cengage Learning. Powered by Cognero.

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Chapter 16: Foreign Exchange Derivative Markets 44. Exchange rates usually change precisely as suggested by the purchasing power parity (PPP) theory. a.

True b.

False ANSWER: False 45. If a country in the eurozone suffers from a weak economy, it may devalue its currency to increase demand for its exports and thereby stimulate its economy. a.

True b.

False ANSWER: False 46. When countries experience substantial net outflows of funds, they commonly use indirect intervention by raising interest rates to discourage excessive outflows of funds and therefore limit any downward pressure on the value of their currency. a.

True b.

False ANSWER: True 47. The forward rate premium reflects the percentage by which the spot rate exceeds the forward rate on an annualized basis. a.

True b.

False ANSWER: False 48. The primary advantage of currency options over forward and futures contracts is that they provide a right rather than an obligation to purchase or sell a particular currency at a specified price within a given period. a.

True b.

False ANSWER: True 49. A speculator who expects a foreign currency to appreciate could purchase the currency forward and, when it is received, sell it in the spot market. a.

True b.

False ANSWER: True 50. The following information refers to Fresno Bank and Champaign Bank.

Fresno Bank Champaign Bank

Bid Rate on Euros $1.002 $0.997

Ask Rate on Euros $1.009 $1.000

Based on this information, locational arbitrage would be profitable. a.

True b.

False Copyright Cengage Learning. Powered by Cognero.

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Chapter 16: Foreign Exchange Derivative Markets ANSWER:

True

51. Purchasing power parity suggests that the forward rate premium (or discount) should be about equal to the differential in interest rates between the countries of concern. a.

True b.

False ANSWER: False 52. ____ are not foreign exchange derivatives. a Forward contracts . b. Currency futures contracts c. Currency swaps d. Currency options e. All of these are foreign exchange derivatives.

ANSWER:

e

53. Which of the following is typically used as the basis of a market-based forecast? a the currency’s spot rate b. a time-series model showing the currency’s moving average c. the currency’s volatility index d. the currency’s forward rate e. the currency's spot rate AND the currency's forward rate ANSWER:

e

54. On a financial website, you observe that the euro (€) is quoted for $1.67. The Canadian dollar (C$) is quoted for $0.62. What is the value of the Canadian dollar in euros? a.

C$2.69 b. €0.37 c. €2.69 d.

C$0.37 e.

None of these are correct.

ANSWER: b 55. In a(n) ____ exchange rate system, the foreign exchange market is totally free from government intervention. a. pegged b. dirty floating c. freely floating d.

Bretton Woods e.

None of these are correct.

ANSWER: c 56. Which of the following does NOT influence the supply of and demand for a currency? a differential interest rates Copyright Cengage Learning. Powered by Cognero.

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Chapter 16: Foreign Exchange Derivative Markets b. differential inflation rates c. direct government intervention d. indirect government intervention e. All of these affect the supply of and demand for a currency.

ANSWER:

e

57. If U.S. inflation suddenly becomes much higher than European inflation, the U.S. demand for European goods will ____. In addition, the supply of euros to be sold for dollars will ____; both forces will place ____ pressure on the value of the euro. a. increase; decline; upward b. increase; decline; downward c. decrease; increase; upward d. decrease; increase; downward e.

None of these are correct.

ANSWER: a 58. Assume an equilibrium state in which European inflation and U.S. inflation are both 4 percent. If U.S. inflation suddenly decreases to 2 percent, the euro will ____ against the dollar by approximately ____ percent, according to purchasing power parity. a. appreciate; 2 b. depreciate; 2 c. appreciate; 4 d. depreciate; 4 e.

None of these are correct.

ANSWER: b 59. The act of capitalizing on the discrepancy between the forward rate premium and the interest rate differential is called a. triangular arbitrage. b. locational arbitrage. c. covered interest arbitrage. d. interest rate parity.

ANSWER: c 60. The indirect exchange rate is always the reciprocal of the direct exchange rate. a.

True b.

False ANSWER:

True

61. The exchange rate between two foreign (nondollar) currencies is known as a(n) a. indirect dollar rate. b. forward rate. c. cross-exchange rate. d. derived exchange rate.

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Chapter 16: Foreign Exchange Derivative Markets ANSWER:

c

62. The devaluation of a country’s currency a makes foreign products more expensive for consumers in that country. b. increases foreign demand for that country’s exports. c. can lead to deflation in that country. d. makes foreign products more expensive for consumers in that country AND increases foreign demand for that country’s exports.

ANSWER: d 63. Currency futures contracts are standardized, whereas forward contracts are more flexible and can specify whatever amount and maturity date are desired. a.

True b.

False ANSWER: True 64. When the Federal Reserve attempts to lower interest rates by increasing the U.S. money supply and has no impact on inflationary expectations, it puts upward pressure on the value of the dollar. a.

True b.

False ANSWER: False

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Chapter 17: Commercial Bank Operations 1. Which of the following statements is NOT correct?

The five largest U.S. banks now account for more than 50 percent of bank assets. b. Acquisitions have been a convenient method for banks to grow quickly and capitalize on economies of scale. c. The banking industry has become less concentrated in recent years. d. All of these statements are correct.

ANSWER: c 2. Interstate banking regulations presently allow commercial banks to acquire other banks in their region of the country, but not to expand across the nation. a.

True b.

False ANSWER: False 3. A commercial bank can be a lender or a borrower when using repurchase agreements and loans in the federal funds market. a.

True b.

False ANSWER: True 4. The operations, management, and regulation of a commercial bank are the same irrespective of the types of services offered. a.

True b.

False ANSWER: False 5. A financial institution is likely to call a callable CD before its maturity if interest rates have risen since the CD was issued. a.

True b.

False ANSWER: False 6. A(n) ____ account provides checking and debit card services as well as interest. a demand deposit . b. negotiable order of withdrawal (NOW) c. passbook savings d. time deposit ANSWER:

b

7. Protective covenants impose conditions that require the bank to provide additional loans to a borrower to protect the borrower from going bankrupt. a.

True b.

False ANSWER: False Copyright Cengage Learning. Powered by Cognero.

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Chapter 17: Commercial Bank Operations 8. A ____ is a time deposit offered by some large banks to corporations, with a specific maturity date, a minimum deposit of $100,000 or more, and a secondary market. a. retail CD b. negotiable CD c. market CD d. protective CD ANSWER: b 9. A bank's sources of funds represent liabilities or equity of the bank. a.

True b.

False ANSWER:

True

10. Which of the following is true in regard to money market deposit accounts? a MMDAs specify a maturity. . b. c. d.

ANSWER:

MMDAs offer limited check-writing privileges.

MMDAs are less liquid than retail CDs. MMDAs require no minimum balance.

11. For any given bank, federal funds ____ represent a(n) ____. a. purchased; asset b. sold; liability c. purchased; liability d. purchased; asset AND sold; liability ANSWER:

b

c

12. The federal funds rate is ____ the yield on a Treasury security with a similar term remaining until maturity. a substantially above b. substantially below c. close to d. The rate is much higher than the Treasury yield in some periods and much lower in other periods.

ANSWER: c 13. Obtaining funds through ____ is not a common way for banks to satisfy a temporary deficiency of funds. a. issuing bonds b. the federal funds market c. repurchase agreements d. borrowing from the Federal Reserve ANSWER: a 14. The Federal Reserve provides loans to banks in order to Copyright Cengage Learning. Powered by Cognero.

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Chapter 17: Commercial Bank Operations a resolve permanent shortages of funds experienced by banks. b. resolve temporary shortages of funds experienced by banks. c. finance the shortages of funds of finance companies. d. None of these are correct.

ANSWER:

b

15. When a bank in need of funds for a few days sells some of its government securities to a corporation with a temporary excess of funds and then buys them back shortly thereafter, this is a a federal funds loan. . b. loan through the Federal Reserve’s lending facility. c. repurchase agreement. d. commercial paper transaction.

ANSWER:

c

16. When banks need funding for just a few days, they would most likely a. issue bonds and then call them. b. issue stock and then repurchase it. c. borrow in the federal funds market. d. issue NCDs. ANSWER:

c

17. Because U.S. dollars are widely used as an international medium of exchange, the Eurodollar market is very active. a.

True b.

False ANSWER: True 18. All other things being equal, when banks issue new stock, they a increase reported earnings per share. b. decrease their ability to absorb operating losses. c. dilute the ownership of the bank. d. increase reported earnings per share AND decrease their ability to absorb operating losses.

ANSWER:

c

19. Cash held ____ represents the major portion of a bank's required reserves. a at other commercial banks . b. in a bank's vault c. at the Federal Reserve district banks d. on deposit with the Board of Governors ANSWER:

c

20. The main use of bank funds is for Copyright Cengage Learning. Powered by Cognero.

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Chapter 17: Commercial Bank Operations a. b. c. d.

loans. investment securities. fixed assets. repurchase agreements.

ANSWER:

a

21. ____ loans are primarily used to finance the purchase of fixed assets. a.

Term b.

Working capital c.

Informal line of credit d.

Revolving credit ANSWER:

a

22. Which of the following is most appropriate for a business that may experience a sudden need for funds but does not know precisely when? a. working capital loan b. direct lease loan c. term loan d. informal line of credit ANSWER: d 23. A ____ loan may be especially appropriate when a firm wishes to avoid adding more debt to its balance sheet. a. term b. bullet c. direct lease d. revolving credit ANSWER: c 24. The interest rate banks charge on business loans is known as the a. federal funds rate. b. primary credit rate. c. prime rate. d. call money rate.

ANSWER:

c

25. Transaction deposits do NOT include a. demand deposits. b.

NCDs. c.

NOW accounts. d.

All of these are transaction deposits.

ANSWER:

b

26. Commercial banks are allowed to invest in Copyright Cengage Learning. Powered by Cognero.

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Chapter 17: Commercial Bank Operations a Treasury securities. b. Freddie Mac securities. c. Fannie Mae securities. d. All of these are correct; banks can invest in all of these securities.

ANSWER:

d

27. Money market deposit accounts (MMDAs) a require a maturity of six months or longer. b. allow a limited number of checks to be written against the account. c. pay a higher interest rate than CDs. d. None of these are correct.

ANSWER:

b

28. Which of the following types of deposits offer check-writing privileges? a NOW accounts b. money market deposit accounts (MMDAs) c. retail CDs d. NOW accounts AND money market deposit accounts (MMDAs) ANSWER:

d

29. Banks sometimes need funds temporarily and sometimes have excess funds available. Which of the following is commonly a source of bank funds and a use of bank funds? a MMDAs . b. federal funds c. the Federal Reserve’s lending facility d. retail CDs ANSWER: b 30. The bank holding company structure allows more flexibility to borrow funds, issue stock, repurchase the company's own stock, and acquire other firms. a.

True b.

False ANSWER: True 31. Like other market interest rates, the federal funds rate moves in reaction to changes in the demand for or supply of funds or both. a.

True b.

False ANSWER: True 32. The yield on repurchase agreements is slightly higher than the federal funds rate at any given point in time. a.

True b.

False Copyright Cengage Learning. Powered by Cognero.

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Chapter 17: Commercial Bank Operations ANSWER:

False

33. Bank regulators are concerned that banks may maintain a higher level of capital than they should and have therefore imposed capital requirements on them. a.

True b.

False ANSWER: False 34. In a revolving credit loan, the bank typically charges businesses a commitment fee on any unused funds. a.

True b.

False ANSWER: True 35. Bank rates on credit card balances are usually similar to the rate charged on business loans. a.

True b.

False ANSWER: False 36. The most common way for U.S. commercial banks to expand internationally is by purchasing banks in other countries. a.

True b.

False ANSWER: False 37. ____ is (are) NOT a major source of funds for commercial banks. a.

Deposit accounts b.

Borrowed funds c.

Commercial loans d.

Bank capital ANSWER:

c

38. Which of the following is NOT correct with respect to the federal funds market? a It allows depository institutions to accommodate the short-term liquidity needs of other financial institutions. b. Federal funds purchased (borrowed) represent an asset to the borrowing bank and a liability to the lending bank. c. It is typically most active on Wednesday when banks that are short of required reserves must compensate before the settlement period ends. d. All of these are correct.

ANSWER: b 39. The federal funds rate is typically ____ the primary credit rate. a. higher than b. less than c. equal to d.

None of these are correct.

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Chapter 17: Commercial Bank Operations ANSWER:

b

40. ____ are the largest bank source of funds as a percentage of total liabilities. a Savings and small time deposits . b.

Large deposits c.

Transaction deposits d.

Borrowed funds e.

Bank capital and bonds issued by the bank ANSWER:

a

41. With a _________, a bank agrees to purchase a firm’s __________ if the firm cannot place the issue in the market at an acceptable interest rate. a note issuance facility; commercial paper . b. c. d.

ANSWER:

note issuance facility; bonds paper placement commitment; commercial paper bond placement commitment; bonds a

42. A ____ is a type of loan commitment. a. standby letter of credit (SLC) b. note issuance facility (NIF) c. forward contract d. swap contract e.

None of these are correct.

ANSWER:

b

43. When a bank obtains funds through a ____, the provider of the funds receives collateral. a. retail CD b.

NOW account c. repurchase agreement d. money market deposit account ANSWER:

c

44. When banks obtain funds in the federal funds market, the funds are provided by a. other depository institutions. b. nonfinancial corporations. c. consumers. d. the Federal Reserve.

ANSWER:

a

45. A single loan in the federal funds market is usually for ____; when a bank sells a single repurchase agreement, the Copyright Cengage Learning. Powered by Cognero.

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Chapter 17: Commercial Bank Operations maturity is usually ____. a. just a few days; one year or more b. several weeks; one year or more c. several weeks; just a few days d. just a few days; just a few days ANSWER:

d

46. The interest rate charged on loans between depository institutions is commonly referred to as the a. federal funds rate. b. discount rate. c. primary credit rate. d.

None of these are correct.

ANSWER:

a

47. The interest rate charged on loans from the Federal Reserve to banks is commonly referred to as the a. federal funds rate. b. primary credit rate. c. repo rate. d.

None of these are correct.

ANSWER:

b

48. The primary credit rate is determined by a. the Federal Reserve. b.

Congress. c. the Treasury. d. the President of the United States.

ANSWER:

a

49. Bank capital represents funds obtained through ____ and through ____. a issuing stock; offering long-term CDs . b. issuing repurchase agreements; issuing bonds c. issuing stock; retaining earnings d. offering long-term CDs; issuing bonds ANSWER:

c

50. When a bank obtains funds through ____, households are not a common provider of the funds. a.

NOW accounts b. retail CDs c. passbook savings accounts d.

NCDs ANSWER:

d

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Chapter 17: Commercial Bank Operations 51. Which of the following is NOT an off-balance sheet activity? a highly leveraged transactions (HLTs) . b. standby letters of credit c. forward contracts d. swap contracts ANSWER: 52. A bank's uses of funds represent liabilities of a bank. a.

True b.

False ANSWER:

a

False

53. States may enact _______ to set a maximum on the rate of interest that banks can charge. a. leveraged loan laws b. credit protection laws c. consumer interest laws d. usury laws ANSWER:

d

54. The five largest banks in the United States account for about one-tenth of all assets in U.S. banks. a.

True b.

False ANSWER: False 55. From a bank manager’s perspective, the differential in interest between a bank’s loans and its deposits a must not exceed the federal funds rate. b. is called the primary credit rate. c. must be sufficient to cover the bank’s expenses and generate a reasonable profit for the bank’s owners. d. must be sufficient to cover the bank’s deposit insurance premiums and its reserve requirements at the Federal Reserve.

ANSWER: c 56. In a loan participation arrangement, normally all of the participating banks are exposed to credit (default) risk. a.

True b.

False ANSWER: True 57. Banks will not accept intangible assets, such as patents and brand names, as collateral for commercial loans. a.

True b.

False ANSWER: False 58. Proprietary trading is generally less risky than a bank’s lending operations.

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Chapter 17: Commercial Bank Operations a. b.

True False

ANSWER:

False

59. When a bank engages in proprietary trading, it a uses its own funds to make investments. . b. is not subject to regulations. c. lends the funds in the federal funds market. d. normally uses the funds to build its capital.

ANSWER:

a

60. In a standby letter of credit, a bank agrees to a charge a fixed interest rate for a line of credit for a specified period. b. back a customer’s obligation to a third party. c. provide a customer with funds up to a specified maximum amount over a specified period. d. service credit card loans originated by another bank.

ANSWER:

b

61. A forward contract on currency a is a way to hedge credit (default) risk. b. is used to swap fixed interest payments in one currency for variable interest payments in another currency. c. is an agreement between a customer and a bank to exchange one currency for another on a specified date at a specified exchange rate. d. is an agreement between a customer and a bank to exchange one currency for another on a specified date at whatever the exchange rate is on that day.

ANSWER: c 62. Before establishing foreign branches, a U.S. bank must obtain the approval of the a U.S. Treasury. . b.

U.S. Commerce Department. c.

Federal Deposit Insurance Corporation. d.

Federal Reserve.

ANSWER:

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d

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Chapter 18: Bank Regulation 1. Deposit insurance has a limit of a. b. c. d.

ANSWER:

$10,000. $25,000. $100,000. $250,000. d

2. The opening of a commercial bank in the United States a does not require a charter. b. always requires a charter from a state government. c. always requires a charter from the federal government. d. requires a charter from a state or the federal government. e. requires a charter from both the state and federal government.

ANSWER:

d

3. National banks are regulated by ____, and state banks are regulated by ____. a the Comptroller of the Currency; their state agency b. the Comptroller of the Currency; the Comptroller of the Currency c. their state agency; their state agency d. their state agency; the Comptroller of the Currency ANSWER:

a

4. All banks that are members of the Federal Reserve must hold a private insurance on deposits. . b. FDIC insurance on deposits. c. both FDIC and private insurance on deposits. d. None of these are correct.

ANSWER:

b

5. In making loans to a single customer, commercial banks ____ restricted to a maximum percentage of their capital, and they ____ allowed to use borrowed or deposited funds to purchase common stock. a. are; are b. are; are not c. are not; are d. are not; are not ANSWER: b 6. Banks commonly use depositor funds to invest in stocks. a.

True b.

False ANSWER:

False

7. The liquidity coverage ratio, which is measured under the Basel III guidelines, is the ratio of a bank’s _________ to its Copyright Cengage Learning. Powered by Cognero.

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Chapter 18: Bank Regulation ___________. a . b. c. d.

ANSWER:

liquid assets; projected net cash outflow liquid assets; retained earnings Tier 1 capital; liquid assets projected net cash outflow; Tier 1 capital a

8. The Depository Institutions Deregulation and Monetary Control Act of 1980 allowed banks to set their own a. reserve requirements. b. capital ratios. c. interest rates on savings deposits. d. corporate loan interest rates.

ANSWER: c 9. The Glass-Steagall Act of 1933 prevented a any firm that accepts deposits from underwriting stocks and bonds of corporations. b. any firm that accepts deposits from underwriting general obligation bonds of states and municipalities. c. any firm that accepts deposits from holding any corporate bonds in its asset portfolio. d. state-chartered banks from offering commercial loans.

ANSWER: a 10. Which of the following was NOT achieved by the Depository Institutions Deregulation and Monetary Control Act of 1980? a removed interest rate ceilings on deposits b. allowed banks to offer NOW accounts c. increased competition among depository institutions d. allowed interstate banking for depository institutions in most states ANSWER: d 11. The Garn-St Germain Act of 1982 a permitted depository institutions to offer money market deposit accounts. b. prevented depository institutions from acquiring problem institutions across geographic boundaries. c. required the Fed to explicitly charge depository institutions for its services. d. allowed the Fed to provide check clearing to depository institutions at no charge.

ANSWER:

a

12. Which of the following is NOT a specific criterion that regulators use to monitor banks? a capital adequacy . b. dollar value of fixed assets c. asset quality d. earnings Copyright Cengage Learning. Powered by Cognero.

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Chapter 18: Bank Regulation e.

ANSWER:

sensitivity to financial market conditions b

13. The potential risk that financial problems can spread through financial institutions and the financial system is referred to as ________ risk. a. systemic b. systematic c. unsystematic d. market ANSWER: a 14. The Basel framework recommends that banks maintain capital in proportion to their a. mortgages. b. commercial paper. c. liabilities. d. risk-weighted assets.

ANSWER:

d

15. In general, a bank defines its value-at-risk as the estimated potential loss from its trading businesses that could result from adverse movements in market prices. a.

True b.

False ANSWER: True 16. Which of the following is an "off-balance-sheet commitment”? a long-term debt b. additional paid-in capital c. notes payable d. standby letters of credit backing commercial paper issued by firms ANSWER:

d

17. The liquidity component of the CAMELS rating refers to a how a bank's earnings would change if economic conditions change. b. how readily a bank's management would detect its financial problems. c. a bank's sensitivity to financial market conditions. d. the type of loans that a bank provides, the bank's process for deciding whether to provide loans, and the credit rating of debt securities that it purchases. e. whether a bank frequently needs to borrow from outside sources, such as the federal funds market.

ANSWER: a 18. Which of the following is NOT a corrective action that regulators may take when a bank is identified as a problem bank? a remove particular officers and directors of the bank b. request that the bank boost its capital level or delay its plans to expand Copyright Cengage Learning. Powered by Cognero.

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Chapter 18: Bank Regulation c. require the bank to provide additional financial information that is periodically updated to allow continued monitoring d. take legal action against the bank if it does not comply with their suggested remedies e. All of these are possible corrective actions taken by bank regulators.

ANSWER: e 19. The premiums banks pay to the FDIC for deposit insurance are a the same fixed dollar amount for all banks. b. the same fixed percentage of the bank's deposits for all banks. c. the same fixed percentage of the bank's loan volume for all banks. d. based on the risk of the bank.

ANSWER:

d

20. A common argument in favor of government rescues of large banks is that rescues can a reduce systemic risk in the financial system. . b. encourage banks to avoid risk. c. ensure that bank executives are properly compensated. d. prevent the moral hazard problem.

ANSWER:

a

21. The Sarbanes-Oxley Act was enacted to make corporate managers, board members, and auditors more accountable for the accuracy of the financial statements that their respective firms provide. a.

True b.

False ANSWER: True 22. The key reason for regulatory examinations (such as CAMELS ratings) is to a rate past performance. . b. detect problems of a bank in time to correct them. c. check for embezzlement. d. monitor reserve requirements.

ANSWER: 23. Deposit insurance now covers all bank deposits without any limit. a.

True b.

False ANSWER:

b

False

24. Which banking act allowed banks to cross state lines in order to acquire a failing institution? a.

McFadden Act Copyright Cengage Learning. Powered by Cognero.

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Chapter 18: Bank Regulation b. c. d.

Glass-Steagall Act DIDMCA Garn-St Germain Act

ANSWER:

d

25. Which banking act allowed for the creation of NOW accounts? a.

McFadden Act b.

Glass-Steagall Act c.

DIDMCA d.

Garn-St Germain Act ANSWER:

c

26. Which banking act allowed interstate banking? a Reigle-Neal Interstate Banking and Branching Efficiency Act b. Glass-Steagall Act c. DIDMCA d. Sarbanes-Oxley Act ANSWER:

a

27. Which banking act removed interest rate ceilings on deposits? a.

McFadden Act b.

Glass-Steagall Act c.

DIDMCA d.

Garn-St Germain Act ANSWER:

c

28. A potential benefit of the Financial Services Modernization Act is that a financial institutions can reduce their reliance on the demand for a single service. b. financial institutions can spread across state lines as a result of the act. c. financial institutions are free to provide loans for highly leveraged transactions and thereby increase their earnings. d. financial institutions can reduce their reliance on the demand for a single service AND financial institutions can spread across state lines as a result of the act.

ANSWER: a 29. Federal deposit insurance a. has existed since the 1800s. b. was created in 1933. c. was created after World War II. d. was created in 1960.

ANSWER:

b

30. ____ is NOT a characteristic used by bank regulators to rate banks.

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Chapter 18: Bank Regulation a. b. c. d. e.

Capital adequacy Current stock price Asset quality Management All of these are used to rate banks.

ANSWER:

b

31. The moral hazard problem is minimized when deposit insurance premiums are a zero (not imposed by the FDIC). b. the same for all banks. c. set at a fixed rate for large banks and at zero for small banks. d. based on the bank's risk.

ANSWER:

d

32. Which of the following statements is NOT correct with respect to the Financial Services Modernization Act of 1999? a It expanded the Glass-Steagall Act. b. It enabled commercial banks to more easily pursue securities and insurance activities. c. It allowed securities firms and insurance companies to acquire banks. d. It required commercial banks to have a strong rating in community lending in order to pursue additional expansion in securities and other nonbank activities. e. All of these are correct.

ANSWER: a 33. The ____ is the fund used to cover insured depositors. a Deposit Insurance Fund . b. Federal Deposit Insurance Corporation Fund c. Bank Depository Insurance Fund d. Financial Institution Insurance Fund e. None of these are correct.

ANSWER:

a

34. ____ is not a rating criterion used by bank regulators. a.

Capital adequacy b.

Savings deposit volume c.

Asset quality d.

Management e.

Liquidity ANSWER:

b

35. The act of taking on more risk because of protection from adverse consequences due to the risk is referred to as a moral hazard problem. a.

True Copyright Cengage Learning. Powered by Cognero.

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Chapter 18: Bank Regulation b.

False

ANSWER:

True

36. The Sarbanes-Oxley Act (SOX) was enacted to ensure a more transparent process for reporting on a firm’s productivity and financial condition. a.

True b.

False ANSWER: True 37. The Sarbanes-Oxley Act (2002) was enacted in response to some banks taking on too much risk. a.

True b.

False ANSWER: False 38. Some publicly traded banks have incurred larger reporting expenses as a result of having to comply with the SarbanesOxley Act. a.

True b.

False ANSWER: True 39. The Financial Services Modernization Act of 1999 a gave banks and other financial service firms less freedom to merge. b. allowed financial institutions to offer a diversified set of financial services. c. offered very few benefits to a financial institution's clients. d. increased the reliance of financial institutions on the demand for the single service they offer.

ANSWER:

b

40. During the credit crisis, the U.S. government’s Troubled Asset Relief Program (TARP) injected capital into banks by purchasing their preferred stock to provide them with a cushion against loan losses. a.

True b.

False ANSWER: True 41. All state banks are required to be members of the Federal Reserve System. a.

True b.

False ANSWER:

False

42. State banks are regulated by the Comptroller of the Currency. a.

True b.

False ANSWER:

False

43. Banks that are insured by the Federal Deposit Insurance Corporation (FDIC) are also regulated by the FDIC. Copyright Cengage Learning. Powered by Cognero.

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Chapter 18: Bank Regulation a. b.

True False

ANSWER: 44. Commercial banks are allowed to invest in junk bonds. a.

True b.

False ANSWER:

True

False

45. The fair value accounting that is used to value a bank’s assets for purposes of meeting capital requirements requires a bank to periodically “mark its assets to market.” a.

True b.

False ANSWER: True 46. When a bank acts as an intermediary on an interest rate swap and guarantees payment in the event that one of the parties to the swap defaults, the bank is engaging in an off-balance sheet commitment. a.

True b.

False ANSWER: True 47. The Reigle-Neal Interstate Banking and Branching Efficiency Act allowed banks to achieve economies of scale through nationwide interstate banking. a.

True b.

False ANSWER: True 48. Regulators put much emphasis on a bank's sensitivity to interest rate movements, since many banks have liabilities that are repriced more frequently than their assets and are adversely affected by rising interest rates. a.

True b.

False ANSWER: True 49. During the credit crisis, the U.S. government purchased the common stock of the largest banks in order to inject funds into the banks and cushion their losses. a.

True b.

False ANSWER: False 50. Which of the following was NOT a provision of the Financial Reform Act of 2010? a established the Financial Stability Oversight Council b. put limits on banks’ proprietary trading c. established the Consumer Financial Protection Bureau d. reestablished the separation between banking and securities activities that had existed under the GlassSteagall Act Copyright Cengage Learning. Powered by Cognero.

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Chapter 18: Bank Regulation e. required derivative securities to be traded through a clearinghouse or exchange ANSWER:

d

51. A federal bank charter is issued by the a Comptroller of the Currency. . b.

Securities and Exchange Commission. c.

U.S. Treasury. d.

Federal Reserve. e.

None of these are correct.

ANSWER:

a

52. Bank regulations typically a involve a trade-off between the safety of the banking system and the efficiency of bank operations. b. impose restrictions on the types of assets in which banks can invest. c. set requirements for the minimum amount of capital that banks must hold. d. All of these are correct.

ANSWER:

d

53. When a bank holds a lower level of capital, a given dollar level of profits represents a lower return on equity. a.

True b.

False ANSWER: False 54. Shareholders and managers of banks may prefer that banks be required to hold higher levels of capital because this would allow for higher share prices for the banks and larger bonuses for bank managers. a.

True b.

False ANSWER: False 55. A bank can increase its capital ratio by a buying back shares of its stock from shareholders. b. selling assets. c. increasing its dividend to encourage more investors to purchase its stock. d. increasing its off-balance sheet activities.

ANSWER:

b

56. The Basel III framework proposes a lower capital requirements for banks to enable them to generate higher earnings to make up for their losses during the credit crisis. b. relying on the rating agencies to assess the risk of bank assets. c. increased capital requirements and liquidity requirements for banks. d. using the gap ratio to set the capital ratio.

ANSWER: c Copyright Cengage Learning. Powered by Cognero.

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Chapter 18: Bank Regulation 57. During the credit crisis, all of the following occurred EXCEPT a some securities firms were allowed to become bank holding companies. b. the Federal Reserve rescued American International Group, an insurance company. c. the Treasury injected funds into financial institutions. d. the Supreme Court ruled that the Federal Reserve had exceeded its authority by assisting Bear Stearns because Bear was a securities firm and not a commercial bank.

ANSWER: d 58. The Volcker Rule, named for a former Fed chair a is intended to increase the powers of the Fed. b. states that the U.S. government will rescue certain large banks if necessary to reduce systemic risk in the financial system. c. sets limits on banks’ proprietary trading. d. requires all banks to undergo annual stress tests.

ANSWER: c 59. The Financial Reform Act (Wall Street Reform and Consumer Protection Act or Dodd-Frank Act) of 2010 a ended the system of risk-based insurance premiums. b. set requirements for the Deposit Insurance Fund’s reserves. c. raised the limit for insured deposits to $750,000 per depositor. d. allowed large insurance companies such as American International Group to compete with the FDIC to insure bank deposits.

ANSWER: b 60. The Volcker Rule prohibits banks from sponsoring or holding an ownership interest in a hedge fund or a private equity fund. a.

True b.

False ANSWER: True

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Dat e:

Chapter 19: Bank Management 1. Which of the following statements is NOT correct?

Managers may be tempted to make decisions that are in their own best interests rather than shareholder interests. b. Directors of a bank determine whether loan applications should be approved. c. To prevent agency problems, some banks provide stock as compensation to managers. d. The underlying goal behind the managerial policies of a bank is to maximize the wealth of the bank's shareholders ANSWER: b 2. Banks can resolve a liquidity problem by a extending new loans. . b. selling assets. c. buying back common stock. d. increasing dividend payouts. e. extending new loans AND selling assets.

ANSWER:

e

3. As the secondary market for loans has become active, banks can attempt to satisfy their liquidity needs with a ____ proportion of loans while achieving ____ profitability. a. higher; higher b. lower; lower c. higher; lower d. lower; higher ANSWER: a 4. Banks are more liquid as a result of securitization because it allows them to request repayment of the loan principal from the borrower upon demand. a.

True b.

False ANSWER: False 5. During a period of rising interest rates, a bank's net interest margin will likely ____ if its liabilities are ____ its assets. a. increase; more rate sensitive than b. decrease; more rate sensitive than c. increase; equally rate sensitive as d. decrease; equally rate sensitive as ANSWER: b 6. If a bank expects interest rates to consistently ____ over time, it will consider allocating most funds to rate-____ assets. a. decrease; sensitive b. decrease; insensitive c. increase; insensitive d.

None of these are correct.

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Chapter 19: Bank Management ANSWER:

b

7. Petri Bank had interest revenues of $70 million last year and $30 million in interest expenses. About $300 million of Petri's $800 million in assets are rate sensitive, while $600 million of its liabilities are rate sensitive. Petri Bank's net interest margin is ____ percent. a.

4.0 b.

3.6 c.

6.7 d.

5.0 ANSWER: d 8. The measure of interest rate risk that uses the difference between rate-sensitive assets and rate-sensitive liabilities is called the a. gap. b. duration measurement. c. duration ratio. d. gap ratio.

ANSWER: a 9. A gap ratio of less than 1.00 suggests that a rate-sensitive assets exceed rate-sensitive liabilities. b. an increase in interest rates would increase the bank's net interest margin. c. rate-sensitive liabilities exceed rate-sensitive assets. d. a decrease in interest rates would decrease the bank's net interest margin. e. an increase in interest rates would increase the bank's net interest margin AND a decrease in interest rates would decrease the bank's net interest margin.

ANSWER: c 10. Each bank may have its own classification system of interest rate sensitivity, because there is no perfect measurement of the gap. a.

True b.

False ANSWER: True 11. The duration of zero-coupon bonds will be ____ the duration of coupon bonds with the same maturity. a lower than b. higher than c. the same as d. either a or b (depending on the size of the coupon payment) ANSWER:

b

12. Other things being equal, assets with shorter maturities have ____ durations. Assets that generate more frequent coupon payments have ____ durations. a. shorter; longer Copyright Cengage Learning. Powered by Cognero.

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Chapter 19: Bank Management b. c. d.

shorter; shorter longer; shorter longer; longer

ANSWER:

b

13. For most banks, the average duration of assets ____ the average duration of liabilities, so the duration gap is ____. a. exceeds; zero b. exceeds; negative c. exceeds; positive d. is less than; negative ANSWER: c 14. Other things being equal, assets with ____ maturities and ____ frequent coupon payments have longer durations. a. shorter; more b. shorter; less c. longer; more d. longer; less ANSWER: d 15. If a bank that relies heavily on short-term deposits for its funds replaces its investment in long-term Treasury securities with more floating-rate commercial loans, it is likely that the bank's exposure to a. credit risk would decrease. b. credit risk would increase. c. interest rate risk would increase. d.

None of the above.

ANSWER: b 16. Which of the following is NOT a likely method used by a bank to reduce interest rate risk? a. maturity matching b. using fixed-rate loans c. using interest rate futures contracts d. using interest rate caps ANSWER:

b

17. Floating-rate loans cannot completely eliminate interest rate risk; if the cost of funds is changing more frequently than the rate on assets, the bank's net interest margin is still affected by interest rate fluctuations. a.

True b.

False ANSWER: True 18. The ____ of interest rate futures ____ the potential adverse effect of rising interest rates on a bank's interest expenses. a sale; increases . b. sale; reduces Copyright Cengage Learning. Powered by Cognero.

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Chapter 19: Bank Management c. d.

ANSWER:

purchase; reduces sale; increases AND purchase; reduces b

19. Which of the following financial institutions would be most willing to swap variable-rate payments for fixed-rate payments in order to reduce exposure to interest rate risk? a one whose assets and liabilities are equally interest-rate sensitive b. one whose assets are more interest-rate sensitive than its liabilities c. one whose liabilities are more interest-rate sensitive than its assets d. one whose gap ratio is equal to 1.0 ANSWER: b 20. Banks increase their risk by increasing their capital as a percentage of assets. a.

True b.

False ANSWER:

False

21. Banks generally ____ loans and ____ their purchases of low-risk securities when the economy is weak. a. increase; increase b. reduce; reduce c. increase; reduce d. reduce; increase ANSWER:

d

22. Banks tend to focus their loans in one industry so that they can specialize on that industry and reduce the credit risk of their loan portfolio. a.

True b.

False ANSWER: False 23. Most loan sales enable the bank originating the loan to continue servicing the loan. a.

True b.

False ANSWER: True 24. ROE is defined as a. b. c.

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Chapter 19: Bank Management d.

ANSWER:

c

25. The greater the ____, the greater the amount of assets per dollar's worth of equity. a leverage measure . b. ratio of equity to debt c. capital ratio d. proportion of loans to securities in the asset portfolio ANSWER:

a

26. A bank has a return on assets of 2 percent, $40 million in assets, and $4 million in equity. What is the return on equity? a.

10 percent b. .2 percent c.

2 percent d.

20 percent e.

None of these are correct.

ANSWER: d 27. A bank has the following asset and liability portfolios. What is the gap?

Ratesensitive assets

Amount (in millions)

Rate-sensitive liabilities

Amount (in millions)

Floating-rate loans

$4,000

NOW accounts

$1,750

Floating-rate mortgages

1,000

MMDAs

4,500

Short-term Treasury securities a. b. c. d. e.

1,500 $6,500

Short-term CDs

1,000 $7,250

$750 million -$750 million 1.12 .896 None of these are correct.

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Chapter 19: Bank Management ANSWER:

b

28. If Bank A has a negative gap and Bank B has a positive gap, which of the following is true? a Bank A is favorably affected by rising interest rates. . b. Bank B is favorably affected by falling interest rates. c. Bank A is adversely affected by falling interest rates. d. None of these are correct.

ANSWER:

d

29. Which of the following is a measure for banks to use to assess their exposure to interest rate risk? a. capital ratio b. leverage measure c. duration d. gap ratio e. duration AND gap ratio ANSWER:

e

30. If a bank sells interest rate futures, it ____ the potential adverse effect of rising interest rates and ____ the potential favorable effect of declining interest rates on its interest expenses. a. reduces; reduces b. increases; increases c. reduces; increases d. increases; reduces ANSWER: a 31. Banks can improve their liquidity position by restructuring their asset portfolio to contain fewer ____ and more ____. a. excess reserves; Treasury bills b.

Treasury bonds; corporate bonds c. loans; Treasury bills d.

None of these are correct.

ANSWER: c 32. Banks would reduce their liquidity by restructuring their asset portfolio to contain fewer ____ and more ____. a.

Treasury securities; excess reserves b. loans; Treasury securities c. corporate bonds; Treasury securities d.

None of these are correct.

ANSWER: d 33. Banks can reduce their credit risk by restructuring their asset portfolio to contain fewer ____ and more ____. a.

Treasury bonds; corporate bonds b.

Treasury bonds; municipal bonds Copyright Cengage Learning. Powered by Cognero.

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Chapter 19: Bank Management c. d.

Treasury bonds; commercial loans None of these are correct.

ANSWER:

d

34. Banks can increase their potential interest revenues by restructuring their asset portfolio to contain fewer ____ and more ____. a.

Treasury bonds; commercial loans b.

Treasury bonds; excess reserves c. consumer loans; Treasury bills d.

None of these are correct.

ANSWER: a 35. If a bank desires to maximize its net interest margin, it would best achieve its goal by attempting to obtain most of its funds through ____ and use most of its funds for ____ (assuming that all loans will be repaid). a traditional demand deposits; commercial loans . b. traditional demand deposits; consumer loans c. NOW accounts; consumer loans d. NOW accounts; commercial loans ANSWER: b 36. When measuring exposure to market risk, banks commonly use the ________. a. value-at-risk method b. operating leverage measure c. matching maturity method d. forward rate method ANSWER:

a

37. A bank's net interest margin is commonly defined as a interest revenues minus interest expenses. b. (interest revenues minus interest expenses)/total assets. c. (interest revenues minus interest expenses)/total liabilities. d. (interest revenues minus interest expenses)/capital.

ANSWER:

b

38. A common method for banks to reduce their credit risk is to a specialize in loans to one or a few industries in which they have expertise in assessing creditworthiness. b. specialize in loans to companies whose earnings patterns are quite similar over time. c. specialize in loans to one or a few industries in which they have expertise in assessing creditworthiness AND specialize in loans to companies whose earnings patterns are quite similar over time. d. None of these are correct.

ANSWER: d 39. International diversification of loans can best reduce a bank's overall credit risk if Copyright Cengage Learning. Powered by Cognero.

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Chapter 19: Bank Management a the loans are made in countries in a single continent. b. the loans are made in countries whose economic cycles do not move together over time. c. the loans are made in countries in a single continent AND the loans are made in countries whose economic cycles do not move together over time. d. None of these are correct.

ANSWER: b 40. During a period of rising interest rates, a bank's net interest margin will likely decline if it has a large amount of a rate-sensitive assets and no rate-sensitive liabilities. . b. rate-sensitive liabilities and no rate-sensitive assets. c. loans to technology firms. d. real estate loans.

ANSWER:

b

41. When a bank makes an international loan containing a clause that allows repayment in a foreign currency, the bank is exposed to a. loan settlement risk. b. exchange rate risk. c. global exchange risk. d. currency transaction risk.

ANSWER: b 42. Bank A has interest revenues of $4 million, interest expenses of $5 million, and assets totaling $20 million. Bank A's net interest margin is a. $1 million. b.

-$1 million. c.

-5 percent. d.

5 percent.

ANSWER: c 43. ____ is not a method used to assess interest rate risk. a.

Efficiency analysis b.

Gap analysis c.

Duration analysis d.

Sensitivity analysis ANSWER:

a

44. Durango Bank has $2 million in rate-sensitive liabilities and $3 million in rate-sensitive assets. Durango's gap is ____, and Durango is probably more concerned about a(n) ____ in interest rates. a.

-$1 million; increase b.

-$1 million; decrease c. $1 million; increase Copyright Cengage Learning. Powered by Cognero.

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Chapter 19: Bank Management d. e.

$1 million; decrease None of these are correct.

ANSWER:

d

45. Leskar Bank has $2 million in rate-sensitive liabilities and $3 million in rate-sensitive assets. Leskar's gap ratio is ____. a.

1.5 b.

0.67 c. $1 million d.

None of these are correct.

ANSWER: a 46. ____ is (are) least likely to be used as a method of reducing interest rate risk. a.

Maturity matching b.

Floating-rate loans c.

Stock options d.

Interest rate swaps e.

Interest rate caps ANSWER:

c

47. Ringo Bank has a profit after taxes of $3 million, total assets of $300 million, and shareholders' equity of $30 million.

Ringo's return on equity (ROE) is ____ percent. a.

1.0 b.

10.0 c.

3.0 d.

None of these are correct.

ANSWER: b 48. For a commercial bank, when the average duration of assets exceeds the average duration of liabilities, the duration gap is a zero. . b. positive. c. negative. d. either b or c, depending on the maturities of the assets.

ANSWER:

b

49. Assume a U.S. bank accepts deposits in dollars and made some fixed-rate loans in British pounds. Which of the following would reduce the bank's profit margin? a The pound appreciates against the dollar. b. The pound depreciates against the dollar. c. British interest rates decrease. d. British interest rates increase.

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Chapter 19: Bank Management e. British interest rates decrease AND British interest rates increase.

ANSWER:

a

50. The performance of a bank that continually concentrates on short-term deposits in euros and adjustable-rate dollar loans with equal rate sensitivity is a unaffected if euro interest rates increase and U.S. rates decrease. b. unaffected if U.S. interest rates increase and euro interest rates decrease. c. adversely affected if euro interest rates increase and U.S. rates decrease. d. adversely affected if U.S. interest rates increase and euro rates decrease. e. unaffected if euro interest rates increase and U.S. rates decrease AND unaffected if U.S. interest rates increase and euro interest rates decrease.

ANSWER: c 51. If a bank has assets and liabilities in dollars and euros, its exposure to interest rate risk can best be minimized if the a currency mix of assets is similar to that of liabilities. b. overall rate sensitivity of assets and liabilities is similar. c. rate sensitivity of assets and liabilities is matched for each currency. d. currency mix of assets is similar to that of liabilities AND overall rate sensitivity of assets and liabilities is similar.

ANSWER: c 52. The risk of a loss due to closing out a transaction is referred to as ____ risk. a. credit b. settlement c. interest rate d. exchange rate e.

None of these are correct.

ANSWER:

b

53. The Sarbanes-Oxley Act has had little impact on the monitoring conducted by the board members of commercial banks. a.

True b.

False ANSWER: False 54. Whether a bank has a temporary or a permanent need for funds, the decision should be to borrow in the federal funds market. a.

True b.

False ANSWER: False 55. A positive gap (or gap ratio of more than 1.00) suggests that rate-sensitive liabilities exceed rate-sensitive assets. a.

True b.

False Copyright Cengage Learning. Powered by Cognero.

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Chapter 19: Bank Management ANSWER:

False

56. For most banks, the average duration of liabilities exceeds the average duration of assets, so the duration gap is positive. a.

True b.

False ANSWER: False 57. Floating-rate loans completely eliminate interest rate risk. a.

True b.

False ANSWER:

False

58. A bank can usually simultaneously maximize its return on assets and minimize credit risk. a.

True b.

False ANSWER: False 59. If the duration of all of a bank’s assets with a maturity of greater than one year is similar to that of its liabilities with a maturity greater than one year, interest rate risk is nonexistent. a.

True b.

False ANSWER: False 60. Macon Bank has interest revenues of $5 million, interest expenses of $4 million, and assets totaling $20 million.

Macon Bank's net interest margin is a. $1 million. b.

-$1 million. c.

5 percent. d.

-5 percent.

ANSWER: c 61. ____ is NOT a method used to assess interest rate risk. a Gap analysis . b. Ratio analysis c. Duration analysis d. Sensitivity analysis e. All of these are methods of assessing interest rate risk.

ANSWER:

b

62. The Financial Reform Act of 2010 provides that if a bank suffers large losses because it took excessive risk, the Federal Reserve will appoint a new board of directors for the bank.

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Chapter 19: Bank Management a. b.

True False

ANSWER:

False

63. Crazer Bank has a profit after taxes of $2 million, total assets of $100 million, and shareholders' equity of $10 million.

Crazer's return on equity (ROE) is ____ percent. a.

18 b.

210 c.

15 d.

20 e.

None of these are correct.

ANSWER: d 64. If a bank expects interest rates to consistently ____ over time, it will consider allocating most of its funds to rate-____ assets. a decrease; sensitive . b. increase; insensitive c. increase; sensitive d. decrease; sensitive AND increase; insensitive e. None of these are correct.

ANSWER: c 65. During a period of ____ interest rates, a bank's net interest margin will likely ____ if its liabilities are more rate sensitive than its assets. a. decreasing; decrease b. increasing; increase c. decreasing; increase d. increasing; remain stable ANSWER: c 66. If interest rates ____, banks with ____ duration gaps will be ____ affected. a. rise; positive; positively b. rise; positive; adversely c. decrease; positive; adversely d. decrease; zero; positively e.

None of these are correct.

ANSWER:

b

67. In a sensitivity analysis using a bank's stock return, an interest rate proxy, and market returns, a ____ coefficient for the interest rate variable suggests that the bank’s performance is ____ affected by ____ interest rates. a. positive; adversely; rising b. positive; favorably; declining c. negative; adversely; rising Copyright Cengage Learning. Powered by Cognero.

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Chapter 19: Bank Management d.

negative; favorably; rising

ANSWER:

c

68. If a bank has a ____ duration gap, its average asset duration is probably ____ than its liability duration. a. zero; smaller b. positive; larger c. negative; larger d.

None of these are correct.

ANSWER:

b

69. In an interest rate swap, a bank whose liabilities are ____ rate sensitive than its assets can swap payments with a ____ interest rate in exchange for payments with a ____ interest rate. a. more; fixed; variable b. more; variable; fixed c. less; fixed; variable d. less; fixed; fixed e.

None of these are correct.

ANSWER: a 70. Because riskier assets offer ____ returns, a bank's strategy to increase its return will typically entail a(n) ____ in the overall credit risk of its asset portfolio. a. lower; increase b. lower; decrease c. higher; increase d. higher; decrease e.

None of these are correct.

ANSWER: c 71. When determining the appropriate interest rate to charge on a loan, a bank uses the Federal Reserve’s primary credit rate as a benchmark and adds a premium to this rate for less creditworthy customers. a.

True b.

False ANSWER: False 72. An effective way to align bank managers’ interests with shareholders’ goal of higher returns is to compensate the managers with fixed salaries without a bonus. a.

True b.

False ANSWER: False 73. Which of the following is NOT a function of a bank’s board of directors? a overseeing acquisitions b. determining a compensation system for the bank’s executives c. overseeing policies for changing the bank’s capital structure Copyright Cengage Learning. Powered by Cognero.

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Chapter 19: Bank Management d. pursuing a proxy contest to change the bank’s dividend policy ANSWER:

d

74. A(n) ____________ is an agreement for a fee to receive payments when the interest rate of a particular security rises above a specified level by a specified date. a. interest rate cap b. interest rate futures contract c. interest rate swap d. maximum rate contract ANSWER: a 75. Which of the following is a method that a bank can use to reduce its credit risk? a diversifying its loans across industries . b. focusing on credit card loans c. focusing on consumer loans d. selling its holdings of Treasury securities ANSWER:

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a

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Chapter 20: Bank Performance 1. Even if other external forces (such as interest rates) are unchanged, a commercial bank's expected cash flows can change in response to a change in its management skills. a.

True b.

False ANSWER: True 2. Interest income generated from all a bank’s assets is called a. net interest margin. b. the spread. c. gross interest income. d. net interest income.

ANSWER:

c

3. Interest paid on deposits and borrowed funds is called a. net interest expense. b. net interest margin. c. gross interest expense. d. net spread expense.

ANSWER:

c

4. Fees charged by a bank on various services allow the bank to generate a. noninterest income. b. components of net interest margin. c. components of net interest income. d. components of gross interest income.

ANSWER:

a

5. The loan loss provision as a percentage of assets should increase during periods of high economic growth. a.

True b.

False ANSWER: False 6. A bank's net interest margin represents the proportion of its investments that are financed with borrowed funds. a.

True b.

False ANSWER: False 7. If a bank has short-term deposits and provides long-term fixed-rate loans, and interest rates decline over time, its net interest margin should be a. declining over time. b. rising over time. c. constant over time. d. consistently negative.

ANSWER: b Copyright Cengage Learning. Powered by Cognero.

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Chapter 20: Bank Performance 8. Net income measured as a percentage of assets is a. return on equity (ROE). b. return on liabilities (ROL). c. return on investment (ROI). d. return on assets (ROA).

ANSWER:

d

9. When only equity counts as capital, the leverage measure is a. equal to the capital ratio. b. equal to return on assets. c. the inverse of return on assets. d. the inverse of the capital ratio.

ANSWER:

d

10. When only equity counts as capital, the higher the capital ratio, the a lower the leverage measure. b. lower the degree of financial leverage. c. higher the leverage measure. d. lower the leverage measure AND lower the degree of financial leverage. e. lower the degree of financial leverage AND higher the leverage measure.

ANSWER:

d

11. If a bank increases its provisions for loan losses, its interest income is ____, and its noninterest income is ____. a. reduced; not affected b. reduced; reduced c. not affected; reduced d. not affected; not affected ANSWER: d 12. Return on assets (ROA) will usually reveal when a bank's performance is not up to par, but it does not indicate the reason for poor performance. a.

True b.

False ANSWER: True 13. Gross interest expense is affected by a market interest rates. b. the composition of assets held by the bank. c. fee services provided by the bank. d. market interest rates AND the composition of assets held by the bank.

ANSWER:

a

14. If a bank has long-term fixed-rate assets and short-term liabilities, and interest rates increase over time, its net interest Copyright Cengage Learning. Powered by Cognero.

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Chapter 20: Bank Performance margin should a decrease. b. increase. c. stay the same. d. EITHER decrease OR increase, depending on whether the asset maturities exceed 10 years.

ANSWER:

a

15. The sum of net interest income, noninterest income, and securities gains, minus the provision for loan losses and noninterest expenses equals a. net interest margin. b. gross interest margin. c. net income. d. income before taxes.

ANSWER: d 16. Which of the following banks would likely have the highest return on equity? a high return on assets, high capital ratio . b. high return on assets, low capital ratio c. low return on assets, low capital ratio d. low return on assets, high capital ratio ANSWER:

b

17. Banks A and B have the same net income. Bank A has a higher capital ratio and more assets than B. Bank A's return on assets is ____ than Bank B's. Bank A's return on equity is ____ than Bank B's. a. higher; higher b. higher; lower c. lower; higher d. lower; lower ANSWER: d 18. Banks G and H are the same size and have similar operations. Bank G holds the minimum level of capital, and Bank H holds a higher level of capital. Bank G's return on equity is probably ____ volatile than that of Bank H. Bank G's risk premium is probably ____ than that of Bank H. a. less; lower b. less; higher c. more; higher d. more; lower ANSWER: c 19. Noninterest income is usually higher for small banks than for money center and large banks because small banks can charge higher rates on loans to small local businesses. a.

True b.

False Copyright Cengage Learning. Powered by Cognero.

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Chapter 20: Bank Performance ANSWER:

False

20. ____ result(s) from a bank's sale of securities. a.

Noninterest income b.

Loan loss provision c.

Securities gains and losses d.

Noninterest expenses e.

None of these are correct.

ANSWER:

c

21. A bank's ROE ____ account for its financial leverage. A bank's ROA ____ account for its financial leverage. a. does; does b. does; does not c. does not; does not d. does not; does ANSWER: b 22. A bank's ROA ____ account for taxes on earnings. A bank's ROE ____ account for taxes on earnings. a. does; does b. does; does not c. does not; does not d. does not; does ANSWER:

a

23. A bank's net interest margin includes a. noninterest expenses. b. noninterest income. c. loan losses. d.

None of these are correct.

ANSWER:

d

24. Banks with relatively ____ ROAs are possibly incurring ____ noninterest expenses. a. low; low b. low; high c. high; high d.

None of these are correct.

ANSWER:

b

25. Bank T generally obtains a high percentage of its funds from negotiable certificates of deposit (NCDs). Bank V obtains most of its funds from retail CDs. Bank Z obtains its funds from checking accounts. The bank that will likely incur the highest interest expense is ____. a.

Bank T b.

Bank V Copyright Cengage Learning. Powered by Cognero.

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Chapter 20: Bank Performance c. d.

Bank Z All three banks are the same

ANSWER:

a

26. The value of a commercial bank can be modeled as the present value of its future cash flows. a.

True b.

False ANSWER: True 27. The level of competition is an industry characteristic that will favorably affect cash flows, because a high level of competition may increase a bank's volume of business or increase the prices it can charge for its services. a.

True b.

False ANSWER: False 28. If the risk premium on a commercial bank rises, so will the required rate of return by investors who invest in the bank. a.

True b.

False ANSWER: True 29. Gross interest expenses of banks are normally higher in periods when market interest rates are higher. a.

True b.

False ANSWER: True 30. If banks continue to offer new services (such as insurance or securities services), their noninterest income will decrease over time. a.

True b.

False ANSWER: False 31. The loan loss provision should increase during periods when loan losses are more likely, such as during a recessionary period. a.

True b.

False ANSWER: True 32. Any individual bank's ROA depends on the bank's policy decisions, but is not affected by uncontrollable factors relating to the economy and government regulations. a.

True b.

False ANSWER: False 33. Access to a bank's ROA without any other information reveals when its performance is not up to par and the reasons for its poor performance.

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Chapter 20: Bank Performance a. b.

ANSWER:

True False False

34. During the credit crisis, the level of ____ was much higher than in other periods. a. interest income b. income expenses c. noninterest expenses d. loan loss provisions ANSWER:

d

35. Changes in ____ are a factor affecting the value of a commercial bank over which the bank has some control. a. economic growth b. the risk-free interest rate c. industry conditions d. management abilities e.

None of these are correct.

ANSWER: d 36. A bank with ____ management may account for ____ loan losses, which _____ reported earnings now. a. conservative; smaller; reduces b. conservative; larger; reduces c. aggressive; larger; increases d. aggressive; smaller; has no effect on ANSWER:

b

37. When interest rates fall, the rates that a bank pays on deposits typically decline less than the interest rates that the bank earns on its loans and investments. a.

True b.

False ANSWER: False 38. Small banks tend to make more loans to small local businesses, and the rates on these loans are typically lower than the rates that larger banks charge on the loans they provide to large businesses. a.

True b.

False ANSWER: False 39. Which of the following factors affecting a bank’s gross interest income is NOT influenced by the bank’s policy decisions? a maturity and rate sensitivity of the bank’s assets . b.

market interest rate movements

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Chapter 20: Bank Performance c. d.

ANSWER:

the bank’s loan rate composition of the bank’s assets

40. A bank’s return on assets (ROA) could be lower than desired because of all of the following EXCEPT a the bank has experienced heavy loan losses. b. the bank was locked into fixed-rate loans prior to a rise in market interest rates. c. the bank is receiving a relatively small amount of noninterest income. d. the bank has reduced its noninterest expenses.

ANSWER:

b

d

41. The accounting process used by banks to determine their earnings is still based on subjective decisions, so the earnings of a bank are partially influenced by the accounting decisions regarding loan losses. a.

True b.

False ANSWER: True 42. Some banks that are experiencing serious financial problems may prefer to overstate their earnings in order to allow more time to correct their operations before the regulators force them to close. a.

True b.

False ANSWER: True 43. Banks increase their loan loss reserves in order to boost their reported earnings. a.

True b.

False ANSWER: False

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Chapter 21: Thrift Operations 1. ____ savings institutions hold the most assets in aggregate. a.

Stock-owned b.

Mutual c.

Closely held d.

Privatized ANSWER:

a

2. Which of the following statements is NOT correct? a A mutual-to-stock conversion allows savings institutions (SIs) to obtain additional capital by issuing stock. b. Because of their ownership structure, mutual SIs are more susceptible to unfriendly takeovers. c. When a mutual SI is involved in an acquisition, it first converts to a stock-owned SI. d. Consolidation and acquisitions have caused the number of mutual and stock SIs to decline consistently over the years.

ANSWER: b 3. Federally chartered savings institutions are regulated by the a Securities and Exchange Commission (SEC). . b. National Credit Union Administration. c. Comptroller of the Currency and the Federal Reserve. d. U.S. Treasury.

ANSWER:

c

4. Savings institutions obtain most of their funds from a. savings and time deposits. b. loans. c. mortgages. d. repurchase agreements.

ANSWER:

a

5. When savings institutions are unable to attract sufficient deposits, they can a borrow in the federal funds market. . b. borrow from the Federal Reserve. c. borrow through a repurchase agreement. d.

All of these are correct.

ANSWER:

d

6. The capital of savings institutions is primarily composed of retained earnings and funds obtained from issuing stock. a.

True b.

False ANSWER: True Copyright Cengage Learning. Powered by Cognero.

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Chapter 21: Thrift Operations 7. If depositors move money from their checking accounts to short-term CDs, this would ____ the rate sensitivity of the savings institution's liabilities to interest rate movements. a increase b. have no effect on c. decrease d. increase AND decrease are correct, depending on the size of the savings institution ANSWER: a 8. ____ are the primary asset of savings institutions. a.

Mortgages b.

Cash balances c.

Investment securities d.

Business loans ANSWER:

a

9. ____ do NOT represent an asset of credit unions. a.

Mortgage-backed securities b.

Home-equity loans c.

Automobile loans d.

Stocks ANSWER:

d

10. Which of the following are NOT an asset of savings institutions? a. loans b. mortgages c.

NOW accounts d. mortgage-backed securities ANSWER:

c

11. Most mortgages originated by savings institutions are for a commercial buildings. . b. land for commercial purposes. c. single-family homes or multifamily dwellings. d. None of these are correct.

ANSWER:

c

12. If a savings institution’s assets have a considerably longer duration than its liabilities, it can reduce its exposure to interest rate risk by a reducing its proportion of assets in the short duration categories. b. increasing its proportion of liabilities in the short duration categories. c. reducing its proportion of assets in the long duration categories. d. reducing its proportion of assets in the short duration categories AND increasing its proportion of liabilities in the short duration categories.

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Chapter 21: Thrift Operations ANSWER:

c

13. Adjustable-rate mortgages ____ the adverse impact of rising interest rates on a typical savings institution's spread.

They ____ the favorable impact of declining interest rates on the spread. a. reduce; reduce b. reduce; increase c. increase; increase d. increase; reduce ANSWER: a 14. To measure ____ risk, some savings institutions measure the duration of their respective assets and liabilities. a. credit b. interest rate c. liquidity d.

None of these are correct.

ANSWER: b 15. A contract that allows for the purchase of a specified debt security for a specified price at a future point in time is known as a(n) a. interest rate futures contract. b. interest rate swap contract. c. interest rate cap contract. d. security swap contract.

ANSWER: a 16. An interest rate swap reduces the favorable impact of declining interest rates. a.

True b.

False ANSWER:

True

17. A savings institution owned by its depositors is a ____ savings institution. a. mutual b. stock c. credit d. closed-end ANSWER:

a

18. Which of the following was NOT a major reason for the savings institution crisis in the late 1980s? a large losses on real estate loans . b. c. d.

large losses on loans to less-developed countries fraud illiquidity

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Chapter 21: Thrift Operations e.

ANSWER:

increased interest expenses b

19. The Financial Institutions Reform, Recovery, and Enforcement Act (FIRREA) prohibited savings institutions from a merging. . b. offering mortgage loans. c. investing in junk bonds. d. making loans to foreign governments.

ANSWER: c 20. The risk that a credit union will experience an unanticipated wave of withdrawals without an offsetting amount of new deposits is ____ risk. a. credit (default) b. interest rate c. liquidity d. exchange rate e.

None of these are correct.

ANSWER: c 21. Money market deposit accounts (MMDAs) are a trust accounts managed by savings institutions. b. checking accounts that do not pay interest. c. accounts offered primarily by money market funds. d. deposit accounts offering limited checking and close-to-market interest rates.

ANSWER:

d

22. Savings institutions commonly ____ to reduce their risk. a purchase futures contracts on stock indexes . b. purchase futures contracts on Treasury bonds c. sell futures contracts on stock indexes d. sell futures contracts on Treasury bonds ANSWER:

d

23. Stock-owned savings institutions ____ susceptible to unfriendly takeovers. Mutual savings institutions ____ susceptible to unfriendly takeovers. a. are; are not b. are; are c. are not; are d. are not; are not ANSWER: a 24. Savings institutions can obtain capital by Copyright Cengage Learning. Powered by Cognero.

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Chapter 21: Thrift Operations a . b. c. d.

ANSWER:

issuing stock. repurchasing stock. borrowing from the Federal Reserve. borrowing in the federal funds market. a

25. To obtain short-term funds, savings institutions commonly borrow funds in the ____ market. a. stock b. bond c. mortgage d. federal funds e. futures ANSWER:

d

26. ____ risk is probably the least concern for savings institutions. a.

Liquidity b.

Exchange rate c.

Credit d.

Interest rate ANSWER:

b

27. Which of the following is NOT an advantage of credit unions? a They can offer attractive rates to their members because they are nonprofit and therefore are not taxed. b. Their noninterest expenses are relatively low, because their offices and furniture are often donated or provided at a very low cost through the affiliation of their members. c. Their large membership allows them to effectively diversify geographically. d. All of these are advantages of credit unions.

ANSWER: c 28. A savings institution's cash flows are ____ interest rate movements. a. positively related to b. inversely related to c. unrelated to d.

None of these are correct.

ANSWER:

b

29. The primary use of credit union funds is a loans to credit union members. . b. the purchase of government securities. c. the purchase of agency securities. d. the purchase of corporate bonds.

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Chapter 21: Thrift Operations e.

ANSWER:

None of these are correct. a

30. ____ are nonprofit organizations composed of members with a common bond. a.

Credit unions b.

Savings banks c.

Savings and loan associations d.

Commercial banks ANSWER:

a

31. Because credit unions ____ stock, they are technically owned by the ____. a. issue; depositors b. do not issue; depositors c. issue; stockholders d. do not issue; management ANSWER:

b

32. Credit unions obtain most of their funds from a. issuing common stock. b. retained earnings. c. share deposits by members. d. issuing long-term bonds.

ANSWER:

c

33. Interest-paying checkable accounts offered by credit unions are called a.

NOW accounts. b. money market deposit accounts. c. share certificates. d. share drafts.

ANSWER:

d

34. The ____ acts as a temporary lender to credit unions. a World Bank . b.

Central Liquidity Facility c.

Federal Home Loan Bank d.

National Credit Union Administration ANSWER:

b

35. The sensitivity of the cost of funds to interest rate movements has generally been a greater for credit unions than for savings institutions. b. greater for credit unions than for commercial banks. c. lower for credit unions than for savings institutions or commercial banks.

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Chapter 21: Thrift Operations d. similar for credit unions as for savings institutions and commercial banks.

ANSWER:

c

36. Credit unions use the majority of their funds to a purchase investment securities. . b. provide commercial real estate loans. c. provide small business loans to members. d. provide consumer loans to members.

ANSWER:

d

37. If a credit union’s members are affiliated with a particular employer and large layoffs occur, the credit union's exposure to ____ risk may increase. a. settlement b. interest rate c. credit d.

None of these are correct.

ANSWER: c 38. The maximum insurance per depositor provided by the National Credit Union Share Insurance Fund is a. $250,000. b. $50,000. c. $40,000. d. $25,000.

ANSWER:

a

39. Which of the following is true about credit unions versus commercial banks and savings institutions? a Credit unions are less able to quickly generate additional deposits. b. Savings institutions and commercial banks can borrow from the Central Liquidity Facility, but credit unions cannot. c. Savings institutions and commercial banks are less able to quickly generate additional deposits. d. Credit unions have more exposure to interest rate risk.

ANSWER: a 40. The majority of maturities on consumer loans offered by credit unions are ____ term, causing income generated on their asset portfolio to be ____ to interest rate movements. a. long; insensitive b. short or medium; sensitive c. long; sensitive d. short or medium; insensitive ANSWER: b 41. Because credit unions' sources and uses of funds are generally interest rate ____, movements in interest revenues and interest expenses of credit unions are ____.

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Chapter 21: Thrift Operations a. b. c. d. e.

sensitive; negatively correlated insensitive; highly correlated sensitive; uncorrelated sensitive; highly correlated insensitive; uncorrelated

ANSWER:

d

42. Deposits at credit unions are called a.

NOW accounts. b. money market deposit accounts. c. shares. d. credit union deposit accounts.

ANSWER:

c

43. Today, credit unions are regulated as to the a types of services they can offer. . b. c. d.

ANSWER:

rates they offer on deposits. maturity of residential loans they can make. size of residential mortgage loans they can make. a

44. The National Credit Union Share Insurance Fund (NCUSIF) requires all a federally chartered credit unions to obtain insurance from the NCUSIF. b. state-chartered credit unions to obtain insurance from the NCUSIF. c. credit unions to pay a supplemental insurance premium each year. d. depository institutions to pay a supplemental insurance premium each year.

ANSWER:

a

45. According to your text, about ____ percent of credit unions are insured by the National Credit Union Share Insurance Fund. a.

20 b.

40 c.

60 d.

90 ANSWER: d 46. In general, savings institutions are larger than commercial banks. a.

True b.

False ANSWER:

False

47. Today, savings institutions are not permitted to invest in junk bonds.

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Chapter 21: Thrift Operations a. b.

True False

ANSWER:

True

48. Because savings institutions commonly use long-term liabilities to finance short-term assets, they depend on additional deposits to accommodate withdrawal requests. a.

True b.

False ANSWER: False 49. Savings institutions commonly measure the gap between their rate-sensitive assets and rate-sensitive liabilities in order to determine their exposure to credit risk. a.

True b.

False ANSWER: False 50. Savings institutions do not really know the actual maturity of the mortgages they hold and cannot perfectly match the interest rate sensitivity of their assets and liabilities. a.

True b.

False ANSWER: True 51. In general, when interest rates fall, a savings institution's cost of obtaining funds declines more than the decline in the interest earned on its loans and investments. a.

True b.

False ANSWER: True 52. High economic growth results in more risk for a savings institution, since its consumer loans, mortgage loans, and investments in debt securities are more likely to default. a.

True b.

False ANSWER: False 53. Because credit unions do not issue stock, they are technically sole proprietorships. a.

True b.

False ANSWER: False 54. Because credit unions are for-profit organizations, their income is taxable. a.

True b.

False ANSWER:

False

55. Credit unions obtain most of their funds by borrowing from the U.S. government.

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Chapter 21: Thrift Operations a. b.

True False

ANSWER:

False

56. Credit unions use the majority of their funds to invest in the stock market. a.

True b.

False ANSWER:

False

57. The National Credit Union Administration (NCUA) is responsible for regulating savings institutions. a.

True b.

False ANSWER: False 58. Credit unions are unregulated as to the types of services they offer. a.

True b.

False ANSWER:

False

59. All federally chartered credit unions are required to obtain insurance from the National Credit Union Share Insurance Fund (NCUSIF). a.

True b.

False ANSWER: True 60. The objective of a credit union is to act as an intermediary for its members by using members’ deposited funds to provide loans to other members who are in need of funds. a.

True b.

False ANSWER: True 61. ____ is (are) not a main source of funds for savings institutions. a.

Deposits b.

Borrowed funds c.

Capital d.

Mortgages ANSWER:

d

62. Which of the following are NOT a deposit source of funds for savings institutions? a passbook savings accounts b. retail CDs c. money market funds d. negotiable order of withdrawal (NOW) accounts e. All of these are deposit sources of funds for savings institutions.

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Chapter 21: Thrift Operations ANSWER:

c

63. ____ is (are) not a main use of funds for savings institutions. a.

Capital b.

Mortgages c.

Consumer and commercial loans d.

Mortgage-backed securities ANSWER:

a

64. To manage interest rate risk, a savings institution could use a. fixed-rate mortgages. b. currency options. c. interest rate futures contracts. d. letters of credit.

ANSWER:

c

65. Under the Financial Reform Act (Dodd-Frank Act) of 2010, all federally chartered savings institutions are to be regulated by the Federal Reserve. a.

True b.

False ANSWER: False 66. During the credit crisis of 2008–2009, some credit unions suffered losses on second mortgages and home-equity loans that they had provided, and some credit unions experienced losses on mortgage-backed securities in which they had invested. a.

True b.

False ANSWER: True 67. During the credit crisis of 2008–2009, savings institutions experienced all of the following EXCEPT a high default rates on loans to finance leveraged buyouts. b. a decline in the level of mortgage originations. c. high default rates on subprime mortgages. d. losses on investments in mortgage-backed securities.

ANSWER:

a

68. The Financial Reform Act of 2010 did all of the following EXCEPT a strengthened the standards required to obtain a mortgage. b. required more disclosures by financial institutions regarding the quality of the underlying assets when they sell mortgage-backed securities. c. required savings institutions to sell off any holdings of junk bonds and prohibited them from investing in junk bonds in the future. d. established the Consumer Financial Protection Bureau.

ANSWER: c Copyright Cengage Learning. Powered by Cognero.

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Chapter 21: Thrift Operations

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Chapter 22: Finance Company Operations 1. ____ finance companies provide financing for customers of retail stores and provide personal loans to individuals. a.

Consumer b.

Sales c.

Commercial d.

None of these are correct.

ANSWER: a 2. Finance companies differ from commercial banks, savings institutions, and credit unions in that they a do not rely heavily on deposits as a source of funds. . b. focus on financing acquisitions by companies. c. focus on providing residential mortgages. d. use most of their funds to purchase stocks ANSWER:

a

3. Which of the following is NOT a main source of funds for finance companies? a. bank loans b. commercial paper issues c. bonds d. borrowing from the Federal Reserve ANSWER:

d

4. Unlike loans made by commercial banks, loans made by finance companies cannot be securitized (bundled together and sold as securities to investors). a.

True b.

False ANSWER: False 5. The ________ is the federal agency responsible for regulating consumer finance products and services that may be offered by finance companies. a Consumer Financial Safety Commission . b.

Securities and Exchange Commission c.

Consumer Financial Protection Bureau d.

Federal Trade Commission ANSWER: c 6. Finance companies would prefer to increase their long-term debt when interest rates a are relatively low and are expected to increase. . b. have increased. c. have been stable for several years. d. are projected to decrease.

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Chapter 22: Finance Company Operations ANSWER:

a

7. When a finance company purchases a firm's receivables at a discount and becomes responsible for processing and collecting the balances of these accounts, it acts as a a. leasing agent. b. lessor. c. lessee. d. factor.

ANSWER: d 8. Finance companies are exempt from state regulations. a.

True b.

False ANSWER:

False

9. Finance companies are not subject to state regulations on intrastate business. a.

True b.

False ANSWER:

False

10. Finance companies are subject to disclosure requirements and truth in lending rules. b. minimum specified interest rates on loans provided. c. a minimum length on loan maturity. d. regulations that require finance companies to only operate in one state.

ANSWER:

a

11. If finance companies have liabilities that are more rate sensitive than their assets and want to reduce interest rate risk, they could a shorten their average asset life. . b. lengthen their average asset life. c. shorten the maturity of debt that they issue. d. make greater use of fixed-rate loans.

ANSWER: a 12. Overall, the liquidity risk of finance companies is higher than that of other financial institutions. a.

True b.

False ANSWER: False 13. A wholly owned subsidiary whose primary purpose is to finance sales of the parent company's products and services, provide wholesale financing to distributors of the parent company's products, and purchase receivables of the parent company is a Copyright Cengage Learning. Powered by Cognero.

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Chapter 22: Finance Company Operations a. b. c. d.

captive finance subsidiary. factor. leasing agent. captive factoring agent.

ANSWER:

a

14. Which of the following is NOT a use of finance company funds? a consumer loans . b. c. d. e.

ANSWER:

business loans commercial paper real estate loans All of the above are uses of finance company funds. c

15. Finance companies commonly act as ____ for accounts receivable; that is, they purchase a firm's receivables at a discount and are responsible for processing and collecting the balances of these accounts. a. brokers b. dealers c. market makers d. factors e.

None of these are correct.

ANSWER: d 16. A finance company’s cash flows are _____ related to changes in economic growth and may be ____ related to changes in the risk-free rate. a. positively; inversely b. inversely; positively c. inversely; inversely d. positively; positively ANSWER: a 17. Finance companies participate in the ____ market to reduce interest rate risk. a. money b. bond c. options d. swap ANSWER:

d

18. Many consumer finance companies provide personal loans directly to individuals to finance purchases of large household items. a.

True b.

False Copyright Cengage Learning. Powered by Cognero.

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Chapter 22: Finance Company Operations ANSWER: 19. Business finance companies focus on loans to very large businesses. a.

True b.

False ANSWER:

True

False

20. Consumer finance companies sometimes provide mortgage loans to individuals. a.

True b.

False ANSWER:

True

21. Although commercial paper is available only for short-term financing, finance companies can continually roll over their issues to create a permanent source of funds. a.

True b.

False ANSWER: True 22. When interest rates increase, finance companies tend to use more long-term debt to lock in their cost of funds over an extended period of time. a.

True b.

False ANSWER: False 23. Some finance companies offer credit card loans through a particular retailer. a.

True b.

False ANSWER:

True

24. The main competition for finance companies in the consumer loan market comes from pension funds and insurance companies. a.

True b.

False ANSWER: False 25. The value of a finance company can be modeled as the present value of its future cash flows. a.

True b.

False ANSWER: True 26. The most important risk for finance companies is ____ risk. a. settlement b. accounting c. credit Copyright Cengage Learning. Powered by Cognero.

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Chapter 22: Finance Company Operations d.

exchange rate

ANSWER:

c

27. Finance companies can accumulate capital by doing all of the following EXCEPT retaining earnings. b. issuing stock. c. issuing commercial paper. d. Finance companies can build their capital base by doing all of these.

ANSWER:

c

28. Consumer finance companies primarily focus on a. consumer loans. b. consumer advising. c. consumer regulation. d.

None of these are correct.

ANSWER:

a

29. Finance companies are regulated by the states and are not subject to regulation by any agency of the federal government. a.

True b.

False ANSWER: False

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Chapter 23: Mutual Fund Operations 1. Which of the following statements is incorrect?

Mutual funds serve as a key financial intermediary. b. Managers of mutual funds do not analyze economic and industry trends. c. Because of their diversification, management expertise, and liquidity, mutual funds have grown at a rapid pace. d. Some mutual funds offer check-writing privileges.

ANSWER: b 2. To cover managerial and other expenses, mutual funds typically charge a management fees of less than 2 percent of total assets per year. b. commissions of 8 to 10 percent on purchases or sales of securities. c. management fees of more than 10 percent of total assets per year. d. a one-time load of 5 percent upon the initial investment in the mutual fund.

ANSWER:

a

3. Mutual funds that are willing to repurchase their shares from investors at any time are referred to as a. closed-end funds. b. load mutual funds. c. no-load mutual funds. d. open-end mutual funds.

ANSWER:

d

4. Most closed-end funds invest in a. bonds and other debt securities. b. money market securities. c. gold. d. derivatives.

ANSWER:

a

5. Exchange-traded funds (ETFs) a are traded on an exchange, and their share price changes throughout the day. b. invest only in bonds. c. are actively managed. d. None of these are correct.

ANSWER:

a

6. Shares of open-end mutual funds are purchased and sold on exchanges. a.

True b.

False ANSWER:

False

7. Mutual funds a are unregulated.

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Chapter 23: Mutual Fund Operations b. are required to disclose the names of their portfolio managers in the prospectus. c. are not required to disclose any information about their past performance. d. are exempt from all taxes.

ANSWER:

b

8. Which of the following is NOT disclosed in a mutual fund prospectus? a the minimum amount of investment required . b. the investment objective of the mutual fund c. the fees incurred by the mutual fund d. All of the above are disclosed.

ANSWER:

d

9. The net asset value of a mutual fund is estimated once every week. a.

True b.

False ANSWER:

False

10. Mutual funds with ____ expense ratios tend to ____ other funds that have a similar investment objective. a lower; underperform . b. higher; outperform c. lower; outperform d. lower; underperform AND higher; outperform ANSWER:

c

11. A front-end load is a withdrawal fee assessed when you withdraw money from the mutual fund. a.

True b.

False ANSWER: False 12. Money market funds invest mostly in a. stocks. b. long-term bonds. c. real estate. d. short-term securities.

ANSWER:

d

13. If investors sell their mutual fund shares after the net asset value of the fund increases, the investors benefit from a. share price appreciation. b. capital gains distribution. c. dividends. d. split net asset value.

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Chapter 23: Mutual Fund Operations ANSWER:

a

14. Mutual funds composed of stocks that have potential for very high growth, but may also be unproven, are called a. income funds. b. capital appreciation funds. c. specialty funds. d. dividend funds.

ANSWER: b 15. Mutual funds composed of bonds that offer periodic coupon payments are a. income funds. b. specialty funds. c. dividend funds d. growth funds.

ANSWER:

a

16. Mutual funds whose bonds have a ____ average time to maturity are ____ sensitive to interest rate fluctuations. a. longer; less b. shorter; less c. shorter; more d. longer; less AND shorter; more ANSWER: b 17. Mutual funds that include both non-U.S. stocks and U.S. stocks are called ____ funds. a. global b. international c. combined d. mixed ANSWER:

a

18. A mutual fund consisting only of stocks of firms that are in a specific industry is an example of a ____ fund. a. specialty b. growth c. capital appreciation d. growth and income ANSWER: a 19. The majority of mutual fund assets are a. common stocks. b. corporate bonds. c.

U.S. government bonds. d. municipal bonds.

ANSWER: Copyright Cengage Learning. Powered by Cognero.

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Chapter 23: Mutual Fund Operations 20. If a mutual fund distributes at least ____ percent of its taxable income to shareholders, the fund is exempt from taxes on dividends, interest, and capital gains distributed to shareholders. a.

25 b.

50 c.

75 d.

90 ANSWER: d 21. Money market fund assets include all of the following, EXCEPT a. stocks. b. repurchase agreements. c.

Treasury bills. d.

CDs. ANSWER:

a

22. If money market fund managers expect interest rates to increase, they will ____ their average asset maturity. a not adjust b. shorten c. lengthen d. shorten (if the expected change is small) or lengthen (if the expected change is large) ANSWER: b 23. Money market funds are normally perceived to have ____ interest rate risk and ____ credit risk. a. low; high b. high; high c. high; low d. low; low ANSWER:

d

24. Equity real estate investment trusts invest in mortgage and construction loans. b. directly in properties. c. in common stocks issued by construction companies. d. in common stocks issued by real estate brokerage firms.

ANSWER:

b

25. When interest rates decline, investors who want to earn a high return may ____ their investments in stock mutual funds and ____ their deposits in depository institutions. a. reduce; reduce b. reduce; increase c. increase; reduce d. increase; increase Copyright Cengage Learning. Powered by Cognero.

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Chapter 23: Mutual Fund Operations ANSWER:

c

26. The composition of an asset allocation fund a includes nontraditional assets such as derivative securities and global real estate. b. is fixed and does not change with market conditions. c. is designed to automatically change as the investor ages. d. is adjusted by the fund’s managers in response to expectations and economic conditions.

ANSWER:

d

27. A mutual fund prospectus is not required to disclose the a minimum amount of investment required. b. return on the fund since its inception in comparison to the returns of other funds in its category. c. investment objective of the mutual fund. d. exposure of the mutual fund to various types of risk. e. fees incurred by the mutual fund and passed on to investors.

ANSWER:

b

28. The ____ of a mutual fund indicates the value per share. a. net asset value b. gross asset value c. net stock value d. net bond value e.

None of these are correct.

ANSWER:

a

29. _______ are promoted strictly by the mutual fund of concern and do not involve a sales charge. a.

Closed-end funds b.

Load mutual funds c.

No-load mutual funds d.

Open-end mutual funds ANSWER:

c

30. Mutual funds composed of _____ bonds with high credit ratings allow investors in high tax brackets to avoid taxes while maintaining a low degree of ______. a.

Treasury; liquidity risk b. municipal; credit risk c. high-yield; credit risk d. international; exchange rate risk ANSWER: b 31. Which of the following are most likely to invest in mortgages? a. stock mutual funds b. real estate investment trusts Copyright Cengage Learning. Powered by Cognero.

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Chapter 23: Mutual Fund Operations c. d.

Treasury bond funds money market funds

ANSWER:

b

32. Hedge funds that exceed a specified size must register with the a Securities and Exchange Commission (SEC). . b. Federal Reserve. c. Office of Thrift Supervision. d. Federal Mutual Fund Board.

ANSWER:

a

33. A mutual fund’s expense ratio represents the ____ divided by the fund's ____. a annual fees charged to investors; 12b-1 fees . b. c. d.

ANSWER:

annual fees charged to investors; net asset value initial sales charge (load); 12b-1 fees initial sales charge (load); net asset value b

34. The majority of closed-end funds invest in a derivatives. . b. c. d.

ANSWER:

bonds and other debt securities. stocks representing a particular sector or country. international equity securities.

35. ____ are beneficial for investors who want to invest in tax-exempt securities. a.

Municipal bond funds b.

Growth and income funds c.

International and global funds d.

Money market funds ANSWER:

b

a

36. Which of the following statements is NOT correct? a Commercial paper is commonly purchased by money market funds. b. Money market funds usually have a low level of credit risk. c. Money market funds tend to have lower interest rate risk than bond funds. d. If money market fund managers expect interest rates to decrease, they should use funds generated from maturing securities to purchase new securities with shorter maturities.

ANSWER: d Copyright Cengage Learning. Powered by Cognero.

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Chapter 23: Mutual Fund Operations 37. The number of exchange-traded funds has declined in recent years because the cost of managing them was excessive. a.

True b.

False ANSWER: False 38. Exchange-traded funds can be purchased on margin. a.

True b.

False ANSWER:

True

39. Investors can sell exchange-traded funds short. a.

True b.

False ANSWER:

True

40. Mutual fund managers seek securities that are very liquid so that they can easily sell them in the secondary market at any time. a.

True b.

False ANSWER: True 41. Closed-end funds are closed to new investment but allow redemptions by shareholders. a.

True b.

False ANSWER: False 42. Closed-end fund managers must hold more cash than open-end mutual fund managers. a.

True b.

False ANSWER: False 43. Index mutual funds are not traded throughout the day, while exchange-traded funds are. a.

True b.

False ANSWER: True 44. Venture capital funds typically invest in stocks of publicly traded companies. a.

True b.

False ANSWER:

False

45. Many businesses that go public are partially backed by venture capital before the IPO.

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Chapter 23: Mutual Fund Operations a. b.

True False

ANSWER:

True

46. Private equity funds use most of their money to invest in stocks of publicly traded companies. a. b.

True False

ANSWER:

False

47. _____ funds contain both stocks and bonds, with the proportions changing automatically as the investor ages. a.

Alternative strategy b.

Automatic allocation c.

Target date d.

Age-in-place ANSWER: c 48. Hedge funds commonly engage in short selling. a. b.

ANSWER:

True False True

49. Which of the following statements is NOT correct? a ETFs are like index mutual funds in that the share price adjusts over time in response to changes in the index level. b. ETFs normally do not have capital gains and losses that must be distributed to shareholders. c. The portfolio management of both ETFs and index mutual funds is very complex. d. ETFs can be traded throughout the day.

ANSWER: c 50. Funds that are designed to mimic particular stock indexes and are traded on a stock exchange are known as a. index mutual funds. b. exchange-traded funds. c. money market funds. d.

None of these are correct.

ANSWER: b 51. Exchange-traded funds can be a. traded throughout the day. b. purchased on margin. c. sold short. d.

All of these are correct.

ANSWER: Copyright Cengage Learning. Powered by Cognero.

d Page 8

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Chapter 23: Mutual Fund Operations 52. ____ trade at one-tenth of the S&P 500 value. a.

Spiders b.

Cubes c.

Diamonds d.

World Equity Benchmark Shares ANSWER:

a

53. Mutual funds must register with the U.S. Treasury and provide interested investors with a prospectus that discloses details about the components of the funds and the risks involved. a. b.

True False

ANSWER:

False

54. The net asset value (NAV) is estimated each day by first determining the market value of all securities comprising the mutual fund. a. b.

True False

ANSWER:

True

55. Portfolio managers are hired by the mutual fund to invest in a portfolio of securities that satisfies the desires of investors. a. b.

ANSWER:

True False True

56. The expenses incurred by a mutual fund are billed separately to investors and are not included in the calculation of the fund's net asset value (NAV). a.

True b.

False ANSWER: False 57. The Securities and Exchange Commission has established rules that allow public firms to disclose their earnings exclusively to hedge funds a few days before announcing the earnings to the public. a.

True b.

False ANSWER: False 58. Large mutual funds can exert some control over the management of firms because they commonly are the largest shareholders. a.

True b.

False Copyright Cengage Learning. Powered by Cognero.

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Chapter 23: Mutual Fund Operations ANSWER:

True

59. Investors who feel capable of making their own investment decisions normally prefer to invest in load funds instead of no-load funds. a.

True b.

False ANSWER: False 60. The term "mutual funds" is normally used to refer to closed-end funds and does not include open-end funds. a.

True b.

False ANSWER: False 61. Exchange-traded funds differ from open-end funds in that their share price is adjusted only at the end of each day. a.

True b.

False ANSWER: False 62. Capital appreciation funds are suited to investors who are more willing to risk a possible loss in value. a.

True b.

False ANSWER: True 63. The returns on international stock mutual funds are affected only by foreign companies' stock prices and are independent of currency movements. a.

True b.

False ANSWER: False 64. Index funds are becoming increasingly unpopular because most mutual fund managers consistently outperform indexes. a.

True b.

False ANSWER: False 65. A mutual fund's performance is usually unrelated to market conditions. a.

True b.

False ANSWER:

False

66. Hedge funds try to obtain an information advantage by using expert networks, whereby they hire consultants with expertise in specific industries. a.

True b.

False Copyright Cengage Learning. Powered by Cognero.

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Chapter 23: Mutual Fund Operations ANSWER:

True

67. Diversification among types of mutual funds usually does little to reduce the volatility of returns on the overall investment. a.

True b.

False ANSWER: False 68. Closed-end funds may sometimes engage in a stock repurchase, in which they purchase shares on the exchange where the shares are listed. a.

True b.

False ANSWER: True 69. Because money market funds contain instruments with short-term maturities, their market values are not very sensitive to movements in market interest rates. a.

True b.

False ANSWER: True 70. Equity REITs are sometimes purchased to hedge against inflation, as rents and property values tend to rise with inflation. a.

True b.

False ANSWER: True 71. Equity REITs essentially represent fixed-income portfolios, so their market values are heavily influenced by interest rate movements. a.

True b.

False ANSWER: False 72. Hedge funds are more heavily regulated than mutual funds. a.

True b.

False ANSWER:

False

73. Which of the following is NOT true regarding mutual funds? a They are a key financial intermediary. b. They provide an important service to individual investors seeking to invest funds. c. Most mutual funds use experienced portfolio managers, so investors do not have to manage the portfolio themselves. d. They provide a way for individual investors to diversify, but most individual investors are unable to afford the purchase of mutual fund shares.

ANSWER: d Copyright Cengage Learning. Powered by Cognero.

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Chapter 23: Mutual Fund Operations 74. Which of the following statements is NOT correct? a Exchange-traded funds (ETFs) are designed to mimic particular stock indexes and are traded on a stock exchange. b. ETFs have very high expense ratios. c. ETFs differ from most open-end and closed-end funds in that they are not actively managed. d. One disadvantage of ETFs is that each purchase of additional shares must be done through the exchange where they are traded.

ANSWER: b 75. Hedge funds a are typically organized as limited partnerships. b. were accused of making market conditions worse during the credit crisis because they commonly took short positions in the stock of financial institutions that held subprime mortgages. c. commonly rely heavily on financial leverage. d. generally charge both a management fee and an incentive fee. e. All of these are correct.

ANSWER: e 76. The ____ of a mutual fund represents the price at which shares can be purchased from the mutual fund. a. gross asset value b. net asset value c. net stock value d. net bond value ANSWER:

b

77. Which of the following is NOT correct about money market funds (MMFs)? a The credit risk of MMFs is normally perceived to be lower than that of corporate bond funds. b. MMFs have higher interest rate risk than long-term bond funds. c. MMFs are normally characterized as having relatively low risk and low expected returns. d. All of these are correct.

ANSWER:

b

78. Most studies that assess mutual fund performance find that mutual funds almost always outperform a benchmark market index. a.

True b.

False ANSWER: False 79. Which of the following is NOT a way in which mutual funds generate returns for their shareholders? a They can pass on any earned income as dividend payments to shareholders. b. They distribute the capital gains resulting from the sale of securities within the fund. c. The mutual fund price appreciates. d. All of these are ways in which a mutual fund generates returns to its shareholders.

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Chapter 23: Mutual Fund Operations ANSWER:

d

80. An investment in a(n) ____ fund incurs a sales charge. a. load b. no-load c. closed-end d. open-end e.

None of these are correct.

ANSWER:

a

81. Based on the market value of total assets, which is the dominant type of mutual fund? a. high-yield (junk) bond funds b. hybrid funds c. stock funds d. taxable bond funds e. municipal bond funds ANSWER:

c

82. Which of the following statements is NOT correct? a Investors can purchase shares directly from an open-end fund at any time. b. The number of shares of an open-end fund is always changing. c. Open-end funds typically maintain some cash on hand in case investments exceed redemptions. d. There are many different categories of open-end mutual funds.

ANSWER:

c

83. ____ funds focus on a group of companies sharing a particular characteristic. a.

Specialty b.

Growth and income c.

Closed-end d.

Capital appreciation e.

None of these are correct.

ANSWER:

a

84. When at least two-thirds of a bond mutual fund’s portfolio consists of bonds rated below Baa by Moody's or BBB by Standard and Poor's, the fund is called a ____ fund. a. growth b. capital appreciation c. high-yield bond d. leveraged bond e.

None of these are correct.

ANSWER: c 85. Which of the following statements is NOT correct?

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Chapter 23: Mutual Fund Operations a A mutual fund is usually run by an investment company. b. Mutual funds with lower expense ratios tend to outperform other funds with a similar investment objective. c. For each mutual fund, all expenses charged and reflected in the expense ratio are always valid. d. The SEC requires that a majority of the directors of a mutual fund board be independent.

ANSWER: c 86. Money market funds commonly invest in a. stocks. b. real estate. c. commercial paper. d.

U.S. Treasury bonds. e.

None of these are correct.

ANSWER:

c

87. Which of the following is NOT true with correct to venture capital (VC) funds? a They typically invest in young, growing firms that need equity funding but are not ready to go public. b. More than half of all VC investing is in businesses that are being created. c. They tend to focus on technology firms, which have the potential for high returns but also exhibit a high level of risk. d. Because VC funds invest in fairly safe ventures, a low percentage of their ventures fail. e. All of these are correct with respect to venture capital funds.

ANSWER: d 88. ____ funds sell shares to wealthy individuals and financial institutions and use the proceeds to invest in securities. a.

Growth b.

Open-end c.

Capital appreciation d.

Hedge e.

Specialty ANSWER: d 89. Compared to open-end mutual funds, exchange-traded funds generate much more capital gain income that must

be distributed to their shareholders, who must pay tax on the gains. a. b.

ANSWER:

True False False

90. Shares of exchange-traded funds can be sold _________, and shares of open-end mutual funds can be sold _________. a at any time during trading hours; at any time via private trading networks b. only at the end of the day; at any time during trading hours c. at any time via private trading networks; at any time during trading hours d. at any time during trading hours; only at the end of the day ANSWER: d Copyright Cengage Learning. Powered by Cognero.

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Chapter 23: Mutual Fund Operations 91. The average annual fee on actively managed exchange-traded funds is ________. a zero b. lower than the typical annual fee on open-end mutual funds c. higher than the typical annual fee on open-end mutual funds d. the same as the typical annual fee on open-end mutual funds ANSWER:

b

92. An investor who believes that technology stocks will perform well but does not want to select individual technology stocks might invest in a.

Spiders. b.

WEBs. c.

Cubes.

d.

Diamonds.

ANSWER:

c

93. If interest rates are expected to ________, mortgage real investment trusts (REITs) ___________. a. decline; become less attractive b. rise; become less attractive c. rise; are not affected d. decline; are not affected ANSWER:

b

94. Investors who invest in a multifund mutual fund essentially pay two layers of management fees. a.

True b.

False ANSWER: True 95. Hedge funds commonly use financial leverage, which can a magnify their returns and magnify their losses. . b. magnify their returns and limit their losses. c. reduce their risk and limit their losses. d. magnify their returns and not affect their risk.

ANSWER:

Copyright Cengage Learning. Powered by Cognero.

a

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Chapter 24: Securities Operations 1. Which of the following is NOT a service that is commonly performed by a securities firm? a setting regulatory rules for stock exchanges . b. origination c. underwriting d. distribution of stock or bond offerings ANSWER:

a

2. The ____ regulates the issuance of securities. a Securities and Exchange Commission . b.

National Association of Securities Dealers c.

Federal Reserve Board d.

Securities Investor Protection Corporation ANSWER:

a

3. When an IPO is planned, all information relevant to the security, as well as the agreement between the issuer and the securities firm, must be included in the ___________ that is submitted to the Securities and Exchange Commission. a. origination b. registration statement c. best-efforts agreement d.

None of these are correct.

ANSWER: b 4. When a stock offering is based on a firm commitment, this means that the securities firm does not guarantee a price to the issuing corporation. a.

True b.

False ANSWER: False 5. Research indicates that securities firms tend to a. overprice IPOs. b. underprice IPOs. c. price IPOs correctly. d.

None of these are correct.

ANSWER:

b

6. The one-day return to investors who purchase IPO shares at the IPO offer price are ____, and the returns to investors who purchase the shares a day after the IPO are generally ____. a. high; high b. high; low c. low; high d. low; low ANSWER: b Copyright Cengage Learning. Powered by Cognero.

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Chapter 24: Securities Operations 7. The ____ determines margin requirements on securities purchased. a Securities and Exchange Commission . b.

Financial Industry Regulatory Authority c.

Federal Reserve Board d.

Securities Investor Protection Corporation ANSWER:

c

8. The ____ can liquidate failing brokerage firms. a Securities and Exchange Commission . b.

Financial Industry Regulatory Authority c.

Federal Reserve Board d.

Securities Investor Protection Corporation ANSWER:

d

9. When securities firms help corporations issue bonds, their primary role is as a(n) a. intermediary. b. lender (creditor). c. investor. d. lendor (creditor) AND investor.

ANSWER:

a

10. The price of newly issued stock should be ____ the market price of the firm's outstanding stock. a about the same as b. much more than c. much less than d. either much more than or much less than, depending on the amount of stock issued ANSWER:

a

11. Under SEC Rule 144A, firms may engage in private placements of stock without filing the extensive registration statement that is required for public placements. a.

True b.

False ANSWER: True 12. Flotation costs as a percentage of the value of securities issued are ____ for ____ issues. a. lower; small b. lower; large c. higher; large d. lower; small AND higher; large ANSWER: Copyright Cengage Learning. Powered by Cognero.

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Chapter 24: Securities Operations 13. The ________ places limits on proprietary trading by commercial banks and securities firms that have become bank holding companies. a.

Bernanke Rule b.

Financial Safety Rule c.

Volcker Rule d.

Securities Reform Act ANSWER: c 14. In a ____ of stock, all of the shares issued may be held by a small number of institutional investors. a. market placement b. public placement c. shelf placement d. private placement ANSWER:

d

15. After a target firm is acquired, the acquirer may sell off divisions of the target that are not compatible with the acquirer’s business. This process is known as a. bridging. b. asset stripping. c. greenmail. d.

None of these are correct.

ANSWER: b 16. When a firm spins off a unit, it creates new shares of stock representing the unit and distributes them to its existing shareholders. a.

True b.

False ANSWER: True 17. The ____ is NOT involved in the regulation of the securities industry. a Deposit Insurance Fund b. Financial Industry Regulatory Authority c. Securities and Exchange Commission d. Federal Reserve Board e. All of these are involved in the regulation of the securities industry.

ANSWER:

a

18. Which of the following is NOT an SEC rule? a Analysts at a securities firm underwriting an IPO cannot promote the stock for the first 40 days after the IPO. b. An analyst's compensation should be directly aligned with the amount of business that the analyst brings to the securities firm. c. Analysts cannot be supervised by the investment banking department within the securities firm. d. When rating a security, an analyst must divulge any recent investment banking business provided by the analyst’s securities firm to the firm that issued the security.

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Chapter 24: Securities Operations ANSWER:

b

19. The value of a securities firm is typically ____ related to interest rate movements. a Positively b. Not c. Inversely d. either Positively or Inversely, depending on the direction of the interest rate movements.

ANSWER:

c

20. ____ is NOT a service that a securities firm provides in placing bonds. a Divestiture b. Underwriting c. Distribution d. Advising e. All of these are services that securities firms provide in placing bonds ANSWER:

a

21. Which of the following is NOT a function that a securities firm commonly performs when facilitating a secondary stock offering? a origination . b. underwriting the stock c. distribution of the stock d. purchasing at least 20 percent of the offering ANSWER: d 22. Asset stripping refers to a acquiring shares in a firm and then causing the firm to repurchase the shares at a premium to prevent a takeover. b. financing provided by a securities firm to help support an acquisition. c. investing in the shares of a firm that is expected to experience a leveraged buyout (LBO). d. selling off individual divisions of an acquired firm that are not compatible with the acquirer’s business.

ANSWER: d 23. A bridge loan provided by a securities firm would most likely be made to a an acquirer that needs temporary financing to complete a merger. b. a commercial bank in the federal funds market. c. a mutual fund that needs to cover share redemptions. d. an institutional investor that has received a margin call and needs to add cash to its margin account.

ANSWER:

a

24. Securities firms commonly engage in all of the following EXCEPT a. proprietary trading. b. underwriting stock.

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Chapter 24: Securities Operations c. d. e.

operating mutual funds. providing brokerage services. operating credit unions.

ANSWER:

e

25. ____ are NOT included in flotation costs. a Issue costs . b. Fees paid to the underwriters c. Taxes paid on income earned from the stock offering d. Registration expenses ANSWER:

c

26. Institutional investors that are willing to hold stock for only a very short period of time are prime candidates for participating in a private placement. a.

True b.

False ANSWER: False 27. Even after new stock is issued, a securities firm may continue to provide advice on the timing, amount, and terms of future financing. a.

True b.

False ANSWER: True 28. When a securities firm increases its financial leverage, the firm reduces both its potential return on equity (ROE) and its risk. a.

True b.

False ANSWER: False 29. The ____ offers insurance on cash and securities deposited at brokerage firms. a Federal Reserve . b. New York Stock Exchange c. Securities Investor Protection Corporation (SIPC) d. Securities and Exchange Commission (SEC) ANSWER:

c

30. Securities firms serve as intermediaries for all of the following, EXCEPT a stock offerings. b. bond offerings.

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Chapter 24: Securities Operations c. IPOs. d. Securities firms serve as intermediaries for all of the these.

ANSWER:

d

31. As a result of the Financial Services Modernization Act a securities firms had to search for loopholes to expand into other types of financial services. b. firms that formed a special finance holding company were regulated by the SEC. c. banking, securities activities, and insurance services could be consolidated in a single financial institution. d. securities firms were prohibited from expanding into other types of financial services.

ANSWER: c 32. One of the main functions of securities firms is helping corporations and governments raise funds. a.

True b.

False ANSWER: True 33. When securities firms facilitate initial public offerings (IPOs), they attempt to price the stock high enough to satisfy the issuing firm. a.

True b.

False ANSWER: True 34. The compensation paid to securities firms for helping a firm raise funds is typically in the form of interest income. a.

True b.

False ANSWER: False 35. The Securities and Exchange Commission’s approval of a registration statement guarantees the quality and safety of the securities to be issued. a.

True b.

False ANSWER: False 36. One reason for the financial problems of securities firms during the credit crisis was that they used a high degree of financial leverage. a.

True b.

False ANSWER: True 37. Securities firms engage in proprietary trading, which means that they serve as an intermediary by trading shares of stock requested by proprietorships. a.

True b.

False ANSWER: False Copyright Cengage Learning. Powered by Cognero.

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Chapter 24: Securities Operations 38. The Financial Reform Act created the Financial Stability Oversight Council, which is responsible for identifying risks to financial stability in the United States. a.

True b.

False ANSWER: True 39. During the credit crisis, many commercial banks were forced to convert to securities firms. a.

True b.

False ANSWER: False 40. During the credit crisis, some large securities firms were either acquired by commercial banks or converted into bank holding companies. a.

True b.

False ANSWER: True 41. The Federal Reserve intervened to help securities firms during the credit crisis in order to reduce the potential adverse effects of systemic risk. a.

True b.

False ANSWER: True 42. Securities firms avoided exposure to mortgages during the credit crisis because they sold their mortgage holdings before the crisis began. a.

True b.

False ANSWER: False 43. If securities firms are subject to systemic risk, this means that their main source of risk is a rise in interest rates, which may cause the value of their bond holdings to decline. a.

True b.

False ANSWER: False 44. When securities firms facilitate an IPO, they attempt to price the stock a at a level that will enable institutional investors who invest in the IPO to earn reasonable returns. b. high enough to satisfy the issuing firm. c. at a level that will enable the securities firms to place the entire issue. d. All of these are correct.

ANSWER:

d

45. Which of the following is NOT an example of a securities firm that experienced financial problems as a result of taking on excessive risk when engaging in proprietary trading? a.

Washington Mutual Copyright Cengage Learning. Powered by Cognero.

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Chapter 24: Securities Operations b. c. d.

Société Générale Bear Stearns Barings Bank

ANSWER:

a

46. Which of the following is NOT a way that a securities firm might advise a corporation to restructure its operations? a. a stock pass-through b. a spinoff of a unit c. a carve-out d. a divestiture ANSWER: a 47. Many of the fees that securities firms charge for advising clients on a possible merger are typically dependent on whether the merger takes place. a.

True b.

False ANSWER: True 48. Which of the following does NOT play a role in regulating securities trading? a Financial Industry Regulatory Authority . b.

Resolution Trust Corporation c.

New York Stock Exchange d.

Federal Reserve ANSWER:

b

49. The SEC’s Regulation Fair Disclosure (FD) a requires firms to disclose any significant information to the SEC before making public announcements. b. requires firms to disclose any significant information to the Federal Reserve before releasing it to the public. c. requires firms to disclose any significant information simultaneously to all market participants. d. prohibits insiders at firms from trading on significant inside information.

ANSWER: c 50. Securities firms that converted to bank holding companies during the credit crisis a gained more flexibility to obtain financing from the Federal Reserve. b. had to give up their traditional securities function of underwriting. c. came under greater regulatory oversight by the Securities Investor Protection Corporation. d. were prohibited from investing in or selling mortgage-backed securities.

ANSWER:

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a

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Chapter 25: Insurance Operations 1. Which of the following statements is NOT correct?

Insurance provides a payment to the insured under conditions specified by the insurance policy contract. b. Individuals who are less exposed to specific conditions that cause financial damage are more likely to purchase insurance against those conditions. c. Insurance can cause the insured to take more risks because they are protected. d. Insurance companies employ underwriters to calculate the risk of specific insurance policies.

ANSWER: b 2. Those insurance companies whose claims are ____ predictable need to maintain ____ liquidity. a. less; less b. more; more c. less; more d.

None of these are correct.

ANSWER:

c

3. A ____ life insurance company is owned by its policyholders; most life insurance companies are ____. a. stock-owned; mutual b. mutual; mutual c. stock-owned; stock-owned d. mutual; stock-owned ANSWER:

d

4. ____ insurance provides insurance for a policyholder only over a specified period. a.

Term b.

Whole life c.

Universal d.

Term AND Universal ANSWER:

d

5. Which type of life insurance policy does NOT build a cash value for policyholders? a. whole life b. term c. universal life d.

All of these build a cash value.

ANSWER:

b

6. Which type of life insurance policy specifically accommodates the needs of people who need more insurance now than later? a. whole life b. term c. decreasing term d. universal life ANSWER: c Copyright Cengage Learning. Powered by Cognero.

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Chapter 25: Insurance Operations 7. Which type of life insurance policy can offer flexibility on the size and timing of premium payments? a. whole life b. term c. universal life d. decreasing term ANSWER:

c

8. Under ____, the benefits awarded by the life insurance company to a beneficiary vary with the assets backing the policy. a. whole life insurance b. term insurance c. variable life insurance d. universal life insurance ANSWER: c 9. ____ is(are) not a typical source of funds for life insurance companies. a.

Deposit insurance premiums b.

Annuity plans c.

Investment income d.

Life and health insurance premiums ANSWER:

a

10. ____ are the most popular assets of life insurance companies. a Corporate debt securities and stocks . b.

Treasury securities c.

Mortgages and mortgage-backed securities d.

State and local bonds ANSWER:

a

11. Which of the following is NOT a characteristic commonly assessed by insurance regulators to detect any problems at an insurance company? a liquidity of the asset portfolio . b. relative size of operating expenses c. return on investment d.

All of these are assessed by regulators.

ANSWER: d 12. The ratio of an insurance company's net profit to policyholders' surplus is called the a. liquidity ratio. b. return on net worth. c. net underwriting margin. d. return on assets.

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Chapter 25: Insurance Operations ANSWER:

b

13. Life insurance companies can attempt to reduce their exposure to interest rate risk by a increasing their proportion of long-term assets. b. diversifying the age distribution of their customer base. c. increasing their proportion of short-term assets. d. concentrating on an older age distribution of their customer base.

ANSWER:

c

14. Which of the following is a difference between life insurance companies and property and casualty insurance companies? a Property and casualty policies are longer term. b. The types of policies offered by life insurance companies are less focused. c. Future compensation amounts to be paid on property and casualty policies are more difficult to forecast. d. Life insurance companies need to maintain a more liquid asset portfolio.

ANSWER: c 15. The most common use of funds for property and casualty insurance companies is for a corporate bonds and municipal securities. . b.

Treasury bills. c. corporate stock. d. commercial paper.

ANSWER:

a

16. ____ effectively reallocates a portion of an insurance company's return and risk to other insurance companies. a.

Reinsurance b.

Cash flow underwriting c.

Factor insurance d.

Universal insurance ANSWER: a 17. Individuals who are insured under a managed health care plan can usually choose any provider of health care services. a.

True b.

False ANSWER: False 18. ____ insurance covers losses due to dishonest employees. a.

Key employee b.

Credit line c.

Malpractice d.

Fidelity bond ANSWER: Copyright Cengage Learning. Powered by Cognero.

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Chapter 25: Insurance Operations 19. ____ insurance covers losses due to a contract not being fulfilled. a.

Fidelity bond b.

Credit line c.

Surety bond d.

Business interruption ANSWER:

c

20. Which of the following is NOT involved in the regulation of the insurance industry? a National Association of Insurance Commissioners (NAIC) b. Insurance Regulatory Information System (IRIS) c. Federal Deposit Insurance Corporation (FDIC) d. All of these are involved in regulating the insurance industry.

ANSWER:

c

21. With a(n) ____ insurance policy, the benefits awarded by the life insurance company to the beneficiary differ, depending on the assets backing the policy. a. universal life b. whole life c. variable life d. group life e.

None of these are correct.

ANSWER: c 22. ____ mortgages are the most common type of mortgage held by life insurance companies. a.

Commercial b.

Residential c.

Farm d.

None of these are correct.

ANSWER:

a

23. The ____ facilitates cooperation among the various state agencies whenever an insurance issue is a national concern. a Securities and Exchange Commission . b. c. d. e.

ANSWER:

Federal Deposit Insurance Corporation National Association of Insurance Commissioners National Association of Securities Dealers None of these are correct. c

24. The adverse selection problem as related to the insurance industry means that people who have insurance are less likely to suffer losses than people who do not have insurance. a.

True b.

False Copyright Cengage Learning. Powered by Cognero.

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Chapter 25: Insurance Operations ANSWER:

False

25. The moral hazard problem as related to the insurance industry means that some people take more risks once they are insured. a.

True b.

False ANSWER: True 26. Policyholders who prefer to invest their savings themselves will likely opt for whole life insurance over term insurance. a.

True b.

False ANSWER: False 27. Group insurance policies are very popular for employers and employees. a.

True b.

False ANSWER:

True

28. Real estate values usually have little impact on the market value of a life insurance company's asset portfolio and only affect property and casualty insurance companies. a.

True b.

False ANSWER: False 29. Property and casualty insurance and life insurance are similar in terms of the predictability of payouts to cover claims. a.

True b.

False ANSWER: False 30. _____ insurance provides a financial payout if specified employees of a business become disabled or die. a.

Best person b.

Employment liability c.

Key employee d.

Credit line ANSWER:

c

31. Bond insurance is available only for corporate bonds and not for municipal securities. a.

True b.

False ANSWER: False 32. An insurance company’s liquidity is measured as a net profit minus losses.

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Chapter 25: Insurance Operations b. premium income minus policy expenses. c. invested assets divided by loss reserves and unearned premium reserves. d. None of these are correct.

ANSWER:

c

33. The largest single source of funds for a life insurance company is a. life insurance premiums. b. annuity plans. c. health insurance premiums. d. investment income. e.

None of these are correct.

ANSWER:

b

34. Property and casualty (PC) insurance companies may use cash flow underwriting, in which they tend to lower their premium prices as interest rates rise. a.

True b.

False ANSWER: True 35. The practice of adapting insurance prices to interest rates by lowering premiums when interest rates rise and raising premiums when interest rates decline is called a. cyclical rate adjusting. b. collateralizing premiums. c. cash flow underwriting. d. reinsurance.

ANSWER: c 36. Mortgage insurance protects a homeowners against damage to their home from storms, fire, or other hazards. b. homeowners in the event that they cannot make their mortgage payments. c. the lender who provided the mortgage in the event that the homeowner defaults on the mortgage. d. All of these are correct.

ANSWER:

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c

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Chapter 26: Pension Fund Operations 1. Pension funds whose contributions are dictated by the benefits that will eventually be provided are called ____ plans. a. defined-benefit b. defined-contribution c. beneficiary d. guarantor-insured ANSWER: a 2. A pension plan that provides benefits that are determined by the accumulated contributions and return on the fund's investment performance is called a ____ plan. a. defined-benefit b. defined-contribution c. beneficiary d. guarantor-insured ANSWER: b 3. A ____ plan allows a firm to know with certainty the amount of funds to contribute. A ____ plan allows a firm to know with certainty the amount of benefits that must be provided. a defined-benefit; defined-benefit . b. defined-contribution; defined-contribution c. defined-contribution; defined-benefit d. defined-benefit; defined-contribution ANSWER: c 4. If pension fund investment decisions are made with the objective of generating cash flows at the same time as planned outflow payments, the fund follows a ____ strategy. When comparing matched funding and projective funding, ____ is more flexible for portfolio managers. a matched funding; matched funding . b. projective funding; matched funding c. projective funding; projective funding d. matched funding; projective funding ANSWER: d 5. Pension funds managed by life insurance companies are normally referred to as a. trust portfolios. b. insured plans. c. matched plans. d. projective plans.

ANSWER:

b

6. The asset composition of private pension portfolios is most heavily concentrated in a. corporate bonds. b. mortgages.

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Chapter 26: Pension Fund Operations c. d.

common stock. money market securities.

ANSWER:

c

7. Investing in a bond index portfolio is an example of a(n) ____ approach. Investing in an equity portfolio that mirrors the stock market is an example of a(n) ____ approach. a. passive; active b. active; active c. active; passive d. passive; passive ANSWER: d 8. Pension funds managed by life insurance companies concentrate on a. common stock. b. bonds and mortgages. c. preferred stock. d. money market instruments.

ANSWER:

b

9. To reduce interest rate risk, pension fund managers can a shift from variable-rate to fixed-rate bonds. . b. increase the average maturity on fixed-rate bonds. c. sell bond futures contracts. d. reduce the investment in money market securities.

ANSWER:

c

10. To deal with the problem of underfunded pension plans, Congress passed the ____________ of 2006. a Pension Protection Act . b. Employee Retirement Income Security Act c.

Retirement Reform Act d. Pension Benefit Guaranty Corporation Act ANSWER:

a

11. Nonqualified private pension plans offer tax deferral benefits to employees, but with qualified plans, income is taxed before it is contributed to the plan. a.

True b.

False ANSWER: False 12. A defined-benefit plan provides benefits that are determined by the accumulated contributions and the fund's investment performance.

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Chapter 26: Pension Fund Operations a. b.

ANSWER:

True False False

13. In recent years, defined-contribution plans have commonly been replaced by defined-benefit plans. a.

True b.

False ANSWER: False 14. Projective funding limits the manager's discretion, allowing only investments that match future payouts. a.

True b.

False ANSWER: False 15. Taking speculative positions in stock options is generally not considered appropriate for retirement funds because of the high degree of risk involved. a.

True b.

False ANSWER: True 16. The composition of the stocks in a pension fund's portfolio is determined by the fund's portfolio managers. a.

True b.

False ANSWER: True 17. With a ____ funding strategy, investment decisions are made with the objective of generating cash flows that match planned outflow payments. a. matched b. mixed c. projective d.

None of these are correct.

ANSWER: a 18. Underfunded pension plans are primarily a problem with defined-contribution pension plans. a.

True b.

False ANSWER: False 19. The government agency that guarantees that participants in defined-benefit plans will receive their benefits upon retirement is the a Federal Pension Insurance Corporation. . b.

Pension Benefit Guaranty Corporation. c.

Office of Pension Insurance.

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Chapter 26: Pension Fund Operations d.

ANSWER:

Employee Pension Protection Bureau. b

20. A pension fund manager might hedge against interest rate movements by selling bond futures contracts. a.

True b.

False ANSWER: True

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