Financial Markets and Institutions, 7e (Mishkin) Chapter 1 Why Study Financial Markets and Institutions? Multiple Choice Questions 1) Financial markets
... [Show More] and institutions A) involve the movement of huge quantities of money. B) affect the profits of businesses. C) affect the types of goods and services produced in an economy. D) do all of the above. Answer: D 2) Financial market activities affect A) personal wealth. B) spending decisions by individuals and business firms. C) the economy's location in the business cycle. D) all of the above. Answer: D 3) Markets in which funds are transferred from those who have excess funds available to those who have a shortage of available funds are called A) commodity markets. B) funds markets. C) derivative exchange markets. D) financial markets. Answer: D 4) The price paid for the rental of borrowed funds (usually expressed as a %age of the rental of $100 per year) is commonly referred to as the A) inflation rate. B) exchange rate. C) interest rate. D) aggregate price level. Answer: C 5) The bond markets are important because A) they are easily the most widely followed financial markets in the United States. B) they are the markets where interest rates are determined. C) they are the markets where foreign exchange rates are determined. D) all of the above. Answer: B 6) Interest rates are important to financial institutions since an interest rate increase ________ the cost of acquiring funds and ________ the income from assets. A) decreases; decreases B) increases; increases C) decreases; increases D) increases; decreases Ans: B 7) Typically, increasing interest rates A) discourages individuals from saving. B) discourages corporate investments. C) encourages corporate expansion. D) encourages corporate borrowing. E) none of the above. Answer: B 8) Compared to interest rates on long-term U.S. government bonds, interest rates on ________ fluctuate more and are lower on average. A) medium-quality corporate bonds B) low-quality corporate bonds C) high-quality corporate bonds D) three-month Treasury bills E) none of the above Answer: D 9) Compared to interest rates on long-term U.S. government bonds, interest rates on three-month Treasury bills fluctuate ________ and are ________ on average. A) more; lower B) less; lower C) more; higher D) less; higher Answer: A 10) The stock market is important because A) it is where interest rates are determined. B) it is the most widely followed financial market in the USA. C) it is where foreign exchange rates are determined. D) all of the above. Answer: B 11) A declining stock market index due to lower share prices A) reduces people's wealth and as a result may reduce their willingness to spend. B) increases people's wealth and as a result may increase their willingness to spend. C) decreases the amount of funds that business firms can raise by selling newly issued stock. D) both A and C E) both B and C Answer: D 12) Changes in stock prices A) affect people's wealth and their willingness to spend. B) affect firms' decisions to sell stock to finance investment spending. C) are characterized by considerable fluctuations. D) all of the above. E) only A and B Answer: D 13) (I) Debt markets are often referred to generically as the bond market. (II) A bond is a security that is a claim on the earnings and assets of a corporation. A) (I) is true, (II) false. B) (I) is false, (II) true. C) Both are true. D) Both are false. Answer: A 14) (I) A bond is a debt security that promises to make payments periodically for a specified period of time. (II) A stock is a security that is a claim on the earnings and assets of a corporation. A) (I) is true, (II) false. B) (I) is false, (II) true. C) Both are true. D) Both are false. Answer: C 15) Price of a country's currency in terms of another's is called A) the foreign exchange rate. B) the interest rate. C) Industrial average. D) none of the above. Ans: A 16) A stronger dollar benefits ________ and hurts ________ A) American businesses; American consumers. B) American businesses; foreign businesses. C) American consumers; American businesses. D) foreign businesses; American consumers. Answer: C 17) A weaker dollar benefits ________ and hurts ________ A) American businesses; American consumers. B) American businesses; foreign consumers. C) American consumers; American businesses. D) foreign businesses; American consumers. Answer: A 18) Money is defined as A) anything that is generally accepted in payment for goods and services or in the repayment of debt. B) bills of exchange. C) a riskless repository of spending power. D) all of the above. E) only A and B Answer: A 19) The central bank of the United States is A) Citicorp. B) The Fed. C) Bank of America. D) The Treasury. E) none of the above. Answer: B 1 contact: royfields212@gmail.com 20) Monetary policy is chiefly concerned with A) how much money businesses earn. B) the level of interest rates and the nation's money supply. C) how much money people pay in taxes. D) whether people have saved enough money for retirement. Answer: B 21) Economists group commercial banks, savings and loan associations, credit unions, mutual funds, mutual savings banks, insurance companies, pension funds, and finance companies together under the heading financial intermediaries. Financial intermediaries A) act as middlemen, borrowing funds from those who have saved and lending these funds to others. B) play an important role in determining the quantity of money in the economy. C) help promote a more efficient and dynamic economy. D) do all of the above. E) do only A and C Answer: D 22) Banks are important to the study of money and the economy because they A) provide a channel for linking those who want to save with those who want to invest. B) have been a source of financial innovation that is expanding the alternatives available to those wanting to invest their money. C) are the only financial institution to play a role in determining the quantity of money in the economy. D) do all of the above. E) do only A and B Answer: E 23) (I) Banks are financial intermediaries that accept deposits and make loans. (II) The term "banks" includes firms such as commercial banks, savings and loan associations, mutual savings banks, credit unions, insurance companies, and pension funds. A) (I) is true, (II) false. B) (I) is false, (II) true. C) Both are true. D) Both are false. Answer: A 24) The largest financial intermediaries are A) insurance companies. B) finance companies. C) banks. D) all of the above. Answer: C 25) A security A) is a claim or price of property that is subject to ownership. B) promises that payments will be made periodically for a specified period of time. C) is the price paid for the usage of funds. D) is a claim on the issuer's future income. Answer: D 26) ________ are an example of a financial institution. A) Banks B) Insurance companies C) Finance companies D) All of the above Answer: D 27) Monetary policy affects A) interest rates. B) inflation. C) business cycles. D) all of the above. Answer: D 28) A rising stock market index due to higher share prices A) increases people's wealth and as a result may increase their willingness to spend. B) increases the amount of funds that business firms can raise by selling newly issued stock. C) decreases the amount of funds that business firms can raise by selling newly issued stock. D) both A and B of the above. Answer: D True/False Questions 1) Money is anything accepted by anyone as payment for services or goods. Answer: TRUE 2) Interest rates are determined in the bond markets. Answer: TRUE 3) A stock is a debt security that promises to make periodic payments for a specific period of time. Answer: FALSE 4) Monetary policy affects interest rates but has little effect on inflation or business cycles. Answer: FALSE 5) Interest rates can be accurately described as the rental price of money. Answer: TRUE 6) Holding everything else constant, as the dollar weakens vacations abroad become less attractive. Answer: TRUE 7) Financial innovation has provided more options to both investors and borrowers. Answer: TRUE 8) A financial intermediary borrows funds from people who have saved. Answer: TRUE 9) Holding everything else constant, as the dollar strengthens foreigners will buy more U.S. exports. Ans: FALSE 10) In a bull market stock prices are rising, on average. Answer: TRUE 11) Financial institutions are among the largest employers in the country and frequently pay very high salaries. Ans: TRUE 12) Different interest rates have a tendency to move in unison. Answer: TRUE 13) Financial markets are what makes financial institutions work. Answer: FALSE Chapter 2 Overview of the Financial System Multiple Choice Questions 1) Every financial market performs the following function: A) It determines the level of interest rates. B) It allows common stock to be traded. C) It allows loans to be made. D) It channels funds from lenders-savers to borrowersspenders. Answer: D 2) Financial markets have the basic function of A) bringing together people with funds to lend and people who want to borrow funds. B) assuring that the swings in the business cycle are less pronounced. C) assuring that governments need never resort to printing money. D) both A and B E) both B and C Answer: A 3) Which of the following can be described as involving direct finance? A) A corporation's stock is traded in an over-the-counter market B) People buy shares in a mutual fund. C) A pension fund manager buys commercial paper in the secondary market. D) An insurance company buys shares of common stock in the over-the-counter markets. E) None of the above. Answer: E 2 4) Which of the following can be described as involving direct finance? A) A corporation's stock is traded in an over-the-counter market B) A corporation buys commercial paper issued by another corporation. C) A pension fund manager buys commercial paper from the issuing corporation. D) Both A and B E) Both B and C Answer: B 5) Which of the following can be described as involving indirect finance? A) A corporation takes out loans from a bank. B) People buy shares in a mutual fund. C) A corporation buys commercial paper in a secondary market. D) All of the above. E) Only A and B Answer: E 6) Financial markets improve economic welfare because A) they allow funds to move from those without productive investment opportunities to those who have such opportunities. B) they allow consumers to time their purchases better. C) they weed out inefficient firms. D) they do all of the above. E) they do A and B of the above. Answer: E 7) A country whose financial markets function poorly is likely to A) efficiently allocate its capital resources. B) enjoy high productivity. C) experience economic hardship and financial crises. D) increase its standard of living. Answer: C 8) Which of the following are securities? A) A certificate of deposit B) A share of Texaco common stock C) A Treasury bill D) All of the above Ans: D 9) Which of the following statements about the characteristics of debt and equity are true? A) They both can be long-term financial instruments. B) They both involve a claim on the issuer's income. C) They both enable a corporation to raise funds. D) All of the above. Answer: D 10) The money market is the market in which ________ are traded. A) new issues of securities B) previously issued securities C) short-term debt instruments D) long-term debt and equity instruments Answer: C 11) Long-term debt and equity instruments are traded in the ________ market. A) primary B) secondary C) capital D) money Answer: C 12) Which of the following are primary markets? A) The New York Stock Exchange B) The U.S. government bond market C) The over-the-counter stock market D) The options markets E) None of above Ans: E 13) Which of the following are secondary markets? A) The New York Stock Exchange B) The U.S. government bond market C) The over-the-counter stock market D) The options markets E) All of the above Ans: E 14) A corporation acquires new funds only when its securities are sold in the A) secondary market by an investment bank. B) primary market by an investment bank. C) secondary market by a stock exchange broker. D) secondary market by a commercial bank. Ans:B 15) Intermediaries who are agents of investors and match buyers with sellers of securities are called A) investment bankers. B) traders. C) brokers. D) dealers. Answer: C 16) Intermediaries who link buyers and sellers by buying and selling securities at stated prices are called A) investment bankers. B) traders. C) brokers. D) dealers. Answer: D 17) An important financial institution that assists in the initial sale of securities in the primary market is the A) investment bank. B) commercial bank. C) stock exchange. D) brokerage house. Ans:A 18) Which of the following statements about financial markets and securities are true? A) Most common stocks are traded over-the-counter, although the largest corporations have their shares traded at organized stock exchanges such as the NYS Exchange. B) A corporation acquires new funds only when its securities are sold in the primary market. C) Money market securities are usually more widely traded than longer-term securities and so tend to be more liquid. D) All of the above are true. E) Only A and B of the above are true. Answer: D 19) Which of the following statements about financial markets and securities are true? A) A bond is a long-term security that promises to make periodic payments called dividends to the firm's residual claimants. B) A debt instrument is intermediate term if its maturity is less than one year. C) A debt instrument is long term if its maturity is ten years or longer. D) The maturity of a debt instrument is the time (term) that has elapsed since it was issued. Answer: C 20) Which of the following statements about financial markets and securities are true? A) Few common stocks are traded over-the-counter, although the over-the-counter markets have grown in recent years. B) A corporation acquires new funds only when its securities are sold in the primary market. C) Capital market securities are usually more widely traded than longer-term securities and so tend to be more liquid. D) All of the above are true. Answer: B 21) Which of the following markets is sometimes organized as an over-the-counter market? A) The stock market B) The foreign exchange market C) The bond market D) The federal funds market E) all of the above Answer: E 22) Bonds that are sold in a foreign country and are denominated in that country's currency are known as A) foreign bonds. B) Eurobonds. C) Eurocurrencies. D) Eurodollars. Ans: A 3 23) Bonds that are sold in a foreign country and are denominated in a currency other than that of the country in which they are sold are known as A) foreign bonds. B) Eurobonds. C) Eurocurrencies. D) Eurodollars. Ans: B 24) Financial intermediaries A) exist because there are substantial information and transaction costs in the economy. B) improve the lot of the small saver. C) are involved in the process of indirect finance. D) do all of the above. Answer: D 25) The main sources of financing for businesses, in order of importance, are A) financial intermediaries, issuing bonds, issuing stocks. B) issuing bonds, issuing stocks, financial intermediaries. C) issuing stocks, issuing bonds, financial intermediaries. D) issuing stocks, financial intermediaries, issuing bonds. Answer: A 26) The presence of transaction costs in financial markets explains, in part, why A) financial intermediaries and indirect finance play such an important role in financial markets. B) equity and bond financing play such an important role in financial markets. C) corporations get more funds through equity financing than they get from financial intermediaries. D) direct financing is more important than indirect financing as a source of funds. Answer: A 27) Financial intermediaries can substantially reduce transaction costs per dollar of transactions because their large size allows them to take advantage of A) poorly informed consumers. B) standardization. C) economies of scale. D) their market power. Ans:C 28) The purpose of diversification is to A) reduce the volatility of a portfolio's return. B) raise the volatility of a portfolio's return. C) reduce the average return on a portfolio. D) raise the average return on a portfolio. Ans: A 29) An investor who puts all her funds into one asset ________ her portfolio's ________. A) increases; diversification B) decreases; diversification C) increases; average return D) decreases; average return Answer: B 30) Through risk-sharing activities, a financial intermediary ________ its own risk and ________ the risks of its customers. A) reduces; increases B) increases; reduces C) reduces; reduces D) increases; increases Ans:B 31) The presence of ________ in financial markets leads to adverse selection and moral hazard problems that interfere with the efficient functioning of financial markets. A) noncollateralized risk B) free-riding C) asymmetric information D) costly state verification Ans:C 32) When the lender and the borrower have different amounts of information regarding a transaction, ________ is said to exist. A) asymmetric information B) adverse selection C) moral hazard D) fraud Ans: A 33) When the potential borrowers who are the most likely to default are the ones most actively seeking a loan, ________ is said to exist. A) asymmetric information B) adverse selection C) moral hazard D) fraud Ans: B 34) When the borrower engages in activities that make it less likely that the loan will be repaid, ________ is said to exist. A) asymmetric information B) adverse selection C) moral hazard D) fraud Ans: C 35) The concept of adverse selection helps to explain A) which firms are more likely to obtain funds from banks and other financial intermediaries, rather than from the securities markets. B) why indirect finance is more important than direct finance as a source of business finance. C) why direct finance is more important than indirect finance as a source of business finance. D) only A and B E) only A and C Answer: D 36) Adverse selection is a problem associated with equity and debt contracts arising from A) the lender's relative lack of information about the borrower's potential returns and risks of his investment activities. B) the lender's inability to legally require sufficient collateral to cover a 100 % loss if the borrower defaults. C) the borrower's lack of incentive to seek a loan for highly risky investments. D) none of the above. Answer: A 37) When the least desirable credit risks are the ones most likely to seek loans, lenders are subject to the A) moral hazard problem. B) adverse selection problem. C) shirking problem. D) free-rider problem. E) principal-agent problem. Answer: B 38) Successful financial intermediaries have higher earnings on their investments because they are better equipped than individuals to screen out good from bad risks, thereby reducing losses due to A) moral hazard. B) adverse selection. C) bad luck. D) financial panics. Answer: B 39) Which of the following are not investment intermediaries? A) A life insurance company B) A pension fund C) A mutual fund D) Only A and B Ans: D 40) Which of the following are investment intermediaries? A) Finance companies B) Mutual funds C) Pension funds D) All of the above E) Only A and B of the above Answer: E 41) The government regulates financial markets for two main reasons: A) to ensure soundness of the financial system and to increase the information available to investors. B) to improve control of monetary policy and to increase the information available to investors. C) to ensure that financial intermediaries do not earn more than the normal rate of return and to improve control of monetary policy. D) to ensure soundness of financial intermediaries and to prevent financial intermediaries from earning less than the normal rate of return. Answer: A 4 42) Asymmetric information can lead to widespread collapse of financial intermediaries, referred to as a A) bank holiday. B) financial panic. C) financial disintermediation. D) financial collapse Ans: B 43) Foreign currencies that are deposited in banks outside the home country are known as A) foreign bonds. B) Eurobond. C) Eurocurrencies. D) Eurodollars. Ans: C 44) U.S. dollars deposited in foreign banks outside the U.S. or in foreign branches of U.S. are referred to as A) Eurodollars. B) Eurocurrencies. C) Eurobonds. D) foreign bonds. Answer: A 45) Banks providing depositors with checking accounts that enable them to pay their bills easily is known as A) liquidity services. B) asset transformation. C) risk sharing. D) transaction costs. Ans: A 46) A ________ is when one party in a financial contract has incentives to act in its own interest rather than in the interests of the other party. A) moral hazard B) risk C) conflict of interest D) financial panic Ans: C 47) Fire and casualty insurance companies are what type of intermediary? A) Contractual savings institution B) Depository institutions C) Investment intermediaries D) None of the above Ans: A True/False Questions 1) Every financial market allows loans to be made. Ans: FALSE 2) An example of direct financing is if you were to lend money to your neighbor. Answer: TRUE 3) The New York Stock Exchange is an example of a primary market. Answer: FALSE 4) A bond denominated in euros and issued in a country that uses the euro as its currency is an example of a Eurobond. Answer: FALSE 5) Most people's involvement with the financial system is through financial intermediaries rather than financial markets. Answer: TRUE 6) A financial intermediary's risk-sharing activities are also referred to as asset transformation. Answer: TRUE 7) The process of financial intermediation is also known as direct finance. Answer: FALSE 8) A mutual fund is not a depository institution. Ans:TRUE 9) A pension fund is not a contractual savings institution. Answer: FALSE 10) Equity represents an ownership interest in a firm and entitles the holder to the residual cash flows. Ans:TRUE 11) Adverse selection refers to those with high credit risks, being most aggressive in their search for funds. Ans:TRUE 12) The capital market is a financial market in which only short-term debt instruments (generally those with an original maturity of less than one year) are traded. Answer: FALSE Chapter 3 What Do Interest Rates Mean and What Is Their Role in Valuation? Multiple Choice Questions 1) A loan that requires the borrower to make the same payment every period until the maturity date is called a A) simple loan. B) fixed-payment loan. C) discount loan. D) same-payment loan. Answer: B 2) A coupon bond pays the owner of the bond A) the same amount every month until the maturity date. B) a fixed interest payment every period, plus the face value of the bond at the maturity date. C) the face value of the bond plus an interest payment once the maturity date has been reached. D) the face value at the maturity date. Ans: B 3) A bond's future payments are called its A) cash flows. B) maturity values. C) discounted present values. D) yields to maturity. Ans:A 4) A credit market instrument that pays the owner the face value of the security at the maturity date and nothing prior to then is called a A) simple loan. B) fixed-payment loan. C) coupon bond. D) discount bond. Ans: D 5) (I) A simple loan requires the borrower to repay the principal at the maturity date along with an interest payment. (II) A discount bond is bought at a price below its face value, and the face value is repaid at the maturity date. A) (I) is true, (II) false. B) (I) is false, (II) true. C) Both are true. D) Both are false. Ans: C 6) Which of the following are true of coupon bonds? A) The owner of a coupon bond receives a fixed interest payment every year until the maturity date, when the face or par value is repaid. B) U.S. Treasury bonds¬es are examples of coupon bonds. C) Corporate bonds are examples of coupon bonds. D) All of the above. Answer: D 7) Which of the following are generally true of all bonds? A) The longer a bond's maturity, the lower is the rate of return that occurs as a result of the increase in the interest rate. B) Even though a bond has a substantial initial interest rate, its return can turn out to be negative if interest rates rise. C) Prices and returns for long-term bonds are more volatile than those for shorter-term bonds. D) All of the above are true. Answer: D 8) (I) A discount bond requires the borrower to repay the principal at the maturity date plus an interest payment. (II) A coupon bond pays the lender a fixed interest payment every year until the maturity date, when a specified final amount (face or par value) is repaid. A) (I) is true, (II) false. B) (I) is false, (II) true. C) Both are true. D) Both are false. Answer: B 9) If a $5,000 coupon bond has a coupon rate of 13 %, then the coupon payment every year is A) $650. B) $1,300. C) $130. D) $13. Answer: A 5 10) An $8,000 coupon bond with a $400 annual coupon payment has a coupon rate of A) 5 %. B) 8 % C) 10 %. D) 40 %. Answer: A 11) The concept of ________ is based on the notion that a dollar paid to you in the future is less valuable to you than a dollar today. A) present value B) future value C) interest D) deflation Answer: A 12) Dollars received in the future are worth ________ than dollars received today. The process of calculating what dollars received in the future are worth today is called ________. A) more; discounting B) less; discounting C) more; inflating D) less; inflating Answer: B 13) The process of calculating what dollars received in the future are worth today is called A) calculating the yield to maturity. B) discounting the future. C) compounding the future. D) compounding the present. Answer: B 14) With an interest rate of 5 %, the present value of $100 received one year from now is approximately A) $100. B) $105. C) $95. D) $90. Ans: C 15) With an interest rate of 10 %, the present value of a security that pays $1,100 next year and $1,460 four years from now is approximately A) $1,000. B) $2,000. C) $2,560. D) $3,000. Ans: B 16) With an interest rate of 8 %, the present value of $100 received one year from now is approximately A) $93. B) $96. C) $100. D) $108. Answer: A 17) With an interest rate of 6 %, the present value of $100 received one year from now is approximately A) $106. B) $100. C) $94. D) $92. Answer: C 18) The interest rate that equates the present value of the cash flow received from a debt instrument with its market price today is the A) simple interest rate. B) discount rate. C) yield to maturity. D) real interest rate. Ans: C 19) The interest rate that financial economists consider to be the most accurate measure is the A) current yield. B) yield to maturity. C) yield on a discount basis. D) coupon rate. Ans: B 20) For a simple loan, the simple interest rate equals the A) real interest rate. B) nominal interest rate. C) current yield. D) yield to maturity. Ans: D 21) The yield to maturity of a one-year, simple loan of $500 that requires an interest payment of $40 is A) 5 % B) 8 % C) 12 % D) 12.5 % Answer: B 22) The yield to maturity of a one-year, simple loan of $400 that requires an interest payment of $50 is A) 5 % B) 8 % C) 12 % D) 12.5 % Ans: D 23) A $10,000, 8 % coupon bond that sells for $10,000 has a yield to maturity of A) 8 %. B) 10 %. C) 12 %.D) 14 %. Answer: A 24) Which of the following $1,000 face value securities has the highest yield to maturity? A) A 5 % coupon bond selling for $1,000 B) A 10 % coupon bond selling for $1,000 C) A 12 % coupon bond selling for $1,000 D) A 12 % coupon bond selling for $1,100 Ans: C 25) Which of the following are true for a coupon bond? A) When the coupon bond is priced at its face value, the yield to maturity equals the coupon rate. B) The price of a coupon bond and the yield to maturity are negatively related. C) The yield to maturity is greater than the coupon rate when the bond price is below the par value. D) All of the above are true. Answer: D 26) Which of the following are true for a coupon bond? A) When the coupon bond is priced at its face value, the yield to maturity equals the coupon rate. B) The price of a coupon bond and the yield to maturity are negatively related. C) The yield to maturity is greater than the coupon rate when the bond price is above the par value. D) Only A and B of the above are true. Ans: D 27) Which of the following are true for a coupon bond? A) When the coupon bond is priced at its face value, the yield to maturity equals the coupon rate. B) The price of a coupon bond and the yield to maturity are positively related. C) The yield to maturity is greater than the coupon rate when the bond price is above the par value. D) All of the above are true. Answer: A 28) A consol bond is a bond that A) pays interest annually and its face value at maturity. B) pays interest in perpetuity and never matures. C) pays no interest but pays its face value at maturity. D) rises in value as its yield to maturity rises. Ans: B 29) The yield to maturity on a consol bond that pays $100 yearly and sells for $500 is A) 5 %. B) 10 %. C) 12.5 %. D) 20 %. E) 25 %. Ans: D 30) The yield to maturity on a consol bond that pays $200 yearly and sells for $1000 is A) 5 %. B) 10 %. C) 20 %. D) 25 %. Answer: C 31) A frequently used approximation for the yield to maturity on a long-term bond is the A) coupon rate. B) current yield. C) cash flow interest rate. D) real interest rate. Ans:B 32) The current yield on a coupon bond is the bond's ________ divided by its ________. A) annual coupon payment; price B) annual coupon payment; face value C) annual return; price D) annual return; face value Answer: A 33) When a bond's price falls, its yield to maturity ________ and its current yield ________. A) falls; falls B) rises; rises C) falls; rises D) rises; falls Answer: B 6 34) If a $10,000 face value discount bond maturing in one year is selling for $8,000, then its yield to maturity is A) 10 %. B) 20 %. C) 25 %. D) 40 %. Answer: C 35) If a $10,000 face value discount bond maturing in one year is selling for $9,000, then its yield to maturity is approximately A) 9 %. B) 10 %. C) 11 %. D) 12 %. Answer: C 36) If a $10,000 face value discount bond maturing in one year is selling for $5,000, then its yield to maturity is A) 5 %. B) 10 %. C) 50 %. D) 100 %. Answer: D 37) If a $5,000 face value discount bond maturing in one year is selling for $5,000, then its yield to maturity is A) 0 %. B) 5 %. C) 10 %. D) 20 %. Answer: A 38) The Fisher equation states that A) the nominal interest rate equals the real interest rate plus the expected rate of inflation. B) the real interest rate equals the nominal interest rate less the expected rate of inflation. C) the nominal interest rate equals the real interest rate less the expected rate of inflation. D) both A and B are true. Answer: D 39) If you expect the inflation rate to be 15 % next year and a one-year bond has a yield to maturity of 7 %, then the real interest rate on this bond is A) 7 %. B) 22 %. C) -15 %. D) -8 %. Answer: D 40) If you expect the inflation rate to be 5 % next year and a one-year bond has a yield to maturity of 7 %, then the real interest rate on this bond is A) -12 %. B) -2 %. C) 2 %. D) 12 %. Answer: C 41) The nominal interest rate minus the expected rate of inflation A) defines the real interest rate. B) is a better measure of the incentives to borrow and lend than the nominal interest rate. C) is a more accurate indicator of the tightness of credit market conditions than the nominal interest rate. D) all of the above. Answer: D 42) In which of the following situations would you prefer to be making a loan? A) The interest rate is 9 % and the expected inflation rate is 7 %. B) The interest rate is 4 % and the expected inflation rate is 1 %. C) The interest rate is 13 % and the expected inflation rate is 15 % D) The interest rate is 25 % and the expected inflation rate is 50 % Answer: B 43) Which of the following are generally true of all bonds? A) The only bond whose return equals the initial yield to maturity is one whose time to maturity is the same as the holding period. B) A rise in interest rates is associated with a fall in bond prices, resulting in capital losses on bonds whose term to maturities are longer than the holding period. C) The longer a bond's maturity, the greater is the price change associated with a given interest rate change. D) All of the above are true. Answer: D 44) The return on a 5 % coupon bond that initially sells for $1,000 and sells for $1,100 one year later is A) 5 %. B) 10 %. C) 14 %. D) 15 %. Answer: D 45) The return on a 10 % coupon bond that initially sells for $1,000 and sells for $900 one year later is A) -10 %. B) -5 %. C) 0 %. D) 5 %. Answer: C 46) Which of the following are true concerning the distinction between interest rates and return? A) The rate of return on a bond will not necessarily equal the interest rate on that bond. B) The return can be expressed as the sum of the current yield and the rate of capital gains. C) The rate of return will be greater than the interest rate when the price of the bond falls between time t and time t + 1. D) All of the above E) Only A and B Ans: E 47) If the interest rates on all bonds rise from 5 to 6 % over the course of the year, which bond would you prefer to have been holding? A) A bond with one year to maturity B) A bond with five years to maturity C) A bond with ten years to maturity D) A bond with twenty years to maturity Ans: A 48) Suppose you are holding a 5 % coupon bond maturing in one year with a yield to maturity of 15 %. If the interest rate on one-year bonds rises from 15 % to 20 % over the course of the year, what is the yearly return on the bond you are holding? A) 5 % B) 10 % C) 15 % D) 20 % Answer: C 49) (I) Prices of longer-maturity bonds respond more dramatically to changes in interest rates. (II) Prices and returns for long-term bonds are less volatile than those for short-term bonds. A) (I) is true, (II) false. B) (I) is false, (II) true. C) Both are true. D) Both are false. Ans: A 50) The riskiness of an asset's return that results from interest rate changes is called A) interest-rate risk. B) coupon-rate risk. C) reinvestment risk. D) yield-to-maturity risk. Ans:A 51) If an investor's holding period is longer than the term to maturity of a bond, he or she is exposed to A) interest-rate risk. B) reinvestment risk. C) bond-market risk. D) yield-to-maturity risk. Ans:B 52) The interest rate that is adjusted for actual changes in the price level is called the A) ex post real interest rate. B) expected interest rate. C) ex ante real interest rate. D) none of the above. Ans:A 53) The change in the bond's price relative to the initial purchase price is A) the current yield. B) coupon payment. C) yield to maturity. D) rate of capital gain. Ans: D 54) Reinvestment risk is the risk that A) a bond's value may fall in the future. B) a bond's future coupon payments may have to be invested at a rate lower than the bond's yield to maturity. C) an investor's holding period will be short and equal in length to the maturity of the bonds he or she holds. D) a bond's issuer may fail to make the future coupon payments and the investor will have no cash to reinvest. Ans:B 7 55) (I) The average lifetime of a debt security's stream of payments is called duration. (II) The duration of a portfolio is the weighted average of the durations of the individual securities, with the weights reflecting the proportion of the portfolio invested in each. A) (I) is true, (II) false. B) (I) is false, (II) true. C) Both are true. D) Both are false. Ans: C 56) The duration of a ten-year, 10 % coupon bond when the interest rate is 10 % is 6.76 years. What happens to the price of the bond if the interest rate falls to 8 %? A) It rises 20 %. B) It rises 12.3 %. C) It falls 20 %. D) It falls 12.3 %. Answer: B 57) When the lender provides the borrower with an amount of funds that must be repaid to the lender at the maturity date, along with an additional payment for the interest, it is called a ________. A) fixed-payment loan B) discount loan C) simple loan D) none of the above Ans: C 58) A discount bond A) is also called a coupon bond. B) is also called a zero-coupon bond. C) is also called a fixed-payment bond. D) is also called a corporate bond. Answer: B 59) The return on a bond is equal to the yield to maturity when A) the holding period is longer than the maturity of the bond. B) the maturity of the bond is longer than the holding period. C) the holding period and the maturity of the bond are identical. D) none of the above. Answer: C 60) Bonds whose term to maturity is shorter than the holding period are also subject to A) default. B) reinvestment risk. C) both of the above. D) none of the above. Ans:B 61) A ________ is a type of loan that has the same cash flow payment every year throughout the life of the loan. A) discount loan B) simple loan C) fixed-payment loan D) interest-free loan Ans:C True/False Questions 1) A bond's current market value is equal to the present value of the coupon payments plus the present value of the face amount. Answer: TRUE 2) Discounting the future is the procedure used to find the future value of a dollar received today. Answer: FALSE 3) The current yield is the best measure of an investor's return from holding a bond. Answer: FALSE 4) Unless a bond defaults, an investor cannot lose money investing in bonds. Answer: FALSE 5) The current yield is the yearly coupon payment divided by the current market price. Answer: TRUE 6) Prices for long-term bonds are more volatile than for shorter-term bonds. Answer: TRUE 7) A long-term bond's price is less affected by interest rate movements than a short-term bond's price. Ans: FALSE 8) Increasing duration implies that interest-rate risk has increased. Answer: TRUE 9) All else being equal, the greater the interest rate the greater the duration is. Answer: FALSE 10) Interest-rate risk is the uncertainty that an investor faces because the interest rate at which a bond's future coupon payments can be invested is unknown. Answer: FALSE 11) The real interest rate is equal to the nominal rate minus inflation. Answer: TRUE 12) The current yield goes up as the price of a bond falls. Answer: TRUE 13) Changes in interest rates make investments in longterm bonds risky. Answer: TRUE 14) Bonds with a maturity that is longer than the holding period have no interest-rate risk. Answer: FALSE Chapter 4 Why Do Interest Rates Change? Multiple Choice Questions 1) As the price of a bond ________ and the expected return ________, bonds become more attractive to investors and the quantity demanded rises. A) falls; rises B) falls; falls C) rises; rises D) rises; falls Answer: A 2) The supply curve for bonds has the usual upward slope, indicating that as the price ________, ceteris paribus, the ________ increases. A) falls; supply B) falls; quantity supplied C) rises; supply D) rises; quantity supplied Answer: D 3) When the price of a bond is above the equilibrium price, there is excess ________ in the bond market and the price will ________. A) demand; rise B) demand; fall C) supply; fall D) supply; rise Answer: C 4) When the price of a bond is below the equilibrium price, there is excess ________ in the bond market and the price will ________. A) demand; rise B) demand; fall C) supply; fall D) supply; rise Answer: A 5) When the price of a bond is ________ the equilibrium price, there is an excess supply of bonds and the price will ________. A) above; rise B) above; fall C) below; fall D) below; rise Answer: B 6) When the price of a bond is ________ the equilibrium price, there is an excess demand for bonds and the price will ________. A) above; rise B) above; fall C) below; fall D) below; rise Answer: D 7) When the interest rate on a bond is above the equilibrium interest rate, there is excess ________ in the bond market and the interest rate will ________. A) demand; rise B) demand; fall C) supply; fall D) supply; rise Answer: B 8 8) When the interest rate on a bond is below the equilibrium interest rate, there is excess ________ in the bond market and the interest rate will ________. A) demand; rise B) demand; fall C) supply; fall D) supply; rise Answer: D 9) When the interest rate on a bond is ________ the equilibrium interest rate, there is excess ________ in the bond market and the interest rate will ________. A) above; demand; fall B) above; demand; rise C) below; supply; fall D) above; supply; rise Ans:A 10) When the interest rate on a bond is ________ the equilibrium interest rate, there is excess ________ in the bond market and the interest rate will ________. A) below; demand; rise B) below; demand; fall C) below; supply; rise D) above; supply; fall Ans: C 11) When the demand for bonds ________ or the supply of bonds ________, interest rates rise. A) increases; increases B) increases; decreases C) decreases; decreases D) decreases; increases Ans:D 12) When the demand for bonds ________ or the supply of bonds ________, interest rates fall. A) increases; increases B) increases; decreases C) decreases; decreases D) decreases; increases Ans:B 13) When the demand for bonds ________ or the supply of bonds ________, bond prices rise. A) increases; decreases B) decreases; increases C) decreases; decreases D) increases; increases Ans:A 14) When the demand for bonds ________ or the supply of bonds ________, bond prices fall. A) increases; increases B) increases; decreases C) decreases; decreases D) decreases; increases Ans:D 15) Factors that determine the demand for an asset include changes in the A) wealth of investors. B) liquidity of bonds relative to alternative assets. C) expected returns on bonds relative to alternative assets. D) risk of bonds relative to alternative assets. E) all of the above. Answer: E 16) The demand for an asset rises if ________ falls. A) risk relative to other assets B) expected return relative to other assets C) liquidity relative to other assets D) wealth Answer: A 17) The higher the standard deviation of returns on an asset, the ________ the asset's ________. A) greater; risk B) greater; expected return C) smaller; risk D) smaller; expected return Ans: A 18) Diversification benefits an investor by A) increasing wealth. B) increasing expected return. C) reducing risk. D) increasing liquidity. Ans: C 19) In a recession when income and wealth are falling, the demand for bonds ___ and the demand curve shifts to the ___ A) falls; right B) falls; left C) rises; right D) rises; left Answer: B 20) During business cycle expansions when income and wealth are rising, the demand for bonds ________ and the demand curve shifts to the ________. A) falls; right B) falls; left C) rises; right D) rises; left Answer: C 21) Higher expected interest rates in the future ________ the demand for long-term bonds and shift the demand curve to the ________. A) increase; left B) increase; right C) decrease; left D) decrease; right Ans: C 22) Lower expected interest rates in the future ________ the demand for long-term bonds and shift the demand curve to the ________ A) increase; left. B) increase; right. C) decrease; left. D) decrease; right. Ans: B 23) When people begin to expect a large stock market decline, the demand curve for bonds shifts to the ________ and the interest rate ________. A) right; falls B) right; rises C) left; falls D) left; rises Answer: A 24) When people begin to expect a large run up in stock prices, the demand curve for bonds shifts to the ________ and the interest rate ________. A) right; rises B) right; falls C) left; falls D) left; rises Answer: D 25) An increase in the expected rate of inflation will ________ the expected return on bonds relative to that on ________ assets, and shift the ________ curve to the left. A) reduce; financial; demand B) reduce; real; demand C) raise; financial; supply D) raise; real; supply Ans:B 26) A decrease in the expected rate of inflation will ____ the expected return on bonds relative to that on ____assets. A) reduce; financial B) reduce; real C) raise; financial D) raise; real Ans: D 27) When the expected inflation rate increases, the demand for bonds ________, the supply of bonds ________, and the interest rate ________. A) increases; increases; rises B) decreases; decreases; falls C) increases; decreases; falls D) decreases; increases; rises Answer: D 28) When the expected inflation rate decreases, the demand for bonds ________, the supply of bonds ________, and the interest rate ________. A) increases; increases; rises B) decreases; decreases; falls C) increases; decreases; falls D) decreases; increases; rises Answer: C 29) When bond prices become more volatile, the demand for bonds ________ and the interest rate ________. A) increases; rises B) increases; falls C) decreases; falls D) decreases; rises Ans:D 30) When bond prices become less volatile, the demand for bonds ________ and the interest rate ________. A) increases; rises B) increases; falls C) decreases; falls D) decreases; rises Ans:B 9 31) When prices in the stock market become more uncertain, the demand curve for bonds shifts to the ________ and the interest rate ________. A) right; rises B) right; falls C) left; falls D) left; rises Answer: B 32) When stock prices become less volatile, the demand curve for bonds shifts to the ________ and the interest rate ________. A) right; rises B) right; falls C) left; falls D) left; rises Answer: D 33) When bonds become more widely traded, and as a consequence the market becomes more liquid, the demand curve for bonds shifts to the ________ and the interest rate ________. A) right; rises B) right; falls C) left; falls D) left; rises Answer: B 34) When bonds become less widely traded, and as a consequence the market becomes less liquid, the demand curve for bonds shifts to the ________ and the interest rate ________. A) right; rises B) right; falls C) left; falls D) left; rises Answer: D 35) Factors that cause the demand curve for bonds to shift to the left include A) an increase in the inflation rate. B) an increase in the liquidity of stocks. C) a decrease in the volatility of stock prices. D) all of the above. Answer: D 36) Factors that cause the demand curve for bonds to shift to the left include A) a decrease in the inflation rate. B) an increase in the volatility of stock prices. C) an increase in the liquidity of stocks. D) all of the above. Answer: C 37) During an economic expansion, the supply of bonds ________ and the supply curve shifts to the ________. A) increases, left B) increases, right C) decreases, left D) decreases, right Ans: B 38) During a recession, the supply of bonds ________ and the supply curve shifts to the ________. A) increases, left B) increases, right C) decreases, left D) decreases, right Ans:C 39) An increase in expected inflation causes the supply of bonds to _____ and the supply curve to shift to the _____. A) increase, left B) increase, right C) decrease, left D) decrease, right Answer: B 40) When the federal government's budget deficit increases, the _____ curve for bonds shifts to the ______ A) demand; right B) demand; left C) supply; left D) supply; right Answer: D 41) When the federal government's budget deficit decreases, the_____ curve for bonds shifts to the ______ A) demand; right B) demand; left C) supply; left D) supply; right Answer: C 42) When the inflation rate is expected to increase, the expected return on bonds relative to real assets falls for any given interest rate; as a result, the ________ bonds falls and the ________ curve shifts to the left. A) demand for; demand B) demand for; supply C) supply of; demand D) supply of; supply Ans: A [Show Less]