Financial Markets and Institutions Test Bank by Madura

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Chapter 1—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.

2. The main provider(s) of funds to the U.S. Treasury is (are)
a. households and businesses.
b. foreign financial institutions.
c. the Federal Reserve System.
d. foreign nonfinancial sectors.

3. The largest deficit unit is (are)
a. households and businesses.
b. foreign financial institutions.
c. the U.S. Treasury.
d. foreign nonfinancial sectors.

4. Those 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.

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

6. Which of the following is a capital market instrument?
a. a six-month CD
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

7. Which of the following is a money market security?
a. Treasury note
b. municipal bond
c. mortgage
d. commercial paper

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

9. Equity securities have a ____ expected return than most long-term debt securities, and they exhibit a ____ degree of risk.
a. higher; higher
b. lower; lower
c. lower; higher
d. higher; lower

10. Money market securities generally have ____. Capital market securities are typically expected to have a ____.
a. less liquidity; higher annualized return
b. more liquidity; lower annualized return
c. less liquidity; lower annualized return
d. more liquidity; higher annualized return

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

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

13. If financial markets are efficient, this implies that all securities should earn the same return.
a. True
b. 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. declared misleading financial statements for public primary securities illegal.
d. required complete disclosure of relevant financial information for securities traded in the secondary market.
e. all of the above

15. The Securities 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 the above

16. Common stock is an example of a(n)
a. debt security.
b. money market security.
c. equity security.
d. A and B

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

18. The typical role of a securities firm in a public offering of securities is to
a. purchase the entire issue for its own investment.
b. place the entire issue with a single large investor.
c. spread the issue across several investors until the entire issue is sold.
d. provide all large investors with loans so that they can invest in the offering.

19. Without the participation of financial intermediaries in financial market transactions,
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.

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

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

22. Which of the following is a nondepository financial institution?
a. savings banks
b. commercial banks
c. savings and loan associations
d. mutual funds

23. Which of the following distinguishes credit unions from commercial banks and savings institutions?
a. Credit unions are non-profit
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

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 transactions between two parties.
d. purchases securities for its own account.

25. When a securities firm acts as a(n) ____, it maintains a position in securities.
a. adviser
b. dealer
c. broker
d. none of the above

26. ____ obtain funds by issuing securities, then lend the funds to individuals and small businesses.
a. Finance companies
b. Securities firms
c. Mutual funds
d. Insurance companies

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

28. ____ concentrate on mortgage loans.
a. Finance companies
b. Commercial banks
c. Savings institutions
d. Credit unions

29. ____ securities have a maturity of one year or less; ____ securities are generally more liquid.
a. Money market; capital market
b. Money market; money market
c. Capital market; money market
d. Capital market; capital market

30. Which of the following is not a major investor in stocks?
a. commercial banks
b. insurance companies
c. mutual funds
d. pension funds

31. Which of the following financial intermediaries commonly invests in stocks and bonds?
a. pension funds
b. insurance companies
c. mutual funds
d. all of the above

32. Securities are certificates that represent a claim on the issuer.
a. True
b. False

33. Debt securities are certificates that represent debt (borrowed funds) by the issuer.
a. True
b. False

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

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

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

37. A broker executes securities transactions between two parties and charges a fee reflected in the bid-ask spread.
a. True
b. False

38. The euro increased business between European countries and created a more competitive environment in Europe.
a. True
b. False

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

40. Securities are certificates that represent a claim on the provider of funds.
a. True
b. False

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

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

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

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

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

46. Financial markets facilitating the flow of short-term funds with maturities of less than one year are known as
a. secondary markets.
b. capital markets.
c. primary markets.
d. money markets.
e. none of the above

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 IBM through his 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 the above are secondary market transactions.

48. If investors speculate in the underlying asset rather than 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

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

50. A common use of funds for ____ is investment in stocks 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

51. Long-term debt securities tend to have a ____ expected return and ____ risk than money market securities.
a. lower; lower
b. lower; higher
c. higher; lower
d. higher; higher

52. Common types of capital market securities include Treasury bills and commercial paper.
a. True
b. False

53. Common types of money market securities include negotiable certificates of deposit and Treasury bills.
a. True
b. False

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

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

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.

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.

58. The term ____ involves decisions such as how much funding to obtain, and how to invest the proceeds to expand operations.
a. corporate finance
b. investment management
c. financial markets and institutions
d. none of the above

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
d. none of the above

60. If a security is undervalued, some investors would capitalize from 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

61. The credit crisis in the 2008-2009 period was caused by weak economies in Asia.
a. True
b. False

62. ____ are classified as a depository institution.
a. Credit unions
b. Pension funds
c. Finance companies
d. Securities firms

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. stock.
d. Treasury bonds.

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

65. Treasury bonds have a maturity of one to three years.
a. True
b. False

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

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

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

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

71. When a depository institution offers a loan, it is acting as a creditor.
a. True
b. False

72. Savings institutions represent a nondepository institution.
a. True
b. False

73. Most mutual funds obtain funds by issuing securities, then lend the funds to individuals and small businesses.
a. True
b. False

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

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 provided.
d. They use their information resources to act as a broker, executing securities transactions between two parties.
e. They have more expertise than individual surplus units in evaluating the creditworthiness of deficit units.

76. According to your text, which of the following is not considered a money market security?
a. Treasury bills
b. Treasury notes
c. retail CD
d. banker’s acceptance
e. commercial paper

77. ____ are not considered capital market securities.
a. Repurchase agreements
b. Municipal bonds
c. Corporate bonds
d. Equity securities
e. Mortgages

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 the above

79. Equity securities should normally have a ____ expected return and ____ risk than money market securities.
a. lower; lower
b. lower; higher
c. higher; lower
d. higher; higher

80. If investors speculate in derivative contracts rather than 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

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 the above

82. Which of the following are not considered depository financial institutions?
a. finance companies
b. commercial banks
c. savings institutions
d. credit unions
e. All of the above are depository financial institutions.

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

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.

85. Which of the following is not a typical money market security?
a. Treasury bills
b. Treasury bonds
c. Commercial paper
d. Negotiable certificates of deposit

86. Debt securities issued by a small firm may be ________, meaning that _______ investors want to invest in those securities.
a. a. liquid; many
b. a. liquid; not many
c. a. illiquid; not many
d. a. illiquid; many

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

88. ____________ applies psychology to financial decisions and offers an explanation for why markets are not always efficient.
a. a. Psychological marketing
b. a. Behavioral finance
c. a. Inefficient markets theory
d. a. Financial psychology

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

90. The foreign exchange market facilitates the exchange of:
a. a. information between investors in different countries.
b. a. debt securities.
c. a. equity securities.
d. a. currencies.

91. Which of the following is not an example of the government’s recent increased role in financial markets?
a. a. the Federal Reserve’s purchase of debt securities during the credit crisis
b. a. regulations changing the way that the credit risk of bonds is assessed
c. a. regulations setting maximum rates for Treasury securities
d. a. increased monitoring of stock trading and prosecution of those who trade on inside information

92. Commercial paper represents long-term debt obligations created to finance the purchase of commercial property.
a. True
b. 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. a. systemic risk.
b. a. leverage risk.
c. a. financial meltdown risk.
d. a. credit risk.

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

Chapter 2—Determination of Interest Rates

MULTIPLE CHOICE

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

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 the above

3. Businesses demand loanable funds to
a. finance installment debt.
b. subsidize other companies.
c. invest in fixed and short-term assets.
d. none of the above

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

5. If interest rates are ____, ____ projects will have positive NPVs.
a. higher; more
b. lower; more
c. lower; no
d. none of the above

6. The demand for funds resulting from business investment in short-term assets 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

7. If economic conditions become less favorable, then:
a. expected cash flows on various projects will increase.
b. more proposed projects will have expected returns greater than the hurdle rate.
c. there would be additional acceptable business projects.
d. there would be a decreased demand by business for loanable funds.

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

9. The federal government demand for loanable funds is ____. If the budget deficit was expected to increase, the federal government demand for loanable funds would ____.
a. interest elastic; decrease
b. interest elastic; increase
c. interest inelastic; increase
d. interest inelastic; decrease

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

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 the above

12. The quantity of loanable funds supplied is normally
a. highly interest elastic.
b. more interest elastic than the demand for loanable funds.
c. less interest elastic than the demand for loanable funds.
d. equally interest elastic as the demand for loanable funds.
e. A and B

13. The ____ sector is the largest supplier of loanable funds.
a. household
b. government
c. business
d. none of the above

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 the above

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

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

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 savings by foreign savers
b. an increase in inflation
c. pessimistic economic projections that cause businesses to reduce expansion plans
d. a decrease in savings by U.S. households

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.

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.
d. actual inflation was greater than the nominal interest rate.

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.

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.

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

23. What is the basis of the relationship between the Fisher effect and the loanable funds theory?
a. the saver’s desire to maintain the existing real rate of interest
b. the borrower’s desire to achieve a positive real rate of interest
c. the saver’s desire to achieve a negative real rate of interest
d. B and C

24. Assume that foreign investors who have invested in U.S. securities decide to decrease their holdings of U.S. securities and to instead 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

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

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

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

28. Due to 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

29. Due to expectations of lower 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

30. If the real interest rate is expected by a particular person to become negative, then the purchasing power of his or her 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

31. If economic expansion is expected to increase, then demand for loanable funds should ____ and interest rates should ____.
a. increase; increase
b. increase; decrease
c. decrease; decrease
d. decrease; increase

32. 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

33. If the real interest rate was stable over time, this would suggest that there is ____ relationship between inflation and nominal interest rate movements.
a. a positive
b. an inverse
c. no
d. an uncertain (cannot be determined from information above)

34. If inflation and nominal interest rates move more closely together over time than they did in earlier periods, this would ____ the volatility of the real interest rate movements over time.
a. increase
b. decrease
c. have an effect, which cannot be determined with above information, on
d. have no effect on

35. Canada and the U.S. are major trading partners. If Canada experiences a major increase in economic growth, it 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

36. If investors shift funds from stocks into bank deposits, this ____ the supply of loanable funds, and places ____ pressure on interest rates.
a. increases; upward
b. increases; downward
c. decreases; downward
d. decreases; upward

37. When Japanese interest rates rise, and if 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 the U.S. interest rates will ____.
a. increase; increase
b. increase; decrease
c. decrease; decrease
d. decrease; increase

38. Which of the following will probably not result in an increase in the business demand for loanable funds?
a. an increase in positive net present value (NPV) projects
b. a reduction in interest rates on business loans
c. a recession
d. none of the above

39. 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

40. 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 the above

41. 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. The expectations of a strong dollar should cause a flow of funds to the U.S.
c. An increase in a foreign country’s interest rates will encourage investors in that country to invest their funds in other countries.
d. All of the above are true regarding foreign interest rates.

42. 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 positive net present value (NPV) projects available
d. All of the above are equally likely to affect household demand for loanable funds.

43. Which of the following statements is incorrect?
a. The Fed’s monetary policy is intended to control the economic conditions in the U.S.
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 the statements above are true.

44. 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 the above

45. Which of the following will probably not result in an increase in the business demand for loanable funds?
a. an increase in positive net present value (NPV) projects
b. a reduction in interest rates on business loans
c. a recession
d. All of the above will result in an increase in the business demand for loanable funds.

46. 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 the above

47. The federal government demand for funds is said to be interest inelastic, or ____ to interest rates.
a. sensitive
b. insensitive
c. relatively sensitive as compared to other sectors
d. none of the above

48. 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

49. 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

50. 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
d. none of the above

51. 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

52. 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

53. 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 the above

54. The federal government’s demand for funds is ________, and municipal governments’ demand for funds is somewhat ____________.
a. interest-inelastic; interest-inelastic
b. interest-elastic; interest-elastic
c. interest-inelastic; interest-elastic
d. interest-elastic; interest-inelastic

55. The substantial decline in interest rates during the credit crisis is attributed to which of the following changes in the market for loanable funds?
a. a. an increase in both the supply of and the demand for loanable funds
b. a. a decrease in both the supply of and the demand for loanable funds
c. a. a decrease in the supply of loanable funds and an increase in the demand for loanable funds
d. a. an increase in the supply of loanable funds and a decrease in the demand for loanable funds

56. The crowding-out effect occurs when:
a. a. foreign investors crowd out U.S. investors in the market for loanable funds.
b. a. 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. a. institutional investors crowd out individual investors in the market for loanable funds.
d. a. firms and municipal governments crowd out households in the market for loanable funds.

TRUE/FALSE

57. 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

58. The supply of loanable funds in the U.S. is partly determined by the monetary policy implemented by the Federal Reserve System.
a. True
b. False

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

60. The business demand for funds resulting from short-term investments is inversely related to the number of projects implemented and inversely related to the interest rate.
a. True
b. False

61. 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

62. If foreign interest rates fall, foreign firms and governments would likely reduce their demand for U.S. funds.
a. True
b. False

63. 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

64. In general, suppliers of loanable funds are willing to supply more funds if the interest rate is higher.
a. True
b. False

65. 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

66. The relationship between interest rates and expected inflation is often referred to as the loanable funds theory.
a. True
b. False

67. 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

68. To forecast interest rates using the Fisher effect, the real interest rate for an upcoming period can be forecasted by subtracting the expected inflation rate over that period from the nominal interest rate quoted for that period.
a. True
b. False

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

70. 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

Chapter 3—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 the above

2. 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.

3. Some financial institutions such as commercial banks are required by law to invest only in
a. junk bonds.
b. corporate stock.
c. Treasury securities.
d. investment-grade bonds.

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

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 default risk.
d. is illiquid.

6. Securities that offer ____ liquidity will need to offer a ____ yield.
a. lower; higher
b. lower; lower
c. higher; higher
d. B and C

7. If all other characteristics are similar, ____ would have to offer ____.
a. taxable securities; a higher after-tax yield than tax-exempt securities
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

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 the above

9. An investor’s tax rate is 30 percent. What must the before-tax yield on a security be to have an after-tax yield of 11 percent?
a. 7.7 percent
b. 15.71 percent
c. 130 percent
d. 11.00 percent
e. none of the above

10. A firm in the 35 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. 7.0 percent.
b. 10.8 percent.
c. 20.0 percent.
d. none of the above

11. Holding other factors such as risk constant, the relationship between the maturity and annualized yield of 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 the above

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.
d. between default risk ratings and maturity.

13. Interest income from municipal bonds is exempt from state taxes but is subject to federal taxes.
a. True
b. False

14. 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).

15. 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.

16. 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. A and B
e. none of the above

17. 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

18. The yield offered on a debt security is ____ related to the prevailing risk-free rate and ____ related to the security’s risk premium.
a. negatively; negatively
b. positively; positively
c. negatively; positively
d. positively; negatively

19. The theory for the term structure of interest rates that says the shape of the yield curve is determined solely by 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.

20. Assume investors are indifferent among security maturities. Today, the annualized 2-year interest rate is 12 percent, and the 1-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

21. 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 the above

22. 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

23. The degree to which the Treasury’s debt management policy could affect the term structure of interest rates is greatest if
a. most debt is financed by foreign investors.
b. the Treasury’s debt level is small.
c. maturity markets are segmented.
d. A and B

24. 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
b. less; greater
c. greater; greater
d. less; less
e. C and D

25. 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 the above

26. 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

27. 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. B and C are possible, depending on the size of the liquidity premium

28. 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.

29. 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
d. is an unbiased forecast of (it has an equal chance of overestimating or underestimating)

30. 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

31. 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.

32. 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 price of long-term securities.
b. upward pressure on the price of short-term securities.
c. downward pressure on the yield of long-term securities.
d. A and C

33. 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.

34. According to segmented markets theory, if investors have mostly short-term funds available and borrowers want long-term 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

35. If a yield curve is upward sloping, the investment strategy of buying long-term securities, then selling them after a 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 the above

36. Other things 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 the above are possible, depending on the size of the bond offering.

37. Assume that the Treasury bond yield today is 2% higher than it was one year ago. Also assume that the credit (default) risk premium of an A-rated bond declined by 0.4% 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

38. 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. A and C

39. According to expectations theory, the sudden expectation of lower interest rates in the future will cause a ____ supply of short-term funds provided by investors, and a ____ supply of long-term funds.
a. large; large
b. large; small
c. small; small
d. small; large

40. The yield curve in a foreign country is
a. always downward sloping.
b. non-existent.
c. the same as the United States at any point in time.
d. none of the above

41. 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. A and B

42. If research showed that all investors attempt to purchase securities that perfectly match their time in 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.

43. If the Treasury uses a relatively large proportion of ____ debt to finance the deficit, this may place upward pressure on ____ interest rates, and corporations may reduce their investment in fixed assets.
a. long-term; long-term
b. long-term; short-term
c. short-term; long-term
d. B and C

44. 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.

45. 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.
a. 2.8
b. 115
c. 103
d. 15.1

46. 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 two years ahead is ____ percent.
a. 1.8
b. 9.0
c. 15.0
d. none of the above

47. According to segmented markets theory, if investors have mostly long-term funds available and borrowers want short-term 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

48. An upward-sloping yield curve indicates that Treasury securities with ____ maturities offer ____ annualized yields.
a. longer; lower
b. longer; higher
c. shorter; lower
d. shorter; higher
e. B and C

49. Assume that the Treasury experiences a large decrease in the budget deficit and purchases a large number of T-bills. This action will ____ the supply of T-bills in the market and places ____ pressure on the yield of T-bills.
a. decrease; downward
b. decrease; upward
c. increase; upward
d. increase; downward

50. 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 default 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 T-bill rates are 7 percent. Based on this information, Vaughn should offer ____ percent on its commercial paper.
a. 8.0
b. 7.6
c. 7.5
d. 7.9
e. none of the above

51. If liquidity influences the yield curve, the forward rate underestimates the market’s expectation of the future interest rate.
a. True
b. False

52. The yield curve for corporate bonds.
a. would typically lie below the Treasury yield curve.
b. is identical to the Treasury yield curve.
c. typically has the same slope as the Treasury yield curve.
d. is irrelevant to investors.

53. Some types of debt securities always offer a higher yield than others.
a. True
b. False

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

55. The higher a bond rating, the lower the perceived default risk.
a. True
b. False

56. Treasury securities are exempt from federal and state income taxes.
a. True
b. False

57. 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

58. The graphic comparison of maturities and annualized yields is known as the interest rate curve.
a. True
b. False

59. 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

60. The forward rate is commonly used to represent the market’s forecast of the future interest rate.
a. True
b. False

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

62. The preference for more liquid short-term securities places downward pressure on the slope of the yield curve.
a. True
b. False

63. 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. True
b. False

64. 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

65. 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
b. False

66. Yield curves are always upward sloping.
a. True
b. False

67. 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 the above are true with respect to debt securities.

68. Which of the following is not a characteristic affecting the yields on debt securities?
a. default risk
b. liquidity
c. tax status
d. term to maturity
e. All of the above affect yields on debt securities.

69. 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 the above

70. 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; higher
e. Answers A and D are correct.

71. Assume that the Treasury experiences a large increase in the budget deficit and issues a large number of 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

72. 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 the above.

73. 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

74. According to segmented markets theory, if investors have mostly long-term funds available and borrowers want short-term 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

75. 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

76. If the Treasury uses a relatively large proportion of ____ debt to finance a budget deficit, this would place ____ pressure on long-term yields.
a. short-term; downward
b. long-term; downward
c. short-term; upward
d. long-term; upward

77. Bonds issued at different times by the same corporation may not receive the same rating from a rating agency.
a. True
b. False

78. 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

79. In response to criticism of the ratings they assigned before the credit crisis, credit rating agencies now:
a. a. are paid through fees assessed on the purchasers of bonds.
b. a. are depending more on sensitivity analysis in which they assess how creditworthiness may change in response to abrupt changes in the economy.
c. a. are not allowing the employees who promote an agency to influence the ratings that the agency assigns.
d. a. B and C

80. The Financial Reform Act of 2010 established the __________ within the _________ to regulate credit rating agencies.
a. a. Bureau of Thrift Agency Supervision; Treasury Department
b. a. Office of Credit Ratings; Securities and Exchange Commission
c. a. Federal Ratings Assurance Corporation; Treasury Department
d. a. Ratings Oversight Commission; Federal Reserve

81. The yields of securities commonly move in the same direction over time.
a. True
b. False

82. 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

Chapter 4—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

2. As a result of the Financial Reform Act of 2010, the ____ was assigned the role of regulating financial products and services.
a. Federal Advisory Committee
b. Federal Open Market Committee
c. Consumer Financial Protection Bureau
d. Board of Governors

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

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. A and B

5. The ____ is made up of seven individual members, and each member is appointed by the president of the U.S.
a. Board of Governors
b. Federal Reserve district bank
c. Federal Open Market Committee (FOMC)
d. Securities and Exchange Commission

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
d. A and C

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

8. With regard to monetary policy, which of the following is under direct control of the Federal Reserve’s Board of Governors?
a. revise reserve requirements for depository institutions
b. authorize changes in the amount of borrowing by the Treasury
c. monitor the stock market for insider trading
d. monitor the derivatives market for illegal trading strategies

9. The ____ rate is the interest rate charged on Fed district bank loans to depository institutions.
a. federal funds
b. prime
c. primary credit lending
d. real

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

11. The Policy Directive is provided by Board of Governors to the FOMC.
a. True
b. 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. A and B

13. The purchase of government securities by someone other than the Fed results in
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.

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 the above

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

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 the above

17. ____ open market operations offset the impact of other conditions that affect the level of funds.
a. Active
b. Passive
c. Dynamic
d. Defensive

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

19. The primary credit lending rate changes in accordance with changes in the federal funds rate.
a. True
b. False

20. ____ credit may be used for any purpose and is available only to depository institutions that meet specific requirements for financial soundness.
a. Primary
b. Secondary
c. Tertiary
d. None of the above

21. To decrease money supply, the Fed could ____ the reserve requirement ratio.
a. increase
b. stabilize
c. reduce
d. eliminate

22. The ____ the reserve requirement ratio, the ____ the ultimate effect of any initial increase in money supply.
a. lower; less
b. lower; greater
c. greater; less
d. B and C

23. The ____ is directly responsible for controlling money supply growth.
a. Federal Advisory Council
b. FOMC
c. Board of Governors
d. President of the United States

24. Assume that the reserve requirements ratio is 15%. An initial injection of $150 million could result in a maximum change in the money supply of
a. $150 million.
b. $1 billion.
c. $1 million.
d. $22.5 million.

25. The form of money consisting of currency held by the public and checkable deposits at depository institutions is called
a. M1.
b. M2.
c. M3.
d. MMDA.

26. The Monetary Control Act of 1980 subjected
a. only member banks to the reserve requirements set by the Fed.
b. only S&Ls to the reserve requirements set by the Fed.
c. all depository institutions to the reserve requirements set by the Fed.
d. only national banks to reserve requirements set by the Fed.

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

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.

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

31. The ____ is directly responsible for conducting monetary policy.
a. Federal Advisory Council
b. FOMC
c. Senate
d. President of the United States

32. Based on a 2003 policy, the primary credit lending rate is set
a. lower than the federal funds rate.
b. lower than the prevailing Treasury bill rate.
c. lower than the expected inflation rate.
d. above the federal funds rate.

33. A(n) ____ in Federal Reserve float causes a(n) ____ in bank funds.
a. increase; increase
b. increase; decrease
c. decrease; decrease
d. A and C

34. The ____ consists of seven members, each of whom is appointed by the President of the United States.
a. Federal Open Market Committee (FOMC)
b. Federal Advisory Council
c. Board of Governors
d. none of the above

35. Assume that the reserve requirement ratio is 12 percent and that the Fed uses open market operations by buying $200 million worth of Treasury securities. Assuming that banks use all funds except required reserves to make loans and that the public does not store any cash, the money supply should ____ by about ____.
a. increase; $200 million
b. increase; $1.67 billion
c. decrease; $200 million
d. decrease; $1.67 billion

36. The federal funds rate is the rate at which the Fed lends money directly to member banks.
a. True
b. False

37. When the Fed purchases securities, the total funds of commercial banks ____ by the market value of securities purchased by the Fed. This activity initiated by the FOMC’s policy directive is referred to as a(n) ____ of money supply growth.
a. increase; loosening
b. decrease; tightening
c. decrease; loosening
d. increase; tightening
e. none of the above

38. The Trading Desk is sometimes directed to ____ a sufficient amount of Treasury securities that will ____ the federal funds rate to a new targeted level set by the FOMC.
a. buy; decrease
b. sell; increase
c. buy; increase
d. sell; decrease
e. A and B

39. Which of the following statements is incorrect with respect to a single European monetary policy?
a. It allows for more consistent economic conditions across the countries.
b. It prevents any participating European country from solving local economic problems with its own unique monetary policy.
c. A policy used in a particular period may not affect the participating countries equally, since they all have the same currency.
d. Each participating country will still be able to apply its own fiscal policy (tax and government expenditure decisions).
e. All of the above are true with respect to a single European monetary policy.

40. Since 2003, the Fed’s rate on short-term loans to depository institutions is referred to as the
a. discount rate.
b. primary credit lending rate.
c. Federal funds rate.
d. prime rate

41. ____ credit extended by the Fed to financial institutions may be used for any purpose and is available only to depository institutions that satisfy specific criteria reflecting financial soundness.
a. Primary
b. Secondary
c. Tertiary
d. None of the above

42. Most of the Fed’s income is transferred to the U.S. Department of Justice.
a. True
b. False

43. All commercial banks are required to be members of the Fed.
a. True
b. False

44. Each member of the Board of Governors is appointed by the president of the United States and serves a nonrenewable 14-year term.
a. True
b. 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

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

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

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

49. To increase the money supply, the Fed may increase the reserve requirement ratio.
a. True
b. False

50. Which of the following is not true with respect to the Federal Reserve Act of 1913?
a. It established reserve requirements for member commercial banks.
b. It specified fourteen districts across the United States as well as a city in each district where a Federal Reserve district bank was to be established.
c. Each district focused on its particular district, without much concern for other districts.
d. All of the above are true.

51. ____ is (are) not a component of the Fed as it exists today.
a. The Federal Advisory Council
b. The Board of Governors
c. National banks
d. The U.S. Department of Commerce
e. All of the above are components of the Fed.

52. The advisory committee making recommendations to the Fed about economic and banking related issues is the
a. Consumer Advisory Council.
b. Thrift Institutions Advisory Council.
c. Federal Advisory Council.
d. none of the above

53. The advisory committee offering views on issues related to credit unions is the
a. Consumer Advisory Council.
b. Thrift Institutions Advisory Council.
c. Federal Advisory Council.
d. none of the above

54. If the Fed desires to ____ the money supply using open market operations, it would instruct the trading desk to ____ government securities.
a. increase; purchase
b. increase; sell
c. decrease; purchase
d. Answers B and C are correct.

55. 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

56. To increase the money supply growth, the Fed could
a. sell government securities in the secondary market.
b. increase the primary credit lending rate.
c. increase the reserve requirement ratio.
d. all of the above
e. none of the above

57. When the Fed sells securities, the total funds of commercial banks ____ by the market value of 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 the above

58. ____ includes only 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 the above

59. The ____ consists of seven members, each of whom is appointed by the president of the United States.
a. Federal Open Market Committee (FOMC)
b. Federal Advisory Council
c. Board of Governors
d. none of the above

60. 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

61. 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

62. The Fed’s purchases of long-term Treasury securities in recent years 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 these securities.

63. A criticism of the Fed’s actions during the credit crisis is that it:
a. did not attempt to increase the liquidity of the debt markets.
b. focused too much on financial institutions.
c. allowed Bear Stearns to fail and file for bankruptcy.
d. periodically raised the primary credit rate.

64. 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. prevent depository institutions from obtaining funding through the discount window

Chapter 5—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

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

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.

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

5. A passive monetary policy adjusts money supply automatically in response to economic conditions.
a. True
b. 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

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 GNP and inflation.
d. a positive relationship between GNP and unemployment.

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

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

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

11. ____ serves as the most direct indicator of economic growth in the United States.
a. Gross domestic product (GDP)
b. National income
c. The unemployment rate
d. The industrial production index

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

13. The ____ indicators tend to occur before a business cycle.
a. leading
b. lagging
c. coincident
d. none of the above

14. The ____ indicators tend to occur after a business cycle.
a. leading
b. lagging
c. coincident
d. none of the above

15. The ____ indicators tend to occur before a business cycle.
a. leading
b. lagging
c. coincident
d. none of the above

16. 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.

17. The time between when an economic problem is realized and when the Fed tries to correct it with its policies is the
a. recognition lag.
b. implementation lag.
c. impact lag.
d. open-market lag.

18. The time between when the Fed adjusts the money supply and when interest rates change reflects the
a. recognition lag.
b. implementation lag.
c. impact lag.
d. open-market lag.

19. If the Fed attempts to reduce inflation, it would likely increase money supply growth.
a. True
b. False

20. Which of the following best describes the relationship between the Fed and the Administration?
a. The Fed must receive approval by the Administration before conducting monetary policy.
b. The Fed must implement a monetary policy specifically to the support the Administration’s policy.
c. The Administration must receive approval from the Fed before implementing fiscal policy.
d. A and C
e. none of the above

21. 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

22. The Fed is usually more willing to monetize the debt when inflation is relatively high.
a. True
b. False

23. International flows of funds can affect the Fed’s monetary policy. For example, if there is downward pressure on U.S. interest rates that can be offset by foreign ____ of funds, the Fed may not feel compelled to use a ____ monetary policy.
a. inflows; loose
b. inflows; tight
c. outflows; loose
d. outflows; tight
e. none of the above

24. 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. monetizes the debt.
b. maintains a stable money supply.
c. uses a tight-money policy.
d. uses a loose-money policy.

25. The ____ lag represents the time from when an economic problem exists until it is recognized.
a. recognition
b. adjustment
c. implementation
d. none of the above

26. A ____ dollar tends to exert inflationary pressure in the U.S.
a. stable
b. strong
c. weak
d. both A and B

27. According to the theory of rational expectations, ____ inflationary expectations encourage businesses and households to ____ their demand for loanable funds in order to borrow and make planned expenditures increase.
a. higher; reduce
b. higher; increase
c. lower; reduce
d. lower; increase

28. Historical evidence has shown that, when the Fed significantly increases money supply, U.S. inflation tends to ____ shortly thereafter which in turn places ____ pressure on U.S. interest rates.
a. increase; upward
b. increase; downward
c. decrease; downward
d. decrease; upward

29. If the Fed uses a passive monetary policy during weak economic conditions,
a. it increases money supply substantially.
b. it reduces money supply substantially.
c. it allows the economy to fix itself.
d. it focuses on monetizing the debt.

30. Which of the following is true?
a. Federal deficits require that the Fed purchase government securities.
b. Federal deficits will always result in an increase in money supply.
c. The Federal Reserve monetizes debt by selling securities which ultimately increases money supply.
d. An agreement between the Fed and the Treasury exists whereby the Fed is directly responsible for monetizing the debt whenever the deficit increases.
e. None of the above.

31. 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.

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

33. 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.

34. Global crowding out is described in the text to mean the impact of
a. excessive U.S. population growth on interest rates.
b. excessive global population growth on interest rates.
c. an excessive budget deficit in one country on interest rates of another country.
d. an excessive budget deficit in one country on exchange rates.

35. If the federal government is willing to pay whatever is necessary to borrow loanable funds, but the private sector is not, this reflects
a. the crowding-out effect.
b. dynamic open market operations.
c. defensive open market operations.
d. monetizing the debt.

36. When the Fed uses open market operations by purchasing Treasury securities from various financial institutions in the U.S., 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.
c. no shift in the supply schedule of loanable funds.
d. an inward shift in the demand schedule for loanable funds.

37. When the Fed uses open market operations by selling some of its Treasury securities to investors in the U.S., 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.
c. no shift in the supply schedule of loanable funds.
d. an outward shift in the demand schedule for loanable funds.

38. 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 complete focus on inflation could result in a much higher unemployment level.
c. The Fed’s complete focus on inflation could result in much higher interest rates, which would discourage economic growth.
d. All of the above are disadvantages of inflation targeting.

39. Financial institutions such as commercial banks, bond mutual funds, insurance companies, and pension funds maintain large portfolios of bonds, so their portfolio is ____ affected when the Fed ____ interest rates.
a. unfavorably; decreases
b. unfavorably; increases
c. favorably; increases
d. Answer A and C are correct.

40. 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

41. A passive monetary policy adjusts money supply automatically in response to economic conditions.
a. True
b. False

42. 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

43. If the Fed attempts to reduce inflation, it would likely increase money supply growth.
a. True
b. False

44. The relationship between the interest rate on loanable funds and the level of business investment is positive.
a. True
b. False

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

46. To correct excessive inflation, the Fed could use open market operations by buying Treasury securities in the secondary market.
a. True
b. False

47. One of the disadvantages of inflation targeting is that the Fed could lose credibility is the U.S. inflation rate deviates substantially from the Fed’s target inflation rate.
a. True
b. False

48. Economists who work at the Fed recognize that a stimulative monetary policy will not always cure a high unemployment rate and could even ignite inflation.
a. True
b. False

49. 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

50. The Fed needs the approval of the presidential administration to make decisions.
a. True
b. False

51. The Fed is more likely to use a stimulative policy during a strong-dollar period.
a. True
b. False

52. A purchase of Treasury securities by the Fed leads to a(n) ____ in interest rates and a(n) ____ in the level of business investment.
a. increase; decrease
b. decrease; decrease
c. increase; increase
d. decrease; increase

53. Which of the following is probably not a goal the Fed is trying to achieve consistently?
a. low inflation
b. high interest rates
c. steady GNP growth
d. low unemployment

54. The ____ is not an indicator of economic growth.
a. producer price index
b. gross domestic product
c. national income
d. unemployment rate
e. All of the above are indicators of economic growth.

55. Which of the following is not true with respect to inflation targeting?
a. The Fed could lose credibility is the inflation rate deviates substantially from the Fed’s target inflation rate.
b. A complete focus on inflation could result in a much higher unemployment rate.
c. Inflation targeting may not only satisfy the inflation goal, but could also achieve the employment stabilization goal in the long run.
d. If unemployment is slightly higher than normal, while inflation is at the peak of the target range, and inflation targeting approach would like advocate a loose monetary policy.

56. 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 the above

57. A weak dollar would 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 the above

58. 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. 1-year certificate of deposit rate.

59. When the Fed purchases Treasury securities, the account balances of the investors who sell their securities to the Fed _________, and there are _________ in the account balances of other financial institutions.
a. increase; offsetting decreases
b. increase; no offsetting decreases
c. decrease; offsetting increases
d. decrease; no offsetting increases

60. 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.

61. 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

62. In the “operation twist” strategy used in 2011 and 2012, the Fed sold _______ Treasury securities and used the proceeds to purchase ________ Treasury securities.
a. long-term; short-term
b. short-term; long-term
c. short-term; long-term
d. long-term; short-term

63. The intent of the Fed’s operation twist strategy in 2011 and 2012 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 long-term interest rates.

64. 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 encourage individuals to increase their savings.

65. In 2012, the Fed stated that it would continue to purchase Treasury bonds in the financial markets until GDP growth increased to a target level.
a. True
b. False

66. Which of the following was not true of the eurozone during the Greek crisis?
a. Fear of a financial crisis throughout Europe discouraged investors and firms from moving funds into Europe.
b. By using a more stimulative monetary policy than it desired, the European Central Bank aroused concerns about potential inflation in the eurozone.
c. There was concern that the austerity conditions could weaken the country’s economy further.
d. Greece, Spain, and Portugal focused their efforts on reducing tax rates in order to stimulate their economies.

Chapter 6—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 the above

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

3. ____ are sold at an auction at a discount from par value.
a. Treasury bills
b. Repurchase agreements
c. Banker’s acceptances
d. Commercial paper

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. 2.78 percent
c. 10.55 percent
d. 2.80 percent
e. none of the above

5. If an investor buys a T-bill with a 90-day maturity and $50,000 par value for $48,500 and holds it to maturity, what is the annualized yield?
a. about 13.4 percent
b. about 12.5 percent
c. about 11.3 percent
d. about 11.6 percent
e. about 10.7 percent

6. An investor buys a T-bill with 180 days to maturity and $250,000 par value for $242,000. He plans to sell it after 60 days, and forecasts a selling price of $247,000 at that time. What is the annualized yield based on this expectation?
a. about 10.1 percent
b. about 12.6 percent
c. about 11.4 percent
d. about 13.5 percent
e. about 14.3 percent

7. 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 the above

8. 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
e. 11.00 percent

9. 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

10. 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. A and B both occur with about equal frequency

11. T-bills and commercial paper are sold
a. with a stated coupon rate.
b. at a discount from par value.
c. at a premium about par value.
d. A and C
e. none of the above

12. ____ is a short-term debt instrument issued only be well-known, creditworthy firms and is normally issued to provide liquidity or finance a firm’s investment in inventory and accounts receivable.
a. A banker’s acceptance
b. A repurchase agreement
c. Commercial paper
d. A Treasury bill

13. Commercial paper has a maximum maturity of ____ days.
a. 45
b. 270
c. 360
d. none of the above

14. 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

15. 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?
a. 12.12 percent
b. 11.11 percent
c. 13.00 percent
d. 14.08 percent
e. 15.25 percent

16. When firms sell commercial paper at a ____ price than they projected, their cost of raising funds is ____ than projected.
a. higher; higher
b. lower; lower
c. A and B
d. none of the above

17. Which of the following is not a money market instrument?
a. banker’s acceptance
b. commercial paper
c. negotiable CDs
d. repurchase agreements
e. all of the above are money market instruments

18. 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

19. 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. B and D

20. 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.

21. Which of the following instruments has a highly active secondary market?
a. banker’s acceptances
b. commercial paper
c. federal funds
d. repurchase agreements

22. 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.
d. They all make periodic coupon (interest) payments.
e. A and B

23. An investor purchased an NCD a year ago in the secondary market for $980,000. He redeems it today and receives $1,000,000. He 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.

24. 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 the above

25. 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

26. ____ are the most active participants in the federal funds market.
a. Savings and loan associations
b. Securities firms
c. Credit unions
d. Commercial banks

27. Eurodollar deposits
a. are U.S. dollars deposited in the U.S. by European investors.
b. are subject to interest rate ceilings.
c. have a relatively large spread between deposit and loan rates (compared to the spread between deposits and loans in the United States).
d. are not subject to reserve requirements.

28. Which money market transaction is most likely to represent a loan from one commercial bank to another?
a. banker’s acceptance
b. negotiable CD
c. federal funds
d. commercial paper

29. 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.

30. 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.

31. 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. greater than; recessionary
b. greater than; boom economy
c. less than; boom economy
d. less than; recessionary

32. 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. greater than; recessionary
b. greater than; boom economy
c. less than; boom economy
d. less than; recessionary

33. Which of the following is sometimes issued in the primary market by nonfinancial firms to borrow funds?
a. NCDs
b. retail CDs
c. commercial paper
d. federal funds

34. The so-called “flight to quality” causes the risk differential between risky and risk-free securities to be
a. eliminated.
b. reduced.
c. increased.
d. unchanged (there is no effect).

35. 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

36. 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

37. Treasury bills are sold through ____ when initially issued.
a. insurance companies
b. commercial paper dealers
c. auction
d. finance companies

38. 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 the above

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

40. 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.

41. 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. 6.02
b. 1.54
c. 1.50
d. 6.20
e. none of the above

42. 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 the above

43. 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 the above

44. An aggregate purchase by investors of low-yield instruments in favor of high-yield instruments places ____ pressure on the yields of low-yield securities and ____ on the yields of high-yield securities.
a. upward; upward
b. downward; downward
c. upward; downward
d. downward; upward

45. 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 not influenced by the supply and demand for funds in the federal funds market.
c. The federal funds rate is closely monitored by all types of firms.
d. Many market participants view changes in the federal funds rate to be an indicator of potential changes in other money market rates.
e. The Federal Reserve adjusts the amount of funds in depository institutions in order to influence the federal funds rate.

46. Buser Corp. purchases certain securities for $4,921,349, with an agreement to sell them back at a price of $4,950,000 at the end of a 30-day period. The repo rate is ____ percent.
a. 7.08
b. 6.95
c. 6.99
d. 7.04
e. none of the above

47. Commercial paper is subject to:
a. interest rate risk.
b. default risk.
c. A and B.
d. none of the above.

48. 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 placed ____ pressure on the yields of money market securities.
a. weak; downward
b. weak; upward
c. strong; upward
d. none of the above

49. In general the money markets are widely perceived to be efficient in the sense that the prices reflect all available public information.
a. True
b. False

50. Money market securities are must have a maturity of three months or less.
a. True
b. False

51. 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

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

53. The interest rate charged for a short-term loan from a bank to a corporation is referred to as the London interbank offer rate (LIBOR).
a. True
b. False

54. 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

55. 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

56. 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

57. T-bills do not offer coupon payments but are sold at a discount from par value.
a. True
b. False

58. Junk commercial paper is commercial paper that is not rated or rated low.
a. True
b. False

59. A line of credit provided by a commercial bank allows 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

60. T-bills must offer a premium above the negotiable certificate of deposit (NCD) to compensate for less liquidity and safety.
a. True
b. False

61. Most repo transactions use government securities.
a. True
b. False

62. Exporters can hold a banker’s acceptance until the date at which payment is to be made, yet they frequently sell the acceptance before then at a discount to obtain cash immediately.
a. True
b. False

63. Money market security values are less sensitive to interest rate movements than bonds.
a. True
b. False

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

65. The price O 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. weighted average price paid by all competitive bidders whose bids were accepted.
d. equally weighted average price paid by all competitive bidders whose bids were accepted.
e. none of the above

66. Bill Yates, a private investor, purchases a six-month (182-day) T-bill with a $10,000 par value for $9,700. If Bill holds the Treasury bill to maturity, his annualized yield is ____ percent.
a. 6.02
b. 1.54
c. 1.50
d. 6.20
e. none of the above

67. You purchase 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 the above

68. A ____ is not a money market security.
a. Treasury bill
b. negotiable certificate of deposit
c. bond
d. banker’s acceptance
e. All of the above are money market securities.

69. 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 the above

70. When a firm sells its commercial paper at a ____ price than projected, their cost of raising funds will be ____ than what they initially anticipated.
a. higher; higher
b. lower; lower
c. higher; lower
d. lower; higher
e. Answers C and D are correct.

71. 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 the above are equally likely to be used in a repo transaction.

72. A major drawback to investing in Treasury bills is that they cannot easily be liquidated.
a. True
b. False

73. At each T-bill auction, the prices paid for three-month T-bills are significantly lower than the prices paid for six-month bills.
a. True
b. False

74. 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.

75. 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.

76. 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.

77. Credit guarantees for commercial paper:
a. ensures 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. A and C

78. 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.

Chapter 7—Bond Markets

1. ____ require the owner to clip coupons attached to the bonds and send them to the issuer to receive coupon payments.
a. Bearer
b. Registered
c. Treasury
d. Corporate

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

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

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

5. The Treasury has relied heavily on ____-year bonds to finance the U.S. budget deficit.
a. 50
b. 70
c. 10
d. 5

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.

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

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.

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

11. A ten-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

12. Bonds issued by ____ are backed by the federal government.
a. the Treasury
b. AAA-rated corporations
c. state governments
d. city governments

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
d. typically zero-coupon bonds; typically zero-coupon bonds

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 the above

15. Which of the following statements is not true regarding zero-coupon bonds?
a. They are issued at a deep discount from par value.
b. Investors are taxed on the total amount of interest earned at maturity.
c. The issuing firm is permitted to deduct the amortized discount as interest expense for federal income tax purposes, even though it does not pay interest until maturity.
d. Zero-coupon bonds are purchased mainly for tax-exempt investment accounts, such as pension funds and individual retirement accounts.
e. All of the above are true.

16. 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 the above.

17. 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 the above

18. A private bond placement has to be registered with the SEC.
a. True
b. False

19. Which of the following institutions is most likely to purchase a private bond placement?
a. commercial bank
b. mutual fund
c. insurance company
d. savings institution

20. A protective covenant may
a. specify all the rights and obligations of the issuing firm and the bondholders.
b. require the firm to retire a certain amount of the bond issue each year.
c. restrict the amount of additional debt the firm can issue.
d. none of the above

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

22. When would a firm most likely call bonds?
a. after interest rates have declined
b. if interest rates do not change
c. after interest rates increase
d. just before the time at which interest rates are expected to decline

23. Assume U.S. interest rates are significantly higher than German rates. A U.S. firm with a German subsidiary could achieve a lower financing rate, without exchange rate risk by denominating the bonds in
a. dollars.
b. euros and making payments from U.S. headquarters.
c. euros and making payments from its German subsidiary.
d. dollars and making payments from its German subsidiary.

24. 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

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

26. Bonds that are secured by personal property are called
a. chattel mortgage bonds.
b. first mortgage bonds.
c. second mortgage bonds.
d. debentures.

27. 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.

28. Assume that you purchased corporate bonds one year ago 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

29. During weak economic periods, newly issued junk bonds require lower risk premiums than in strong economic periods.
a. True
b. False

30. ____ bonds have the most active secondary market.
a. Treasury
b. Zero-coupon corporate
c. Junk
d. Municipal

31. Some bonds are “stripped,” which means that
a. they have defaulted.
b. the call provision has been eliminated.
c. they are transferred into principal-only and interest-only securities.
d. their maturities have been reduced.

32. ____ are not primary purchasers of bonds.
a. Insurance companies
b. Finance companies
c. Mutual funds
d. Pension funds

33. Leveraged buyouts are commonly financed by the issuance of:
a. money market securities.
b. Treasury bonds.
c. corporate bonds.
d. municipal bonds.

34. 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

35. 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 the above are true regarding STRIPS

36. (Financial calculator required.) Lisa can purchase bonds with 15 years until maturity, a par value of $1,000, and a 9 percent annualized coupon rate for $1,100. Lisa’s yield to maturity is ____ percent.
a. 9.33
b. 7.84
c. 9.00
d. none of the above

37. (Financial calculator required.) Erin is, a private investor, who 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 the above

38. Devin is, 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

39. 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 the interest will not be received until maturity.
c. The issuing firm is permitted to deduct the amortized discount as interest expense for federal income tax purposes, even though it does not pay interest.
d. Zero-coupon bonds are purchased mainly for tax-exempt investment account, such as pension funds and individual retirement accounts.
e. all of the above are true

40. 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.

41. 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 the above

42. Which of the following would not be a likely example of a protective covenant provision?
a. a limit on the amount of dividends a firm can pay
b. a limit on the corporate officers’ salaries a firm can pay
c. the amount of additional debt a firm can issue
d. a call feature

43. Bonds are issued in the primary market through a telecommunications network.
a. True
b. False

44. Corporate bonds can be placed with investors through a public offering or a private placement.
a. True
b. False

45. 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

46. Rule 144A, which allows small individual investors to trade privately-placed bonds (and some other securities) with each other without requiring that the firms that issued the securities to register them with the SEC.
a. True
b. False

47. Rule 144A creates liquidity for securities that are privately placed.
a. True
b. False

48. Corporate bonds are more standardized than stocks.
a. True
b. False

49. Structured notes are issued by firms to borrow funds, and the repayment of interest and principal is based on specified market conditions.
a. True
b. False

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

51. The bond market is served by bond dealers, who can play a broker role by matching up buyers and sellers.
a. True
b. False

52. Bond dealers do not have an inventory of bonds.
a. True
b. False

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

54. Many bonds are listed on the New York Stock Exchange (NYSE).
a. True
b. False

55. 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

56. 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

57. Treasury bonds are issued by state and local governments.
a. True
b. False

58. 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

59. 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.
a. True
b. False

60. Savings bonds are bonds issued by the Federal Reserve.
a. True
b. False

61. Corporate bonds usually pay interest on an annual basis.
a. True
b. False

62. The bond debenture is a legal document specifying the rights and obligations of both the issuing firm and the bondholders.
a. True
b. False

63. 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

64. Subordinated indentures are debentures that have claims against the firm’s assets that are junior to the claims of both mortgage bonds and regular debentures.
a. True
b. False

65. High-risk bonds are called trash bonds.
a. True
b. False

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

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

68. 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 the above are true regarding STRIPS.

69. (Financial calculator required.) Paul can purchase bonds with 15 years remaining until maturity, a par value of $1,000, and a 9 percent annual coupon rate for $1,100. Paul’s yield to maturity is ____ percent.
a. 9.33
b. 7.84
c. 9.00
d. none of the above

70. (Financial calculator required.) Steven, 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. Steven’s yield to maturity is ____ percent.
a. 9.96
b. 10.00
c. 10.33
d. 10.24
e. none of the above

71. Jim purchases $1,000 par value bonds with a 12 percent coupon rate and a 9 percent yield to maturity. Jim will hold the bonds until maturity. Thus, he will earn a return of ____ percent.
a. 12.00
b. 9.00
c. 10.50
d. More information is needed to answer this question.

72. Which of the following is not an example of a municipal bond?
a. general obligation bond
b. revenue bond
c. Treasury bond
d. All of the above are examples of municipal bonds.

73. Which of the following statements is incorrect?
a. The municipal bond must pay a risk premium to compensate for the possibility of default risk.
b. The 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 the above are true.

74. Which of the following is not mentioned in your text as a protective covenant?
a. a limit on the amount of dividends a firm can pay
b. a limit on the corporate officers’ salaries a firm can pay
c. the amount of additional debt a firm can issue
d. the appointment of a trustee in all bond indentures
e. All of the above are mentioned in the text as protective covenants.

75. Everything else being equal, which of the following bond ratings is associated with the highest yield?
a. Baa
b. A
c. Aa
d. Aaa

76. A ____ has first claim on specified 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 the above

77. 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 the above

78. 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

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

80. 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

81. 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

82. Which of the following eurozone countries has not recently experienced debt repayment problems?
a. Finland
b. Greece
c. Portugal
d. Spain

83. 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

84. 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.

85. All of the bonds issued by a particular company will have the same maturity, price, and credit rating.
a. True
b. False

86. When purchasing bonds, individual investors can use a ________ to specify the maximum price they are willing to pay for a bond.
a. limit order
b. market order
c. stop order
d. price order

87. Online bond brokerage services offer several advantages including:
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 the above

Chapter 8—Bond Valuation and Risk

1. The appropriate discount rate for valuing any bond is the
a. 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.

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 the above

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. $9712
d. $927.66
e. none of the above

4. A bond with a ten percent coupon rate bond pays interest semi-annually. Par value is $1,000. The bond has three years to maturity. The investors’ required rate of return is 12 percent. What is the present value of the bond?
a. $1,021
b. $1,000
c. $981
d. $951
e. none of the above

5. 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. 763
c. 761
d. 1,299

6. 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

7. The value of ____-risk securities will be relatively ____.
a. high; high
b. high; low
c. low; low
d. none of the above

8. The larger the investor’s ____ relative to the ____, the larger the ____ of a bond with a particular par value.
a. discount rate; required rate of return; discount
b. required rate of return; discount rate; discount
c. required rate of return; discount rate; premium
d. none of the above

9. 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.

10. 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. B and C

11. For a given par value of a bond, 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.

12. 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. none of the above

13. 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. B and C
e. none of the above

14. As interest rates increase, long-term bond prices
a. increase by a greater degree than short-term bond prices.
b. increase by an equal degree as short-term bond prices.
c. decrease by a greater degree than short-term bond prices.
d. decrease by an equal degree as short-term bond prices.
e. decrease by a smaller degree than short-term bond prices.

15. The prices of bonds with ____ are most sensitive to interest rate movements.
a. high coupon payments
b. zero coupon payments
c. small coupon payments
d. none of the above (The size of the coupon payment does not affect sensitivity of bond prices to interest rate movements.)

16. 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 the above

17. Other things held constant, bond prices should increase when inflationary expectations rise.
a. True
b. False

18. An expected ____ in economic growth places ____ pressure on bond prices.
a. increase; downward
b. increase; upward
c. decrease; downward
d. none of the above

19. 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 the above

20. 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

21. The prices of ____-coupon and ____ maturities are most sensitive to changes in the required rate of return.
a. low; short
b. low; long
c. high; short
d. high; long

22. An insurance company purchases corporate bonds in the secondary market with six years to maturity. Total par value is $55 million. The coupon rate is 11 percent, with annual interest payments. If the expected required rate of return in 4 years is 9 percent, what will the market value of the bonds be then?
a. $52,115,093
b. $55,341,216
c. $55,000,000
d. $56,935,022

23. A $1,000 par bond with five years to maturity is currently priced at $892. Annual interest payments are $90. What is the yield to maturity?
a. 13 percent
b. 12 percent
c. 11 percent
d. 10 percent

24. A bank buys bonds with a par value of $25 million for $24,040,000. The coupon rate is 10 percent, and the bonds pay 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

25. The price of short-term bonds are commonly ____ those of long-term bonds.
a. more volatile than
b. equally volatile as
c. less volatile than
d. A and C occur with about equal frequency

26. Assume that the value of liabilities equals that of earning assets. If asset portfolio durations are ____ than liability portfolio durations, then the market value of assets are ____ interest-rate sensitive than the market value of liabilities.
a. greater; more
b. greater; equally
c. greater; less
d. less; equally
e. B and D

27. As 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 default risk.)
a. consistently increase
b. consistently decrease
c. remain unchanged
d. change in a direction that cannot be determined with the above information

28. As 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 default risk.)
a. consistently increase
b. consistently decrease
c. remain unchanged
d. change in a direction that cannot be determined with the above information

29. 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
d. decrease; increase

30. If analysts expect that the demand for loanable funds will decrease, and the supply of loanable funds will increase, they would most likely expect interest rates to ____ and prices of existing bonds to ____.
a. increase; increase
b. increase; decrease
c. decrease; decrease
d. decrease; increase

31. 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 bonds will be ____ its par value.
a. above; above
b. above; below
c. below; below
d. below; above

32. Consider a coupon bond that sold at par value two years ago. If interest rates are much higher 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 bonds will be ____ its par value.
a. above; above
b. above; below
c. below; below
d. below; above

33. 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

34. If bond portfolio managers expect interest rates to decrease 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

35. 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

36. If the United States announces that it will borrow an additional $10 billion, this announcement will normally cause the bond traders to expect
a. higher interest rates in the future, and will buy bonds now.
b. higher interest rates in the future, and will sell bonds now.
c. stable interest rates in the future, and will buy bonds now.
d. lower interest rates in the future, and will buy bonds now.
e. lower interest rates in the future, and will sell bonds now.

37. 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

38. 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.

39. When two securities have the same expected cash flows, the value of the ____ security will be higher than the value of the ____ security.
a. high-risk; low-risk
b. low-risk; high-risk
c. high-risk; high-risk
d. low-risk; low-risk
e. none of the above

40. 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 the above

41. 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 the above

42. 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 Bullock intends to sell the bonds in two years and expects investors’ required rate of return at that time 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 the above

43. 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. 1.92 years.
d. none of the above

44. 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. 1.71 years.
c. 1.90 years.
d. none of the above

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

46. 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

47. 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 the above

48. 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
b. laddered
c. barbell
d. interest rate
e. none of the above

49. 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

50. 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

51. If the Treasury issues an unusually large amount of bonds in the primary market, it places ____ on bond prices, and ____ on yields to be earned by investors that purchase bonds and plan to hold them to maturity.
a. downward pressure; downward pressure
b. downward pressure; upward pressure
c. upward pressure; upward pressure
d. upward pressure; downward pressure

52. 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

53. The market price of a bond is partly determined by the timing of the payments made to bondholders.
a. True
b. False

54. The appropriate price of a bond is simply the sum of the cash flows to be received.
a. True
b. False

55. The valuation of bonds is generally perceived to be more difficult than the valuation of equity securities.
a. True
b. False

56. Bonds that sell below their par value are called premium bonds.
a. True
b. False

57. A zero-coupon bond makes no coupon payments.
a. True
b. False

58. 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

59. 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

60. 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

61. 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

62. 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.
a. True
b. False

63. Any announcement that signals stronger than expected economic growth tends to increase bond prices.
a. True
b. False

64. 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

65. As interest rates increase, prices of short-term bonds will decline by a greater degree than prices on long-term bonds.
a. True
b. False

66. Duration is a measure of bond price sensitivity.
a. True
b. False

67. 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

68. International diversification of bonds reduces the sensitivity of a bond portfolio to any single country’s interest rate movements.
a. True
b. False

69. 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

70. Which of the following formulas best describes the value of a bond?
a.
b.
c.
d.
e. none of the above

71. Stephanie 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 ten years remaining until maturity. If the prevailing annualized yield on other bonds with similar characteristics is 6 percent, how much will Stephanie pay for the bond?
a. $1,000.00
b. $1,147.20
c. $856.80
d. none of the above

72. Julia just purchased a $1,000 par value bond with a 10 percent annual coupon rate and a life of twenty 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 the above

73. 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. The annual discount rate should be divided by 2.
c. The number of annual periods should be doubled.
d. The par value should be split in half.
e. All of the above adjustments have to be made.

74. 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 the above.

75. 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; upward; upward
e. increase; downward; upward

76. An economic announcement signaling ____ economic growth in the future will probably cause bond prices to ____.
a. weak; decrease
b. strong; increase
c. weak; increase
d. strong; decrease
e. Answers C and D are correct.

77. 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 the above.

78. 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.

79. 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 ____ years.
a. 1.92
b. 1.50
c. 1.90
d. none of the above

80. 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 the above

81. 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.
a. underestimate; underestimate
b. overestimate; overestimate
c. underestimate; overestimate
d. overestimate; underestimate

82. In the ____ strategy, funds are allocated to bonds with a short term to maturity and bonds with a long term to maturity.
a. matching
b. laddered
c. barbell
d. interest rate
e. none of the above

83. 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 the above

84. 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 the above are factors affecting the market price of a foreign bond.

85. 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

86. 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

87. The credit risk premium tends to be larger for bonds that have longer terms to maturity.
a. True
b. False

88. The ____________ was recently 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

89. When the European Central Bank provides credit to a country that is experiencing debt repayment problems, the ECB commonly:
a. allows the country’s government to conduct its own monetary policy.
b. recommends that the country withdraw from the eurozone.
c. urges the country’s government to increase spending and lower taxes to stimulate the economy.
d. imposes austerity conditions to enable the government to reduce its budget deficit.

90. Although the European debt crisis has had substantial effects on European financial markets, the crisis has been contained and has not affected markets and financial institutions outside Europe.
a. True
b. False

Chapter 9—Mortgage Markets

1. Mortgage-backed securities are commonly contained within collateralized debt obligations.
a. True
b. False

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 the above

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 the above are very common

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

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.

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.

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.

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.

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

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

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

12. Use an amortization schedule. A 15-year $100,000 mortgage has a fixed mortgage rate of 9 percent. In the first month, the total mortgage payment is $____, and $____ of this amount represents payment of interest.
a. 1,014; 264
b. 1,241; 750
c. 1,014; 750
d. none of the above

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.
b. balloon payment mortgage.
c. variable-rate mortgage.
d. open-ended mortgage bond.

14. In an amortization schedule of monthly mortgage payments
a. the amount of interest in each payment is equal to the principal paid.
b. interest payments exceed principal payments early on.
c. principal payments exceed interest payments early on.
d. B and C both occur with about equal frequency

15. 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.

16. The interest rate on a second mortgage is ____ 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

17. 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

18. 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

19. Mortgage companies, commercial banks and savings institutions are the primary originators of mortgages.
a. True
b. False

20. ____ was created in 1968 as a corporation that is wholly owned by the federal government. It guarantees payment on mortgages that meet specific criteria.
a. Freddie Mac
b. Ginnie Mae
c. Fannie Mae
d. None of the above

21. “Securitization” refers to the private insurance of conventional mortgages.
a. True
b. False

22. A financial institution may service a mortgage even after selling it.
a. True
b. False

23. The difference between the 30-year mortgages 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.

24. Mortgage prices would normally be expected to ____ when the interest rates ____, holding other factors constant.
a. increase; increase
b. decrease; decrease
c. increase; decrease
d. none of the above

25. Collateralized mortgage obligations (CMOs) are generally perceived to have
a. no prepayment risk but some default risk.
b. no prepayment risk and no default risk.
c. the same interest rate risk as money market securities.
d. a high degree of prepayment risk.

26. Mortgage prices are subject to
a. interest rate risk.
b. credit risk.
c. prepayment risk.
d. all of the above.

27. During a weak economy, the credit risk to a financial institution from investing in mortgage-backed securities representing subprime mortgages is ____ than that of mortgage-backed securities representing prime mortgages.
a. equal to
b. slightly less than
c. more than
d. substantially less than

28. ____ are backed by conventional mortgages.
a. Ginnie Mae mortgage-backed securities
b. Federal Reserve mortgage-backed securities
c. Private-label pass-through securities
d. Shared appreciation pass-through securities

29. Which of the following is not a guarantor of federally insured mortgages?
a. the Federal Housing Administration (FHA)
b. the Veteran’s Administration (VA)
c. the Federal Deposit Insurance Corporation (FDIC)
d. all of the above are guarantors of federally insured mortgages

30. ____ economic growth will probably ____ the risk premium on mortgages and ____ the price of mortgages.
a. Strong; increase; decrease
b. Strong; increase; increase
c. Weak; decrease; increase
d. Weak; increase; increase
e. Weak; decrease; decrease

31. A ____ mortgage allows borrowers to initially make small payments on the mortgage, which are then increased on a graduated basis over the first five to ten years; payments then level off from there on.
a. balloon-payment
b. graduated-payment
c. shared-appreciation
d. growing-equity
e. none of the above

32. The adjustable-rate mortgage creates uncertainty for the ____ profit margin, but reduces the uncertainty for the ____.
a. originator’s; borrower
b. borrower’s; originator
c. government’s; originator
d. none of the above

33. When financial institutions originate residential mortgages, the mortgage contract should not specify
a. whether the mortgage is federally insured.
b. the amount of the loan.
c. whether the interest rate is fixed or adjustable.
d. the maturity.
e. the mortgage contract should specify all of the above

34. Which of the following is not a common type of mortgage-backed security according to your text?
a. participation certificates (PCs)
b. collateralized mortgage obligations (CMOs)
c. balloon-payment mortgage certificates
d. private-label pass-through securities
e. all of the above are common types of mortgage pass-through securities

35. ____ 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

36. Mortgage-backed securities are assigned ratings by:
a. rating agencies.
b. the Treasury.
c. the Fed.
d. the mortgage originator.

37. In a collateralized mortgage obligation (CMO), mortgages are segmented into ____ (or classes).
a. balloon payments
b. caps
c. tranches
d. strips

38. The credit crisis is mostly attributed to the use of:
a. strict criteria applied by mortgage originators.
b. liberal criteria applied by mortgage originators.
c. very tough credit ratings applied to mortgages.
d. fixed-rate mortgages with long terms to maturity.

39. 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 mortgages.
c. invested only in prime mortgages that offered very low returns.
d. invested heavily in subprime mortgages.

40. ____ mortgages enabled 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

41. The secondary mortgage market that accommodates originators of mortgages who desire to sell their mortgages before maturity.
a. True
b. False

42. 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

43. Some adjustable-rate mortgages (ARMs) contain an option clause that allows mortgage holders to switch to a fixed-rate mortgage within a specified period.
a. True
b. False

44. Mortgage lenders normally charge a higher initial interest rate on adjustable-rate mortgages than on fixed-rate mortgages.
a. True
b. False

45. A balloon-payment mortgage requires 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

46. During the early years of a mortgage, most of the monthly payment reflects principal.
a. True
b. False

47. Mortgages are rarely sold in the secondary market.
a. True
b. False

48. 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 mortgage prices to decrease.
a. True
b. False

49. Strong economic growth tends to reduce the probability that the issuer of a mortgage will default on its debt payments and therefore tends to decrease mortgage prices.
a. True
b. False

50. The higher the level of equity invested by the borrower, the higher the probability that the loan will default.
a. True
b. False

51. Borrowers who have a lower level of income relative to the periodic loan payments are more likely to default on their mortgages.
a. True
b. False

52. Non-U.S. financial institutions never hold mortgages on U.S. property.
a. True
b. False

53. The ____ market accommodates originators of mortgages that desire to sell their mortgages prior to maturity.
a. primary
b. secondary
c. money
d. none of the above

54. 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

55. 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. lower; higher
e. Answers B and C are correct.

56. During the early 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. Cannot answer without more information.

57. Which of the following will typically require homeowners to ultimately request a new mortgage?
a. graduated-payment mortgage (GPM)
b. growing-equity mortgage
c. balloon-payment mortgage
d. shared-appreciation mortgage

58. Which of the following is not true with respect to a growing-equity mortgage?
a. It is similar to a graduated-payment mortgage.
b. It allows borrowers to initially make small payments on the mortgage.
c. It involves increased payments, on a graduated basis, over the first five to ten years of the mortgage.
d. It involves payments that level off after the first five to ten years of the mortgage.

59. ____ economic growth will probably ____ the risk premium on mortgages and ____ the price of mortgages.
a. Strong; decrease; decrease
b. Strong; increase; increase
c. Weak; increase; increase
d. Weak; decrease; increase
e. Weak; decrease; decrease

60. 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 income level.
d. the borrower’s credit history.
e. Credit risk is affected by all of the above.

61. 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. B and C
e. A and C

62. An investor in interest-only collateralized mortgage obligations (CMOs) would not be concerned that homeowners will prepay the underlying mortgages.
a. True
b. False

63. The valuation of mortgage-backed securities is difficult because of limited
transparency.
a. True
b. False

64. A(n) _________ problem occurs when a person or institution does not have to bear the full consequence of its behavior and therefore assumes more risk than it otherwise would.
a. asymmetric information
b. M

oral hazard
c. risk adjustment
d. specific hazard

65. 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

66. Speculators sell credit default swaps to benefit from the default of specific subprime mortgages.
a. True
b. False

Chapter 10—Stock Offerings and Investor Monitoring

1. Which of the following statements is incorrect?
a. A stock is a certificate representing 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.

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.

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

4. A ____ requires that dividends cannot be 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

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

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 the above

7. A firm can best avoid the time lag between registering new securities with the SEC and actually selling them by
a. use of proxy.
b. shelf-registration.
c. use of a margin call.
d. use of preemptive rights.

8. The process by which the lead underwriter solicits indications of interest by institutional investors in an IPO at various possible ____ prices is referred to as ____.
a. IPO; margin selling
b. offer; secondary market building
c. offer; bookbuilding
d. IPO; bookbuilding

9. 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

10. The transaction costs to the issuing firm in an IPO is usually ____ percent of the funds raised.
a. 1
b. 3
c. 7
d. 25

11. 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 the above

12. 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.

13. When the lockup period expires, the share price commonly
a. remains unchanged.
b. increases significantly.
c. decreases significantly.
d. none of the above

14. IPOs tend to occur more primarily during recessions.
a. True
b. False

15. The initial (one-day) return of IPOs in the United States has averaged about ____ percent over the last 30 years.
a. 10
b. 20
c. 30
d. 50

16. 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 the above

17. ____ occurs when a securities firm allocates share from an IPO to corporate executives who may be considering an IPO or other business that will require the help of an investment bank.
a. Flipping
b. Spinning
c. Laddering
d. None of the above

18. When brokers encourage investors to place bids for IPO shares on the first day that are above the offer price this is referred to as
a. flipping.
b. spinning.
c. laddering.
d. none of the above

19. On average, IPOs of firms 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 the above

20. 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

21. 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.

22. Buy and sell orders on the OTC market are completed by
a. auction on the trading floor.
b. sealed competitive bids.
c. noncompetitive bids.
d. a telecommunications network.

23. A(n) ____ is a certificate which represents ownership of a foreign stock.
a. ADR
b. SEAQ
c. Nasdaq
d. AMEX

24. The first-time issuance of shares by a specific firm to the public is referred to as a(n)
a. stock repurchase.
b. secondary stock offering.
c. initial rights issue.
d. initial public offering (IPO).

25. 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).

26. Managers of firms may consider a stock repurchase or even a leveraged buyout when they believe their stock is ____ by the market, or a secondary stock offering when they believe their stock is ____ by the market.
a. undervalued; undervalued
b. overvalued; overvalued
c. undervalued; overvalued
d. overvalued; undervalued
e. none of the above

27. The largest organized exchange, listing the largest firms, is the
a. New York Stock Exchange.
b. American Stock Exchange.
c. Midwest Stock Exchange.
d. Pacific Stock Exchange.

28. ____ are employed by brokerage firms and execute orders for clients on the floor of the NYSE.
a. Specialists
b. Commission brokers
c. Independent brokers
d. Dealers

29. The OTC market does not have a trading floor.
a. True
b. False

30. Firms listed as “pink sheets” on the OTC market
a. are typically very large.
b. satisfy Nasdaq’s listing requirements.
c. are typically owned by various institutional and individual investors.
d. none of the above

31. 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.

32. 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

33. 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

34. 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

35. Analysts periodically communicate with high-level managers of the firms whose stock they rate.
a. True
b. False

36. 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

37. Which of the following is not true regarding the Sarbanes-Oxley Act?
a. It attempts to force accountants to conform to regular accounting standards in preparing a firm’s financial statements.
b. It requires that only outside board members of a firm be on the firm’s audit committee.
c. It allows public accounting firms to offer nonaudit consulting services to an audit client whether the client’s audit committee pre-approves the nonaudit services or not.
d. It prevents members of a firm’s audit committee from receiving consulting of advising fees or other compensation from the firm beyond that earned from serving on the board.

38. 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 the above

39. ____ are acquisitions that require substantial amounts of borrowed funds.
a. Stock repurchases
b. Corporate controls
c. Leveraged buyouts
d. Stock splits

40. ____ are not barriers to corporate control to eliminate agency problems.
a. Leveraged buyouts
b. Antitakeover amendments
c. Poison pills
d. Golden parachutes

41. Listing stock on a foreign stock exchange
a. enhances the stock’s liquidity.
b. may increase the firm’s perceived financial standing.
c. may protect a firm against hostile takeovers.
d. all of the above

42. American Depository Receipts (ADRs) are similar to
a. stock options.
b. bank deposits.
c. stocks.
d. bonds.

43. ____ 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

44. ____ 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

45. 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.

46. Whenever _____, the stock price will be driven up.
a. supply exceeds demand
b. demand exceeds supply
c. demand is reduced
d. none of the above

47. Which of the following is not a form of shareholder activism?
a. investors communicating their concerns to other investors in an effort to place more pressure on the firm’s managers or its board members
b. poison pills
c. shareholder lawsuits
d. all of the above

48. Initial public offerings (IPOs) tend to occur more frequently during bearish (weak) stock markets.
a. True
b. False

49. Initial public offerings (IPOs) perform ____ on the day following 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

50. Which of the following is not a part of the over-the-counter market?
a. the Nasdaq National Market
b. the Nasdaq Small Cap Market
c. the OTC Bulletin Board
d. the New York Stock Exchange

51. 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.

52. If the secondary market is inactive, then the shares would be illiquid.
a. True
b. False

53. 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

54. 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

55. Venture capital (VC) funds commonly serve as advisors to the businesses in which they invest.
a. True
b. False

56. Venture capital (VC) funds usually invest in publicly-traded businesses.
a. True
b. False

57. Venture capital (VC) funds typically plan to exit from their original investment within a period of about one year.
a. True
b. False

58. The phrase “leaving money on the table” refers to investors who pay 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

59. Underwriters sell most or all of the shares of an IPO to institutional investors.
a. True
b. False

60. The total cost of engaging in an IPO is usually about 1 percent of the total proceeds.
a. True
b. False

61. Since the Sarbanes-Oxley Act of 2002, the initial returns resulting from an IPO have generally been smaller.
a. True
b. False

62. In general, secondary offerings cause an immediate increase in the market price of the stock.
a. True
b. False

63. Electronic stock exchanges that execute stock transactions electronically are referred to as electronic communications networks (ECNs).
a. True
b. False

64. 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

65. As a result of the Sarbanes-Oxley Act, there was a reduced likelihood of fraudulent financial reporting by firms.
a. True
b. False

66. The legal protection of shareholders varies substantially among countries.
a. True
b. False

67. Common law countries such as the U.S., Canada, and the United Kingdom allow for more legal protection than civil law countries such as France or Italy.
a. True
b. False

68. The government enforcement of securities laws varies among countries.
a. True
b. False

69. The laws of the financial information that must be provided by public companies is similar among all developed countries.
a. True
b. False

70. Electronic communications networks (ECNs) are passive funds that track a specific index.
a. True
b. False

71. A venture capital fund typically plans to exit from its original investment within about four to seven years.
a. True
b. False

72. Venture capital funds typically take over businesses and manage them.
a. True
b. False

73. 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

74. If investors become dissatisfied with a firm’s performance, they can compete with management in soliciting proxy votes in what is known as a proxy fight.
a. True
b. False

75. Initial public offerings (IPOs) tend to occur more frequently during bullish stock markets.
a. True
b. False

76. 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

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

78. In addition to the Nasdaq market, the OTC market has another segment known as “pink sheets,” where smaller stocks are traded.
a. True
b. False

79. The Dow Jones Industrial Average (DJIA) is a value-weighted average of stock prices of 30 large U.S. firms.
a. True
b. False

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

81. 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

82. International exchange-traded funds (ETFs) represent international indexes that reflect composites of stocks for particular countries; shares of the index can be purchased or sold, thereby allowing investors to invest directly in a stock index representing any one of several countries.
a. True
b. False

83. 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 negotiate the terms of its investment, including the amount of funds it is willing to invest.
b. One common exit strategy for VC funds is to sell its equity stake to the public before the business engages in a public stock offering.
c. VC funds receive money from wealthy investors and from pension funds that are willing to maintain the investment for a long-term period.
d. All of the above are true with respect to VC funds.

84. Assume a firm that is valued at $800 million with 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 the above

85. The owners of common stock are permitted to vote on the
a. election of the board of directors.
b. authorization to issue new shares of common stock.
c. approval of amendments to the corporate charter.
d. adoption of bylaws.
e. all of the above

86. 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 from which 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 the above are true.

87. Which of the following is false with respect to initial public offerings (IPOs)?
a. IPOs are first-time offerings of shares by a specific firm to the public.
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 3 years before selling them in the secondary market.
d. IPOs are typically intended to raise funds so the corporation can expand.

88. 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. Answers A and B are correct.

89. There is strong evidence that IPOs of firms perform ____ on average over a period of a year or longer.
a. well
b. poorly
c. very well relative to other firms in their industry
d. none of the above

90. 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 the above

91. “Pink sheets” are traded on the
a. New York Stock Exchange.
b. American Stock Exchange.
c. over-the-counter market.
d. Nasdaq market.

92. The annual dividend on Grozky, Inc. stock is $5 per share and the stock’s prevailing price is $93.13 per share. Thus, the stock’s dividend yield is ____ percent.
a. 18.63
b. 5.37
c. 8.81
d. none of the above

93. Which of the following is not a provision specified in the Sarbanes-Oxley Act?
a. It requires that only inside board members of a firm be on the firm’s audit committee.
b. It prevents the members of a firm’s audit committee from receiving consulting or advising fees or other compensation from the firm beyond that earned from serving on the board.
c. It requires that the CEO and CFO of firms that are of at least a specified size certify the audited financial statements are accurate.
d. It allows public accounting firms to offer nonaudit consulting services to an audit client only if the client’s audit committee pre-approves the nonaudit services to be rendered before the audit begins.

94. Which of the following is not a form of shareholder activism?
a. proxy contests
b. antitakeover amendments
c. shareholder lawsuits
d. all of the above are forms of shareholder activism

95. 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 the above are barriers to corporate control

96. 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. B and C

97. After an IPO, firms commonly list their shares on a private stock exchange.
a. True
b. False

98. 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

99. 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.

100. Most individual investors attend road shows of firms that are about to go public before they purchase shares at the time of an IPO.
a. True
b. False

101. 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.

102. When a firm goes public and issues stock in the primary market:
a. the equity investment in the firm declines.
b. the firm’s debt level increases.
c. the number of the firm’s owners increases.
d. A and C

Chapter 11—Stock Valuation and Risk

1. The price-earnings valuation method applies the ____ price-earnings ratio to ____ 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

2. A firm is expected to generate earnings of $2.22 per share next year. The mean ratio of share price to expected earnings of competitors in the same industry is 15. Based on this information, the valuation of the firm’s shares based on the price-earnings (PE) method is
a. $2.22.
b. $6.76.
c. $33.30.
d. none of the above

3. 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

4. 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

5. Protsky Inc. just paid a dividend of $2.20 per share. The dividend growth rate for Protsky’s dividends is 3 percent per year. If the required rate of return on Protsky stock is 12 percent, the stock should be valued at $____ per share according to the dividend discount model.
a. 24.44
b. 25.18
c. 18.88
d. 75.53

6. 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.

7. 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. none of the above

8. 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
c. intercept; beta
d. beta; error term

9. 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

10. A beta of 1.8 implies that the stock has a risk premium of 1.8%.
a. True
b. False

11. 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

12. 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

13. 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

14. 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 the above

15. The ____ index can be used to measure risk-adjusted performance of a stock while controlling for the stock’s volatility.
a. Sharpe
b. Treynor
c. arbitrage
d. margin

16. 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

17. Stock price volatility increased during the credit crisis.
a. True
b. False

18. 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.

19. A stock’s average return is 11 percent. The average risk-free rate is 9 percent. The stock’s beta is 1 and its standard deviation of returns is 10 percent. What is the Sharpe Index?
a. .05
b. .5
c. .1
d. .02
e. .2

20. 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. 50

21. 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. semi-strong form efficient.
c. strong form efficient.
d. B and C
e. none of the above

22. If security markets are semi-strong form efficient, investors cannot solely use ____ to earn excess returns.
a. previous price movements
b. insider information
c. publicly available information
d. A and C

23. The ____ is commonly used to determine what a stock’s price should have been.
a. Capital Asset Pricing Model
b. Treynor Index
c. Sharpe Index
d. B and C

24. A stock’s beta is estimated to be 1.3. The risk-free rate is 5 percent, and the market return is expected to be 9 percent. What is the expected return on the stock based on the CAPM?
a. 5.2 percent
b. 11.7 percent
c. 16.7 percent
d. 4 percent
e. 10.2 percent

25. 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

26. 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. B and C

27. A higher beta of an asset reflects
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 the above

28. 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.

29. 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

30. 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 the industry competition.
b. beta.
c. liquidity.
d. size (market capitalization).

31. 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 the above

32. 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.
e. none of the above

33. Morgan stock has an average return of 15 percent, a beta of 2.5, and a standard deviation of returns of 20 percent. The Treynor index of Morgan stock is
a. 0.04.
b. 0.05.
c. 0.35.
d. 0.03.
e. none of the above

34. Zilo stock has an average return of 15 percent, a beta of 2.5, and a standard deviation of returns of 20 percent. The Sharpe index of Zilo stock is
a. 0.36.
b. 0.35.
c. 0.28.
d. 0.45.
e. none of the above

35. Sorvino Co. is expected to offer a dividend of $3.2 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 the above

36. Kandle stock just paid a dividend of $4.76 per share 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 the above

37. 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 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 the above

38. 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. none of the above

39. The standard deviation of a stock’s returns is used to measure a stock’s
a. volatility.
b. beta.
c. Treynor Index.
d. risk-free rate.

40. The formula for a stock portfolio’s volatility does not contain the
a. weight (proportional investment) assigned to each stock.
b. variance (standard deviation squared) of returns of each stock.
c. correlation coefficients between returns of each stock.
d. risk-free rate.

41. 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.

42. 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

43. 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
b. stock’s value
c. stock’s standard deviation
d. correlation coefficient

44. Stock X has a lower beta than Stock Y. The market return for next month is expected to be either −1 percent, +1 percent, or +2 percent with an equal probability of each scenario. The probability distribution of Stock X returns for next month is
a. the same as that of Stock Y.
b. more dispersed than that of Stock Y.
c. less dispersed than that of Stock Y.
d. zero.

45. 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.

46. 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

47. 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.

48. 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.

49. Which of the following is not commonly used as the estimate of a stock’s volatility?
a. the estimate of its standard deviation of returns over a recent period
b. the trend of historical standard deviations of returns over recent periods
c. the implied volatility derived from an option pricing model
d. the estimate of its option premium derived from an option pricing model

50. The credit crisis caused major problems in the mortgage market but had no impact on the stock market.
a. True
b. False

51. When new information suggests that a firm will experience lower cash flows than previously anticipated or lower risk, investors will revalue the corresponding stock downward.
a. True
b. False

52. 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

53. 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

54. 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

55. 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

56. 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

57. 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

58. 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

59. 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

60. 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

61. Stocks that have relatively little trading are normally subject to less price volatility.
a. True
b. False

62. A firm’s stock price is affected not only by macroeconomic and market conditions but also by firm specific conditions.
a. True
b. False

63. Stock repurchases are commonly viewed as an unfavorable signal about the firm.
a. True
b. False

64. The main source of uncertainty in computing the return of a stock is the dividend to be received next year.
a. True
b. False

65. A stock portfolio has more volatility when its individual stock returns are uncorrelated.
a. True
b. False

66. 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

67. The value-at-risk method is intended to warn investors about the potential maximum loss that could occur.
a. True
b. False

68. 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

69. Portfolio managers who monitor systematic risk rather than total risk are more concerned about stock volatility than about beta.
a. True
b. False

70. 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

71. A portfolio’s beta is the sum of the individual forecasted betas, weighted by the market value of each stock.
a. True
b. False

72. 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

73. 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

74. Fabrizio, Inc. is expected to generate earnings of $1.50 per share this year. If the mean ratio of share price to expected earnings of competitors in the same industry is 20, then the stock price per share is $____.
a. 13.33
b. 3.00
c. 20.00
d. 30.00
e. none of the above

75. Which of the following is not a reason the PE ratio method may result in an inaccurate valuation for a firm?
a. potential errors in the forecast of the firm’s beta
b. potential errors in the forecast of the firm’s future earnings
c. potential errors in the choice of the industry composite used to derive the PE ratio
d. All of the above are reasons the PE ratio method may result in an inaccurate valuation for a firm.

76. The ____ is not a measure of a stock’s risk.
a. stock’s price volatility
b. stock’s return
c. stock’s beta
d. value-at-risk method
e. All of the above are measures of a stock’s risk.

77. 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 the above

78. The limitations of the dividend discount model are most pronounced for a firm that
a. has a high beta.
b. has high expected future earnings.
c. distributes most of its earnings as dividends.
d. retains all of its earnings.
e. none of the above

79. Which of the following is incorrect 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 the above are true.

80. 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 returns and market returns
e. All of the above are factors used in the CAPM.

81. 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 the above

82. 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.

83. The general mood of investors represents:
a. investor sentiment.
b. beta.
c. systematic risk.
d. unsystematic risk.

84. ____ is (are) not a firm-specific factor(s) that affect(s) stock prices.
a. Exchange rates
b. Dividend policy changes
c. Stock offerings and repurchases
d. Earnings surprises
e. All of the above are firm-specific factors that affect stock prices.

85. The U.S. government’s budget deficit has a significant impact on the bond market but does not affect the stock market.
a. True
b. False

86. 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.

87. 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.

88. The market risk premium is stable over time and is not affected by stock market conditions.
a. True
b. False

89. Holding other factors constant, an increase in the capital gains tax rate will:
a. have more effect on the valuation of dividend-paying stocks than on stocks with high growth prospects.
b. have less effect on the valuation of dividend-paying stocks than on stocks with high growth prospects.
c. have no effect on the valuations of stocks.
d. have the same effect on the valuation of dividend-paying stocks and stocks with high growth prospects.

90. The VIX (volatility index) indicates the volatility of the bond market in general.
a. True
b. False

91. 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

92. Emerging market stocks tend to exhibit all of the following except:
a. high political risk.
b. high exchange risk.
c. high correlation with stocks of more developed countries.
d. high volatility.

93. Even though a foreign stock that appears to be overvalued in its own country, the stock may not generate a reasonable return for a U.S. investor if the currency of that country appreciates against the U.S. dollar.
a. True
b. False

94. 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

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

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

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.

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

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

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.

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 of the stock had not been borrowed.

8. Program trading
a. is commonly used to reduce the susceptibility of a stock portfolio to stock market movements.
b. may involve the purchase of stocks that become “underpriced.”
c. may involve the sale of stocks that become “overpriced.”
d. can be combined with the trading of individual bonds to create portfolio insurance.
e. none of the above

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.

10. Mark would like to purchase a stock priced at $70. Mark thinks he can sell the stock for $100 after one year. If Mark does not borrow any money from his brokerage firm, what is the estimated return on the stock?
a. 30.00 percent
b. −42.86 percent
c. −30.00 percent
d. 42.86 percent
e. none of the above

11. Mark would like to purchase a stock priced at $70. The stock is not expected to pay any dividends in the coming year. Mark can either put up the entire amount and purchase the stock, or borrow half of the investment amount from his brokerage firm at an annual interest rate of 12 percent and put up the remainder. Mark thinks he can sell the stock for $100 after one year. If Mark borrows from his brokerage firm, his estimated return on the stock would be ____ percent.
a. 42.86
b. 85.71
c. 73.71
d. 30.00

12. Karen just purchased a stock costing $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 the return on the stock?
a. 27.60 percent
b. 82.61 percent
c. 76.09 percent
d. 58.70 percent
e. none of the above

13. The present margin requirement is that 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 the above

14. An investor sold a stock short a year ago for $50 per share. The stock’s price is currently $52 per share. If the investor is unwilling to accept a loss on the short sale of more than $5 per share on the transaction, she could place a
a. stop-loss order with a specified selling price of $55 per share.
b. stop-buy order with a specified purchase price of $55 per share.
c. stop-loss order with a specified selling price of $45 per share.
d. stop-buy order with a specified purchase price of $45 per share.

15. The short interest ratio is commonly measured as the number of shares shorted divided by the number of shares that the firm has repurchased in the last quarter.
a. True
b. False

16. Investors can reduce their risk by purchasing a stock on margin instead of using all cash to buy the stock.
a. True
b. False

17. A short seller
a. anticipates that the price of the stock sold short will increase.
b. earns the difference between what they initially paid for the stock versus what they later sell the stock for.
c. makes a profit equal to the difference between the original sell 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 the above

18. ____ are enforced to restrict the amount of credit extended to customers by stockbrokers.
a. Limit orders
b. Margin requirements
c. Maintenance margins
d. Initial margins

19. 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.

20. 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.

21. 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 the above

22. ____ facilitate stock transactions by taking positions in specific stocks.
a. Board members
b. Capstone members
c. Market makers
d. None of the above

23. ____ facilitate transactions on a stock exchange by executing stock transactions for their clients.
a. Board members
b. Capstone members
c. Floor brokers
d. None of the above

24. The short interest represents the amount of interest that borrowers owe on loans used to purchase stock.
a. True
b. False

25. Which of the following statements is incorrect?
a. Market-makers take positions to capitalize on the discrepancy between the prevailing stock price and their own valuation of a stock.
b. Market-makers may take the opposite position of uninformed investors and therefore stand to benefit if their expectations are correct.
c. Market makers are required to purchase the stocks they are assigned for a price existing when the market opened on any given day.
d. The spread quoted for a given stock may vary among market-makers.

26. A short-interest ratio of 20 or more 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. both A and C

27. Lisa would like to purchase a stock priced at $70. The stock is not expected to pay any dividends in the coming year. She can either put up the entire amount and purchase the stock, or borrow $35 from her brokerage firm at an annual interest rate of 12 percent and put up the remainder. She thinks she can sell the stock for $100 after one year. If she borrows from her brokerage firm, her estimated return on the stock would be ____ percent.
a. 42.86
b. 85.71
c. 73.71
d. 30.00

28. 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.

29. Trading halts are imposed by
a. the SEC.
b. brokers.
c. stock exchanges.
d. the Treasury.

30. The size of the spread on stocks that have relatively little trading is
a. smaller to reflect the lower degree of uncertainty.
b. the same as that of stocks with higher volumes of trading.
c. wider to reflect the higher degree of uncertainty.
d. not affected by trading volume.

31. The ____ the trading volume of a stock, the ____ the spread.
a. higher; wider
b. higher; narrower
c. lower; narrower
d. none of the above

32. Electronic communications networks are primarily intended to prevent executives from using inside information when trading stocks.
a. True
b. False

33. A ____ is a trading platform on a computer web site 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

34. The NYSE defines ____as the simultaneous buying and selling of a portfolio of at least 15 different stocks that are valued at more than $1 million.
a. direct access brokering
b. electronic communication networking
c. program trading
d. regulation of stock trading

35. Trading halts are intended to ensure that the market has complete information before trading on news.
a. True
b. False

36. The Division of ____ of the SEC regulates the fair and orderly disclosure trading by ensuring honest practices by various organizations that facilitate the trading of securities.
a. Corporate Finance
b. Enforcement
c. Administration
d. Market Regulation

37. The Division of ____ of the SEC assesses possible violations of regulations imposed by the SEC, and can take action against individuals or firms.
a. Corporate Finance
b. Enforcement
c. Administration
d. Market Regulation

38. Until recently, international trading of stocks was limited by
a. transaction costs.
b. information costs.
c. exchange rate risk.
d. all of the above

39. The transaction costs associated with international trading of stocks have been reduced by
a. the consolidation of stock exchanges.
b. extensive computerization.
c. the Eurolist system.
d. all of the above

40. The exchange rate risk associated with international trading of stock has been reduced by
a. information available on the Internet.
b. extensive computerization of stock exchanges.
c. the conversion of many European countries to a single currency.
d. the Eurolist system.

41. A market order is an order to buy or sell a stock at the best possible price.
a. True
b. False

42. 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

43. When investors place a limit order, they can place it for the day only.
a. True
b. False

44. 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

45. 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
b. False

46. 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

47. A relatively high percentage (such as 3 percent) of the ratio of the number of shares sold short divided by the total number of shares outstanding 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

48. Trading halts are intended to prevent insider trading.
a. True
b. False

49. A trading halt prevents a stock from experiencing a loss in response to news.
a. True
b. False

50. The SEC’s Division of Market Regulation assesses possible violations of the SEC’s regulations and can take action against individuals or firms.
a. True
b. False

51. Regulation Fair Disclosure (FD) requires firms to disclose relevant information first to their most important clients.
a. True
b. False

52. ____ 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

53. Which of the following statements is incorrect with respect to Regulation Fair Disclosure (FD)?
a. It required firms to disclose relevant information broadly to investors at the same time.
b. It restricts firms from providing analysts with information that they could use before the market is aware of the information.
c. It requires firms to announce a change in expected earnings to all investors and other interested parties at the same time.
d. It prohibits firms from communicating with analysts after a news announcement is made to all investors.
e. All of the above are correct with respect to Regulation FD.

54. 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

55. The short-interest ratio is the shares sold short divided by the
a. average shares purchased over a recent period.
b. average daily trading volume over a recent period.
c. interest rate paid on the short sale.
d. average daily trading volume on other stocks from the same industry.

56. A short seller
a. anticipates that the price of the stock sold short will increase.
b. earns the difference between what he initially paid for the stock versus what he later sell the stock 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 the above

57. The bid-ask spread is negatively related to
a. order costs.
b. inventory costs.
c. risk
d. trading volume.

58. Marziano Co. stock is quoted by a broker as bid $21.20, ask $21.40. The bid-ask spread is ____ percent.
a. 0.94
b. 0.93
c. 0.20
d. none of the above

59. 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.

60. The SEC’s ____ requires the orderly disclosure of securities trades by various organizations that facilitate the trading of securities.
a. Division of Corporate Finance
b. Division of Market Regulation
c. Division of Enforcement
d. none of the above

61. The SEC’s ____ reviews the registration statement files 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 Corporate Finance
b. Division of Market Regulation
c. Division of Enforcement
d. none of the above

62. 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

63. In naked short selling, short-sellers sell a stock short that they presently own.
a. True
b. False

64. Dark pools:
a. are private stock markets used by institutional investors.
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.

65. 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

66. 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
d. an increase in margin requirements

67. An advantage of trading in dark pools is that:
a. the bid or ask prices offered can be more favorable than those available in the public stock exchanges.
b. an investor can accumulate a large number of shares of a particular stock without putting excessive upward pressure on the stock price.
c. they are convenient for high-frequency traders using computer algorithms to catch price discrepancies.
d. all of the above

68. 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.

69. 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. B and C

70. 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

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

2. Interest rate futures are not available on
a. Treasury bonds.
b. Treasury notes.
c. Eurodollar CDs.
d. the S&P 500 index.

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 the above

4. ____ trade futures contracts for their own account.
a. Commission brokers
b. Floor brokers
c. Commission traders
d. Floor traders

5. 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

6. Futures exchanges take buy or sell positions on futures contracts.
a. True
b. False

STA: DISC.FMAI.MADU.15.03

7. If the prices of Treasury bonds ____, the value of an existing Treasury bond futures contract should ____.
a. increase; be unaffected
b. decrease; be unaffected
c. A and B
d. decrease; decrease
e. decrease; increase

8. 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 the above

9. 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

10. Financial futures contracts on U.S. securities are ____ by non-U.S. financial institutions.
a. not allowed to be traded
b. are rarely desired
c. are commonly traded
d. A and B

11. Assume that speculators had purchased a futures contract at the beginning of the year. If the price of a security represented by a futures contract ____ over the year, then these speculators would likely have purchased the futures contract for ____ than they can sell it for.
a. increased; more
b. decreased; less
c. remains the same; more
d. increased; less

12. 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 transactions costs?
a. $1,180,000
b. $118
c. $11,800
d. $15,625
e. $1,562.50

13. The use of financial leverage
a. magnifies the positive returns of futures contracts.
b. magnifies losses of futures contracts.
c. both A and B
d. none of the above

14. According to the text, when a financial institution sells futures contracts on securities in order to hedge against a change in interest rates, this is referred to as
a. a long hedge.
b. a short hedge.
c. a closed out position.
d. basis trading.

15. 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

16. 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 transactions costs.
e. price paid for an option contract.

17. The profits of a financial institution with interest-rate sensitive liabilities and interest rate-insensitive assets are ____ with hedging than without hedging if interest rates decrease.
a. higher
b. the same
c. lower
d. higher or the same

18. Assume that a bank obtains most of its funds from large CDs with a one-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 increase. To partially hedge its position, it could ____ futures contracts.
a. adversely; purchase
b. favorably; sell
c. favorably; purchase
d. adversely; sell

19. According to the text, a futures contract on one financial instrument to protect a position in a different financial instrument is known as
a. cross-hedging.
b. ratio hedging.
c. basis hedging.
d. liquid hedging.

20. The effectiveness of a cross-hedge depends on the degree of correlation between the market values of the two financial instruments.
a. True
b. False

21. If a futures contract is more volatile than the portfolio value, the amount of principal represented by the futures contracts to hedge the portfolio is ____ the market value of the securities to be hedged.
a. smaller than
b. greater than
c. equal to
d. B and C are both possible

22. In cross-hedging, if the futures contract value is ____ volatile than the portfolio value, hedging will require a ____ amount of principal represented by the futures contracts.
a. less; greater
b. more; greater
c. more; smaller
d. none of the above

23. Municipal Bond Index (MBI) futures
a. involve a physical exchange of bonds.
b. are based on a Treasury bond index.
c. are based on actively traded corporate bonds.
d. are settled in cash.

24. 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.

25. A savings and loan association has long-term fixed-rate mortgages financed by short-term funds. It hedges by selling Treasury bond futures. If interest rates decline, and many mortgages are prepaid
a. the gain on the futures contracts offsets the loss on the mortgages.
b. the gain on the mortgages offsets the loss on the futures contracts.
c. the gain on the futures contracts more than offsets any unfavorable effects on mortgages.
d. a loss on the futures contracts more than offsets the favorable effect on the mortgage portfolio.

26. 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; a Municipal Bond Index
d. selling; a Municipal Bond Index

27. The net gain or loss on a futures contract for a stock index that is not closed out is based on 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.

28. The value of an S&P 500 futures contract is $500 times the index. Assume the futures price on the S&P 500 index is 1612 at the time of purchase. If the index price is $1619 when the position is closed out, the gain is
a. $700.
b. $7,000.
c. $3,190.
d. $3,120.
e. $3,500.

29. Assume that a stock mutual fund uses stock index futures as it conducts dynamic asset allocation. This means that the mutual fund
a. liquidates its stocks 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 the above

30. Companies with international trade can hedge ____ by ____ currency futures.
a. payables; selling
b. receivables; buying
c. payables; buying
d. A and B
e. B and C

31. 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 default risk. A short position in Treasury bill futures ____ an effective hedge against the 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

32. Which of the following statements is incorrect with respect to cross-hedging?
a. Even when the futures contract is highly correlated with the portfolio being hedged, the value of the futures contract may change by a higher or lower percentage than the portfolio’s market value.
b. If the futures contract value is more volatile than the portfolio value, hedging will require a greater amount of principal represented by the futures contracts.
c. The effectiveness of a cross-hedge depends on the degree of correlation between the market values of the two financial instruments.
d. If the price of the underlying security of the futures contract moves closely in tandem with the security hedged, the futures contract can provide an effective hedge.
e. All of the above are correct with respect to cross-hedging.

33. ____ 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 the above

34. Trading restrictions imposed on specific stocks or stock indices are referred to as
a. index busters.
b. index options.
c. circuit breakers.
d. protective covenants.

35. Financial leverage, when used in association with a futures contract, ____ the positive returns and ____ losses.
a. magnifies; reduces
b. reduces; magnifies
c. magnifies; magnifies
d. reduces; reduces

36. 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

37. The risk that the position being hedged by a futures position is not affected in the same manner as the instrument underlying the financial futures contract, is referred to as
a. market risk.
b. liquidity risk.
c. default risk.
d. basis risk.

38. 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

39. 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 the above

40. 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.

41. Speculators in futures contracts that normally close out their futures positions on the same day that the positions were initiated are referred to as
a. day traders.
b. hedgers.
c. closed-end traders.
d. position traders.

42. Speculators in futures contracts that normally maintain the futures position that they initiate 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.

43. Which of the following is incorrect regarding organized exchanges trading financial futures contracts?
a. Organized exchanges establish and enforce rules for the trading of financial futures contracts.
b. Organized exchanges ensure that the seller of the futures contract always delivers the securities covered by the contract, whether the contract was settled prior to the settlement date or not.
c. Organized exchanges clear, settle, and guarantee all transactions that occur on their exchanges.
d. The operations of financial futures exchanges are regulated by the Commodity Futures Trading Commission (CFTC).
e. All of the above are correct.

44. Marcia buys an S&P 500 futures contract with a September settlement date when the index is 1,750. By the settlement date, the S&P 500 index falls to 1,400. The return on Marcia’s position in the S&P 500 futures contract is ____ percent.
a. −20
b. −10
c. 25
d. 20
e. 0

45. Laura sells an S&P 500 futures contract with a September settlement date when the index is 1,750. By the settlement date, the S&P 500 index falls to 1,400. The return on Laura’s position in the S&P 500 futures contract is ____ percent.
a. −20
b. −10
c. 25
d. 20
e. 0

46. 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 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 the above

47. 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 the above

48. 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.

49. ____ risk is the risk of losses as a result of inadequate management or controls.
a. Basis
b. Systemic
c. Operational
d. Prepayment

50. Financial futures contracts on stock indexes are referred to as interest rate futures.
a. True
b. False

51. Financial futures contracts are rarely sold over the counter.
a. True
b. False

52. Brokers commonly require margin deposits from their customers above those required by the exchanges.
a. True
b. False

53. Purchasers of financial futures contracts usually know who the sellers are, and vice versa.
a. True
b. False

54. 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

55. A financial institution that hedges with interest rate futures is less sensitive to economic events than an institution that does not hedge.
a. True
b. False

56. 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

57. 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

58. Stock index futures cannot be closed out before the settlement date.
a. True
b. False

59. The value of a stock index futures contract has little correlation with the value of the underlying stock index.
a. True
b. False

60. 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

61. The price of stock index futures may reflect investor expectations about the market more rapidly than stock prices.
a. True
b. False

62. 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

63. 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.
a. True
b. False

64. Which of the following statements is incorrect regarding organized futures exchanges?
a. Organized exchanges establish and enforce rules for the trading of financial futures contracts.
b. Organized exchanges serve as market makers for futures contracts by taking positions in futures.
c. Organized exchanges clear, settle, and guarantee all transactions that occur on their exchanges.
d. The operations of financial futures exchanges are regulated by the Commodity Futures Trading Commission (CFTC).
e. All of the above are correct.

65. Stock index futures are priced ____ than the stock index itself.
a. higher
b. lower
c. either higher or lower
d. none of the above

66. 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

67. Bill Baher, a private investor, purchased a futures contract on Treasury bonds at a price of 102-12. Two months later, Baher sells the same futures contract in order to close out the position. At that time, the futures contract specifies 103-15. What is Baher’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 the above

68. Clarke 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 declined to 97-20, Clarke would make a ____ of $____ from closing 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 the above

69. _________ 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

70. Some specialized futures contracts are sold over the counter, whereas standardized financial futures contracts are traded on exchanges.
a. True
b. False

71. 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.

72. Settlement of stock index futures contracts occurs through delivery of the underlying securities.
a. True
b. False

73. ___________ 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

74. Which of the following is not a type of risk associated with futures contracts?
a. basis risk
b. liquidity risk
c. market risk
d. postpayment risk

75. 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

76. __________ 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

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

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. B and C

3. A call option is “in the money” when the
a. market price of the underlying security exceeds the exercise price.
b. market price of the underlying security equals the exercise price.
c. market price of the underlying security is less than the exercise price.
d. premium on the option is less than the exercise price.

4. 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.

5. When the market price of the underlying security exceeds the exercise price, the
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.

6. When the exercise price exceeds the market price of the underlying security, the
a. call option is in the money.
b. put option is in the money.
c. call option is at the money.
d. put option is out of the money.

7. Sellers (writers) of call options can offset 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. all of the above
e. A and B

8. The ____ is the most important exchange for trading options.
a. New York Stock Exchange (NYSE)
b. Chicago Board of Options Exchange (CBOE)
c. Boston Options Exchange
d. American Stock Exchange

9. The Options Clearing Corporation (OCC) serves as a guarantor on option contracts traded in the United States.
a. True
b. False

10. ____ execute transactions desired by investors and trade stock options for their own account.
a. Floor brokers
b. Discount brokers
c. Market-makers
d. none of the above

11. 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. The speculator will exercise the option on the expiration date (if it is feasible to do so). What is the speculator’s profit per unit?
a. $1
b. $5
c. $2
d. −$1
e. −$2

12. 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

13. 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

14. 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

15. The ____, the higher the call option premium, other things being equal.
a. lower the existing price of the security relative to the exercise price
b. lower the variability of the security’s market price
c. longer the maturity of the option
d. A and B

16. The ____, the lower the premium on a put option, other things being equal.
a. higher the existing price of the security relative to the exercise price
b. greater the variability of the security’s market value
c. longer the maturity of the option
d. A and B

17. 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

18. 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

19. 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. call on futures.
d. futures on options.

20. 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

21. 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

22. Put options are typically used to hedge
a. when portfolio managers are mainly concerned with a permanent decline in a stock’s value.
b. when portfolio managers are mainly concerned with a permanent increase in a stock’s value.
c. when portfolio managers are mainly concerned with a temporary decline in a stock’s value.
d. when portfolio managers are mainly concerned with a temporary increase in a stock’s value.

23. A savings institution has long-term fixed rate mortgages supported by short-term funds. A put option on Treasury bond futures could be used to (ignore the premium paid for the option when you answer this question)
a. maintain its interest rate spread if interest rates rise, and increase its spread if interest rates fall.
b. maintain its interest rate spread if interest rates fall, and increase its spread if interest rates rise.
c. maintain its interest rate spread whether interest rates rise or fall.
d. increase its interest rate spread whether interest rates rise or fall.

24. A speculator purchases a put option on Treasury bond futures with a September delivery date with a strike 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

25. Assume an insurance company purchases a call option on an S&P 500 Index futures contract for a premium of 14, with an exercise price of 1800. The value of an S&P 500 futures contract is 250 times the index. If the 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

26. 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. A and B

27. 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; less
c. let the option expire; greater
d. let the option expire; less
e. A and D

28. 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

29. 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. A and D

30. 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 the above

31. 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

32. A speculator purchased a put option with an exercise price of $56 for a premium of $10. The option was exercised a few days later when the stock price was $44. What was the return to the speculator?
a. −20 percent
b. 120 percent
c. −100 percent
d. 20 percent

33. The premium on an existing call option should ____ when the underlying stock price decreases.
a. be negative
b. decline
c. increase
d. be unaffected
e. A and B

34. The premium on an existing put option should ____ when the underlying stock price increases.
a. be negative
b. decline
c. increase
d. be unaffected
e. A and B

35. The premium on an existing put option should ____ when there is an increase in the expected short-term volatility of the stock price.
a. be negative
b. decline
c. increase
d. be unaffected
e. A and B

36. The premium on an existing call option should ____ when there is a reduction in the expected short-term volatility of the stock price.
a. be negative
b. decline
c. increase
d. be unaffected
e. A and B

37. The premium on an existing put option should ____ when there is an increase in the expected short-term volatility of the stock price.
a. be negative
b. decline
c. increase
d. be unaffected
e. A and B

38. The premium on an existing call option should ____ when there is a reduction in the expected short-term volatility of the stock price.
a. be negative
b. decline
c. increase
d. be unaffected
e. A and B

39. When a stock index option is exercised, the cash payment is equal to a specified dollar amount
a. multiplied by the index level.
b. multiplied by the exercise price.
c. multiplied by the difference between the index level and the exercise price.
d. multiplied by the sum of the index level and the exercise price.

40. Long-term equity anticipations (LEAPS) represent
a. stocks that have a maturity date.
b. stocks that are converted to bonds once the price reaches a specified level.
c. stock options with longer terms to expiration than the more traditional stock options.
d. stock index futures that can have a more distant settlement date than the more typical stock options.

41. When stock portfolio managers use dynamic asset allocation by purchasing call options on a stock index, they ____ their exposure to stock market conditions.
a. reduce
b. completely eliminate
c. have no effect on
d. increase

42. When stock portfolio managers use dynamic asset allocation by writing call options on a stock index, they ____ their exposure to stock market conditions.
a. reduce
b. completely eliminate
c. have no effect on
d. increase

43. 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

44. Which of the following is not a difference between purchasing an option and purchasing a futures contract?
a. The option requires that a premium be paid in addition to the price of the financial instrument.
b. Owners of options can choose to let the option expire on the so-called expiration date without exercising it.
c. The fulfillment of futures contracts is regulated by exchanges, while the fulfillment of options is not.
d. All of the above are differences between purchasing an option and purchasing a futures contract.

45. 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 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 the above

46. 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 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 the above

47. 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 the above

48. 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. The world is risk-neutral.
d. The variability of a stock’s return is constant.
e. There are no transaction costs involved in trading options.

49. 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 the risk of loss on their positions in options.
d. All of the above are true with respect to market makers.

50. Option trading is regulated by the
a. Options Clearing Corporation.
b. International Securities Exchange.
c. Securities and Exchange Commission.
d. Federal Reserve.

51. On an exchange, option trades can be executed
a. by a floor broker.
b. electronically.
c. by a market maker.
d. all of the above
e. A and B only

52. When investors purchase an option that does not hedge their existing investments, the option can be referred to as “naked.”
a. True
b. False

53. Backdating implies that CEO (or other executives) reset the date that their options were granted to a different date when the stock price was lower.
a. True
b. False

54. The motive for a CEO to backdate options is that it allowed them to exercise the options at a lower exercise price.
a. True
b. False

55. Stock options can be used by speculators to benefit from their expectations and by financial institutions to reduce their risk.
a. True
b. False

56. 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

57. 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

58. Market makers can execute stock option transactions for customers and do not trade stock options for their own account.
a. True
b. False

59. American-style stock options can be exercised only just before expiration.
a. True
b. False

60. An option with a higher exercise price has a higher call option premium and a lower put option premium.
a. True
b. False

61. Several call options are available for a given stock, and the risk-return potential will vary among them.
a. True
b. False

62. The greater 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

63. The longer a call option’s time to maturity, the lower the call option premium, other things being equal.
a. True
b. False

64. The results with covered call writing are better than without covered call writing when the stock performs poorly and better when the stock performs well.
a. True
b. False

65. 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

66. 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

67. 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

68. Speculators who anticipate a decline in interest rates may consider writing a call option on Treasury bond futures.
a. True
b. False

69. Speculators sell call options on currencies that they expect to strengthen against the dollar.
a. True
b. False

70. Market makers
a. can execute stock option transactions for their customers.
b. can trade options for their own account.
c. are subject to the risk of losses from their positions in options.
d. benefit from the spread.
e. all of the above

71. ____ of options can close out their positions at any time by ____ an identical option.
a. Sellers; purchasing
b. Sellers; selling
c. Buyers; purchasing
d. none of the above

72. 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 the above

73. Which of the following statements is least correct regarding corporations involved in international business transactions?
a. They may purchase currency put options to hedge future receivables denominated in a foreign currency.
b. They may purchase currency call options to hedge future payables denominated in a foreign currency.
c. They may purchase currency call options to hedge future receivables denominated in a foreign currency.
d. They benefit from currency put options if the currency’s value declines before the expiration date of the option.

74. The ____ is not a factor affecting the call option premium.
a. market price of the underlying instrument (relative to 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

75. Speculators who anticipate a decline in interest rates may consider ____ a ____ option on Treasury bond futures.
a. purchasing; put
b. selling; call
c. purchasing; call
d. none of the above

76. Brad 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. Brad exercises the option and closes out the position by purchasing an identical futures contract. Brad’s net gain from this speculative strategy is $____.
a. −812.50
b. 4,718.75
c. −4,718.75
d. −406.25
e. none of the above

77. Which of the following statements is incorrect?
a. Some firms allowed their CEOs to backdate options that they were granted to an earlier period when the stock price was lower.
b. Backdating is completely inconsistent with the idea of granting options to encourage managers to focus on maximizing the stock price.
c. Firms readily promote their option compensation programs and are more than willing to acknowledge that the options are an expense.
d. All of the above are correct.

78. 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

79. 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

80. Options on small stocks normally have higher premiums than options on large stocks because small stocks typically are more volatile.
a. True
b. False

81. Which of the following can normally be found in quotations for stock options provided by the financial media?
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

82. The CBOE volatility index (VIX):
a. represents the implied volatility derived from options on the Wilshire 5000 index.
b. represents the implied volatility derived from options on the S&P 500 index.
c. is referred to as the “fear index” because low values are perceived to reflect a high degree of likelihood that stock prices will decline.
d. B and C

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 the above

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 rate will move in an unfavorable direction to not hedge their positions.

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 the above

4. In a swap arrangement, the most common index used for floating-rate payments would be the
a. coupon rate on existing bonds.
b. stock dividend rate based on a U.S. stock index.
c. London Interbank Offer Rate (LIBOR).
d. Treasury bond yield.

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.

6. A plain vanilla swap is especially beneficial when interest rates are expected to
a. rise consistently.
b. decline consistently.
c. be stable.
d. rise and then decline.

7. Swap transactions are only used to
a. hedge against upward interest rate movements.
b. hedge against downward interest rate movements.
c. speculate.
d. none of the above

8. If a firm negotiates a plain vanilla swap, it will provide ____ payments in exchange for ____ payments.
a. fixed-rate; floating-rate
b. floating-rate; fixed rate
c. stock dividend; fixed-rate
d. stock dividend; floating rate

9. A ____ swap allows the party making floating-rate payments to terminate the swap prior to maturity.
a. zero coupon-for-floating
b. forward
c. callable
d. putable

10. A(n) ____ allows the party making fixed payments to extend the swap period.
a. forward
b. extendable
c. callable
d. putable

11. 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

12. 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

13. In a(n) ____ swap, the fixed-rate payer makes a single payment at the maturity date of the swap agreement, while the floating-rate payer makes periodic payments throughout the swap period.
a. rate-capped
b. zero-coupon-for-floating
c. extendable
d. callable

14. 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.

15. The option on a putable swap would most likely be exercised if interest rates
a. rise.
b. fall.
c. remain constant.
d. remain somewhat stable.

16. 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

17. Assume a financial institution that has rate-sensitive liabilities and rate-insensitive assets. If interest rates are expected to decline consistently, this institution would benefit by negotiating a(n)
a. forward swap.
b. callable swap.
c. extendable swap.
d. none of the above

18. Assume a financial institution has rate-sensitive liabilities and rate-sensitive assets. If this institution 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

19. 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

20. 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 the above

21. According to the text, any political aspects that prevent a counterparty on a swap from meeting its payment obligations represent
a. sovereign risk.
b. basis risk.
c. credit risk.
d. none of the above

22. ____ risk prevents the interest rate swap from completely eliminating a financial institution’s exposure to interest rate risk.
a. Credit
b. Basis
c. Sovereign
d. None of the above

23. ____ risk in a swap is typically not overwhelming because the affected party can simply discontinue its payments to the other party.
a. Basis
b. Credit
c. Sovereign
d. None of the above

24. 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

25. 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

26. 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

27. 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

28. 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

29. The advantage of a rate-capped interest rate swap to a party exchanging fixed payments for floating payments (relative to a plain vanilla swap) is that
a. there is a minimum limit set on 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 the above

30. The advantage of a rate-capped interest rate swap (relative to a plain vanilla swap) to a party exchanging floating payments for fixed payments is that
a. there is a minimum limit set on 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 the above

31. A plain vanilla swap enables firms to exchange ____ for ____.
a. fixed rate payments; variable interest 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

32. An arrangement which enables firms to exchange currencies at periodic intervals is called a
a. currency swap.
b. interest rate swap.
c. swap exchange.
d. eurobond swap.

33. 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.

34. 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.

35. A firm is involved in an agreement in which 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.

36. 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

37. A firm is involved in an agreement in which 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.

38. A firm is involved in an agreement in which it makes 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.

39. A firm is involved in an agreement in which 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.

40. An interest rate collar represents the ____ of an interest rate cap and a simultaneous ____ of an interest rate floor.
a. sale; sale
b. sale; purchase
c. purchase; purchase
d. purchase; sale

41. Firms A and B have entered into an interest rate swap. On the first payment date, Firm A owes Firm B 12 percent of $10 million, and Firm B owes Firm A 14 percent of $10 million. Most likely, this transaction will be settled in what manner?
a. Firm A will send Firm B $120,000 and Firm B will send Firm A $140,000
b. Firm B will send Firm A $120,000 and Firm A will send Firm B $140,000
c. Firm A will send Firm B $20,000
d. Firm B will send Firm A $20,000
e. none of the above

42. 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 the above

43. The Bank of Moronto has negotiated a plain vanilla swap in which 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
c. 450,000
d. −450,000
e. none of the above

44. 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, 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 the above

45. 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. Assume that LIBOR is expected to be 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 the above

46. 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. Assume that LIBOR is expected to be 9 percent, 12 percent, and 13 percent at the end of each of the next three years, respectively. The dollar amount to be received (or paid) by the seller of the interest rate cap based on the forecast of LIBOR assumed above over the three-year period is $____.
a. −500,000
b. 500,000
c. −1,500,000
d. 1,500,000
e. none of the above

47. 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

48. A common maturity of a credit default swap contract is:
a. one month
b. three months
c. five years
d. 25 years

49. AIG’s financial problems during the credit crisis were attributed to:
a. its weak returns on its investments in junk bonds.
b. its potential losses from its life insurance policies.
c. fraud from avoiding taxes on its gains from credit default swaps.
d. its potential losses from credit default swaps.

50. Buyers of credit default swaps are most likely going to receive a payment from the seller of credit default swaps when the economy:
a. is very weak.
b. is stable.
c. experiences high growth.
d. experiences low inflation.

51. The primary purpose of interest rate swaps is to reduce exchange rate risk.
a. True
b. False

52. 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

53. A putable swap gives the party making the fixed-rate payments the right to terminate the swap.
a. True
b. False

54. A rate-capped swap may limit the fixed-rate payer’s ability to effectively hedge against interest rate risk.
a. True
b. False

55. 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

56. There is risk that a firm involved in an interest rate swap may not meet its payment obligations; this risk is called systemic risk.
a. True
b. False

57. 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

58. The most common proxy for the benchmark rate from which a floating-rate payment is determined is the prime rate.
a. True
b. False

KEY: Bloom’s: Analysis

59. Interest rate swaps are rarely used by companies that issue bonds.
a. True
b. False

60. An interest rate cap offers payments in periods when a specified interest rate index exceeds a specified floor interest rate.
a. True
b. False

61. Interest rate floors are commonly used to hedge against lower interest rates.
a. True
b. False

62. 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

63. 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 floating interest rate
d. the underwriter of the bond
e. All of the above are provisions of an interest rate swap.

64. 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

65. 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
c. decrease; declining
d. decrease; increasing
e. none of the above

66. 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 the above

67. 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 the above

68. Which of the following is not a reason for financial institutions to 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 the above are reasons for financial institutions to engage in swaps

69. 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. A and B

70. The London Interbank Offer Rate (LIBOR) varies among currencies.
a. True
b. False

71. 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
b. False

72. Which of the following is not an advantage of having derivative securities such as swaps traded on an exchange instead of over the counter?
a. more transparent pricing
b. increased trading volume
c. less standardarized contracts, allowing contracts to be tailored to the parties’ specific needs
d. more accurate information about the collateral backing a particular contract

73. 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

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 the above

2. Which of the following is most likely to provide currency forward contracts to their customers?
a. commercial banks
b. international mutual funds
c. brokerage firms
d. insurance companies

3. The ____ allowed for the devaluation of the dollar in 1971.
a. Bretton Woods Agreement
b. Louvre Accord
c. Smithsonian Agreement
d. none of the above

4. 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.

5. 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.

6. A system whereby one currency is maintained within specified boundaries of another currency or unit of account is a
a. pegged system.
b. free float.
c. dirty float.
d. managed float.

7. A country that pegs its currency is still able to maintain complete control over its local interest rates.
a. True
b. False

8. If the demand for British pounds ____, the pound will ____, other things being equal.
a. increases; appreciate
b. decreases; appreciate
c. increases; depreciate
d. B and C

9. A(n) ____ in the supply of euros for sale will cause the euro to ____.
a. increase; appreciate
b. increase; depreciate
c. decrease; depreciate
d. none of the above

10. Beginning with an equilibrium situation, if European inflation suddenly ____ than U.S. inflation, this forced ____ pressure on the value of the euro.
a. becomes much higher; upward
b. becomes much higher; downward
c. becomes much less; upward
d. becomes much less; downward
e. B and C

11. 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

12. In reality, exchange rates do not always change as suggested by purchasing power parity.
a. True
b. False

13. If U.S. interest rates suddenly become much higher than European interest rates (and if it does not cause concern about higher inflation there), 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

14. Assume interest rate parity exists. If the spot rate on the British pound is $2 and the 1-year British interest rate is 7 percent, and the 1-year U.S. interest rate is 11 percent, what is the pound’s forward discount or premium?
a. 3.74 percent premium
b. 3.74 percent discount
c. 3.60 percent premium
d. 3.60 percent discount

15. 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.

16. Which of the following statements is incorrect?
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.

17. Direct intervention is always extremely effective.
a. True
b. False

18. 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

19. 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

20. Generally, a ____ home currency can ____ domestic economic growth.
a. weak; dampen
b. strong; stimulate
c. strong; dampen
d. A and B

21. A ____ home currency can ____ domestic inflation.
a. strong; increase
b. weak; decrease
c. strong; decrease
d. A and B

22. 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. A and B

23. ____ forecasting involves the use of historical exchange rate data to predict future values.
a. Technical
b. Fundamental
c. Market-based
d. Mixed

24. ____ forecasting is usually based on either the spot rate or the forward rate.
a. Technical
b. Fundamental
c. Market-based
d. Mixed

25. Fundamental forecasting has been found to be consistently superior to the other forecasting techniques.
a. True
b. False

26. Which of the following is not a method of forecasting exchange rate volatility?
a. using the volatility of historical exchange rate movements
b. using a time series of volatility patterns in previous periods
c. using the volatility of future exchange rate movements
d. using the exchange rate’s implied standard deviation

27. 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 for €0.83 per dollar (one € = $1.20)
• Expected spot rate in five days is €0.85 per dollar
• Alonso Bank can borrow €10 million

What is the euro profit to Alonso Bank over the five-day period from shorting euros and going long on dollars?
a. €200,311.11
b. €207,111.11
c. €201,555.56
d. none of the above

28. Which of the following statements is incorrect?
a. Forward contracts are contracts typically negotiated with a commercial bank that allow the purchase or sale of a specified amount of a particular foreign currency at a specified exchange rate on a specified future date.
b. The forward market is located in New York City.
c. Many of the commercial banks that offer foreign exchange on a spot basis also offer forward transactions for the widely traded currencies.
d. Forward contracts can hedge a corporation’s risk that a currency’s value may appreciate over time.

29. 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

30. 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.

31. If the spot rate ____ the exercise price, a currency ____ option would not be exercised.
a. remains below; call
b. remains below; put
c. remains below; put
d. A and B

32. The pegged exchange rate system is no longer used by any countries.
a. True
b. False

33. If a firm planning to hedge receivables is certain of the future direction a spot rate will move, and requires a tailor-made hedge in terms of amount and maturity date, it should use a
a. call options contract traded on an exchange.
b. futures contract traded on an exchange.
c. forward contract.
d. put options contract traded on an exchange.

34. 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

35. The speculative risk of purchasing a ____ is that the foreign currency value ____ over time.
a. put option; increases
b. put option; decreases
c. call option; increases
d. futures contract; increases

36. Bank A asks $.555 for Swiss francs and Banks B and C are willing to pay $.557 for francs. An institution could capitalize on these differences by engaging in
a. covered interest arbitrage.
b. triangular arbitrage.
c. locational arbitrage.
d. witching hour arbitrage.

37. 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 country will have a ____.
a. higher; discount
b. lower; premium
c. higher; premium
d. A and B

38. ____ 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
e. None of the above

39. In the Wall Street Journal, you observe that the British pound (£) is quoted for $1.65. The Australian dollar (A$) is quoted for $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 the above

40. 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 the above

41. If British interest rates suddenly increase substantially relative to U.S. interest rates, the demand by U.S. investors for British pounds ____, the supply of British pounds to be sold in exchange for dollars ____, and the British pound will ____.
a. increases; decreases; appreciate
b. increases; decreases; depreciate
c. decreases; increases; appreciate
d. decreases; increases; depreciate
e. none of the above

42. 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 the above

43. A country that pegs its exchange rate to another exchange rate does not have complete control over its interest rates.
a. True
b. False

44. The euro is presently pegged to the British pound in order to stabilize international payments between European countries.
a. True
b. False

45. Financial institutions rarely use the forward market.
a. True
b. False

46. If the quoted cross rate between two foreign currencies is not aligned with the two corresponding exchange rates, investors can profit from triangular arbitrage.
a. True
b. False

47. The indirect exchange rate specifies the value of the currency in U.S. dollars.
a. True
b. False

48. The forward rate premium is dictated by the national income differential of the two currencies.
a. True
b. False

49. The potential benefits from using foreign exchange derivatives are independent of the expected exchange rate movements.
a. True
b. False

50. The forward rate is the exchange rate for immediate delivery.
a. True
b. False

51. 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

52. A country that pegs its currency does not have complete control over its local interest rates, as its interest rates must be aligned with the interest rates of the currency to which it is tied.
a. True
b. False

53. Exchange rates usually change precisely as suggested by the purchasing power parity (PPP) theory.
a. True
b. False

54. Central bank intervention can be overwhelmed by market forces and may not always succeed in reversing exchange rate movements.
a. True
b. False

55. 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

56. The forward rate premium reflects the percentage by which the spot rate exceeds the forward rate on an annualized basis.
a. True
b. False

57. 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

58. A speculator who expects a foreign currency to appreciate could purchase the currency forward and, when received, sell it in the spot market.
a. True
b. False

59. The following information refers to Fresno Bank and Champaign Bank.

Bid Rate on Euros Ask Rate on Euros
Fresno Bank $1.002 $1.009
Champaign Bank $0.997 $1.000

Based on this information, locational arbitrage would be profitable.
a. True
b. False

60. 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

61. ____ are not foreign exchange derivatives.
a. Forward contracts
b. Currency futures contracts
c. Currency swaps
d. Currency options
e. All of the above are foreign exchange derivatives.

62. ____ serve as financial intermediaries in the foreign exchange market by buying or selling currencies to accommodate customers.
a. Commercial banks
b. International mutual funds
c. Insurance companies
d. Pension funds
e. All of the above

63. In the Wall Street Journal, you observe that the British pound (£) is quoted for $1.67. The Australian dollar (A$) is quoted for $0.62. What is the value of the Australian dollar in British pounds?
a. A$2.69
b. £0.37
c. £2.69
d. A$0.37
e. none of the above

64. 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 the above

65. The supply and demand for a currency are influenced by all of the following, except
a. differential interest rates.
b. differential inflation rates.
c. direct government intervention.
d. indirect government intervention.
e. The supply and demand for a currency are affected by all of the above.

66. 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 the above

67. Assume an equilibrium state in which European inflation and U.S. inflation are both 4 percent. If U.S. inflation suddenly decreased 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 the above

68. Which of the following is the least feasible strategy for a speculator who expects the Australian dollar to depreciate?
a. sell Australian dollars forward and then purchase them in the spot market just before fulfilling the forward obligation
b. sell futures contracts on Australian dollar; purchase Australian dollars in the spot market just before fulfilling the futures obligation
c. purchase put options on Australian dollars, at some point before the expiration date, when the spot rate is less than the exercise price, purchase Australian dollars in the spot market and then exercise the put option
d. purchase call options on Australian dollars; at some point before the expiration date, exercise the call option and then sell the Australian dollars received in the spot market
e. All of the above are possible strategies for a speculator who expects the Australian dollar to depreciate.

69. 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.

70. The indirect exchange rate is always the reciprocal of the direct exchange rate.
a. True
b. False

71. 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.

72. 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. A and B

73. 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

74. When the Federal Reserve attempt to lower interest rates by increasing the U.S. money supply, it puts upward pressure on the value of the dollar.
a. True
b. False

75. A speculator who expects the euro to depreciate might:
a. sell euros forward and then purchase them in the spot market just before fulfilling the forward obligation.
b. purchase euros forward and, when they are received, sell them in the spot market.
c. purchase futures contracts on euros and, when the euros are received, sell them in the spot market.
d. all of the above

Chapter 17—Commercial Bank Operations

1. Which of the following statements is incorrect?
a. Banks have expanded their business across services over time.
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 the statements above are correct.

2. Commercial banks have expanded in recent years not only by acquiring other banks but also by acquiring other types of financial service firms.
a. True
b. False

3. Commercial banks can be a lender or a borrower when using repurchase agreements and loans in the federal funds market.
a. True
b. False

4. The operations, management, and regulation of a financial conglomerate are the same irrespective of the types of services offered.
a. True
b. False

5. ____ are offered to bank customers who desire to write checks against their account.
a. Time deposit accounts
b. CDs
c. Demand deposit accounts
d. Money market deposit accounts

6. Which type of savings account transfers funds to a checking account when checks are written?
a. ATS
b. passbook savings
c. CDs
d. MMDAs

7. A(n) ____ account provides checking services as well as interest.
a. demand deposit
b. negotiable order of withdrawal (NOW)
c. passbook savings
d. time deposit

8. Protective covenants impose conditions in which the bank must provide additional loans to a borrower to protect the borrower from going bankrupt.
a. True
b. False

9. A ____ is a time deposit offered by some large banks to corporations, with a specific maturity date, minimum deposit of $100,000 or more, and a secondary market.
a. retail CD
b. negotiable CD
c. market CD
d. protective CD

10. A bank’s sources of funds represent liabilities or equity of the bank.
a. True
b. False

11. Money market deposit accounts differ from conventional time deposits in that they
a. specify a maturity.
b. offer limited check writing privileges.
c. are less liquid.
d. none of the above

12. The intent of federal funds transactions is to
a. correct short-term fund imbalances experienced by banks.
b. correct long-term fund imbalances experienced by banks.
c. serve as a permanent source of bank capital.
d. serve as the primary depository source of funds.

13. For any given bank, federal funds ____ represent a(n) ____.
a. purchased; asset
b. sold; liability
c. purchased; liability
d. A and B

14. 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. none of the above; the rate is much higher than the Treasury yield in some periods, and much lower than the Treasury yield in other periods

15. Obtaining funds through ____ is not a common source of funds 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

16. Which of the following is true?
a. The primary credit lending rate is set by the president of the United States.
b. The federal funds rate is set by the president of the United States.
c. The primary credit lending rate is set by commercial banks.
d. The primary credit lending rate is now set at a level above the federal funds rate.
e. A and B

17. The Federal Reserve provides loans to banks in order to
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 the above

18. 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, then buys them back shortly thereafter, this is a
a. federal funds loan.
b. discount window loan.
c. repurchase agreement.
d. commercial paper transaction.

19. 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.

20. Because U.S. dollars are widely used as an international medium of exchange, the Eurodollar market is very active.
a. True
b. False

21. Subordinated notes and debentures are examples of
a. primary capital.
b. secondary capital.
c. depository sources of funds.
d. repurchase agreements.

22. All other things 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. A and B

23. As a source of funds, small banks rely more heavily on ____, and larger banks rely more heavily on ____.
a. time deposits and foreign deposits; savings deposits and short-term borrowings
b. savings deposits and short-term borrowings; foreign deposits and time deposits
c. savings and time deposits; foreign deposits and short-term borrowings
d. foreign deposits and short-term borrowings; savings and time deposits

24. Cash held ____ represents the major portion of a bank’s required reserves.
a. at other commercial banks
b. in a bank’s vault
c. on deposit at the federal funds window
d. on deposit with the Board of Governors

25. The main use of bank funds is for
a. loans.
b. investment securities.
c. fixed assets.
d. repurchase agreements.

26. Bank loans designed to support a firm’s ongoing business operations are called
a. term loans.
b. working capital loans.
c. direct lease loans.
d. revolving credit loans.

27. ____ loans are primarily used to finance the purchase of fixed assets.
a. Term
b. Working capital
c. Informal line of credit
d. Revolving credit

28. 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

29. A ____ loan may be especially appropriate when the bank wishes to avoid adding more debt to its balance sheet.
a. term
b. bullet
c. direct lease
d. revolving credit

30. The interest rate banks charge their most creditworthy customers is known as the
a. federal funds rate.
b. primary credit lending rate.
c. prime rate.
d. call money rate.

31. Transaction deposits do not include
a. demand deposits.
b. NCDs.
c. NOW accounts.
d. all of the above are transactions deposits

32. Commercial banks are not allowed to invest in
a. Treasury securities.
b. Freddie Mac securities.
c. Fannie Mae securities.
d. Banks can invest in all securities mentioned above.

33. Money market deposit accounts (MMDAs)
a. require a maturity of 6 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 the above

34. Which of the following accounts does not allow checks (at least a limited amount) to be written?
a. NOW accounts
b. money market deposit accounts (MMDAs)
c. retail CDs
d. all of the above allow checks to be written

35. Banks sometimes need funds 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 discount window
d. retail CDs

36. 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

37. Like other market interest rates, the primary credit lending rate moves in reaction to changes in demand or supply of funds or both.
a. True
b. False

38. The yield on repurchase agreements is slightly higher than the federal funds rate at any given point in time.
a. True
b. False

39. 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

40. In a revolving credit loan, the bank typically charges businesses a commitment fee on any unused funds.
a. True
b. False

41. Bank rates on credit card balances are usually not very different from the rate charged on business loans.
a. True
b. False

42. While U.S. banks have expanded into non-U.S. markets, few non-U.S. banks have entered U.S. markets.
a. True
b. False

43. ____ is (are) not a major source of funds for commercial banks.
a. Deposit accounts
b. Borrowed funds
c. Commercial loans
d. Bank capital
e. All of the above are commercial banks sources of funds.

44. Which of the following statements is incorrect 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 represent an asset to the borrowing bank and a liability to the lending bank that sells them.
c. The federal funds market is typically most active on Wednesday, because that is the final day of each particular settlement period for which each bank must maintain a specified volume of reserves required by the Fed.
d. All of the above are true with respect to the federal funds market.

45. The federal funds rate is typically ____ the primary credit lending rate.
a. greater than
b. less than
c. equal to
d. none of the above

46. ____ are the largest bank source of funds as a percentage of total liabilities.
a. Small-denomination time deposits
b. Money market deposit accounts (MMDAs)
c. Transaction deposits
d. Borrowed funds
e. Savings deposits (including MMDAs)

47. ____ do not specify a maturity and provide limited check-writing ability (they allow only a limited number of transactions per month).
a. Money market deposit accounts (MMDAs)
b. Negotiable CDs (NCDs)
c. Retail CDs
d. Callable CDs
e. Negotiable order of withdrawal (NOW) accounts

48. ____ loans are extended primarily to finance the purchase of fixed assets such as machinery.
a. Term
b. Working capital
c. Federal fund
d. Direct lease

49. Which of the following is not an off-balance sheet activity for commercial banks?
a. consumer loans
b. loan commitments
c. standby letters of credit
d. swap contracts
e. All of the above are off-balance sheet activities.

50. 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 the above

51. 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

52. When banks obtain funds in the federal funds market, the providers of the funds are
a. other depository institutions.
b. nonfinancial corporations.
c. consumers.
d. the Federal Reserve.

53. A single loan in the federal funds market is usually for ____; when a bank sells a single repurchase agreement, the 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

54. 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 lending rate.
d. none of the above

55. 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 lending rate.
c. repo rate.
d. none of the above

56. The primary credit lending rate is determined by
a. the Federal Reserve.
b. Congress.
c. the Treasury.
d. the President of the United States.

57. 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

58. Banks sometimes prefer to minimize their amount of capital since
a. interest payments must be paid by the bank on all capital that is held.
b. they try to avoid diluting ownership of the bank.
c. A and B
d. none of the above

59. 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

60. 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

61. A bank’s uses of funds represent liabilities of a bank.
a. True
b. False

62. ____ are the largest bank source of funds (as a percentage of total liabilities).
a. Small-denomination time deposits
b. Large-denomination time deposits
c. Transaction deposits
d. Savings deposits (including MMDAs)

63. The five largest banks in the United States account for about one-tenth of all assets in U.S. banks.
a. True
b. False

STA: DISC.FMAI.MADU.15.03

64. 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 lending rate.
c. must be sufficient to cover the bank’s other 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.

65. In a loan participation arrangement, normally all of the participating banks are exposed to credit (default) risk.
a. True
b. False

66. Banks will not accept intangible assets, such as patents and brand names, as collateral for commercial loans.
a. True
b. False

67. Proprietary trading is generally less risky than a bank’s lending operations.
a. True
b. False

68. 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.

69. 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.

70. A forward contract on currency:
a. is a way to hedge credit (default) risk.
b. is used to to swap fixed interest payments in euros for variable interest payments in dollars.
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.

71. Before the credit crisis, _________ were heavily used to protect against the credit (default) risk from investing in mortgage-backed securities.
a. standby letters of credit
b. interest rate swap contracts
c. credit default swap contracts
d. forward contracts on mortgages

72. 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.

Chapter 18—Bank Regulation

1. Deposit insurance has a limit of:
a. $10,000.
b. $25,000.
c. $100,000.
d. $250,000.

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.

3. Commercial banks that are not members of the Federal Reserve System ____ borrow from the Fed, and ____ subject to the Fed’s reserve requirements.
a. may; are
b. may; are not
c. may not; are not
d. may not; are

4. 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

5. All Fed member banks must hold
a. private insurance on deposits.
b. FDIC insurance on deposits.
c. both FDIC and private insurance on deposits.
d. none of the above

6. Commercial banks ____ restricted to a maximum percentage of their capital to loan to a single customer, and ____ 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

7. Banks commonly use depositor funds to invest in stocks.
a. True
b. False

8. An “off-balance-sheet commitment” that provides the bank’s guarantee on the financial obligations of a borrower to a specific party is a
a. standby letter of credit.
b. federal funds agreement.
c. repurchase agreement.
d. discount window agreement.

9. 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.

10. 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.

11. Which of the following is not a main deregulatory provision of Depository Institutions Deregulation and Monetary Control Act of 1980?
a. phase-out of deposit rate ceilings
b. allowance of checkable deposits for all depository institutions
c. new lending flexibility of depository institutions
d. allowance of interstate banking for depository institutions in most states

12. The Financial Reform Act was intended to:
a. prevent another credit crisis.
b. reduce capital ratios.
c. impose interest rate ceilings on deposits.
d. prevent banks from offering securities services.

13. 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 geographical 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.

14. Which of the following is not a specific criterion the FDIC uses to monitor banks?
a. capital adequacy
b. dollar value of fixed assets
c. asset quality
d. earnings
e. sensitivity to financial market conditions

15. The potential risk that financial problems can spread through financial institutions and the financial system is referred to as:
a. systemic
b. systematic
c. unsystematic
d. market

16. The Basel framework recommends capital requirements in proportion to:
a. mortgages
b. commercial paper
c. liabilities
d. risk-weighted assets

17. The Basel Accord
a. forces banks with greater risk to maintain more deposits.
b. forces banks with greater risk to maintain more capital.
c. forces banks with greater risk to maintain less capital.
d. none of the above

18. In general, a bank defines its value-at-risk as the estimated potential loss from its traditional businesses that could result from adverse movements in market prices.
a. True
b. False

19. Which of the following statements is incorrect?
a. The validity of a bank’s estimated VAR is assessed with backtests in which the actual daily trading gains or losses are compared to the estimated VAR over a particular period.
b. Some banks supplement the VAR estimate with stress tests.
c. In general, the VAR model does not lend itself to determine capital requirements.
d. All of the statements above are correct.

20. Which of the following is an “off-balance-sheet commitment?”
a. long-term debt
b. additional paid-in capital
c. notes payable
d. guarantees backing commercial paper issued by firms

21. The liquidity component of the CAMELS rating refers to
a. regulators’ concern about how a bank’s earnings would change if economic conditions change.
b. how well the bank’s management would detect its own financial problems.
c. a bank’s sensitivity to financial market conditions.
d. monitoring the type of loans that are given, the bank’s process for deciding whether to provide loans, and the credit rating of debt securities that it purchases.
e. excessive borrowing by banks from outside sources, such as the discount window.

22. Which of the following is not a corrective action taken by regulators when a bank is identified as a problem bank?
a. Regulators may examine such banks frequently and thoroughly.
b. Regulators may request that a bank boost its capital level or delay its plans to expand.
c. Regulators can require that additional financial information be periodically updated to allow continued monitoring.
d. Regulators have the authority to take legal action against a problem bank if the bank does not comply with their suggested remedies.
e. All of the above are possible corrective actions taken by bank regulators.

23. The fee banks pay to the FDIC for deposit insurance is now
a. a fixed dollar amount for all banks.
b. a fixed percentage of the bank’s deposit level for all banks.
c. a fixed percentage of the bank’s loan volume for all banks.
d. based on the risk of the bank.

24. Generally, the failure of small banks
a. causes more widespread concern about the safety of the banking system than the failure of large banks.
b. causes equal concern about the safety of the banking system as the failure of large banks.
c. causes less concern about the safety of the banking system than the failure of large banks.
d. Either A or B can be true, depending on the type of business cycle that exists while the failures occur.

25. 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

26. Bank A has a 10 percent capital ratio and uses a significant proportion of its assets to invest in very highly-rated bonds. Bank B has an 12 percent capital ratio and uses a significant proportion of its assets to invest in highly leveraged transactions. How would Bank A rate versus Bank B using the capital and asset quality criteria?
a. Bank A is perceived as safer by both criteria.
b. Bank B is perceived as safer by both criteria.
c. Bank A is perceived as safer according to capital, but more risky according to asset quality.
d. Bank B is perceived as safer according to capital, but more risky according to asset quality.

27. 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.

28. Deposit insurance now covers all bank deposits without imposing any limit.
a. True
b. False

29. Which banking act allowed banks to cross state lines in order to acquire a failing institution?
a. McFadden Act
b. Glass-Steagall Act
c. DIDMCA
d. Garn-St. Germain Act

30. Which banking act allowed for the creation of NOW accounts?
a. McFadden Act
b. Glass-Steagall Act
c. DIDMCA
d. Garn-St. Germain Act

31. 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

32. Which banking act permanently increased FDIC insurance up to $250,000?
a. DIDMCA
b. Sarbanes-Oxley Act
c. Financial Reform Act
d. Garn-St. Germain Act

33. Which banking act removed deposit rate ceilings?
a. McFadden Act
b. Glass-Steagall Act
c. DIDMCA
d. Garn-St. Germain Act

34. The argument that interstate banking would allow banks to grow and more fully achieve a reduction in operating costs per unit of output as output increases is based on
a. economies of scale.
b. financial leverage.
c. diseconomies of scale.
d. capital adequacy theory.

35. Federal deposit insurance
a. existed since the 1800s.
b. was created in 1933.
c. was created after World War II.
d. was created in 1960.

36. ____ is not a characteristics used by the Federal Deposit Insurance Corporation (FDIC) to rate banks.
a. Capital adequacy
b. Current stock price
c. Asset quality
d. Management
e. All of the above are used by the FDIC to rate banks.

37. The moral hazard problem is minimized when deposit insurance premiums are
a. zero (not imposed by the FDIC).
b. the same percentage of assets for all banks.
c. set at a fixed percentage of assets for large banks, and is zero for small banks.
d. set at a percentage of assets that is based on the bank’s risk level.

38. Which of the following statements is incorrect with respect to the Financial Services Modernization Act of 1999?
a. It complemented the Glass-Steagall Act.
b. It enabled commercial banks to more easily pursue securities and insurance activities.
c. It gave securities firms and insurance companies the right to acquire banks.
d. The Act requires that commercial banks must have a strong rating in community lending in order to pursue additional expansion in securities and other nonbank activities.
e. All of the above are true.

39. The ____ is the fund used to cover insured depositors.
a. Bank Insurance Fund
b. Federal Deposit Insurance Corporation (FDIC)
c. money market mutual fund
d. growth fund
e. none of the above

40. ____ is not a rating criterion used by the FDIC.
a. Capital adequacy
b. Off-balance sheet financing
c. Asset quality
d. Management
e. Liquidity

41. The uniform global capital requirements mandated a minimum level of Tier 1 capital, which primarily consists of funds obtained from
a. issuing commercial paper and bonds.
b. retaining earnings and issuing commercial paper.
c. retaining earnings and issuing common stock.
d. issuing bonds and common stock.

42. During the 2008-2010 period, the ____ was implemented to alleviate the financial problems experienced by banks and other financial institutions with excessive exposure to mortgages or mortgage-backed securities.
a. Riegle Program
b. Sarbanes-Oxley Program
c. FDIC Program
d. Troubled Asset Relief Program (TARP)

43. The act of taking a risk because of protection from adverse consequences due to the risk is referred to as a moral hazard problem.
a. True
b. False

44. The Sarbanes-Oxley Act (SOX) was enacted in 2002 in order to ensure a more transparent process for reporting on productivity and the financial condition of the firm.
a. True
b. False

45. The Sarbanes-Oxley Act (2002) was enacted in response to some banks taking too much risk.
a. True
b. False

46. Publicly-traded banks have incurred larger reporting expenses to comply with the Sarbanes-Oxley Act.
a. True
b. False

47. 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 without being subjected to stringent constraints.
c. offers 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.

48. Which of the following is not true regarding the Financial Services Modernization Act of 1999?
a. It provided more momentum for the consolidation of financial services.
b. Financial institutions were finally able to offer a diversified set of financial services without being subjected to stringent constraints on the form or amount of financial services that they could offer.
c. Banks and other financial service firms were given more freedom to merge, but were forced to divest some of the financial services that they acquired.
d. Financial institutions no longer had to search for loopholes or monitor their business to ensure that the degree of financial services offered remained within the regulatory constraints that were previously imposed.
e. all of the above are true

49. All state banks are required to be members of the Federal Reserve System.
a. True
b. False

50. State banks are regulated by the Comptroller of the Currency.
a. True
b. False

51. Banks that are insured by the Federal Deposit Insurance Corporation (FDIC) are also regulated by the FDIC.
a. True
b. False

52. Commercial banks are allowed to invest in junk bonds.
a. True
b. False

53. In general, banks would prefer to maintain a high amount of capital to boost their return on equity ratio, yet regulators have argued that banks need only a sufficient amount of capital to absorb potential operating losses.
a. True
b. False

54. The provision of a letter of credit by a bank to issue commercial paper issued by a corporation is an example of an off-balance sheet commitment.
a. True
b. False

55. As a result of the Reigle-Neal Act, bank customers have benefited because of lower costs to banks and because of convenience.
a. True
b. False

56. There is much emphasis by regulators on the 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

57. If regulators reduce bank failures by imposing regulations that reduce competition, bank efficiency will be increased.
a. True
b. False

58. An ideal solution to react to a large failing bank would prevent a run on deposits of other large banks, yet not reward a poorly performing bank with a bailout.
a. True
b. False

59. ____ is not a rating criterion used by the Federal Deposit Insurance Corporation (FDIC).
a. Capital adequacy
b. Off-balance sheet financing
c. Asset quality
d. Management
e. Liquidity

60. 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 the above

61. Bank regulations typically:
a. involve a tradeoff 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 the above

62. 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

63. 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

64. 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.

65. 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.

66. 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.

67. 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.

68. The Wall Street Reform and Consumer Protection Act (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.

Chapter 19—Bank Management

1. Which of the following statements is incorrect?
a. Managers may be tempted to make decisions that are in their own best interests rather than shareholder interests.
b. Directors are responsible for making most of the bank’s decisions regarding loans to customers, which encourages a loan department to extend loans with a very high concern for risk.
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.

2. When cash outflows temporarily exceed cash inflows, banks are most likely to experience
a. higher dividend payments.
b. illiquidity.
c. a negative duration on its assets.
d. an excess of capital.

3. Banks can resolve cash deficiencies by
a. creating additional liabilities.
b. selling assets.
c. buying back common stock.
d. increasing dividend payouts.
e. A or B

4. As the secondary market for loans has become active, banks are more able 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

5. 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

6. If a bank that relies heavily on short-term deposits expects interest rates to consistently decrease over time, it would allocate most of its loans with ____ rates if it desires to maximize its expected returns. It could reduce its exposure to interest rate risk by setting ____ rates on its loans.
a. fixed; fixed
b. variable; fixed
c. variable; variable
d. fixed; variable

7. 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

8. If a bank expected 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 the above

9. 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

10. 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 gap is $____.
a. −300 million
b. 300 million
c. −500 million
d. 500 million

11. 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 gap ratio is ____ percent.
a. 37.5
b. 50.0
c. 100.0
d. 40.0

12. The measure of interest rate risk that uses the difference between rate-sensitive assets and rate-sensitive liabilities is called
a. gap measurement.
b. duration measurement.
c. duration ratio.
d. gap ratio.

13. A gap ratio of less than one 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. B and D

14. 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

15. 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. A or B, depending on the size of the coupon payment

16. In general, the duration of zero-coupon securities with short maturities is ____ than the duration of zero-coupon securities with long maturities.
a. higher than
b. lower than
c. equal to
d. A or B, depending on the issuer of the securities

17. Other things equal, assets with shorter maturities have ____ durations. Assets that generate more frequent coupon payments have ____ durations.
a. shorter; longer
b. shorter; shorter
c. longer; shorter
d. longer; longer

18. 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

19. Other things being equal assets with ____ maturities and ____ frequent coupon payments have shorter durations.
a. shorter; more
b. shorter; less
c. longer; more
d. longer; less

20. If a bank attempts to reduce exposure to interest rate risk by replacing long-term marketable securities with more floating-rate commercial loans, it is likely that the bank’s
a. default risk would decrease.
b. default risk would increase.
c. liquidity risk would increase.
d. liquidity risk would decrease.
e. B and C

21. 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

22. 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

23. 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
c. purchase; reduces
d. both A and C are correct

24. 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

25. Banks increase their risk by increasing their capital as a percentage of assets.
a. True
b. False

26. 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

27. Banks tend to focus their loans in one industry so that they can specialize on one industry and reduce the credit risk of their loan portfolio.
a. True
b. False

28. Most loan sales enable the bank originating the loan to continue servicing the loan.
a. True
b. False

29. ROE is defined as
a. .
b. .
c. .
d. .

30. 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

31. 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 the above

32. A bank has the following asset and liability portfolios. What is the gap?

Rate-sensitive Amount Rate-sensitive Amount
assets (in millions) liabilities (in millions)
Floating-rate
loans $4,000 NOW accounts $1,750

Floating-rate
mortgages 1,000 MMDAs 4,500

Short-term
Treasury securities 1,500 Short-term CDs 1,000

$6,500 $7,250

a. $750 million
b. −$750 million
c. 1.12
d. .896
e. none of the above

33. A bank has the following asset and liability portfolios. What is the gap ratio?

Rate-sensitive Amount Rate-sensitive Amount
assets (in millions) liabilities (in millions)
Floating-rate
loans $4,000 NOW accounts $1,750

Floating-rate
mortgages 1,000 MMDAs 4,500

Short-term
Treasury securities 1,500 Short-term CDs 1,000

$6,500 $7,250

a. $750 million
b. −$750 million
c. 1.12
d. .896
e. none of the above

34. If Bank A has a negative gap and Bank B has a positive gap. Which of the following is true?
a. Bank A is more favorably affected by rising interest rates.
b. Bank B is more favorably affected by falling interest rates.
c. Bank A is adversely affected by falling interest rates.
d. none of the above

35. Which of the following is a measure for banks to assess their exposure to interest rate risk?
a. capital ratio
b. leverage measure
c. duration measurement
d. gap ratio
e. C and D

36. If a bank sells interest rate futures, it ____ of rising interest rates and ____ of declining interest rates on its interest expenses.
a. reduces the potential adverse effect; reduces the potential favorable effect
b. increases the potential adverse effect; increases the potential favorable effect
c. decreases the potential adverse effect; increases the potential favorable effect
d. increases the potential adverse effect; decreases the potential favorable effect

37. Which of the following loan portfolios are best diversified against default risk?
a. consumer loans to farmers and commercial loans to farm equipment dealers in a local area
b. commercial loans to the same industry
c. commercial loans to various retail stores in the same city
d. consumer and commercial loans to different industries in different cities

38. Banks can increase their liquidity position by restructuring their asset portfolio to contain less ____ and more ____.
a. excess reserves; Treasury bills
b. Treasury bonds; corporate bonds
c. loans; Treasury bills
d. none of the above

39. Banks would reduce their liquidity position by restructuring their asset portfolio to contain less ____ and more ____.
a. Treasury securities; excess reserves
b. loans; Treasury securities
c. corporate bonds; Treasury securities
d. none of the above

40. Banks can reduce their default risk by restructuring their asset portfolio to contain less ____ and more ____.
a. Treasury bonds; corporate bonds
b. Treasury bonds; municipal bonds
c. Treasury bonds; commercial loans
d. none of the above

41. Banks can increase their potential interest revenues by restructuring their asset portfolio to contain less ____ and more ____.
a. Treasury bonds; commercial loans
b. Treasury bonds; excess reserves
c. consumer loans; Treasury bills
d. none of the above

42. If a bank desired 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

43. A bank that holds a greater percentage of traditional demand deposits and loans will likely incur ____ non-interest expenses and have a ____ net interest margin than other banks of the same size (assuming that its loan losses are no higher than those at other banks).
a. greater; higher
b. greater; lower
c. less; higher
d. less; lower

44. 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.

45. A common method for banks to reduce their default risk is to
a. specialize in loans to just one or a few particular industries in which they have expertise in assessing creditworthiness.
b. specialize in loans of companies whose earnings patterns are quite similar over time.
c. A and B
d. none of the above

46. International diversification of loans can best reduce the bank’s overall default risk if
a. the countries where loans are given are clustered together in a single continent.
b. the countries where loans are given have economic cycles that do not move together over time.
c. A and B
d. none of the above

47. 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.

48. Banks can reduce their required capital levels by
a. increasing their loans.
b. reducing their loans.
c. increasing their dividends.
d. obtaining more deposits.

49. Terp Bank obtains a relatively large portion of its funds from conventional demand deposits as it creates many branches with many employees to attract demand deposits. Its interest expenses should be relatively ____, while its noninterest expenses should be relatively ____.
a. high; low
b. low; high
c. high; high
d. low; low
e. none of the above

50. 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.

51. ____ is not a method used to assess interest rate risk.
a. Efficiency analysis
b. Gap analysis
c. Duration analysis
d. Regression analysis

52. 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
d. $1 million; decrease
e. none of the above

53. 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 the above

54. ____ is (are) least likely to be used as a method of reducing interest rate risk.
a. Maturity matching
b. Using floating-rate loans
c. Stock options
d. Using interest rate swaps
e. Using interest rate caps

55. Ringo Bank has a profit after taxes of $3.0 million, total assets of $300 million, and shareholder’s equity of $30 million. Ringo’s return on equity (ROE) is ____ percent.
a. 1.0
b. 10.0
c. 3.0
d. none of the above

56. 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. B or C

57. Assume a bank accepts deposits on Australian dollars (A$) and makes some fixed-rate loans in British pounds. Which of the following would reduce the bank’s profit margin?
a. the A$ appreciates against the pound
b. the A$ is stable against the pound
c. the A$ depreciates against the pound
d. the British interest rates increase
e. C and D

58. The performance of a bank that continually concentrates in short-term deposits in euros and adjustable-rate dollar loans with equal rate-sensitivity is
a. unaffected if European interest rates increase and U.S. rates decrease.
b. unaffected if U.S. interest rates increase and European interest rates decrease.
c. adversely affected if European interest rates increase and U.S. rates decrease.
d. adversely affected if U.S. interest rates increase and European rates decrease.
e. A and B

59. 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 are similar.
c. rate sensitivity of assets and liabilities is matched for each currency.
d. A and B

60. 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 the above

61. The Sarbanes-Oxley Act has had little impact on the monitoring conducted by the board members of commercial banks.
a. True
b. False

62. 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

63. A positive gap (or gap ratio of more than 1.00) suggests that rate-sensitive liabilities exceed rate-sensitive assets.
a. True
b. False

64. For most banks, the average duration of liabilities exceeds the average duration of assets, so the duration gap is positive.
a. True
b. False

65. Floating-rate loans completely eliminate interest rate risk.
a. True
b. False

66. A bank can usually simultaneously maximize its return on assets and minimize credit risk.
a. True
b. False

67. If the currency mix of a bank’s assets is similar to that of its liabilities and the overall rate sensitivity of its assets and liabilities is similar, interest rate risk is completely nonexistent.
a. True
b. False

68. Macon Bank has interest revenues of $4 million, interest expenses of $5 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.

69. ____ is not a method used to assess interest rate risk.
a. Gap analysis
b. Ratio analysis
c. Duration analysis
d. Regression analysis
e. All of the above are methods to assess interest rate risk.

70. ____ 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

71. Crazer Bank has a profit after taxes of $2 million, total assets of $100 million, and shareholder’s equity of $10 million. Crazer’s return on equity (ROE) is ____ percent.
a. 18
b. 210
c. 15
d. 20
e. none of the above

72. Parsons Bank reported $3 million in interest revenues and $1 million in interest expenses. Parsons has $20 million in assets and $8 million in liabilities. Parsons net interest margin is ____ percent.
a. 10
b. −10
c. 35
d. 25
e. none of the above

73. 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. answers A and B are correct
e. none of the above

74. 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; decrease
e. answers C and D are correct

75. If interest rates ____, banks with ____ duration gaps will be ____ affected.
a. rise; positive; positively
b. rise; positive; adversely
c. decrease; positive; adversely
d. decrease; negative; positively
e. none of the above

76. In a regression of a bank’s stock return on an interest rate proxy and market returns, a ____ coefficient for the interest rate variable suggests that bank performance is ____ affected by ____ interest rates.
a. positive; adversely; rising
b. positive; favorably; declining
c. negative; adversely; rising
d. negative; favorably; rising
e. none of the above

77. If a bank has a ____ duration gap, its average asset duration is probably ____ than its liability duration.
a. negative; smaller
b. positive; larger
c. negative; larger
d. none of the above

78. 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 the above

79. 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 the above

80. The risk of a loss due to closing out a transaction is referred to as ____ risk.
a. settlement
b. credit
c. interest rate
d. exchange rate
e. none of the above

81. 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

82. 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
d. pursuing a proxy contest to change the bank’s dividend policy

83. As part of its liquidity management, a bank might:
a. purchase interest rate swaps.
b. issue commercial paper.
c. purchase long-term Treasury securities.
d. A and C

84. 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

85. 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

Chapter 20—Bank Performance

1. A(n) ____ in interest rates could reduce a commercial bank’s expected cash flows because the interest paid on deposits may ____ than the interest earned on loans and investments.
a. increase; increase to a greater degree
b. increase; increase to a lesser degree
c. decrease; increase to a greater degree
d. decrease; increase to a lesser degree

2. 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

3. The risk premium on a commercial bank is ____ related to economic growth and ____ related to management skills.
a. positively; negatively
b. positively; positively
c. negatively; negatively
d. negatively; positively

4. Interest income generated from all assets is called
a. net interest margin.
b. the spread.
c. gross interest income.
d. net interest income.

5. 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.

6. Net interest income is the difference between gross interest income and interest expenses and is measured as a percentage of
a. liabilities.
b. shareholder’s equity.
c. assets.
d. revenues.

7. 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

8. The loan loss provision as a percentage of assets should increase during periods of high economic growth.
a. True
b. False

9. A bank’s net interest margin represents the proportion of its investments that are financed with borrowed funds.
a. True
b. False

10. 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.

11. For a given level of return on assets, a bank with a higher level of capital will have a lower
a. return on equity.
b. leverage measure.
c. noninterest income.
d. liquidity.

12. 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).

13. 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. assets divided by equity.

14. 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. A and B
e. B and C

15. Gross interest income is affected by
a. market interest rates.
b. the composition of assets held by banks.
c. interest expenses.
d. non-interest expenses.
e. A and B

16. 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

17. 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

18. 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. A and B

19. If a bank had long-term fixed-rate assets and short-term liabilities, and interest rates increased over time, its net interest margin should
a. decrease.
b. increase.
c. stay the same.
d. either A or B, depending on whether the asset maturities exceed 10 years

20. The sum of net interest income, non-interest income, and securities gains, minus provision for loan losses and non-interest expenses equals
a. net interest margin.
b. gross interest margin.
c. net income.
d. income before taxes.

21. 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

22. 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

23. 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 beta is probably ____ than that of Bank H.
a. less; lower
b. less; higher
c. more; higher
d. more; lower

24. Bank K is conservatively managed. It benefits slightly when general economic conditions are very favorable and is hurt slightly when general economic conditions are very unfavorable. Its beta would likely be
a. less than zero.
b. zero.
c. between zero and 1.00.
d. greater than 1.00.

25. ____ results 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 the above

26. Bank X obtains most of its funds from NCDs, while Bank Y obtains much of its funds from passbook savings and from demand deposit accounts. Given this information, the net interest margin of Bank X would likely be ____ than that of Bank Y, and noninterest expenses would likely be ____ than that of Bank Y.
a. greater; greater
b. greater; less
c. less; less
d. less; greater

27. 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

28. 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

29. A bank’s ROA ____ account for loan losses. A bank’s ROE ____ account for loan losses.
a. does; does
b. does; does not
c. does not; does not
d. does not; does

30. A bank’s net interest margin includes
a. noninterest expenses.
b. noninterest income.
c. loan losses.
d. none of the above

31. Banks with relatively ____ ROAs often incur ____ noninterest expenses.
a. low; very low
b. low; very high
c. high; very high
d. none of the above

32. Bank T generally obtains a high percentage of its funds from wholesale CDs. Bank V which obtains most of its funds from retail CDs. Bank Z obtains its funds from checking accounts. The bank that will incur the highest interest expenses is ____.
a. Bank T
b. Bank V
c. Bank Z
d. all banks are the same

33. Which of the following is not a factor that affects cash flows of a commercial bank?
a. changes in economic growth
b. changes in the risk-free interest rate
c. changes in industry conditions
d. changes in management abilities
e. all of the above are factors that affect cash flows of a commercial bank

34. The value of a commercial bank can be modeled as the present value of its future cash flows.
a. True
b. False

35. 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

36. 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

37. Gross interest expenses of banks are normally higher in periods when market interest rates are higher
a. True
b. False

38. If banks continue to offer new services (such as insurance or securities services), their noninterest income will decrease over time.
a. True
b. False

39. The loan loss provision should increase during periods when loan losses are more likely, such as during a recessionary period.
a. True
b. False

40. Any individual bank’s ROA depends on the bank’s policy decisions, but not on uncontrollable factors relating to the economy and government regulations.
a. True
b. False

41. 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.
a. True
b. False

42. 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 provision

43. During periods of ____ economic growth, loan demand tends to be ____, allowing banks to provide ____ loans.
a. strong; higher; more
b. weak; higher; more
c. weak; lower; more
d. strong; lower; fewer
e. none of the above

44. 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 the above

45. If a bank is too ____ in attempting to avoid loan losses, its net interest margin will be ____.
a. conservative; high
b. conservative; low
c. aggressive; high
d. aggressive; low
e. none of the above

46. Banks offering ____ nontraditional services will incur ____ noninterest expenses and ____ noninterest income.
a. fewer; higher; higher
b. more; lower; higher
c. more; higher; higher
d. fewer; lower; higher
e. none of the above

47. 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

48. 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

49. 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
c. the bank’s loan rate
d. composition of the bank’s assets

50. 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.

Chapter 21—Thrift Operations

1. The insuring agency for savings institutions is the
a. Securities and Exchange Commission (SEC).
b. Federal Deposit Insurance Corporation (FDIC).
c. U.S. Treasury.
d. Federal Reserve

2. The ____ savings institutions hold the most assets in aggregate.
a. stock owned
b. mutual
c. closely-held
d. privatized

3. Which of the following statements is incorrect?
a. A mutual-to-stock conversion allows savings institutions to obtain additional capital by issuing stock.
b. Because of the difference in owner control, mutual savings institutions are more susceptible to unfriendly takeovers.
c. When a mutual savings institution is involved in an acquisition, it first converts to a stock-owned savings institution.
d. Consolidation and acquisitions have caused the number of mutual and stock savings institutions to decline consistently over the years.

4. Savings institutions use most of their funds for ____. Commercial banks use most of their funds for ____.
a. mortgages; mortgages
b. mortgages; business loans and commercial real estate loans
c. business loans; commercial real estate loans and mortgages
d. commercial real estate loans and mortgages; business loans

5. Federally-chartered savings institutions are regulated by the
a. Securities and Exchange Commission (SEC).
b. National Credit Union Administration.
c. Federal Reserve.
d. U.S. Treasury.

6. Savings institutions obtain most of their funds from
a. savings and time deposits.
b. loans.
c. mortgages.
d. repurchase agreements.

7. 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 the above

8. The capital of savings institutions is primarily composed of retained earnings and funds obtained from issuing stock.
a. True
b. False

9. If depositors move money from their checking account 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. A or C, depending on the size of the savings institution

10. ____ are the primary asset of savings institutions.
a. Mortgages
b. Cash balances
c. Investment securities
d. Business loans

11. Savings institutions that reduce their amount of ____ will best reduce their exposure to interest rate risk.
a. fixed-rate mortgages
b. consumer loans
c. commercial loans
d. short-term securities

12. ____ do not represent an asset of credit unions.
a. Mortgage-backed securities
b. Home equity loans
c. Automobile loans
d. Stocks

13. Which of the following is not an asset of savings institutions?
a. loans
b. mortgages
c. NOW accounts
d. mortgage-backed securities

14. 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 the above.

15. If a savings institutions’ assets have 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. increasing its proportion of liabilities in the long duration category.
d. A and B

16. Adjustable-rate mortgages ____ of rising interest rates on a typical savings institution’s spread. They ____ of declining interest rates on the spread.
a. reduce the adverse impact; reduce the favorable impact
b. reduce the adverse impact; increase the favorable impact
c. increase the adverse impact; increase the favorable impact
d. increase the adverse impact; reduce the favorable impact

17. 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 the above

18. 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 cap contract.
d. security swap contract.

19. When a savings institution uses interest rate swaps to hedge interest rate risk, it would likely exchange ____ outflows for ____ inflows.
a. variable-rate; fixed-rate
b. variable-rate; variable-rate
c. fixed-rate; variable-rate
d. fixed-rate; fixed-rate

20. An interest rate swap reduces the favorable impact of declining interest rates.
a. True
b. False

21. A savings institution owned by its depositors is a ____ savings institution.
a. mutual
b. stock
c. credit
d. closed-end

22. Which of the following was not a major reason for the savings institution crisis in the late 1980s?
a. a large proportion of loan losses on real estate loans
b. a large proportion of loan losses on loans by savings institutions to less-developed countries
c. fraud
d. illiquidity
e. increased interest expenses

23. The Financial Institutions Reform, Recovery, and Enforcement Act (FIRREA) prohibited
a. savings institutions from merging.
b. commercial banks from acquiring savings institutions.
c. savings institutions.
d. savings institutions from making loans to foreign governments.

24. 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 the above

25. Money market deposit accounts (MMDAs) represent
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.

26. Savings institutions ____ allowed to borrow funds in the federal funds market; savings institutions ____ allowed to borrow funds from the Federal Reserve.
a. are; are
b. are; are not
c. are not; are not
d. are not; are

27. 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

28. 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

29. Savings institutions can obtain capital by:
a. issuing stock.
b. repurchasing stock.
c. borrowing from the Federal Reserve.
d. borrowing in the federal funds market.

30. To obtain short-term funds, savings institutions commonly borrow funds in the ____ market.
a. stock
b. bond
c. mortgage
d. federal funds
e. futures

31. ____ risk is probably the least concern for savings institutions.
a. Liquidity
b. Exchange rate
c. Credit
d. Interest rate

32. Which of the following is not an advantage of credit unions?
a. They can offer attractive rates to their member savers and borrowers because they are nonprofit and therefore are not taxed.
b. Their noninterest expenses are relatively low, because their labor, office, 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 the above are advantages of credit unions.

33. A savings institution’s cash flows are ____ related to interest rate movements.
a. positively related to
b. negatively related to
c. unrelated to
d. none of the above

34. 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.
e. none of the above

35. ____ are non-profit organizations composed of members with a common bond.
a. Credit unions
b. Savings banks
c. Savings and loan associations
d. Commercial banks

36. 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

37. 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.

38. Checkable accounts offered by credit unions are called
a. NOW accounts.
b. money market deposit accounts.
c. share certificates.
d. share drafts.

39. 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

40. The sensitivity of cost of funds to interest rate movements has been
a. greater for credit unions than savings institutions.
b. greater for credit unions than commercial banks.
c. lower for credit unions than for savings institutions or commercial banks.
d. similar for credit unions as savings institutions and commercial banks.

41. 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.

42. If credit union members have a particular affiliation with their employers and large layoffs occur, the credit union’s exposure to ____ risk may increase.
a. settlement
b. interest rate
c. credit
d. none of the above

43. The maximum insurance per depositor by the National Credit Union Insurance Fund is
a. $250,000.
b. $50,000.
c. $40,000.
d. $25,000.

44. Comparing credit unions with 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 less exposure to liquidity risk.

45. 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

46. Because credit unions’ sources and uses of funds are generally interest rate ____, movements in interest revenues and interest expenses of credit unions are ____.
a. sensitive; negatively correlated
b. insensitive; highly correlated
c. sensitive; uncorrelated
d. sensitive; highly correlated
e. insensitive; uncorrelated

47. Deposits at credit unions are called
a. NOW accounts.
b. money market deposit accounts.
c. shares.
d. credit union deposit accounts.

48. Credit unions differ from savings institutions in that they use a ____ proportion of their funds for mortgages and are ____ institutions.
a. smaller; non-profit
b. larger; non-profit
c. smaller; for-profit
d. larger; for-profit

49. Today, credit unions are regulated as to the
a. types of services they can offer.
b. rates they offer on deposits.
c. maturity of residential loans they make.
d. size of residential mortgage loans.

50. The National Credit Union Share Insurance Fund (NCUSIF) requires all
a. federal-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 an annual supplemental insurance premium each year.
d. depository institutions to pay a supplemental insurance premium each year.

51. Federal credit unions are regulated and supervised by the
a. Central Liquidity Facility.
b. National Credit Union Administration.
c. Securities and Exchange Commission.
d. Corporate Credit Union Network.
e. none of the above

52. 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

53. In general, savings institutions are larger than commercial banks.
a. True
b. False

54. Today, savings institutions are not permitted to invest in junk bonds.
a. True
b. False

55. 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

56. 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

57. 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

58. 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

59. 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

60. Because credit unions do not issue stock, they are technically sole proprietorships.
a. True
b. False

61. Because credit unions are for-profit organizations, their income is taxable.
a. True
b. False

62. Credit unions obtain most of their funds by borrowing from the U.S. government.
a. True
b. False

63. Credit unions use the majority of their funds to invest in the stock market.
a. True
b. False

64. The National Credit Union Administration (NCUA) is responsible for regulating savings institutions.
a. True
b. False

65. Credit unions are unregulated as to the types of services they offer.
a. True
b. False

66. All federally chartered credit unions are required to obtain insurance from the National Credit Union Share Insurance Fund (NCUSIF).
a. True
b. False

67. The primary source of funds for credit unions is
a. share certificates.
b. share deposits.
c. share drafts.
d. borrowed funds from the Central Liquidity Facility (CLF).
e. none of the above

68. Which of the following is not an objective of a credit union?
a. to satisfy credit union members
b. to act as an intermediary for members by repackaging deposits
c. to provide loans to members who are in need of funds
d. all of the above are objectives of credit unions.

69. ____ are not a main source of funds for savings institutions.
a. Deposits
b. Borrowed funds
c. Capital
d. Mortgages

70. Which of the following is not a deposit source of funds for savings institutions?
a. passbook savings
b. retail CDs
c. money market deposit accounts
d. negotiable order of withdrawal (NOW) accounts
e. All of the above are deposit sources of funds for savings institutions.

71. ____ is not a main use of funds for savings institutions.
a. Capital
b. Mortgages
c. Consumer and commercial loans
d. Mortgage-backed securities

72. Savings institutions were adversely affected by the credit crisis because of their exposure to ____.
a. deposits
b. mortgages
c. commercial loans
d. loans from the Federal Reserve

73. 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.

74. Under the Wall Street Reform and Consumer Protection Act (Dodd-Frank Act), all federally chartered savings institutions are to be regulated by the Federal Reserve, so these savings institutions no longer have an incentive to go regulator shopping.
a. True
b. False

75. 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

76. During the credit crisis of 2008–2009:
a. the Resolution Trust Corporation was formed to deal with insolvent savings institutions.
b. several large savings institutions failed, including Countrywide Financial and Washington Mutual.
c. savings institutions were insulated because their regulator subsidized any of them that experienced large loan defaults.
d. the main problem for savings institutions was exposure to interest rate risk.

77. 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.

78. 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.

Chapter 22—Finance Company Operations

1. ____ finance companies concentrate on purchasing credit contracts from retailers and dealers.
a. Consumer
b. Sales
c. Commercial
d. None of the above

2. Which of the following is not a source of finance company funds to support operations?
a. loans from banks
b. commercial paper
c. federal funds
d. bonds

3. When a finance company’s assets are ____ interest rate sensitive than its liabilities and when interest rates are expected to ____, bonds can provide long-term financing at a rate that is completely insulated from rising market rates.
a. less; increase
b. less; decrease
c. more; increase
d. more; decrease

4. Finance companies differ from commercial banks, savings institutions, and credit unions in that they
a. normally do not obtain funds from deposits.
b. focus on financing acquisitions by companies.
c. focus on providing residential mortgages.
d. use most of their funds to purchase stocks.

5. Which of the following is not a main source of funds for finance companies?
a. bank loans
b. commercial paper issues
c. bonds
d. capital

6. Finance companies are more likely to issue bonds when their assets are presently ____ interest-rate sensitive than their liabilities, and when interest rates are expected to ____.
a. more; decrease
b. less; increase
c. more; increase
d. less; decrease

7. If finance companies were confident about projections of ____ interest rates, they may consider using the funds obtained from issuing bonds to offer loans with ____ rates.
a. declining; variable
b. rising; fixed
c. rising; variable
d. A and B

8. Finance companies would prefer to increase their long-term debt most once interest rates
a. have declined.
b. have increased.
c. were stable for several years.
d. were projected to decline.

9. The main competition for finance companies in the consumer loan market comes from
a. pension funds.
b. life insurance companies and property and casualty insurance companies.
c. commercial banks and savings and institutions.
d. mutual funds.

10. When finance companies purchase a firm’s receivables at a discount, and are responsible for processing and collecting the balances of these accounts, they act as a
a. leasing agent.
b. lessor.
c. lessee.
d. factor.

11. When a finance company purchases equipment for use by another business, the finance company provides financing in the form of
a. factoring.
b. leasing.
c. a banker’s acceptance.
d. a letter of credit.

12. Finance companies are exempt from state regulations.
a. True
b. False

13. Finance companies are not subject to state regulations on intrastate business.
a. True
b. False

14. Finance companies are subject to
a. a maximum limit on loan size.
b. ceiling interest rates on loans provided.
c. a maximum length on loan maturity.
d. regulations on intra-state banking.
e. all of the above

15. If finance companies with a greater rate-sensitivity of liabilities than assets wanted 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.

16. Overall, the liquidity risk of finance companies is higher than that of other financial institutions.
a. True
b. False

17. Compared to other lending financial institutions, finance companies have a ____ loan delinquency rate, and the average rate charged on loans is ____ on average.
a. lower; lower
b. lower; higher
c. higher; higher
d. higher; lower

18. 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
a. captive finance subsidiary.
b. factor.
c. leasing agent.
d. captive factoring agent.

19. Which of the following statements is incorrect?
a. A captive finance subsidiary’s purpose is to finance sales of the parent company’s products and services.
b. An operating agreement between the parent and the captive specifies the type of receivables that qualify for same and specific services provided by the parent.
c. A captive can be used to finance distributor or dealer inventories until a sale occurs.
d. A captive is rarely used to finance products leased to others.

20. ____ provide loans to firms that cannot obtain financing from commercial banks.
a. Consumer finance companies
b. Sales finance companies
c. Commercial finance companies
d. None of the above

21. Which of the following is not a use of finance company funds?
a. consumer loans
b. business loans
c. commercial paper
d. real estate loans
e. All of the above are uses of finance company funds.

22. 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 the above

23. Most finance companies are commonly exposed to all forms of risk below except ____ risk.
a. exchange rate
b. interest rate
c. liquidity
d. credit

24. Changes in economic growth are ____ related to a finance company’s cash flows, and changes in the risk-free rate are ____ related to a finance company’s cash flows.
a. positively; negatively
b. negatively; positively
c. negatively; negatively
d. positively; positively

25. Finance companies participate in the ____ market to reduce interest rate risk.
a. money
b. bond
c. options
d. swap

26. Many consumer finance companies also provide personal loans, directly to individuals to finance purchases of large household items.
a. True
b. False

27. Business finance companies focus on loans to very large businesses.
a. True
b. False

28. Consumer finance companies sometimes provide Business finance companies to individuals.
a. True
b. False

29. 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

30. After interest rates increase, finance companies tend to use more long-term debt to lock in the cost of funds over an extended period of time.
a. True
b. False

31. Some finance companies offer credit card loans through a particular retailer.
a. True
b. False

32. The main competition for finance companies in the consumer loan market comes from pension funds and insurance companies.
a. True
b. False

33. The value of a finance company can be modeled as the present value of its future cash flows.
a. True
b. False

34. The most important risk for finance companies is ____ risk.
a. settlement
b. accounting
c. credit
d. exchange rate

35. Finance companies can accumulate capital by doing all of the following except
a. retaining earnings.
b. issuing stock.
c. issuing commercial paper.
d. Finance companies can build their capital base by doing all of the above.

36. Consumer finance companies primarily focus on for
a. consumer loans.
b. consumer advising.
c. consumer regulation.
d. none of the above

37. Finance companies are regulated by the states but are not subject to regulation by an agency of the federal government.
a. True
b. False

38. Historically, captive finance subsidiaries were associated with:
a. the automobile industry.
b. the oil and gas industry.
c. the textile industry.
d. department stores.

Chapter 23—Mutual Fund Operations

1. Which of the following statements is incorrect?
a. 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.

2. No-load mutual funds are normally promoted by ____. Load funds are promoted by ____.
a. registered representatives of a brokerage firm; registered representatives of a brokerage firm
b. registered representatives of a brokerage firm; the mutual fund of concern
c. the mutual fund of concern; registered representatives of a brokerage firm
d. the mutual fund of concern; the mutual fund of concern

3. To cover managerial expenses, mutual funds typically charge
a. management fees of less than 2 percent of total assets per year.
b. commissions of typically 8 to 10 percent of transaction market value per year.
c. management fees of typically more than 10 percent of total assets per year.
d. commissions of typically 3 to 5 percent of the transaction market value per year.

4. 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.

5. ____ funds do not normally repurchase their shares from investors.
a. Closed-end
b. Load mutual
c. No-load mutual
d. Open-end mutual

6. Most closed-end funds invest in
a. stock and bonds.
b. money market securities.
c. gold.
d. derivatives.

7. Exchange-traded funds are like open-end funds in the sense that
a. their shares are traded on an exchange, and their share price changes throughout the day.
b. they have a fixed number of shares.
c. they are not actively managed.
d. none of the above

8. Hedge funds differ from open-end mutual funds in the sense that
a. they require a much smaller initial investment.
b. they are open to additional investments at any time.
c. their investors cannot sell shares back to the fund at any time they desire.
d. they invest in very limited set of securities.

9. Shares of open-end mutual funds are purchased and sold on exchanges.
a. True
b. False

10. Mutual funds
a. are unregulated.
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.

11. Which of the following is not disclosed in the prospectus?
a. the minimum amount of investment required
b. the investment objective of the funds
c. the fees incurred by the mutual fund
d. all of the above are disclosed

12. The net asset value of a mutual fund is estimated once every week.
a. True
b. False

13. Mutual funds with ____ expense ratios tend to ____ others that have a similar investment objective.
a. lower; underperform
b. higher; outperform
c. lower; outperform
d. A and B

14. A front-end load is a withdrawal fee assessed when you withdraw money from the mutual fund.
a. True
b. False

15. Money market funds invest mostly in
a. stocks.
b. long-term bonds.
c. real estate.
d. short-term securities.

16. If investors sell their mutual fund shares after the net asset value of the fund increases, the return is called
a. share price appreciation.
b. capital gains distribution.
c. dividends.
d. split net asset value.

17. 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.

18. Mutual funds composed of bonds that offer periodic coupon payments are
a. income funds.
b. specialty funds.
c. dividend funds.
d. growth funds.

19. 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. A and C

20. The net asset value of international stock mutual funds ____ as the dollar strengthens against foreign currencies. (Assume no change in the prices of foreign stocks.)
a. increases
b. decreases
c. is unaffected
d. can increase or decrease depending on the dollar’s degree of strength

21. Mutual funds that include some non-U.S. stocks and U.S. stocks are called ____ funds.
a. global
b. foreign
c. combined
d. mixed

22. 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

23. The majority of mutual fund assets are in the form of
a. common stocks.
b. preferred stocks.
c. U.S. government bonds.
d. municipal bonds.

24. 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

25. When the redemptions of money market mutual fund shares exceeds sales of shares, the fund accommodates the amount of excessive redemptions by
a. selling some of the assets contained in the portfolio.
b. issuing stock.
c. issuing bonds.
d. borrowing from banks.

26. Money market fund assets include all of the following, except
a. stocks.
b. repurchase agreements.
c. Treasury bills.
d. CDs.

27. If money market funds definitely 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)

28. Money market funds are normally perceived to have ____ interest rate risk, and ____ default risk.
a. low; high
b. high; high
c. high; low
d. low; low

29. Equity real estate investment trusts invest
a. 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.

30. Because ____ real estate investment trusts essentially represent a fixed income portfolio, their market value will ____ as interest rates increase.
a. equity; increase
b. equity; decrease
c. mortgage; increase
d. mortgage; decrease

31. When interest rates decline, investors who want to earn a high return may tend to ____ in stock mutual funds, and ____ deposits in depository institutions.
a. reduce; reduce
b. reduce; increase
c. increase; reduce
d. increase; increase

32. The composition of asset allocation funds
a. is focused completely on one type of security as specified by the particular mutual fund.
b. is fixed and not altered by the mutual fund managers.
c. A and B
d. none of the above

33. A mutual fund prospectus does not contain
a. minimum amount of investment required.
b. return on the fund since its inception.
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.

34. 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 the above

35. Mutual funds whose funds are promoted strictly by the mutual fund of concern are called
a. closed-end funds.
b. load mutual funds.
c. no-load mutual funds.
d. open-end mutual funds.

36. Mutual funds that are composed of bonds that offer periodic coupon payments are called ____ mutual funds.
a. tax-free
b. income
c. high-yield
d. growth
e. none of the above

37. ____ are most likely to invest in mortgages.
a. Stock mutual funds
b. Bond mutual funds
c. Load funds
d. Closed-end funds

38. 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.

39. According to SEC regulations, the majority of the members on a mutual fund’s board of directors must be
a. employed by the fund.
b. outsiders (not employed by the fund).
c. certified public accountants.
d. certified financial analysts.

40. An expense ratio represents ____ divided by the fund’s ____.
a. annual fees charged to investors; 12b-1 fees
b. annual fees charged to investors; net asset value
c. initial sales charge (load); 12b-1 fees
d. initial sales charge (load); net asset value

41. The most common investment by closed-end funds is in
a. derivatives.
b. bonds.
c. money market securities.
d. international equity securities.

42. ____ 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

43. When the demand for a particular closed-end fund is ____, the fund is likely priced at a ____.
a. high; discount
b. low; discount
c. high; premium
d. B and C are correct

44. Which of the following statements is incorrect?
a. Commercial paper is commonly purchased by money market funds.
b. From an investor’s perspective, money market funds usually have a low level of credit risk.
c. Money market funds tend to have low interest rate risk compared to bond funds.
d. If mutual fund managers expect interest rates to decrease in the future, they should use funds generated from maturing securities today to purchase new securities with shorter maturities.

45. The number of exchange-traded funds has declined over the last several years because the cost of managing them was excessive.
a. True
b. False

46. Exchange-traded funds can be purchased on margin.
a. True
b. False

47. Investors can sell exchange-traded funds short.
a. True
b. False

48. Mutual fund managers seek securities that have much liquidity so that they could easily sell them in the secondary market at any time.
a. True
b. False

49. Closed-end funds are closed to new investment but allow redemptions by shareholders.
a. True
b. False

50. Closed-end fund managers must hold more cash than mutual fund managers.
a. True
b. False

51. Index mutual funds are not traded throughout the day, while exchange-traded funds are.
a. True
b. False

52. Venture capital funds typically invest in stocks of publicly-traded companies.
a. True
b. False

53. Many businesses that go public are partially backed by venture capital before the IPO.
a. True
b. False

54. Private equity funds use most of their money to invest in stocks of publicly-traded companies.
a. True
b. False

55. Vulture funds are a type of private equity fund that purchase distressed assets of a firm that is in or near bankruptcy.
a. True
b. False

56. Hedge funds commonly engage in short selling.
a. True
b. False

57. ____ are not exchange-traded funds.
a. Spiders
b. Growth mutual funds
c. Diamonds
d. Sector Spiders

58. Which of the following statements is incorrect?
a. ETFs are like index mutual funds because the share price adjusts over time in response to the change in the index level.
b. Both ETFs and index mutual funds pay dividends in the form of additional shares to investors.
c. The portfolio management of both ETFs and index mutual funds is very complex.
d. ETFs can be traded throughout the day.

59. 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 the above

60. Exchange traded funds can be
a. traded throughout the day.
b. purchased on margin.
c. sold short.
d. all of the above

61. ____ trade at one-tenth of the S&P 500 value.
a. Spiders
b. Cubes
c. Diamonds
d. World Equity Benchmark Shares

62. Mutual funds must register with the U.S. Treasury and provide to interested investors a prospectus that discloses details about the components of the funds and risks involved.
a. True
b. False

63. The net asset value (NAV) is estimated each day by first determining the market value of all securities comprising the mutual fund.
a. True
b. False

64. Portfolio managers are hired by the mutual fund to invest in a portfolio of securities that satisfies the desires of investors.
a. True
b. False

65. The expenses incurred by a mutual fund are billed separately to investors, and are not included in the fund’s net asset value (NAV).
a. True
b. False

66. A front-end load is a withdrawal fee assessed when you withdraw money from the mutual fund.
a. True
b. False

67. Large mutual funds can exert some control over the management of firms because they commonly represent the largest shareholders.
a. True
b. False

68. Investors who feel capable of making their own investment decisions often prefer to invest in load funds.
a. True
b. False

69. The term “mutual funds” is normally used to represent closed-end funds, and does not include open-end funds.
a. True
b. False

70. Exchange-traded funds differ from open-end funds in that their share price is adjusted only at the end of every day.
a. True
b. False

71. Capital appreciation funds are suited for investors who are more willing to risk a possible loss in value.
a. True
b. False

72. 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

73. Index funds are becoming increasingly unpopular because most mutual fund managers consistently outperform indexes.
a. True
b. False

74. A mutual fund’s performance is usually unrelated to market conditions.
a. True
b. False

75. The SEC requires that a majority of the directors of a mutual fund board be independent (not employed by the fund).
a. True
b. False

76. Diversification among types of mutual funds usually does little to reduce the volatility of returns on the overall investment.
a. True
b. False

77. 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

78. 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

79. Equity REITs are sometimes purchased to hedge against inflation, as rents and property values tend to rise with inflation.
a. True
b. False

80. Equity REITs essentially represent fixed-income portfolios. Thus, their market values will be influenced by interest rate movements.
a. True
b. False

81. Hedge funds are more heavily regulated than mutual funds.
a. True
b. False

82. 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.

83. Which of the following statements is incorrect?
a. Exchange-traded funds (ETFs) are designed to mimic particular stock indexes and are traded on a stock exchange.
b. Unlike a closed-end fund, an ETF has a fixed number of shares.
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.

84. A mutual fund prospectus does not contain the
a. minimum amount of investment required.
b. investment objective of the mutual fund.
c. exposure of the mutual fund to various types of risk.
d. return on the fund since its inception.
e. fees incurred by the mutual fund.

85. The ____ of a mutual fund represents the price at which shares can be purchased from a mutual fund.
a. gross asset value
b. net asset value
c. net stock value
d. net bond value

86. Which of the following is incorrect about money market funds (MMFs)?
a. The credit risk of MMFs is normally perceived to be lower than that of corporate bonds.
b. MMFs have higher interest rate risk than bond funds.
c. MMFs normally generate positive returns over time
d. All of the above are correct.

87. ____ are most likely to invest in mortgages.
a. Stock mutual funds
b. Real estate investment trusts (REITs)
c. Load funds
d. Closed-end funds
e. None of the above

88. Mutual funds are not required to disclose which of the following in the prospectus?
a. the names of the portfolio managers
b. the length of time that the portfolio managers have been employed by the fund in that position
c. the performance record in recent years
d. the number of investors currently investing in the mutual fund
e. Mutual funds are required to disclose all of the above in a prospectus

89. 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 the above are ways in which a mutual fund generates returns to its shareholders.

90. A(n) ____ fund contains a sales charge.
a. load
b. no-load
c. closed-end
d. open-end
e. none of the above

91. ____ funds are open to investment from investors at any time.
a. Load
b. No-load
c. Open-end
d. Closed-end
e. None of the above

92. Which of the following statements is incorrect?
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.

93. ____ 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 the above

94. Bond portfolios with some bonds rated below Baa by Moody’s or BBB by Standard and Poor’s, available for investors desiring high return and willing to incur high risk, are called ____ funds.
a. growth
b. capital appreciation
c. junk bond
d. bond
e. none of the above

95. Which of the following statements is incorrect?
a. A mutual fund is usually run by an investment company.
b. Although many mutual funds have grown substantially over time, their expense ratios have generally increased over time.
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.

96. Money market funds commonly invest in
a. stocks.
b. real estate.
c. commercial paper.
d. U.S. Treasury bonds.
e. none of the above

97. Which of the following is not true with respect to venture capital funds?
a. They typically invest in young, growing firms that need equity funding but are not ready or willing to go public.
b. More than half of all VC investing is in businesses that are being created.
c. Venture capital funds 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 the above are correct with respect to venture capital funds.

98. ____ 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

99. Exchange-traded funds distribute their capital gains to their shareholders, who must pay tax on the gains.
a. True
b. False

100. 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

101. The average annual fee on actively managed exchange-traded funds is ________, which 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.

102. 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.

103. 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

104. Investors who invest in a hedge fund of funds essentially pay two layers of management fees.
a. True
b. False

105. 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.

Chapter 24—Securities Operations

1. Which of the following is not a service that is commonly performed by an securities firm?
a. setting regulatory rules for stock exchanges
b. origination
c. underwriting
d. distribution

2. Securities firms facilitate IPOs in the ____ market; they facilitate the trades of stocks between investors in the ____ market.
a. primary; primary
b. secondary; primary
c. primary; secondary
d. secondary; secondary

3. 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

4. All information relevant to the security, as well as the agreement between the issuer and the securities firm, must be provided in the
a. origination.
b. registration statement.
c. best-efforts agreement.
d. none of the above

5. 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

6. Research indicates that securities firms tend to
a. overprice IPOs.
b. underprice IPOs.
c. price IPOs correctly.
d. none of the above

7. 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

8. The ____ determines margin requirements on securities purchased.
a. Securities and Exchange Commission
b. National Association of Securities Dealers
c. Federal Reserve Board
d. Securities Investor Protection Corporation

9. The ____ can liquidate failing brokerage firms.
a. Securities and Exchange Commission
b. National Association of Securities Dealers
c. Federal Reserve Board
d. Securities Investor Protection Corporation

10. Which of the following is not a major function of the securities industry?
a. brokerage
b. raising new capital
c. underwriting
d. decisions regarding open market operations

11. When securities firms help corporations issue bonds, their primary role is as a(n)
a. intermediary.
b. lender (creditor).
c. investor.
d. B and C

12. 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. B or C, depending on the amount of stock to be issued

13. A(n) ____ discloses relevant financial data on a firm issuing securities, and the provisions applicable to the security.
a. SEC preferred disclosure form
b. 1040 disclosure form
c. shelf-registration
d. prospectus

14. 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

15. Which of the following statements is incorrect?
a. A private bond placement avoids the underwriting fee.
b. Private placements of stocks are more common than private placements of bonds.
c. The provisions of a privately placed bond issue can be tailored to the desires of the purchaser.
d. A possible disadvantage of a private placement is that the demand may not be as strong as for a publicly placed issue.

16. Flotation costs as a percentage of the value of securities issued are ____ for ____ issues.
a. lower; small
b. lower; large
c. higher; large
d. A and C

17. Competitive bidding by securities firms for underwriting the issue of new bonds is primarily used for
a. federal government bonds.
b. bonds issued by banks.
c. public utility bonds.
d. bonds issued by non-banking financial institution.

18. The underwriting spread on newly issued bonds is normally ____ that on newly issued stock.
a. less than
b. greater than
c. about the same as
d. less than (for newly issued preferred stock) but greater than (for newly issued common stock)

19. In a ____, a 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

20. ____ is motivated by the perception that the sum of the parts is sometimes greater than the whole.
a. Bridging
b. Asset stripping
c. Greenmail
d. None of the above

21. As a result of a spinoff, the ownership of a firm’s is separated into two parts with separate ownership.
a. True
b. False

22. The ____ is not involved in the regulation of the securities industry.
a. Deposit Insurance Fund
b. National Association of Securities Dealers
c. Securities and Exchange Commission
d. Federal Reserve Board
e. All of the above are involved in the regulation of the securities industry.

23. Which of the following is not an SEC rule?
a. Analysts of securities firms underwriting an IPO cannot promote new 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 securities department within the securities firm.
d. An analyst’s rating must divulge any recent securities business provided by the securities firm that assigned the rating.

24. The value of a securities firm is typically ____ related to interest rate movements.
a. positively
b. not
c. inversely
d. A or B

25. ____ is not a service that a securities firm provides in placing bonds.
a. Origination
b. Underwriting
c. Distribution
d. Advising
e. All of the above are services securities firms provide in placing bonds

26. Securities firms commonly perform all of the following functions except for _____ when facilitating a secondary stock offering.
a. origination
b. underwriting stock
c. distribution of stock
d. its own purchase of at least 20 percent of the offering

27. Asset-stripping refers to
a. acquiring shares in a firm, causing the firm to repurchase the shares at a premium to prevent a takeover.
b. financing provided by securities firms to help support an acquisition.
c. investing in the shares of a firm that is anticipated to experience a leveraged buyout (LBO).
d. acquiring a firm and selling off individual divisions of the firm separately.

28. When a securities firm provides a bridge loan, it would most likely be
a. to a corporation until the corporation raises funds in other ways.
b. to a commercial bank in the federal funds market.
c. to a mutual fund that needs cover share redemptions.
d. to an investor who needs to cover his margin from buying stock.

29. Funds received from a bridge loan are commonly used to
a. purchase junk bonds.
b. purchase high-grade corporate bonds.
c. provide temporary financing for an acquisition.
d. provide financing for individual investors that wish to purchase Treasury bonds.

30. Securities firms commonly engage in all of the following functions except
a. proprietary trading
b. underwriting stock
c. operating mutual funds
d. brokerage services
e. operating credit unions

31. ____ is (are) not included in flotation costs.
a. Issue costs
b. Underwriting spread
c. Taxes paid on income earned from the proceeds through the securities firm
d. Registration expenses

32. Institutional investors that are willing to hold stock only for a very short period of time are prime candidates for participating in a private placement.
a. True
b. False

33. 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

34. Unlike the standardized provisions of a publicly placed issue, the provisions of a privately placed issue can be tailored to the desires of the purchaser.
a. True
b. False

35. When the stock market is depressed, stock transactions tend to decline, causing a reduction in business for securities firms. This is an example of ____ risk.
a. interest rate
b. credit
c. market
d. exchange rate

36. 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)

37. Securities firms serve as an intermediary for each of the following, except
a. stock offerings.
b. debt offerings.
c. IPOs.
d. they serve as intermediary for all of the above.

38. 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.

39. One of the main functions of securities firms is raising capital for corporations.
a. True
b. False

40. When securities firms facilitate initial public offerings, they attempt to price the stock high enough to satisfy the issuing firm.
a. True
b. False

41. The compensation paid to securities firms for raising funds is typically in the form of interest income.
a. True
b. False

42. Securities and Exchange Commission (SEC) approval of a registration statement guarantees the quality and safety of the securities to be issued.
a. True
b. False

43. One reason for financial problems of securities firms during the credit crisis is that they used a high degree of financial leverage.
a. True
b. False

44. 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

45. The Financial Reform Act created the Financial Stability Oversight Council, which is responsible for identifying risks to financial stability in the U.S.
a. True
b. False

46. During the credit crisis, many commercial banks were forced to convert into securities firms.
a. True
b. False

47. During the credit crisis, some large securities firms were either acquired by or converted into commercial banks.
a. True
b. False

48. 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

49. Securities firms avoided exposure to mortgages during the credit crisis because they sold their mortgage holdings before the crisis began.
a. True
b. False

50. 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

51. 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 the above

52. 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
b. Société Générale
c. Bear Stearns
d. Barings Bank

53. The process of obtaining mortgages from the financial institutions that originated them, bundling the mortgages into tranches based on their risk level, and selling the tranches to institutional investors is called:
a. mortgage stripping.
b. mortgage underwriting.
c. securitization.
d. intermediation.

54. 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 spin-off of a unit
c. a carve-out
d. divestiture

55. Employees of a securities firm are less likely to engage in unethical behavior when the firm rewards employees with higher compensation based on:
a. the number of transactions that employees execute for clients.
b. clients’ assessments of the employees’ services.
c. the amount of specific securities from the firm’s holdings that employees sell to clients.
d. the number of transactions that the employees promote to clients in which the firm is the counterparty.

56. 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

57. Which of the following does not play a role in regulating securities trading?
a. National Association of Securities Dealers
b. Resolution Trust Corporation
c. New York Stock Exchange
d. Federal Reserve

58. 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.

59. 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.

Chapter 25—Insurance and Pension Fund Operations

1. Which of the following statements is incorrect?
a. 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.

2. The insurance premium is ____ related to the uncertainty about the size of the payments; the premium is also ____ for group plans.
a. higher; lower
b. higher; higher
c. lower; higher
d. lower; lower

3. Those insurance companies whose claims are ____ predictable need to maintain ____ liquidity.
a. less; less
b. more; more
c. less; more
d. none of the above

4. 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

5. A life insurance policy that protects the policyholder until death, or as long as premiums are promptly paid is a
a. whole life policy.
b. term policy.
c. universal life policy.
d. B and C

6. ____ insurance provides insurance for a policyholder only over a specified period.
a. Term
b. Whole life
c. Universal
d. A and C

7. 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 the above build a cash value

8. 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

9. Which type of life insurance policy specifies a limited period of time over which the policy will exist, and builds a cash value for policyholders over time?
a. whole life
b. term
c. universal life
d. decreasing term

10. Which type of life insurance policy can offer flexibility on the size and timing of premium payments? (The policyholder can decide the size of payments each period.)
a. whole life
b. term
c. universal life
d. decreasing term

11. 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

12. ____ is not a typical source of funds to life insurance companies.
a. Deposit insurance premiums
b. Annuity plans
c. Investment income
d. Life and health insurance premiums

13. ____ represent the most popular asset of life insurance companies.
a. Corporate bonds
b. Treasury securities
c. Corporate stock
d. State and local bonds

14. Which of the following is not a common use of funds by life insurance companies?
a. government securities
b. corporate bonds
c. stocks
d. commercial paper

15. Which of the following is not a ratio (or group of ratios) commonly used by insurance regulators to detect any problems in time to search for a remedy before the company deteriorates further?
a. liquidity ratios
b. operating expense ratios
c. profitability ratios
d. all of the above are used by regulators

16. The ratio of an insurance company’s net profit to policyholders’ surplus is called
a. liquidity ratio.
b. return on net worth.
c. net underwriting margin.
d. return on assets.

17. Because life insurance companies carry a large amount of ____ securities, the market value of their asset portfolio can be ____ to interest rate fluctuations.
a. short-term; insensitive
b. short-term; very sensitive
c. long-term; insensitive
d. long-term; very sensitive

18. 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.

19. Which of the following is a difference in characteristics between life insurance companies and property and casualty insurance companies?
a. Property and casualty policies are longer term.
b. The type of policies offered by life insurance companies are less focused.
c. Future compensation amounts paid on property and casualty policies are more difficult to forecast.
d. Life insurance companies need to maintain a more liquid asset portfolio.

20. The most common use of funds for property and casualty insurance companies is
a. municipal securities.
b. Treasury bills.
c. corporate stock.
d. commercial paper.

21. Which of the following is not a difference between PC insurance and life insurance?
a. PC policies often last ten years or more, as opposed to the short-term life insurance policies.
b. PC insurance encompasses a wide variety of activities, while life insurance is more focused.
c. Forecasting the amount of future compensation to be paid is more difficult for PC insurance than for life insurance.
d. All of the above are differences between PC insurance and life insurance.

22. ____ 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

23. Individuals who are insured under a managed health care plan can usually choose any provider of health care services.
a. True
b. False

24. ____ usually require individuals to choose a primary care physician.
a. Indemnity plans
b. Health maintenance organizations
c. Preferred provider organizations
d. None of the above

25. ____ insurance covers losses due to dishonest employees.
a. Key employee
b. Credit line
c. Malpractice
d. Fidelity bond

26. ____ insurance covers losses due to lawsuits by dissatisfied customers.
a. Fidelity bond
b. Credit line
c. Surety bond
d. Business interruption

27. Which of the following is not involved in the regulation of the insurance industry?
a. the National Association of Insurance Commissioners (NAIC)
b. the Insurance Regulatory Information System (IRIS)
c. the Federal Deposit Insurance Corporation (FDIC)
d. All of the above are involved in the regulation of the insurance industry.

28. All regulation of insurance companies is performed by
a. federal agencies.
b. the National Association of Insurance Commissioners.
c. the Insurance Regulatory Information System.
d. state agencies.

29. In 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 the above

30. The most common type of mortgage held by life insurance companies are ____ mortgages.
a. commercial
b. residential
c. farm
d. none of the above

31. The ____ facilitates cooperation among the various state agencies whenever an insurance issue is a national concern.
a. Securities and Exchange Commission
b. Federal Deposit Insurance Corporation
c. National Association of Insurance Commissioners
d. National Association of Securities Dealers
e. none of the above

32. Life insurance companies can reduce their exposure to ____ risk by diversifying the age distribution of their customer base.
a. interest rate
b. market
c. credit
d. liquidity

33. 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

34. 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

35. A ____ plan allows a firm to know with certainty the amount of funds to contribute. The ____ 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

36. There are more defined ____ pension plans; there are more participants in defined ____ plans.
a. benefit; contribution
b. contribution; benefit
c. contribution; contribution
d. benefit; benefit

37. 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

38. Pension funds managed by life insurance companies are normally referred to as
a. trust portfolios.
b. insured plans.
c. matched plans.
d. projective plans.

39. Pension portfolios managed by trusts are expected to offer ____ returns than those managed by insurance companies and have a(n) ____ degree of risk.
a. lower; higher
b. lower; lower
c. the same; equal
d. higher; lower
e. higher; higher

40. The asset composition of private pension portfolios is most heavily concentrated in
a. corporate bonds.
b. mortgages.
c. common stock.
d. money market securities.

41. 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

42. Pension funds managed by life insurance companies concentrate on
a. common stock.
b. bonds and mortgages.
c. preferred stock.
d. money market instruments.

43. Pension portfolios managed by trusts concentrate on
a. common stock.
b. bonds.
c. mortgages.
d. money market instruments.

44. 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. decrease the average maturity on fixed-rate bonds.
d. reduce the investment in money market securities.

45. Most pension fund contributions are contributed by the
a. employer.
b. employee.
c. state government.
d. federal government.
e. none of the above

46. 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

47. 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

48. Policyholders who prefer to invest their savings themselves will likely opt for whole life insurance over term insurance.
a. True
b. False

49. Group insurance policies are very popular for employers and employees.
a. True
b. False

50. 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

51. Property and casualty insurance and life insurance are similar in terms of the predictability of payouts to cover claims.
a. True
b. False

52. Public pension funds can be classified by the manner in which contributions are received and benefits are paid.
a. True
b. False

53. A defined-benefit plan provides benefits that are determined by the accumulated contributions and the fund’s investment performance.
a. True
b. False

54. In recent years, defined-contribution plans have commonly been replaced by defined-benefit plans.
a. True
b. False

55. Projective funding limits the manager’s discretion, allowing only investments that match future payouts.
a. True
b. False

56. 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

57. The composition of the stocks in a pension fund’s portfolio is determined by the fund’s portfolio managers.
a. True
b. False

58. The ____ facilitates cooperation among the various state agencies whenever an insurance issue is a national concern.
a. Securities and Exchange Commission
b. Federal Deposit Insurance Corporation
c. National Association of Insurance Commissioners
d. National Association of Securities Dealers
e. none of the above

59. ____ insurance protects the policyholders until death or as long as premiums are promptly paid.
a. Whole life
b. Variable life
c. Term life
d. Annuity life
e. None of the above

60. ____ life insurance specifies a period of time over which the policy will exist but also builds a cash value for policyholders over time.
a. Whole
b. Variable
c. Term
d. Universal
e. None of the above

61. The primary source of life insurance company income is a result of
a. life insurance premiums.
b. annuity plans.
c. health insurance premiums.
d. investment income.
e. none of the above

62. Property and casualty (PC) insurance differs from life insurance in all of the following ways, except
a. PC policies often last one year or less, as opposed to the long-term or even permanent life insurance policies.
b. PC insurance is more focused than life insurance.
c. the amount of future compensation to be paid on PC insurance is more difficult to forecast than that paid on life insurance.
d. All of the above are differences between PC and life insurance.

63. With a(n) ____ plan, contributions are dictated by the benefits that will eventually be provided.
a. matched funding
b. projective funding
c. defined-benefit
d. defined-contribution
e. none of the above

64. In a ____ 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 the above

65. Pension portfolios managed by trusts offer potentially ____ returns than insured plans and have a ____ degree of risk.
a. higher; lower
b. higher; higher
c. lower; lower
d. lower; higher
e. none of the above

66. If a pension fund holds long-term, fixed-rate bonds, the market value of the portfolio will ____ during periods when interest rates ____.
a. increase; increase
b. decrease; increase
c. decrease; decrease
d. none of the above

67. A pension fund’s bond portfolio is not directly affected by
a. general stock market conditions.
b. changes in the risk-free rate.
c. changes in the risk premium.
d. the abilities of the portfolio managers.
e. All of the above are factors affecting the performance of a pension fund’s bond portfolio.

68. In periods when the risk-free interest rate ____ substantially, the required rate of return by bondholders ____, and most bond portfolios managed by pension funds perform ____.
a. declines; declines; poorly
b. declines; increases; well
c. declines; declines; well
d. declines, increases; poorly
e. none of the above

69. The adverse selection problem in insurance occurs because:
a. those who are most likely to need insurance are also most likely to purchase it.
b. some insurance companies set their premiums too high, causing them to lose customers.
c. some insurance companies do not select investment that generate suffcient funds for the companies to pay insurance claims.
d. people who purchase insurance are less likely to engage in risky behavior.

70. 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.

71. Underfunded pensions are primary a problem with defined-contribution pension plans.

a. True
b. False

72. The problems that some state government agencies are experiencing with underfunded pension plans can be attributed to:
a. making unrealistic promises about pensions to employees in the past.
b. overestimating the return that the plans’ investments would earn.
c. changing from defined-benefit plans to defined-contribution plans.
d. A and B

73. 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.
d. Employee Pension Protection Bureau.

74. A pension fund manager might hedge against interest rate movements by selling bond futures contracts.
a. True
b. False

75. Mortgage insurance protects:
a. homeowners against damage to their home such as from storms or fire.
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 the above

76. When long-term interest rates are very low, the future returns that a pension fund can earn on long-term low-risk bonds are __________ if the bonds are held to maturity; if the bonds are not held to maturity, there is ____________ potential for their prices to increase.
a. low; significant
b. low; not much
c. high; significant
d. high; not much