ECON 311 exam 4 review

Question 1

advantages and disadvantages of money markets for long term and short term

Answer 1

short term - money markets are neither as liquid nor as safe as deposits placed in banks, distinct cost advantage over banks
long-term - for investors, brokers, etc.

Question 2

who participates in money markets

Answer 2

U.S. Treasury, Federal Reserve System, commercial banks, businesses, investments, and securities firms, and invidviduals

Question 3

who is the largest participants within the money market?

Answer 3

U.S. Treasury Department

Question 4

what is the role that finance companies play within the money market?

Answer 4

lend funds to individuals for cars, boats, and home improvements
primarily by selling commercial paper

Question 5

characteristics of the money market

Answer 5

flexibility and innovation
liquidity, safety, and short maturities

Question 6

which are used within the money market, treasury bills, bonds, or notes

Answer 6

treasury bill

Question 7

maturity of treasury bill

Answer 7

4, 13, 26, and 52 week maturities
less than a year
discount from par
does not pay interest

Question 8

maturity of treasury bonds

Answer 8

10 to 30 years
low interest rate, have no default risk
face value $100

Question 9

maturity of treasury notes

Answer 9

1 to 10 years
pays about 10 interest payments, one every 6 months for 5 years
face value $100

Question 10

federal funds

Answer 10

short term funds transferred (loaned/borrowed) between institutions for a period of one day
fed reserve has set minimum reserve requirements that all banks must maintain
can increase amount of money in the financial system by buying securities
increases supply of reserves and lowers interest rates

Question 11

commercial paper

Answer 11

unsecured securities of maturity of less than 270 days
avoid need to register security issue with the SEC
actually matures in 20-45 days, issued on discounted basis

Question 12

mutual funds

Answer 12

allow small investors to participate in the money market
paid at a higher rate
give investors with small amounts of cash, access to large-denomination securities

Question 13

capital markets

Answer 13

used to warehouse funds for short periods of time until a more important need use for the funds arises
firms and individuals use these for long-term investments
federal and local govts and corporations issue capital markets
largest purchasers of capital markets are households, use the funds to purchase bonds or stock

Question 14

discount bond

Answer 14

issued at a lower price than its par value

Question 15

coupon bond

Answer 15

latter does not pay interest until maturity
fixed for the duration of the bonds and does not fluctuate with market interest rates

Question 16

treasury bonds

Answer 16

no default risk
face value of $100
long-term rates do not change as much as short-term rates with high or low inflation

Question 17

revenue bonds

Answer 17

backed by cash flow
issued to build a municipal construction

Question 18

bond paid by tax revenue

Answer 18

has to approved by taxpayers bc taxing authority of the govt. is pledged for their repayment
AKA General Obligation Bonds
backed by “full faith and credit of issuer”

Question 19

indenture

Answer 19

contract that states the lender’s rights and privileges and the borrower’s obligations
specifies the terms of the loan agreement
includes management restrictions called covenants

Question 20

convertible bonds

Answer 20

bonds can be converted to a certain number of common shares at the discretion of the bondholder
one way firms avoid sending a negative signal to the market
higher price received for the bonds by the firms implies a lower interest rate

Question 21

secured bonds

Answer 21

collateral attached
mortgage bonds - specific projects (building)
lower interest rate

Question 22

unsecured bonds

Answer 22

debentures are long-term unsecured bonds
backed by the general creditworthiness of issuer
no specific collateral is pledged to repay debt

Question 23

debenture bonds

Answer 23

long-term
lower priority that secured bonds if the firm defaults
higher interest rate than otherwise comparable secured bonds

Question 24

common stock

Answer 24

in a firm represents an ownership interest in that firm
receive dividends, hope that the price of their stock will rise
does not have any meaning that is standard across all companies
distribution of dividends or voting rights

Question 25

preferred stock

Answer 25

form of equity from a legal and tax standpoint
receive a fixed dividend that never changes
price is relatively stable
do not usually vote unless the firm has failed to pay the promised dividend

Question 26

PE Ratio

Answer 26

P/E x E = P
23 x $1.13 = $26
measure how much the market is willing to pay for $1 of earnings from a firm

Question 27

fluctuations in stock market

Answer 27

inflation, interest rates, etc.

Question 28

mortgages

Answer 28

long-term loan secured by real estate
interest rate determined by current market rates, the term of the mortgage, and number of discount points
payments pass through the trustee before being disbursed to the investors in the mortgage pass-thru

Question 29

discount points

Answer 29

interest payments made at the beginning of a loan
the borrower pays 1% of the loan amount at closing
in exchange for the points, the lender reduces the interest rate on the loan
borrower must determine whether the reduced interest rate over the life of the loan fully compensates for the increased up-front expense
should not be paid if the borrower will pay off loan in five years or less

Question 30

lien

Answer 30

public record that attaches to the title of the property advising that the property is security for a loan and it gives the lender the right to sell the property if the underlying loan defaults

Question 31

private insurance mortgage

Answer 31

insurance policy that guarantees to make up any discrepancy between the value of the property and the loan amount, should a default occur
protection against losses on mortgage investments

Question 32

conventional mortgage

Answer 32

originated by the same sources as insured loans but are not guaranteed
usually requires private mortgage insurance
5% to 20% down payment

Question 33

FHA (Federal Housing Administration and VA (Veterans Administration)

Answer 33

loans where applicants must meet certain qualifications, having served in the military or having income below a given level and can borrow only up to a certain amount
guarantees the agency will pay off the mortgage loan if the borrower defaults

Question 34

adjustable-rate mortgage

Answer 34

tied to some market rate and therefore changes over time
have limits called caps, on how high (or low) the interest rate can move in one year during the term of the loan
might tie the interest rate to the average Treasury bill rate
caps make ARM’s more palatable to borrowers

Question 35

reverse annuity mortgages

Answer 35

lender disburses a monthly payment to the borrower on an increasing-balance loan
loan come due when the real estate is sold
borrower does make any payments against the loan

Question 36

factors that affect interest rates that investors will pay on mortgages

Answer 36

market rates, term mortgages have higher interest rates than shorter-term mortgages
discount points - interest payments made at the beginning of a loan