Exam 2 Flashcards
That most used cars are sold by intermediaries (i.e., used car dealers) provides evidence that these intermediaries
are able to prevent potential competitors from free-riding off the information that they provide.
Which of the following are accurate statements concerning the role that restrictive covenants play in reducing moral hazard in financial markets?
- Covenants reduce moral hazard by restricting borrowers’ undesirable behavior.
- Covenants require that borrowers keep collateral in good condition.
- Covenants require periodic accounting statements and income reports.
Because of the adverse selection problem,
lenders are reluctant to make loans that are not secured by collateral.
Of the sources of external funds for nonfinancial businesses in the United States, bonds account for approximately ________ of the total.
30%
A clause in a mortgage loan contract requiring the borrower to purchase homeowner’s insurance is an example of
a restrictive covenant.
During the 2007-2009 financial crisis, housing prices began to fall and subprime mortgages began to default. Which of the following statements is true about the rating of subprime mortgage products?
Many AAA-rated subprime products had to be downgraded over and over again until they reached junk status.
Of the following sources of external finance for American nonfinancial businesses, the most important is
nonbank loans.
A venture capital firm protects its equity investment from moral hazard through which of the following means?
It places people on the board of directors to better monitor the borrowing firm’s activities.
Conflicts of interest in the Arthur Andersen accounting firm intensified when ________ became the firm’s largest source of profits and large clients pressured ________ office managers to give favorable audits.
consulting; regional
When an accounting firm conducts on independent audit , the accounting firms certify that
- the firm’s management is qualified to conduct the firm’s business in the best interest of share holders.
- the firm is adhering to standard accounting principles and disclosing accurate information about sales, assets, and earnings.
- the firm is adhering to federal regulations with regard to product safety, hiring practices, and environmental regulations.
Factors that lead to worsening conditions in financial markets include
- increases in interest rates.
- increasing uncertainty in financial markets.
- declining stock prices.
Most financial crises in the United States have begun with
- a steep stock market decline.
- an increase in uncertainty resulting from the failure of a major firm.
What is a credit boom?
Essentially a lending spree on the part of banks and other financial institutions
Stage Three of a financial crisis in an advanced economy features
debt deflation.
Factors that lead to worsening conditions in financial markets include
bank panics.
What is a collateralized debt obligation?
A tranche of an SPV that has been setup based on default risk
In addition to having a direct effect on increasing adverse selection problems, increases in interest rates also promote financial crises by ________ firms’ and households’ interest payments, thereby ________ their cash flow.
increasing; decreasing
Stage Two of a financial crisis in an advanced economy usually involves a ________ crisis.
banking
Financial crises
- invariably lead to debt deflation.
- cause failures of financial intermediaries and leave only securities markets to channel funds from savers to borrowers.
- are a recent phenomenon that occur only in developing countries.
Stock market declines preceded a full-blown financial crisis
in the United States in 1929.
The Board of Governors
effectively sets the discount rate.
- establishes, within limits, reserve requirements.
- sets margin requirements.
Critics of Fed independence argue
that it is undemocratic to have monetary policy controlled by an elite group responsible to no one.
The “________ book” is produced by the Federal Reserve banks and details evidence on the state of the economy in each of the Federal Reserve districts.
beige
Members of Congress are able to influence monetary policy, albeit indirectly, through their ability to
propose legislation that would force the Fed to submit budget requests to Congress, as must other government agencies.
The Federal Advisory Council has ________ member(s) from each district.
one
Which of the following are true statements?
- The FOMC issues directives to the trading desk at the New York Fed.
- Designers of the Federal Reserve Act did not envision the use of open market operations as a monetary policy tool.
- The FOMC usually meets every six weeks to set monetary policy.
The theory of bureaucratic behavior suggests that the Federal Reserve will
try to gain regulatory power over more banks.
- try to avoid a conflict with the president and Congress over increases in interest rates.
- devise clever strategies in an effort to avoid blame for poor economic performance.
Americans’ fear of centralized power and their distrust of moneyed interests explain why the U.S. did not have a central bank until the
20th century.
The case for Federal Reserve independence includes the idea that
a politically insulated Fed would be more concerned with long-run objectives and thus be a defender of a sound dollar and a stable price level.
-a Federal Reserve under the control of Congress or the president might make the so-called political business cycle more pronounced.
Which of the following functions are not performed by any of the twelve regional Federal Reserve banks?
Setting interest rates payable on time deposits
Inflation targeting involves
- increased accountability of the central bank for attaining its inflation objectives.
- a public announcement of medium-term numerical targets for inflation.
- an information-inclusive approach in which many variables are used in making decisions about monetary policy.
Which of the following statements is true?
Credit-driven asset bubbles are particularly dangerous. When asset prices fall, the deleveraging of credit markets reduces economic activity.
Although the goals of high employment and economic growth are closely related, policies can be specifically aimed at encouraging economic growth by
encouraging firms to invest and people to save.
Although the goals of high employment and economic growth are closely related, policies can be specifically aimed at encouraging economic growth by
encouraging people to save.
-encouraging firms to invest.
The European Central Bank uses open market operations as its primary tool for conducting monetary policy. ________ are the predominant form of open market operations.
Main refinancing operations
Price stability is desirable because
inflation creates uncertainty, making it difficult to plan for the future.
If the Federal Reserve wants to expand reserves in the banking system, it will
purchase government securities.
The type of open market operation intended to offset movements in other factors that affect reserves and the monetary base is
the defensive open market operations.
The discount rate is
the interest rate on loans from the Fed to a bank.
If the Federal Reserve wants to lower the monetary base and the money supply, it will
sell government securities.
In its simplest form, a credit default swap provides
insurance against default in the principle and interest payments of a credit instrument.
The security with the longest maturity is a Treasury
bond.
Call provisions will be exercised when interest rates ________ and bond values ________.
fall; rise
(I) Firms and individuals use the capital markets for long-term investments.
(II) Capital markets provide an alternative to investment in assets such as real estate and gold.
Both are true.
Corporations may enter the capital markets because
they do not have sufficient capital to fund their investment opportunities.
Which of the following are true for the current yield?
The current yield is defined as the yearly coupon payment divided by the price of the security.
Financial guarantees
- lower the risk of the bonds covered by the guarantee.
- are insurance policies to back bond issues.
- are purchased by financially weaker security issuers.
(I) Municipal bonds that are issued to pay for essential public projects are exempt from federal taxation. (II) General obligation bonds do not have specific assets pledged as security or a specific source of revenue allocated for their repayment.
Both are true.
The current yield on a $6,000, 10 percent coupon bond selling for $5,000 is
12%.
Compared to money market securities, capital market securities have
longer maturities.
(I) Because interest rates on Treasury bills are more volatile than rates on long-term securities, the return on short-term Treasury securities is usually above that on longer-term Treasury securities.
(II) A Treasury STRIP separates the periodic interest payments from the final principal repayment.
(I) is false, (II) true.
In its simplest form, a credit default swap provides
insurance against default in the principle and interest payments of a credit instrument.
Typically, the interest rate on corporate bonds will be ________ the more restrictions are placed on management through restrictive covenants, because ________.
lower; the bonds will be considered safer by buyers
The risk on an agency bond is
low
The largest purchasers of capital market securities are
households.
STRIPS (Separate Trading of Registered Interest and Principal Securities) are also called
zero-coupon securities.
The nearer a bond’s price is to its par value and the longer the maturity of the bond, the more closely the ________ approximates the ________.
current yield; yield to maturity
Compared to money market securities, capital market securities have
longer maturities.
The primary reason that individuals and firms choose to borrow long-term is to reduce the risk that interest rates will ________ before they pay off their debt.
rise
The primary issuers of capital market securities include
the federal and local governments, and corporations.
(I) Firms issue common stock in far greater amounts than preferred stock.
(II) In a given year, the total volume of stock issued is much less than the volume of bonds issued.
Both are true.
A stock currently sells for $30 per share and pays $1.00 per year in dividends. What is an investor’s valuation of this stock if he expects it to be selling for $37 in one year and requires a 12 percent return on equity investments?
$33.93
A high price earnings ratio (PE) gives what interpretation?
The market expects the earnings to rise in the future.
The problem with buying foreign stocks is that most foreign companies are not listed on any of the U.S. stock exchanges, so the purchase of shares is difficult. Intermediaries have found a way to solve this problem by selling
ADRs.
The most active stock exchange in the world is the
NYSE
Which of the following is not an element of the Gordon growth model of stock valuation?
The stock’s expected future price
(I) Preferred stockholders hold a claim on assets that has priority over the claims of common stockholders, but after that of bondholders.
(II) Firms issue preferred stock in far greater amounts than common stock.
(I) is true, (II) false.
The subprime financial crisis led to one of the worst bear markets in the last 50 years. Stock prices likely fell due to
an increase in required returns on equity investments.
(I) A share of common stock in a firm represents an ownership interest in that firm.
(II) A share of preferred stock is as much like a bond as it is like common stock.
Both are true.
Stock values computed by valuation models may differ from actual market prices because it is difficult to
- estimate future dividend growth rates.
- forecast a stock’s future dividends.
- estimate the risk of a stock.
