Finance

Question 1

What do higher expected future returns result in?

Answer 1

Lowers the expected return for long term bonds, decreases their demand, shifts the demand curve to the left.

Question 2

What does an increase in expected return on alternative assets result in?

Answer 2

lowers the demand for bonds, shifts the demand curve to the left.

Question 3

What does an increase in the expected rate of inflation result in?

Answer 3

lowers expected return on bonds causing their demand to decline and shifts the demand curve to the left

Question 4

What is risk premium?

Answer 4

the spread between the interest rate on bonds with default risk and interest rates on default free bonds, both with the same maturity. Indicates how much additional interest people must earn to be willing to hold the risky bond.

Question 5

What is default risk

Answer 5

It is an attribute of a bond which influences interest rate. Occurs when issuer is unwilling/unable to make interest payments when promised or pay off face value when the bond matures

Question 6

What is segmented market theory?

Answer 6

it sees the market for different maturity bonds as completely separate and segmented. Assumption is that bonds of different maturities are not substitutes at all

Question 7

What happens to the demand for money due to the price level effect?

Answer 7

a rise in price level caused demand for money at each interest rate to increase and the demand curve shifts to the right. Vice versa when price level falls.

Question 8

What happens to the demand for money due to the income effect?

Answer 8

A higher level of income causes the demand for money at each interest rate to increase and the demand curve shifts to the right

Question 9

Define income and state its variable time

Answer 9

flow of earnings per unit time. Flow variable

Question 10

Define wealth and state what type of variable it is?

Answer 10

Total collection of pieces of property that serve to store value. Stock variable

Question 11

What is included in M2?

Answer 11

M1 + small denomination time deposits + savings deposits and money market deposit accounts + money market mutual fund shares (retail)

Question 12

What is a money market?

Answer 12

A financial market in which only short-term debt instruments are traded

Question 13

What is included in M1?

Answer 13

currency + traveller’s checks + demand deposits + other checkable deposits

Question 14

What is perpetuity/consol?

Answer 14

a special case of a coupon bond. It Is a perpetual bond with no maturity date and no repayment of principal that makes fixed coupon payments of $C forever

Question 15

What does expected inflation do to the bond price and demand curve when there is an increase in change in variable

Answer 15

Decreases the bond price
Shifts the demand curve to the left.

Question 16

What is the fisher effect?

Answer 16

When expected inflation rises, interest rates will rise

Question 17

What are the functions of financial intermediaries?

Answer 17

Lower transaction costs

Reduce risk

Reduces information costs of screening and monitoring borrowers

Question 18

What are reasons to regulate the financial system?

Answer 18

To increase info available to investors.
To ensure soundness of financial intermediaries.

Question 19

Stockholders are?

Answer 19

those who hold stock in a corporation - own an interest in the corporation equal to the percentage of outstanding shares they own. they are residual claimants

Question 20

What is Dividends?

Answer 20

payments made periodically, usually every quarter, to stockholders

Question 21

The theory of rational expectations

Answer 21

Expectations will be identical to optimal forecasts (best guess of the future) using all available informations

Question 22

What are implications of Ration Expectations

Answer 22

1. if there is a change in the way a variable moves, the way in which expectations of this variable are formed will change as well
2. The forecast errors of expectations will, on average, be zero and cannot be predicted ahead of time

Question 23

Efficient Market Hypothesis?

Answer 23

Based on the assumption that prices of securities in financial markets fully reflect all available information.

Question 24

What is behavioural finance?

Answer 24

Applies concepts from other social sciences, such as anthropology, sociology and particularly psychology to explain behaviour of securities prices.

Question 25

What are debt contracts?

Answer 25

extremely complicated legal documents that place substantial restrictions on the behaviour of the borrower.

Question 26

True or False: Indirect finance is more important than direct finance and stocks

Answer 26

True

Question 27

How do financial intermediaries reduce transaction costs?

Answer 27

Economies of scale

Expertise

Question 28

What are Economies of scales and give an example?

Answer 28

Investors funds may be bundled together to reduce transaction costs for each individual investor. An example is a mutual fund, which is a financial intermediary that sells shares to individuals and then invests the proceeds in bonds or stocks. Because it buys large blocks of bonds or stocks, a mutual fund can take advantage of lower transaction costs.

Question 29

What is asymmetric information?

Answer 29

A situation where one party’s insufficient knowledge about the other party involved in a transaction makes it impossible for the first party to make accurate decisions when conducting a transaction.

Question 30

What is adverse selection?

Answer 30

An asymmetric information problem that occurs before a transaction

Question 31

What is Moral Hazard?

Answer 31

arises after a transaction occurs. ‘The likeliness of repayment of a loan by the borrower is uncertain’

Question 32

Why are stocks not the primary sources of financing for businesses in any country in the world?

Answer 32

only bad firms will want to sell stocks at average market price, while good firms will not want to sell stocks at average market price. This means few stocks will sell in this market and not be a good source of financing.

Question 33

What are tools to help solve adverse selection problems?

Answer 33

Private production and sale of information

Government regulation to increase information

Financial intermediation

Collateral and Net Worth

Question 34

what is the principal-agent problem?

Answer 34

Equity contracts, like common stocks, are subject to a particular type of moral hazard. Stockholders who most of the firm’s equity have more incentives to maximize profits for the firm than managers, who own a small fraction. By owning a small fraction, they may act in their own interest

Question 35

What are tools to help solve the principal agent problem?

Answer 35

Production of information: Monitoring

Government Regulation to Increase Info

Financial Intermediation - Venture Capital Firms

Debt Contracts

Question 36

What are the four restictive covenants to reduce moral hazard

Answer 36

1. Covenants to discourage undesirable behaviour
2. Covenants to encourage desirable behaviour
3. Covenants to keep collateral valuable
4. Covenants to provide information

Question 37

What are drawbacks of the government safety net?

Answer 37

Moral hazard

Adverse selection

“too big to fail”

Financial consolidation

Question 38

What are the 6 types of financial regulation?

Answer 38

Restrictions on asset holdings

Capital Requirements

Financial supervision: Chartering and Examination

Disclosure Requirements

Consumer Protection

Restrictions on competition

Question 39

Describe capital requirements as a type of financial regulation

Answer 39

By forcing a financial institution to hold a large amount of equity capital, the institution has more to lose if it fails and thus more likely to pursue less risky activities

Question 40

What is Chartering?

Answer 40

a method to prevent adverse selection. through chartering, proposals for new institutions are screened to prevent undesirable people from controlling them. Once a bank has been chartered, it is required to file periodic call reports, revealing assets, liabilities, income etc …

Question 41

What are disclosure requirements

Answer 41

to ensure that better information is available in the marketplace, regulators can require that financial institutions adhere to certain standard accounting principles and disclose a wide range of info that helps the market assess the quality of an institution’s portfolio and the amount of its exposure to risk.