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FIN 453 > MIDTERM #2 review questions > Flashcards

MIDTERM #2 review questions Flashcards

1
Q

What are the conventional policy tools of the Federal Reserve?

A
  • The target fed funds rate
  • The discount rate
  • The deposit rate
  • Required reserve ratio.
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2
Q

If the price of a $100 FV bond is $98.58, which is larger, the CY or the YTM?

A

The CY is less than the YTM.

CY

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3
Q

What is the maturity date on British Consol bonds?

A

There is no maturity date.

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4
Q

If the price of a $100 FV bond is $102.35, which is larger, CY or the YTM?

A

The CY is greater than the YTM

CY > YTM

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5
Q

In the 1970’s and early 80’s we experienced difficult times in the US associated with BONDS. We learned that:

A

It is possible to experience negative holding period returns even if you buy a bond with a seemingly high YTM that does not default.

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6
Q

What is a SALIENT lesson we learn form the financial crisis related to bonds?

A

Panic as a result of snowballing default risk can cause corporate and treasury bond prices to move in opposite directions.

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7
Q

The Federal reserve is widely expected to end its long-standing monthly bond buying program (Ceteris Paribas) what impact should the decrease in purchases have on long term treasuries?

A

The demand for BONDS will shift to the left.

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8
Q

The risk structure of interest rates is a graph that plots the yield to maturity on bonds that are similar in every way except for:

A

Default risk.

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9
Q

The ___________ explains why the yield curve generally slopes upward.

A

Liquidity premium theory.

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10
Q

What type of bond is the most sensitive to sharp downturns in the economy.

A

High level Baa rate Corporate bonds

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11
Q

2 important facts about credit spread:

A
  • Provides information about the current state?direction of our macro economy.
  • Provides more frequent data than GDP reports do.
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12
Q

What happened when S&P downgraded the credit rating of the US government?

A

The YTM on treasuries decreased.

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13
Q

In order for the Yield curve to invert what must happen?

A

Investors must believe that interest rates will decline in the future.

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14
Q

2 important statements that are true about bonds.

A

–Yields on bonds with similar characteristics but different times to maturity tend to move in the same direction (yields of bonds with different maturities are positively correlated).

–The Yield curve tends to slope upwards.

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15
Q

Summary of the Liquidity Premium Theory that explains the term structure of interest rates.

A

–Even if two bonds are exactly the same in every way except time to maturity, the bond with the longer time to maturity necessarily carries more interest rate risk, therefore bonds with longer times to maturity should have higher yields.

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16
Q

An invert yield curve suggests what?

A

The bond markets expect the macro economy to contract in the next year or two.

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17
Q

eBay took a step to protect buyers who have less information than the sellers. What was it?

A

They offered insurance for the buyers who don’t receive their goods.

18
Q

What would be a situation in which a financial institution is pooling the resources of MANY small investors?

A

The bank extends a mortgage to a worthy borrower in the amount of $150,000.

19
Q

Clear example of Certification

A

A small tech company hires Goldman Sachs as its investment bank to help with the IPO process.

20
Q

What is the primary cause for adverse selection in the car market?

A

Sellers of cars know more about the condition of their cars then potential buyers do.

21
Q

Example in marriage of someone decreasing the risk of moral hazard.

A

Husband goes to look for his wife on Eharmony.

22
Q

What to banks do before issuing a loan to decrease adverse selection risk?

A

–Review potential borrower’s credit history and credit score.

–Include debt covenants in the loan contract to prevent misuse of the funds.

23
Q

What is an example of Moral hazard in the Financial market?

A

An otherwise reputable company that has received a $20 million loan from a bank pays a $5 million, one-time dividend to shareholders, which is a direct violation of the debt covenants in the contract.

24
Q

Tyco’s dumbest mistake and clearest form of moral agency problem.

A

Spending over $1 million on his wife birthday party.

25
Q

Example of an attempt to prevent moral hazard.

A

A company paying a large portion of its CEO’s salary in the form of restricted stock.

26
Q

What was one of the root causes of the financial crisis in 2008?

A

The investors who ultimately ended up holding the mortgage-backed securities had little or no understanding of how good or bad the loans were that backed up the securities.

27
Q

2 Other factors that contributed to the crisis of 2008:

A

—-The bursting of the dot.com bubble in the stock market.

—-The percentage of subprime mortgage loan originations increased significantly.

28
Q

What is a CDO?

A

A bond formed by bundling the riskiest tranches of mortgage backed securities and then forming various tranches with varying risk profiles.

29
Q

Why did the US government allow Lehman brothers to go bankrupt?

A

They needed to send a message to the public to prevent the potential moral hazard that could result from other bailouts.

30
Q

Reserves in a bank include the cash in a banks vault (and currency in it’s ATMs), called vault cash as well as ______.

A

The banks deposits at the Federal Reserve.

31
Q

Savings account = ?

A

Passbook savings

32
Q

To estimate a bank’s profit for each one-percentage-point change in the interest rate managers must perform _______ analysis.

A

GAP

33
Q

A ____ is a short term collateralized loan in which an agreement is made that both parties will reverse the transaction on a specific future date.

A

Repurchase agreement

34
Q

Total assets of US commercial banks:

A

$15 trillion

35
Q

What do banks do to deal with liquidity risk?

A

Sell some of their loans and use the proceeds to buy T-bills and muni-bonds.

36
Q

Which of the following represent interest rate risk for a typical commercial bank?

1) The entire yield curve increases.
2) The entire yield curve decreases.
3) The Yield curve inverts.

A

1 and 3.

37
Q

Rogue traders who single-handedly screwed over a huge English bank.

A

Nick Leeson

38
Q

Holding fixed-rate mortgage-backed securities, instead of individual loans helps to minimize what 2 risks?

A

1) Liquidity risk

2) Credit risk

39
Q

What is the best way a bank can meet a large unexpected withdrawal from a customer?

A

Use its secondary reserves.

40
Q

What was the most significant problem that arose from banks use of derivatives?

A

Banks began to use derivatives to speculate, instead of to simply hedge risk.

FIN 453 (11 decks)

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