Test 1

Question 1

Expectations Theory

Answer 1

Risk neutral lenders & borrowers view long & short term securities as perfect substitutes

Question 2

Liquidity Preference Theory

Answer 2

Lenders/borrowers are NOT risk neutral. Lenders prefer to decrease wealth risk, while borrowers prefer to decrease income risk. (Shorts & longs are NOT perfect subs)

Question 3

Segmented Markets Theory

Answer 3

Borrowers/lenders keep to one preferred maturity so that shorts & longs are not viewed as subs

Question 4

Key 4 Functions of Money

Answer 4

Medium of Exchange
Unit of Account
Store of Value
Standard of Deferred Payment

Question 5

Organized Market

Answer 5

Exchanges for stocks & futures

Question 6

Over-the-Counter Markets

Answer 6

Bonds, foreign exchange, derivatives

Question 7

Money Market

Answer 7

High liquidity, short maturity

Question 8

Capital Market

Answer 8

Low liquidity, long maturity

Question 9

Treasury Bills

Answer 9

a short term government issued security

Question 10

Commercial Paper

Answer 10

Short term unsecured promissory note

Question 11

Negotiable CDs

Answer 11

Minimum FV of 100K and can be cashed before maturity

Question 12

Repurchase Agreements

Answer 12

vendor agrees to repurchase security from buyer at an agreed price

Question 13

Bonds

Answer 13

a security issued by a corp. or by the govt. with a promise to repay a fixed amt. of money

Question 14

Mortgages

Answer 14

bank/creditor lends money at interest in exchange for title of debtor’s property

Question 15

Yield to Maturity

Answer 15

interest rates that make present value equal to today’s price

Question 16

Real IR

Answer 16

removes effects of inflation

Question 17

Nominal IR

Answer 17

the IR before taking inflation into account

Question 18

Risk Averse

Answer 18

require a higher expected return

Question 19

Risk Neutral

Answer 19

only care about expected return

Question 20

Risk Loving

Answer 20

will accept a lower expected return for more risk

Question 21

What is the yield curve?

Answer 21

plot at a point in time showing yield to maturity of bonds against maturity of bonds, holding all else equal

Question 22

3 Main Theories of Term Structure

Answer 22

Expectations Theory, Liquidity Preference Theory, Segmented Markets

Question 23

Dividends

Answer 23

profits distributed to shareholders

Question 24

Retained Earnings

Answer 24

profits that are kept by the company for its own purposes (re-investment, savings, etc.)

Question 25

Assumption of Efficient Market Theory

Answer 25

The theory assumes that actual stock prices equal the fundamental model’s predictions & expectations are rational.

Question 26

Dow Jones Industrial Avg.

Answer 26

The avg. price of 30 stocks of large corporations

Question 27

S&P 500

Answer 27

Index of the prices of the largest US companies weighted by size