Test 2 Quizzes Flashcards by Eli Smith

Bonds that offer no periodic coupon payments are referred to as \_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_.
Zero-coupon bonds
Coupon bonds
Consol bonds
TIPS

Zero-coupon bonds

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What is the price of a one-year Treasury bill that pays $100 at maturity if the yield to maturity on the bond is 4%?

$96.15

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If the price of a $100 face value bond with an annual coupon rate of 4% is $97.50, what is the current yield?

4.1%

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If the price of a $100 face value bond is $104.35, _______________.
The yield to maturity equals the coupon rate
The yield to maturity is greater than the coupon rate
The current yield is greater than the coupon rate
The current yield is greater than the yield to maturity

The current yield is greater than the yield to maturity

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Assume an investor purchases a long-term bond with the following characteristics: $100 face value, 6.5% coupon rate, and semi-annual coupon payments. If the investor buys the bond for $102.35 and sells the bond one year later at a price of $99.50, what is the investor’s holding period return? Hint: the investor received two coupon payments (assume the coupon payments are not reinvested).

3.57%

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\_\_\_\_\_\_\_\_\_\_\_\_\_ is the risk that the issuer of a bond may not make the promised payments
Inflation risk
Default risk
Interest-rate risk
Inversion risk

Default risk

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Generally speaking, which of the following characteristics would create a higher level of interest-rate risk in a bond? Another way of saying this is which of the following characteristics would make the price of a bond more volatile in the face of changing yields to maturity?
A high coupon rate
A long time to maturity
A high current yield
Low inflation risk

A long time to maturity

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See picture from Ch. 6 Quiz:
Any increase in the government’s borrowing needs \_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_.
Shifts the supply of bonds to the left
Shifts the supply of bonds to the right
Shifts the demand for bonds to the left
Shifts the demand for bonds to the right

Shifts the supply of bonds to the right

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See picture from Ch. 6 Quiz:
Increases in wealth in the general population \_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_.
Shift the supply of bonds to the left
Shift the supply of bonds to the right
Shift the demand for bonds to the left
Shift the demand for bonds to the right

Shift the demand for bonds to the right

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See picture from Ch. 6 Quiz: Assume market participants’ (investors and borrowers alike) expectations for inflation rise considerably. What effect(s) will this have on bond markets?

I. The supply of bonds will shift to the right

II. The demand for bonds will shift to the left

III. The prices on bonds will decrease
I
I and II
I and III
II and III
I, II, and III

I, II, III

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See picture from Ch. 6 Quiz:
Assume the borrowing needs of the US government increase considerably. Simultaneously, bonds become increasingly risky investments relative to stocks. What is/are the likely effect(s) in the bond markets?

I. The demand for bonds will shift to the right

II. The supply of bonds will shift to the right

III. The yields to maturity on bonds will increase
I
I and II
I and III
II and III
I, II, and III

II and III

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Credit ratings issued by Moody’s and Standard &amp; Poor’s measure the \_\_\_\_\_\_\_\_\_\_\_\_ risk of a bond.
Inflation
Default
Interest-rate
Liquidity

Default

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The top four categories, Aaa down to Baa in the Moody’s scheme, are considered \_\_\_\_\_\_\_\_\_\_\_\_\_\_\_ bonds.
Investment-grade
Speculative-grade
Non-investment-grade
Subprime-grade

Investment-grade

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Which of the following is most commonly used as the benchmark when comparing bond yields to determine risk (credit) spreads?
Municipal bonds
Commercial paper
Junk bonds
US Treasury bonds

US Treasury bonds

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Junk bonds that were once investment-grade bonds are known as \_\_\_\_\_\_\_\_\_\_\_\_.
Sliders
Fallen angels
Broken vessels
TIPS

Fallen angels

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The general rule in the United State is that _____________________.
The interest income from a bond issued by one government is not taxed by another government
The yield to maturity on municipal bonds is higher than the yield to maturity on US Treasury bonds
The interest income from municipal bonds is taxed by the federal government but not by the states that issued the bonds
The interest income from zero-coupon bonds is taxed by states but not by the federal government

The interest income from a bond issued by one government is not taxed by another government

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The relationship among bonds with the same risk characteristics but different maturities is called the \_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_ of interest rates
Term structure
Risk structure
Ratings structure
Maturity structure

term structure

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The \_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_\_ explains why yields on bonds of different times to maturity tend to move together but does NOT explain why the yield curve slopes upwards.
Liquidity premium theory
Expectations hypothesis
Mark-to-market hypothesis
Indeterminate theory

expectations hypothesis

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The key to understanding why the yield curve generally slopes upwards is the fact that longer-term Treasury bonds have higher __________ than shorter-term Treasury bonds and bills.
Inflation risk
Interest-rate risk
Default risk

1 and 2

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The risk (credit) spread __________________.
Measures the difference between the yields of US Treasury bonds and corporate bonds
Is a reliable concurrent signal of moderate to severe recessions
Offers more frequent data than GDP reports

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1, 2, 3

When the yield curve becomes inverted, ______________________.
The economy tends to enter a period of expansion roughly a year later
The economy tends to enter a period of expansion immediately
The economy tends to go into a recession roughly a year later
The economy tends to go into a recession immediately

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The economy tends to go into a recession roughly a year later

According to the text, which of the following was the clearest concurrent indicator or predictor of the 2007-2008 recession?
The yield curve
Statements by the Federal Reserve
The risk spread
The 2008 presidential election

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The risk spread

Which of the following is not one of the primary functions of financial intermediaries
Pooling the resources of small savers
Provide lobbying services to steer important financial regulation
Provide ways to diversify risk
Collecting and processing information in ways that reduce information costs

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Provide lobbying services to steer important financial regulation

Much of what financial intermediaries do (to reduce transaction costs) takes advantage of what are known as \_\_\_\_\_\_\_\_\_\_\_\_, in which the average cost of producing a good or service falls as the quantity produced increases.
Marginal decay
Economies of scope
Negative externalities
Economies of scale

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Economies of scale

``` Borrowers who want to issue bonds and firms that want to issue stock know much more about their business prospects and their willingness to work than potential lenders or investors. This is known as ____________________. Collateral Disclosure paralysis Information asymmetry Intention masking ```

Info asymmetry

Sellers on eBay have much more information about the items they are selling and their own reliability. Aware of this problem, the people who started eBay took two steps. Which of the following was one of those steps? They forced sellers to accept prices that represent extreme discounts relative to market prices They offered insurance to protect buyers who don’t receive their purchases They allowed buyers the power of suspending the account of a seller They policed activities on the site and arranged the arrest of any sellers found violating the site’s policies or contracts

They offered insurance to protect buyers who don’t receive their purchases

``` _________ is something of value pledged by a borrower to the lender in the event of the borrower’s default. Goodwill Usury Reverse credit Collateral ```

Collateral

Which of the following is an example of adverse selection in the financial markets? When considering lending to two potential borrowers, a bank cannot tell which of the two borrowers is a higher credit risk GM defaulting on its bonds in 2009 and filing for bankruptcy After lending money to your brother to start a restaurant, he is seriously injured in an auto accident and is unable to repay your loan After several years of strong performance, a CEO inexplicably begins to embezzle millions of dollars from the company’s bank account

When considering lending to two potential borrowers, a bank cannot tell which of the two borrowers is a higher credit risk

``` Private information services face what is called a ______________ problem. Lone ranger Moral hazard Free rider Sweetheart ```

Free rider

The phrase moral hazard originated when economists who were studying insurance noted that ______________________________. People generally do not like to use insurance An insurance policy changes the behavior of the person who is insured Insurance policies are generally too complex for the average person to understand Doctors prefer to see patients who are insured

An insurance policy changes the behavior of the person who is insured

``` The separation of ownership and management is known as ________________________ and is a prime example of moral hazard in equity contracts. The distant-ownership strain The absentia dilemma The cat-and- mouse conundrum The principal-agent problem ```

principal-agent prob

``` Most companies seeking to raise capital in the stock or bond markets would be unsuccessful without the assistance and reputation of a well-known investment bank (such as Goldman Sachs or JP Morgan) backing them up. This is an example of financial intermediaries providing ____________ to reduce adverse selection. Certification Monitoring Counseling Reputational capital ```

Certification

One of the common ways that CalPERS monitors the companies in which it invests is by _________________. Directing the SEC to investigate the companies Placing CalPERS representatives on the companies’ boards of directors Requiring the companies to pay CalPERS a 5% dividend Hiring an independent auditor to perform quarterly audits of the companies

Placing CalPERS representatives on the companies’ boards of directors

Banks hold reserves because regulation requires it and because prudent business practice dictates it. Reserves include the cash in the bank’s vault (and currency in its ATMs), called vault cash, as well as _________________________. Cash items in process of collection The bank’s deposits at other banks The bank’s deposits at the Federal Reserve System Corporate stocks held by the bank

The bank’s deposits at the Federal Reserve System

``` Since securities are often very liquid, we sometimes refer to them as ___________________. Water Secondary reserves Cash Primary funding ```

Secondary reserves

``` Which of the following is correct? Checking account = Time deposit Savings account = Time deposit Savings account = Passbook savings Checking deposit = Passbook savings ```

Savings account = Passbook savings

Capital is the cushion that banks have against ______________________. A surge in the amount of deposits placed with the bank Unexpected early repayment of loans by customers A sudden increase in the value of their assets Unexpected withdrawals of liabilities

Unexpected withdrawals of liabilities

``` _________________ are amounts the bank sets aside to cover potential losses from defaulted loans. Provisions for uncollectible accounts Contingency accounts Bad loan provisions Loan loss reserves ```

Loan loss reserves

uppose a bank customer unexpectedly withdraws $10 million. Which of the following is the quickest PLAUSIBLE method the bank will use to meet this withdrawal demand? The bank will simply pull the money from its reserves The bank will sell T-bills and other liquid securities The bank will sell a bundle of loans to another bank The bank will sell some of the stock it owns

The bank will sell T-bills and other liquid securities

``` For a typical U.S. bank, prior to the financial crisis of 2007 – 2009, the return on assets was about 1.3%, while the return on equity was 10 to 12 times that high. Which of the following words or phrases best explains this phenomenon? Subsidies Fraud Leverage Luck ```

Leverage

Banks use which of the following to try to mitigate credit risk? (1 or more) I. Diversification II. Interest-Rate Swaps III. Credit Risk Analysis

1 and 3

``` Managers must compute an estimate of the change in the bank’s profit for each one-percentage-point change in the interest rate. This procedure is called ________ analysis. SWOT Operational Chasm Gap ```

Gap

The problem is that traders normally share in the profits from good investments, but the bank pays for the losses. Heads, the trader wins; tails, the bank loses. This arrangement creates ________________. An incentive for traders to be too conservative in their trading Excessive profits for the bank Moral hazard Adverse selection

Moral hazard

``` When the World Trade Center Towers collapsed on September 11, 2001, the Bank of New York was shut down for several days and recovered very slowly. Which of the following was the primary reason for their problems? Foreign exchange risk Sovereign risk Operational risk Credit risk ```

Operational risk

Current yield equation

Yearly coupon payment / Price Paid

Price of zero-coupon bond equation

Face value / (1 + i)^n (i is int rate and n is years until payment is made)

Coupon rate vs. current yield vs. yield to maturity comparison: Bond Price < Face Value:

Coupon rate < Current yield < YTM

Coupon rate vs. current yield vs. yield to maturity comparison: Bond Price = Face Value:

Coupon rate = Current yield = YTM

Coupon rate vs. current yield vs. yield to maturity comparison: Bond Price > Face Value:

Coupon rate > Current yield > YTM

Test 2 Quizzes Flashcards

(49 cards)