Ch.6 Understanding Financial Markets and + Exam Questions

Finance, 5e (Cornett)

Chapter 6 Understanding Financial Markets and Institutions

1) Which of these provide a forum in which demanders of funds raise funds by issuing new financial instruments, such as stocks and bonds?

A) investment banks

B) money markets

C) primary markets

D) secondary markets

2) In the United States, which of these financial institutions arrange most primary market transactions for businesses?

A) investment banks

B) asset transformer

C) direct transfer agents

D) over-the-counter agents

3) Primary market financial instruments include stock issues from firms allowing their equity shares to be publicly traded on the stock market for the first time. We usually refer to these first-time issues as which of the following?

A) initial public offerings

B) direct transfers

C) money market transfers

D) over-the-counter stocks

4) Once firms issue financial instruments in primary markets, these same stocks and bonds are then traded in which of these?

A) initial public offerings

B) direct transfers

C) secondary markets

D) over-the-counter stocks

5) Which of these feature debt securities or instruments with maturities of one year or less?

A) money markets

B) primary markets

C) secondary markets

D) over-the-counter stocks

6) Which of the following is NOT a money market instrument?

A) treasury bills

B) commercial paper

C) corporate bonds

D) bankers' acceptances

7) Which of these money market instruments are short-term funds transferred between financial institutions, usually for no more than one day?

A) treasury bills

B) federal funds

C) commercial paper

D) banker acceptances

8) Which of the following is NOT a capital market instrument?

A) U.S. Treasury notes and bonds

B) U.S. Treasury bills

C) U.S. government agency bonds

D) corporate stocks and bonds

9) Which of the following are money market securities to obtain short-term funds?

A) U.S. Treasury notes and bonds

B) U.S. Treasury bills

C) Commercial paper

D) Both b and c

10) Which of the following is/are NOT a capital market security

A) Corporate bonds

B) Banker's acceptances

C) Corporate stocks

D) State and local government bonds

11) Which of these capital market instruments are long-term loans to individuals or businesses to purchase homes, pieces of land, or other real property?

A) treasury notes and bonds

B) mortgages

C) mortgage-backed securities

D) corporate bonds

12) Which of these markets trade currencies for immediate or for some future stated delivery?

A) money markets

B) primary markets

C) foreign exchange markets

D) over-the-counter stocks

13) Which of these formalizes an agreement between two parties to exchange a standard quantity of an asset at a predetermined price on a specified date in the future?

A) derivative security

B) initial public offering

C) liquidity asset

D) trading volume

14) Which of these does NOT perform vital functions to securities markets of all sorts by channelling funds from those with surplus funds to those with shortages of funds?

A) commercial banks

B) secondary markets

C) insurance companies

D) mutual funds

15) Which of these refer to the ease with which an asset can be converted into cash?

A) direct transfer

B) liquidity

C) primary market

D) secondary market

16) Which of the following is the risk that an asset's sale price will be lower than its purchase price?

A) default risk

B) liquidity risk

C) price risk

D) trading risk

17) Financial intermediaries provide which of the following?

A) Purchase the financial claims that fund users issue.

B) Finance purchases by selling financial claims to household investors and other fund suppliers.

C) Both a and b

D) None of the above

18) Which of these is the interest rate that is actually observed in financial markets?

A) nominal interest rates

B) real interest rates

C) real risk-free rate

D) market premium

19) Which of these is the interest rate that would exist on a default-free security if no inflation were expected?

A) nominal interest rate

B) real interest rate

C) default premium

D) market premium

20) Which of the following is the risk that a security issuer will miss an interest or principal payment or continue to miss such payments?

A) default risk

B) liquidity risk

C) maturity risk

D) price risk

21) Which of these is NOT a participant in the shadow banking system?

A) structured investment vehicles (SIVs)

B) special purpose vehicles (SPVs)

C) limited-purpose finance companies

D) credit unions

22) How is the shadow banking system the same as the traditional banking system?

A) It intermediates the flow of funds between net savers and net borrowers.

B) It serves as a middle man.

C) The complete credit intermediation is performed through a series of steps involving many nonbank financial service firms.

D) The complete credit intermediation is performed by a single bank.

23) Which statement is NOT true of the loanable funds theory?

A) Views the level of interest rates as resulting from factors that affect the supply and demand for loanable funds.

B) Categorizes financial market participants as net suppliers or demanders of funds.

C) Is a model that is rarely used to explain interest rates and interest rate movement.

D) Is a theory of interest rate determination that views equilibrium interest rates in financial markets as a result of the supply and demand for loanable funds.

24) Which of the following is the continual increase in the price level of a basket of goods and services?

A) deflation

B) inflation

C) recession

D) stagflation

25) Which of these statements is true?

A) The higher the default risk, the higher the interest rate that securities buyers will demand.

B) The lower the default risk, the higher the interest rate that securities buyers will demand.

C) The higher the default risk, the lower the interest rate that securities buyers will demand.

D) The default risk does not impact the interest rate that securities buyers will demand.

26) Which of these is a comparison of market yields on securities, assuming all characteristics except maturity are the same?

A) liquidity risk

B) market risk

C) maturity risk

D) term structure of interest rates

27) According to this theory of term structure of interest rates, at any given point in time, the yield curve reflects the market's current expectations of future short-term rates.

A) expectations theory

B) future short-term rates theory

C) term structure of interest rates theory

D) unbiased expectations theory

28) Which of the following theories argues that individual investors and financial institutions have specific maturity preferences, and to encourage buyers to hold securities with maturities other than their most preferred requires a higher interest rate?

A) liquidity premium hypothesis

B) market segmentation theory

C) supply and demand theory

D) unbiased expectations theory

29) Which of these is the expected or "implied" rate on a short-term security that will originate at some point in the future?

A) current yield

B) forward rate

C) spot rate

D) yield to maturity

30) Which of these is NOT a theory that explains the shape of the term structure of interest rates?

A) liquidity theory

B) market segmentation theory

C) short-term structure of interest rates theory

D) unbiased expectations theory

31) A particular security's default risk premium is 3 percent. For all securities, the inflation risk premium is 2 percent and the real interest rate is 2.25 percent. The security's liquidity risk premium is 0.75 percent and maturity risk premium is 0.90 percent. The security has no special covenants. What is the security's equilibrium rate of return?

A) 1.78 percent

B) 3.95 percent

C) 8.90 percent

D) 17.8 percent

32) You are considering an investment in 30-year bonds issued by a corporation. The bonds have no special covenants. The Wall Street Journal reports that one-year T-bills are currently earning 3.50 percent. Your broker has determined the following information about economic activity and the corporation's bonds:

Real interest rate = 2.50 percent

Default risk premium = 1.75 percent

Liquidity risk premium = 0.70 percent

Maturity risk premium = 1.50 percent

What is the inflation premium? What is the fair interest rate on the corporation's 30-year bonds?

A) 1 percent and 1.49 percent, respectively

B) 1 percent and 6.45 percent, respectively

C) 1 percent and 7.45 percent, respectively

D) 3.50 percent and 9.95 percent, respectively

33) A corporation's 10-year bonds have an equilibrium rate of return of 7 percent. For all securities, the inflation risk premium is 1.50 percent and the real interest rate is 3.0 percent. The security's liquidity risk premium is 0.15 percent and maturity risk premium is 0.70 percent. The security has no special covenants. What is the bond's default risk premium?

A) 1.40 percent

B) 1.65 percent

C) 5.35 percent

D) 9.35 percent

34) A two-year Treasury security currently earns 5.25 percent. Over the next two years, the real interest rate is expected to be 3.00 percent per year and the inflation premium is expected to be 2.00 percent per year. What is the maturity risk premium on the two-year Treasury security?

A) 0.25 percent

B) 1.00 percent

C) 1.05 percent

D) 5.00 percent

35) Suppose that the current one-year rate (one-year spot rate) and expected one-year T-bill rates over the following three years (i.e., years 2, 3, and 4, respectively) are as follows:

1R1 = 5%,

E(2r1) = 5.5%,

E(3r1) = 6.5%,

E(4r1) = 7.0%

Using the unbiased expectations theory, what is the current (long-term) rate for four-year-maturity Treasury securities?

A) 6.00 percent

B) 6.33 percent

C) 6.75 percent

D) 7.00 percent

36) One-year Treasury bills currently earn 5.50 percent. You expect that one year from now, one-year Treasury bill rates will increase to 5.75 percent. If the unbiased expectations theory is correct, what should the current rate be on two-year Treasury securities?

A) 5.50 percent

B) 5.625 percent

C) 5.75 percent

D) 11.25 percent

37) Which statement(s) are true regarding the liquidity premium theory:

A) States that long-term rates are equal to geometric averages of current and expected short-term rates.

B) Liquidity premiums that increase with maturity result in upward sloping yield curves.

C) An upward sloping yield curve may reflect investor's expectations that future short-term rates will be flat.

D) All of the above.

38) One-year Treasury bills currently earn 5.50 percent. You expect that one year from now, one-year Treasury bill rates will increase to 5.75 percent. The liquidity premium on two-year securities is 0.075 percent. If the liquidity theory is correct, what should the current rate be on two-year Treasury securities?

A) 3.775 percent

B) 5.625 percent

C) 5.662 percent

D) 11.325 percent

39) Based on economists' forecasts and analysis, one-year Treasury bill rates and liquidity premiums for the next four years are expected to be as follows: Using the liquidity premium theory, what is the current rate on a four-year Treasury security?

A) 7.736 percent

B) 7.600 percent

C) 7.738 percent

D) 8.400 percent

40) One-year Treasury bills currently earn 3.15 percent. You expect that one year from now, 1-year Treasury bill rates will increase to 3.65 percent and that two years from now, one-year Treasury bill rates will increase to 4.05 percent. If the unbiased expectations theory is correct, what should the current rate be on three-year Treasury securities?

A) 3.40 percent

B) 3.62 percent

C) 3.75 percent

D) 3.85 percent

41) One-year Treasury bills currently earn 2.55 percent. You expect that one year from now, one-year Treasury bill rates will increase to 2.85 percent and that two years from now, one-year Treasury bill rates will increase to 3.15 percent. If the unbiased expectations theory is correct, what should the current rate be on 3-year Treasury securities?

A) 2.55 percent

B) 2.85 percent

C) 2.93 percent

D) 3.15 percent

42) The Wall Street Journal reports that the rate on three-year Treasury securities is 7.00 percent, and the six-year Treasury rate is 7.25 percent. From discussions with your broker, you have determined that the expected inflation premium will be 1.75 percent next year, 2.25 percent in year 2, and 2.40 percent in year 3 and beyond. Further, you expect that real interest rates will be 3.75 percent annually for the foreseeable future. What is the maturity risk premium on the six-year Treasury security?

A) 0.83 percent

B) 0.983 percent

C) 1.10 percent

D) 1.233 percent

43) A corporation's 10-year bonds are currently yielding a return of 7.75 percent. The expected inflation premium is 3.0 percent annually and the real interest rate is expected to be 3.00 percent annually over the next 10 years. The liquidity risk premium on the corporation's bonds is 0.50 percent. The maturity risk premium is 0.25 percent on two-year securities and increases by 0.10 percent for each additional year to maturity. What is the default risk premium on the corporation's 10-year bonds?

A) 0.18 percent

B) 0.20 percent

C) 0.22 percent

D) 0.27 percent

44) Suppose we observe the following rates: 1R1 = 6 percent, 1R2 = 7.5 percent. If the unbiased expectations theory of the term structure of interest rates holds, what is the one-year interest rate expected one year from now, E(2r1)?

A) 6.75 percent

B) 7.50 percent

C) 9.02 percent

D) 13.5 percent

45) The Wall Street Journal reports that the rate on four-year Treasury securities is 4.75 percent and the rate on five-year Treasury securities is 5.95 percent. According to the unbiased expectations hypotheses, what does the market expect the one-year Treasury rate to be four years from today, E(5r1)?

A) 1.11 percent

B) 5.95 percent

C) 10.70 percent

D) 10.89 percent

46) The Wall Street Journal reports that the rate on three-year Treasury securities is 4.75 percent and the rate on four-year Treasury securities is 5.00 percent. The one-year interest rate expected in three years is E(4r1), 5.25 percent. According to the liquidity premium theory, what is the liquidity premium on the four-year Treasury security, L4?

A) 0.0375 percent

B) 0.504 percent

C) 5.01 percent

D) 5.04 percent

47) Suppose we observe the following rates: 1R1 = 8 percent, 1R2 = 10 percent, and E(2r1) = 8 percent. If the liquidity premium theory of the term structure of interest rates holds, what is the liquidity premium for year 2, L2?

A) 1.02 percent

B) 4.04 percent

C) 6.15 percent

D) 12.03 percent

48) You note the following yield curve in The Wall Street Journal. According to the unbiased expectations hypothesis, what is the one-year forward rate for the period beginning one year from today, 2f1?

A) 1.01 percent

B) 1.19 percent

C) 5.625 percent

D) 7.51 percent

49) On May 23, 20XX, the existing or current (spot) one-year, two-year, three-year, and four-year zero-coupon Treasury security rates were as follows:

1R1 = 5.25%,

1R2 = 5.75%,

1R3 = 6.25%,

1R4 = 6.45%

Using the unbiased expectations theory, what is the one-year forward rate on zero-coupon Treasury bonds for year 4 as of May 23, 20XX?

A) 5.925 percent

B) 6.45 percent

C) 7.05 percent

D) 10.32 percent

50) The Wall Street Journal reports that the current rate on 10-year Treasury bonds is 6.75 percent, on 20-year Treasury bonds is 7.25 percent, and on a 20-year corporate bond is 8.50 percent. Assume that the maturity risk premium is zero. If the default risk premium and liquidity risk premium on a 10-year corporate bond is the same as that on the 20-year corporate bond, what is the current rate on a 10-year corporate bond.

A) 7.50 percent

B) 8.00 percent

C) 8.50 percent

D) 8.75 percent

51) The Wall Street Journal reports that the current rate on 5-year Treasury bonds is 6.50 percent and on 10-year Treasury bonds is 6.75 percent. Assume that the maturity risk premium is zero. Calculate the expected rate on a 5-year Treasury bond purchased five years from today, E(5r1).

A) 6.625 percent

B) 6.75 percent

C) 7.00 percent

D) 7.58 percent

52) Suppose we observe the three-year Treasury security rate (1R3) to be 6 percent, the expected one-year rate next year E(2r1) to be 3 percent, and the expected one-year rate the following year E(3r1) to be 5 percent. If the unbiased expectations theory of the term structure of interest rates holds, what is the one-year Treasury security rate, 1R1?

A) 3.00 percent

B) 10.13 percent

C) 14.00 percent

D) 19.88 percent

53) The Wall Street Journal reports that the rate on three-year Treasury securities is 6.25 percent and the rate on five-year Treasury securities is 6.45 percent. According to the unbiased expectations hypothesis, what does the market expect the two-year Treasury rate to be three years from today, E(4r2)?

A) 6.35 percent

B) 6.75 percent

C) 7.25 percent

D) 7.45 percent

54) One-year Treasury bills currently earn 3.25 percent. You expect that one year from now, one-year Treasury bill rates will increase to 3.45 percent and that two years from now, one-year Treasury bill rates will increase to 3.95 percent. The liquidity premium on two-year securities is 0.05 percent and on three-year securities is 0.15 percent. If the liquidity theory is correct, what should the current rate be on three-year Treasury securities?

A) 3.25 percent

B) 3.55 percent

C) 3.62 percent

D) 4.10 percent

55) One-year Treasury bills currently earn 2.95 percent. You expect that one year from now, one-year Treasury bill rates will increase to 3.15 percent and that two years from now, one-year Treasury bill rates will increase to 3.35 percent. The liquidity premium on two-year securities is 0.05 percent and on three-year securities is 0.15 percent. If the liquidity theory is correct, what should the current rate be on three-year Treasury securities?

A) 2.95 percent

B) 3.15 percent

C) 3.22 percent

D) 3.35 percent

56) Assume the current interest rate on a one-year Treasury bond (1R1) is 5.00 percent, the current rate on a two-year Treasury bond (1R2) is 5.75 percent, and the current rate on a three-year Treasury bond (1R3) is 6.25 percent. If the unbiased expectations theory of the term structure of interest rates is correct, what is the one-year interest rate expected on Treasury bills during year 3, 3f1?

A) 5.00 percent

B) 5.67 percent

C) 7.26 percent

D) 8.00 percent

57) A recent edition of The Wall Street Journal reported interest rates of 3.10 percent, 3.50 percent, 3.75 percent, and 3.95 percent for three-year, four-year, five-year, and six-year Treasury security yields, respectively, According to the unbiased expectation theory of the term structure of interest rates, what are the expected one-year rates for year 6?

A) 3.575 percent

B) 3.95 percent

C) 4.96 percent

D) 5.33 percent

58) A particular security's default risk premium is 3 percent. For all securities, the inflation risk premium is 1.75 percent and the real interest rate is 4.2 percent. The security's liquidity risk premium is 0.35 percent and maturity risk premium is 0.95 percent. The security has no special covenants. Calculate the security's equilibrium rate of return.

A) 8.50 percent

B) 6.05 percent

C) 10.25 percent

D) 9.90 percent

59) You are considering an investment in 30-year bonds issued by Moore Corporation. The bonds have no special covenants. The Wall Street Journal reports that one-year T-bills are currently earning 3.55 percent. Your broker has determined the following information about economic activity and Moore Corporation bonds:

Real interest rate = 2.75 percent

Default risk premium = 1.05 percent

Liquidity risk premium = 0.50 percent

Maturity risk premium = 1.85 percent

What is the inflation premium?

A) 0.80 percent

B) 1.25 percent

C) 6.25 percent

D) 8.00 percent

60) You are considering an investment in 30-year bonds issued by Moore Corporation. The bonds have no special covenants. The Wall Street Journal reports that one-year T-bills are currently earning 3.55 percent. Your broker has determined the following information about economic activity and Moore Corporation bonds:

Real interest rate = 2.75 percent

Default risk premium = 1.05 percent

Liquidity risk premium = 0.50 percent

Maturity risk premium = 1.85 percent

What is the fair interest rate on Moore Corporation 30-year bonds?

A) 3.80 percent

B) 6.45 percent

C) 6.95 percent

D) 9.70 percent

61) Dakota Corporation 15-year bonds have an equilibrium rate of return of 9 percent. For all securities, the inflation risk premium is 1.95 percent and the real interest rate is 3.65 percent. The security's liquidity risk premium is 0.35 percent and maturity risk premium is 0.95 percent. The security has no special covenants. Calculate the bond's default risk premium.

A) 2.10 percent

B) 3.05 percent

C) 3.40 percent

D) 2.45 percent

62) A two-year Treasury security currently earns 5.13 percent. Over the next two years, the real interest rate is expected to be 2.15 percent per year and the inflation premium is expected to be 1.75 percent per year. Calculate the maturity risk premium on the two-year Treasury security.

A) 5.13 percent

B) 3.38 percent

C) 2.98 percent

D) 1.23 percent

63) Suppose that the current one-year rate (one-year spot rate) and expected one-year T-bill rates over the following three years (i.e., years 2, 3, and 4, respectively) are as follows:

1R1 = 5 percent,

E(2r1) = 7 percent,

E(3r1) = 7.5 percent

E(4r1) = 7.85 percent

Using the unbiased expectations theory, calculate the current (long-term) rates for one-year and two-year-maturity Treasury securities.

A) one-year: 5.00 percent,two-year: 5.50 percent

B) one-year: 5.00 percent, two-year: 6.00 percent

C) one-year: 5.50 percent, two-year: 6.15 percent

D) one-year: 5.50 percent, two-year: 5.75 percent

64) Suppose that the current one-year rate (one-year spot rate) and expected one-year T-bill rates over the following three years (i.e., years 2, 3, and 4 respectively) are as follows:

1R1 = 5 percent,

E(2r1) = 6 percent,

E(3r1) = 7.5 percent

E(4r1) = 7.85 percent

Using the unbiased expectations theory, calculate the current (long-term) rates for three-year- and four-year-maturity Treasury securities.

A) one-year: 6.16 percent, two-year: 6.58 percent

B) one-year: 6.16 percent, two-year: 6.78 percent

C) one-year: 6.25 percent, two-year: 6.45 percent

D) one-year: 5.95 percent, two-year: 6.45 percent

65) Suppose that the current one-year rate (one-year spot rate) and expected one-year T-bill rates over the following three years (i.e., years 2, 3, and 4, respectively) are as follows:

1R1 = 5 percent,

E(2r1) = 6 percent,

E(3r1) = 7.5 percent

E(4r1) = 6.85 percent

Using the unbiased expectations theory, calculate the current (long-term) rates for one-, two-, three-, and four-year-maturity Treasury securities.

A) 5.00 percent, 5.50 percent, 6.16 percent, 6.33 percent

B) 5.00 percent, 5.25 percent, 6.10 percent, 6.27 percent

C) 5.00 percent, 5.50 percent, 6.10 percent, 6.23 percent

D) 5.00 percent, 5.25 percent, 6.16 percent, 6.49 percent

66) One-year Treasury bills currently earn 3.75 percent. You expect that one year from now, one-year Treasury bill rates will increase to 4.15 percent. If the unbiased expectations theory is correct, what should the current rate be on two-year Treasury securities?

A) 4.25 percent

B) 3.85 percent

C) 3.95 percent

D) 4.35 percent

67) One-year Treasury bills currently earn 4.5 percent. You expect that one year from now, one-year Treasury bill rates will increase to 6.65 percent. The liquidity premium on two-year securities is 0.05 percent. If the liquidity theory is correct, what should the current rate be on two-year Treasury securities?

A) 5.24 percent

B) 5.59 percent

C) 5.65 percent

D) 5.95 percent

68) Based on economists' forecasts and analysis, one-year Treasury bill rates and liquidity premiums for the next four years are expected to be as follows:

Using the liquidity premium theory, what should be the current rate on four-year Treasury securities?

A) 6.59 percent

B) 6.75 percent

C) 6.82 percent

D) 7.13 percent

69) The Wall Street Journal reports that the rate on three-year Treasury securities is 7.00 percent, and the six-year Treasury rate is 6.20 percent. From discussions with your broker, you have determined that the expected inflation premium will be 2.25 percent next year, 2.50 percent in year 2, and 2.50 percent in year 3 and beyond. Further, you expect that real interest rates will be 4.4 percent annually for the foreseeable future. Calculate the maturity risk premium on the 3-year Treasury security.

A) 0.00 percent

B) 0.10 percent

C) 4.50 percent

D) 2.60 percent

70) The Wall Street Journal reports that the rate on three-year Treasury securities is 6.50 percent, and the six-year Treasury rate is 6.80 percent. From discussions with your broker, you have determined that the expected inflation premium will 2.25 percent next year, 2.50 percent in year 2, and 2.60 percent in year 3 and beyond. Further, you expect that real interest rates will be 3.4 percent annually for the foreseeable future. Calculate the maturity risk premium on the three-year and the six-year Treasury security.

A) 3-year: 0.6 percent, 6-year: 0.80 percent

B) 3-year: 0.5 percent, 6-year: 0.90 percent

C) 3-year: 0.6 percent, 6-year: 1.20 percent

D) 3-year: 0.5 percent, 6-year: 0.80 percent

71) Nikki G's Corporation's 10-year bonds are currently yielding a return of 9.25 percent. The expected inflation premium is 2.0 percent annually and the real interest rate is expected to be 3.10 percent annually over the next 10 years. The liquidity risk premium on Nikki G's bonds is 0.1 percent. The maturity risk premium is 0.10 percent on two-year securities and increases by 0.05 percent for each additional year to maturity. Calculate the default risk premium on Nikki G's 10-year bonds.

A) 2.55 percent

B) 5.65 percent

C) 3.55 percent

D) 1.85 percent

72) Suppose we observe the following rates: 1R1 = 12 percent, 1R2 = 15 percent. If the unbiased expectations theory of the term structure of interest rates holds, what is the one-year interest rate expected one year from now, E(2r1)?

A) 13.5 percent

B) 14.2 percent

C) 15.6 percent

D) 18.0 percent

73) The Wall Street Journal reports that the rate on four-year Treasury securities is 7.50 percent and the rate on five-year Treasury securities is 9.15 percent. According to the unbiased expectations hypothesis, what does the market expect the one-year Treasury rate to be four years from today, E(5r1)?

A) 16.0 percent

B) 18.4 percent

C) 15.9 percent

D) 13.7 percent

74) The Wall Street Journal reports that the rate on three-year Treasury securities is 7.25 percent and the rate on four-year Treasury securities is 8.50 percent. The one-year interest rate expected in three years is E(4r1), 4.10 percent. According to the liquidity premium theory, what is the liquidity premium on the four-year Treasury security, L4?

A) 6.7 percent

B) 7.1 percent

C) 8.2 percent

D) 9.6 percent

75) Suppose we observe the following rates: 1R1 = 13 percent, 1R2 = 16 percent, and E(2r1) = 10 percent. If the liquidity premium theory of the term structure of interest rates holds, what is the liquidity premium for year 2, L2?

A) 8.7 percent

B) 9.1 percent

C) 9.7 percent

D) 10.0 percent

76) You note the following yield curve in The Wall Street Journal. According to the unbiased expectations hypothesis, what is the one-year forward rate for the period beginning one year from today, 2f1?

A) 7.6 percent

B) 8.6 percent

C) 9.0 percent

D) 10.2 percent

77) On May 23, 20XX, the existing or current (spot) one-year, two-year, three-year, and four-year zero-coupon Treasury security rates were as follows:

1R1 = 4.55 percent,

1R2 = 4.75 percent,

1R3 = 5.25 percent,

1R4 = 5.95 percent

Using the unbiased expectations theory, calculate the one-year forward rates on zero-coupon Treasury bonds for years two, three, and four as of May 23, 20XX.

A) year 1: 4.95 percent, Year 2: 6.26 percent, Year 3: 8.08 percent

B) year 1: 3.75 percent, Year 2: 6.02 percent, Year 3: 9.00 percent

C) year 1: 4.95 percent, Year 2: 7.26 percent, Year 3: 8.08 percent

D) year 1: 3.65 percent, Year 2: 6.32 percent, Year 3: 11.08 percent

78) The Wall Street Journal reports that the current rate on 10-year Treasury bonds is 6.25 percent, on 20-year Treasury bonds is 7.95 percent, and on a 20-year corporate bond is 10.75 percent. Assume that the maturity risk premium is zero. If the default risk premium and liquidity risk premium on a 10-year corporate bond is the same as that on the 20-year corporate bond, calculate the current rate on a 10-year corporate bond.

A) 9.05 percent

B) 6.15 percent

C) 7.60 percent

D) 8.70 percent

79) The Wall Street Journal reports that the current rate on five-year Treasury bonds is 6.45 percent and on 10-year Treasury bonds is 7.75 percent. Assume that the maturity risk premium is zero. Calculate the expected rate on a five-year Treasury bond purchased five years from today, E(5r5).

A) 7.25 percent

B) 8.12 percent

C) 9.07 percent

D) 10.16 percent

80) Suppose we observe the three-year Treasury security rate (1R3) to be 11 percent, the expected one-year rate next year E(2r1) to be 4 percent, and the expected one-year rate the following year E(3r1) to be 5 percent. If the unbiased expectations theory of the term structure of interest rates holds, what is the one-year Treasury security rate, 1R1?

A) 18.57 percent

B) 10.19 percent

C) 23.19 percent

D) 25.24 percent

81) Assume the current interest rate on a one-year Treasury bond (1R1) is 5.50 percent, the current rate on a two-year Treasury bond (1R2) is 5.95 percent, and the current rate on a three-year Treasury bond (1R3) is 8.50 percent. If the unbiased expectations theory of the term structure of interest rates is correct, what is the one-year interest rate expected on Treasury bills during year 3, 3f1?

A) 13.79 percent

B) 12.29 percent

C) 11.69 percent

D) 10.29 percent

82) If the yield curve is downward sloping, what is the yield to maturity on a 30-year Treasury bond relative to a 10-year Treasury bond?

A) The yield on the 10-year bond must be greater than the yield on the 30-year bond.

B) The yield on the 10-year bond must be less than the yield on the 30-year bond.

C) The yields on the two bonds are equal.

D) We need to know the other risk premiums to answer this question.

83) One-year Treasury bill rates in 20XX averaged 5.15 percent and inflation for the year was 7.3 percent. If investors had expected the same inflation rate as that realized, calculate the real interest rate for 20XX according to the Fisher effect.

A) 0.00 percent

B) −2.15 percent

C) 2.15 percent

D) 3.95 percent

84) Assume that you observe the following rates on long-term bonds:

U.S. Treasury bonds = 4.15 percent AAA

Corporate bonds = 6.2 percent BBB

The main reason for the differences in the interest rates is:

A) maturity risk premium

B) inflation premium

C) default risk premium

D) convertibility premium

85) Which of the following statements is correct?

A) According to the unbiased expectations theory, the return for holding a two-year bond to maturity is equal to the nominal rate divided by the real interest rate.

B) The rate on a 10-year Corporate bond can never be less than the rate on a 10-year Treasury.

C) We usually observe the inverted yield curve.

D) The rate on a three-year Treasury can never be less than the rate on a 15-year Treasury.

86) One-year interest rates are 3 percent. The market expects one-year rates to be 5 percent one year from now. The market also expects one-year rates to be 7 percent two years from now. Assume that the unbiased expectations theory holds. Which of the following is correct?

A) The yield curve is downward sloping.

B) The yield curve is flat.

C) The yield curve is upward sloping.

D) We need the maturity risk premiums to be able to answer this question.

87) Which of the following statements is correct?

A) If the unbiased expectations theory is correct, we could see an inverted yield curve.

B) If a yield curve is inverted, long-term bonds have higher yields than short-term bonds.

C) If the maturity risk premium is zero, the yield curve would be flat.

D) If the unbiased expectations theory is correct, the maturity risk premium is zero.

88) The Wall Street Journal states that the yield curve for Treasuries is downward sloping and there is no liquidity premium or maturity risk premium. Given this information, which of the following statements is correct?

A) A 30-year corporate bond must have a higher yield than a five-year corporate bond.

B) A five-year corporate bond must have a higher yield than a 30-year Treasury bond.

C) A five-year Treasury bond must have a higher yield than a five-year corporate bond.

D) All of these choices are correct.

89) Which of the following statements is correct?

A) An IPO is an example of a primary market transaction.

B) Money markets are subject to wider price fluctuations and are therefore more risky than capital market instruments.

C) A direct transfer of funds is more efficient than utilizing financial institutions.

D) The market segmentation theory argues that the different investors have different risk preferences which determine the shape of the yield curve.

90) In 20XX, the 10-year Treasury rate was 4.5 percent while the average 10-year Aaa corporate bond debt carried an interest rate of 6.0 percent. What is the average default risk premium on Aaa corporate bonds?

A) 0.75 percent

B) 1.5 percent

C) 1.95 percent

D) 2.25 percent

91) Which of the following statements is correct?

A) The default risk premium of Baa 20-year corporate bonds over Aaa 20-year corporate bonds does not vary.

B) The market segmentation theory assumes that borrowers and investors do not want to shift from one maturity sector to another without an interest rate premium.

C) Real interest rates are the rates that are quoted in the news.

D) All of these choices are correct.

92) All of the following are types of financial institutions EXCEPT

A) insurance companies.

B) pension funds.

C) thrifts.

D) Federal reserve.

93) All of the following are benefits that financial institutions provide to our economy EXCEPT

A) increased liquidity.

B) increased monitoring.

C) increased dollar amount of funds flowing from suppliers to fund users.

D) increased price risk.

94) All of the following are factors that affect nominal interest rates EXCEPT

A) time to maturity.

B) real interest rate.

C) convertibility features.

D) foreign exchange.

95) Which of the following statements is correct?

A) A flat yield curve occurs when the yield-to-maturity is virtually unaffected by the term-to-maturity.

B) Real interest rates are generally lower than nominal interest rates.

C) Liquidity risk is the risk that a security may be difficult to sell on short notice for its true value.

D) All of these choices are correct.

96) Which of the following statements is incorrect?

A) Governments affect foreign exchange rates indirectly by altering prevailing interest rates within their own countries.

B) Foreign currency exchange rates vary with the day-to-day demand and supply of the two foreign currencies.

C) Central governments can intervene in foreign exchange markets directly and value their currency at high rates relative to another currency.

D) All of these choices are correct.

97) The theory that argues that individual investors and financial institutions have specific maturity preferences is called the

A) market segmentation theory.

B) unbiased expectations theory.

C) liquidity preference theory.

D) inverted forward theory.

98) The theory that states that the yield curve reflects the market's current expectations of future short-term rates is called the

A) market segmentation theory.

B) liquidity premium theory.

C) unbiased expectations theory.

D) inverted forward theory.

99) Which of the following statements is incorrect?

A) The over-the-counter market operates in a fixed location to conduct trades for local stocks.

B) Liquidity is the ease with which an asset can be converted into cash.

C) An initial public offering is an example of a primary market transaction.

D) Money market instruments have maturities of less than one year.

100) All of the following are secondary market transactions EXCEPT

A) GE sells $30 million of new preferred stock.

B) Microsoft sells $2 million of IBM preferred stock out of its marketable securities portfolio.

C) The Magellan Fund buys $100 million of Apple previously issued bonds.

D) Allstate Insurance Co. sells $5 million in IBM bonds.

101) Which of the following is NOT correct with respect to derivative securities?

A) They are among the riskiest of securities in the financial securities markets.

B) They can be used for hedging purposes.

C) Examples of derivatives include futures, options, and swaps.

D) All of these choices are correct.

102) Which of the following is NOT correct with respect to financial institutions?

A) Financial institutions channel funds from those with shortages to those with surplus funds.

B) Commercial banks, insurance companies, and mutual funds are examples of financial institutions.

C) Financial institutions reduce monitoring costs and liquidity costs.

D) Financial institutions reduce price risk.

103) All of the following are factors that influence interest rates for individual securities EXCEPT

A) the security's term to maturity.

B) inflation.

C) special provisions regarding the use of funds raised by a particular security issuer.

D) the home mortgage rate.

104) The real interest rate is

A) the rate charged to the corporations with the best credit rating or least amount of default risk.

B) the rate that a security would pay if no inflation were expected over its holding period.

C) the rate that a security would pay if the security had no maturity risk.

105) All of the following special provisions benefit security holders EXCEPT

A) tax-free status.

B) convertibility.

C) callability.

D) All of these choices are correct.

106) Which of the following assets has the lowest liquidity?

A) U.S. Treasury bill.

B) bonds issued by GM.

C) common stock issued by Apple Inc.

D) common stock issued by a small but financially strong firm.

107) All of the following are common shapes for the yield curve EXCEPT

A) elliptical.

B) upward-sloping.

C) flat.

D) inverted.

108) The Wall Street Journal reports that the current rate on five-year Treasury bonds is 2.85 percent and on 10-year Treasury bonds is 4.35 percent. Assume that the maturity risk premium is zero. Calculate the expected rate on a five-year Treasury bond purchased five years from today, E(5r5).

A) 3.60 percent

B) 5.87 percent

C) 7.20 percent

D) 8.28 percent

109) The Wall Street Journal reports that the current rate on 10-year Treasury bonds is 3.25 percent and on 20-year Treasury bonds is 5.50 percent. Assume that the maturity risk premium is zero. Calculate the expected rate on a 10-year Treasury bond purchased 10 years from today, E(10r10).

A) 2.25 percent

B) 4.38 percent

C) 7.80 percent

D) 8.75 percent

110) Which of the following are suppliers of loanable funds?

A) households

B) government units

C) foreign investors

D) All of these choices are correct.

111) Which of the following do foreign suppliers of funds in the U.S. financial market assess?

A) interest rates offered on financial securities

B) their total wealth

C) risk of the securities

D) All of these choices are correct.

112) Which of the following are demanders of loanable funds?

A) households

B) businesses

C) governments

D) All of these choices are correct.

113) Why would foreign participants borrow from U.S. financial markets?

A) They look for the cheapest source of funds.

B) They look at the economic conditions of their home country.

C) All of these choices are correct.

114) Which of the following factors cause the supply of funds curve to shift?

A) total wealth

B) risk of the financial security

C) future spending needs

D) All of these choices are correct.

115) When monetary policy objectives are to contract the economic growth, which of the following occurs?

A) The Federal Reserve decreases the supply of funds available in the financial markets.

B) At every interest rate the supply of loanable funds increases.

C) The supply curve shifts down and to the right.

D) The equilibrium interest rate decreases.

116) Which of the following factors cause the demand for funds curve to shift?

A) utility derived from assets purchased with borrowed funds

B) restrictiveness of non-price conditions of borrowing

C) domestic and foreign economic conditions

D) All of these choices are correct.

117) Which of the following occurs as the utility derived from an asset purchased with borrowed funds increases?

A) The willingness of market participants to borrow decreases.

B) The absolute dollar value borrowed increases.

C) At every interest rate the demand for loanable funds decrease.

118) Which of the following occurs as the nonprice restrictions put on borrowers as a condition of borrowing increase?

A) The willingness of market participants to borrow decreases.

B) The absolute dollar value borrowed increases.

C) At every interest rate the demand for loanable funds increases.

119) Which of the following occurs as domestic economic conditions experience a period of growth especially relative to other countries?

A) Market participants are willing to borrow more heavily.

B) At every interest rate the supply of loanable funds increases.

C) At every interest rate the demand for loanable funds increases.

D) All of these choices are correct.