Financial markets improve economic welfare? because
they allow consumers to time their purchases better and
they channel funds from savers to investor
One of the factors contributing to the financial crisis of? 2007-2009 was the widespread issuance of subprime mortgages. How does this demonstrate adverse? selection?
Lenders loaned money to a pool of potential homeowners with the highest credit risk and lowest net wealth
If you suspect that an airline will go bankrupt next? week, which would you rather? hold, bonds...issued by the? company, or equities...issued by the? company?
bonds
Complete the following table related to the structure of financial markets...
Direct finance & Savers: Buy securities
Direct finance & Borrowers: Sell securities
Indirect finance & Savers: Make deposits
Indirect Finance & Borrowers: Take out loans
When interest rates? decrease, how might businesses and consumers change their economic? behavior?
There will be more consumption spending on? interest-sensitive items and more investment by businesses.
As a? bank, you make a loan to an individual seeking funds to open a coffee shop. When the loan is? made, the borrower uses the funds to take a vacation to Greenland.
This is an example of
Moral Hazard
A share of Microsoft common stock? is:
an asset for its? owner, which Microsoft shows as shareholder equity on its balance sheet.
Why are financial markets important to the health of the? economy?
They channel funds from savers to investors
The concept of? ________ is based on the common?sense notion that a dollar paid to you in the future is less valuable to you than a dollar today.
present value
When talking about a coupon? bond, face value and? ________ mean the same thing.
par value
For simple? loans, the simple interest rate is? ________ the yield to maturity.
equal to
The price of a coupon bond and the yield to maturity are? ________ related; that? is, as the yield to maturity? ________, the price of the bond? ________.
?negatively; rises; falls
A credit market instrument that provides the borrower with an amount of funds that must be repaid at the maturity date along with an interest payment is known as a
simple loan
With an interest rate of 6? percent, the present value of? $100 next year is approximately
?$94
A? ________ pays the owner a fixed coupon payment every year until the maturity? date, when the? ________ value is repaid.
coupon? bond; face
The? ________ states that the nominal interest rate equals the real interest rate plus the expected rate of inflation.
Fisher equation
A fully amortized loan is another name for
a fixed?payment loan
The present value of an expected future payment? ________ as the interest rate increases.
falls
Assuming the terms of issuance to be the same for different types of ? loans, a government would choose to issue? a:
perpetuity
Calculate the present value of a ?$1,500 discount bond with 6 years to maturity if the yield to maturity is 6?%. What is the present value? (rounded to two decimal places)
$1057.44
What is the yield to maturity? (YTM) on a simple loan for ?$2,000 that requires a repayment of ?$10,000 in five? years' time?
38%
If a coupon bond has two years to? maturity, a coupon rate of 99?%, a par value of ?$1000 and a yield to maturity of 12?%, then the coupon bond will sell for ?
$949.30
The price of a bond and its yield to maturity are
negatively related
True or False:
Bond prices vary proportionately with the interest rate for both coupon bonds and discount bonds
False
The interest rate on a consol equals the
coupon payment divided by the price.
If the interest rates on all bonds rise from 5 to 6 percent over the course of the? year, which bond would you prefer to have been? holding?
A bond with one year to maturity
The? ________ interest rate more accurately reflects the true cost of borrowing.
real
If you expect the inflation rate to be 15 percent next year and a oneminus?year bond has a yield to maturity of 7? percent, then the real interest rate on this bond is
-8 percent
When the? ________ interest rate is? low, there are greater incentives to? ________ and fewer incentives to? ________.
?real; borrow; lend
Which of the following? $1,000 face?value securities has the lowest yield to? maturity?
A 10 percent coupon bond selling for? $1,000
A 15 percent coupon bond selling for? $900
A 15 percent coupon bond selling for? $1,000
A 5 percent coupon bond selling fo
A 5 percent coupon bond selling for? $1,000
Would you be more or less willing to buy a house under the following? circumstances:
1) You just inherited? $100,000.
2) Real estate commissions fall from? 6% of the sales price
to? 5% of the sales price.
3)You expect Microsoft stock to double in value ne
1) More Willing
2) More Willing
3) Less Willing
4) More Willing
5) Less Willing
Explain why you would be more or less willing to buy a house under the following? circumstances:
You would be
more willing to buy a house if you just inherited? $100,000 because
you now have more wealth to spend on all assets
Explain why you would be more or less willing to buy a house under the following? circumstances:
You would be
less
willing to buy a house if you expect Microsoft stock to double in value next year because
the stock will earn you a very large return
Explain why you would be more or less willing to buy a house under the following? circumstances:
You would be
more
willing to buy a house if prices in the stock market become more volatile because
stocks have become relatively more risky
Explain why you would be more or less willing to buy a house under the following? circumstances:
You would be
less
willing to buy a house if you expect housing prices to fall because
the return on your house will actually be negative
Pieces of property that serve as a store of value are called
assets
If housing prices are expected to? increase, then, other things? equal, the demand for houses will? ________ and that of Treasury bills will? ________.
?increase; decrease
The demand for silver? decreases, other things? equal, when
the gold market is expected to boom.
Holding the expected return on bonds? constant, an increase in the expected return on common stocks would? ________ the demand for? bonds, shifting the demand curve to the? ________.
?decrease; left
Everything else held? constant, during a business cycle? expansion, the supply of bonds shifts to the? ________ as businesses perceive more profitable investment? opportunities, while the demand for bonds shifts to the? ________ as a result of the increas
right; right
In? Keynes's liquidity preference? framework, as the expected return on bonds increases? (holding everything else? unchanged), the expected return on money? ________, causing the demand for? ________ to fall.
falls; money
When the Fed decreases the money? stock, the money supply curve shifts to the? ________ and the interest rate? ________, everything else held constant.
left; rises
Of the four effects on interest rates from an increase in the money? supply, the one that works in the opposite direction of the other three is the
liquidity effect.
What would happen to the demand for Rembrandt paintings if the stock market undergoes a? boom?
The demand for Rembrandt paintings would increase because of the increase in? people's wealth
Explain why you would be more or less willing to buy a share of Microsoft stock in the following? situations:
You would be
less
willing to buy a share of Microsoft stock if your wealth falls because
you have less money to spend on all of your potential assets
Explain why you would be more or less willing to buy a share of Microsoft stock in the following? situations:
You would be
more
willing to buy a share of Microsoft stock if you expect the stock to appreciate in value because
you believe the amount of the return on your investment will be positive
Explain why you would be more or less willing to buy a share of Microsoft stock in the following? situations:
You would be
less
willing to buy a share of Microsoft stock if the bond market becomes more liquid because
you can now sell bonds easier than stocks
Explain why you would be more or less willing to buy a share of Microsoft stock in the following? situations:
You would be
less willing to buy a share of Microsoft stock if you expect gold to appreciate in value because
the return on gold relative to stocks has improved
Explain why you would be more or less willing to buy a share of Microsoft stock in the following? situations:
You would be
more willing to buy a share of Microsoft stock if prices in the bond market become more volatile because
stocks have become relatively safer than bonds
If the demand for bonds shifts to the? left, the price of bonds
?decreases, and interest rates rise
If the supply of bonds shifts to the right?, the price of bonds
___________ and the interest rate
____________.
.
decreases, increases
When the wealth of individuals decreases
the price of bonds decreases while the interest rates increase
?A/an increase in the volatility of the bond market causes the demand for bonds to
_____ and the demand curve to ____________.
fall, shift to the left
Holding everything else? constant, if interest rates are expected to? increase, the demand for bonds? ________ and the demand curve shifts? ________.
decreases; left
Everything else held? constant, an increase in expected? inflation, lowers the expected return on? ________ compared to? ________ assets.
?bonds; real
A factor that could cause the supply of bonds to shift to the right? is:
a business cycle expansion.
When real income? ________, the demand curve for money shifts to the? ________ and the interest rate? ________, everything else held constant.
rises; right; rises
When the Fed? ________ the money? stock, the money supply curve shifts to the? ________ and the interest rate? ________, everything else held constant.
increases; right; falls
If the Fed wants to permanently lower interest? rates, then it should raise the rate of money growth if
the liquidity effect is larger than the other effects.
The risk structure of interest rates is
the relationship among interest rates of different bonds with the same maturity.
Which of the following bonds are considered to be default?risk ?free?
U.S. Treasury bonds
A bond with default risk will always have a? ________ risk premium and an increase in its default risk will? ________ the risk premium.
?positive; raise
?A(n) ________ in the riskiness of corporate bonds will? ________ the price of corporate bonds and? ________ the yield on corporate? bonds, all else equal.
increase; decrease; increase
If you have a very low tolerance for? risk, which of the following bonds would you be least likely to hold in your? portfolio?
a corporate bond with a rating of Baa
The term structure of interest rates is
the relationship among interest rates on bonds with different maturities.
Differences in? ________ explain why interest rates on Treasury securities are not all the same.
time to maturity
The typical shape for a yield curve is
gently upward sloping
If bonds with different maturities are perfect? substitutes, then the? ________ on these bonds must be equal.
expected return
According to the segmented markets theory of the term structure
the interest rate for each maturity bond is determined by supply and demand for that maturity bond.
If the yield curve is flat for short maturities and then slopes downward for longer? maturities, the liquidity premium theory? (assuming a mild preference for shorter?term ?bonds) indicates that the market is predicting.
a decline in short?term interest rates in the near future and an even steeper decline further out in the future
A particularly attractive feature of the? ________ is that it tells you what the market is predicting about future short?term interest rates by just looking at the slope of the yield curve.
liquidity premium theory
If the probability of a bond default increases because corporations begin to suffer large? losses, then the default risk on corporate bonds will? ________ and the expected return on these bonds will? ________, everything else held constant.
increase; decrease
An increase in the riskiness of corporate bonds will? ________ the yield on corporate bonds and? ________ the yield on Treasury? securities, everything else held constant.
increase; reduce
Which of the following statements is? true?
A liquid asset is one that can be quickly and cheaply converted into cash
When yield curves are downward? sloping,
short?term interest rates are above long?term interest rates.
According to the segmented markets theory of the term structure
the interest rate for each maturity bond is determined by supply and demand for that maturity bond.
Municipal bonds tend to pay lower interest rates than U.S. Treasury bonds because
interest payments received from holding municipal bonds are exempt from federal income tax.
A increase in the tax rate causes
a ______________
in the interest rate on tax exempt? bonds, such as municipal bonds.
decrease
Consider the following two? bonds: Bond A and Bond B are considered to be close substitute. Bond A is a? one-year instrument and Bond B is a? two-year instrument.? Currently, the following yields exist on these? bonds:
Bond - Yield
A: 4.50%
B: 4.75%
If in
sell, increase
A plot of the yields on bonds with different terms to maturity but the same? risk, liquidity, and tax considerations is known as
a yield curve.
In the case of? default, what would happen to the risk premium between U.S. Treasury debt and comparable maturity Greek? debt?
The risk premium would? increase, which corresponds to segment B on the graphs above.
What basic principle of finance can be applied to the valuation of any investment? asset?
Present value
Periodic payments of net earnings to shareholders are known as
dividends
?'Forecasters' predictions of inflation are notoriously? inaccurate, so their expectations of inflation cannot be rational. This statement? is:
false, as expectations can be highly inaccurate and still be rational
Economists have focused more attention on the formation of expectations in recent years. This increase in interest can probably best be explained by the recognition that
expectations influence the behavior of participants in the economy and thus have a major impact on economic activity.
If a forecast is made using all available? information, then economists say that the expectation formation is
rational
An expectation may fail to be rational if
relevant information is available but ignored at the time the forecast is made.
According to the Generalized Dividend? Model, the final sales price of a stock depends on the following except the
price of the stock in the last period.
If a company called Advanced Technologies has yet to pay a dividend on its? stock, the generalized dividend model predicts that the? company's stock may still have value because
people expect Advanced Technologies to pay dividends in the future.
Using the Gordon growth? model, a? stock's current price will increase if
the dividend growth rate increases
John values ABC stock at? $10 per share. Susan values it at? $15 per? share, and Bill values it at? $20 per share. In a? free-market auction, the individual who ends up buying the item is
Bill
Which of the following is true regarding the pricing of? assets?
Other things being the same, the price is set by buyers with the most amount of information regarding the stock
If? John, Jennifer,? Arthur, and Lisa are the only prospective buyers of a? stock, and they have the discount rates 99?%, 1515?%, 77?% and 1313?%, ?respectively, then the buyer who will be able to obtain the stock is
Arthur
In asset? markets, an? asset's price is
set by the buyer willing to pay the highest price
If monetary policy becomes more transparent about the future course of interest? rates, how would that affect stock? prices, if at? all?
Stock prices will? increase, as the risk and required return on the investment will be reduced.
If expectations are formed? adaptively, then people
use only the information from past data on a single variable to form their expectations of that variable.