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Mid-Term

Assessment

FIN 204

Financial Markets

25 Questions Plus 1 Extra-Credit

Total of 100 Points (each question is worth 4 points)

1. The appropriate discount rate for valuing any bond is the

a. bond’s coupon rate.

b. bond’s coupon rate adjusted for the expected inflation rate over the life of the bond.

c. Treasury bill rate with an adjustment to include a risk premium if one exists.

d. yield that could be earned on alternative investments with similar risk and

maturity.

2. The main provider(s) of funds to the U.S. Treasury is (are)

a. households and businesses.

b. foreign financial institutions.

c. the Federal Reserve System.

d. foreign nonfinancial sectors.

3. The appropriate discount rate for valuing any bond is the

a. bond’s coupon rate.
b. bond’s coupon rate adjusted for the expected inflation rate over the life of the bond.
c. Treasury bill rate with an adjustment to include a risk premium if one exists.
d. yield that could be earned on alternative investments with similar risk and
maturity.

4. You are considering the purchase of a tax-exempt security that is paying a yield of 10.08

percent. You are in the 28 percent tax bracket. To match this after-tax yield, you would

consider taxable securities that pay

a. 31.1 percent.

b. 19 percent.

c. 12.5 percent.

d. 14 percent.

5. In general, securities with ____ characteristics will offer ____ yields.

a. favorable; higher

b. favorable; lower

c. unfavorable; lower

d. none of the above

6. Which of the following is not true with respect to the Federal Reserve Act of 1913?

a. It established reserve requirements for member commercial banks.

b. It specified fourteen districts across the United States as well as a city in each

district where a Federal Reserve district bank was to be established.

c. Each district focused on its particular district, without much concern for other

districts.

d. All of the above are true.

7. When open market operations are used to ____ bank funds, the yield on debt instruments

____.

a. reduce; decreases

b. reduce; increases

c. increase; increases

d. none of the above

8. Which of the following is an action that the Fed uses to increase or decrease the money

supply?

a. buying or selling Treasury securities in the secondary market

b. adjusting the tax rate imposed on income earned on Treasury securities

c. adjusting the coupon rate on Treasury bonds

d. selling Treasury securities in the primary market

9. Which of the following is true?

a. Federal deficits require that the Fed purchase government securities.

b. Federal deficits will always result in an increase in money supply.

c. The Federal Reserve monetizes debt by selling securities which ultimately

increases money supply.

d. An agreement between the Fed and the Treasury exists whereby the Fed is directly

responsible for monetizing the debt whenever the deficit increases.

e. None of the above.

10. A high budget deficit tends to place ____ pressure on interest rates; the Fed’s tightening

of the money supply tends to place ____ pressure on interest rates.

a. upward; upward

b. upward; downward

c. downward; downward

d. downward; upward

11. If the level of inflation is expected to ____, there will be ____ pressure on interest rates

and ____ pressure on the required rate of return on bonds.

a. increase; upward; downward

b. decrease; upward; downward

c. decrease; upward; upward

d. increase; downward; upward

e. increase; upward; upward

12. Which of the following is not an indicator of inflation?

a. housing price indexes

b. wage rates

c. oil prices

d. consumer confidence surveys

13. In general, there is:

a. a positive relationship between unemployment and inflation.

b. an inverse relationship between unemployment and inflation.

c. an inverse relationship between GNP and inflation.

d. a positive relationship between GNP and unemployment.

14. (Financial calculator required.) Paul can purchase bonds with 15 years remaining until

maturity, a par value of $1,000, and a 9 percent annual coupon rate for $1,100. Paul’s

yield to maturity is ____ percent.

a. 9.33

b. 7.84

c. 9.00

d. none of the above

15. The Fed can ____ the level of spending as a means of stimulating the economy by ____

the money supply.

a. increase; decreasing

b. decrease; increasing

c. decrease; decreasing

d. increase; increasing

16. When a firm sells its commercial paper at a ____ price than projected, their cost of

raising funds will be ____ than what they initially anticipated.

a. higher; higher

b. lower; lower

c. higher; lower

d. lower; higher

e. Answers C and D are correct.

17. Which of the following is true of money market instruments?

a. Their yields are highly correlated over time.

b. They typically sell for par value when they are initially issued (especially T-bills

and commercial paper).

c. Treasury bills have the highest yield.

d. They all make periodic coupon (interest) payments.

e. A and B

18. If an investor buys a T-bill with a 90-day maturity and $50,000 par value for $48,500 and

holds it to maturity, what is the annualized yield?

a. about 13.4 percent

b. about 12.5 percent

c. about 11.3 percent

d. about 11.6 percent

e. about 10.7 percent

19. A ten-year, inflation-indexed bond has a par value of $10,000 and a coupon rate of 5

percent. During the first six months since the bond was issued, the inflation rate was 2

percent. Based on this information, the coupon payment after six months will be $____.

a. 250

b. 255

c. 500

d. 510

20. If interest rates suddenly ____, those existing bonds that have a call feature are ____

likely to be called.

a. decline; more

b. decline; less

c. increase; more

d. none of the above

21. Julia just purchased a $1,000 par value bond with a 10 percent annual coupon rate and a

life of twenty years. The bond has four years remaining until maturity, and the yield to

maturity is 12 percent. How much did Julia pay for the bond?

a. $1,063.40

b. $1,000

c. $939.25

d. none of the above

22. When financial institutions expect interest rates to ____, they may ____.

a. increase; sell bonds and buy short-term securities

b. increase; sell short-term securities and buy bonds

c. decrease; sell bonds and buy short-term securities

d. B and C

23. A bond with a 12 percent quarterly coupon rate has a yield to maturity of 16 percent. The

bond has a par value of $1,000 and matures in 20 years. Based on this information, a fair

price of this bond is $____.

a. 1,302

b. 763

c. 761

d. 1,299

24. The term structure of interest rates defines the relationship

a. between risk and return.

b. between risk and maturity.

c. between maturity and yield.

d. between default risk ratings and maturity.

25. A bond with a $1,000 par value has an 8 percent annual coupon rate. It will mature in 4

years, and annual coupon payments are made at the end of each year. Present annual

yields on similar bonds are 6 percent. What should be the current price?

a. $1,069.31

b. $1,000.00

c. $9712

d. $927.66

e. none of the above

Extra Credit

26. Money market securities generally have ____. Capital market securities are typically

expected to have a ____.

a. less liquidity; higher annualized return

b. more liquidity; lower annualized return

c. less liquidity; lower annualized return

d. more liquidity; higher annualized return

PART 1

1. Choose three economic indicators one of each type (leading, lagging, and coincident). Define the measure, explain the timing and source of reporting, provide current measure and trend over the last year.

2. Which financial statement shows the amount of bonds and money market instruments a company has issued or invested in?

3. In most current financial statement from question #2 – what are the dollar amounts of bonds and money market securities that Amazon has issued? How much has Amazon invested in money marked securities?

PART 2

Find out which bonds Amazon has outstanding and share info about five of these bond issues based on info in the annual report. Info should include: Issue Date, Issue Size, Initial Term, Remaining Term, and Coupon rate.

What is the approximate size of the Bond Market and the Money Markets? For comparison, how large is the equity market? What are reasons for the significant difference?

PART 3

1. Let’s think about factors that can influence each of these components, give at least one factor that affects each of the following:

a. Risk free rate

b. Inflation premium

c. Default risk premium

d. Liquidity premium

e. Maturity risk premium

2. How does collateral affect the interest rate on a bond? How does subordination affect the interest rate on a bond too?

3. Which financial statement is used to determine outstanding debt (bonds)? What bond issues does Amazon have outstanding (from annual report details)? Provide characteristics, features, and provisions of different bond issues from Amazon .

4. What are the primary bond categories and how do they differ?

Assignment 3

Chapter 4

1. The Fed Briefly describe the origin of the Federal Reserve System. Describe the functions of the Fed district banks.

5. Beige Book What is the Beige Book, and why is it important to the FOMC?

10. Effect on Money Supply Why do the Fed’s open market operations have a different effect on the money supply than do transactions between two depository institutions?

15. The Fed’s Impact on Home Purchases Explain how the Fed influences the monthly mortgage

payments on homes. How might the Fed indirectly influence the total demand for home by consumers?

chapter 5

1. Impact of Monetary Policy How does the Fed’s monetary policy affect economic conditions?

2. Trade-offs of Monetary Policy Describe the economic trade-off faced by the Fed in achieving its economic goals.

4. Active Monetary Policy Describe an active monetary policy.

5. Passive Monetary Policy Describe a passive monetary policy.

20. Impact of Inflation Targeting by the Fed Assume that the Fed adopts an inflation targeting

strategy. Describe how the Fed’s monetary policy would be affected by an abrupt 15 percent rise in oil prices in response to an oil shortage. Do you think an inflation targeting strategy would be more or less effective in this situation than a strategy of balancing inflation concerns with unemployment concerns?

Explain.

24. Monetary Policy during the Credit Crisis During the credit crisis, the Fed used a stimulative

monetary policy. Why do you think the total amount of loans to households and businesses did not increase as much as the Fed had hoped? Are the lending institutions to blame for the relatively small increase in the total amount of loans extended to households and businesses?

Assignment 4

Chapter 6

1. Primary Market Explain how the Treasury uses the primary market to obtain adequate funding.

2. T-Bill Auction How can investors using the primary T-bill market be assured that their bid will be accepted? Why do large corporations typically make competitive bids rather than noncompetitive bids for
T-bills?
3. Secondary Market for T-Bills Describe the activity in the secondary T-bill market. How can this degree of activity benefit investors in T-bills? Why might a financial institution sometimes consider T-bills as a potential source of funds?
4. Commercial Paper Who issues commercial paper? What types of financial institutions issue
commercial paper? Why do some firms create a department that can directly place commercial paper?
What criteria affect the decision to create such a department?
7. Negotiable CDs How can small investors participate in investments in negotiable certificates of
deposits (NCDs)?
Chapter 7
1. Bond Indenture What is a bond indenture? What is the function of a trustee with respect to the
bond indenture?
2. Sinking-Fund Provision Explain the use of a sinking-fund provision. How can it reduce the investor’s risk?
3. Protective Covenants What are protective covenants? Why are they needed?
4. Call Provisions Explain the use of call provisions on bonds. How can a call provision affect the price of a bond?
5. Bond Collateral Explain the use of bond collateral, and identify the common types of collateral for bonds.
6. Debentures What are debentures? How do they differ from subordinated debentures?
7. Zero-Coupon Bonds What are the advantages and disadvantages to a firm that issues low- or zerocoupon bonds?
8. Variable-Rate Bonds Are variable-rate bonds attractive to investors who expect interest rates to decrease? Explain. Would a firm that needs to borrow funds consider issuing variable-rate bonds if it expects that interest rates will decrease? Explain.
9. Convertible Bonds Why can convertible bonds be issued by firms at a higher price than other bonds?
11. Impact of Credit Crisis on Junk Bonds Explain how the credit crisis affected the default rates of junk bonds and the risk premiums offered on newly issued junk bonds.
Assignment 5

Chapter 8

1. Bond Investment Decision Based on your forecast of interest rates, would you recommend that investors purchase bonds today?
Explain.
2. How Interest Rates Affect Bond Prices Explain the impact of a decline in interest rates on:
a. An investor’s required rate of return.
b. The present value of existing bonds.
c. The prices of existing bonds.