CHAPTER 1-3

What does an asset transformer do? Why is asset transformation a risky activity?

Asset Transformers buy securities from corporation create mutual funds out of
the securities bought and resell it to the public with a spread on their purchase
price. The financial claims issued by an FI that are more attractive to investor
than are the claims directly issued by corporations. 

It is a risky activity because rate of return required from asset transformer will
be higher than from individual company due to the spread on it making it more
risky. Higher the spread more is the risk of these assets.

A corporation seeking to sell new equity securities to the public for the first time in order to raise
cash for capital investment would most likely

conduct an IPO with the assistance of an investment banker.

There are three types of major financial markets today: primary, secondary, and derivatives markets. The
NYSE and NASDAQ are both examples of derivatives markets. FALSE

Money markets trade securities that

1. I. mature in one year or less.
2. II. have little chance of loss of principal.
3. III. must be guaranteed by the federal government.
Ans I and ii

Discuss how secondary markets benefit issuers and investors.- For investors seconday
markets provide the opportunity to trade securities at their market values quickly as
well as to purchase securities with varying risk-return characteristics.
The ussers can obtain information about the current market value; the price
information allows issuers to evaluate how well they are using the fundsgenerated
from the financial instruments they have already issued and provides information on
how well any subsequent offerings of debt or equity might do in terms of raising
money. At the same time offer buyers and sellers liquity.
Liquidity risk at a financial intermediary (FI) is the risk.- t hat a sudden surge in liability withdrawals may
require an FI to liquidate assets quickly at fire sale prices.

Money markets are the markets for securities with an original maturity of one year or less. TRUE

An increase in interest rates increases the demand loanable funds. FALSE

The term structure of interest rates is the relationship between interest rates on bonds similar in terms
except for maturity.TRUE

According to the market segmentation theory, short-term investors will not normally switch to
intermediate- or long-term investments. TRUE

An investor earned a 5 percent nominal risk-free rate over the year. However, over the year, prices
increased by 2 percent. The investor's real risk-free rate was less than his nominal rate of return. TRUE

As the liquidity of corporate bonds decrease, the risk premium required on those bonds decrease as
wellFALSE

Which of the following would normally be expected to result in an increase in the supply of
funds, all else equal?
 
1. I. The perceived riskiness of all investments decreases.
2. II. Expected inflation increases.
3. III. Current income and wealth levels increase.
4. IV. Near term spending needs of households increase as energy costs rise.

ANS 1 AND III ONLY

The real risk-free rate is the increment to purchasing power that the lender earns in order to induce him or
her to forego current consumption TRUE
The one-year spot rate is currently 4 percent; the one-year spot rate one year from now will be 3 percent;
and the one-year spot rate two years from now will be 6 percent. Under the unbiased expectations theory,
what must today's three-year spot rate be? Suppose the three-year spot rate is actually 3.75 percent, how
could you take advantage of this? Explain..

One year spot rate=4%

One year spot rate from one year from now=3%
One year spot rate from two years from now=6%
So three year spot rate will be,
[1+(4/100)*1+(3/100)*1+(6/100)]-1
=0.04329*100=4.329%
As spot rate is actually 3.75% actually after 3 years so the spot rate is actually less so
the only advantage we can take is by increasing forward contract so this will yield me
arbitrage oppurtunity and riskless profit.

An investor requires a 3 percent increase in purchasing power in order to induce her to lend. She expects
inflation to be 2 percent next year. The nominal rate she must charge is about 5%

A zero coupon bond has a duration equal to its maturity and a convexity equal to zero.
TRUE

If a security's realized return is negative, it must have been true that the expected
return was greater than the required return. FALSE
A 15-year, 7 percent coupon annual payment corporate bond has a PV of $1,055.62. However,
you pay $1,024.32 for the bond. By how many basis points is your E(r) different from your r?
32.56 basis points
this is more than rrr

A decrease in interest rates will INCREASES THE BONDS DURATION

Which would have a longer duration: (a) a five-year fully amortized installment loan
with semiannual payments or (b) a five-year semiannual payment bond, ceteris
paribus. Why?

The five-year bond will have a longer duration because  you can receive interest
payments only until maturity, in the other hand  the amortizing loan pays principle
and interest throughout the life of the loan.
In other words the loans pays more money back sooner 

Suppose two bonds of equivalent risk and maturity have different prices such that one
is a premium bond and one is a discount bond. The premium bond must have a greater
expected return than the discount bond. FALSE
At equilibrium a security's required rate of return will be less than its expected rate of
return FALSE

The greater a security's coupon, the lower the security's price sensitivity to an interest
rate change, ceteris paribus. TRUE

You are evaluating a company’s stock. The stock just paid a dividend of $1.75.
Dividends are expected to grow at a constant rate of 5 for long time into the future.
The required rate of return (Rs) on the stock is 12 percent. What is the fair present
value? 26.25

CHAPTER 4,5 11

The major monetary policy-making arm of the Federal Reserve is the

 Board of Governors.

Federal Reserve Bank of New York.

Council of Federal Reserve Bank presidents.

Office of the Comptroller of the Currency.

None of these choices are correct.

The Federal Open Market Committee is the correct answer.

If the FOMC wished to generate faster economic growth, they could issue a policy directive to the
Federal Reserve Board Trading Desk to purchase U.S. government securities. TRUE

What are the intended consequences from charging an interest on excess reserves by Central banks?

Banks lend more money.

What supervisory and regulatory authority does the Fed have under current law?
1. The authority to conduct examinations and inspections of member banks, bank holding companies,
and foreign bank offices by teams of bank examiners
2. The authority to require banks to suspend bank activities deemed excessively risky or in violation of
federal laws
3. The authority to approve or not allow mergers and acquisitions and other line of business restrictions
for both banks and bank holding companies

One of the objectives of the FOMC is to formulate policies to promote 100 percent employment.TRUE

f the Fed wishes to stimulate the economy, it could

1. I. buy U.S. government securities.
2. II. raise the discount rate.
3. III. lower reserve requirements.

During the 2010–2014 period, the Federal Reserve purchased long-term treasury securities as part of the
Quantitative Easing program. TRUE

The _____________ is a network linking over 9,000 banks with the Federal Reserve that is used to
transfer deposits and make loan payments between participants. Fedwire

Which of the following is the major monetary policy-making body of the U.S. Federal Reserve System?
FOMC

A noncompetitive bid for Treasury bill auction provides

all noncompetitive bidders the same price.

You buy a $10,000 par Treasury bill at $9,575 and sell it 60 days later for $9,675. What was your EAR?
(9,675/9,575)(365/60) − 1 = .06524 = 6.52%

Which one of the following statements about commercial paper is not true? Commercial paper issued in
the United States carries an interest rate above the prime rate.

Suppose that $10 million face value commercial paper with a 270-day maturity is selling for $9.55
million. What is the BEY on the paper? ((10 million/9.55 million) − 1) × (365/270) 6.37 percent

Commercial paper is a short-term obligation of the U.S. government issued to cover government budget
deficits and to refinance maturing government debt. FALSE

The majority of money market securities are low-denomination, low-risk investments designed to appeal
to individual investors with excess cash. FALSE

Everything else equal, an effective annual rate will be greater than the bond equivalent yield on the same
security. TRUE

A $2 million jumbo CD is paying a quoted 3.55 percent interest rate on 180-day maturity CDs. How
much money will you have at maturity if you invest in the CD? 2,000,000 × [1 + (0.0355 × 180/360)]
$2,035,500

The provision of banking services to other banks, such as check clearing, foreign exchange trading, and
so forth, is an example of correspondent banking.

The largest single category of loans on the typical bank's balance sheet in 2016 was
real estate loans.

Most of the changes in size, structure, and composition of the banking industry in recent years are due to
mergers and acquisitions.

Which of the following is the primary regulator of bank holding company activities? Federal
Reserve

The majority of banks are nationally chartered and insured by the FDIC. FALSE
In terms of profitability, a well-run bank usually has an ROA of 0.5–3 percent.

Banks have an average total debt ratio of about 90 percent. TRUE

Advantages of going global for U.S. banks include all but which one of the following?

CHAPTER 12,13,14
A bank holding company that only has one bank is termed a unit bank. FALSE
In the post-Depression era the largest number of bank failures occurred in which time period?
1985–1995

Tier II (supplementary) capital includes which of the following?

1.I. Allowance for loan and lease losses, up to 1.25 percent of risk-weighted
assets
2.II. Subordinated debt with original maturity of at least 5 years
3.III. Common stock and retained earnings
4.IV. Nontransaction deposits

There were a greater number of bank failures from 1980 to 1990 inclusive than from 1934 to 1979. TRUE

The Financial Services Modernization Act first allowed Section 20 affiliates. FALSE
A financial intermediary that can engage in a broad range of financial service activities is termed a
universal FI. TRUE

What changes to foreign bank operations in the United States have been brought about by the Foreign
Bank Supervision and Enhancement Act of 1991?
 Entry: Foreign banks must now have the Fed's approval to establish a U.S. operation. The Fed will not
grant such approval unless the foreign bank is subject to home country supervision. The Fed also
requires the home country regulators to supply information about the applicant bank to the Fed.
 Closures: The Fed may close the U.S. operations of a foreign bank (as they did with Daiwa).
 Examinations: The Fed will examine each U.S. operation of a foreign bank.
 Deposit taking: Only foreign banks with access to FDIC insurance can take retail deposits.
 Activity powers: State-licensed foreign banks must adhere to federal standards.

In the United States, regulators currently use a _ lagged reserve accounting system_______________ to
calculate required reserve balances.

Recent regulation such as the Riegle-Neal Act of 1994 has removed some of the federal banking laws that
formerly constrained profitable opportunities for commercial banks. The Riegle-Neal Act removes the
major restrictions on banks' ability to diversify geographically

Deposits at savings banks are backed by the _______________ and deposits at savings institutions are
backed by the ______________. DIF; DIF

Which of the following trends in the number and industry assets of savings institutions is/are
correct?
1. I. The number of savings institutions has fallen over time.
2. II. The number of savings institutions has increased over time.
3. III. Total industry assets fell during the recession of the late 2000s.
4. IV. Total industry assets are falling over time.
5. V. Total industry assets are stable but the number of savings institutions has fallen.

Finance companies enjoy several advantages over banks. These include all but which one of the
following? Finance companies have lower funds costs than banks.
SI profitability declined in the mid-2000s due to
1. I. the yield curve becoming more positively sloped.
2. II. decreases in the NIM ratio.
3. III. increases in the NIM ratio.
4. IV. the yield curve becoming flatter and even inverted.

The U.S. Central Credit Union and the corporate credit union

provide investment and liquidity services to corporate credit unions

Savings institution deposits and bank deposits are backed by two different insurance funds. FALSE

Aggregate finance company profitability was poor in the late 2000s primarily due to which segment of
the finance company industry? Subprime lending

Factoring is the term used when a finance company purchases accounts receivable from corporate
customers at premium FALSE

Rate-sensitive funding sources at a bank are termed core deposits. FALSE

Bank A (Dollars in Millions)

Assets  Liability and Equity
Cash $ 850 Deposits $6,475  
Securities  1,925 Other Borrowing  1,645  
Loans  5,400 Equity  1,030  
Others   975 Total $9,150  
Total $9,150        

 
Income Statement
Interest income on loans $450 
Interest income on securities   95 
Interest expenses  246 
Noninterest income   78 
Nonincome expenses  112 
Provision for loan loss   35 
Taxes  115 
NI $115 

The bank's asset utilization ratio is

6.81 percent.
.
At almost all banks noninterest expense is greater than noninterest income; hence, the overhead efficiency
ratio is usually greater than 100 percent. FALSE

The AU ratio measures the bank's ability to __________ and the PM ratio measures the bank's ability to
__________________ generate income from assets; control expenses

MMDAs are a type of savings account that has some limited checking features. These accounts were
designed to help banks compete with MMMFs. TRUE

The provision for loan loss account is actual loan losses less loan recoveries in a given time period.
FALSE

Both retail and wholesale CDs are negotiable instruments despite their different denominations.FALSE

Banks generally pay higher interest rates on NOW accounts than on MMDAs. FALSE

The layers of regulation imposed on banks to protect depositors against bank failure are termed
credit allocation regulations.
FALSE

What changes to foreign bank operations in the United States have been brought
about by the Foreign Bank Supervision and Enhancement Act of 1991?

The main objective was to extend federal regulatory authority over foreign
banking organizations in US, especially when these organizations had entered
using state licenses.
The act’s five main features have significantly enhanced the power of federal
bank regulations over foreign banks in the US.
Entry under FBSEA. A foreign bank must have the Fed’s approval to stablish
a branch etc
Closure. Give Fed authority to close a foreign bank if home country its
inadequate.
Examination- Fed has the power to examine each office of a foreign bank
Deposit- taking only limit amount for deposits
Activity Powers.- not allowing any activity that was not permitted for the
federal branch
The Investment Company Act of 1940 and the Securities Acts of 1933 and 1934 are
examples of investor protection regulations. TRUE

The law that largely repealed the Depression era banking laws was the

R= Financial Services Modernization Act.

Which act led to interstate banking in the United States?

Riegle-Neal Act

The Financial Services Modernization Act first allowed Section 20 affiliates. FALSE

The term disintermediation refers to

R= the withdrawal of deposits from depository institutions that are reinvested in other types of intermediaries.
A bank holding company that only has one bank is termed a unit bank. FALSE

Which act allowed the establishment of full-service financial institutions in the United States?
R= Financial Services Modernization Act

Finance companies enjoy several advantages over banks. These include all but which one of the
following?
R=
Finance companies have lower funds costs than banks.

Which one of the following has the highest concentration of mortgage-related assets on the balance sheet?
R= Savings institutions

Savings institutions must have at least 65 percent of their assets in mortgage-related areas in order to
maintain their thrift charter. TRUE

Explain why low interest rates and strong mortgage markets help keep profitability high at savings
institutions.
R= Low interest rates have helped savings institutions to  maintain profitability
because many thrifts fund long-term mortgages with short-term deposits. Low interest
rates have encouraged mortgage refinancing and new home buying; both activities
allow thrifts to earn origination and servicing fees and to profit on the spread between
interest earned on the mortgages and costs paid on deposits. Saving institutions
concentrate in mortgages, the health of the real state industry will strongly affect their
profitability. Because many mortgages are sold, the default risk may not lie with the
originating SI, but defaults will result in tighter origination standards and less fees for
the originating institution. Higher default rates will affect the mortgage portfolio that
SIs keep and can result in impaired capital and poor profitability

Of all the depository institutions, as a percentage of assets, credit unions rely the most on deposit sources
of funds. TRUE

The U.S. Central Credit Union and the corporate credit union
R=

provide investment and liquidity services to corporate credit unions.

After 2011, savings institutions have primarily been regulated by

R= Office of the Comptroller of the Currency.
Deposits at savings banks are backed by the _______________ and deposits at savings institutions are
backed by the ______________.
R= DIF, DIF

All but which one of the following is an example of noninterest income or noninterest expense?

R= Earnings on securities held for investment

How has the negotiable feature of wholesale CDs improved banks’ ability to manage their liquidity?
The fact that the wholesale CDs are negotiable instruments, and if the bank need liquidity funds, they can
be resold by title assignment in a secondary market to other investors.

Because they are fixed-maturity instruments with face values under 100.000 and by
selling them the depositors to liquidate their positions
The fact that the wholesale CDs are negotiable instruments, and if the bank need liquidity funds, they can
be resold by title assignment in a secondary market to other investors.

Purchased funds include all but which one of the following?

R= Demand deposits

Uniform principles, standards, and report forms for depository institutions are prescribed by the
R= Federal Financial Institutions Examination Council.

The AU ratio measures the bank's ability to __________ and the PM ratio measures the bank's ability to
__________________.
R= generate income from assets; control expenses

The largest source of income at a typical bank is

R=interest income on loans and leases.

Bank A has a higher ROA than Bank B. Both banks have similar interest income to asset ratios
and noninterest income to asset ratios. We know that
 
1. I. Bank A has a higher profit margin than Bank B.
2. II. Bank A has a higher AU ratio than Bank B.
3. III. Bank A must have a higher PLL/OI ratio.
R= I only

What is the largest operating expense for a bank?

R= Interest paid on deposits

 CHAPTER 6 Y 7
1. In a Treasury bond quote with a $1,000 face value, you find the bid is equal to 100-24
and the ask is equal to 100-26. You could buy this bond for $1,008.125.====TRUE The
value of the bond is (100 + 26/32) × (1,000/100) = $1,008.125
2. Debt securities with maturities of 1-year or less are traded in capital markets. FALSE
3. With TIPS, the security's coupon rate is changed every six months by the inflation
rate as measured by the CPI. FALSE
4. T-notes and T-bonds are issued in minimum denominations of $100, or
multiples of $100 TRUE
5. Sovereign bonds are long-term debt issued by governments of foreign
countries. TRUE
6. Accrued interest owed to the bond seller increases as the next coupon
payment date approaches. –TRUE
7. "On the run" Treasury notes and bonds are newly issued securities and
"off-the-run" Treasuries are securities that have been previously issued.
TRUE
8. Treasury notes and bonds and municipal bonds are default risk free.—
FALSE
9. Callable bonds have lower required yields than similar convertible bonds,
ceteris paribus. –FALSE
10. You purchase a $1,000 face value convertible bond for $975. The bond can
be converted into 150 shares of stock. The stock is currently priced at
$5.25. At what minimum stock price would you be willing to convert?===
(975/150) = 6.50
11. An investor is in the 28 percent federal tax bracket and pays a 9 percent state tax rate
and 4 percent in local income taxes. For this investor a municipal bond paying 6 percent
interest is equivalent to a corporate bond paying _____ interest.== 0.06/[1 − (0.28 + 0.09
+ 0.04)] 10.17 percent

12. Bearer bonds are bonds===with coupons attached that are redeemable by whoever has the
bond.
13. You obtain a $265,000, 15-year fixed-rate mortgage. The annual interest rate is 6.25 percent. In
addition to the principal and interest paid, you must pay $275 a month into an escrow account for
insurance and taxes. What is the total monthly payment (to the nearest dollar)?===
265,000 = [Pmt × PVIFA (0.0625/12, 180 months)] + 275 = 2,547

Calculator Solution:
PV = 265,000
N = 180
FV = 0
I = 6.25/12 = 0.52083
Solve for PMT to get $2,272.17; the total monthly payment will be 2,272.17 + 275 = $2,547.17.
 14. A subprime mortgage is a mortgage made to a borrower who has a below normal credit rating.
TRUE
15. Private mortgage insurance (and hence, that part of the homeowner's monthly payment) is
automatically removed from a mortgage when the loan-to-value ratio on the mortgage falls below
80 percent. FALSE
16. Why were CMOs created? Some investors desired more protection from prepayment risk than
offered by pass-throughs. The creation of different payment tranches in a CMO allows investors to
better tailor their prepayment risk exposure.
17. The process of mortgage securitization results in a separation between mortgage origination and
mortgage financing. TRUE
18. A homeowner is looking to buy a home in Marvin Gardens. The most he can afford to pay in total
is $1,800 per month. Yearly property taxes will be about $3,000 (escrowed monthly) and
insurance is $110 per month. There are no other costs.
If mortgage rates are 6.25 percent for a 30-year fixed-rate mortgage, how large can his mortgage
be? RE
Max monthly payment = $1,800 − $3,000/12 − $110 = $1,440
PV = $1,440 × PVIFA (6.25/12,360) = $233,874

Calculator Solution:
PMT = 1,440
N = 360
FV = 0
I = 6.25/12 = 0.5208

Solve for PV = 233,873.60.

19. A Collateralized mortgage obligation (CMO) has:=== high degree of interest rate risk.
20. Federally insured mortgages are called conventional mortgages. FALSE
21. In synthetic securitization, the transfer of risk on a pool of assets is achieved by the use of credit
derivatives or guarantees to a third party. TRUE

22. As compared to fixed-rate mortgages, ARMs result in which of the following for the
lender?
I. Higher interest rate risk
II. Lower default risk
III. Greater prepayment penalty fees

RE None of these choices are correct.

22. Discount points are paid to reduce the down payment required. FALSE
23. A borrower took out a 30-year fixed-rate mortgage of $2,250,000 at a 7.2 percent annual rate.
After five years, he wishes to pay off the remaining balance. Interest rates have by then fallen to 7
percent. How much must he pay to retire the mortgage (to the nearest dollar)?
$2,250,000 = Pmt × PVIFA (0.072/12, 360 months); Pmt = $15,272.73; New Balance = $15,272.73 ×
PVIFA (0.072/12, 300 months) = $2,122,425.62

Calculator Solution:
PV = 2,250,000
 N = 360
FV = 0
I = 7.2/12 = 0.6
Solve for PMT to get $15,272.73; in the amortization schedule of the financial calculator, use P1 = 1
and P2 = 60 to find the balance at the end of the 5th year, which is $2,122,425.62.

24. The least used form of mortgage securitization is the ______________________. mortgage-backed
bond

CHAPTER 8, 9 17
1. The electronic-based market for less actively traded U.S. securities is the
OTC Bulletin Board.

2 - As a small (minority) stockholder would you prefer to have cumulative voting or straight voting
shares? As a majority shareholder?

Minority Shareholders prefer to have Cumulative voting because Cumulative voting

gives a small shareholder a better chance of electing a given board member because
they don't have to own (or control by proxy) a majority of shares. A cumulative voting
can allocate any number of votes to a single seat

Cumulative voting allows minority shareholders to have a say in the board of director
meetings. This is because a minority shareholder, may be able to put all of their votes
on one person and the majority shareholder cannot divide up their votes in a way to
elect all of their directors.

A Majority or large Shareholder prefer to have Straight voting because can ensure
that will always be able to elect the entire board of choice if have a straight voting.
With straight voting, the vote on the board of director occurs one director at a time,
thus the number of votes eligible for each director is the number of shares
outstanding.

3 A publicly traded company gave its existing shareholders the opportunity to purchase from the
new stocks that it will issue. The existing shareholders can purchase 3 new shares at a price of
$10 per share for every 8 shares held. This is an example of: RIGHTS OFFERING

4 Compared to the market order, a limit order may not be executed if the market is moving fast.
TRUE
5 Computerized markets that automatically match orders between buyers and sellers and are used
primarily by institutions traders are called… ECN’s

6 If the stock markets are semi-strong efficient, stock prices reflect all historic
and current public information about a firm but prices do not reflect inside
information. TRUE
7 On the NASDAQ system, the inside quotes are the -Highest bid and lowest ask.
8 You buy a stock for $34 per share and sell it for $36 after you collect a $1.00
per share dividend. Your pretax capital gain yield is ________________ and
your pretax dividend yield is ________________. 5.88 percent; 2.94 percent
9 NYSE listing has traditionally benefited a firm by- Improving the stock’s price,
generating increased publicity for the firm, and providing easier access to primary market
capital.
10 If the dollar appreciates relative to the Euro then: European cars will become less
expensive in the United States.
11 The largest center for trading in foreign exchange is LONDON
12 If the United States has inflation of 3 percent and Europe has inflation of 5
percent, the value of the euro should increase, ceteris paribus. FALSE
13 A negotiated OTC agreement to exchange currencies at a fixed date in the
future but at an exchange rate specified today is a -FOrward foreign exchange
transaction.
14 If a firm has more foreign currency assets than liabilities, and no other foreign
currency transactions, it has- Positive net exposure.
15 A country with lower interest rates than another country is likely to see its
currency appreciate if parity holds. TRUE
16 The value of the Euro changed from $1.15 to $1.25. We can say that the dollar
has ________ and the euro has ________.Depreciated; appreciated
17 At the beginning of the year the exchange rate between the Brazilian real and
the U.S. dollar was 2.2 reals per dollar. Over the year, Brazilian inflation was
12 percent and U.S. inflation was 4 percent. If purchasing power parity holds,
at year-end the exchange rate should be approximately ________________
dollars per real. 0. 4182
18 ETFs are a direct competitor to ___________.Index funds
19 Money market mutual funds consist of a mixture of bonds and money market
securities. FALSE
20 Index funds have the highest cost among the different types of mutual funds.
FALSE
21 Open-end fund shares often trade at a discount or premium relative to NAV.
FALSE
22 Offshore hedge funds are not subject to taxation on fund distributions nor to
U.S. estate taxes. TRUE
23 Because of their ability to hedge, the subprime mortgage crisis did not cause
any significant losses to hedge funds. FALSE
24 As the economy weakens, one would expect investment in ____________
funds to increase and investment in _____________ funds to decrease, ceteris
paribus.. Money market mutual; equity
 25 Which of the following is not considered an abusive activity in mutual funds
investing? INDEXING

26 A firm is using cumulative voting and four director spots are up for election. There
are 3.6 million shares outstanding. How many shares must a minority owner own or
control to ensure that he or she can gain control of one seat on the board of
directors? 720,001.. [((1/(4 + 1)) × 3.6 million] + 1
27 Data show that since 1942, only 8 of the 14 recessions predicted by the stock
market actually occurred. Although stocks are a leading economic indicator, what
are some reasons why a stock price decline might not indicate an upcoming
recession? Stock prices might drop because equity risk premiums temporarily rise,
depressing stock prices without foreshadowing lower growth. It may also be that current stock
prices are overly optimistic about future growth; when the over-optimism is corrected, stock
prices fall, sometimes sharply. This may occur even if no change in underlying economic
growth takes place. One might also observe slower growth than expected that does not result in
a recession. More succinctly, expectations may change more rapidly than actual economic
growth rates.
28 n cumulative voting, a stockholder who owns 51 percent of the shares can be assured of the
ability to elect the entire board of directors. FALSE
29 When would preferred stock be a better investment choice than common stock or bonds?
RES Preferred stocks have higher yields than bonds and much higher dividend yields than
stocks. One will not get capital gains with preferred stock, however. Thus, if steady high pretax
yields are desired, with little or no chance of capital gains, and a tax-sheltered investment
vehicle such as an IRA is available, preferred may be an ideal choice.
30 The NASDAQ automatic order execution system for individual traders placing buy or sell
orders of 1,000 or fewer shares is called the---- SOE System.
31 Stock splits change the divisor in a price-weighted index but do not result in any net
change in the divisor of a value-weighted index. TRUE
The preemptive right is designed to;;;RE
allow existing shareholders to buy shares of the new offering if they desire.
The NYSE specialists are charged with
32 I. trading for their own account.
II. ensuring public limit orders are executed.
III. facilitating processing public market orders.
 33 The NYSE merged with the London Stock Exchange to form the merged company
NYSE Euronext. FALSE

Which of the following conditions may lead to a decline in the value of a country's currency?
I. Low interest rates
II. High inflation
III. Large current account deficit

35 The concept underlying purchasing power parity is the---

law of one price.

36 The large U.S. current account deficit implies that--- the United States must rely on foreigners to
be willing to invest in the United States.
37. A British bank has borrowed dollars in the United States, but is now concerned about its
currency risk. What alternatives does it have to limit its risk? Be specific. RE The bank could buy
dollars (sell pounds) forward for when the loan(s) is(are) due. The bank could also sell the appropriate
number of pound futures contracts. Finally, the bank could acquire dollar assets either by lending
dollars or by acquiring dollar-denominated real assets (perhaps by branching in the United States).
38 If the euro per yen ratio falls, the value of the yen has risen. FALSE

39 A drop in value of the dollar hurts U.S. importers and helps U.S. exporters, ceteris paribus. TRUE
40 A U.S. bank has £120 million in loans to corporate customers and has £70 million in deposits it owes
to customers with the same maturity. The bank has also sold £20 million pounds forward. The bank's net
exposure is===RE

£30 million.

41. In 2015, the U.S. imported goods and services worth about _____________ and exported about
_________ leading to a current account ____________.

$3.7 trillion; $3.3 trillion; deficit

42. Money market mutual funds (MMMFs) have caused disintermediation at banks at times. This is
because MMMFs---

sometimes pay higher interest rates than bank deposits.

43. Load funds charge one-time sales commissions that can be paid either upfront or at end
of the investing period in the mutual fund. TRUE

44. Why are mutual funds popular with individual investors?- They provide opportunities for
small investors to obtain low-cost diversification; professional fund management according to specific
objectives; economies of scale in investing (lower commissions and research costs); higher rates of
return than available on bank deposits; and convenience services such as switching funds, low-cost
reinvestment, and sometimes even check-writing capabilities.

45. The shares of a closed-end fund with market value assets of $200 million and two
million shares outstanding will always trade at a market value of $100 per share. FALSE

A fund that has a fixed number of shares outstanding and is traded on an exchange is called
a(n)=== closed-end fund.

A(n) ___________ fund must hold substantial cash reserves in order to meet fund
redemptions from shareholders--- open-end mutual

The market value of a fund's net assets divided by the number of mutual fund shares
outstanding is called the NAV of the fund. TRUE
How are hedge fund expenses different from mutual fund expenses? What are hurdle rates
and high water marks at a hedge fund? Why are these used?

Hedge funds charge the normal annual management expenses similar to mutual funds, but hedge funds
also charge performance fees. Performance fees give the fund managers a percentage of any positive
returns on the fund. These fees average 20 percent and have been as high as 50 percent! Because these
fees are so large and because having them might tempt managers to seek exorbitant risk levels, fund
investors require a hurdle rate, which is a minimum rate of return the fund must earn before the
performance fee can be assessed. Likewise, many funds have a requirement that the hedge fund NAV
must be at an all-time high (high water mark) before the performance fee can be assessed.

CHAPTER 10 Y 16
Your firm enters into a swap agreement with a notional principal of $40 million wherein the firm
pays a fixed rate of interest of 5.50 percent and receives a variable rate of interest equal to
LIBOR plus 150 basis points. If LIBOR is currently 3.75 percent, the NET amount your firm will
receive (+) or pay (−) on the next transaction date is--- − $100,000.

The type of swap most closely linked to the subprime mortgage crisis is the ---

credit default swap

An investor is committed to purchasing 100 shares of World Port Management stock in six months. She is
worried the stock price will rise significantly over the next six months. The stock is at $45 and she buys a
six-month call with a strike of $50 for $250. At expiration the stock is at $54. What is the net economic
gain or loss on the entire stock/option portfolio?--- −$750

Refer to the Listed Stock Option Price Quote from February and assume it is now January:
 
IRQ Underlying stock price $45.2
Call Put
OPEN OPEN
Expiration STRIKE LAST VOLUME INTEREST LAST VOLUME INTERES
Mar 50 ? 102 12,578 6.55 80 11,175
Jun 50 2.25 35 1,062 ? 48 909

Based on the option quote, the Mar

ch call should cost---- less than $225.;;’ The March call price must be less than the June call price quote *
100.
Which of the following is true?---

Futures contracts req

uire an initial margin requirement be paid.

FNMA has direct holdings of 30-year fixed-rate mortgages financed by three- to five-year
agency securities sold to the public.
 
What kind of interest rate option could FNMA use to limit the interest rate risk? Explain how
this would work. Explain how a collar could also be used.-------- If the interest rate rises, the
cost of funds will increase for FNMA however the interest income from the
mortgages will remain the same. FNMA needs protection against this risk.
Interest rate Caps are the popular derivatives that generate income for the buyer of the
cap if interest rate rises. FNMA, will receive payments at the end of each period when
interest rate is higher than the strike price of the Cap. Caps, practically are, a series of
call options on the index with floating rate. The payoff from the cap to the buyer will
be:
Nominal Principal x (Index Level – Strike Price) x n / 360 where "n" is the number of
days.
FNMA should buy interest rate caps for protection against rising interest rate risk.
Explain how a collar could also be used. However, there is one problem with Caps.
They are costly. FNMA may have to spend a significant amount as upfront as
commission, or fees or premium to buy the Caps. Understanding this situation,
sources of funds can be Interest Rate Floors. So, FNMA can sell Floors to get the cash
flows to buy the Caps. Such a situation where a borrower is long on Caps and short on
Floor with the same underlying and same strike price, is called Collar. Thus, Collar
position will be Help get the initial cash flows to buy the Caps and Limit the interest
rate risk
My bank has a larger number of adjustable-rate mortgage loans outstanding. To protect our
interest rate income on these loans, the bank could
 
1. I. enter into a swap to pay fixed and receive variable.
2. II. enter into a swap to pay variable and receive fixed.
3. III. buy an interest rate floor.
4. IV. buy an interest rate cap.
5.

The higher the exercise price, the ________________ the value of a put and the _______________ the
value of a call.=
== higher; lower

Forward contracts are marked to market daily. FALSE

In a futures contract, if funds in the margin account fall below the maintenance margin requirement, a
margin call is issued. TRUE

A stock is priced at $27. An American call option on this stock with a $25 strike must
be worth at least how much? Numerically show why.
must be worth at least $2 per share or $200 per contract.
explanation 
The premium is instead only $1 per share. This could be call for $1 and sell stock
short at $27, use the call immediately and buy the stock for $25. The all in cost of the
stock per share is $25+1=26
and must sell the stock for $27.
A $1 gain that involves no risk and no investment. With this the option price will rise
until the option premium is at least equal to the difference between the stock price and
the exercise price .

You buy euros in New York from Deutsche Bank and simultaneously sell them in London to Barclays for
a gain. This is an example of=== pure arbitrage.

f an underwriter overestimates the demand for a firm's securities in a firm commitment offering, the
underwriter can NONE

are examples of investment bankers offering traditional commercial banking services.==

Cash management accounts

Although an investor can write checks on a cash management account held with a broker, regulations
prevent the use of ATMs or debit cards on these accounts. FALSE

Firms underwriting securities assist corporate clients in selling them in secondary markets. D=FALSE

An investment bank agrees to pay $26.75 for 5 million shares of a company in a firm commitment stock
offering. It then can sell those shares to the public for $25.50 per share. What is the profit to the
investment bank?

Loss of $6,250,000

The largest asset on the typical broker-dealers’ balance sheet in 2015 was===

receivables from other broker-dealers.

FINRA is a government agency with mandate to protect America’s investors by making sure the
securities industry operates fairly and honestly. FALSE

Firms in the securities industry are required to maintain a minimum capital to asset ratio of
______________. 2%

Describe an agency transaction (brokerage) and a principal transaction (dealer) that is involved
in trading. What determines profits in each activity? Which is riskier?==== In a principal
transaction the market maker buys and sells securities for their own account. They can
profit two ways. First, the market maker charges a slightly higher price to sell
securities while buying at a lower price.  The principal carries an inventory of
securities and does bear the risk of a large price move, so the principal has more risk
than the broker.
Agency transaction, face less risk when compared to investors who carry out principal
transactions.With the broker, a high volume of either buys or sells or both can thus
lead to high profits. Market makers can also take on even more risk by taking larger
bullish or bearish positions if they believe they can predict the direction of the
security's price change. This kind of speculative market making activity is more risky
but can lead to larger. The agents whether carrying out lesser volume or more volume
of trading activities of securities, they earn confirm profit through commissions.
In case of the principals, they carry risk by holding securities which show downward
price movement for some time. They suffer two types of risk- carrying the securities
until price movement turns back to upward, and finance cost involving carrying the
value of securities.
Principal transactions involve more risk than the agency transactions.
The more the risk the principal takes, the more the profit they can earn

Program trading is the simultaneous buying and selling of at least 15 stocks worth a total of $1 million or
more. TRUE

An unregistered issue sold to a few large institutional buyers is an example of a(n) private placement.

An example of a pure arbitrage strategy is to simultaneously buy and sell the same security in two
different markets at different prices.TRUE

Day-to-day trading practices of securities firms currently may be regulated by which of the
following?
1. I. FINRA
2. II. SEC
3. III. Federal Reserve
4. IV. SIPC

A professional futures trader who buys and sells futures for his own account
throughout the day but typically closes out his positions at the end of the day is called
a=== day trader.

A clearinghouse backs the buyer's and seller's position in a forward contract. FALSE
FNMA has direct holdings of 30-year fixed-rate mortgages financed by three- to five-
year agency securities sold to the public.
 
What kind of interest rate swap could FNMA use to limit their interest rate risk?
Explain. FNMA's risk is from rising interest rates because the bonds mature more quickly than
the mortgages (the mortgage duration is greater). Rising interest rates will increase FNMA's
funding cost, but the mortgage income will stay the same. To offset this risk, FNMA could agree to
pay a fixed rate of interest on a given notional principal and receive a variable rate of interest. If
rates rose, FNMA would receive more interest income, but pay out the same fixed rate on the swap.
The swap gain could then offset any loss on the balance sheet.

Marking to market of futures contracts is the process of realizing gains and losses each day as
the futures contract changes in price. TRUE

By convention, a swap buyer on an interest rate swap agrees to===periodically pay a

fixed rate of interest and receive a floating rate of interest.

The type of swap most closely linked to the subprime mortgage crisis is the ____________.
credit default swap

In a bear market, which option positions make money?

 
1. I. Buying a call.
2. II. Writing a call.
3. III. Buying a put.
4. IV. Writing a put.

When would an option hedge be better than a futures or forward hedge?=== An option hedge is better than
a futures or forward hedge when you want the choice of whether or not to use the derivative instrument and
you are willing to pay to have that choice. Futures and forward hedges limit losses, but also limit profit
opportunities. Because options are a right, rather than a commitment, using options to hedge preserves the
upside potential foregone with other hedging methods. Options require the payment of a nonrefundable
premium to acquire, whereas forward, futures, and swaps do not have this outright cost.
European-style options are options that may only be exercised at maturity. TRUE

A negotiated non-standardized agreement between a buyer and seller (with no third-party involvement) to
exchange an asset for cash at some future date with the price set today is called a forward agreement.
TRUE

The Securities Investor Protection Corporation protects investors against losses due to unfavorable market
moves of up to $500,000. FALSE

Day-to-day trading practices of securities firms currently may be regulated by which of the
following?
1. I. FINRA
2. II. SEC
3. III. Federal Reserve
4. IV. SIPC

Which one of the following statements about venture capitalists is not correct?=== Venture capitalists are
passive investors.

A company issued 5 million new shares of stock. An investment bank agrees to underwrite these shares
on a best efforts basis. The investment bank is able to sell 3.7 million shares for $34.50 per share, and it
charges commission of $0.52 per share sold. How much money will the company receive?== 3,700,000 ×
(34.50 − 0.52) = 125,726,000===$125,726,000

An example of a national full-line investment banker that specializes in corporate finance is Goldman
Sachs. TRUE

When the investment banker sells the new securities on commission without guaranteeing the sale of the
whole issue, the process is called: BEST EFFORT

Firms underwriting securities assist corporate clients in selling them in secondary markets. FALSE

For securities firms, income from investment management is more stable than income from underwriting
or trading activities. TRUE

The trading activity involving purchases of large blocks of securities on the expectation of a favorable
price move over the next several weeks or months is called===

position trading

Cash management accounts offered by a securities firm allow investors to write checks on funds invested
in money market securities. TRUE

An unregistered issue sold to a few large institutional buyers is an example of a(n)=== private placement.
A stockbroker acts as a principal on behalf of the customer. FALSE

A best efforts offering is one in which==The investment banker acts only as a distribution agent.

Brokerage commission income and stock market valuations tend to move inversely in most years,
including in 2010==FALSE

CHAPTER 19

The Fed allowed nonbank financial institutions to borrow money from the discount window
during the mortgage crisis and even allowed nonbanks to swap mortgages for Treasury
securities. This was an attempt by the Fed to reduce ________________ at institutions.====

liquidity risk

Interest rate risk is probably greatest at which of the following intermediaries?====

Savings institutions

The subprime crisis is a good example of the credit risk faced by financial institutions. TRUE

Regulators’ overall evaluation of the riskiness of a depository institution is measured by the

_______________.

CAMELS rating
Suppose you purchase a 10-year AAA-rated British bond for par that is paying an annual
coupon of 9 percent and has a face value of 1,000 British Pounds (£). The spot rate is
US$1.105 for £. At the end of the year, the bond is downgraded to AA and the yield
increases to 11 percent. In addition, the new spot rate becomes US$0.985 for £.
What is the loss or gain to a British investor who holds this bond for a year?===== The
initial bond value is 1,000 £. In one year, find the value of the bond using a financial calculator: N = 9,
PMT = 90, I = 11, FV = 1,000 and solve for PV to get 889.26 £.
The loss for the British investor is (889.26 − 1,000 + 90)/1,000 = −2.07%

Risk arising from unhedged positions in securities, currencies, and derivatives is called
market risk. TRUE

MONDEX spent $50 million to develop the Smart Card, but tests of prototypes in New
York and Canadian cities revealed very little consumer interest. This is an example
of====Technological risk.

Which one of the following intermediaries is likely to engage in more asset liability
maturity matching?=== Life insurers

Breakdowns of ATMs and fraudulent use of information stored on a bank's computer

system are examples of operational risk. TRUE

A corporate borrower failing to repay a loan on time due to equipment breakdowns is an

example of firm specific credit risk. TRUE
Rising interest rates decrease the value of fixed-income assets and increase the value of
fixed-income liabilities. FALSE

Which of the following would normally be banking book assets rather than trading book
assets?===Long-term loans

A U.S. bank has £900 million in loans it has made to corporate customers and it has £750
million in deposits when the exchange rate is £1 = $1.98. The bank will have a net foreign
exchange loss on these accounts if the exchange rate moves to £1 = $1.95. TRUE

For most financial institutions, present value uncertainty is the risk that===The market value
of an asset (liability) will decline if interest rates increase.

The £ is worth 1.2569 euros and the euro is worth $1.5568. Statistical analysis indicates that
when the euro rises 1 percent against the dollar, the pound rises 0.5 percent against the euro and
vice versa. A U.S. bank has assets of £40 million that mature in one year funded with liabilities
of €55 million due in six months. The bank would be hurt by
1. I. an increase in the value of the euro against the dollar.
2. II. a decrease in the value of the euro against the dollar.
3. III. an increase in euro interest rates relative to pound interest rates.
4. IV. an increase in pound interest rates relative to euro interest rates.