1. The New York Stock Exchange (NYSE) is: a. a secondary market. b. a physical asset market. c. a primary market d.

Statements a and b are correct. e. Statements b and c are correct. a. Correct. 2. An example of a primary market transaction is: a. buying 100 shares of Wal-Mart stock from your uncle. b. buying 100 shares of IBM stock through the New York Stock Exchange via an online brokerage firm c. buying 100 shares of a new issue of Home Depot common stock c. Correct. 3. Money markets are: a. markets for long-term debt and common stocks. b. markets for real or tangible assets. c. markets for short-term, highly liquid debt securities. c. Correct. 4. Investment banking firms: a. facilitate the issue of new securities. b. are secondary market participants. c. are primary market participants. d. a and b are true e. a and c are true e. Correct. 5. Financial intermediaries: a. act as middlemen to facilitate the issuance of new securities by firms and governments. b. literally create new forms of capital (securities). c. facilitate the transfer of funds from savers to demanders of capital d. a and b e. b and c e. Correct. 6. Which of the following are financial intermediaries? a. commercial banks b. mutual funds c. life insurance companies d. all of the above e. none of the above d. Correct.

7. The NASDAQ is primarily a. a primary market. b. a physical location auction market. c. an over-the-counter market. d. Statements a and b are correct. e. Statements b and c are correct. c. Correct. 8. The NYSE does not exist as a physical location; rather it represents a loose collection of dealers who trade stock electronically. a. True b. False Correct. 9. Which of the following is likely to lead to an increase in the cost of funds? a. Companies production opportunities decline, leading to a decline in the demand for funds. b. Households save a larger portion of their income. c. Households increase the amount of money they borrow from their local banks. d. Statements a and b are correct. e. Statements a and c are correct. c. Correct. 10. Prices for capital: a. remain stable over time. b. change in response to shifts in supply and demand conditions c. are always zero d. none of the above are true b. Correct. 11. The real risk-free rate of interest is: a. static, it does not change over time. b. changes over time depending on economic conditions c. is always zero d. none of the above are correct b. Correct. 12. The default risk premium: a. compensates investors for interest rate risk, which is that long-term securities are more price sensitive to interest changes than short-term securities. b. is equal to expected inflation over the life of the security c. is added to the equilibrium interest rate on a security if the security cannot be converted to cash quickly at close to fair market value. d. is the difference between the interest rate on a U.S. Treasury bond and a corporate bond of equal maturity and marketability d. Correct.

13. A large liquidity premium: a. is required for assets that can be converted into cash on short notice at a reasonable price. b. is required for assets that cannot be converted into cash on short notice at a reasonable price. c. is required for assets with high default risk d. is required for assets when inflation was high in the past b. Correct. 14. The inflation premium: a. should be an average of the inflation rate experienced in the past. b. should be an average of the inflation rate expected over the life of the security. c. is required for assets that cannot be converted into cash on short notice at a reasonable price. d. reflects interest rate risk. b. Correct. 15. If the yield curve is downward sloping, what is the yield to maturity on a 10-year Treasury coupon bond, relative to that on a 1-year T-bond? a. The yield on the 10-year bond is less than the yield on a 1-year bond. b. The yield on a 10-year bond will always be higher than the yield on a 1-year bond because of maturity risk premiums. c. It is impossible to tell without knowing the coupon rates of the bonds. d. The yields on the two bonds are equal. e. It is impossible to tell without knowing the relative risks of the two bonds. a. Correct. 16. Assume that inflation is expected to steadily decline in the years ahead, but that the real riskfree rate, k*, is expected to remain constant. Which of the following statements is most correct? a. If the expectations theory holds, the Treasury yield curve must be downward sloping. b. If the expectations theory holds, the Treasury yield curve must be upward sloping. c. If there is a positive maturity risk premium, the Treasury yield curve must be upward sloping. d. Statements a and c are correct. a. Correct.

17. Investing overseas adds: a. country risk which refers to the risk that arises from investing or doing business in a particular country b. exchange rate risk which is the risk that changes in the relative value of the currencies will reduce the value of the investment in terms of the home currency. c. both a and b are true d. neither a nor b are true c. Correct 18. Federal Reserve policy rarely affects interest rates. a. True

b. False Correct. 19. Federal budget deficits: a. can help drive interest rates up. b. can help drive interest rates down. c. have no effect on interest rates. a. Correct. 20. Foreign trade deficits: a. push interest rates down. b. push interest rates up. c. have no effect on interest rates. b. Correct. 21. Because of the lack of predictability of interest rates, sound corporate financial policy generally calls for using a mix of long- and short-term debt and equity. a. True Correct. b. False 22. The real risk-free rate of interest is 3 percent. Inflation is expected to be 5 percent this coming year, jump to 6 percent next year, and increase to 7 percent the following year (Year 3). According to the expectations theory, what should be the interest rate on 3-year, risk-free securities today? a. 3% b. 6% c. 8% d. 9% e. 10% d. Correct. 23. Assume that the expectations theory holds, and that liquidity and maturity risk premiums are zero. If the annual rate of interest on a 2-year Treasury bond is 9 percent and the rate on a 1-year Treasury bond is 11 percent, what rate of interest should you expect on a 1-year Treasury bond one year from now? a. 2% b. 7% c. 10% d. 20% e. 30% b. Correct.

24. One-year Treasury securities yield 6 percent, 2-year Treasury securities yield 6.5 percent, and 3-year Treasury securities yield 7 percent. Assume that the expectations theory holds. What does the market expect will be the yield on 1-year Treasury securities two years from now? a. 7% b. 8% c. 8.5% d. 13% e. 15% b. Correct. 25. Drongo Corporations 4-year bonds currently yield 8.4 percent. The real risk-free rate of interest, k*, is 2.7 percent and is assumed to be constant. The maturity risk premium (MRP) is estimated to be 0.1%(t - 1), where t is equal to the time to maturity. The default risk and liquidity premiums for this companys bonds total 0.9 percent and are believed to be the same for all bonds issued by this company. If the average inflation rate is expected to be 5 percent for years 5, 6, and 7, what is the yield on a 7-year bond for Drongo Corporation? a. 12.22% b. 8.71% c. 7.90% d. 8.91% e. 8.95% d. Correct. 26. Ten-year bonds have an interest rate of 7.5 percent, while 15-year bonds have an interest rate of 7.0 percent. If the expectations theory is correct, what does the market believe will be the interest rate on 5-year bonds, 10 years from now? a. 6% b. 6.5% c. 7% d. 7.5% e. 8% a. Correct. 27. Assume that a 3-year Treasury note has no maturity risk premium, and that the real risk-free rate of interest is 3 percent. If the T-note carries a yield to maturity of 10 percent, and if the expected average inflation rate over the next 2 years is 8 percent, what is the implied expected inflation rate during Year 3? a. 4% b. 5% c. 6% d. 7% e. 8% b. Correct.

28. The real risk-free rate is 3 percent. The inflation rate is expected to be 4 percent a year for the next three years and then 5 percent a year thereafter. Assume that the default risk and liquidity premiums on all Treasury securities equal zero. You observe that 10-year Treasury bonds yield 1 percent more than the yield on 5-year Treasury bonds. What is the difference in the maturity risk premium on the two bonds? a. 1% b. 0.3% c. 0.7% d. 2.2% e. 3.3% c. Correct. 29. You see that the current 30-day T-bill rate is 4.5%. You are told by a friend who works for an investment firm that the best estimates of the current interest rate premiums for relatively safe corporate firms is as follows: inflation premium = 2.1%; default risk premium = 1.4%. Based on this data, what is the real risk-free rate of return? a. 2.4% b. 3.1% c. 1% d. 6.6% e. 5.9% a. Correct. 30. The 5-year bonds of Bonanza Inc. are yielding 9.2 percent per year. The real risk-free rate has not changed in recent years and is 2.3%. The average inflation premium is 2.6%, and the maturity risk premium takes the form: MRP=0.1%(t 1), where t = number of years to maturity. If the liquidity premium is 1.1 percent, what is the default risk premium on Bonanzas bonds? a. 2.8% b. 3.2% c. 4.5% d. 5.4% e. 6.5% a. Correct. 31. An investor in Treasury securities expects inflation to be 5.5% in year 1, 4.2% in year 2, and 3.8% each year thereafter. What should the inflation premium be for a three-year bond? a. 3.8% b. 5.5% c. 4.2% d. 13.5% e. 4.5% e. Correct.