Overview of the Financial System Sample Questions

Overview of the Financial System 1) Financial markets have the basic function of A) bringing together people with funds to lend and people who want to borrow funds. B) assuring that the swings in the business cycle are less pronounced. C) assuring that governments need never resort to printing money. D) both A and B of the above. E) both B and C of the above. Answer: A 2) Which of the following can be described as involving direct finance? A) A corporation's stock is traded in an over-the-counter market. B) A corporation buys commercial paper issued by another corporation. C) A pension fund manager buys commercial paper from the issuing corporation. D) Both A and B of the above. E) Both B and C of the above. Answer: B 3) Which of the following can be described as involving indirect finance? A) A corporation takes out loans from a bank. B) People buy shares in a mutual fund. C) A corporation buys commercial paper in a secondary market. D) All of the above. E) Only A and B of the above. Answer: E 4) Financial markets improve economic welfare because A) they allow funds to move from those without productive investment opportunities to those who have such opportunities. B) they allow consumers to time their purchases better. C) they weed out inefficient firms. D) they do all of the above. E) they do A and B of the above. Answer: E 5) Which of the following are securities? A) A certificate of deposit B) A share of Texaco common stock C) A Treasury bill D) All of the above E) Only A and B of the above Answer: D 6) The money market is the market in which ________ are traded. A) new issues of securities B) previously issued securities C) short-term debt instruments D) long-term debt and equity instruments Answer: C 7) Which of the following are secondary markets? A) The New York Stock Exchange B) The U.S. government bond market C) The over-the-counter stock market D) All of the above Answer: D 8) A corporation acquires new funds only when its securities are sold in the A) secondary market by an investment bank. B) primary market by an investment bank. C) secondary market by a stock exchange broker. D) secondary market by a commercial bank. Answer: B 9) Which of the following statements about financial markets and securities are true? A) A bond is a long-term security that promises to make periodic payments called dividends to the firm's residual claimants. B) A debt instrument is intermediate term if its maturity is less than one year. C) A debt instrument is long term if its maturity is ten years or longer. D) The maturity of a debt instrument is the time (term) that has elapsed since it was issued. Answer: C 10) Bonds that are sold in a foreign country and are denominated in that country's currency are known as A) foreign bonds. B) Eurobonds. C) Eurocurrencies. D) Eurodollars. Answer: A 11) Bonds that are sold in a foreign country and are denominated in a currency other than that of the country in which they are sold are known as A) foreign bonds. B) Eurobonds. C) Eurocurrencies. D) Eurodollars. Answer: B 12) Financial intermediaries can substantially reduce transaction costs per dollar of transactions because their large size allows them to take advantage of A) poorly informed consumers. B) standardization. C) economies of scale. D) their market power. Answer: C 13) The presence of ________ in financial markets leads to adverse selection and moral hazard problems that interfere with the efficient functioning of financial markets. A) noncollateralized risk B) free-riding C) asymmetric information D) costly state verification Answer: C 14) When the lender and the borrower have different amounts of information regarding a transaction, ________ is said to exist. A) asymmetric information B) adverse selection C) moral hazard D) fraud Answer: A 15) When the potential borrowers who are the most likely to default are the ones most actively seeking a loan, ________ is said to exist. A) asymmetric information B) adverse selection C) moral hazard D) fraud Answer: B 16) When the least desirable credit risks are the ones most likely to seek loans, lenders are subject to the A) moral hazard problem. B) adverse selection problem. C) shirking problem. D) free-rider problem. E) principal-agent problem. Answer: B What Do Interest Rates Mean and What Is Their Role in Valuation? 1) A loan that requires the borrower to make the same payment every period until the maturity date is called a A) simple loan. B) fixed-payment loan. C) discount loan. D) same-payment loan. E) none of the above. Answer: B 2) A coupon bond pays the owner of the bond A) the same amount every month until the maturity date. B) a fixed interest payment every period, plus the face value of the bond at the maturity date. C) the face value of the bond plus an interest payment once the maturity date has been reached. D) the face value at the maturity date. E) none of the above. Answer: B 3) A bond's future payments are called its A) cash flows. B) maturity values. C) discounted present values. D) yields to maturity. Answer: A 4) A credit market instrument that pays the owner the face value of the security at the maturity date and nothing prior to then is called a A) simple loan. B) fixed-payment loan. C) coupon bond. D) zero-coupon bond. Answer: D 5) (I) A simple loan requires the borrower to repay the principal at the maturity date along with an interest payment. (II) A discount bond is bought at a price below its face value, and the face value is repaid at the maturity date. A) (I) is true, (II) false. B) (I) is false, (II) true. C) Both are true. D) Both are false. Answer: C 6) Which of the following are true of coupon bonds? A) The owner of a coupon bond receives a fixed interest payment every year until the maturity date, when the face or par value is repaid. B) U.S. Treasury bonds and notes are examples of coupon bonds. C) Corporate bonds are examples of coupon bonds. D) All of the above. E) Only A and B of the above. Answer: D 7) If a $5,000 coupon bond has a coupon rate of 13 percent, then the coupon payment every year is A) $650. B) $1,300. C) $130. D) $13. E) None of the above. Answer: A 8) An $8,000 coupon bond with a $400 annual coupon payment has a coupon rate of A) 5 percent. B) 8 percent. C) 10 percent. D) 40 percent. Answer: A 9) The concept of ________ is based on the notion that a dollar paid to you in the future is less valuable to you than a dollar today. A) present value B) future value C) interest D) deflation Answer: A 10) Dollars received in the future are worth ________ than dollars received today. The process of calculating what dollars received in the future are worth today is called ________. A) more; discounting B) less; discounting C) more; inflating D) less; inflating Answer: B 11) The interest rate that equates the present value of the cash flow received from a debt instrument with its market price today is the A) simple interest rate. B) discount rate. C) yield to maturity. D) real interest rate. Answer: C 12) The interest rate that financial economists consider to be the most accurate measure is the A) current yield. B) yield to maturity. C) yield on a discount basis. D) coupon rate. Answer: B 13) The process of calculating what dollars received in the future are worth today is called A) calculating the yield to maturity. B) discounting the future. C) compounding the future. D) compounding the present. Answer: B 14) The yield to maturity of a one-year, simple loan of $500 that requires an interest payment of $40 is A) 5 percent. B) 8 percent. C) 12 percent. D) 12.5 percent. Answer: B 15) A $10,000, 8 percent coupon bond that sells for $10,100 has a yield to maturity ________. A) equal to 8 percent B) greater than 8 percent C) less than 8 percent D) that cannot be calculated Answer: C 16) With an interest rate of 8 percent, the present value of $100 received one year from now is approximately A) $93. B) $96. C) $100. D) $108. Answer: A 17) With an interest rate of 6 percent, the present value of $100 received one year from now is approximately A) $106. B) $100. C) $94. D) $92. Answer: C 18) Which of the following $1,000 face value securities has the highest yield to maturity? A) A 5 percent coupon bond selling for $1,000 B) A 10 percent coupon bond selling for $1,000 C) A 12 percent coupon bond selling for $1,000 D) A 12 percent coupon bond selling for $1,100 Answer: C 19) Which of the following $1,000 face value securities has the highest yield to maturity? A) A 5 percent coupon bond selling for $1,000 B) A 10 percent coupon bond selling for $1,000 C) A 15 percent coupon bond selling for $1,000 D) A 15 percent coupon bond selling for $900 Answer: D 20) Which of the following $1,000 face value securities has the lowest yield to maturity? A) A 5 percent coupon bond selling for $1,000 B) A 5 percent coupon bond selling for $1,100 C) A 15 percent coupon bond selling for $1,000 D) A 15 percent coupon bond selling for $900 Answer: B How Do Risk and Term Structure Affect Interest Rates? 1) Bonds with relatively high risk of default are called A) Brady bonds. B) junk bonds. C) zero coupon bonds. D) investment-grade bonds. Answer: B 2) The risk structure of interest rates is A) the structure of how interest rates move over time. B) the relationship among interest rates of different bonds with the same maturity. C) the relationship among the terms to maturity of different bonds. D) the relationship among interest rates on bonds with different maturities. Answer: B 3) (I) An increase in default risk on corporate bonds shifts the demand curve for corporate bonds to the right. (II) An increase in default risk on corporate bonds shifts the demand curve for Treasury bonds to the left. A) (I) is true, (II) false. B) (I) is false, (II) true. C) Both are true. D) Both are false. Answer: D 4) (I) An increase in default risk on corporate bonds shifts the demand curve for corporate bonds to the left. (II) An increase in default risk on corporate bonds shifts the demand curve for Treasury bonds to the right. A) (I) is true, (II) false. B) (I) is false, (II) true. C) Both are true. D) Both are false. Answer: C 5) The spread between interest rates on low-quality corporate bonds and U.S. government bonds ________ during the Great Depression. A) was reversed B) narrowed significantly C) widened significantly D) did not change Answer: C 6) If Moody's or Standard and Poor's downgrades its rating on a corporate bond, the demand for the bond ________ and its yield ________. A) increases; decreases B) decreases; increases C) increases; increases D) decreases; decreases Answer: B 7) Corporate bonds are not as liquid as government bonds because A) fewer bonds for any one corporation are traded, making them more costly to sell. B) the corporate bond rating must be calculated each time they are traded. C) corporate bonds are not callable. D) all of the above. E) only A and B of the above. Answer: A 8) (I) The risk premium widens as the default risk on corporate bonds increases. (II) The risk premium widens as corporate bonds become less liquid. A) (I) is true, (II) false. B) (I) is false, (II) true. C) Both are true. D) Both are false. Answer: C 9) When the corporate bond market becomes less liquid, other things equal, the demand curve for corporate bonds shifts to the ________ and the demand curve for Treasury bonds shifts to the ________. A) right; right B) right; left C) left; left D) left; right Answer: D 10) (I) If a corporate bond becomes less liquid, the demand for the bond will fall, causing the interest rate to rise. (II) If a corporate bond becomes less liquid, the demand for Treasury bonds does not change. A) (I) is true, (II) false. B) (I) is false, (II) true. C) Both are true. D) Both are false. Answer: A The Bond Market & The Stock Market 1) (I) Securities that have an original maturity greater than one year are traded in money markets. (II) The best known money market securities are stocks and bonds. A) (I) is true, (II) false. B) (I) is false, (II) true. C) Both are true. D) Both are false. Answer: D 2) (I) There are two types of exchanges in the secondary market for capital securities: organized exchanges and over-the-counter exchanges. (II) When firms sell securities for the very first time, the issue is an initial public offering. A) (I) is true, (II) false. B) (I) is false, (II) true. C) Both are true. D) Both are false. Answer: C 3) (I) The coupon rate is the rate of interest that the issuer of the bond must pay. (II) The coupon rate is usually fixed for the duration of the bond and does not fluctuate with market interest rates. A) (I) is true, (II) false. B) (I) is false, (II) true. C) Both are true. D) Both are false. Answer: C 4) The security with the longest maturity is a Treasury A) note. B) bond. C) acceptance. D) bill. Answer: B 5) (I) To sell an old bond when interest rates have risen, the holder will have to discount the bond until the yield to the buyer is the same as the market rate. (II) The risk that the value of a bond will fall when market interest rates rise is called interest-rate risk. A) (I) is true, (II) false. B) (I) is false, (II) true. C) Both are true. D) Both are false. Answer: C 6) (I) Preferred stockholders hold a claim on assets that has priority over the claims of common stockholders. (II) Bondholders hold a claim on assets that has priority over the claims of preferred stockholders. A) (I) is true, (II) false. B) (I) is false, (II) true. C) Both are true. D) Both are false. Answer: C 7) Preferred stockholders hold a claim on assets that has priority over the claims of A) both common stockholders and bondholders. B) neither common stockholders nor bondholders. C) common stockholders, but after that of bondholders. D) bondholders, but after that of common stockholders. Answer: C 8) The riskiest capital market security is A) preferred stock. B) common stock. C) corporate bonds. D) Treasury bonds. Answer: B 9) A stock currently sells for $25 per share and pays $0.24 per year in dividends. What is an investor's valuation of this stock if she expects it to be selling for $30 in one year and requires a 15 percent return on equity investments? A) $30.24 B) $26.30 C) $26.09 D) $27.74 Answer: B 10) In the one-period valuation model, a stock's value will be higher A) the higher its expected future price is. B) the lower its dividend is. C) the higher the required return on investments in equity is. D) all of the above. Answer: A 11) Which of the following is not an element of the Gordon growth model of stock valuation? A) The stock's most recent dividend paid B) The expected constant growth rate of dividends C) The required return on investments in equity D) The stock's expected future price Answer: D 12) According to the Gordon growth model, what is an investor's valuation of a stock whose current dividend is $1.00 per year if dividends are expected to grow at a constant rate of 10 percent over a long period of time and the investor's required return is 15 percent? A) $20 B) $11 C) $22 D) $7.33 E) $4.40 Answer: C 13) Holding other things constant, a stock's value will be highest if its most recent dividend is A) $2.00. B) $5.00. C) $0.50. D) $1.00. Answer: B