FINAL EXAM EC26102: MONEY, BANKING AND FINANCIAL MARKETS MAY 11, 2004

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1 FINAL EXAM EC26102: MONEY, BANKING AND FINANCIAL MARKETS MAY 11, 2004 This exam has 50 quesions on 14 pages. Before you begin, please check o make sure ha your copy has all 50 quesions and all 14 pages. All quesions will receive equal weigh in deermining your exam score. Please answer all quesions on he answer shee provided. 1. When borrowers borrow in financial markes, hey do so by: A) Issuing securiies. B) Buying securiies. 2. A shor-erm deb insrumen is bes defined as one wih: A) Mauriy of one day or less. B) Mauriy of less han one monh. C) Mauriy of less han six monhs. D) Mauriy of less han one year. E) Mauriy of less han en years. 3. Which of he following is rue? A) As of he end of 2002, he value of all deb insrumens ousanding in he US financial sysem was larger han he value of all equiies. B) As of he end of 2002, he value of all deb insrumens ousanding in he US financial sysem was approximaely he same as he value of all equiies. C) As of he end of 2002, he value of all equiies ousanding in he US financial sysem was larger han he value of all deb insrumens.

2 2 4. When Ford Moor Company issues new shares of sock and sells hem off o privae invesors, hese ransacions are said o ake place in an A) Broker s marke. B) Dealer s marke. C) Secondary marke. D) None of he above. 5. Invesmen banks play a key role in financial markes by underwriing securiies. This means ha invesmen banks A) Help mach up buyers and sellers of exising securiies. B) Hold invenories of securiies and sand ready o buy from and sell o oher marke paricipans. C) Help firms sell newly-issued securiies. D) Guaranee ha firms will pay ineres and principal on heir deb. 6. Which of he following securiies markes is organized as an exchange? A) The New York Sock Exchange. B) The NASDAQ marke for socks. C) The US Governmen bond marke. D) Boh (B) and (C) above. E) All hree, (A), (B), and (C), above. 7. Which of he following is rue? A) Negoiable CD s are shor-erm deb insrumens. B) Negoiable CD s are issued by banks. C) Negoiable CD s rade on a secondary marke. D) Boh (A) and (B) above. E) All hree, (A), (B), and (C), above. 8. Which of he following is rue? A) Commercial paper is issued by corporaions. B) Mauriies on commercial paper rarely exceed 9-monhs. C) Commercial paper makes no regular ineres paymens, bu insead sells a a discoun. D) Commercial paper rades on a secondary marke. E) All of he above.

3 3 9. Which of he following is rue? A) Moral hazard refers o he problem ha arises afer a loan is made, because he borrower may use his or her borrower funds irresponsibly. B) Banks help solve he problem of moral hazard by experly monioring he aciviies of borrowers. C) Boh (A) and (B) above. D) None of he above. 10. Unlike oher muual funds ha inves mainly in corporae socks and bonds, money marke muual funds ofen allow heir shareholders o wrie checks agains he value of he shareholdings. Money marke muual funds can do his because: A) They are a ype of deposiory insiuion. B) They are a ype of conracual savings insiuion. C) The money marke insrumens ha hey hold end o have longer mauriies han corporae bonds and socks. D) The money marke insrumens ha hey hold end o be more liquid han corporae bonds and socks. E) Their principal asses, including US Treasury bills and Negoiable Bank CDs, are all payable on demand. 11. A simple loan of $100 requires he borrower o repay $100 principal plus $10 ineres one year from now. For his loan, he simple ineres rae can be calculaed as: A) $110 - $10 = $100. B) $110 - $100 = $10. $100 $100 C) = = = 90.9%. $100 + $10 $110 D) $100 - $90 = $10. E) None of he above. 12. If he simple ineres rae is i, hen he presen value of $1 received n years from now is A) $1 x i n. B) $1 x (1+i) n. $1 C). n (1 + i) $1 D). i (1 + n) E) None of he above.

4 4 13. Consider a simple loan of $100 ha ges repaid wih $10 ineres afer one year. For his loan, he yield o mauriy i mus saisfy: $100 A) $10 =. 1+ i $100 B) $110 =. 1+ i $10 C) $100 =. 1+ i $110 D) $100 =. 1+ i E) None of he above. 14. Consider a coupon bond wih $1000 face value, $100 annual coupon paymen, and one year o mauriy ha sells for he price of $900 oday. For his bond, he yield o mauriy i mus saisfy: $100 A) i =. $1000 $100 B) i =. $900 $100 C) $900 =. 1+ i $1000 D) $900 =. 1+ i E) None of he above. 15. When a coupon bond sells for a price ha is above is face value, he yield o mauriy: A) Is always equal o he coupon rae. B) Is always greaer han he coupon rae. C) Is always less han he coupon rae. D) None of above.

5 5 16. Consider a discoun bond wih face value F and n years o mauriy ha sells for price P oday. For his bond, he yield o mauriy i mus saisfy: F A) P =. n (1 + i) P B) F =. n (1 + i) F P C) P =. n (1 + i) P F D) F =. n (1 + i) E) None of he above. 17. For a coupon bond, he curren yield provides a beer approximaion o he yield o mauriy when: A) The bond price is closer o face value. B) The bond s mauriy is shorer. C) Boh (A) and (B) above. D) None of he above. 18. For a discoun bond, he yield on a discoun basis: A) Is always equal o he yield o mauriy. B) Is always greaer han he yield o mauriy. C) Is always less han he yield o mauriy. D) May be greaer han, equal o, or less han he yield o mauriy, depending on wheher he bond is selling for a price ha is above or below face value. E) None of he above.

6 6 Quesions refer o Figure 1, below: In his figure, he y-axis (verical axis) keeps rack of he price P of a one-year discoun bond wih $1000 face value. Noe ha he bond price rises as we move up he y-axis. The x-axis (horizonal axis) keeps rack of he quaniy of bonds demanded and supplied, wih he quaniy of bonds increasing as we move o he righ along he x-axis. 19. In figure 1, he upward-sloping line represens he: A) Demand curve for bonds. B) Supply curve for bonds. 20. In figure 1, when P = $950: A) The demand for bonds exceeds he supply of bonds, hence he bond price P mus fall. B) The demand for bonds exceeds he supply of bonds, hence he bond price P mus rise. C) The supply of bonds exceeds he demand for bonds, hence he bond price P mus fall. D) The supply of bonds exceeds he demand for bonds, hence he bond price P mus rise. E) None of he above. 21. In figure 1, he equilibrium price of bonds is: A) $950. B) $900. C) $850. D) $800. E) $750.

7 7 Quesions 22 and 23 refer o figure 2, below: In his figure, he y-axis (verical axis) keeps rack of he yield o mauriy i on a one-year discoun bond wih $1000 face value. Noe ha he ineres rae rises as we move up he y-axis. The x-axis (horizonal axis) keeps rack of he quaniy of loanable funds demanded and supplied, wih he quaniy of loanable funds increasing as we move o he righ along he x-axis. 22. In figure 2, he downward-sloping line represens he: A) Demand curve for loanable funds. B) Supply curve for loanable funds. 23. In figure 2, when i = 5.3%: A) The demand for loanable funds exceeds he supply of loanable funds, hence he ineres rae i mus fall. B) The demand for loanable funds exceeds he supply of loanable funds, hence he ineres rae i mus rise. C) The supply of loanable funds exceeds he demand for loanable funds, hence he ineres rae i mus fall. D) The supply of loanable funds exceeds he demand for loanable funds, hence he ineres rae i mus rise.

8 8 24. Which of he following facors work o shif he demand curve for loanable funds? A) Changes in he liquidiy of bonds. B) Changes in he expeced profiabiliy of invesmen opporuniies. C) Changes in he relaive riskiness of bonds. D) Changes in wealh. E) All hree facors, (A), (B), and (C), lised above. F) All hree facors, (A), (C), and (D), lised above. 25. According o he loanable funds framework, when bonds become more liquid, he ineres rae: A) Rises. B) Falls. C) May eiher rise or fall, depending on he relaive magniude of he shifs in he supply of and demand for loanable funds. 26. According o he loanable funds framework, when invesmen opporuniies become more profiable, he ineres rae: A) Rises. B) Falls. C) May eiher rise or fall, depending on he relaive magniude of he shifs in he supply of and demand for loanable funds. 27. In he acual US economy before 1940, he ineres rae on municipal bonds was above he ineres rae on US governmen bonds. This fac can be explained by A) Defaul risk. B) Liquidiy consideraions. C) Income ax consideraions. D) Boh (A) and (B) above. 28. Consider wo corporae bonds wih he same erm o mauriy: one is raed Aaa by Moody s and he oher is raed Baa by Moody s. Based on consideraions of defaul risk, which one should have he smaller risk premium, relaive o a US Treasury bond wih he same erm o mauriy? A) The Aaa corporae bond. B) The Baa corporae bond.

9 9 29. The expecaions hypohesis assumes ha: A) Invesors regard bonds of differen mauriies as perfec subsiues. B) Invesors regard bonds of differen mauriies as no subsiues a all. C) Invesors regard bonds of differen mauriies as subsiues, bu no perfec subsiues. 30. Preferred habia heory assumes ha: A) Invesors regard bonds of differen mauriies as perfec subsiues. B) Invesors regard bonds of differen mauriies as no subsiues a all. C) Invesors regard bonds of differen mauriies as subsiues, bu no perfec subsiues. 31. The expecaions hypohesis can explain: A) Why ineres raes on bonds of differen mauriies end o move ogeher over ime. B) Why he yield curve someimes slopes up and someimes slopes down. C) Why mos of he ime he yield curve slopes up. D) Boh (A) and (B) above. E) Boh (A) and (C) above. F) Boh (B) and (C) above. 32. Preferred habia heory can explain: A) Why ineres raes on bonds of differen mauriies end o move ogeher over ime. B) Why he yield curve someimes slopes up and someimes slopes down. C) Why mos of he ime he yield curve slopes up. D) Boh (A) and (B) above. E) Boh (A) and (C) above. F) Boh (B) and (C) above. G) All hree, (A), (B), and (C), above. 33. Segmened markes heory implies ha: A) The ineres rae on a long-erm bond equals he average of he shor-erm ineres raes ha are expeced o prevail over he lifeime of ha long-erm bond. B) The ineres rae on a long-erm bond equals he average of he shor-erm ineres raes ha are expeced o prevail over he lifeime of ha long-erm bond, plus an addiional liquidiy or erm premium. C) The ineres rae on a long-erm bond is deermined in he marke for long-erm bonds, wih no effecs from changes in ineres raes on shor-erm bonds.

10 Preferred habia heory implies ha: A) The ineres rae on a long-erm bond equals he average of he shor-erm ineres raes ha are expeced o prevail over he lifeime of ha long-erm bond. B) The ineres rae on a long-erm bond equals he average of he shor-erm ineres raes ha are expeced o prevail over he lifeime of ha long-erm bond, plus an addiional liquidiy or erm premium. C) The ineres rae on a long-erm bond is deermined in he marke for long-erm bonds, wih no effecs from changes in ineres raes on shor-erm bonds. 35. Consider he following wo invesmen sraegies. Sraegy 1: buy a share of sock oday (a ime ) ha pays a sream of dividends D +1, D +2, D +3, in fuure years +1, +2, +3, ou ino he possibly infinie fuure. Sraegy 2: buy a porfolio of discoun bonds oday (a ime ) ha includes a one-year discoun bond wih face value D +1, a wo-year discoun bond wih face value D +2, a hree-year discoun bond wih face value D +3, and so on ou ino he possibly infinie fuure. Le P denoe oday s price of he share of sock. In addiion, le Q 1 denoe oday s price of he one-year discoun bond, le Q 2 denoe oday s price of he wo-year discoun bond, le Q 3 denoe oday s price of he hree-year discoun bond, and so on ou ino he possibly infinie fuure. Finally, le i 1 denoe he yield o mauriy on he one-year bond, le i 2 denoe he yield o mauriy on he wo-year bond, le i 3 denoe he yield o mauriy on he hree-year bond, and so on ou ino he possibly infinie fuure. Then, if he sock and he bonds are equally risky, heir prices mus be relaed according o: A) P = Q1 + Q2 + Q B) P = i1 + i2 + i C) P = D D+ 2 + D Q1 Q2 Q3 D) P = i1 (1 + i2 ) (1 + i3 ) E) None of he above. 36. Using he same noaion as in quesion 35 above, which of he following equaions bes summarizes he dividend valuaion model? A) P = i1 + i2 + i B) P = D D+ 2 + D Q1 Q2 Q3 C) P = i1 (1 + i2 ) (1 + i3 ) D) P = D+ 1 ( 1+ i1 ) + D + 2 (1 + i2 ) + D+ 3 (1 + i3 ) +... E) None of he above.

11 The dividend valuaion model implies ha all else equal, a sock ha is expeced o pay smaller dividends in he fuure ough o have a: A) Higher price oday. B) Lower price oday. 38. In he Gordon growh model, he fuure dividends paid by a share of sock are assumed o grow a he consan rae g. If D denoes he dividend paid by he share of sock his year, and if D +1 denoes he dividend paid by he share of shock years from now, his assumpion implies ha A) D = ( 1+ g) D+. B) D + = ( 1+ g) D. C) D = ( 1+ g) (1 + D+ ). D) D = 1+ g) (1 + D ). + ( 39. According o he Gordon growh model, a share of sock wih fuure dividends ha are expeced o grow a a faser rae ough o have: A) A higher price oday. B) A lower price oday. 40. According o he Gordon growh model, when he required reurn on equiy k is larger, he sock should: A) Sell for a higher price oday. B) Sell for a lower price oday.

12 Le P denoe he price of he sock oday (a ime ), le D denoe he dividend paid by he sock his pas year, le g denoe he assumed consan growh rae of fuure dividends, and le k denoe he assumed consan required reurn on equiy. Then which of he following equaions summarizes he Gordon growh model? 1+ g A) P = D. k g 1+ g B) D = P. k g 1+ g C) P = D. k + g 1+ g D) P = D. 1+ k E) None of he above. 42. The Gordon growh model assumes ha: A) The fuure dividends paid by a sock will grow a a consan rae. B) The ineres raes used o discoun he fuure dividends are consan. C) The growh rae of dividends mus be larger han he required reurn on equiy. D) Boh (A) and (B) above. E) All hree, (A), (B), and (C), above. 43. A bank s checkable deposis ha do no pay ineres are called is: A) Demand deposis. B) NOW (Negoiable Order of Wihdrawal) accouns. C) MMDA s (Money Marke Deposi Accouns). D) Savings accouns. E) Boh (A) and (B) above. F) All hree, (A), (B), and (C), above. G) All four, (A), (B), (C), and (D), above.

13 A bank s nonransacions deposis include is: A) Savings accouns. B) Small (under $100,000) ime deposis (CD s). C) Large (over $100,000) ime deposis (CD s). D) MMDA s (Money Marke Deposi Accouns). E) Boh (A) and (B) above. F) All hree, (A), (B), and (C), above. G) All four, (A), (B), (C), and (D), above. 45. Discoun loans are included on he: A) Liabiliy side of a bank s balance shee. B) Asse side of a bank s balance shee. 46. Suppose ha Flee Bank borrows $100 million from Ciibank in he Federal Funds marke. Then his inerbank loan is: A) A liabiliy for Flee and a liabiliy for Ciibank. B) A liabiliy for Flee and an asse for Ciibank. C) An asse for Flee and a liabiliy for Ciibank. D) An asse for Flee and an asse for Ciibank. 47. Banks earn profis when: A) The ineres rae on heir asses exceeds he ineres rae on heir liabiliies. B) The ineres rae on heir liabiliies exceeds he ineres rae on heir asses. 48. The securiies lised on a bank s balance shee can include: A) US Treasury bills, noes, and bonds. B) US Governmen Agency bonds. C) Sae and Local Governmen bonds. D) Boh (A) and (B) above. E) All hree, (A), (B), and (C), above. 49. Whenever a bank gains an addiional $100 in deposis i: A) Loses an addiional $100 in reserves. B) Gains an addiional $100 in reserves.

14 Consider an example in which Flee Bank iniially holds no excess reserves and experiences a deposi ouflow. To cope wih his deposi ouflow, Flee s opions include: A) Borrowing funds from anoher bank. B) Selling securiies. C) Reducing is loans. D) Boh (A) and (B) above. E) All hree, (A), (B), and (C), above.