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C H A P T E R12R I S K/R E T U R N A N D A S S E T P R I C I N G M O D E L S PORTFOLIO THEORYPortfolio theory proceeds from the axiom that investors seek to maximize returns given some risk level they are willing to accept. Portfolios that maximize the expected return from an investment subject to a given level of risk are said to be efficient. From among efficient portfolios, the one which risk-averse investors prefer, is said to be an optimal portfolio. To construct an efficient portfolio, it is necessary to understand what is meant by expected return and risk.Investment ReturnThe return on an investment portfolio during a given interval of time is equal to the change in value of the portfolio plus any distributions received from the assets in the portfolio. These returns are expressed as a fraction of the initial portfolio value.R = (V1– V0 + D) / V0where V1 = portfolio value at the end of intervalV0 = portfolio value at the beginning of intervalD = cash distribution during intervalFor purposes of comparison, returns are expressed per unit of time, usually a year. If several years of units are included in the time horizon, then the return can be computed by averaging the return over the several unit intervals. There are three averaging methods in use: (1) the arithmetic average return (simple average of total return divided by number of time units), (2) time-weighted rate of return (also referred to as the geometric average), (3) dollar weighted return. One measure of risk is the extent to which future portfolio values are likely to diverge from the expected value.Portfolio RiskPortfolio risk can be measured in terms of the dispersion of returns about the expected value or mean return. The variance of return is a weighted sum of the squared deviations from the expected return. The standard deviation is the square root of the variance.Expected Portfolio ReturnA particularly useful way to quantify the uncertainty about the portfolio return is to specify the probability associated with each of the possible future returns and calculate the expected value of the portfolio return. The expected value is the weighted average of the possible outcomes, where the weights are the relative chances of occurrence. The expected return on the portfolio isexpressed as:E(R) = P1 R1 + P2 R2 + . . . + P N R NProbability distributions can take various shapes. For a symmetrical distribution, the dispersion of returns on one side of the expected return is the same as the dispersion on the other side of the expected return. The risk of a portfolio is measured by the variance and standard deviation of returns.DiversificationDiversification results from combining securities whose returns are less than perfectly correlated in order to reduce portfolio risk. It smoothes out the variation of returns and reduces the variability. Much of the total risk is diversifiable. But not all risks can be eliminated via diversification. Unsystematic risk (that which relates uniquely to the security or issuing firm) can be substantially reduced with a large, well-diversified portfolio. Still some risks remain which affect all firms to some degree (e.g. business cycles and interest rate changes). This is the market or systematic risk.Mathematically, a security’s return is compos ed of: R =βrm + e where, beta is a market sensitivity index, indicating how sensitive the security return is to changes in the market level. The unsystematic return is independent of the market return and is represented by the epsilon e. The systematic risk of a security is equal to β times the standard deviation of the market return. The unsystematic risk equals the standard deviation of the residual return factor. Portfolio systematic risk is equal to the portfolio beta factor times the risk of the market index. The portfolio beta factor is simply the average of the individual security betas, weighted by the proportion of each security in the portfolio.The Risk of Individual SecuritiesThe systematic risk of an individual security is that portion of its total risk that cannot be eliminated by combining it with other securities in a well diversified portfolio. Thus, we have: Security Return = Systematic Return + Unsystematic ReturnThe security return may be expressed as:R = β R M + ε where ε is unsystematic returnThe security return model is usually written in such a way that the average value of the unsystematic return is zero. This is accomplished by adding a factor alphaαto the model to represent the average value of the unsystematic returns over time.R = α + β R M + ε where ε is unsystematic returnThis model for security returns is referred to as the market model.Estimating BetaBeta can be estimated by regressing returns of a security on the returns of a market portfolio. Since historical data are employed the beta computed will vary with the time period used, number of observations, and market index employed. Thus a question may be raised about the stability of beta over time.THE CAPITAL ASSET PRICING MODELThe capital asset pricing model (CAPM) asserts that the expected return on a portfolio should exceed the risk-less rate of return by an amount that is proportional to the portfolio beta. The relationship between expected return and risk should be linear.Underlying AssumptionsThe model contains several critical assumptions: (1) investors are risk-averse; (2) investors have common time horizon; (3) investors have homogeneous expectations; (4) perfect markets exist, with no transactions costs and borrowing rates are equal to lending rates.Tests of the CAPMOne major difficulty in testing the CAPM is that the model is stated in terms of investor expectations and not in terms of required returns. Yet a number of tests have been tried, the results suggesting that there is indeed a linear risk/return relationship. More noted is Roll’s critique which states while the CAPM is testable in principle, no correct test of the theory has yet been presented. There is only one potentially testable hypothesis, namely that the true market portfolio is mean-variance efficient. Because the true market portfolio must contain all worldwide assets, the value of most of which cannot be observed, the hypothesis is in all probability untestable.THE MULTIFACTOR CAPMThe CAPM assumes the only risk is uncertainty about future market prices. But Robert Merton suggests that there exist extra-market sources of risk of concern to investors as well, such as future income, inflation, future investment opportunities. These risks affect ability to consume goods and to invest in securities in the future. Thus Merton has developed a “multifactor CAPM” to incorporate these extra-market risks in the model. In essence a security’s return has a Beta sensitivity to several factors. What these precise factors are and how many, however, has not been established. Thus this model is even harder to test than the straight CAPM.ARBITRAGE PRICING THEORY MODELDeveloped by Stephen Ross, the arbitrage pricing model (APT) assumes that there are several factors that determine the rate of return on a security, not just one as in the case of the CAPM. Rather, a security’s return is linearly related to “H” factors, but what they are is not specified. It is like the multifactor CAPM but distinguished from it in that it does not require a market index or standard deviation of returns.Empirical EvidenceEmpirical work suggests the following four plausible factors:1. unanticipated changes in industrial production;2. unanticipated changes in the spread between the yield on low grade and high grade bonds;3. unanticipated changes in interest rates and the shape of the yield curve;4. unanticipated changes in inflation.ATTACKS ON THE THEORYPortfolio theory is a normative theory. It describes how investors should behave. However, a number of positive theories have challenged portfolio theory by showing disparities between how investors should behave and how they actually behave.Asset Return Distribution and Risk MeasuresThere is empirical evidence to suggest that the probability distribution of returns is not normal, but is skewed. This means that between periods when the market exhibits relatively modest changes in returns, there will be periods when there are changes that are much higher (i.e., crashes and bubbles) than the normal distribution predicts.Assault by the Behavioral Finance Theory CampBehavioral finance looks at how psychology affects investor decisions and the implications not only for portfolio theory but also asset pricing theory and market efficiency. There are three themes in the behavioral finance literature: (1) investors err in making investment decisions because they rely on rules of thumb, (2) investors are influenced by form as well as substance in making investment decisions, (3) prices in the financial market are affected by errors and decision frames.The first theme involves heuristics, a term meaning a rule of thumb strategy to follow in order to shorten the time it takes to make a decision. There are circumstances where heuristics can workfairly well. But it can also lead to cognitive biases, or heuristic-driven biases.The second theme involves the concept of framing, meaning the way in which a situation or choice is presented to an investor can drive results. For example, investors often fail to treat the value of their stock portfolio at market value. Instead, they have a “mental account” where they continue to market the value of each stock in their portfolio at the purchase price despite the change in the market value.The third them of behavioral finance involves how errors caused by heuristics and framing dependence affect the pricing of assets.ANSWERS TO QUESTIONS FOR CHAPTER 12(Questions are in bold print followed by answers.)1. A friend has asked you to help him figure out a statement he received from his broker. It seems that, at the start of last year, your friend paid $900 for a bond, and sold it at the end of the year for $890. During the year, he received a single coupon payment of $110. The statement claims that his return (not including commissions and taxes) is 11.11% for the year. Is this claim correct?Returns can be measured by taking all the cash flows (interest payments and capital gains) and dividing by the cost of the security. The formula is:R=(I+P1-P0)/P0=$110+$890-$900/$900=11.11%,so the statement is correct.2. Suppose the probability distribution for the one-period return of some asset is as follows:Return Probability0.20 0.100.15 0.200.10 0.300.03 0.25-0.06 0.15a. W hat is this asset’s expected one-period return?b. What is this asset’s variance and standard deviation for the one-period return?a.The expected return for the asset is:(0.20) (0.10) + (0.15) (0.20) + (0.10) (0.30) + (0.03) (0.25) + (-0.06) (0.15) = 7.85%b.The asset’s return variance is:(0.10) [0.20-0.0785]2+(0.20) [0.15-0.0785]2+(0.30) [0.10-0.0785]2+(0.25) [0.03-0.0785]2+(0.15) [(-0.06) -0.0785] 2=0.006102.The square root of the variance is the standard deviation. Hence, the standard deviation is 0.07812.3. “A portfolio’s expected return and variance of return are simply the weighted average of the expected return and variance of the individual assets.” Do you agree with this statement?This statement is only partially correct. A portfolio’s expe cted return is a weighted average of the expected return of the assets comprising the portfolio. But the portfolio variance is not because it also depends on the correlation (covariance) of the asset returns.4. In the January 25, 1991, issue of The Value Line Investment Survey, you note the following:Company Beta (β)IBM 0.95Bally Manufacturing 1.40Cigna Corporation 1.00British Telecom 0.60a.How do you interpret these betas?b.Is it reasonable to assume that the expected return on British Telecom is less thanthat on IBM shares?c.“Given that Cigna Corporation has a β of 1.00, one can mimic the performance ofthe stock market as a whole by buying only these shares.” Do you agree with thisstatement?a.These figures represent the systematic risk of these stocks; how the stock’s return shouldmove relative to a market index return.b.According to the CAPM, the higher the beta, the greater the expected return. So, accordingtot he reported values for beta, the expected return for British Telecom is less than for IBM.c.This statement is not true. Investing in only these shares will still expose the investor to muchunsystematic risk, which can only be diversified away by investing in a portfolio of different securities.5. Assume the following:Expected market return = 15%Risk-free rate = 5.7%If a security’s beta is 1.3, what is its expected return according to the CAPM?The expected return is:.07+1.3 (.15-.07) =.174=17.4%, (assume risk free rate =7%).6. Professor Harry Markowitz, corecipient of the 1990 Nobel Prize in Economics, wrote the following:A portfolio with sixty different railway securities, for example, wouldnot be as well diversified as the same size portfolio with some railroad,some public utility, mining, various sorts of manufacturing, etc.Why is this true?This is true because railway securities are likely to be highly correlated with each other, whereas a well-diversified portfolio of issues from different industries leads to elimination of unsystematic risk.7. Following is an excerpt from an article, “Risk and Reward,” in The Economist of October 20, 1990:Next question: is the CAPM supported by the facts? That iscontroversial, to put it mildly. It is a tribute to Mr. Sharpe [cowinnerof the 1990 Nobel Prize in Economics] that his work, which dates fromthe early 1960s, is still argued over so heatedly. Attention has latelyturned away from beta to more complicated ways of carving up risk.But the significance of CAPM for financial economics would be hardto exaggerate.a.Summarize Roll’s argument on the problems inherent in empirically verifying theCAPM.b.What are some of the other “more complicated ways of carving up risk”?a.Roll argues that while the CAPM is testable in principle, no correct test of the theory has yetbeen presented. He also argues that there is practically no possibility that a correct test will be done because there is only one potentially testable hypothesis associated with the CAPM, namely that the true market portfolio is mean-variance efficient. Since this portfolio must contain all worldwide assets, the value of most of which cannot be observed, the hypothesis is probably untestable.b.CAPM assumes investors are only concerned with one risk -- the future prices of their assets.Merton asserts that there are other investor concerns, such as the ability to consume goods and services in the future. He has tried to incorporate more than one risk factor in his model.8.a.What are the difficulties in practice of applying the arbitrage pricing theory model?b.Does Roll’s criticism also apply to this pricing model?c.“In the CAPM investors should be compensated for accepting systematic risk: forthe APT model, investors are rewarded for accepting both systematic risk andunsystematic risk.” Do you agree with this statement?a.The difficulty lies in identifying the systematic factors.b.Roll’s criticism does not apply to the APT model because that model does not rely on a truemarket index.c.This statement is true for the CAPM, but not for the APT model. The latter also asserts thatinvestors should be compensated only for accepting systematic risk. But unlike the CAPM, there is more than one systematic risk.9.a.What does it mean that a return distribution has a fat tail?b.What is the implication if a return distribution is assumed to be normallydistributed but is in fact a fat-tailed distribution?a.Probability distributions are not normal, but are instead skewed. The tails of the distributionare more likely than predicted by a normal probability distribution.b.The implication is that between periods when the market exhibits relatively modest changesin returns, there will be periods when there are changes that are much higher (i.e., crashes and bubbles) than the normal distribution predicts.10. How does the behavioral finance approach differ from the standard finance theory approach?Standard financial theory assumes investors are rational utility maximizers. Behavioral finance theory challenges this assumption. It argues that investors are systematically subject to cognitive biases and errors. They make decisions based on mental shortcuts, called heuristics, and these shortcuts are not necessarily consistent with rational wealth maximizing behavior as predicted by the standard finance theory.。
金融市场讲义1、参考书：Anthony M. Santomero& Dacid F. Babbel《金融市场、工具与结构》东北财经大学出版社（着眼于提供一个对金融市场的职能、定价和制度性结构的透析，略去宏观经济学工具的同时，给出了不同金融工具的定价方法，以及市场中运做的工具与机构间的差别）2、Peter S.Mishkin《货币与资本市场》机械工业出版社（货币与资本市场课程，热中于对机构和金融工具的描述）3、Frederic S Mishkin《货币金融学》中国人民大学出版社（货币和银行业课程，从货币在社会的作用入手，到金融市场的宏观经济学意义。
对金融工具并不注重，也不对金融市场与机构的结构进行任何细节的分析。
）第一部分金融体系的结构与作用第一章概论基本概念：金融工具：标明交易双方权利、义务关系的书面凭证。
包括股票、债券和存单等。
金融机构：根据借贷双方的要求创造和交易金融工具的机构。
指从社会聚集资金,然后投资于各种股票,债券货币市场工具,银行存款等金融资产或发放贷款的机构.金融市场:指经济生活中用来进行资本和信贷资金交易的场所,即金融工具进行交易的场所和机构.一、金融体系的作用金融体系对现代经济的作用：1、为交易提供了支付手段交换的两方面：实物的过程与金融的过程，伴随交换的发展，金融的形式日益复杂。
有实际资产和金融资产的划分。
对金融资产的划分。
对金融资产的购买称之为金融投资----因为放弃了当前消费（产出）而获得的对经济其他部分的未来消费（产出）的书面所有权。
2、储蓄－投资的转化金融体系为储蓄－投资的转化提供了一个桥梁的作用金融体系在整个经济中储蓄－投资到转化的过程金融体系与个人、企业的活动密切相关金融体系为整个经济的盈余提供渠道并通过企业投资使资金增值。
二、储蓄、投资与金融市场储蓄在经济学上是一种延迟的消费是为了未来的不确定性而进行的储蓄储蓄取决与消费者的投资决策投资是指获得新生的生产设备、建筑和库存，即实际资产的购买投资决策取决于预期收益储蓄、投资与金融市场的联系：储蓄和投资在本质上与金融无关。
金融市场与金融机构中文答案【篇一：fabozzi_金融市场与金融机构基础课后答案】the u.s. federal reserveand the creation of moneycentral banks and their purposethe primary role of a central bank is to maintain the stability of the currency and money supply for a country or a group of countries. the role of central banks can be categorized as: (1) risk assessment, (2) risk reduction, (3) oversight of payment systems, (4) crisis management.one of the major ways a central bank accomplishes its goals is through monetary policy. for this reason, central banks are sometimes called monetary authority. in implementing monetary policy, central banks, acting as a reserve bank, require private banks to maintain and deposit the required reserves with the central bank. in times of financial crisis, central banks perform the role of lender of last resort for the banking system. countries throughout the world may have central banks. additionally, the european central bank is responsible for implementing monetary policy for the member countries of the european union.in implementing monetary and economic policies, the united states is a member of an informal network of nations. this group started in 1976 as the group of 6, or g6: us, france, germany, uk, italy, and japan. thereafter, canada joined to for the g7. in 1998, russia joined to form the g8.the central bank of the united states: the federal reserve systemthe federal reserve system consists of 12 banking districts covering the entire country. created in 1913, the federal reserve is the government agency responsible for the management of the us monetary and banking systems. it is independent of the political branches of government. the fed is managed by a seven-member board of governors, who are appointed by the president and approved by congress.the fed’s tools for monetary management have been made more difficult by financial innovations. the public’s increasing acceptance of money market mutual funds has funneled alarge amount of money into what are essentially interest-bearing checking accounts. securitization permits commercial banks to change what once were illiquid consumer loans of several varieties into securities. selling these securities gives the banks a source of funding that is outside the fed’s influence.instrument of monetary policy: how the fed influences the supply of moneythe fed has three instruments at its disposal to affect the level of reserves.under our fractional reserve banking system have to maintain specified fractional amounts of reserves against their deposits. the fed can raise or lower these required reserve ratios, thereby permitting banks to decrease or increase their lending and investment portfolios. a bank’s total reserves equal its required reserves plus any excess reserves.the fed’s most powerful instrument is its authority to conduct open market operation. it buys and sells in open debt markets government securities for its own accounts. the fed prefers to use treasury bills because it can make its substantial transactions without seriously disrupting the prices or yields of bills.the federal open market committee, or fomc, is the unit that decides on the general issues of changing the rate of growth in the money supply, by open market sales or purchases of securities. the implementation of policy through open market operations is the responsibility of the trading desk of the federal reserve bank of new york.the fed often employs variants of simple open market purchases and sales, these are called the repurchase agreement (or repo) and the reverse repo. in a repo, the fed buys a particular amount of securities from a seller that agrees to repurchase the same number of securities for a higher price at some future time. in a reverse repo, the fed sells securities and makes a commitment to buy them back at a higher price later.a bank borrowing from the fed is said to use the discount window. the discount rate is the rate charged to banks borrowing directly from the fed. raising the rate is designed todiscourage such borrowing, while lowering should have the opposite effect.different kinds of moneymoney is that item which serves as a numeraire. in a basic sense money can be defined as anything that serves as a unit of account and medium of exchange. we measure prices in dollars and exchange dollars for goods. hence coins, currency, and any items readily exchanged into dollars (checking deposits or now accounts) constitute our money supply.money and monetary aggregatesmonetary aggregates measure the amount of money available to the economy at any time. the monetary base is defined as currency in circulation (coins and federal reserve notes) and reserves in the banking system. the instruments that serve as a medium of exchange can be narrowly defined as m1, which is currency and demand deposits. m2 is m1 plus time and savings accounts, and money market mutual funds. finally, m3 is m2 plus short-term treasury liabilities. while all three aggregates are watched and monitored, m1 is the most common form of the money supply, with its trait as being the most liquid. the ratio of the money supply to the economy’s income is known as the velocity of money.the money multipier: the expansion of the money supplythe money multiplier effect arises from the fact that a small change in reserves can produce a large change in the money supply. through our fractional reserve system, a small increase will allow an individual bank, to lend out the greater part of these additional funds. these loans subsequently become deposits in other banks allowing them to expand proportionately. so, while one bank can expand its loans (or deposits) by an amount 1% of reserves required, all banks in the system can do likewise. thus, in a simple format total change in deposits can be stated as change in reserves divided by the reserve requirement, which is also the formula for perpetuity. for example, if the change in the level of reserves is $100 and the reserve requirement is 20%, the change in total deposits will be $500 for a multiplier of 5. of course, major assumptions are that banks will fully loan out their excess reserves and that depositors will not withdraw any of these extra reserves.the impact of interest rates on the money supplyhigh rates of interest may make keeping excess reserves costly, since unused funds represent loans not made and interest not earned. high rates of interest will also affect the public’s demand for hol ding cash. if deposits pay competitive interest rates, customers will be more willing to hold such bank liabilities and less cash. therefore, a higher rate of interest can actually spur growth of the money supply. more likely, however, it will deter borrowing and slow monetary growth.the money supply process in an open economyin the modern era, almost every country has an open economy. foreign commercial and central banks hold dollar accounts in the united states. their purchases and sales of these deposits can affect exchange rates of the dollar against their own currency. the fed has responsibility for maintaining stability in exchange rates. a purchase of foreign exchange with dollars depreciates the dollar’s value, but it also adds dollars to the accounts of foreign banks in this country, thus adding to the u.s. monetary base. most central banks of large economies own or stand ready to own a large amount of each of the world’s major currencies, which are considered international reserves. sales of foreign exchange transactions have monetary base implication and hence consequences for the domestic money supply, emphasis is given to coordinating monetarypolicies among developed nations.answers to questions for chapter 4(questions are in bold print followed by answers.)1. what is the role of a central bank?the role of a central bank has several functions: risk assessment, risk reduction, oversight of payment systems, and crisis management. it can do this through monetary policies, and through the implementation of regulations.2. why is it argued that a central bank should be independent of the government?central banks should be independent of the short-term political interests and political influences generally in setting economic policies.3. identify each participant and its role in the process bywhich the money supply changes and monetary policy is implemented.the fed determines monetary policy and seeks to implement it through changes in reserves. it is up to the nation’s banking system to act on changes in reserves thereby affecting deposits, which constitute the greater part of the m1 definitionof the money supply.4. describe the structure of the board of governors of the federal reserve system.the board of governors of the federal reserve system consistsof 7 members who are appointed to staggered 14-year terms.the board reviews discount operations and sets legal reserve requirements. in addition, all 7 members of the board serve on the federal open market committee (fomc), which determinesthe direction and magnitude of open-market operations. such operations constitute the key instrument for implementing monetary policy.5.a. explain what is meant by the statement “the united stateshas a fractional reserve banking system.”b. how are these items related: total reserves, required reserves, and excess reserves?a. a fractional reserve system requires that a fraction orpercent of a bank’s reserve be placed either in currency invault or with the federal reserve system.b. total reserves are the amounts that banks hold in cash or at the fed. required reserves are amounts required by the fed to meet some specific or legal reserve ratio to deposits. excess reserves are bank reserves in currency and at the fed whichare in excess of legal requirements. since these amounts arenon-interest bearing, banks are often willing to lend these surplus funds to deficit banks at the fed funds rate.【篇二：金融市场与金融机构基础(第9章) 英文版答案】ter 9(questions are in bold print followed by answers.)1. your broker is recommending that you purchase u.s. government bonds. here is the explanation: listen, in thesetimes of uncertainty, with many companies going bankrupt, itmakes sense to play it safe and purchase long-term government bonds. they are issued by the u.s. government, so they are risk free. how would you respond to the broker?u.s. government bonds may be free of default risk, but they are not free from interest rate risk, which may cause the bond price to decline, resulting in a capital loss should the holder of bond sell it before maturity. even then there is the inflation premium risk, which means that the principal may have less purchasing power at maturity than it does today.2. you just inherited 30,000 shares of a company you have never heard of, abd corporation. you call your broker to find out if you have finally struck it rich. afterseveral minutes, she comes back on the telephone and says: “i don’t have a clue about these shares. it’s too bad they are not traded in a financial market. that would make life a lot easier for you. ”what does she mean by this?if the shares are traded on the market, and if the market is efficient, the current price would denote the value of the stock. without market price information, share value would have to be approximated through other time-consuming and less reliable methods.3. suppose you own a bond that pays $75 yearly in coupon interest and that is likely to be called in two years (because the firm has already announced that it will redeem the issue early). the call price will be $1,050.what is the price of your bond now, in the market, if the appropriate discount rate for this asset is 9%?po = $75 (pvifa) 2.09 + $1050 (pvif) 2.09= $75 x 1.7591 + $1050 x .8417 = $1015.724. your broker has advised you to buy shares of hungry boy fast foods, which has paid a dividend of $1.00 per year for 10 years and will (according to the broker) continue to do so for many years. the broker believes that the stock, which now has a price of $12, will be worth $25 per share in five years. you have good reason to think that the discount rate for this firm’s stock is 22% per year, because that rate compensates the buyer for all pertinent risks. is the stock’s present price a good approximation of its true financial value?po = $1 (pvifa) 5.22 + $25 x (pvif) 5.22 = .3715 = $12.15the price is right, in fact the stock is slightly undervalued.5. you have been considering a zero-coupon bond, which pays no interest but will pay a principal of $1,000 at the end of five years. the price of the bond is now $712.99, and its required rate of return is 7.0%. this morning’s news contained a surprising development. the government announced that the rate of inflation appears to be 5.5% instead of the 4% that most people had been expecting. (suppose most people had thought the real rate of interest was 3%.) what would be the price of the bond, once the market began to absorb this new information about inflation?the nominal required rate of return is (real rate plus inflation) ir + if or currently 3% plus 4% = 7%. if if becomes 5.5% then the new required rate of return becomes 8.5%. the price of the bond would then be $1000/(1.085)5 or $665.05.6. state the difference in basis points between each of the following:a. 5.5% and 6.5%b. 7% and 9%c. 6.4% and 7.8%d. 9.1% and 11.9%a. 100 basis pointsb. 200 basis pointsc. 140 basis pointsd. 280 basis points7.a. does a rise of 100 basis points in the discount rate change the price of a 20-year bond as much as it changes the price of a four-year bond, assuming that both bonds have the same coupon rate and offer the same yield?b. does a rise of 100 basis points in the discount rate change the price of a 4% coupon bond as much as it changes the price of a 10% coupon bond, assuming that both bonds have the same maturity and offer the same yield?c. does a rise of 100 basis points in the discount rate change the price of a 10-year bond to the same extent if the discount rate is 4% as it does if the discount rate is 12%?a. the price of the 20-year bond will fall more than that of the 4-year bond because there are more years for the new discount to apply to the cash flows of the 20-year bond.b. the price of the low coupon bond will change more due to the low amount of cash flows that can be reinvested at the higher rate.c. a change from the 4% base will lead to a larger change in price.8.during the early 1980s, interest rates for many long-term bonds were above 14%. in the early 1990s, rates on similar bonds were far lower. what do you think this dramatic decline in market interest rates means for the price volatility of bonds in response to a change in interest rates?since the direction of the interest rate change is downward, price volatility should increase.9.a. what is the cash flow of a 6% coupon bond that pays interest annually, matures in seven years, and has a principal of $1,000?b. assuming a discount rate of 8%, what is the price of this bond?c. assuming a discount rate of 8.5%, what is the price of this bond?d. assuming a discount rate of 7.5%, what is the price of this bond?e. what is the duration of this bond, assuming that the price is the one you calculated in part (b)?f. if the yield changes by 100 basis points, from 8% to 7%, by how much would you approximate the percentage price change to be using your estimate of duration in part (e)?g. what is the actual percentage price change if the yield changes by 100 basis points?a. $60 a year interest for 7 years plus $1000 principal in year 7 for a total of $1420 in cash flow.b. 5.2064 x $60 + .583 x $1000 = $895.38c. 5.119 x $60 + .565 x $1000 = $872.14d. 5.297 x $60 + .603 x $1000 = $920.82e. =$48.68/8.95=5.44$895.38 (0.85-.075)f. applying the formula-d (change in yield) = -5.44 (.01) or a price increase of 5.42%.g. price at 8% =$895.88, at 7% = $946.06, so actual percentage change is ($946.06 - $895.88)/$895.88=5.6%.10. why is it important to be able to estimate the duration of a bond or bond portfolio?to answer this question, we must understand that duration is related to percentage price change.a simple formula can be used to calculate the approximate duration of a bond or bond portfolio. all we are interested in is the percent price change of a bond when interest rates change by a small amount. to control interest rate risk, it is thus necessary to be able to measure it. duration provides that measure.11. explain why you agree or disagree with the following statement: “determining the duration of a financial asset is a simple process.”disagree. determining the duration of a financial asset is not simple process. because for most assets, the cash flow can change when interest rates change. therefore, if a change in the cash flow is not considered, duration calculations can be misleading.12. explain why the effective duration is a more appropriate measure of a complexfinancial instrument’s price sensitiv ity to interest rate changes than is modified duration.modified duration is derived with the assumption that cash flows do not change as interest rates change. effective duration is calculated with the assumption of changing cash flows. for complex finan cial instruments’ price sensitivity to interest rate changes could be very large. hence, the importance of effective duration becomes significant.【篇三：米什金《金融市场与金融机构》课后习题及其答案】class=txt>345。
C H A P T E R12R I S K/R E T U R N A N D A S S E T P R I C I N G M O D E L S PORTFOLIO THEORYPortfolio theory proceeds from the axiom that investors seek to maximize returns given some risk level they are willing to accept. Portfolios that maximize the expected return from an investment subject to a given level of risk are said to be efficient. From among efficient portfolios, the one which risk-averse investors prefer, is said to be an optimal portfolio. To construct an efficient portfolio, it is necessary to understand what is meant by expected return and risk.Investment ReturnThe return on an investment portfolio during a given interval of time is equal to the change in value of the portfolio plus any distributions received from the assets in the portfolio. These returns are expressed as a fraction of the initial portfolio value.R = (V1– V0 + D) / V0where V1 = portfolio value at the end of intervalV0 = portfolio value at the beginning of intervalD = cash distribution during intervalFor purposes of comparison, returns are expressed per unit of time, usually a year. If several years of units are included in the time horizon, then the return can be computed by averaging the return over the several unit intervals. There are three averaging methods in use: (1) the arithmetic average return (simple average of total return divided by number of time units), (2) time-weighted rate of return (also referred to as the geometric average), (3) dollar weighted return. One measure of risk is the extent to which future portfolio values are likely to diverge from the expected value.Portfolio RiskPortfolio risk can be measured in terms of the dispersion of returns about the expected value or mean return. The variance of return is a weighted sum of the squared deviations from the expected return. The standard deviation is the square root of the variance.Expected Portfolio ReturnA particularly useful way to quantify the uncertainty about the portfolio return is to specify the probability associated with each of the possible future returns and calculate the expected value of the portfolio return. The expected value is the weighted average of the possible outcomes, where the weights are the relative chances of occurrence. The expected return on the portfolio isexpressed as:E(R) = P1 R1 + P2 R2 + . . . + P N R NProbability distributions can take various shapes. For a symmetrical distribution, the dispersion of returns on one side of the expected return is the same as the dispersion on the other side of the expected return. The risk of a portfolio is measured by the variance and standard deviation of returns.DiversificationDiversification results from combining securities whose returns are less than perfectly correlated in order to reduce portfolio risk. It smoothes out the variation of returns and reduces the variability. Much of the total risk is diversifiable. But not all risks can be eliminated via diversification. Unsystematic risk (that which relates uniquely to the security or issuing firm) can be substantially reduced with a large, well-diversified portfolio. Still some risks remain which affect all firms to some degree (e.g. business cycles and interest rate changes). This is the market or systematic risk.Mathematically, a security’s return is compos ed of: R =βrm + e where, beta is a market sensitivity index, indicating how sensitive the security return is to changes in the market level. The unsystematic return is independent of the market return and is represented by the epsilon e. The systematic risk of a security is equal to β times the standard deviation of the market return. The unsystematic risk equals the standard deviation of the residual return factor. Portfolio systematic risk is equal to the portfolio beta factor times the risk of the market index. The portfolio beta factor is simply the average of the individual security betas, weighted by the proportion of each security in the portfolio.The Risk of Individual SecuritiesThe systematic risk of an individual security is that portion of its total risk that cannot be eliminated by combining it with other securities in a well diversified portfolio. Thus, we have: Security Return = Systematic Return + Unsystematic ReturnThe security return may be expressed as:R = β R M + ε where ε is unsystematic returnThe security return model is usually written in such a way that the average value of the unsystematic return is zero. This is accomplished by adding a factor alphaαto the model to represent the average value of the unsystematic returns over time.R = α + β R M + ε where ε is unsystematic returnThis model for security returns is referred to as the market model.Estimating BetaBeta can be estimated by regressing returns of a security on the returns of a market portfolio. Since historical data are employed the beta computed will vary with the time period used, number of observations, and market index employed. Thus a question may be raised about the stability of beta over time.THE CAPITAL ASSET PRICING MODELThe capital asset pricing model (CAPM) asserts that the expected return on a portfolio should exceed the risk-less rate of return by an amount that is proportional to the portfolio beta. The relationship between expected return and risk should be linear.Underlying AssumptionsThe model contains several critical assumptions: (1) investors are risk-averse; (2) investors have common time horizon; (3) investors have homogeneous expectations; (4) perfect markets exist, with no transactions costs and borrowing rates are equal to lending rates.Tests of the CAPMOne major difficulty in testing the CAPM is that the model is stated in terms of investor expectations and not in terms of required returns. Yet a number of tests have been tried, the results suggesting that there is indeed a linear risk/return relationship. More noted is Roll’s critique which states while the CAPM is testable in principle, no correct test of the theory has yet been presented. There is only one potentially testable hypothesis, namely that the true market portfolio is mean-variance efficient. Because the true market portfolio must contain all worldwide assets, the value of most of which cannot be observed, the hypothesis is in all probability untestable.THE MULTIFACTOR CAPMThe CAPM assumes the only risk is uncertainty about future market prices. But Robert Merton suggests that there exist extra-market sources of risk of concern to investors as well, such as future income, inflation, future investment opportunities. These risks affect ability to consume goods and to invest in securities in the future. Thus Merton has developed a “multifactor CAPM” to incorporate these extra-market risks in the model. In essence a security’s return has a Beta sensitivity to several factors. What these precise factors are and how many, however, has not been established. Thus this model is even harder to test than the straight CAPM.ARBITRAGE PRICING THEORY MODELDeveloped by Stephen Ross, the arbitrage pricing model (APT) assumes that there are several factors that determine the rate of return on a security, not just one as in the case of the CAPM. Rather, a security’s return is linearly related to “H” factors, but what they are is not specified. It is like the multifactor CAPM but distinguished from it in that it does not require a market index or standard deviation of returns.Empirical EvidenceEmpirical work suggests the following four plausible factors:1. unanticipated changes in industrial production;2. unanticipated changes in the spread between the yield on low grade and high grade bonds;3. unanticipated changes in interest rates and the shape of the yield curve;4. unanticipated changes in inflation.ATTACKS ON THE THEORYPortfolio theory is a normative theory. It describes how investors should behave. However, a number of positive theories have challenged portfolio theory by showing disparities between how investors should behave and how they actually behave.Asset Return Distribution and Risk MeasuresThere is empirical evidence to suggest that the probability distribution of returns is not normal, but is skewed. This means that between periods when the market exhibits relatively modest changes in returns, there will be periods when there are changes that are much higher (i.e., crashes and bubbles) than the normal distribution predicts.Assault by the Behavioral Finance Theory CampBehavioral finance looks at how psychology affects investor decisions and the implications not only for portfolio theory but also asset pricing theory and market efficiency. There are three themes in the behavioral finance literature: (1) investors err in making investment decisions because they rely on rules of thumb, (2) investors are influenced by form as well as substance in making investment decisions, (3) prices in the financial market are affected by errors and decision frames.The first theme involves heuristics, a term meaning a rule of thumb strategy to follow in order to shorten the time it takes to make a decision. There are circumstances where heuristics can workfairly well. But it can also lead to cognitive biases, or heuristic-driven biases.The second theme involves the concept of framing, meaning the way in which a situation or choice is presented to an investor can drive results. For example, investors often fail to treat the value of their stock portfolio at market value. Instead, they have a “mental account” where they continue to market the value of each stock in their portfolio at the purchase price despite the change in the market value.The third them of behavioral finance involves how errors caused by heuristics and framing dependence affect the pricing of assets.ANSWERS TO QUESTIONS FOR CHAPTER 12(Questions are in bold print followed by answers.)1. A friend has asked you to help him figure out a statement he received from his broker. It seems that, at the start of last year, your friend paid $900 for a bond, and sold it at the end of the year for $890. During the year, he received a single coupon payment of $110. The statement claims that his return (not including commissions and taxes) is 11.11% for the year. Is this claim correct?Returns can be measured by taking all the cash flows (interest payments and capital gains) and dividing by the cost of the security. The formula is:R=(I+P1-P0)/P0=$110+$890-$900/$900=11.11%,so the statement is correct.2. Suppose the probability distribution for the one-period return of some asset is as follows:Return Probability0.20 0.100.15 0.200.10 0.300.03 0.25-0.06 0.15a. W hat is this asset’s expected one-period return?b. What is this asset’s variance and standard deviation for the one-period return?a.The expected return for the asset is:(0.20) (0.10) + (0.15) (0.20) + (0.10) (0.30) + (0.03) (0.25) + (-0.06) (0.15) = 7.85%b.The asset’s return variance is:(0.10) [0.20-0.0785]2+(0.20) [0.15-0.0785]2+(0.30) [0.10-0.0785]2+(0.25) [0.03-0.0785]2+(0.15) [(-0.06) -0.0785] 2=0.006102.The square root of the variance is the standard deviation. Hence, the standard deviation is 0.07812.3. “A portfolio’s expected return and variance of return are simply the weighted average of the expected return and variance of the individual assets.” Do you agree with this statement?This statement is only partially correct. A portfolio’s expe cted return is a weighted average of the expected return of the assets comprising the portfolio. But the portfolio variance is not because it also depends on the correlation (covariance) of the asset returns.4. In the January 25, 1991, issue of The Value Line Investment Survey, you note the following:Company Beta (β)IBM 0.95Bally Manufacturing 1.40Cigna Corporation 1.00British Telecom 0.60a.How do you interpret these betas?b.Is it reasonable to assume that the expected return on British Telecom is less thanthat on IBM shares?c.“Given that Cigna Corporation has a β of 1.00, one can mimic the performance ofthe stock market as a whole by buying only these shares.” Do you agree with thisstatement?a.These figures represent the systematic risk of these stocks; how the stock’s return shouldmove relative to a market index return.b.According to the CAPM, the higher the beta, the greater the expected return. So, accordingtot he reported values for beta, the expected return for British Telecom is less than for IBM.c.This statement is not true. Investing in only these shares will still expose the investor to muchunsystematic risk, which can only be diversified away by investing in a portfolio of different securities.5. Assume the following:Expected market return = 15%Risk-free rate = 5.7%If a security’s beta is 1.3, what is its expected return according to the CAPM?The expected return is:.07+1.3 (.15-.07) =.174=17.4%, (assume risk free rate =7%).6. Professor Harry Markowitz, corecipient of the 1990 Nobel Prize in Economics, wrote the following:A portfolio with sixty different railway securities, for example, wouldnot be as well diversified as the same size portfolio with some railroad,some public utility, mining, various sorts of manufacturing, etc.Why is this true?This is true because railway securities are likely to be highly correlated with each other, whereas a well-diversified portfolio of issues from different industries leads to elimination of unsystematic risk.7. Following is an excerpt from an article, “Risk and Reward,” in The Economist of October 20, 1990:Next question: is the CAPM supported by the facts? That iscontroversial, to put it mildly. It is a tribute to Mr. Sharpe [cowinnerof the 1990 Nobel Prize in Economics] that his work, which dates fromthe early 1960s, is still argued over so heatedly. Attention has latelyturned away from beta to more complicated ways of carving up risk.But the significance of CAPM for financial economics would be hardto exaggerate.a.Summarize Roll’s argument on the problems inherent in empirically verifying theCAPM.b.What are some of the other “more complicated ways of carving up risk”?a.Roll argues that while the CAPM is testable in principle, no correct test of the theory has yetbeen presented. He also argues that there is practically no possibility that a correct test will be done because there is only one potentially testable hypothesis associated with the CAPM, namely that the true market portfolio is mean-variance efficient. Since this portfolio must contain all worldwide assets, the value of most of which cannot be observed, the hypothesis is probably untestable.b.CAPM assumes investors are only concerned with one risk -- the future prices of their assets.Merton asserts that there are other investor concerns, such as the ability to consume goods and services in the future. He has tried to incorporate more than one risk factor in his model.8.a.What are the difficulties in practice of applying the arbitrage pricing theory model?b.Does Roll’s criticism also apply to this pricing model?c.“In the CAPM investors should be compensated for accepting systematic risk: forthe APT model, investors are rewarded for accepting both systematic risk andunsystematic risk.” Do you agree with this statement?a.The difficulty lies in identifying the systematic factors.b.Roll’s criticism does not apply to the APT model because that model does not rely on a truemarket index.c.This statement is true for the CAPM, but not for the APT model. The latter also asserts thatinvestors should be compensated only for accepting systematic risk. But unlike the CAPM, there is more than one systematic risk.9.a.What does it mean that a return distribution has a fat tail?b.What is the implication if a return distribution is assumed to be normallydistributed but is in fact a fat-tailed distribution?a.Probability distributions are not normal, but are instead skewed. The tails of the distributionare more likely than predicted by a normal probability distribution.b.The implication is that between periods when the market exhibits relatively modest changesin returns, there will be periods when there are changes that are much higher (i.e., crashes and bubbles) than the normal distribution predicts.10. How does the behavioral finance approach differ from the standard finance theory approach?Standard financial theory assumes investors are rational utility maximizers. Behavioral finance theory challenges this assumption. It argues that investors are systematically subject to cognitive biases and errors. They make decisions based on mental shortcuts, called heuristics, and these shortcuts are not necessarily consistent with rational wealth maximizing behavior as predicted by the standard finance theory.。
CHAPTER 4THE U.S. FEDERAL RESERVEAND THE CREATION OF MONEYCENTRAL BANKS AND THEIR PURPOSEThe primary role of a central bank is to maintain the stability of the currency and money supply for a country or a group of countries. The role of central banks can be categorized as: (1) risk assessment, (2) risk reduction, (3) oversight of payment systems, (4) crisis management.One of the major ways a central bank accomplishes its goals is through monetary policy. For this reason, central banks are sometimes called monetary authority. In implementing monetary policy, central banks, acting as a reserve bank, require private banks to maintain and deposit the required reserves with the central bank. In times of financial crisis, central banks perform the role of lender of last resort for the banking system. Countries throughout the world may have central banks. Additionally, the European Central Bank is responsible for implementing monetary policy for the member countries of the European Union.There is widespread agreement that central banks should be independent of the government so that decisions of the central bank will not be influenced for short-term political purposes such as pursuing a monetary policy to expand the economy but at the expense of inflation.In implementing monetary and economic policies, the United States is a member of an informal network of nations. This group started in 1976 as the Group of 6, or G6: US, France, Germany, UK, Italy, and Japan. Thereafter, Canada joined to for the G7. In 1998, Russia joined to form the G8.THE CENTRAL BANK OF THE UNITED STATES: THE FEDERAL RESERVE SYSTEMThe Federal Reserve System consists of 12 banking districts covering the entire country. Created in 1913, the Federal Reserve is the government agency responsible for the management of the US monetary and banking systems. It is independent of the political branches of government. The Fed is managed by a seven-member Board of Governors, who are appointed by the President and approved by Congress.The Fed's tools for monetary management have been made more difficult by financial innovations. The public's increasing acceptance of money market mutual funds has funneled a large amount of money into what are essentially interest-bearing checking accounts. Securitization permits commercial banks to change what once were illiquid consumer loans of several varieties into securities. Selling these securities gives the banks a source of funding that is outside the Fed's influence.INSTRUMENT OF MONETARY POLICY: HOW THE FED INFLUENCES THE SUPPLY OF MONEYThe Fed has three instruments at its disposal to affect the level of reserves.Reserve RequirementsUnder our fractional reserve banking system have to maintain specified fractional amounts of reserves against their deposits. The Fed can raise or lower these required reserve ratios, thereby permitting banks to decrease or increase their lending and investment portfolios. A bank's total reserves equal its required reserves plus any excess reserves.Open Market OperationsThe Fed's most powerful instrument is its authority to conduct open market operation. It buys and sells in open debt markets government securities for its own accounts. The Fed prefers to use Treasury bills because it can make its substantial transactions without seriously disrupting the prices or yields of bills.The Federal Open Market Committee, or FOMC, is the unit that decides on the general issues of changing the rate of growth in the money supply, by open market sales or purchases of securities. The implementation of policy through open market operations is the responsibility of the trading desk of the Federal Reserve Bank of New York.Open Market Repurchase AgreementsThe Fed often employs variants of simple open market purchases and sales, these are called the repurchase agreement (or repo) and the reverse repo. In a repo, the Fed buys a particular amount of securities from a seller that agrees to repurchase the same number of securities for a higher price at some future time. In a reverse repo, the Fed sells securities and makes a commitment to buy them back at a higher price later.Discount RateA bank borrowing from the Fed is said to use the discount window. The discount rate is the rate charged to banks borrowing directly from the Fed. Raising the rate is designed to discourage such borrowing, while lowering should have the opposite effect.DIFFERENT KINDS OF MONEYMoney is that item which serves as a numeraire. In a basic sense money can be defined as anything that serves as a unit of account and medium of exchange. We measure prices in dollars and exchange dollars for goods. Hence coins, currency, and any items readily exchanged into dollars (checking deposits or NOW accounts) constitute our money supply.MONEY AND MONETARY AGGREGATESMonetary aggregates measure the amount of money available to the economy at any time. The monetary base is defined as currency in circulation (coins and federal reserve notes) and reserves in the banking system. The instruments that serve as a medium of exchange can be narrowly defined as Mi, which is currency and demand deposits. M2 is Mi plus time and savings accounts, and money market mutual funds. Finally, M3 is M? plus short-term Treasury liabilities. While all three aggregates are watched and monitored, Mi is the most common form of the money supply, with its trait as being the most liquid. The ratio of the money supply to the economy's income is known as the velocity of money.THE MONEY MULTIPIER: THE EXPANSION OF THE MONEY SUPPLYThe money multiplier effect arises from the fact that a small change in reserves can produce a large change in the money supply. Through our fractional reserve system, a small increase will allow an individual bank, to lend out the greater part of these additional funds. These loans subsequently become deposits in other banks allowing them to expand proportionately. So, while one bank can expand its loans (or deposits) by an amount 1% of reserves required, all banks in the system can do likewise. Thus, in a simple format total change in deposits can be stated as change in reserves divided by the reserve requirement, which is also the formula for perpetuity. For example, if the change in the level of reserves is $100 and the reserve requirement is 20%, the change in total deposits will be $500 for a multiplier of 5. Of course, major assumptions are that banks will fully loan out their excess reserves and that depositors will not withdraw any of these extra reserves. THE IMPACT OF INTEREST RATES ON THE MONEY SUPPLYHigh rates of interest may make keeping excess reserves costly, since unused funds represent loans not made and interest not earned. High rates of interest will also affect the public's demand for holding cash. If deposits pay competitive interest rates, customers will be more willing to hold such bank liabilities and less cash. Therefore, a higher rate of interest can actually spur growth of the money supply. More likely, however, it will deter borrowing and slow monetary growth.THE MONEY SUPPLY PROCESS IN AN OPEN ECONOMYIn the modern era, almost every country has an open economy. Foreign commercial and central banks hold dollar accounts in the United States. Their purchases and sales of these deposits can affect exchange rates of the dollar against their own currency. The Fed has responsibility for maintaining stability in exchange rates. A purchase of foreign exchange with dollars depreciates the dollar's value, but it also adds dollars to the accounts of foreign banks in this country, thus adding to the U.S. monetary base. Most central banks of large economies own or stand ready to own a large amount of each of the world's major currencies, which are considered international reserves. Sales of foreign exchange transactions have monetary base implication and hence consequences for the domestic money supply, emphasis is given to coordinating monetarypolicies among developed nations.ANSWERS TO QUESTIONS FOR CHAPTER 4(Questions are in bold print followed by answers.)1.What is the role of a central bank?The role of a central bank has several functions: risk assessment, risk reduction, oversight of payment systems, and crisis management. It can do this through monetary policies, and through the implementation of regulations.2.Why is it argued that a central bank should be independent of the government?Central banks should be independent of the short-term political interests and political influences generally in setting economic policies.3.Identify each participant and its role in the process by which the money supply changes and monetary policy is implemented.The Fed determines monetary policy and seeks to implement it through changes in reserves. It is up to the nation's banking system to act on changes in reserves thereby affecting deposits, which constitute the greater part of the M| definition of the money supply.4.Describe the structure of the board of governors of the Federal Reserve System.The Board of Governors of the Federal Reserve System consists of 7 members who are appointed to staggered 14-year terms. The Board reviews discount operations and sets legal reserve requirements. In addition, all 7 members of the Board serve on the Federal Open Market Committee (FOMC), which determines the direction and magnitude of open-market operations. Such operations constitute the key instrument for implementing monetary policy.5.a・ Explain what is meant by the statement "the United States has a fractional reserve banking system."b. How are these items related: total reserves, required reserves, and excess reserves?a. A fractional reserve system requires that a fraction or percent of a bank's reserve be placedeither in currency in vault or with the Federal Reserve System.b.Total reserves are the amounts that banks hold in cash or at the Fed. Required reserves areamounts required by the Fed to meet some specific or legal reserve ratio to deposits. Excess reserves are bank reserves in currency and at the Fed which are in excess of legal requirements.Since these amounts are non-interest bearing, banks are often willing to lend these surplus funds to deficit banks at the Fed funds rate.5.What is the required reserve ratio, and how has the 1980 Depository Institutions Deregulation and Monetary Control Act constrained the Fed's control over the ratio?The required reserve ratio is the fraction of deposits a bank must hold as reserves. The DIDMCA constrained the Fed's control over the ratio by letting Congress set ranges of reserves for demand and time deposits.6.In what two forms can a bank hold its required reserves?A bank can hold its reserves in the form of currency in vault or in deposit at the Fed.8.a.What is an open market purchase by the Fed?b.Which unit of the Fed decides on open market policy, and what unit implements thatpolicy?c.What is the immediate consequence of an open market purchase?a.An open market purchase by the Fed consists of the purchase of U.S. Treasury securities.b.The FOMC decides on open market policy and directs the Federal Reserve Bank of New Yorkto implement it through sales and purchases of these securities.c.The immediate consequence of an open market purchase is to supply the seller of the securitywith a check on the Federal Reserve System that he can deposit in his bank, therebyimmediately increasing the excess reserves and thus nation's money supply.7.Distinguish between an open market sale and a matched sale (which is the same as a matched sale-purchase transaction or a reverse repurchase agreement).A matched sale or reverse repo involves the sale of a Treasury security with an agreement to buy it back at a later date and at a higher price as the cost for borrowing the funds. This contrasts with an outright sale at some discounted or premium price.8.What is the discount rate, and to what type of action by a bank does it apply?The discount rate is the rate a bank pays to borrow a t the "discount window” of the Fed. Such borrowings are often undertaken to meet temporary liquidity needs. Bank needs are monitored and the Fed likes to state that borrowing from it is a "privilege and not a right.”IL Define the monetary base and M2The monetary base includes total bank reserves plus currency in the hands of the public. M2 = Mi (currency and demand deposits) + savings and time deposits.12.Describe the basic features of the money multiplier.The money multiplier is crucial to the concept of money creation and is analogous to the idea of the autonomous spending multiplier and formula for a perpetuity. It is the inverse of the required reserve ratio (1/rr). If the reserve ratio is .2 then the money supply will expand five times any increase in new deposits. The multiplier will be less if banks hold excess reserves or experience cash drains.13.Suppose the Fed were to inject $100 million of reserves into the banking system by an open market purchase of Treasury bills. If the required reserve ratio were 10%, what is the maximum increase in Mi that the new reserves would generate? Assume that banks make all the loans their reserves allow, that firms and individuals keep all their liquid assets in depository accounts, and no money is in the form of currency.The maximum increase in Mi will be $1 billion assuming no cash drains in the system, and banks are fully loaned up.14.Assume the situation from question 13, except now assume that banks hold a ratio of0.5% of excess reserves to deposits and the public keeps 20% of its liquid assets in the form of cash. Under these conditions, what is the money multiplier? Explain why this value of the multiplier is so much lower than the multiplier from question 13.Substitute the given values of currency ratio, required reserves ratio, and excess reserves ratio of 20%, 10% and 0.5% respectively into the formula given on page 94 of the textbook. Now we have a lower multiplier value of 3.9=1.20A 305. This is because public and banks do not deposit or lend, all they can.。
证券从业资格考试金融市场基础知识三色笔记使用法证券从业资格考试金融市场基础知识三色笔记使用方法介绍：1、三色勾画法。
红色表示是重点记忆内容，蓝色表示次重点记忆内容或较难理解内容，黑色表示暂时不需要记忆的内容或简单理解内容。
现实中可用红笔划红色内容，蓝笔或黑笔划蓝色内容，一定用铅笔划褐色内容。
日常复习主要关注三色划线内容，考前快速浏览红色和蓝色内容，铅笔内容确定掌握时请擦掉。
2、知识点把握。
日常复习注意明确知识点，特别注意多选题知识点的提示。
“□”代表一个明显的知识点。
3、复习流程。
第一阶段，①自主快速浏览全书一遍；②在培训师指导下划三色重点，讲解和记忆重要知识点；③记忆三色重点一遍；④模拟测试一，确定成绩：参考分为55分以上。
233网校督促50分以下者加大复习力度。
第二阶段，①讲解模拟试卷一，学员在书中寻找做错试题对应的知识点，寻找做错原因，若内容未记录请用三色中一色自己勾画；②记忆三色重点一遍；③模拟测试二，确定成绩：参考分为60分以上。
233网校督促55分以下者加大复习力度。
70分以上者可结束该们课程复习，考前三天突击温习即可。
第三阶段，①讲解模拟试卷二，学员在书中寻找做错试题对应的知识点，寻找做错原因，若内容未记录请用三色中一色自己勾画；②记忆三色重点一遍；③模拟测试三，确定成绩：参考分为66分以上。
233网校督促60分以下者加大复习力度。
将确定已掌握的铅笔勾画内容擦掉。
④考前三天开始自由温习，考前1-2小时快速浏览红色和蓝色勾画内容。
第一章金融市场体系证券从业金融市场基础知识三色笔记：全球金融体系证券从业金融市场基础知识三色笔记：中国的金融体系证券从业金融市场基础知识三色笔记：中国多层次资本市场第二章证券市场主体证券从业金融市场基础知识三色笔记：证券发行人证券从业金融市场基础知识三色笔记：证券投资者证券从业金融市场基础知识三色笔记：中介机构证券从业金融市场基础知识三色笔记：自律性组织证券从业金融市场基础知识三色笔记：监管机构第三章股票市场证券从业金融市场基础知识三色笔记：股票证券从业金融市场基础知识三色笔记：股票发行证券从业金融市场基础知识三色笔记：股票交易第四章债券市场证券从业金融市场基础知识三色笔记：债券证券从业金融市场基础知识三色笔记：债券的发行与承销证券从业金融市场基础知识三色笔记：债券的交易第五章证券投资基金与衍生工具证券从业金融市场基础知识三色笔记：证券投资基金证券从业金融市场基础知识三色笔记：衍生工具第六章金融风险管理证券从业金融市场基础知识三色笔记：风险管理证券从业金融市场基础知识三色笔记：金融风险证券从业资格考试金融市场基础知识第一章金融市场体系(第一节全球金融体系)金融市场的概念金融市场是指以金融资产为交易对象、以金融资产的供给方和需求方为交易主体形成的交易机制及其关系的总和。
《金融市场与金融机构》米什金第七版课后习题答案
（请集中复习1-6、10-13、15章）
第一章为什么研究金融市场与金融机构
第二章金融体系概览
第三章利率的含义及其在定价中的作用
第四章为什么利率会变化
第五章利率的风险结构和期限结构如何影响利率
第六章金融市场是否有效
第十章货币政策传导：工具、目标战略和战术
第七版中的12题在第五六版中没有，此处的12-19题即为第七版的13-20题
第十一章货币市场
第十二章债券市场
第十三章股票市场
第十四章抵押贷款市场
第十五章外汇市场。
C H A P T E R6I N S U R A N C E C O M P A N I E STYPE OF INSURANCE COMPANIESInsurance companies sell insurance policies for a premium. They have two sources of income: underwriting income, and investment income.Life InsuranceThe life insurance company pays the beneficiary of the life insurance policy in the event of the death of the insured.Health InsuranceThe health insurance company pays the insured all or a portion of the medical treatment of the insured. Until the last decade, the major type of health insurance available was indemnity insurance. Due to the lack of constraints and incentives for cost savings, the medical service insured by indemnity insurance became very expensive. In response, various forms of managed health care have been developed. In general, these forms of managed health care put constraints on the choice of the provider by the insured and on the types of service provided by the provider.Property and Casualty InsuranceProperty and casualty (P&C) insurance companies insure the risk of damage to various types of property.Liability InsuranceThe risk insured against is litigation, or the risk of lawsuits against the insured due to actions by the insured or others. This is typically a third-party claim.Disability InsuranceDisability insurance insures against the inability of employed persons to earn an income. Typically, “own occ” disability insurance is written for professionals in white-collar occupations, and “any occ” for blue-collar workers. There are two types of policies regarding the sustainability of the policy. First, guaranteed renewable is a term where the issuer has to sustain the policy for a specified period of time, but can change the premium rates for the entire class. The other type is noncancellable and guaranteed renewable whereby the issuer has no right to make any changes in any policy during the specified period.Long-Term Care InsuranceLong-term care insurance provides coverage for custodial care for the aged who are no longer able to care for themselves.Structured SettlementsStructured settlements are fixed, guaranteed periodic payments over a long period of time, typically resulting from a settlement on a disability policy or other type of policy.Investment Oriented ProductsA guaranteed investment contract or guaranteed income contract (or simply GIC), is a pure investment product. In a GIC, a life insurance company agrees, for a single premium, to pay the principal amount and a predetermined annual crediting rate over the life of the investment, all of which is paid at the maturity date. A life insurance company agrees in return for a premium to pay the principal amount and a predetermined annual crediting rate over the life of the investment. Effectively, a GIC is a zero coupon bond issued by a life insurance company and as such exposes the investor to the same credit risk. Some GICs require a single premium payment (bullet), others provide windows wherein deposits are accepted over time at the same interest rate. GICs are popular contracts for pension funds, since interest rate risk assumed by insurance company. But investors still have to worry about the credit risk of the insurance company. AnnuityAn annuity is often described as a mutual fund in an insurance wrapper. The income and realized gains are not taxable if not withdrawn from the annuity product. Thus, the “inside buildup” of returns receives a favorable tax treatment. Annuities can be either fixed, or variable. For a single payment or premium the insurance company will provide fixed payments for the life of the policyholder. It can also provide a “lump sum” payment to the retiree after a number of years of accumulating and investing premium payments.Monoline Insurance CompaniesMonoline insurers guarantee the timely repayment of the bond principal and interest when a bond insurer defaults on these payments. The insured securities have traditionally been municipal bonds, but they now include structured finance bonds, CDOs, CLOs, and asset-backed bonds. Monoline insurers have been rated AAA and must have this high rating to be effective since they transfer their rating to the bond issue being insured.INSURANCE COMPANIES VERSUS TYPES OF PRODUCTSTraditionally, life and health products were coupled by an insurance company because of some of the similarities of the products. Property and casualty products were also provided by P&C companies. Companies that provide both types of insurances (life, health, property, casualty) are called multiline insurance companies. Investment products tend to be sold by life insurance companies.Recently, health insurance companies have separated from life insurance. This change has been due to mainly federal regulation of the health industry. Life insurance companies have focused on investment products. Also, disability insurance is now sold primarily by pure disability companies.FUNDAMENTALS OF INSURANCE INDUSTRYA fundamental aspect of the insurance industry results from the relationship between the revenues and costs. A company collects its premium income initially and invests these receipts in its portfolio. The payments on the insurance policy occur later and, depending on the type of insurance, in a perhaps very unpredictable manner. The payments are contingent on potential future events.An insurance policy is a binding contract for which the policyholder pays premium in exchange for the insurance company’s promise to pay specified amounts contingent on future events. The accepted policy is an asset for the owner and a liability for the insurance company.Life insurance and property and casualty insurance companies are financial intermediaries that, for a price, will make a payment if a certain event occurs. They function as risk bearers. The principal event that the life insurance company insures against is death: a life insurance company agrees to make either a lump sum payment to the beneficiary of the policy or make a series of payments. However, life insurance protection is not the only financial product sold by these companies. A major portion of the business of life insurance companies is now in the area of providing retirement benefits. The key distinction between life insurance and property and casualty insurance (P&C) companies is the difficulty of projecting whether a policyholder will be paid off and how much the payment will be.REGULATIONS OF INSURANCE INDUSTRYRegulation is primarily at the state level as a result of 1945 federal statute (McCarran-Ferguson Act). Model laws and regulations are developed by National Association of Insurance Commissioners (NAIC). Insurance companies are also rated by the rating agencies.To assure financial stability, insurance companies must maintain reserves or surplus, which are the excess of assets over liabilities. State statutory surplus requirements are called statutory surplus, which is distinguished from generally accepted accounting principles (GAAP) surplus.STRUCTURE OF INSURANCE COMPANIESInsurance companies are really a composite of three companies. First there is the “home office” or actual insurance company. Second, there is the investment component, which invests the premium collected in the investment portfolio. This is the investment company. The third is the distribution component of the sales force. There are different typed of distribution forces. Finally there are also brokers who sell insurance products of many companies.Insurance companies are attracted by commercial bank customer contacts. As a result, commercial bank distribution of insurance company products has grown. This relationship is called bankassurance.FORMS OF INSURANCE COMPANIESThere are two forms of insurance companies: stock and mutual. A stock insurance company is similar in structure to any corporation or public company. Shares (of ownership) are owned by independent shareholders and are traded publicly. The shareholders care only about the performance of their shares that is the stock appreciation and the dividends. The insurance policies are simply the products or business of the company. In contrast, mutual insurance companies have no stock and no external owners. Their policyholders are also their owners. The owners, that is the policyholders, care primarily or even solely about the performance on their insurance policie s, notably the company’s ability to pay on the policy. Since theses payments may occur considerably into the future, the policyholders view may be long term.Finally a new form of insurance company, which is a hybrid between a pure mutual and a pure stock company has been approved by some states and implemented by some insurance companies in these states since their introduction in 1996. This form is called a mutual holding company (MHC).INDIVIDUAL VERSUS GROUP INSURANCEInsurance products can be sold on individual and group bases. Also, in the P&C business, insurers can sell personal lines and commercial lines of insurance products.TYPES OF LIFE INSURANCEThere are two fundamentally different types of life insurance: term (life) insurance and cash value life insurance.Term InsuranceTerm policies pay off only on death. Three are no investment benefits and so the premiums are substantially lower than those on whole life policies. Most group policies are term policies. “Term” implies that c overage is available only during the premium-paying term of the contract.Cash Value or Permanent Life InsuranceThere is a broad classification of life insurance, which is cash value, or permanent or investment type life insurance. A common type of cash value life insurance is whole life insurance. This cash value can be withdrawn and can also be borrowed against by the owner of the policy. If the owner wishes to let the policy lapse, he or she can withdraw the cash value. A major advantage of this type of policy is that the inside buildup is not subject to tax, i.e., is taxed as either income or capital gains. Neither is the beneficiary subject to income tax.Guaranteed cash value life insurance:This insurance provides a cash value based on a minimum dividend paid on the policy. Additionally, the policy can be either participating or nonparticipating. For a nonparticipating policy, the minimum dividend and the minimum cash value on the policy are the guaranteed amounts. For the participating policy, the dividend paid on the policy is based on the realized actuarial experience of the company and its investment portfolio.Variable life insurance: Contrary to the guaranteed or fixed cash value policies based on the general account portfolio of the insurance company, variable life insurance policies allow the policy owner to, within limits, allocate their premium payments to and among separate investment accounts maintained by the insurance company. Variable life insurance, which typically has common stock investment options, has grown quickly with the stock market rally of the 1990’s.Flexible premium policies—universal life insurance: The key element of universal life is the flexibility of the premium. The policy cash value is set up as the cash value fund to which the investment income is credited and from which the cost of term insurance for the insured is debited. This separation of the cash value from the pure insurance is called the unbundling of the traditional life insurance policy.Variable universal life insurance: Variable universal life insurance combines the features of variable life and universal life policies, i.e., the choice of separate account investment products and flexible premiums.Survivorship (Second to Die) InsuranceAn added dimension of the whole life policies is that two people are jointly insured and the policy pays the death benefit not when the first person dies, but when the second person dies. This is called survivorship insurance or second-to-die insurance.GENERAL ACCOUNT AND SEPARATE ACCOUNT PRODUCTSThe general account of an insurance company refers to the investment portfolio of the overall company. Insurance companies must support the guaranteed performance of their general account products to the extent of their solvency. These are called general account products.Other types of insurance products receive no guarantee from the insurance company’s general account, and their performance is not based on the performance of the insurer’s general account but solely on the performance of an account separate from the general account of the insurer. These products are called separate account products.PARTICIPATING POLICIESThe performance of some general account products is not affected by the performance of the general account portfolio. The policy performance may not participate in the investment performance of the insurer’s general account investment portfolio. Such a policy is nonparticipating policy. Other general insurance products participate in the performance of the company’s general account performance. Such a policy is called a participating policy. Both stock and mutual insurance companies write both general and separate account products, but most participating general account products are written in mutual companies.INSURANCE COMPANIES INVESTMENT STRATEGIESIn general the characteristics of insurance company investment portfolio should reflect their liabilities - the insurance products they underwrite. There are many differences among the various types of insurance policies. Among them are:▪The expected time at which the average payment will be made by the insurance company (Technically, the “duration” of the payments)▪The statistical or actuarial accuracy of estimates▪Other factorsThe key distinction between life insurance, property and casualty insurance companies lies in the difficulty of projecting whether or not a policyholder will be paid off and how much the payment will be. There are also differences in investment strategy between public (or stock) and mutual insurance companies of the same type. The major difference is that stock companies tend to have less common stock than mutual companies.Most insurance company assets consist of debt, both public and private. In fact, life insurers as a group are the largest holders of bonds. Since life insurers are effectively taxed at very low rates, there are no advantages to holding municipals. The reason for bond holdings are (1) to match maturities, since liabilities are often long-term and at a fixed rate, and (2) regulations require that bonds be booked at cost, while stocks must be written at market value.CHANGES IN THE INSURANCE INDUSTRYThere have been three major types of changes in the insurance industry in the last two decades: (1) deregulation of the financial system; (2) internationalization of the insurance industry; (3) demutulization.Deregulation of the Financial SystemIn 1933, Congress passed the Glass-Steagall Act, which separated commercial banking, investment banking, and insurance. This act resulted in the breakup of the House of Morgan into separate investment banking and commercial banking entities. . On November 12, 1999 the Gramm-Leach-Bliley Act (GLB), called the Financial Modernization Act of 1999, was signed into law. This act removed the 50 year old “anti-affiliation restrictions” among commercial banks, investments banks and insurance companies. The passage of this act has eliminated the barriers between insurance companies, commercial banks, and investment banks and various combinations of these types of companies will continue to evolve. Since then, however, Citigroup sold its insurance business (Travelers) to MetLife, and no other major combinations between banking and insurance have taken place.Internationalization of the Insurance IndustryGlobalization has occurred in many industries, including insurance industry. With respect to the U.S. globalization operates in two directions. First, U.S. insurance companies have both acquired and entered into agreements with international insurance companies and begun operations in other countries. Second, international insurance companies, mainly European, have become even more active in acquiring U.S. insurance and investment companies. The reasons are: (1) more rapid growth of the US financial business, (2) attractive demographics and income potential of the US market, and (3) less regulations.DemutualizationSince the mid-1990s, several insurance companies have changed from mutual to stock companies. Many industry observers believe that the recent demutualized insurance companies will either acquire other financial companies or will be acquired by other financial companies.EVOLUTION OF INSURANCE INVESTMENT AND RETIREMENT PRODUCTSEven prior to the Financial Modernization Act of 1999, there was an increasing overlap of insurance, investment and pension products and the distribution of those products. The passage of this Act has accelerated this convergence.Three decades ago there were three distinct types of products for individuals: insurance, savings/investment, and retirement. Retirement products include individual retirement accounts. During the last two decades, many products have been developed that fit into two or even three of these categories. Products that are hybrid of retirement and investment products are 401k and Roth 401k.401(k) Plans and Roth 401(k) Plans401(k) plans are plans provided by an employer whereby an employee may elect to contribute pretax dollars to a qualified tax-deferred retirement plan.IRAs and Roth IRAsWhile a 401(k) is an employer-sponsored retirement program, the most common types of IRAs are personal tax-deferred retirement plans. Individually sponsored IRAs include traditional IRA, Roth IRA, and rollover IRA. Employer-sponsored IRA included Simplified Employee Pension (SEP) plans, and Savings Incentives Matching Plan for Employees (SIMPLE).ANSWERS TO QUESTIONS FOR CHAPTER 6(Questions are in bold print followed by answers.)1.a.What are the major sources of revenue for an insurance company?b.How are its profits determined?a.An insurance company's revenue is generated from two sources: (1) premium income forpolicies written during the year; (2) investment income resulting from the investment of both the reserves established to pay off future claims and the P&C's surplus (asset less liabilities).b.Profit is determined by subtracting from the revenue for the year (as defined above inquestion 1a) each of the following items: (1) claim expenses: funds that must be added to reserves for new claims for policies written during the year; (2) claim adjustment expenses: funds that must be added to reserves because of underestimates of actuarially projected claims from previous years; (3) taxes; (4) administrative and marketing expenses associated with issuing policies. If annual premiums exceed the sum of (1), (2) and (4), the difference is said to be the underwriting profit. An underwriting loss results otherwise.2. Name the major types of insurance and investment oriented products sold by insurance companies.The major types of insurance products sold are: Life insurance, Health insurance, Property and casualty insurance, Liability insurance, Disability insurance, long-term care insurance, GIC and annuities.3.a.What is a GIC?b.Does a GIC carry a “guarantee” like a government obligation?a. A guaranteed investment contract (GIC) guarantees a fixed interest income compounded overthe life of the contract. It is like a zero-coupon bond issued by an insurance company, usually to pension funds. A GIC shifts the interest rate risk from a pension fund to the issuer.b.The guarantee is given only by the insurance company. There is no government bailout incase of insolvency of the issuer.4. What are some key differences between a mutual fund and an annuity?In a mutual fund, all income is taxable, and no guarantees are given in its performance. An annuity is an investment product often called a “mutual fund is in an insurance wrapper”. The wrapper is the guarantee by the insurance company. The company will pay the annuity holder.5. Why should a purchaser of life insurance be concerned about the credit rating of his or her insurance company?The credit rating of an insurance company is extremely important to the purchaser of the LIC product. The credit risk of insurance company has been prominent by the default of several major issues of GIC e.g. mutual Benefits and Executive Life in 1991.6.a.Does the SEC regulate all insurance companies?b.If not, who regulates them?a.No. The insurance industry is regulated by individual states and only the SEC regulates thoseinsurance companies whose stock is publicly traded.b.State laws and NAIC, a voluntary association of state insurance commissioners.7. Does the insurance industry have a self-regulatory group and, if so, what is its role?Model laws and regulations are developed by the National Association of Insurance Commissioners (NAIC), a voluntary association of the state insurance commissioners, for application on insurance companies in all states. An adoption of a model law or regulation by the NAIC is not, however, binding on any state. States typically use these as a model when writing their own laws and regulations.8. What is the statutory surplus and why is it an important measure for an insurance company?For an insurance company, surplus is simply total assets minus liabilities, or net worth. Due to state regulations the size of the surplus dictates the amount of common stock that an insurance company can hold and ultimately the amount of business it can write.9. What is bank assurance?“Banc assurance” means combining the activities of banking and insurance companies. Several factors could explain the growing interest in banc assurance in certain regions: (1) deregulation and increased competition are forcing banking and insurance firms to seek new markets and products, (2) a growth in savings, and (3) an increased demand for insurance with investment features.10.a.What is meant by “demutualization”?b.What are the perceived advantages of demutualization?a.Demutualization refers to changing structure of insurance companies from being mutualcompanies stocks to ownership companies. This recent trend of demutualization in 1990’s is changing the landscape of insurance industry.b.The advantages of demutualization is more competition, transparency and pressure for betterperformance for the shareholders.11. Comment on the following quotation from Frank J. Jones, “An Overview of Institutional Fixed In come Strategies,” in Volume 1 of Professional Perspectives on Fixed Income Portfolio Management (Hoboken, NJ: John Wiley & Sons, 2000):An important impediment to the use of the total rate of return objective by stock life insurance companies is the role of equity analysts on Wall Street. . . . These equity analysts emphasize the stability of earnings and thereby prefer stable income to capital gains. Therefore, they consider only income and not capital gains, either realized or unrealized, in operating income—an important measure in their overall rating. While this practice of not considering capital gains may be appropriate for bonds, it certainly is inappropriate for common stock and provides a significant disincentive to life insurance companies for owning common stock in their portfolios. . . . this equity analyst practice does a disservice to policyholders of stock life insurance companies since their insurance companies end up having inferior asset allocations.The statement by Jones has elements of subjective judgment and has several dimensions. It begs the merit of stocks vs. mutual structure of ownership and the respective rates of returns for the shareholders. It may be true that equity analysts emphasize the stability of earnings at the cost of capital gains. But those capital gains are reflected in the current price of the stock. It is up to the shareholders to realize those gains. Thus, the total rate of return objective by stock life insurance companies is not a real impediment.12. What are term insurance, whole life insurance, variable life insurance, universal life insurance, and survivorship insurance?Term insurance is pure life. If the insured person dies while the policy is intact, the beneficiary receives the death benefit.Whole life insurance pays off a stated amount upon the death of the insured and accumulates a cash value that can be redeemed by the policyholder.Universal life pays a dividend that is tied to market interest rates. Essentially, the cash value of a universal life policy builds and is used to buy term insurance.Variable life insurance provides a death benefit that depends on the market value of the investment at the time of the insured’s death. The premiums are typically invested in common stock; hence such policies are referred to as equity-linked policies. While the death benefits are variable, there is a guaranteed minimum death benefit that the insurer agrees to pay regardless of the market value of the portfolio.Universal Life Insurance: the main element of the universal life insurance is the flexibility of premium for the policyholder. It separates term insurance from cash value element of the policy.13. Why are all participating policies written in an insurance company’s general account?All participating policies by the insurance company are written in the general account. The general account of an insurance company refers to the investment portfolio of the overall company. Such products “Written by the company itself” are said to have a “general acco unt guarantee” i.e. they are a liability of the insurance company. The rating agencies provide a credit rating based on products written by or guaranteed by the general account.14. Whose liabilities are harder to predict, life insurers or property and casualty insurers? Explain why.Property and casualty insurers P&Cs. Life insurance actuaries can predict death rates among various age groups based upon historical data. With P&Cs, the timing and amount of payoffs are almost random by nature. Past experience provides little predictive assistance. Homeowner claims are just as likely to arise in the first year of a policy or ten years later. Even then, the dollar amount of damage claims can be small or for the entire value of the policy.15. How does the Financial Modernization Act of 1999 affect the insurance industry?The Financial Modernization Act of 1999 will affect significantly the insurance industry in several ways. Even before this act, there was an increase overlap of insurance, investment, pension products and the distribution of products. The passage of this act has accelerated this convergence. This act has eliminated the barriers between insurance companies, commercial banks, and investment banks and various combinations will continue to evolve.。
Foundations of Financial Markets and Institutions, 4e (Fabozzi/Modigliani/Jones)Chapter 10 The Level and Structure of Interest RatesMultiple Choice Questions1 The Theory of Interest Rates1) An interest rate is the price paid by a ________ to a ________ for the use of resources during some interval.A) borrower; debtorB) lender; creditorC) borrower; lenderD) lender; borrowerAnswer: CComment: An interest rate is the price paid by a borrower (or debtor) to a lender (or creditor) for the use of resources during some interval.Diff: 2Topic: 10.1 The Theory of Interest RatesObjective: 10.1 Fisher's classical approach to explaining the level of the interest rate2) By the ________, we mean the rate on a loan whose borrower will not default on any obligation.A) risk-free rateB) short termC) real rateD) long termAnswer: AComment: The interest rate that provides the anchor for other rates is the short-term rate:risk-free plus real rate. By short term, we mean the rate on a loan that has one year to maturity. (All other interest rates differ from this rate according to particular aspects of the loan, such as its maturity or risk of default, or because of the presence of inflation.) By the risk-free rate, we mean the rate on a loan whose borrower will not default on any obligation. By the real rate, we mean the rate that would prevail in the economy if the average prices for goods and services were expected to remain constant during the loan’s life.Diff: 1Topic: 10.1 The Theory of Interest RatesObjective: 10.4 the structure of Fisher's Law, which states that the nominal and observable interest rate is composed of two unobservable variables; the real rate of interest and the premium for expected inflation3) By the ________, we mean the rate that would prevail in the economy if the average prices for goods and services were expected to remain constant during the loan's life.A) risk-free rateB) short termC) real rateD) long termAnswer: CComment: The interest rate that provides the anchor for other rates is the short-term rate:risk-free plus real rate. By short term, we mean the rate on a loan that has one year to maturity. (All other interest rates differ from this rate according to particular aspects of the loan, such as its maturity or risk of default, or because of the presence of inflation.) By the risk-free rate, we mean the rate on a loan whose borrower will not default on any obligation. By the real rate, we mean the rate that would prevail in the economy if the average prices for goods and services were expected to remain constant during the loan’s life.Diff: 1Topic: 10.1 The Theory of Interest RatesObjective: 10.4 the structure of Fisher's Law, which states that the nominal and observable interest rate is composed of two unobservable variables; the real rate of interest and the premium for expected inflation4) By the ________, we mean the rate on a loan that has one year to maturity.A) risk-free rateB) short termC) real rateD) long termAnswer: BComment: The interest rate that provides the anchor for other rates is the short-term rate:risk-free plus real rate. By short term, we mean the rate on a loan that has one year to maturity. (All other interest rates differ from this rate according to particular aspects of the loan, such as its maturity or risk of default, or because of the presence of inflation.) By the risk-free rate, we mean the rate on a loan whose borrower will not default on any obligation. By the real rate, we mean the rate that would prevail in the economy if the average prices for goods and services were expected to remain constant during the loan’s life.Diff: 2Topic: 10.1 The Theory of Interest RatesObjective: 10.1 Fisher's classical approach to explaining the level of the interest rate5) Which of the below statements about consumptions and savings is FALSE?A) A chief influence on the saving decision is the individual's marginal rate of time preference, which is the willingness to trade some consumption now for more future consumption.B) Generally, higher current income means the person will save more, although people with the same income may have different time preferences.C) A variable affecting savings is the reward for saving, or the rate of interest on loans that savers make with their unconsumed income.D) The total savings (or the total supply of loans) available at any time is the sum of everybody's savings and a negative function of the interest rate.Answer: DComment: The total savings (or the total supply of loans) available at any time is the sum of everybody’s savings and a positive function of the interest rate.Diff: 2Topic: 10.1 The Theory of Interest RatesObjective: 10.2 the role in Fisher's theory of the saver's time preference and the borrowing firm's productivity of capital6) Which of the below statements about the rate of interest and cost of capital is FALSE?A) The maximum that a firm will invest depends on the rate of interest, which is the cost of loans; the firm will invest only as long as the marginal productivity of capital exceeds or equals the rate of interest.B) Firms will reject only projects whose gain is not less than their cost of financing.C) The firm's demand for borrowing is negatively related to the interest rate; if the rate is high, only limited borrowing and investment make sense.D) At a low rate of interest, more projects offer a profit, and the firm wants to borrow more; his negative relationship exists for each and all firms in the economy.Answer: BComment: The maximum that a firm will invest depends on the rate of interest, which is the cost of loans. The firm will invest only as long as the marginal productivity of capital exceeds or equals the rate of interest. In other words, firms will accept only projects whose gain is not less than their cost of financing. Thus, the firm’s demand for borrowing is negatively related to the interest rate. If the rate is high, only limited borrowing and investment make sense. At a low rate, more projects offer a profit, and the firm wants to borrow more. This negative relationship exists for each and all firms in the economy.Diff: 2Topic: 10.1 The Theory of Interest RatesObjective: 10.2 the role in Fisher's theory of the saver's time preference and the borrowing firm's productivity of capital7) The ________ rate of interest is determined by interaction of the supply and demand functions. As a cost of borrowing and a reward for lending, the rate must reach the point where total supply of savings ________ total demand for borrowing and investment.A) equilibrium; is greaterB) minimum; equalsC) equilibrium; equalsD) minimum; is greaterAnswer: CDiff: 2Topic: 10.1 The Theory of Interest RatesObjective: 10.3 the meaning of equilibrium and how changes in the demand and supply function affect the equilibrium level of the interest rate8) In the absence of inflation, the nominal rate ________ the real rate.A) equalsB) is greater thanC) is less thanD) greater than or equal toAnswer: ADiff: 1Topic: 10.1 The Theory of Interest RatesObjective: 10.3 the meaning of equilibrium and how changes in the demand and supply function affect the equilibrium level of the interest rate9) The relationship between inflation and interest rates is the well-known Fisher's Law, which can be expressed this way: (1 + i) = (1 + r) × (1 + i) where ________.A) r is the nominal rate.B) i is the real rate.C) p is the expected percentage change in the price level of goods and services over the loan's life.D) the nominal rate, p, reflects both the real rate and expected inflation.Answer: CComment: The relationship between inflation and interest rates is the well-known Fisher’s Law, which can be expressed this way: (1 + i) = (1 + r) × (1 + i) where i is the nominal rate, r is the real rate, and p is the expected percentage change in the price level of goods and services over the loan’s life. This equation shows that the nominal rate, i, reflects both the real rate and expected inflation.Diff: 2Topic: 10.1 The Theory of Interest RatesObjective: 10.4 the structure of Fisher's Law, which states that the nominal and observable interest rate is composed of two unobservable variables; the real rate of interest and the premium for expected inflation10) Which of the below IS considered by Fisher's theory.A) Fisher's theory takes into account the power of the government (in concert with depository institutions) to create money.B) Fisher's theory considers the government's often large demand for borrowed funds, which is frequently immune to the level of the interest rateC) Fisher's theory takes into account the possibility that individuals and firms might invest in cash balances.D) Fisher's theory considers an interest rate on loans that embodies no premium for default risk because borrowing firms are assumed to meet all obligations.Answer: DComment: Fisher’s theory is a general one and obviously neglects certain practical matters, such as the power of the government (in concert with depository institutions) to create money and the government’s often la rge demand for borrowed funds, which is frequently immune to the level of the interest rate. Also, Fisher’s theory does not consider the possibility that individuals and firms might invest in cash balances. Expanding Fisher’s theory to encompass these situations produces the loanable funds theory of interest rates.Diff: 2Topic: 10.1 The Theory of Interest RatesObjective: 10.4 the structure of Fisher's Law, which states that the nominal and observable interest rate is composed of two unobservable variables; the real rate of interest and the premium for expected inflation11) The loanable funds theory of interest rates proposes that the general level of interest rates is determined by the complex interaction of two forces. Which of the below is ONE of these forces?A) One force is that the total demand for funds by firms, governments, and households (or individuals) is negatively related to the interest rate including the government's demand.B) One force affecting the level of the interest rate is the total supply of funds by firms, governments, banks, and individuals with rising rates causing banks to be less eager to extend more loans.C) One force is that the total demand for funds by firms, governments, and households (or individuals) is positively related to the interest rate except the government's demand.D) One force affecting the level of the interest rate is the total supply of funds by firms, governments, banks, and individuals with rising rates causing firms and individuals to save and lend more.Answer: DComment: The loanable funds theory of interest rates proposes that the general level of interest rates is determined by the complex interaction of two forces. The first is the total demand for funds by firms, governments, and households (or individuals), which carry out a variety of economic activities with those funds. This demand is negatively related to the interest rate (except for the government’s demand, which may frequently not depend on the level of the interest rate). The second force affecting the level of the interest rate is the total supply of funds by firms, governments, banks, and individuals. Supply is positively related to the level of interest rates, if all other economic factors remain the same. With rising rates, firms and individuals save and lend more, and banks are more eager to extend more loans. (A rising interest rate probably does not significantly affect the government’s supply of savings.)Diff: 3Topic: 10.1 The Theory of Interest RatesObjective: 10.5 the loanable funds theory, which is an expansion of Fisher's theory12) The ________, originally developed by John Maynard Keynes,analyzes the equilibrium level of the interest rate through the interaction of the supply of money and the public's aggregate demand for holding money.A) loanable funds theory of interest ratesB) expectation theory of interest ratesC) liquidity preference theoryD) Fisher theoryAnswer: CDiff: 2Topic: 10.1 The Theory of Interest RatesObjective: 10.6 the meaning of liquidity preference in Keynes's theory of the determination of interest rates13) The public (consisting of individuals and firms) holds money for several reasons. Which of the below is three of these?A) Difficulty of translations, precaution against expected events, and speculation about possible rises in the interest rate.B) Ease of transactions, precaution against unexpected events, and speculation about possible rises in the interest rate.C) Ease of unexpected events, precaution against transactions, and speculation about possible rises in the interest rate.D) Speculation about transactions, fear against unexpected events, and precaution about possible rises in the interest rate.Answer: BDiff: 2Topic: 10.1 The Theory of Interest RatesObjective: 10.6 the meaning of liquidity preference in Keynes's theory of the determination of interest rates14) The ________ represents the initial reaction of the interest rate to a change in the money supply.A) Income effectB) Price expectation effectC) Liquidity effectD) Interest rate effectAnswer: CDiff: 2Topic: 10.1 The Theory of Interest RatesObjective: 10.7 how an increase in the money supply can affect the level of the interest rate through an impact on liquidity, income, and price expectations15) Which of the below statements is FALSE?A) Although an increase in the money supply is an economically expansionary policy, the resultant increase in income depends substantially on the amount of slack in the economy at the time of the Fed's action.B) In Fisher's terms, the interest rate reflects the interaction of the savers' marginal rate of time preference and borrowers' marginal productivity of capital.C) Changes in the money supply can affect the level of interest rates through the liquidity effect, the income effect, and the price expectations effect; their relative magnitudes depend upon the level of economic activity at the time of the change in the money supply.D) Because the price level (and expectations regarding its changes) affects the money demand function, the liquidity effect is an increase in the interest rate.Answer: DComment: Because the price level (and expectations regarding its changes) affects the money demand function, the price expectations effect is an increase in the interest rate.Diff: 2Topic: 10.1 The Theory of Interest RatesObjective: 10.7 how an increase in the money supply can affect the level of the interest rate through an impact on liquidity, income, and price expectations2 The Determinants of the Structure of Interest Rates1) A ________ is an instrument in which the issuer (debtor/borrower) promises to repay to the lender/investor the amount borrowed plus interest over some specified period of time.A) bondB) common stockC) preferred stockD) T-billAnswer: ADiff: 1Topic: 10.2 The Determinants of the Structure of Interest RatesObjective: 10.8 the features of a bond issue2) The ________ should reflect the coupon interest that will be earned plus either (1) any capital gain that will be realized from holding the bond to maturity, or (2) any capital loss that will be realized from holding the bond to maturity.A) yield on a bond investmentB) dividend yield on a bond investmentC) bid-ask spreadD) yield on a stock investmentAnswer: ADiff: 1Topic: 10.2 The Determinants of the Structure of Interest RatesObjective: 10.8 the features of a bond issue3) The ________ the market price, the higher the yield to maturity.A) higherB) less riskyC) more safeD) lowerAnswer: DDiff: 1Topic: 10.2 The Determinants of the Structure of Interest RatesObjective: 10.8 the features of a bond issue4) The ________ of a bond is the amount that the issuer agrees to repay the bondholder at the maturity date.A) principal value (or simply principal)B) face valueC) redemption valueD) All of theseAnswer: DComment: The principal value (or simply principal) of a bond is the amount that the issuer agrees to repay the bondholder at the maturity date. This amount is also referred to as the par value, maturity value, redemption value, or face value.Diff: 2Topic: 10.2 The Determinants of the Structure of Interest RatesObjective: 10.8 the features of a bond issue5) The yield to maturity is determined by a trial-and-error process. The first step in this trial and error process is ________.A) Compute the present value of each cash flow using the best guess interest rate.B) Total the present value of the cash flows using the best guess interest rate.C) Select an interest rate.D) Compare the total present value using the best guess interest rate with the market price of the bond.Answer: CComment: The yield to maturity is determined by a trial-and-error process. Even the algorithm in a calculator or computer program, which computes the yield to maturity (or internal rate of return) in an apparently direct way, uses a trial-and-error process. The steps in that process are as follows:Step 1: Select an interest rate.Step 2: Compute the present value of each cash flow using the interest rate selected in Step 1. Step 3: Total the present value of the cash flows found in Step 2.Step 4: Compare the total present value found in Step 3 with the market price of the bond and, if the total present value of the cash flows found in Step 3 is• equal to the market price, then the interest rate used in Step 1 is the yield to maturity;• greater than the market price, then the interest rate is not the yield to maturity. Therefore, go back to Step 1 and use a higher interest rate;• less than the market price, then the interest rate is not the yield to maturity. Therefore, go back to Step 1 and use a lower interest rate.Diff: 2Topic: 10.2 The Determinants of the Structure of Interest RatesObjective: 10.9 how the yield to maturity of a bond is calculated6) There are several interesting points about the relationship among the coupon rate, market price, and yield to maturity. Which of the below is NOT one of these.A) If the market price is equal to the par value, then the yield to maturity is equal to the coupon rate.B) If the market price is less than the par value, then the yield to maturity is greater than the coupon rate.C) If the market price is greater than the par value, then the yield to maturity is greater than the coupon rate.D) If the market price is greater than the par value, then the yield to maturity is less than the coupon rate.Answer: CComment: There are several interesting points about the relationship among the coupon rate, market price, and yield to maturity as summarized below.1. If the market price is equal to the par value, then the yield to maturity is equal to the coupon rate;2. If the market price is less than the par value, then the yield to maturity is greater than the coupon rate, and;3. If the market price is greater than the par value, then the yield to maturity is less than the coupon rate.Diff: 2Topic: 10.2 The Determinants of the Structure of Interest RatesObjective: 10.9 how the yield to maturity of a bond is calculated7) Consider an 20-year bond with a coupon rate of 8% and a par value of $1,000. The cash flow for this bond is ________ every six months for the first 39 semi-annual periods and then________ for the last (or 40th) six-month period.A) $1,040; $40B) $40; $1,040C) $80; $1,080D) $80; $1,000Answer: BComment: Consider an 20-year bond with a coupon rate of 8% and a par value of $1,000. The cash flow for this bond is $40 every six months for the first 39 semi-annual periods and then $1,040 for the last (or 40th) six-month period.Diff: 2Topic: 10.2 The Determinants of the Structure of Interest RatesObjective: 10.8 the features of a bond issue8) The difference between the yield on any two bond issues is called a ________.A) yield differenceB) difference spreadC) coupon rate spreadD) yield spreadAnswer: DDiff: 2Topic: 10.2 The Determinants of the Structure of Interest RatesObjective: 10.13 what factors affect the yield spread between two bonds9) Treasury securities are used to develop the benchmark interest rates. There are two categories of U.S. Treasury securities: ________.A) discount and coupon securities.B) discount and coupon stocks.C) interest rate and coupon securities.D) discount and compound securities.Answer: ADiff: 2Topic: 10.2 The Determinants of the Structure of Interest RatesObjective: 10.1 Fisher's classical approach to explaining the level of the interest rate10) The most recently auctioned Treasury issues for each maturity are referred to as ________.A) off-the-run issues or current coupon issues.B) minimum interest rate or base interest rateC) on-the- run or current coupon issues.D) benchmark interest rate or minimum interest rate.Answer: CComment: The most recently auctioned Treasury issues for each maturity are referred to as on-the- run or current coupon issues. Issues auctioned prior to the current coupon issues are typically referred to as off-the- run issues; they are not as liquid as on-the-run issues, and, therefore, offer a higher yield than the corresponding on-the-run Treasury issue. The minimum interest rate or base interest rate that investors will demand for investing in a non-Treasury security is the yield offered on a comparable maturity on-the-run Treasury security. The base interest rate is also referred to as the benchmark interest rate.Diff: 2Topic: 10.2 The Determinants of the Structure of Interest RatesObjective: 10.10 why historically the yields on securities issued by the U.S. Department of the Treasury have been used as the benchmark interest rates throughout the world11) Market participants talk of interest rates on non-Treasury securities as ________ to a particular on-the-run Treasury security (or a spread to any particular benchmark interest rate selected). This spread reflects the additional risks the investor faces by acquiring a security thatis not issued by the U.S. government and, therefore, can be called a ________.A) "trading at a premium"; risk premiumB) "trading at a spread"; risk premiumC) "trading at a premium"; risk spreadD) "trading at a discount"; discount premiumAnswer: BComment: Market participants talk of interest rates on non-Treasury securities as “trading at a spread” to a particular on-the-run Treasury security (or a spread to any particular benchmark interest rate selected). For example, if the yield on a 10-year non-Treasury security on May 20, 2008, is 4.78%, then the spread is 100 basis points over the 3.78% Treasury yield. This spread reflects the additional risks the investor faces by acquiring a security that is not issued by the U.S. government and, therefore, can be called a risk premium.Diff: 2Topic: 10.2 The Determinants of the Structure of Interest RatesObjective: 10.13 what factors affect the yield spread between two bonds12) The factors that affect the spread include ________.A) the type of issuer and the expected liquidity of the issueB) the provisions that grant either the issuer or the investor the obligation to do something and the taxability of the interest received by the issuerC) the investor's perceived creditworthiness and the term or maturity of the investor's horizon.D) All of theseAnswer: AComment: The factors that affect the spread are (1) the type of issuer, (2) the issuer’s perceived creditworthiness, (3) the term or maturity of the instrument, (4) provisions that grant either the issuer or the investor the option to do something, (5) the taxability of the interest received by investors, and (6) the expected liquidity of the issue.Diff: 2Topic: 10.2 The Determinants of the Structure of Interest RatesObjective: 10.13 what factors affect the yield spread between two bonds13) Within the corporate market sector, issuers are classified as ________.A) (1) utilities, (2) industrials, (3) finance, and (4) banks.B) (1) high-risk, (2) medium-risk, (3) low-risk, and (4) no-risk.C) (1) foreign, (2) domestic, (3) European, and (4) Asian.D) (1) intramarket, (2) extramarket, (3) ultramarket, and (4) intermarket.Answer: AComment: Within the corporate market sector, issuers are classified as follows: (1) utilities, (2) industrials, (3) finance, and (4) banks.Diff: 2Topic: 10.2 The Determinants of the Structure of Interest RatesObjective: 10.12 the different types of bonds14) The highest-grade bonds are designated by Moody's by the symbol ________.A) BaB) AC) AaD) AaaAnswer: DComment: In all systems, the term high grade means low credit risk, or conversely, high probability of future payments. The highest-grade bonds are designated by Moody’s by the symbol Aaa, and by S&P and Fitch by the symbol AAA. The next highest grade is denoted by the symbol Aa (Moody’s) or AA (S&P and Fitch); for the third grade, all rating systems use A. The next three grades are Baa or BBB, Ba or BB, and B, respectively. There are also C grades. Moody’s uses 1, 2, or 3 to provi de a narrower credit quality breakdown within each class, andS&P and Fitch use plus and minus signs for the same purpose.Diff: 1Topic: 10.2 The Determinants of the Structure of Interest RatesObjective: 10.12 the different types of bonds15) Which of the below statements is FALSE?A) The spread between Treasury securities and non-Treasury securities that are identical in all respects except for credit quality is referred to as a credit spread.B) The spread between any two maturity sectors of the market is called a maturity spread or yield curve spread.C) An option that is included in a bond issue is referred to as a prepayment option.D) The most common type of option in a bond issue is a call provision.Answer: CComment: It is not uncommon for a bond issue to include a provision that gives either the bondholder and/or the issuer an option to take some action against the other party. An option that is included in a bond issue is referred to as an embedded option.Diff: 2Topic: 10.2 The Determinants of the Structure of Interest RatesObjective: 10.12 the different types of bondsTrue/False Questions1 The Theory of Interest Rates1) The liquidity preference theory is Keynes's view that the rate of interest is set in the market for money balances.Answer: TRUEDiff: 1Topic: 10.1 The Theory of Interest RatesObjective: 10.6 the meaning of liquidity preference in Keynes's theory of the determination of interest rates2) Interest is the price paid for the permanent use of resources, and the amount of a loan is its principal.Answer: FALSEComment: Interest is the price paid for the temporary use of resources, and the amount of a loan is its principal.Diff: 1Topic: 10.1 The Theory of Interest RatesObjective: 10.7 how an increase in the money supply can affect the level of the interest rate through an impact on liquidity, income, and price expectations3) In Fisher's terms, the interest rate reflects the interaction of the savers' marginal productivity of capital and borrowers' marginal rate of time preference.Answer: FALSEComment: In Fisher’s terms, the interest rate reflects the interaction of the savers’ marginal rate of time preference and borrowers’ marginal productivity of capital.Diff: 1Topic: 10.1 The Theory of Interest RatesObjective: 10.2 the role in Fisher's theory of the saver's time preference and the borrowing firm's productivity of capital4) The loanable funds theory is an extension of Fisher's theory and proposes that the equilibrium rate of interest reflects the demand and supply of funds, which depend on savers' willingness to save, borrowers' expectations regarding the profitability of investing, and the government's action regarding money supply.Answer: TRUEDiff: 1Topic: 10.1 The Theory of Interest RatesObjective: 10.5 the loanable funds theory, which is an expansion of Fisher's theory2 The Determinants of the Structure of Interest Rates1) Convertible bonds are securities issued by state and local governments and by their creations, such as "authorities" and special districts.Answer: FALSEComment: Municipal bonds are securities issued by state and local governments and by their creations, such as “authorities” and special districts.Diff: 1Topic: 10.2 The Determinants of the Structure of Interest RatesObjective: 10.11 the reason why the yields on U.S. Treasury securities are no longer as popular as benchmark interest rates and what alternative benchmarks are being considered by market participants。
Foundations of Financial Markets and Institutions, 4e (Fabozzi/Modigliani/Jones)Chapter 10 The Level and Structure of Interest RatesMultiple Choice Questions1 The Theory of Interest Rates1) An interest rate is the price paid by a ________ to a ________ for the use of resources during some interval.A) borrower; debtorB) lender; creditorC) borrower; lenderD) lender; borrowerAnswer: CComment: An interest rate is the price paid by a borrower (or debtor) to a lender (or creditor) for the use of resources during some interval.Diff: 2Topic: 10.1 The Theory of Interest RatesObjective: 10.1 Fisher's classical approach to explaining the level of the interest rate2) By the ________, we mean the rate on a loan whose borrower will not default on any obligation.A) risk-free rateB) short termC) real rateD) long termAnswer: AComment: The interest rate that provides the anchor for other rates is the short-term rate:risk-free plus real rate. By short term, we mean the rate on a loan that has one year to maturity. (All other interest rates differ from this rate according to particular aspects of the loan, such as its maturity or risk of default, or because of the presence of inflation.) By the risk-free rate, we mean the rate on a loan whose borrower will not default on any obligation. By the real rate, we mean the rate that would prevail in the economy if the average prices for goods and services were expected to remain constant during the loan’s life.Diff: 1Topic: 10.1 The Theory of Interest RatesObjective: 10.4 the structure of Fisher's Law, which states that the nominal and observable interest rate is composed of two unobservable variables; the real rate of interest and the premium for expected inflation3) By the ________, we mean the rate that would prevail in the economy if the average prices for goods and services were expected to remain constant during the loan's life.A) risk-free rateB) short termC) real rateD) long termAnswer: CComment: The interest rate that provides the anchor for other rates is the short-term rate:risk-free plus real rate. By short term, we mean the rate on a loan that has one year to maturity. (All other interest rates differ from this rate according to particular aspects of the loan, such as its maturity or risk of default, or because of the presence of inflation.) By the risk-free rate, we mean the rate on a loan whose borrower will not default on any obligation. By the real rate, we mean the rate that would prevail in the economy if the average prices for goods and services were expected to remain constant during the loan’s life.Diff: 1Topic: 10.1 The Theory of Interest RatesObjective: 10.4 the structure of Fisher's Law, which states that the nominal and observable interest rate is composed of two unobservable variables; the real rate of interest and the premium for expected inflation4) By the ________, we mean the rate on a loan that has one year to maturity.A) risk-free rateB) short termC) real rateD) long termAnswer: BComment: The interest rate that provides the anchor for other rates is the short-term rate:risk-free plus real rate. By short term, we mean the rate on a loan that has one year to maturity. (All other interest rates differ from this rate according to particular aspects of the loan, such as its maturity or risk of default, or because of the presence of inflation.) By the risk-free rate, we mean the rate on a loan whose borrower will not default on any obligation. By the real rate, we mean the rate that would prevail in the economy if the average prices for goods and services were expected to remain constant during the loan’s life.Diff: 2Topic: 10.1 The Theory of Interest RatesObjective: 10.1 Fisher's classical approach to explaining the level of the interest rate5) Which of the below statements about consumptions and savings is FALSE?A) A chief influence on the saving decision is the individual's marginal rate of time preference, which is the willingness to trade some consumption now for more future consumption.B) Generally, higher current income means the person will save more, although people with the same income may have different time preferences.C) A variable affecting savings is the reward for saving, or the rate of interest on loans that savers make with their unconsumed income.D) The total savings (or the total supply of loans) available at any time is the sum of everybody's savings and a negative function of the interest rate.Answer: DComment: The total savings (or the total supply of loans) available at any time is the sum of everybody’s savings and a positive function of the interest rate.Diff: 2Topic: 10.1 The Theory of Interest RatesObjective: 10.2 the role in Fisher's theory of the saver's time preference and the borrowing firm's productivity of capital6) Which of the below statements about the rate of interest and cost of capital is FALSE?A) The maximum that a firm will invest depends on the rate of interest, which is the cost of loans; the firm will invest only as long as the marginal productivity of capital exceeds or equals the rate of interest.B) Firms will reject only projects whose gain is not less than their cost of financing.C) The firm's demand for borrowing is negatively related to the interest rate; if the rate is high, only limited borrowing and investment make sense.D) At a low rate of interest, more projects offer a profit, and the firm wants to borrow more; his negative relationship exists for each and all firms in the economy.Answer: BComment: The maximum that a firm will invest depends on the rate of interest, which is the cost of loans. The firm will invest only as long as the marginal productivity of capital exceeds or equals the rate of interest. In other words, firms will accept only projects whose gain is not less than their cost of financing. Thus, the firm’s demand for borrowing is negatively related to the interest rate. If the rate is high, only limited borrowing and investment make sense. At a low rate, more projects offer a profit, and the firm wants to borrow more. This negative relationship exists for each and all firms in the economy.Diff: 2Topic: 10.1 The Theory of Interest RatesObjective: 10.2 the role in Fisher's theory of the saver's time preference and the borrowing firm's productivity of capital7) The ________ rate of interest is determined by interaction of the supply and demand functions. As a cost of borrowing and a reward for lending, the rate must reach the point where total supply of savings ________ total demand for borrowing and investment.A) equilibrium; is greaterB) minimum; equalsC) equilibrium; equalsD) minimum; is greaterAnswer: CDiff: 2Topic: 10.1 The Theory of Interest RatesObjective: 10.3 the meaning of equilibrium and how changes in the demand and supply function affect the equilibrium level of the interest rate8) In the absence of inflation, the nominal rate ________ the real rate.A) equalsB) is greater thanC) is less thanD) greater than or equal toAnswer: ADiff: 1Topic: 10.1 The Theory of Interest RatesObjective: 10.3 the meaning of equilibrium and how changes in the demand and supply function affect the equilibrium level of the interest rate9) The relationship between inflation and interest rates is the well-known Fisher's Law, which can be expressed this way: (1 + i) = (1 + r) × (1 + i) where ________.A) r is the nominal rate.B) i is the real rate.C) p is the expected percentage change in the price level of goods and services over the loan's life.D) the nominal rate, p, reflects both the real rate and expected inflation.Answer: CComment: The relationship between inflation and interest rates is the well-known Fisher’s Law, which can be expressed this way: (1 + i) = (1 + r) × (1 + i) where i is the nominal rate, r is the real rate, and p is the expected percentage change in the price level of goods and services over the loan’s life. This equation shows that the nominal rate, i, reflects both the real rate and expected inflation.Diff: 2Topic: 10.1 The Theory of Interest RatesObjective: 10.4 the structure of Fisher's Law, which states that the nominal and observable interest rate is composed of two unobservable variables; the real rate of interest and the premium for expected inflation10) Which of the below IS considered by Fisher's theory.A) Fisher's theory takes into account the power of the government (in concert with depository institutions) to create money.B) Fisher's theory considers the government's often large demand for borrowed funds, which is frequently immune to the level of the interest rateC) Fisher's theory takes into account the possibility that individuals and firms might invest in cash balances.D) Fisher's theory considers an interest rate on loans that embodies no premium for default risk because borrowing firms are assumed to meet all obligations.Answer: DComment: Fisher’s theory is a general one and obviously neglects certain practical matters, such as the power of the government (in concert with depository institutions) to create money and the government’s often la rge demand for borrowed funds, which is frequently immune to the level of the interest rate. Also, Fisher’s theory does not consider the possibility that individuals and firms might invest in cash balances. Expanding Fisher’s theory to encompass these situations produces the loanable funds theory of interest rates.Diff: 2Topic: 10.1 The Theory of Interest RatesObjective: 10.4 the structure of Fisher's Law, which states that the nominal and observable interest rate is composed of two unobservable variables; the real rate of interest and the premium for expected inflation11) The loanable funds theory of interest rates proposes that the general level of interest rates is determined by the complex interaction of two forces. Which of the below is ONE of these forces?A) One force is that the total demand for funds by firms, governments, and households (or individuals) is negatively related to the interest rate including the government's demand.B) One force affecting the level of the interest rate is the total supply of funds by firms, governments, banks, and individuals with rising rates causing banks to be less eager to extend more loans.C) One force is that the total demand for funds by firms, governments, and households (or individuals) is positively related to the interest rate except the government's demand.D) One force affecting the level of the interest rate is the total supply of funds by firms, governments, banks, and individuals with rising rates causing firms and individuals to save and lend more.Answer: DComment: The loanable funds theory of interest rates proposes that the general level of interest rates is determined by the complex interaction of two forces. The first is the total demand for funds by firms, governments, and households (or individuals), which carry out a variety of economic activities with those funds. This demand is negatively related to the interest rate (except for the government’s demand, which may frequently not depend on the level of the interest rate). The second force affecting the level of the interest rate is the total supply of funds by firms, governments, banks, and individuals. Supply is positively related to the level of interest rates, if all other economic factors remain the same. With rising rates, firms and individuals save and lend more, and banks are more eager to extend more loans. (A rising interest rate probably does not significantly affect the government’s supply of savings.)Diff: 3Topic: 10.1 The Theory of Interest RatesObjective: 10.5 the loanable funds theory, which is an expansion of Fisher's theory12) The ________, originally developed by John Maynard Keynes,analyzes the equilibrium level of the interest rate through the interaction of the supply of money and the public's aggregate demand for holding money.A) loanable funds theory of interest ratesB) expectation theory of interest ratesC) liquidity preference theoryD) Fisher theoryAnswer: CDiff: 2Topic: 10.1 The Theory of Interest RatesObjective: 10.6 the meaning of liquidity preference in Keynes's theory of the determination of interest rates13) The public (consisting of individuals and firms) holds money for several reasons. Which of the below is three of these?A) Difficulty of translations, precaution against expected events, and speculation about possible rises in the interest rate.B) Ease of transactions, precaution against unexpected events, and speculation about possible rises in the interest rate.C) Ease of unexpected events, precaution against transactions, and speculation about possible rises in the interest rate.D) Speculation about transactions, fear against unexpected events, and precaution about possible rises in the interest rate.Answer: BDiff: 2Topic: 10.1 The Theory of Interest RatesObjective: 10.6 the meaning of liquidity preference in Keynes's theory of the determination of interest rates14) The ________ represents the initial reaction of the interest rate to a change in the money supply.A) Income effectB) Price expectation effectC) Liquidity effectD) Interest rate effectAnswer: CDiff: 2Topic: 10.1 The Theory of Interest RatesObjective: 10.7 how an increase in the money supply can affect the level of the interest rate through an impact on liquidity, income, and price expectations15) Which of the below statements is FALSE?A) Although an increase in the money supply is an economically expansionary policy, the resultant increase in income depends substantially on the amount of slack in the economy at the time of the Fed's action.B) In Fisher's terms, the interest rate reflects the interaction of the savers' marginal rate of time preference and borrowers' marginal productivity of capital.C) Changes in the money supply can affect the level of interest rates through the liquidity effect, the income effect, and the price expectations effect; their relative magnitudes depend upon the level of economic activity at the time of the change in the money supply.D) Because the price level (and expectations regarding its changes) affects the money demand function, the liquidity effect is an increase in the interest rate.Answer: DComment: Because the price level (and expectations regarding its changes) affects the money demand function, the price expectations effect is an increase in the interest rate.Diff: 2Topic: 10.1 The Theory of Interest RatesObjective: 10.7 how an increase in the money supply can affect the level of the interest rate through an impact on liquidity, income, and price expectations2 The Determinants of the Structure of Interest Rates1) A ________ is an instrument in which the issuer (debtor/borrower) promises to repay to the lender/investor the amount borrowed plus interest over some specified period of time.A) bondB) common stockC) preferred stockD) T-billAnswer: ADiff: 1Topic: 10.2 The Determinants of the Structure of Interest RatesObjective: 10.8 the features of a bond issue2) The ________ should reflect the coupon interest that will be earned plus either (1) any capital gain that will be realized from holding the bond to maturity, or (2) any capital loss that will be realized from holding the bond to maturity.A) yield on a bond investmentB) dividend yield on a bond investmentC) bid-ask spreadD) yield on a stock investmentAnswer: ADiff: 1Topic: 10.2 The Determinants of the Structure of Interest RatesObjective: 10.8 the features of a bond issue3) The ________ the market price, the higher the yield to maturity.A) higherB) less riskyC) more safeD) lowerAnswer: DDiff: 1Topic: 10.2 The Determinants of the Structure of Interest RatesObjective: 10.8 the features of a bond issue4) The ________ of a bond is the amount that the issuer agrees to repay the bondholder at the maturity date.A) principal value (or simply principal)B) face valueC) redemption valueD) All of theseAnswer: DComment: The principal value (or simply principal) of a bond is the amount that the issuer agrees to repay the bondholder at the maturity date. This amount is also referred to as the par value, maturity value, redemption value, or face value.Diff: 2Topic: 10.2 The Determinants of the Structure of Interest RatesObjective: 10.8 the features of a bond issue5) The yield to maturity is determined by a trial-and-error process. The first step in this trial and error process is ________.A) Compute the present value of each cash flow using the best guess interest rate.B) Total the present value of the cash flows using the best guess interest rate.C) Select an interest rate.D) Compare the total present value using the best guess interest rate with the market price of the bond.Answer: CComment: The yield to maturity is determined by a trial-and-error process. Even the algorithm in a calculator or computer program, which computes the yield to maturity (or internal rate of return) in an apparently direct way, uses a trial-and-error process. The steps in that process are as follows:Step 1: Select an interest rate.Step 2: Compute the present value of each cash flow using the interest rate selected in Step 1. Step 3: Total the present value of the cash flows found in Step 2.Step 4: Compare the total present value found in Step 3 with the market price of the bond and, if the total present value of the cash flows found in Step 3 is• equal to the market price, then the interest rate used in Step 1 is the yield to maturity;• greater than the market price, then the interest rate is not the yield to maturity. Therefore, go back to Step 1 and use a higher interest rate;• less than the market price, then the interest rate is not the yield to maturity. Therefore, go back to Step 1 and use a lower interest rate.Diff: 2Topic: 10.2 The Determinants of the Structure of Interest RatesObjective: 10.9 how the yield to maturity of a bond is calculated6) There are several interesting points about the relationship among the coupon rate, market price, and yield to maturity. Which of the below is NOT one of these.A) If the market price is equal to the par value, then the yield to maturity is equal to the coupon rate.B) If the market price is less than the par value, then the yield to maturity is greater than the coupon rate.C) If the market price is greater than the par value, then the yield to maturity is greater than the coupon rate.D) If the market price is greater than the par value, then the yield to maturity is less than the coupon rate.Answer: CComment: There are several interesting points about the relationship among the coupon rate, market price, and yield to maturity as summarized below.1. If the market price is equal to the par value, then the yield to maturity is equal to the coupon rate;2. If the market price is less than the par value, then the yield to maturity is greater than the coupon rate, and;3. If the market price is greater than the par value, then the yield to maturity is less than the coupon rate.Diff: 2Topic: 10.2 The Determinants of the Structure of Interest RatesObjective: 10.9 how the yield to maturity of a bond is calculated7) Consider an 20-year bond with a coupon rate of 8% and a par value of $1,000. The cash flow for this bond is ________ every six months for the first 39 semi-annual periods and then________ for the last (or 40th) six-month period.A) $1,040; $40B) $40; $1,040C) $80; $1,080D) $80; $1,000Answer: BComment: Consider an 20-year bond with a coupon rate of 8% and a par value of $1,000. The cash flow for this bond is $40 every six months for the first 39 semi-annual periods and then $1,040 for the last (or 40th) six-month period.Diff: 2Topic: 10.2 The Determinants of the Structure of Interest RatesObjective: 10.8 the features of a bond issue8) The difference between the yield on any two bond issues is called a ________.A) yield differenceB) difference spreadC) coupon rate spreadD) yield spreadAnswer: DDiff: 2Topic: 10.2 The Determinants of the Structure of Interest RatesObjective: 10.13 what factors affect the yield spread between two bonds9) Treasury securities are used to develop the benchmark interest rates. There are two categories of U.S. Treasury securities: ________.A) discount and coupon securities.B) discount and coupon stocks.C) interest rate and coupon securities.D) discount and compound securities.Answer: ADiff: 2Topic: 10.2 The Determinants of the Structure of Interest RatesObjective: 10.1 Fisher's classical approach to explaining the level of the interest rate10) The most recently auctioned Treasury issues for each maturity are referred to as ________.A) off-the-run issues or current coupon issues.B) minimum interest rate or base interest rateC) on-the- run or current coupon issues.D) benchmark interest rate or minimum interest rate.Answer: CComment: The most recently auctioned Treasury issues for each maturity are referred to as on-the- run or current coupon issues. Issues auctioned prior to the current coupon issues are typically referred to as off-the- run issues; they are not as liquid as on-the-run issues, and, therefore, offer a higher yield than the corresponding on-the-run Treasury issue. The minimum interest rate or base interest rate that investors will demand for investing in a non-Treasury security is the yield offered on a comparable maturity on-the-run Treasury security. The base interest rate is also referred to as the benchmark interest rate.Diff: 2Topic: 10.2 The Determinants of the Structure of Interest RatesObjective: 10.10 why historically the yields on securities issued by the U.S. Department of the Treasury have been used as the benchmark interest rates throughout the world11) Market participants talk of interest rates on non-Treasury securities as ________ to a particular on-the-run Treasury security (or a spread to any particular benchmark interest rate selected). This spread reflects the additional risks the investor faces by acquiring a security thatis not issued by the U.S. government and, therefore, can be called a ________.A) "trading at a premium"; risk premiumB) "trading at a spread"; risk premiumC) "trading at a premium"; risk spreadD) "trading at a discount"; discount premiumAnswer: BComment: Market participants talk of interest rates on non-Treasury securities as “trading at a spread” to a particular on-the-run Treasury security (or a spread to any particular benchmark interest rate selected). For example, if the yield on a 10-year non-Treasury security on May 20, 2008, is 4.78%, then the spread is 100 basis points over the 3.78% Treasury yield. This spread reflects the additional risks the investor faces by acquiring a security that is not issued by the U.S. government and, therefore, can be called a risk premium.Diff: 2Topic: 10.2 The Determinants of the Structure of Interest RatesObjective: 10.13 what factors affect the yield spread between two bonds12) The factors that affect the spread include ________.A) the type of issuer and the expected liquidity of the issueB) the provisions that grant either the issuer or the investor the obligation to do something and the taxability of the interest received by the issuerC) the investor's perceived creditworthiness and the term or maturity of the investor's horizon.D) All of theseAnswer: AComment: The factors that affect the spread are (1) the type of issuer, (2) the issuer’s perceived creditworthiness, (3) the term or maturity of the instrument, (4) provisions that grant either the issuer or the investor the option to do something, (5) the taxability of the interest received by investors, and (6) the expected liquidity of the issue.Diff: 2Topic: 10.2 The Determinants of the Structure of Interest RatesObjective: 10.13 what factors affect the yield spread between two bonds13) Within the corporate market sector, issuers are classified as ________.A) (1) utilities, (2) industrials, (3) finance, and (4) banks.B) (1) high-risk, (2) medium-risk, (3) low-risk, and (4) no-risk.C) (1) foreign, (2) domestic, (3) European, and (4) Asian.D) (1) intramarket, (2) extramarket, (3) ultramarket, and (4) intermarket.Answer: AComment: Within the corporate market sector, issuers are classified as follows: (1) utilities, (2) industrials, (3) finance, and (4) banks.Diff: 2Topic: 10.2 The Determinants of the Structure of Interest RatesObjective: 10.12 the different types of bonds14) The highest-grade bonds are designated by Moody's by the symbol ________.A) BaB) AC) AaD) AaaAnswer: DComment: In all systems, the term high grade means low credit risk, or conversely, high probability of future payments. The highest-grade bonds are designated by Moody’s by the symbol Aaa, and by S&P and Fitch by the symbol AAA. The next highest grade is denoted by the symbol Aa (Moody’s) or AA (S&P and Fitch); for the third grade, all rating systems use A. The next three grades are Baa or BBB, Ba or BB, and B, respectively. There are also C grades. Moody’s uses 1, 2, or 3 to provi de a narrower credit quality breakdown within each class, andS&P and Fitch use plus and minus signs for the same purpose.Diff: 1Topic: 10.2 The Determinants of the Structure of Interest RatesObjective: 10.12 the different types of bonds15) Which of the below statements is FALSE?A) The spread between Treasury securities and non-Treasury securities that are identical in all respects except for credit quality is referred to as a credit spread.B) The spread between any two maturity sectors of the market is called a maturity spread or yield curve spread.C) An option that is included in a bond issue is referred to as a prepayment option.D) The most common type of option in a bond issue is a call provision.Answer: CComment: It is not uncommon for a bond issue to include a provision that gives either the bondholder and/or the issuer an option to take some action against the other party. An option that is included in a bond issue is referred to as an embedded option.Diff: 2Topic: 10.2 The Determinants of the Structure of Interest RatesObjective: 10.12 the different types of bondsTrue/False Questions1 The Theory of Interest Rates1) The liquidity preference theory is Keynes's view that the rate of interest is set in the market for money balances.Answer: TRUEDiff: 1Topic: 10.1 The Theory of Interest RatesObjective: 10.6 the meaning of liquidity preference in Keynes's theory of the determination of interest rates2) Interest is the price paid for the permanent use of resources, and the amount of a loan is its principal.Answer: FALSEComment: Interest is the price paid for the temporary use of resources, and the amount of a loan is its principal.Diff: 1Topic: 10.1 The Theory of Interest RatesObjective: 10.7 how an increase in the money supply can affect the level of the interest rate through an impact on liquidity, income, and price expectations3) In Fisher's terms, the interest rate reflects the interaction of the savers' marginal productivity of capital and borrowers' marginal rate of time preference.Answer: FALSEComment: In Fisher’s terms, the interest rate reflects the interaction of the savers’ marginal rate of time preference and borrowers’ marginal productivity of capital.Diff: 1Topic: 10.1 The Theory of Interest RatesObjective: 10.2 the role in Fisher's theory of the saver's time preference and the borrowing firm's productivity of capital4) The loanable funds theory is an extension of Fisher's theory and proposes that the equilibrium rate of interest reflects the demand and supply of funds, which depend on savers' willingness to save, borrowers' expectations regarding the profitability of investing, and the government's action regarding money supply.Answer: TRUEDiff: 1Topic: 10.1 The Theory of Interest RatesObjective: 10.5 the loanable funds theory, which is an expansion of Fisher's theory2 The Determinants of the Structure of Interest Rates1) Convertible bonds are securities issued by state and local governments and by their creations, such as "authorities" and special districts.Answer: FALSEComment: Municipal bonds are securities issued by state and local governments and by their creations, such as “authorities” and special districts.Diff: 1Topic: 10.2 The Determinants of the Structure of Interest RatesObjective: 10.11 the reason why the yields on U.S. Treasury securities are no longer as popular as benchmark interest rates and what alternative benchmarks are being considered by market participants。
ANSWERS TO QUESTIONS FOR CHAPTER 9(Questions are in bold print followed by answers.)1. Your broker is recommending that you purchase U.S. government bonds. Here is the explanation: Listen, in these times of uncertainty, with many companies going bankrupt, it makes sense to play it safe and purchase long-term government bonds. They are issued by the U.S. government, so they are risk free. How would you respond to the broker?U.S. Government bonds may be free of default risk, but they are not free from interest rate risk, which may cause the bond price to decline, resulting in a capital loss should the holder of bond sell it before maturity. Even then there is the inflation premium risk, which means that the principal may have less purchasing power at maturity than it does today.2. You just inherited 30,000 shares of a company you have never heard of, ABD Corporation. You call your broker to find out if you have finally struck it rich. After several minutes, she comes back on the telephone and says: “I don’t have a clue about these shares. It’s too bad they are not traded in a financial market. That would make life a lot easier for you. ”What does she mean by this?If the shares are traded on the market, and if the market is efficient, the current price would denote the value of the stock. Without market price information, share value would have to be approximated through other time-consuming and less reliable methods.3. Suppose you own a bond that pays $75 yearly in coupon interest and that is likely to be called in two years (because the firm has already announced that it will redeem the issue early). The call price will be $1,050.What is the price of your bond now, in the market, if the appropriate discount rate for this asset is 9%?P O = $75 (PVIFA) 2.09 + $1050 (PVIF) 2.09= $75 X 1.7591 + $1050 X .8417 = $1015.724. Your broker has advised you to buy shares of Hungry Boy Fast Foods, which has paid a dividend of $1.00 per year for 10 years and will (according to the broker) continue to do so for many years. The broker believes that the stock, which now has a price of $12, will be worth $25 per share in five years. You have good reason to think that the discount rate for this firm’s stock is 22% per year, because that rate compensates the buyer fo r all pertinent risks. Is the stock’s present price a good approximation of its true financial value?P O= $1 (PVIFA) 5.22 + $25 X (PVIF) 5.22 = .3715 = $12.15The price is right, in fact the stock is slightly undervalued.5. You have been considering a zero-coupon bond, which pays no interest but will pay a principal of $1,000 at the end of five years. The price of the bond is now $712.99, and its required rate of return is 7.0%. This morning’s news contained a surprising development. The government announced that the rate of inflation appears to be 5.5% instead of the 4% that most people had been expecting. (Suppose most people had thought the real rate of interest was 3%.) What would be the price of the bond, once the market began to absorb this new information about inflation?The nominal required rate of return is (real rate plus inflation) i r + i f or currently 3% plus 4% = 7%. If i f becomes 5.5% then the new required rate of return becomes 8.5%. The price of the bond would then be $1000/(1.085)5 or $665.05.6. State the difference in basis points between each of the following:a. 5.5% and 6.5%b.7% and 9%c. 6.4% and 7.8%d.9.1% and 11.9%a.100 basis pointsb.200 basis pointsc.140 basis pointsd.280 basis points7.a.Does a rise of 100 basis points in the discount rate change the price of a 20-yearbond as much as it changes the price of a four-year bond, assuming that both bonds have the same coupon rate and offer the same yield?b.Does a rise of 100 basis points in the discount rate change the price of a 4% couponbond as much as it changes the price of a 10% coupon bond, assuming that bothbonds have the same maturity and offer the same yield?c.Does a rise of 100 basis points in the discount rate change the price of a 10-yearbond to the same extent if the discount rate is 4% as it does if the discount rate is12%?a.The price of the 20-year bond will fall more than that of the 4-year bond because there aremore years for the new discount to apply to the cash flows of the 20-year bond.b.The price of the low coupon bond will change more due to the low amount of cash flows thatcan be reinvested at the higher rate.c. A change from the 4% base will lead to a larger change in price.8.During the early 1980s, interest rates for many long-term bonds were above 14%. In the early 1990s, rates on similar bonds were far lower. What do you think this dramatic decline in market interest rates means for the price volatility of bonds in response to a change in interest rates?Since the direction of the interest rate change is downward, price volatility should increase.9.a.What is the cash flow of a 6% coupon bond that pays interest annually, matures inseven years, and has a principal of $1,000?b.Assuming a discount rate of 8%, what is the price of this bond?c.Assuming a discount rate of 8.5%, what is the price of this bond?d.Assuming a discount rate of 7.5%, what is the price of this bond?e.What is the duration of this bond, assuming that the price is the one you calculatedin part (b)?f.If the yield changes by 100 basis points, from 8% to 7%, by how much would youapproximate the percentage price change to be using your estimate of duration inpart (e)?g.What is the actual percentage price change if the yield changes by 100 basis points?a.$60 a year interest for 7 years plus $1000 principal in year 7 for a total of $1420 in cash flow.b. 5.2064 X $60 + .583 X $1000 = $895.38c. 5.119 X $60 + .565 X $1000 = $872.14d. 5.297 X $60 + .603 X $1000 = $920.82e. D = $920-.82-$872.14=$48.68/8.95=5.44$895.38 (0.85-.075)f.Applying the formula-D (change in yield) = -5.44 (.01) or a price increase of 5.42%.g.Price at 8% =$895.88, at 7% = $946.06, so actual percentage change is ($946.06 -$895.88)/$895.88=5.6%.10. Why is it important to be able to estimate the duration of a bond or bond portfolio?To answer this question, we must understand that duration is related to percentage price change.A simple formula can be used to calculate the approximate duration of a bond or bond portfolio. All we are interested in is the percent price change of a bond when interest rates change by a small amount. To control interest rate risk, it is thus necessary to be able to measure it. Duration provides that measure.11. Explain why you agree or disagree with the following statement: “Determining the duration of a financial asset is a simple process.”Disagree. Determining the duration of a financial asset is not simple process. Because for most assets, the cash flow can change when interest rates change. Therefore, if a change in the cash flow is not considered, duration calculations can be misleading.12. Explain why the effective duration is a more appropriate measure of a complex financial instrument’s price sensitivity to interest rate changes than is modified duration. Modified duration is derived with the assumption that cash flows do not change as interest rates change. Effective duration is calculated with the assumption of changing cash flows. For complex financial instruments’ price sensitivity to interest rate changes could be very large. Hence, the importance of effective duration becomes significant.。
Financial Markets and Institutions, 8e (Mishkin)Chapter 13 The Stock Market13.1 Multiple Choice1) (I) A share of common stock in a firm represents an ownership interest in that firm. (II) A share of preferred stock is as much like a bond as it is like common stock.A) (I) is true, (II) false.B) (I) is false, (II) true.C) Both are true.D) Both are false.Answer: CTopic: Chapter 13.1 Investing in StocksQuestion Status: Previous Edition2) Preferred stockholders hold a claim on assets that has priority over the claims ofA) 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: CTopic: Chapter 13.1 Investing in StocksQuestion Status: Previous Edition3) (I) Preferred stockholders hold a claim on assets that has priority over the claims of common stockholders, but after that of bondholders.(II) Firms issue preferred stock in far greater amounts than common stock.A) (I) is true, (II) false.B) (I) is false, (II) true.C) Both are true.D) Both are false.Answer: ATopic: Chapter 13.1 Investing in StocksQuestion Status: Previous Edition4) (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: CTopic: Chapter 13.1 Investing in StocksQuestion Status: Previous Edition5) (I) Firms issue common stock in far greater amounts than preferred stock.(II) In a given year, the total volume of stock issued is much less than the volume of bonds issued.A) (I) is true, (II) false.B) (I) is false, (II) true.C) Both are true.D) Both are false.Answer: CTopic: Chapter 13.1 Investing in StocksQuestion Status: Previous Edition6) The riskiest capital market security isA) preferred stock.B) common stock.C) corporate bonds.D) Treasury bonds.Answer: BTopic: Chapter 13.1 Investing in StocksQuestion Status: Previous Edition7) (I) The largest of the organized stock exchanges in the United States is the New York Stock Exchange.(II) To be listed on the NYSE, a firm must have a minimum of $100 million in market value or $10 million in revenues.A) (I) is true, (II) false.B) (I) is false, (II) true.C) Both are true.D) Both are false.Answer: ATopic: Chapter 13.1 Investing in StocksQuestion Status: Previous Edition8) To list on the NYSE, a firm mustA) have earnings of at least $10 million per year.B) have at least $500 million in outstanding debt.C) have a total of $100 million in market value.D) meet all of the above requirements.E) meet A and C of the above requirements.Answer: ETopic: Chapter 13.1 Investing in StocksQuestion Status: Updated from Previous Edition9) Securities not listed on one of the exchanges trade in the over-the-counter market. In this exchange, dealers "make a market" byA) buying stocks for inventory when investors want to sell.B) selling stocks from inventory when investors want to buy.C) doing both of the above.D) doing neither of the above.Answer: CTopic: Chapter 13.1 Investing in StocksQuestion Status: Previous Edition10) The most active stock exchange in the world is theA) Nikkei Stock Exchange.B) London Stock Exchange.C) Shanghai Stock Exchange.D) New York Stock Exchange.Answer: ATopic: Chapter 13.1 Investing in StocksQuestion Status: Previous Edition11) Which of the following statements about trading operations in an organized exchange is correct?A) Floor traders all deal in a wide variety of stocks.B) In most trades, specialists match buy and sell orders.C) In most trades, specialists buy for or sell from their own inventories.D) The SuperDOT system is used to expedite large trades of over 100,000 shares. Answer: BTopic: Chapter 13.1 Investing in StocksQuestion Status: Previous Edition12) Which of the following is not an advantage of Electronic Communications Networks (ECNs)?A) All unfilled orders are available for review by ECN traders.B) Transactions costs are lower for ECN trades.C) Trades are made and confirmed faster.D) ECNs work well for thinly traded stocks.Answer: DTopic: Chapter 13.1 Investing in StocksQuestion Status: Previous Edition13) Which of the following statements is false regarding Electronic Communications Networks (ECNs)?A) Archipelago and Instinet are two examples of ECNs.B) Competition from ECNs has forced NASDAQ to cut its fees.C) Traders benefit from lower trading costs and faster service.D) ECNs allow institutional investors, but not individuals, to trade after hours. Answer: DTopic: Chapter 13.1 Investing in StocksQuestion Status: Previous Edition14) A basic principle of finance is that the value of any investment isA) the present value of all future net cash flows generated by the investment.B) the undiscounted sum of all future net cash flows generated by the investment.C) unrelated to the future net cash flows generated by the investment.D) unrelated to the degree of risk associated with the future net cash flows generated by the investment.Answer: ATopic: Chapter 13.2 Computing the Price of Common StockQuestion Status: Previous Edition15) 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) $30.24B) $26.30C) $26.09D) $27.74Answer: BTopic: Chapter 13.2 Computing the Price of Common StockQuestion Status: Previous Edition16) A stock currently sells for $30 per share and pays $1.00 per year in dividends. What is an investor's valuation of this stock if he expects it to be selling for $37 in one year and requires a 12 percent return on equity investments?A) $38B) $33.50C) $34.50D) $33.93Answer: DTopic: Chapter 13.2 Computing the Price of Common StockQuestion Status: Previous Edition17) In the one-period valuation model, a stock's value will be higherA) 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: ATopic: Chapter 13.2 Computing the Price of Common StockQuestion Status: Previous Edition18) In the one-period valuation model, a stock's value falls if the ________ rises.A) dividendB) expected future priceC) required return on equityD) current priceAnswer: CTopic: Chapter 13.2 Computing the Price of Common StockQuestion Status: Previous Edition19) In the generalized dividend valuation model, a stock's value depends only onA) its future dividend payments and its future price.B) its future dividend payments and the required return on equity.C) its future price and the required return on investments on equity.D) its future dividend payments.Answer: BTopic: Chapter 13.2 Computing the Price of Common StockQuestion Status: Previous Edition20) Which of the following is not an element of the Gordon growth model of stock valuation?A) The stock's most recent dividend paidB) The expected constant growth rate of dividendsC) The required return on investments in equityD) The stock's expected future priceAnswer: DTopic: Chapter 13.2 Computing the Price of Common StockQuestion Status: Previous Edition21) 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 11 percent?A) $110B) $100C) $11D) $10E) $5.24Answer: ATopic: Chapter 13.2 Computing the Price of Common StockQuestion Status: Previous Edition22) 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) $20B) $11C) $22D) $7.33E) $4.40Answer: CTopic: Chapter 13.2 Computing the Price of Common StockQuestion Status: Previous Edition23) Holding other things constant, a stock's value will be highest if its dividend growth rate isA) 15%.B) 10%.C) 5%.D) 2%.Answer: ATopic: Chapter 13.2 Computing the Price of Common StockQuestion Status: Previous Edition24) Holding other things constant, a stock's value will be highest if its most recent dividend isA) $2.00.B) $5.00.C) $0.50.D) $1.00.Answer: BTopic: Chapter 13.2 Computing the Price of Common StockQuestion Status: Previous Edition25) Holding other things constant, a stock's value will be highest if the investor's required return on investments in equity isA) 20%.B) 15%.C) 10%.D) 5%.Answer: DTopic: Chapter 13.2 Computing the Price of Common Stock Question Status: Previous Edition26) Suppose the average industry PE ratio for auto parts retailers is 20. What is the current price of Auto Zone stock if the retailer's earnings per share is projected to be $1.85?A) $21.85B) $37C) $10.81D) $9.25Answer: BTopic: Chapter 13.2 Computing the Price of Common StockQuestion Status: Previous Edition27) Which of the following is true regarding the Gordon growth model?A) Dividends are assumed to grow at a constant rate forever.B) The dividend growth rate is assumed to be greater than the required return on equity.C) Both A and B of the above.D) Neither A nor B of the above.Answer: ATopic: Chapter 13.2 Computing the Price of Common StockQuestion Status: Previous Edition28) The PE ratio approach to valuing stock is especially useful for valuingA) privately held firms.B) firms that don't pay dividends.C) both A and B of the above.D) neither A nor B of the above.Answer: CTopic: Chapter 13.2 Computing the Price of Common StockQuestion Status: Previous Edition29) The PE ratio approach to valuing stock is especially useful for valuingA) publicly held corporations.B) firms that regularly pay dividends.C) both A and B of the above.D) neither A nor B of the above.Answer: DTopic: Chapter 13.2 Computing the Price of Common StockQuestion Status: Previous Edition30) A weakness of the PE approach to valuing stock is that it isA) difficult to estimate the constant growth rate of a firm's dividends.B) difficult to estimate the required return on equity.C) difficult to predict how much a firm will pay in dividends.D) based on industry averages rather than firm-specific factors.Answer: DTopic: Chapter 13.2 Computing the Price of Common Stock Question Status: Previous Edition31) (I) The market price of a security at a given time is the highest value any investor puts on the security. (II) Superior information about a security increases its value by reducing its risk.A) (I) is true, (II) is false.B) (I) is false, (II) is true.C) Both are true.D) Both are false.Answer: BTopic: Chapter 13.2 Computing the Price of Common StockQuestion Status: Previous Edition32) The main cause of fluctuations in stock prices is changes inA) tax laws.B) errors in technical stock analysis.C) daily trading volume in stock markets.D) information available to investors.E) total household wealth in the economy.Answer: DTopic: Chapter 13.3 How the Market Sets Security PricesQuestion Status: Previous Edition33) Stock values computed by valuation models may differ from actual market prices because it is difficult toA) estimate future dividend growth rates.B) estimate the risk of a stock.C) forecast a stock's future dividends.D) all of the above are true.Answer: DTopic: Chapter 13.4 Errors in ValuationQuestion Status: Previous Edition34) The 2001 terrorist attacks and the Enron financial scandal caused anticipated dividend growth to ________, investors' required return on equity to ________, and stock prices to ________.A) decrease; increase; decreaseB) decrease; increase; increaseC) increase; decrease; decreaseD) increase; decrease; increaseAnswer: ATopic: Chapter 13.4 Errors in ValuationQuestion Status: Previous Edition35) Which of the following is not an objective of the Securities and Exchange Commission?A) Maintain integrity of the securities marketsB) Advise investors about which particular stocks are good buysC) Require firms to provide specific information to investorsD) Regulate major participants in securities marketsAnswer: BTopic: Chapter 13.6 Regulation of the Stock MarketQuestion Status: Previous Edition36) A share of common stock in a firm represents an ownership interest in that firm and allows stockholders toA) vote.B) receive dividends.C) receive interest payments.D) only A and B of the above.Answer: DTopic: Chapter 13.1 Investing in StocksQuestion Status: Previous Edition37) In 2013, the NYSE traded ________ shares on an average trading day.A) 4 billionB) 7 billionC) 10 billionD) 12 billionAnswer: ATopic: Chapter 13.1 Investing in StocksQuestion Status: Updated from Previous Edition38) Exchange traded funds (ETFs) have which of the following features?A) They are listed and traded as individual stocks on a stock exchange.B) They are indexed rather than actively managed.C) Their value is based on the underlying net asset value of the stocks held in the index basket.D) All of the above.Answer: DTopic: Chapter 13.1 Investing in StocksQuestion Status: Previous Edition39) What is the primary disadvantage of an ETF?A) ETFs tend to have lower management fees than comparable index mutual bonds.B) ETFs usually have no minimum investment amount.C) Investors have to pay a broker commission each time they buy or sell shares.D) None of the above are disadvantages of an ETF.Answer: CTopic: Chapter 13.1 Investing in Stocks Question Status: Previous Edition40) A high price earnings ratio (PE) gives what interpretation?A) The market expects earnings to fall in the future.B) The market feels the firm's earnings are very high risk and are willing to pay a premium for them.C) The market expects the earnings to rise in the future.D) The firm is not paying a dividend.Answer: CTopic: Chapter 13.2 Computing the Price of Common StockQuestion Status: Previous Edition41) A ________ PE may indicate that the market feels the firm's earnings are very ________ risk and is therefore willing to pay a ________ for them.A) high; low; premiumB) high; high; discountC) low; low; discountD) high; high; premiumAnswer: ATopic: Chapter 13.2 Computing the Price of Common StockQuestion Status: Previous Edition42) The subprime financial crisis led to one of the worst bear markets in the last 50 years. Stock prices likely fell due toA) an increase in required returns on equity investments.B) a decline in growth prospects for U.S. companies.C) Both A and B are likely reasons.D) None of the above are correct.Answer: ATopic: Chapter 13.4 Errors in ValuationQuestion Status: New Question43) The Securities Acts of 1933 and 1934 established the S.E.C. to enforce which of the follow laws?A) Require firms to tell the public the truth about their businesses.B) Require brokers, dealers, and exchanges to treat investors fairly.C) To ensure that no investment ever loses money.D) All of the above are laws the S.E.C. enforces.E) A and B above are laws the S.E.C. enforces.Answer: ETopic: Chapter 13.6 Regulation of the Stock MarketQuestion Status: New Question44) Which of the following is not a division of the S.E.C.?A) The Division of Fraud InvestigationB) The Division of Corporate FinanceC) The Division of Market RegulationD) The Division of Investment ManagementE) The Division of EnforcementAnswer: ATopic: Chapter 13.6 Regulation of the Stock MarketQuestion Status: New Question13.2 True/False1) More stock trading in the U.S. occurs in over-the-counter markets rather than on organized exchanges.Answer: FALSETopic: Chapter 13.1 Investing in StocksQuestion Status: Previous Edition2) In over-the-counter markets, dealers increase the liquidity of thinly traded securities.Answer: TRUETopic: Chapter 13.1 Investing in StocksQuestion Status: Previous Edition3) Electronic Communications Networks apply technology to make organized exchanges more efficient and speedy.Answer: FALSETopic: Chapter 13.1 Investing in StocksQuestion Status: Previous Edition4) All stocks pay dividends, as that is the only way an investor can profit from holding stock.Answer: FALSETopic: Chapter 13.1 Investing in StocksQuestion Status: Previous Edition5) Common stock is the riskiest corporate security, followed by preferred stock and then bonds.Answer: TRUETopic: Chapter 13.1 Investing in StocksQuestion Status: Previous Edition6) The Enron financial scandal increased uncertainty about the quality of accounting information and as a result, increased required return on investment in stocks. Answer: TRUETopic: Chapter 13.4 Errors in Valuation Question Status: Previous Edition7) The Dow Jones Industrial Average is the broadest and best indicator of the stock market's day-to-day performance.Answer: FALSETopic: Chapter 13.4 Stock Market IndexesQuestion Status: Previous Edition8) The Securities and Exchange Commission requires firms to submit various documents to increase the flow of information to investors but does not verify the accuracy of that information.Answer: TRUETopic: Chapter 13.6 Regulation of the Stock MarketQuestion Status: Previous Edition9) About half of new equity issues are preferred stock.Answer: FALSETopic: Chapter 13.1 Investing in StocksQuestion Status: Previous Edition10) A stock's market value will be higher the higher its expected dividend stream is, all else being equal.Answer: TRUETopic: Chapter 13.2 Computing the Price of Common StockQuestion Status: Previous Edition11) The Gordon growth model assumes that a stock's dividend grows at a constant rate forever.Answer: TRUETopic: Chapter 13.2 Computing the Price of Common StockQuestion Status: Previous Edition12) A stock's market value will be higher the higher the investor's required rate of return is, all else being equal.Answer: FALSETopic: Chapter 13.2 Computing the Price of Common StockQuestion Status: Previous Edition13) A lower than average PE may mean that the market expects earnings to rise in the future.Answer: FALSETopic: Chapter 13.2 Computing the Price of Common StockQuestion Status: Previous Edition14) About 75% of orders to buy or sell on the NYSE are executed using SuperDOT. Answer: TRUETopic: Chapter 13.1 Investing in StocksQuestion Status: Updated from Previous Edition13.3 Essay1) How do corporate stocks differ from bonds?Topic: Chapter 13.1 Investing in StocksQuestion Status: Previous Edition2) How do common stocks differ from preferred stocks?Topic: Chapter 13.1 Investing in StocksQuestion Status: Previous Edition3) How do over-the-counter markets differ from organized exchanges?Topic: Chapter 13.1 Investing in StocksQuestion Status: Previous Edition4) What is the role of specialists on a stock exchange?Topic: Chapter 13.1 Investing in StocksQuestion Status: Previous Edition5) What are the advantages and disadvantages of Electronic Communications Networks (ECNs) for trading stocks?Topic: Chapter 13.1 Investing in StocksQuestion Status: Previous Edition6) What is the role of the required return on equity investments in stock valuation models?Topic: Chapter 13.2 Computing the Price of Common StockQuestion Status: Previous Edition7) Using the Gordon growth model, explain why the 2001 terrorist attacks and the Enron financial scandal caused stock prices to decline.Topic: Chapter 13.2 Computing the Price of Common StockQuestion Status: Previous Edition8) What are American Depository Receipts (ADRs)?Topic: Chapter 13.5 Buying Foreign StocksQuestion Status: Previous Edition9) What are the objectives of the Securities and Exchange Commission?Topic: Chapter 13.6 Regulation of the Stock MarketQuestion Status: Previous Edition10) What are the advantages and disadvantages of exchange traded funds (ETFs) fro trading stocks?Topic: Chapter 13.1 Investing in StocksQuestion Status: Previous Edition11) Why would a crisis in the subprime mortgage market lead to declining prices in the U.S. equity markets?Topic: Chapter 13.4 Errors in ValuationQuestion Status: New Question。
Foundations of Financial Markets and Institutions, 4e (Fabozzi/Modigliani/Jones)Chapter 13 Primary Markets and the Underwriting of Securities Multiple Choice Questions1 The Traditional Process for Issuing New Securities1) The ________ involves the distribution to investors of newly issued securities by centralgovernments, its agencies, municipal governments, and corporationsA) OTC marketB) secondary marketC) primary marketD) stock marketAnswer: CDiff: 1Topic: 13.1 The Traditional Process for Issuing New SecuritiesObjective: 13.1 the role investment bankers play in the distribution of newly issued securities2) The participants in the marketplace that work with issuers to distribute newly issued securitiesare called investment bankers. Investment banking is performed by two groups:________.A) commercial banks and securities houses.B) hometown banks and securities houses.C) commercial banks and bank houses.D) savings & loans and bank houses.Answer: ADiff: 2Topic: 13.1 The Traditional Process for Issuing New SecuritiesObjective: 13.1 the role investment bankers play in the distribution of newly issued securities3) The traditional process in the United States for issuing new securities involves investmentbankers performing up to three functions. Which of the below is NOT one of these functions?A) One function is advising the issuer on the terms and the timing of the offering.B) One function is selling the securities to the issuer.C) One function is distributing the issue to the public.D) One function is buying the securities from the issuer.Answer: BComment: The traditional process in the United States for issuing new securities involvesinvestment bankers performing one or more of the following three functions:(1) advising the issuer on the terms and the timing of the offering,(2) buying the securities from the issuer, and(3) distributing the issue to the public.Diff: 1Topic: 13.1 The Traditional Process for Issuing New Securities13.1 the role investment bankers play in the distribution of newly issued securities Objective:4) An investment banker may merely act as an advisor and/or distributor of the new security. Thefunction of buying the securities from the issuer is called ________.A) advising.B) distributing.C) purchasing.D) underwriting.Answer: DDiff: 2Topic: 13.1 The Traditional Process for Issuing New SecuritiesObjective: 13.1 the role investment bankers play in the distribution of newly issued securities5) An ________ is a common stock offering issued by companies that have NOT previouslyissued common stock to the public.A) initial private issuance (IPI)B) seasoned equity offering (SEO)C) initial public offering (IPO)D) seasoned offering (SO)Answer: CDiff: 1Topic: 13.1 The Traditional Process for Issuing New SecuritiesObjective: 13.1 the role investment bankers play in the distribution of newly issued securities6) Which of the below statements is FALSE?A) A secondary common stock offering is an offering of common stock that had been issued inthe past by the corporation.B) For a secondary offering, the range for the gross spread as a percentage of the amount raisedis between 3% and 6%.C) For traditional bond offerings, the gross spread as a percentage of the principal is around 100basis points.D) The typical underwritten transaction involves so much risk of capital loss that a singleinvestment banking firm undertaking it alone would be exposed to the danger of losing asignificant portion of its capital.Answer: CComment: For traditional bond offerings, the gross spread as a percentage of the principal isaround 50 basis points.Diff: 2Topic: 13.1 The Traditional Process for Issuing New SecuritiesObjective: 13.2 the risk associated with the underwriting of a security2 Regulation of the Primary Market1) Underwriting activities are regulated by the ________.A) Initial Public Offerings Market (IPOM).B) Securities and Exchange Commission (SEC).C) Investment Banking Industry (IBI).D) Federal Bureau of Investigation (FBI).Answer: ADiff: 1Topic: 13.2 Regulation of the Primary MarketObjective: 13.4 how the SEC regulates the distribution of newly issued securities2) The type of information contained in the registration statement includes ________.A) the nature of the business of the issuer and key provisions or features of the security.B) the nature of the investment risks associated with the security and the background ofmanagement.C) the nature of the business of the issuer and the background of management.D) All of theseAnswer: DComment: The type of information contained in the registration statement is the nature of thebusiness of the issuer, key provisions or features of the security, the nature of the investmentrisks associated with the security, and the background of management.Diff: 2Topic: 13.2 Regulation of the Primary MarketObjective: 13.5 what a registration statement is3) The registration is actually divided into two parts. Part I is the ________. It is this part that istypically distributed to the public as an offering of the securities. Part II contains________,which is not distributed to the public as part of the offering but is available from the SEC uponrequest.A) registration; additional informationB) prospectus; supplemental informationC) supplemental information; registrationD) beginning information; prospectusAnswer: BDiff: 2Topic: 13.2 Regulation of the Primary MarketObjective: 13.5 what a registration statement is4) The Securities Act of 1933 ________.A) does not provide for penalties in the form of fines and/or imprisonment if the informationprovided is inaccurate or material information is omitted.B) governs the issuance of securities.C) provides that investors who purchase the security are entitled to sue the issuer but not theunderwriter to recover damages if they incur a loss as a result of the misleading information.D) provides that financial statements must be included after the registration statement. Answer: BComment: The Securities Act of 1933 governs the issuance of securities. The act requires thata registration statement be filed with the SEC by the issuer of a security. Financial statementsmust be included in the registration statement, and they must be certified by an independentpublic accountant. The act provides for penalties in the form of fines and/or imprisonment if theinformation provided is inaccurate or material information is omitted. Moreover, investors whopurchase the security are entitled to sue the issuer to recover damages if they incur a loss as aresult of the misleading information. The underwriter may also be sued if it can bedemonstrated that the underwriter did not conduct a reasonable investigation of the informationreported by the issuer. One of the most important duties of an underwriter is to perform duediligence.Diff: 2Topic: 13.2 Regulation of the Primary MarketObjective: 13.4 how the SEC regulates the distribution of newly issued securities5) Which of the below statements is TRUE?A) The filing of a registration statement with the SEC means that the security can be offered tothe public.B) When the SEC declares the registration statement is effective, it means that an amendmentto the registration statement can be filed.C) The registration statement must be reviewed and approved by the SEC's Division ofCorporate Finance before a public offering can be made.D) The approval of the SEC means that the securities have investment merit or are properlypriced or that the information is accurate.Answer: CComment: The filing of a registration statement with the SEC does not mean that the securitycan be offered to the public. The registration statement must be reviewed and approved by theSEC's Division of Corporate Finance before a public offering can be made. Typically, the staffof this division will find a problem with the registration statement. The staff then sends a letterof comments or deficiency letter to the issuer explaining the problem it has encountered. Theissuer must remedy any problem by filing an amendment to the registration statement. If thestaff is satisfied, the SEC will issue an order declaring that the registration statement is敜晦捥楴敶尬and the underwriter can solicit sales. The approval of the SEC, however, does notmean that the securities have investment merit or are properly priced or that the information isaccurate. It merely means that the appropriate information appears to have been disclosed.Diff: 3Topic: 13.2 Regulation of the Primary MarketObjective: 13.5 what a registration statement is6) A red herring is ________.A) a period of waiting for SEC approval.B) an amended prospectus.C) a preliminary prospectus.D) a prospectus printed fully in red ink.Answer: CComment: During the waiting period, the SEC does allow the underwriters to distribute apreliminary prospectus. Because the prospectus has not become effective, its cover page statesthis in red ink and, as a result, the preliminary prospectus is commonly called a red herring.Diff: 2Topic: 13.2 Regulation of the Primary MarketObjective: 13.4 how the SEC regulates the distribution of newly issued securities3 Variations in the Underwriting Process1) Not all deals are underwritten using the traditional syndicate process. For example, variationsin the United States, the Euromarkets, and foreign markets include ________.A) the auction process and rights offering for the underwriting of bonds.B) the bought deal of the Eurostock market.C) a rights offering for underwriting common stock.D) All of theseAnswer: CComment: Not all deals are underwritten using the traditional syndicate process we havedescribed. Variations in the United States, the Euromarkets, and foreign markets include thebought deal for the underwriting of bonds, the auction process for both stocks and bonds, and arights offering for underwriting common stock.Diff: 2Topic: 13.3 Variations in the Underwriting ProcessObjective: 13.3 the different types of underwriting arrangements2) The mechanics of a bought deal are that ________.A) the lead manager or a group of managers offers a potential issuer of debt securities a firm bidto purchase an undetermined amount of the securities with an interest (coupon) rate and maturityto be announced later.B) the issuer is given a month or more to accept or reject the bid.C) if the bid is rejected, the underwriting firm has bought the deal.D) the underwriter can sell the securities to other investment banking firms for distribution totheir clients and/or distribute the securities to its clients.Answer: DComment: The mechanics of a bought deal are as follows. The lead manager or a group ofmanagers offers a potential issuer of debt securities a firm bid to purchase a specified amount ofthe securities with a certain interest (coupon) rate and maturity. The issuer is given a day orso (maybe even only a few hours) to accept or reject the bid. If the bid is accepted, theunderwriting firm has bought the deal. It can, in turn, sell the securities to other investmentbanking firms for distribution to their clients and/or distribute the securities to its clients.Typically, the underwriting firm that buys the deal will have presold most of the issue to itsinstitutional clients.Diff: 2Topic: 13.3 Variations in the Underwriting ProcessObjective: 13.7 what is a bought deal underwriting for a bond issue, and why it is used3) A consequence of ________ is that underwriting firms need to expand their capital so thatthey can commit greater amounts of funds to such deals.A) accepting auction dealsB) rejecting bought dealsC) accepting bought dealsD) rejecting auction dealsAnswer: CDiff: 2Topic: 13.3 Variations in the Underwriting Process13.5 what a registration statement isObjective:4) A variation for underwriting securities is the auction process. In this method,________.A) the issuer announces the terms of the issue, and interested parties submit bids for part of theissue.B) the auction form is mandated for certain securities of regulated public utilities but not formunicipal debt obligations.C) the issuer announces the terms of the issue, and interested parties submit bids for the entireissue.D) mandated for many municipal debt obligations but not for certain securities of regulatedpublic utilities.Answer: CComment: A variation for underwriting securities is the auction process. In this method, theissuer announces the terms of the issue, and interested parties submit bids for the entire issue.The auction form is mandated for certain securities of regulated public utilities and for manymunicipal debt obligations. It is more commonly referred to as a competitive biddingunderwriting.Diff: 2Topic: 13.3 Variations in the Underwriting ProcessObjective: 13.3 the different types of underwriting arrangements5) In a variant of the auction process, a security is allocated to bidders from the highest bid price(________) to the lower ones (________) until the entire issue is allocated.A) (highest yield in the case of a bond); (higher yield in the case of a bond)B) (lowest yield in the case of a bond); (higher yield in the case of a bond)C) (lowest yield in the case of a bond); (lower yield in the case of a bond)D) (highest yield in the case of a bond); (lower yield in the case of a bond) Answer: BComment: The security is then allocated to bidders from the highest bid price (lowest yield inthe case of a bond) to the lower ones (higher yield in the case of a bond) until the entire issue isallocated.Diff: 3Topic: 13.3 Variations in the Underwriting Process13.3 the different types of underwriting arrangementsObjective:6) Suppose that an issuer is offering $600 million of a bond issue, and nine bidders submit thefollowing yield bids:Bidder Amount BidA $150 million 5.1%B $140 million 5.2%C$130 million5.2%D$100 million5.3%E$75 million5.4%F$25 million5.4%G$80 million5.5%H$70 million5.6%Which of the below statements is FALSE?A) The first five bidders (A, B, C, D, and E) will be allocated the amount for which they bidbecause they submitted the lowest-yield bids. In total, they will receive $595 million of the $600million to be issued.B) After allocating $420 million to the highest three bidders, then $180 million can be allocatedto the next two highest bidders.C) The lowest bidders will receive an amount proportionate to the amount for which they bid.D) After allocating $595 million to the highest bidders, then $5 million can be allocated to thenext lowest bidders.Answer: BComment: If we allocate $420 million to the highest three bidders, then $180 million cannotbe allocated to the next two highest bidders because they only have bid for $175 million.Diff: 2Topic: 13.3 Variations in the Underwriting ProcessObjective: 13.8 what a competitive bidding underwriting is7) When all bidders buy the amount allocated to them, then the auction is referred to ________.A) as a multiple-price auction or a Dutch auction.B) as a single-price auction or a German auction.C) as a single-price auction or a Dutch auction.D) as a multiple-price auction or a German auction.Answer: CDiff: 2Topic: 13.3 Variations in the Underwriting Process13.8 what a competitive bidding underwriting isObjective:8) Which of the below statements is FALSE?A) The value of a right can be found by calculating the difference between the price of a sharebefore the rights offering and the price of a share after the rights offering.B) The difference between the price before the rights offering and after the rights offeringexpressed as a percentage of the original price is called the concentration effect of the rightsissue.C) Value of a right = Share price rights on - Share price ex rightsD) Value of a right = Price before rights offering - Price after rights offering Answer: BComment: The difference between the price before the rights offering and after the rightsoffering expressed as a percentage of the original price is called the dilution effect of the rightsissue.Diff: 3Topic: 13.3 Variations in the Underwriting ProcessObjective: 13.9 what a rights offering for the sale of common stock is9) Which of the below statements is FALSE?A) Using an auction allows corporate issuers to place newly issued debt obligations directly withinstitutional investors rather than follow the indirect path of using an underwriting firm.B) By dealing with just a few institutional investors, investment bankers argue, issuers cannot besure of obtaining funds at the lowest cost.C) A preemptive right grants existing shareholders the right to buy some proportion of the newshares issued at a price below market value.D) For the shares sold via a preemptive rights offering, the underwriting services ofaninvestment banker are needed.Answer: DComment: For the shares sold via a preemptive rights offering, the underwriting services of aninvestment banker are not needed.Diff: 2Topic: 13.3 Variations in the Underwriting ProcessObjective: 13.8 what a competitive bidding underwriting is4 Private Placement of Securities1) In addition to underwriting securities for distribution to the public, securities may be placedwith a limited number of institutional investors such as ________.A) insurance companies.B) investment companies.C) pension funds.D) All of theseAnswer: DDiff: 2Topic: 13.4 Private Placement of SecuritiesObjective: 13.10 the advantages and disadvantages from an issuer's perspective of a privateplacement2) ________ are the major investors in private placements.A) Life insurance companies .B) Credit Unions.C) Pension funds.D) Auto insurance companies.Answer: ADiff: 2Topic: 13.4 Private Placement of SecuritiesObjective: 13.10 the advantages and disadvantages from an issuer's perspective of a privateplacement3) The Securities Act of 1933 does not provide specific guidelines to identify what is a________.A) private security.B) public placement.C) public offering.D) private offering.Answer: DDiff: 2Topic: 13.4 Private Placement of SecuritiesObjective: 13.10 the advantages and disadvantages from an issuer's perspective of a privateplacement4) In 1982, the SEC adopted Regulation D,which ________.A) exempts securities sold only within a state.B) states that if the offering is for $1 million or less, the securities need not be registeredC) sets forth the guidelines that determine if an issue is qualified for exemption from registration.D) exempts from registration ransactions by an issuer not involving any public offering.Answer: CComment: Public and private offerings of securities differ in terms of the regulatory requirements that the issuer must satisfy. The Securities Act of 1933 and the Securities ExchangeAct of 1934 require that all securities offered to the general public must be registered with theSEC, unless there is a specific exemption. The Securities Acts allow three exemptions fromfederal registration. First, intrastate offerings–that is, securities sold only within a state–areexempt. Second, there is a small- offering exemption (Regulation A). Specifically, if theoffering is for $1 million or less, the securities need not be registered. Finally, Section 4(2) ofthe 1933 act exempts from registration ransactions by an issuer not involving any publicoffering. At the same time, the 1933 act does NOT provide specific guidelines to identify whatis a private offering or placement. In 1982, the SEC adopted Regulation D, which sets forth theguidelines that determine if an issue is qualified for exemption from registration.Diff: 2Topic: 13.4 Private Placement of SecuritiesObjective: 13.10 the advantages and disadvantages from an issuer's perspective of a privateplacement5) Investment banking firms assist in the private placement of securities by ________.A) working with the issuer and potential investors on the design and pricing of thesecurity.B) lining up the investors but not designing or pricing the issue.C) designing the issue but not lining up the investors or pricing the issue.D) participating in the transaction on a fixed efforts underwriting arrangement Answer: AComment: Investment banking firms assist in the private placement of securities in severalways. They work with the issuer and potential investors on the design and pricing of thesecurity. Often, it has been in the private placement market that investment bankers first designnew security structures. Field testing of many of the innovative securities that we describe in thisbook occurred in the private placement market. The investment bankers may be involved withlining up the investors as well as designing the issue. Or, if the issuer has already identified theinvestors, the investment banker may serve only in an advisory capacity. An investment bankercan also participate in the transaction on a best efforts underwriting arrangement.Diff: 2Topic: 13.4 Private Placement of SecuritiesObjective: 13.10 the advantages and disadvantages from an issuer's perspective of a privateplacement6) In April 1990, the SEC Rule 144A became effective and ________.A) eliminated the five-year holding period by permitting large institutions to trade securitiesacquired in a private placement among themselves by registering these securities with the SEC.B) eliminated the two-year holding period by disallowing large institutions to trade securitiesacquired in a private placement among themselves without having to register these securitieswith the SEC.C) eliminated the two-year holding period by permitting large institutions to trade securitiesacquired in a private placement among themselves without having to register these securitieswith the SEC.D) added the two-year holding period by permitting small institutions to trade securities acquiredin a public placement among themselves without having to register these securities with the SEC.Answer: CComment: eliminated the two-year holding period by permitting large institutions to tradesecurities acquired in a private placement among themselves without having to register thesesecurities with the SEC.Diff: 2Topic: 13.4 Private Placement of SecuritiesObjective: 13.11 the reason for Rule 144A and its potential impact on the private placementmarket7) In regards to Rule 144a, which of the below statements is FALSE?A) Rule 144A encouraged non-U.S. corporations to issue securities in the U.S. private placementmarket by relaxing the requirement to hold the securities for two years.B) Rule 144A encourages non-U.S. corporations to issue securities in the U.S. private placementmarket by relaxing the requirement to furnish necessary disclosure set forth by U.S. securitieslaws.C) Rule 144A improved liquidity, reducing the cost of raising funds.D) Rule 144A improved the liquidity of securities acquired by all institutional investors in aprivate placement.Answer: DComment: Rule 144A encourages non-U.S. corporations to issue securities in the U.S. privateplacement market for two reasons. First, it will attract new large institutional investors into themarket that were unwilling previously to buy private placements because of the requirement tohold the securities for two years. Such an increase in the number of institutional investors mayencourage non-U.S. entities to issue securities. Second, foreign entities were unwilling to raisefunds in the United States prior to establishment of Rule 144A because they had to register theirsecurities and furnish the necessary disclosure set forth by U.S. securities laws. Privateplacement requires less disclosure. Rule 144A also improves liquidity, reducing the cost ofraising funds. SEC Rule 144A improves the liquidity of securities acquired bycertaininstitutional investors in a private placement.Diff: 3Topic: 13.4 Private Placement of SecuritiesObjective: 13.11 the reason for Rule 144A and its potential impact on the private placementmarketTrue/False Questions1 The Traditional Process for Issuing New Securities 1) Because of the low risks associated with the underwriting of securities, an underwritingsyndicate and a selling group are rarely formed.Answer: FALSEComment: Because of the risks associated with the underwriting of securities, an underwritingsyndicate and a selling group are typically formed.Diff: 1Topic: 13.1 The Traditional Process for Issuing New SecuritiesObjective: 13.2 the risk associated with the underwriting of a security2) The gross spread earned by the underwriter depends on numerous factors. Answer: TRUEDiff: 1Topic: 13.1 The Traditional Process for Issuing New Securities13.1 the role investment bankers play in the distribution of newly issued securities Objective:3) Depending on the type of underwriting agreement, the underwriting function may expose theinvestment banking firm to the risk of selling the securities to the public at a price greater thanthe price paid to the issuer.Answer: FALSEComment: Depending on the type of underwriting agreement, the underwriting function mayexpose the investment banking firm to the risk of selling the securities to the public at a price lessthan the price paid to the issuer.Diff: 1Topic: 13.1 The Traditional Process for Issuing New SecuritiesObjective: 13.1 the role investment bankers play in the distribution of newly issued securities2 Regulation of the Primary Market1) Rule 415 permits certain issuers to file a single registration document indicating that theyintend to sell a certain amount of a certain class of securities at one or more times within the nexttwo years.Answer: TRUEDiff: 1Topic: 13.2 Regulation of the Primary MarketObjective: 13.4 how the SEC regulates the distribution of newly issued securities 2) Rule 415 is popularly referred to as the closet registration rule because the securities can beviewed as sitting in the closet, and can be taken out of the closet and sold to the public withoutobtaining additional SEC approval.Answer: FALSEComment: Rule 415 is popularly referred to as the shelf registration rule because thesecurities can be viewed as sitting on a “shelf,”and can be taken off that shelf and sold to thepublic without obtaining additional SEC approval.Diff: 1Topic: 13.2 Regulation of the Primary MarketObjective: 13.6 the impact of the SEC Rule 415 (shelf registration)3) The time interval between the initial filing of the registration statement and the time theregistration statement becomes effective is referred to as the waiting period. Answer: TRUEDiff: 1Topic: 13.2 Regulation of the Primary MarketObjective: 13.4 how the SEC regulates the distribution of newly issued securities3 Variations in the Underwriting Process1) A corporation can offer existing shareholders new shares in a preemptive rights offering, andusing a standby underwriting arrangement, the corporation can have an investment banking firmagree to distribute any shares not subscribed to.。
