1) The price paid for the rental of borrowed funds (usually expressed as a percentage ofthe rental of $100 per year) is commonly referred to as theA) inflation rate.B) exchange rate.C) interest rate.D) aggregate price level.Answer: C2) Financial markets and institutionsA) involve the movement of huge quantities of money.B) affect the profits of businesses.C) affect the types of goods and services produced in an economy.D) do all of the above.E) do only (A) and (B) of the above.Answer: D3) Which of the following can be described as involving direct finance?A) A corporationʹs stock is traded in an over-the-counter market.B) People buy shares in a mutual fund.C) A pension fund manager buys commercial paper in the secondary market.D) An insurance company buys shares of common stock in the over-the-counter markets.E) None of the above.Answer: E4) The purpose of diversification is toA) reduce the volatility of a portfolioʹs return.B) raise the volatility of a portfolioʹs return.C) reduce the average return on a portfolio.D) raise the average return on a portfolio.Answer: A5) When the interest rate on a bond is _________ the equilibrium interest rate, there is excess_________ in the bond market and the interest rate will _________.A) below; demand; riseB) below; demand; fallC) below; supply; riseD) above; supply; fallAnswer: C6) In a recession when income and wealth are falling, the demand for bonds _________ and thedemand curve shifts to the _________.A) falls; rightB) falls; leftC) rises; rightD) rises; leftAnswer: B7) When people begin to expect a large stock market decline, the demand curve for bonds shifts to the _________ and the interest rate _________.A) right; fallsB) right; risesC) left; fallsD) left; risesAnswer: A8) The spread between interest rates on low quality corporate bonds and U.S. government bonds_________ during the Great Depression.A) was reversedB) narrowed significantlyC) widened significantlyD) did not changeAnswer: C9) If income tax rates were lowered, thenA) the interest rate on municipal bonds would fall.B) the interest rate on Treasury bonds would rise.C) the interest rate on municipal bonds would rise.D) the price of Treasury bonds would fall.Answer: C10) According to the expectations theory of the term structure,A) yield curves should be equally likely to slope downward as to slope upward.B) when the yield curve is steeply upward-sloping, short-term interest rates are expected torise in the future.C) when the yield curve is downward-sloping, short-term interest rates are expected to remain relatively stable in the future.D) all of the above.E) only A and B of the above.Answer:E11) According to the efficient market hypothesisA) one cannot expect to earn an abnormally high return by purchasing a security.B) information in newspapers and in the published reports of financial analysts is alreadyreflected in market prices.C) unexploited profit opportunities abound, thereby explaining why so many people getrich by trading securities.D) all of the above are true.E) only A and B of the above are true.Answer: E12) To say that stock prices follow a ʺrandom walkʺ is to argue thatA) stock prices rise, then fall.B) stock prices rise, then fall in a predictable fashion.C) stock prices tend to follow trends.D) stock prices are, for all practical purposes, unpredictable.Answer:D13) The efficient market hypothesis suggests thatA) investors should purchase no-load mutual funds which have low management fees.B) investors can use the advice of technical analysts to outperform the market.C) investors let too many unexploited profit opportunities go by if they adopt a ʺbuy andholdʺ strategy.D) only A and B of the above are sensible strategies.Answer: A14) Which of the following is empirical evidence indicating that the efficient market hypothesismay not always be generally applicable?A) Small-firm effectB) January effectC) Market OverreactionD) All of the aboveAnswer: D15) An open market purchase of securities by the Fed willA) increase assets of the nonbank public and increase assets of the banking system.B) decrease assets of the nonbank public and increase assets of the Fed.C) decrease assets of the banking system and increase assets of the Fed.D) have no effect on assets of the nonbank public but increase assets of the Fed.E) increase assets of the banking system and decrease assets of the Fed.Answer: D16) Under usual circumstances, an increase in the discount rate causesA) the federal funds rate to fall.B) the federal funds rate to rise.C) no change in the federal funds rate.D) the supply of reserves to increase.E) the supply of reserves to decrease.Answer: C17) Which of the following is not an operating target?A) Nonborrowed reservesB) Monetary baseC) Federal funds interest rateD) Discount rateE) All are operating targets.Answer: D18) Money market instrumentsA) are usually sold in large denominations.B) have low default risk.C) mature in one year or less.D) are characterized by all of the above.E) are characterized by only A and B of the above.Answer: D19) If the Fed wants to lower the federal funds interest rate, it will _________ the banking system by _________ securities.A) add reserves to; sellingB) add reserves to; buyingC) remove reserves from; sellingD) remove reserves from; buyingAnswer: B20) Money market transactionsA) do not take place in any one particular location or building.B) are usually arranged purchases and sales between participants over the phone by tradersand completed electronically.C) both (a) and (b).D) none the the above.Answer: C21) The primary reason that individuals and firms choose to borrow long-term is to reduce the risk that interest rates will fall before they pay off their debt.Answer：False22) Typically, the interest rate on corporate bonds will be higher the more restrictions areplaced on management through restrictive covenants, because the bonds will beconsidered safer by bondholdersAnswer: False23) A change in the current yield always signals a change in the same direction of the yield tomaturity.Answer: True24) A bankʹs balance sheet indicates whether or not the bank is profitable. Answer: False25) Deposits that banks keep in accounts at the Federal Reserve less vault cash is called reserves.Answer: False26) Since a bankʹs assets exceed its equity capital, the return on assets always exceeds the return on equity.Answer: False27) Adverse selection refers to those most at risk being most aggressive in their search for funds.Answer: True28) Financial innovation has provided more options to both investors and borrowers. Answer: True28) When the federal governmentʹs budget deficit decreases, the demand curve for bonds shifts tothe right.Answer: False29) An increase in the inflation rate will cause the demand curve for bonds to shift to the right.Answer: False30) A positive liquidity premium indicates that investors prefer long-term bonds over short-termbonds.Answer: False31) When yield curves are downward sloping, long-term interest rates are above short-terminterest rates.Answer: False32) In an efficient market, abnormal returns are not possible even using inside information.Answer: False33) Technical analysis is a popular technique used to predict stock prices by studying past stock price data and search for patterns such as trends and regular cycles. Answer: True34) An open market sale leads to an expansion of reserves and deposits in the banking system and hence to a decline in the monetary base and the money supply.Answer: False35) Open market purchases by the Fed increase the supply of nonborrowed reserves. Answer: True36) In general, money market instruments are low risk, high yield securities. Answer: False37) Money markets are referred to as retail markets because small individual investors are theprimary buyers of money market securities.Answer: False38) Capital market securities are less liquid and have longer maturities than money marketsecurities.Answer: True39) The current yield on a bond is a good approximation of the bondʹs yield to maturity when the bond matures in five years or less and its price differs from its par value by a large amount.Answer: False40) A bankʹs largest source of funds is its borrowing from the Fed. Answer: False1.Consider a bond with a 7% annual coupon and a face value of $1,000. Completethe following table:Years to Maturity Discount Rate Current Price3 53 76 79 79 9What relationship do you observe between yield to maturity and the current market value?（10分）Solution:Years to Maturity Yield to Maturity Current Price3 5 $1,054.463 7 $1,000.006 7 $1,000.009 5 $1,142.169 9 $ 880.10When yield to maturity is above the coupon rate, the band’s current price is below its face value. The opposite holds true when yield to maturity is below the coupon rate. For a given maturity, the bond’s current price falls as yield to maturity rises.For a given yield to maturity, a bond’s value rises as its maturity increases. When yield to maturity equals the coupon rate, a bond’s current price equal s its facevalue regardless of years to maturity.2. At your favorite bond store, Bonds-R-Us, you see the following prices:1-year $100 zero selling for $90.193-year 10% coupon $1000 par bond selling for $10002-year 10% coupon $1000 par bond selling for $1000Assume that the pure expectations theory for the term structure of interest rates holds, no liquidity or maturity premium exists, and the bonds are equally risky. What is the implied 1-year rate two years from now? （10分）Solution:From (a), you know that the 1-year rate today is 10.877%.Using this information, (c) tells you that:2-year rate)^2+ 1100/(1 + 100/1.10877 =1000So, the 2-year rate today is 9.95%.Using these two rates, (b) tells you that:3-year rate)3+ 1100/(1 + 100/1.09952 + 100/1.10877 =1000So, the 3-year rate today is 9.97%⨯ 9.97% – 2 ⨯ (3 =year rate 2 years from now 10.01%=9.95%)3. A bank has two, 3-year commercial loans with a present value of $70 million. The first is a $30 million loan that requires a single payment of $37.8 million in 3 years, with no other payments until then. The second is for $40 million. It requires an annual interest payment of $3.6 million. The principal of$40 million is due in 3 years. (15分)What is the duration of the bank’s commercial loan portfolio?What will happen to the value of its portfolio if the general level of interest rates increased from 8% to 8.5%?Solution:The duration of the first loan is 3 years since it is a zero-coupon loan. The duration of the second loan is as follows:Year 1 2 3 SumPayment 3.60 3.60 43.60PV of Payments 3.33 3.09 34.61 41.03Time Weighted PV of Payments 3.33 6.18 103.83Time Weighted PV of PaymentsDivided by Price 0.08 0.15 2.53 2.76The duration of a portfolio is the weighted average duration of its individual securities.So, the portfolio’s 2.86= (2.76) ⨯ 4/7 + (3) ⨯ 3/ 7 =durationIf rates increased,4. According to the loanable funds frameworks, draw two figures to explain the changes of interest rates during expansion and recession. （5分）Problems1. The following table lists foreign exchange rates between US dollars and British pounds during April.Date US Dollars perGBP Date US Dollars perGBP4/1 1.9564 4/18 1.75044/4 1.9293 4/19 1.72554/5 1.914 4/20 1.69144/6 1.9374 4/21 1.6724/7 1.961 4/22 1.66844/8 1.8925 4/25 1.66744/11 1.8822 4/26 1.68574/12 1.8558 4/27 1.69254/13 1.796 4/28 1.72014/14 1.7902 4/29 1.75124/15 1.7785Which day would have been the best day to convert $200 into British pounds?Which day would have been the worst day? What would be the difference in pounds?2. Consider a bond with a 7% annual coupon and a face value of $1,000. Complete the following table:Years to Maturity Discount Rate CurrentPrice3 53 76 79 79 9What relationship do you observe between yield to maturity and the current market value?3. You are willing to pay $15,625 now to purchase a perpetuity which will pay you and your heirs $1,250 each year, forever, starting at the end of this year. If your required rate of return does not change, how much would you be willing to pay if this were a 20-year, annual payment, ordinary annuity instead of a perpetuity?4. A bank has two, 3-year commercial loans with a present value of $70 million. The first is a $30 million loan that requires a single payment of $37.8 million in 3 years, with no other payments until then. The second is for $40 million. It requires an annual interest payment of $3.6 million. The principal of$40 million is due in 3 years.a. What is th e duration of the bank’s commercial loan portfolio?b. What will happen to the value of its portfolio if the general level of interest rates increased from 8% to 8.5%?5. Consider a bond that promises the following cash flows. The required discount rate is 12%.Year 0 1 2 3 4Promised Payments 160 170 180 230You plan to buy this bond, hold it for 2½ years, and then sell the bond.a. What total cash will you receive from the bond after the 2½ years? Assume that periodic cash flows are reinvested at 12%.b. If immediately after buying this bond, all market interest rates drop to 11% (including your reinvestment rate), what will be the impact on your total cash flow after 2½ years? How doesthis compare to part (a)?c. Assuming all market interest rates are 12%, what is the duration of this bond?Solution:a. You will receive 160, reinvested that for 1.5 years, and 170 reinvested for 0.5 years. Then you will sell the remaining cash flows, discounted at 12%. This gives you:1.50.50.5 1.5180230160(1.12)170(1.12)$733.69.1.12 1.12⨯+⨯++= b. This is the same as part (a), but the rate is now 11%.1.50.50.5 1.5180230160(1.11)170(1.11)$733.74.1.11 1.11⨯+⨯++= Notice that this is only $0.05 different from part (a).6. You own a $1,000-par zero-coupon bond that has 5 years of remaining maturity. You plan on selling the bond in one year, and believe that the required yield next year will have the following probability distribution:Probability Required Yield0.1 6.60% 0.2 6.75% 0.4 7.00% 0.2 7.20% 0.17.45%a. What is your expected price when you sell the bond?b. What is the standard deviation?Multiple Choice1.When the inflation rate is expected to increase, the real cost of borrowing declines at any given interest rate; as a result, the _________ bonds increases and the _________ curve shifts to the right. A) demand for; demand B) demand for; supply C) supply of; demand D) supply of; supplyIn Figure 4.1, the most likely cause of the increasein the equilibrium interest rate from i1 to i2 isA)an increase in the price of bonds. B) a business cycle boom.C) an increase in the expected inflation rate. D) a decrease in the expected inflation rate.In Figure 4.2, one possible explanation for the increase in the interest rate from i1 to i2 is a(n) _________ in _________. A) increase; the expected inflation rateB) decrease; the expected inflation rateC) increase; economic growthD) decrease; economic growthSolution:Years to Maturity Yield to Maturity Current Price3 5 $1,054.463 7 $1,000.006 7 $1,000.009 5 $1,142.169 9 $ 880.10When yield to maturity is above the coupon rate, the band’s current price is below its facevalue. The opposite holds true when yield to maturity is below the coupon rate. For a givenmaturity, the bond’s current price falls as yield to maturity rises. For a given y ield to maturity, a bond’s value rises as its maturity increases. When yield to maturity equals thecoupon rate, a bond’s current price equals its face value regardless of years to maturity.Solution: To find your yield to maturity, Perpetuity value = PMT/I.So, 15625 = 1250/I. I = 0.08The answer to the final part, using a financial calculator:N = 20; I = 8; PMT = 1250; FV = 0Compute PV : PV = 12,272.69Solution:a. You will receive 160, reinvested that for 1.5 years, and 170 reinvested for 0.5 years. Then you will sell the remaining cash flows, discounted at 12%. This gives you:1.50.50.5 1.5180230160(1.12)170(1.12)$733.69.1.12 1.12⨯+⨯++= b. This is the same as part (a), but the rate is now 11%.1.50.50.5 1.5180230160(1.11)170(1.11)$733.74.1.11 1.11⨯+⨯++= Notice that this is only $0.05 different from part (a). c. The duration is calculated as follows:Year1 2 3 4 Sum Payments160.00 170.00 180.00 230.00 PV of Payments142.86 135.52 128.12 146.17 552.67Time Weighted PV of Payments142.86 271.05 384.36 584.68 Time Weighted PV of PaymentsDivided by Price0.260.490.701.062.50Since the duration and the holding period are the same, you are insulated from immediate changes in interest rates! It doesn’t always work out this perfectly, but the idea is important.Solution: The duration of the first loan is 3 years since it is a zero-coupon loan. The duration of the second loan is as follows:Year1 2 3 Sum Payment3.60 3.60 43.60PV of Payments3.33 3.09 34.61 41.03Time Weighted PV of Payments3.33 6.18 103.83 Time Weighted PV of PaymentsDivided by Price0.080.152.532.76The duration of a portfolio is the weighted average duration of its individual securities.So, the portfolio’s duration = 3/7 ⨯ (3) + 4/7 ⨯ (2.76) = 2.86If rates increased, 0.005DUR 2.8670,000,000926,852.1 1.08i P P i ∆∆=-⨯⨯=-⨯⨯=-+ ASMT 02_1112A1. Consider a bond with a 7% annual coupon and a face value of $1,000. Completethe following table:Years to Maturity Yield to MaturityCurrent Price3 5 3 7 6 7 9 7 9 9What relationship do you observe between yield to maturity and the current market value?2. You are willing to pay $15,625 now to purchase a perpetuity which will pay youand your heirs $1,250 each year, forever, starting at the end of this year. If your required rate of return does not change, how much would you be willing to pay if this were a 20-year, annual payment, ordinary annuity instead of a perpetuity? 3. Assume you just deposited $1,000 into a bank account. The current real interestrate is 2% and inflation is expected to be 6% over the next year. What nominal interest rate would you require from the bank over the next year? How much money will you have at the end of one year? If you are saving to buy a stereo that currently sells for $1,050, will you have enough to buy it? 4. A 10-year, 7% coupon bond with a face value of $1,000 is currently selling for$871.65. Compute your rate of return if you sell the bond next year for $880.10.。
