Finance Midterm Exam

1. (TCO 1) A comparative advantage of financial intermediaries can be classified as (Points : 4)

the ability to achieve economies of scale.

the ability to reduce transaction costs.

the ability to find confidential information.

All of the above



Question 2.2. (TCO 1) An example of denomination intermediation is (Points : 4)

issuing insured deposits and making risky business loans.

bringing together investors of different religions.

issuing two $10,000 CDs and making one $20,000 loan.

promising liquidity to SSUs while investing the funds long-term.



Question 3.3. (TCO 1) An example of a not–for–profit financial institution are (Points : 4)

thrift institutions.

credit unions.

pension funds.

commercial banks.



Question 4.4. (TCO 1) Money market instruments and capital market instruments differ appreciably in (Points : 4)




All of the above



Question 5.5. (TCO 1) Security exchanges (Points : 4)

create interest in stocks.

increase the marketability of securities.

provide a legal way to gamble.

supply money to deficit spending units.



Question 6.6. (TCO 2) One of the more important goals of the Federal Open Market Committee (FOMC) is to (Points : 4)

set monetary policy.

supervise and examine member banks.

guarantee excess reserves to National Banks.

enforce margin requirements.



Question 7.7. (TCO 2) If the Fed buys government securities, this action will (Points : 4)

not change the money supply.

increase security prices.

increase interest rates.

decrease credit availability.



Question 8.8. (TCO 2) Regulatory powers do not include (Points : 4)

margin requirements.

interest rate disclosures on deposits.

prosecution of counterfeiting and money laundering.

bank holding companies.



Question 9.9. (TCO 2) Using the data below, what is the level of excess reserves?

Total Reserves $90,000,000

Reserve Requirement 3%

Total Deposits $750,000,000 (Points : 4)

$ 22,500,000

$ 67,500,000

$ 90,000,000

Not ascertainable



Question 10.10. (TCO 3) Business investment and consumption spending should increase if  (Points : 4)

financial wealth decreases.

reserve requirements decrease.

interest rates increase.

credit availability decreases.



Question 11.11. (TCO 4) Another way to classify interest is (Points : 4)

the price of money.

the rent on money.

time value money.

All of the above



Question 12.12. (TCO 4) There will be an upward shift in the demand for loanable funds if there is (Points : 4)

a decline in the supply of loanable funds.

a decline in business prospects.

an improvement in technology.

an expectation of an upcoming recession.



Question 13.13. (TCO 4) We can associate the flow of funds approach to interest rate forecasting with (Points : 4)

the Flow of Funds Accounts.

the loanable funds theory of interest rate determination.

the Federal Reserve System.

All of the above



Question 14.14. (TCO 4) The ______ equation indicates that nominal interest rates are influenced by changes in price levels and the real rate of interest. (Points : 4)


Loanable funds

Nominal rate




Question 15.15. (TCO 4) An investor received a 3% coupon rate last year on a $1,000 bond purchased at par. The inflation rate during the year was 4% and is expected to be 5% next year. The realized real rate earned by the investor last year was (Points : 4)







Question 16.16. (TCO 5) In a fixed-rate bond, the variable which changes to determine market rate of return is _____. (Points : 4)


coupon rate

coupon amount

face value



Question 17.17. (TCO 5) When a bond’s coupon rate is greater than the market rate of interest, the bond will sell for (Points : 4)

a discount.

a premium.


a variable rate.



Question 18.18. (TCO 5) Which of the following statements is true? (Points : 4)

Bonds vary directly with interest rates.

Bond volatility varies inversely with maturity.

Low coupon bonds have lower bond volatility than high coupon bonds.

Bond duration increases with maturity.



Question 19.19. (TCO 5) Which of the following statements about duration is true? (Points : 4)

Duration is the length of time necessary to pay back the investor’s original investment.

The duration of a bond is some time longer than the maturity of the bond.

Duration is the investment period necessary to offset price risk and reinvestment risk.

A bond sold at the duration point will always be priced at $1,000.



Question 20.20. (TCO 5) If market interest rates fall after a bond is issued, the (Points : 4)

face value of the bond increases.

investor will sell the bond.

market value of the bond is increasing.

market value of the bond is decreasing.Page 2:

1. (TCO 5) The yield curve is a plot of (Points : 4)

maturity changes as risk changes.

yields of securities with different levels of default risk.

yields by maturity of securities with similar default risk.

interest rates over time.



Question 2.2. (TCO 5) A downward sloping yield curve indicates that future short-term rates are expected to _____ and outstanding security prices will _____. (Points : 4)

fall; rise

fall; fall

rise; rise

rise; fall



Question 3.3. (TCO 5) A two-year interest rate is 7% and a one-year forward rate one year from now is 8%. According to the expectations theory, what is the current one-year rate? (Points : 4)







Question 4.4. (TCO 5) Which of the following statements about interest rates is true? (Points : 4)

Interest rates generally do not tend to move together.

The expected rate of inflation does not influence the level of interest rates.

At the bottom of the business cycle, the yield curve is typically upward sloping.

All the above are true.



Question 5.5. (TCO 5) Which of the following statements about interest rates is not true? (Points : 4)

Interest rates generally tend to move together.

It is frequent to observe downward sloping and level yield curves.

At the bottom of the business cycle, the yield curve is typically upwards sloping.

None of the above are true.



Question 6.6. (TCO 6) Investors in the money markets are generally not willing to take which of the following risks? (Points : 4)

Default risk

Interest rate risk

Liquidity risk

All of the above



Question 7.7. (TCO 6) Which statement about Treasury bills is true? (Points : 4)

They have maturities less than one year.

Most are sold by “book-entry” method.

They are sold at a discount.

All of the above



Question 8.8. (TCO 6) Most issuers of commercial paper include (Points : 4)

large financial and nonfinancial firms.

firms with high credit risk.

small banks.

wealthy individuals.



Question 9.9. (TCO 6) Which of the following securities are examples of a money market security? (Points : 4)

Treasury bills

Certificates of deposit

Banker’s acceptance

All of the above



Question 10.10. (TCO 6) If a firm is to buy securities with the agreement to sell them back later at a higher price, this is a _____. (Points : 4)

reversion agreement

reverse repurchase agreement

reverse purchase agreement

repurchase agreement



Question 11.11. (TCO 7) Which of the following is an example of capital market securities? (Points : 4)

Common stocks

Convertible bonds


All of the above



Question 12.12. (TCO 7) When comparing “regular” Treasury securities of the same maturity, TIPS have less _____ risk. (Points : 4)




foreign exchange



Question 13.13. (TCO 7) STRIPs are created by Treasury security dealers because (Points : 4)

STRIPs are sold directly by the Treasury Department.

when a STRIP is created, all interest payments become one security and the principal payment becomes the other.

many small investors prefer STRIPs because they require a lower minimum investment than original Treasury notes and bonds.

they expect to sell the created zero-coupon securities for more than what they paid for the original Treasury security.


Question 14.14. (TCO 7) _____ is not commonly associated with municipal bonds. (Points : 4)

Inflation-protected bonds

Serial bonds

General obligation bonds

Revenue bonds



Question 15.15. (TCO 7) Bonds are classified as a junk bonds if (Points : 4)

issued in large volumes.

originate within small businesses.

its with high default risk.

None of the above



Question 16.16. (TCO 7) All of the following signify differences between Eurobonds and bonds sold in the U.S. except (Points : 4)

Eurobonds are usually issued in bearer form; bonds sold in the U.S. are usually registered bonds.

Eurobonds usually pay interest once a year; bonds sold in the U.S. usually pay interest semiannually.

Eurobonds are denominated in Euros; bonds sold in the U.S. are denominated in dollars.

interest on Eurobonds is computed using a 360-day year vs. a 365-day year for bonds issued in the U.S.


Question 17.17. (TCO 8) All of the following can be used to adjust ARM rates except (Points : 4)

Treasury security rates

Dow Jones Mortgage Rate Index

S & L cost of funds index




Question 18.18. (TCO 8) The primary goal of private mortgage insurance (PMI) is to protect the (Points : 4)

seller of the home.






Question 19.19. (TCO 8) Home equity line popularity increased as a result of The Tax Reform Act of 1986 because (Points : 4)

tax deductibility of interest for homeowners was reduced.

interest incurred under home equity lines was made tax deductible.

banks and savings and loans were given tax incentives to make home equity lines of credit.

credit card debt was made tax deductible.



Question 20.20. (TCO 8) If an investor invests in a first-level CMO tranche with claims on a pool of mortgages, this investor will (Points : 4)

have a much higher risk position than lower level tranches.

have more certain returns and less default-risk exposure.

wait until all tranches are paid before receiving a return.

have lower risk but a much more varied return than lower level tranches.Page 3



Question 1.1. (TCO 1) Evaluate why secondary capital markets play an important role in our economy and summarize how secondary markets assist the primary market? (Points : 15)



Question 2.2. (TCO 2) Analyze why the Federal Reserve is less “independent” than what it appears to be. (Points : 15)



Question 3.3. (TCO 4) Evaluate how price expectations influence the level of interest rates? Explain the impact inflation premiums have had on interest rate levels in recent years. (Points : 15)


Question 4.4. (TCO 5) Explain and examine interest rate risk. Identify the two risk components of interest rate risk and explain how these interact with each other. (Points : 15)


Question 5.5. (TCO 5) Explain why municipal bonds have lower yields than comparable corporate taxable bonds. (Points : 15)



Question 6.6. (TCO 6) Determine and explain the economic functions of money markets. (Points : 15)



Question 7.7. (TCO 7) Analyze why U.S. Treasury STRIPs are of interest to individuals with IRA’s or 401k pension plans. (Points : 15)


Question 8.8. (TCO 8) Determine and explain why mortgage-backed securities guaranteed by Federal government agencies often have yields above U.S. Treasury bond rates. (Points : 15)



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