Question 1

The risk that a security cannot be sold at a predictable price with low transaction costs at short notice is called liquidity risk.

Accepted Answer

A) True 
 B)False

Question 2

What is the difference between the expected real interest rate and the real rate of interest actually earned?

Accepted Answer

The expected real rate of interest is th

Question 3

Households generally supply more funds to the markets as their income and wealth increase, ceteris paribus.

Accepted Answer

A) True 
 B)False

Question 4

Everything else equal, the interest rate required on a callable bond will be less than the interest rate on a convertible bond.

Accepted Answer

A) True 
 B)False

Question 5

An improvement in economic conditions would likely shift the supply curve down and to the right and shift the demand curve for funds up and to the right.

Accepted Answer

A) True 
 B)False

Question 6

A bank manager lends a corporate client $1,000,000 for six months. The bank charges a $1,000 fee to set up the loan. The corporate borrower repays $1,050,000 in six months. What is the effective annual rate on the loan?

Accepted Answer

A)  5% 
B)  5.1% 
C)  10.25% 
D)  10.47% 
E)  none of the above {$1,050,000/($1,000,000 - $1,000)}2 - 1 = 10.47% 
A)  5% 
B)  5.1% 
C)  10.25% 
D)  10.47% 
E)  none of the above {$1,050,000/($1,000,000 - $1,000)}2 - 1 = 10.47%

Question 7

Investment A pays 8% simple interest for 10 years. Investment B pays 7.75% compound interest for 10 years. Both require an initial $10,000 investment. The future value of A minus the future value of B is equal to ______________ (to the nearest penny).

Accepted Answer

A)  $2,500.00 
B)  -$2,500.00 
C)  $1,643.32 
D)  $3,094.67 
E)  -$3,094.67 [10000 + (800 F1F1F1S1F1F1F10 10)] - [10000 F1F1F1S1F1F1F10 1.077510] 
A)  $2,500.00 
B)  -$2,500.00 
C)  $1,643.32 
D)  $3,094.67 
E)  -$3,094.67 [10000 + (800 F1F1F1S1F1F1F10 10)] - [10000 F1F1F1S1F1F1F10 1.077510]

Question 8

You want to have $5 million when you retire in 40 years. You believe you can earn 9% per year on your investment. How much must you invest each year to achieve your goal when you retire? (Ignore all taxes)

Accepted Answer

A)  $10,412 
B)  $11,619 
C)  $14,798 
D)  $15,295 
E)  none of the above $5 million/[((1.09)40 -1)/0.09] 
A)  $10,412 
B)  $11,619 
C)  $14,798 
D)  $15,295 
E)  none of the above $5 million/[((1.09)40 -1)/0.09]

Question 9

The term structure of interest rates is upward sloping for all bond types. A certain AAA rated non-callable 10-year corporate bond has been issued at a 6.15% promised yield. Which one of the following bonds probably has a higher promised yield?

Accepted Answer

A)  A similar quality municipal bond. 
B)  A non-callable AAA rated corporate bond with a 5-year maturity. 
C)  A callable AAA rated corporate bond with a 15-year maturity. 
D)  A non-callable AAA rated convertible corporate bond with a 10-year maturity. 
E)  All of the above would have a higher promised yield. 
A)  A similar quality municipal bond. 
B)  A non-callable AAA rated corporate bond with a 5-year maturity. 
C)  A callable AAA rated corporate bond with a 15-year maturity. 
D)  A non-callable AAA rated convertible corporate bond with a 10-year maturity. 
E)  All of the above would have a higher promised yield.

Question 10

Simple interest calculations assume that interest earned is never reinvested.

Accepted Answer

A) True 
 B)False

Question 11

We expect liquidity premiums to move inversely with interest rate volatility.

Accepted Answer

A) True 
 B)False

Question 12

According to the unbiased expectations theory,

Accepted Answer

A)  markets are segmented and buyers stay in their own segment 
B)  liquidity premiums are negative and time varying 
C)  the term structure will most often be upward sloping 
D)  the long-term spot rate is an average of the current and expected future short-term interest rates 
E)  forward rates are less than the expected future spot rates 
A)  markets are segmented and buyers stay in their own segment 
B)  liquidity premiums are negative and time varying 
C)  the term structure will most often be upward sloping 
D)  the long-term spot rate is an average of the current and expected future short-term interest rates 
E)  forward rates are less than the expected future spot rates

Question 13

Earning a 5% interest rate with annual compounding is better than earning a 4.95% interest rate with semiannual compounding.

Accepted Answer

A) True 
 B)False

Question 14

You just bought a fifteen-year maturity Xerox corporate bond rated AA with a 0% coupon. You expect to sell the bond in eight years. Find the expected interest rate at the time of sale (watch out for rounding error).

Accepted Answer

A)  11.00% 
B)  8.85% 
C)  12.49% 
D)  12.80% 
E)  13.92% ((1.107515/1.09258))(1/7) -1 
A)  11.00% 
B)  8.85% 
C)  12.49% 
D)  12.80% 
E)  13.92% ((1.107515/1.09258))(1/7) -1

Question 15

Which of the following would normally be expected to result in an increase in the supply of funds, all else equal?
I. The perceived riskiness of all investments decreases.
II. Expected inflation increases.
III. Current income and wealth levels increase.
IV. Near term spending needs of households increase as energy costs rise.

Accepted Answer

A)  I and III only 
B)  II and III only 
C)  II, III, and IV only 
D)  I and IV only 
E)  I, II, III, and IV 
A)  I and III only 
B)  II and III only 
C)  II, III, and IV only 
D)  I and IV only 
E)  I, II, III, and IV

Question 16

An investor earned a 5% nominal rate of return over the year. However, over the year, prices increased by 2%. The investor's real rate of return was less than his nominal rate of return.

Accepted Answer

A) True 
 B)False

Question 17

The unbiased expectations hypothesis of the term structure posits that long-term interest rates are unrelated to expected future short-term rates.

Accepted Answer

A) True 
 B)False

Question 18

Classify each of the following in terms of their effect on interest rates (increase or decrease):
I. Covenants on borrowing become more restrictive
II. The Federal Reserve increases the money supply
III. Total household wealth increases

Accepted Answer

A)  I increases; II increases; III increases 
B)  I increases; II decreases; III decreases 
C)  I decreases; II increases; III increases 
D)  I decreases; II decreases; III decreases 
E)  none of the above 
A)  I increases; II increases; III increases 
B)  I increases; II decreases; III decreases 
C)  I decreases; II increases; III increases 
D)  I decreases; II decreases; III decreases 
E)  none of the above

Question 19

A foreign investor placing money in dollar denominated assets desires a 4% real rate of return. Global inflation is running about 3% and the dollar is expected to decline against her home currency by 1.5% over the investment period. What is her minimum required rate of return? Explain

Accepted Answer

Approximately 4% + 3% + 1.5% = 8.5%
She

Question 20

An insurance company is trying to sell you a retirement annuity. The annuity will give you 20 payments with the first payment in 12 years when you retire. The insurance firm is asking you to pay $50,000 today. If this is a fair deal, what must the payment amount be (to the dollar) if the interest rate is 8%?

Accepted Answer

A)  $5,093 
B)  $12,824 
C)  $9,472 
D)  $11,874 
E)  $10,422 $50,000 F1F1F1S1F1F1F10 1.0811 = Pmt F1F1F1S1F1F1F10 PVIFA (8%, 20 yrs) 
A)  $5,093 
B)  $12,824 
C)  $9,472 
D)  $11,874 
E)  $10,422 $50,000 F1F1F1S1F1F1F10 1.0811 = Pmt F1F1F1S1F1F1F10 PVIFA (8%, 20 yrs)

Exam 2: Determinants of Interest Rates

The risk that a security cannot be sold at a predictable price with low transaction costs at short notice is called liquidity risk.

What is the difference between the expected real interest rate and the real rate of interest actually earned?

Households generally supply more funds to the markets as their income and wealth increase, ceteris paribus.

Everything else equal, the interest rate required on a callable bond will be less than the interest rate on a convertible bond.

An improvement in economic conditions would likely shift the supply curve down and to the right and shift the demand curve for funds up and to the right.

A bank manager lends a corporate client $1,000,000 for six months. The bank charges a $1,000 fee to set up the loan. The corporate borrower repays $1,050,000 in six months. What is the effective annual rate on the loan?

Investment A pays 8% simple interest for 10 years. Investment B pays 7.75% compound interest for 10 years. Both require an initial $10,000 investment. The future value of A minus the future value of B is equal to ______________ (to the nearest penny).

You want to have $5 million when you retire in 40 years. You believe you can earn 9% per year on your investment. How much must you invest each year to achieve your goal when you retire? (Ignore all taxes)

The term structure of interest rates is upward sloping for all bond types. A certain AAA rated non-callable 10-year corporate bond has been issued at a 6.15% promised yield. Which one of the following bonds probably has a higher promised yield?

Simple interest calculations assume that interest earned is never reinvested.

We expect liquidity premiums to move inversely with interest rate volatility.

According to the unbiased expectations theory,

Earning a 5% interest rate with annual compounding is better than earning a 4.95% interest rate with semiannual compounding.

You just bought a fifteen-year maturity Xerox corporate bond rated AA with a 0% coupon. You expect to sell the bond in eight years. Find the expected interest rate at the time of sale (watch out for rounding error).

An investor earned a 5% nominal rate of return over the year. However, over the year, prices increased by 2%. The investor's real rate of return was less than his nominal rate of return.

The unbiased expectations hypothesis of the term structure posits that long-term interest rates are unrelated to expected future short-term rates.

Classify each of the following in terms of their effect on interest rates (increase or decrease): I. Covenants on borrowing become more restrictive II. The Federal Reserve increases the money supply III. Total household wealth increases

A foreign investor placing money in dollar denominated assets desires a 4% real rate of return. Global inflation is running about 3% and the dollar is expected to decline against her home currency by 1.5% over the investment period. What is her minimum required rate of return? Explain

Introduction

Interest Rates and Security Valuation

The Federal Reserve System, Monetary Policy, and Interest Rates

Money Markets

Bond Markets

Mortgage Markets

Stock Markets

Foreign Exchange Markets

Derivative Securities Markets

Commercial Banks: Industry Overview

Commercial Banks Financial Statements and Analysis

Regulation of Commercial Banks

Other Lending Institutions: Savings Institutions, Credit Unions, and Finance Companies

Insurance Companies

Securities Firms and Investment Banks

Mutual Funds and Hedge Funds

Pension Funds

Types of Risks Incurred by Financial Institutions

Managing Credit Risk on the Balance Sheet

Managing Liquidity Risk on the Balance Sheet

Managing Interest Rate Risk and Insolvency Risk on the Balance Sheet

Managing Risk Off the Balance Sheet With Derivative Securities

Managing Risk Off the Balance Sheet With Loan Sales and Securitization

Filters