Deck 3: The Canadian Financial System

Question 1

________ is a company that obtains funds primarily from wealthy investors and uses the funds to make complicated,often risky investments.

A) A mutual fund
B) A pension fund
C) A hedge fund
D) An investment bank

Answer 1

C

Question 2

One difference between stocks and bonds is that

A) unlike stocks, bonds do not represent a claim on a share in the profits and assets of firms.
B) stocks are government-issued securities and bonds are financial securities.
C) unlike stocks, bonds do not promise to repay a fixed amount of money.
D) bonds represent ownership in companies and stocks represent corporate assets.

Answer 2

A

Question 3

Some borrowers with low credit scores have difficulty finding any lenders willing to make loans to them.These people typically have seriously flawed credit histories that may include failure to make payments on credit cards or on car loans or they may have declared personal bankruptcy in the recent past.These borrowers are often referred to as

A) payday borrowers.
B) default-risk intermediaries.
C) subprime borrowers.
D) bankrupt customers.

Answer 3

C

Question 4

It is often said that bank managers have unlimited upside and limited downside.In other words,banks and other financial intermediaries can experience significant ________ problems.

A) insolvency
B) adverse selection
C) liquidity
D) moral hazard

Question 5

________ is an institution that receives contributions from workers and uses the funds received to invest in financial securities to fund retirement benefits.

A) A mutual fund
B) A pension fund
C) A hedge fund
D) An investment bank

Question 6

Briefly describe the following types of financial intermediaries:
1. Commercial bank
2. Investment bank
3. Mutual fund
4. Hedge fund
5. Pension fund
6. Insurance company

Question 7

The subprime mortgage crisis was far less detrimental to the Canadian economy than to that of the United States.Subprime mortgages never became popular in Canada because

A) Canadian banks are very conservative.
B) Canadian mortgages are not regulated.
C) securitization is common in Canada.
D) subprime lending is not profitable.

Question 8

Lenders encounter the ________ problem before a loan is made when they try to distinguish borrowers who are likely to pay back loans from borrowers who are unlikely to do so.

A) adverse selection
B) principal-agent
C) asset deflation
D) moral hazard

Question 9

Janie convinces her Uncle Seymour that she is on the Dean's list each semester and asks him to lend her $5000 to help pay for her university tuition for the upcoming year,assuring him that she will be able to pay him back as soon as she graduates and gets a job.In reality,Janie has flunked out of university,has spent all her savings on food for her 40 ferrets,and wants to use the money to bail her boyfriend out of jail.Not being honest with her uncle when asking for the loan is an example of ________,and spending the borrowed money to pay her boyfriend's bail is an example of ________.

A) moral hazard; asymmetric information
B) moral hazard; the principal-agent problem
C) adverse selection; moral hazard
D) the principal-agent problem; adverse selection

Question 10

A financial asset is considered a security if

A) its value increases after it is sold in a primary market.
B) it guarantees to repay its owner a fixed amount of money at maturity.
C) it represents financial ownership in a corporation.
D) it can be sold in a secondary market.

Question 11

A measure of how much debt an investor takes on in making an investment is referred to as

A) asset management.
B) the debt-equity ratio.
C) securitization.
D) leverage.

Question 12

One difference between stocks and bonds is that

A) unlike bonds, stocks do not represent a claim on a share in the profits and assets of firms.
B) stocks are financial securities and bonds are labour market securities.
C) unlike bonds, stocks do not promise to repay a fixed amount of money.
D) stocks represent ownership in companies and bonds represent ownership in the government.

Question 13

Which of the following is not one of the three key services provided by the financial system to savers and borrowers?

A) risk sharing
B) credit counselling
C) liquidity
D) information

Question 14

How does a primary financial market differ from a secondary financial market?

Question 15

Institutions that borrow money from savers to lend to borrowers are known as

A) financial markets.
B) bond brokers.
C) financial intermediaries.
D) asset exchanges.

Question 16

________ is a company that provides advice to firms issuing new securities,underwrites the issuing of securities,and develops new securities.

A) A mutual fund
B) A pension fund
C) A hedge fund
D) An investment bank

Question 17

Some mutual funds in Canada are now investing in stocks of foreign firms.By expanding to global financial markets,these mutual funds will be able to diversify their stock portfolios,allowing savers more options to spread their money among many financial investments.This is an example of

A) risk sharing.
B) providing information.
C) investor securitization.
D) decreasing liquidity.

Question 18

Which of the following is an example of securitization?

A) A bank bundles a group of mortgage loans and sells the bundle to investors.
B) An investor sells his shares of stock and uses the proceeds to purchase Canada Savings Bonds.
C) A household deposits cash in a savings account that is insured by the CDIC.
D) A government chooses to only purchase Treasury securities from other governments that are financially sound.

Question 19

All of the following are examples of financial securities,except

A) chequing accounts.
B) corporate bonds.
C) shares of stock.
D) Treasury bonds.

Question 20

The main source of loans to small businesses are

A) financial markets.
B) privately-issued bonds.
C) shares of stock issued by the businesses.
D) financial intermediaries.

Question 21

Suppose you purchase a new home for $250 000,making a down payment of 25% and taking out a mortgage on the balance.What is the return on your investment in your home if one year later the price of your home increases by 30%?

A) 27.5%
B) 41.7%
C) 83.3%
D) 120%

Question 22

Suppose you made a 5% down payment on a house on January 1,2013,and on January 1,2014 you decided to sell the house.If the price of your house decreased by 10%,the return on your investment in the house would be

A) -5%.
B) -10%.
C) -50%.
D) -200%.

Question 23

Suppose you made a 20% down payment on a house on January 1,2013,and on January 1,2014 you decided to sell the house.If the price of your house increased by 10%,the return on your investment in the house would be

A) 10%.
B) 20%.
C) 50%.
D) 200%.

Question 24

A situation in which many banks simultaneously experience rapid deposit withdrawals is called

A) a bank run.
B) a bank panic.
C) contagion.
D) asset deflation.

Question 25

The ________ the down payment made by a borrower when taking out a mortgage,the ________.

A) lower; lower the interest rate usually charged by the financial company issuing the mortgage
B) lower; more highly leveraged that borrower is on the mortgage
C) higher; more likely the mortgage-issuer will be faced with a mortgage default
D) higher; greater the risk that the borrower will find herself upside down on the mortgage

Question 26

Suppose you purchase a new home for $150 000,making a down payment of 10% and taking out a mortgage on the balance.What is the return on your investment in your home if one year later the price of your home decreases by 20%?

A) -10%
B) -30%
C) -50%
D) -200%

Question 27

The ________ plays an important role in preventing bank panics by insuring individual bank deposits up to $100 000 per institution.

A) Bank of Canada
B) Federal Deposit Insurance Corporation
C) Federal Reserve
D) Canada Deposit Insurance Corporation

Question 28

Explain how a bank run can cause a bank to fail.

Question 29

One of the key reasons that the Bank of Canada acts as a lender of last resort is to prevent ________,the process by which a run on one bank spreads to other banks,resulting in a bank panic.

A) contagion
B) asset inflation
C) moral hazard
D) bailouts

Question 30

Suppose you purchase a new home for $75 000,making a down payment of 20% and taking out a mortgage on the balance.What is the return on your investment in your home if one year later the price of the home increases by 5%? What if the price of the home decreases by 5%?

Question 31

For a public firm,net worth is called shareholder's equity; for a bank,net worth is often referred to as

A) bank's reserves.
B) bank's leverage.
C) bank's capital.
D) loan allowance.

Question 32

The more leveraged an investment,the ________ the potential gain and the ________ the potential loss from that investment.

A) greater; greater
B) greater; smaller
C) smaller; smaller
D) smaller; greater

Question 33

What is the difference between a bank run and a bank panic? How might a bank run and asymmetric information lead to a bank panic?

Question 34

Canada,like nearly all countries,has a fractional reserve banking system,meaning

A) banks keep less than 100% of deposits as reserves.
B) bank reserve requirements can vary significantly.
C) banks must keep 100% of deposits as reserves.
D) only certain banks must meet the minimum reserve requirement.

Question 35

When the value of a bank's or another firm's assets declines to less than the value of its liabilities,the firm

A) is experiencing asset deflation.
B) is insolvent.
C) has positive net worth.
D) has high liquidity.

Question 36

When multiple banks have to sell the same assets,such as securitized loans,the prices of these assets are likely to decline.This process is called

A) securitization.
B) asset deflation.
C) whole-selling.
D) syndication.

Question 37

Suppose you purchase a new home for $300 000,making a down payment of 50% and taking out a mortgage on the balance.What is the return on your investment in your home if one year later the price of your home increases by 50%?

A) 0%
B) 10%
C) 50%
D) 100%

Question 38

The text lists five policy responsibilities of most central banks,including the Bank of Canada.What are those five policy responsibilities?

Question 39

By acting as a lender of last resort during a banking panic,a central bank allows commercial banks to

A) encourage the public to borrow directly from the central bank, taking pressure off the banking system.
B) satisfy customer withdrawal needs and eventually restore the public's faith in the banking system.
C) call in their loans to their customers and eventually restore the public's faith in the banking system.
D) make additional loans to increase the assets on their balance sheets.

Question 40

What would happen to the availability of credit if banks chose to either increase or decrease the percentage of deposits they hold as reserves?

Question 41

An increase in real GDP will shift the money demand curve to the ________,causing the nominal interest rate to ________.

A) right; increase
B) right; decrease
C) left; increase
D) left; decrease

Question 42

If you want to know the present value of $4000 in two years and the annual interest rate is 5%,what formula can you use?

A) Present value = $4000 / (0.05) × ².
B) Present value = $4000 / (1 + 0.05)².
C) Present value = $4000 × (1 + 0.05)².
D) Present value = $4000 × (1 + 0.05 )/ ².

Question 43

Joshua has decided that he will only purchase a one-year Treasury bill with a face value of $500 000 if he receives an interest rate of 6.25%.How much will Joshua end up paying for this Treasury bill?

A) $439 338
B) $468 750
C) $470 588
D) $531 250

Question 44

When nominal interest rates increase,the opportunity cost of holding money will ________,and the quantity of money demanded by households and firms will ________.

A) increase; increase
B) increase; decrease
C) decrease; increase
D) decrease; decrease

Question 45

An increase in the money supply will cause the nominal interest rate to ________ and the quantity of money to ________.

A) increase; increase
B) increase; decrease
C) decrease; increase
D) decrease; decrease

Question 46

Which of the following has the highest present value?

A) $1000 received in 3 years if the current interest rate is 4%
B) $1500 received in 5 years if the current interest rate is 6%
C) $2000 received in 6 years if the current interest rate is 11%
D) $3000 received in 10 years if the current interest rate is 12%

Question 47

A decrease in the money supply will shift the money supply curve to the ________,causing the nominal interest rate to ________.

A) right; increase
B) right; decrease
C) left; increase
D) left; decrease

Question 48

Which of the following has the lowest present value?

A) $1000 received in 3 years if the current interest rate is 4%
B) $1500 received in 5 years if the current interest rate is 6%
C) $2000 received in 6 years if the current interest rate is 11%
D) $3000 received in 10 years if the current interest rate is 13%

Question 49

If you put $2000 in a saving account that earns 3% interest per year,what is the formula you should use to determine the account's future value in one year?

A) Future value = $2000 × 0.03.
B) Future value = $2000 / 0.03.
C) Future value = $2000 / (1 + 0.03).
D) Future value = $2000 × (1 + 0.03).

Question 50

If you pay $17 500 for a $20 000 face value one-year Treasury bill,what is the rate of interest you will receive?

A) 8.75%
B) 11.43%
C) 12.5%
D) 14.29%

Question 51

If you pay $4888 for a $5000 face value one-year Treasury bill,what is the rate of interest you will receive?

A) 1.02%
B) 2.29%
C) 4.46%
D) 9.78%

Question 52

If Elvira purchases a $10 000 face value one-year Treasury bill for $9302.33,the interest rate she will receive on the Treasury bill is

A) 1.07%.
B) 6.98%.
C) 7.5%.
D) 9.3%.

Question 53

The price of a financial asset should equal the

A) present value of the payments to be received from owning the asset.
B) future value of the payments to be received from owning the asset.
C) face value of the asset less the future payments to be received from owning the asset.
D) coupon value of the asset divided by the effective interest rate at the time the asset was purchased.

Question 54

The money demand curve will shift to the left if real GDP ________ or if the price level ________.

A) increases; increases
B) increases; decreases
C) decreases; increases
D) decreases; decreases

Question 55

What will the value of $18 000 be in 10 years if the current interest rate is 12%?

A) $5795.52
B) $39 600.00
C) $40 579.20
D) $55 905.27

Question 56

What is the present value of $750 received three years from now if the current rate of interest is 7%?

A) $612.22
B) $700.93
C) $918.78
D) $2407.50

Question 57

A decrease in the price level will shift the money demand curve to the ________,causing the nominal interest rate to ________.

A) right; increase
B) right; decrease
C) left; increase
D) left; decrease

Question 58

Sammy is willing to lend Oscar $625 today so Oscar can purchase a new set of tires for his pick-up truck.Oscar agrees to pay the loan back plus 5% interest in one year.What is the future value of this loan?

A) $595.24
B) $656.25
C) $750.00
D) $812.50

Question 59

An increase in interest rates

A) increases the prices of existing financial assets.
B) increases the prices of existing financial assets and of newly issued financial assets.
C) reduces the prices of existing financial assets.
D) reduces the prices of existing financial assets and of newly issued financial assets.

Question 60

Ramona has decided that she will only purchase a one-year Treasury bill with a face value of $15 000 if she receives an interest rate of 4.125%.How much will Ramona end up paying for this Treasury bill?

A) $12 447.66
B) $14 381.25
C) $14 405.76
D) $15 618.75

Question 61

________ bonds tend to have lower interest rates than ________ bonds.

A) Lower coupon payment; higher coupon payment
B) Higher denomination; lower denomination
C) Longer-maturity; shorter-maturity
D) Shorter-maturity; longer-maturity

Question 62

Your loss from an increase in interest rates is ________,and your gain from a decrease in interest rates is ________,if you hold a two-year bond compared to holding a one-year bond.

A) greater; greater
B) greater; less
C) less; greater
D) less; less

Question 63

Suppose an increase in real GDP is accompanied by an increase in the money supply from $600 billion to $700 billion.Draw a graph of the money market showing these changes,where the equilibrium nominal interest rate remains at 5%.

Question 64

Suppose a Canada Savings Bond will mature in 4 years.If the bond pays a coupon of $200 per year and will make a final par value payment of $5000 at maturity,what is its price if the relevant market interest rate is 3%?

A) $5185.85
B) $5304.26
C) $5743.42
D) $6011.82

Question 65

Suppose you purchase a two-year bond that has a $450 coupon and a face value of $5000,and immediately after you purchase the bond,new bonds are issued that are otherwise identical,except they have coupons of $375.If you sell your bond,the price of your bond will be

A) $4868.07.
B) $5000.00.
C) $5069.76.
D) $5134.67.

Question 66

Luke purchases a $50 000 face value one-year Treasury bill for $46 296.30,and the next day investors decide they will only buy one-year Treasury bills if they receive an interest rate of 4%.If Luke decides to sell his Treasury bill to another investor the day after he purchased it,he will

A) receive a capital gain of $1780.62.
B) receive a capital gain of $2000.00.
C) suffer a capital loss of $1923.08.
D) suffer a capital loss of $1851.85.

Question 67

Assume the interest rate on a current one-year bond is 3%,and the expected interest rate on the one-year bond one year from now is 6%.If the term premium on a two-year bond is 0.5%,then the interest rate on the two-year bond will be

A) 4%.
B) 4.5%.
C) 5%.
D) 6.5%.

Question 68

Bonds with ________ tend to have lower interest rates than bonds with ________.

A) high liquidity; low liquidity
B) high default risk; low default risk
C) longer maturity; shorter maturity
D) high tax burdens on their interest; low tax burdens on their interest

Question 69

The relationship among interest rates on bonds that all mature at the same time is known as the

A) term structure of interest rates.
B) risk structure of interest rates.
C) term premium.
D) Treasury yield.

Question 70

Suppose you purchase a one-year bond that has a $450 coupon and a face value of $5000,and immediately after you purchase the bond,new bonds are issued that are otherwise identical,except they have coupons of $375.If you sell your bond,you will

A) suffer a loss of $5.76.
B) suffer a loss of $412.84.
C) receive a gain of $69.77.
D) receive a gain of $418.60.

Question 71

Assume the current interest rate on a one-year bond is 7%,and the interest rate investors expect on the one-year bond one year from now is 3%.According to the expectations hypothesis,the current interest rate (per year)on a two-year bond should be

A) 3%.
B) 5%.
C) 7%.
D) 10%.

Question 72

The yield curve will be downward sloping when

A) investors expect future short-term interest rates to be significantly lower than current short-term interest rates.
B) investors expect future short-term interest rates to be significantly higher than current short-term interest rates.
C) short-term interest rates are significantly lower than long-term interest rates.
D) short-term interest rates are equal to long-term interest rates.

Question 73

Suppose a Canada Savings Bond will mature in 3 years.If the bond pays a coupon of $100 per year and will make a final par value payment of $3000 at maturity,what is its price if the relevant market interest rate is 7%?

A) $2448.89
B) $2711.33
C) $3247.57
D) $3510.00

Question 74

Zelda won the jackpot on a penny slot machine in Las Vegas and is given the following three options to receive her jackpot:
Option 1: $100 000 to be received right away,with four additional payments of $100 000 to be received each year for the next four years.
Option 2: $250 000 to be received right away with two additional payments of $100 000 to be received each year for the next two years.
Option 3: $400 000 to be received right away.
Which option should Zelda choose if the interest rate is 8%? Would she choose the same option if the interest rate were 10%? Why?

Question 75

Suppose you purchase a two-year bond that has a $450 coupon and a face value of $5000,and immediately after you purchase the bond,new bonds are issued that are otherwise identical,except they have coupons of $375.If you sell your bond,you will receive a gain of

A) $67.33.
B) $134.66.
C) $269.32.
D) $389.40.

Question 76

Assume the current price investors are willing to pay on a $1000 face value one-year Canada Savings Bond is $980.39,and investors expect that they will be willing to pay $961.54 on a $1000 face value one-year Canada Savings Bond one year from now.According to the expectations hypothesis,the current interest rate (per year)on a $1000 face value two-year Canada Savings Bond should be

A) 3%.
B) 4%.
C) 5%.
D) 6%.

Question 77

Bonds with ________ tend to have higher interest rates than bonds with ________.

A) high liquidity; low liquidity
B) high default risk; low default risk
C) shorter maturity; longer maturity
D) low tax burdens on their interest; high tax burdens on their interest

Question 78

Isabel purchases a $1000 face value one-year Treasury bill for $934.58,and the next day investors decide they will only buy one-year Treasury bills if they receive an interest rate of 9%.If Isabel decides to sell her Treasury bill to another investor the day after she purchased it,she will

A) receive a capital gain of $28.04.
B) receive a capital gain of $7.76.
C) suffer a capital loss of $18.69.
D) suffer a capital loss of $17.15.

Question 79

Suppose you purchase a one-year bond that has a $450 coupon and a face value of $5000,and immediately after you purchase the bond,new bonds are issued that are otherwise identical,except they have coupons of $375.If you sell your bond,the price of your bond will be

A) $4931.20.
B) $5000.00.
C) $5069.77.
D) $5134.66.

Question 80

The relationship among interest rates on bonds that are otherwise similar but that have different maturities is known as the

A) term structure of interest rates.
B) risk structure of interest rates.
C) term premium.
D) Treasury bond coupon.