Deck 10: The Investment Function in Financial-Services Management

Question 1

_________________________ are instruments which have more than one year to reach maturity.

Answer 1

Capital market securities

Question 2

A short term debt security issued by major corporations is known as _________________.

Answer 2

commercial paper

Question 3

A(n)_________________________ is an interest-bearing receipt for the deposit of funds in a bank for a stipulated time period.Ones that are oriented towards business customers or institutions are known as jumbos.

Answer 3

certificate of deposit

Question 4

_________________________ are instruments which have less than one year to reach maturity.

Question 5

A money market security which represents a bank's commitment to pay a stipulated amount of money,on a specific future date,under specific conditions,and which is often used in international trade is known as a(n)________________________.

Question 6

_________________________ is the risk that the economy of the market area in which a bank service,may take a down turn in the future.

Question 7

Debt instruments issued by cities,states,and other political entities and which are exempt from federal taxes are collectively known as ________________________.

Question 8

_________________________ is the risk that a bank may have to sell a part of its investment portfolio before maturity for a capital loss.

Question 9

Long-term debt obligations of major corporations (with maturities beyond five years)are known as _______________________.

Question 10

A(n)_________________________ is one where the interest portion of a security is sold separately from the principal portion.

Question 11

Securities sold by Fannie Mae,Freddie Mac,and other similar agencies owned or sponsored by the federal government are known as ________________________.

Question 12

__________________ is the risk that a company whose bonds a financial institution owns,may retire the entire issue in advance of its maturity,leaving the bank with the risk of earnings losses resulting from reinvesting the cash at lower interest rates.

Question 13

An investment maturity strategy which calls for a bank to have one-half of its investment portfolio in very short term assets and the other half in long term assets is known as the ________________________.

Question 14

Claims against the expected income and principal generated by a pool of similar type of loans are known as ________________________.

Question 15

A security issued by the federal government with 1 to 10 years to maturity when it is issued is called a(n)________________________.

Question 16

_________________________ are imposed by the federal,state,and local governments to guarantee the safety of their deposits with banks.

Question 17

The most aggressive investment maturity strategy calls for a bank to continually shift the maturities of its securities in response to changes in forecasts of interest rates and is called the _________________.

Question 18

An investment maturity strategy which calls for a bank to have all of its investment assets in very short term maturities is called the ________________________.

Question 19

A(n)_________________________ is a security issued by the federal government which has less than one year to maturity when it is issued.

Question 20

An investment maturity strategy which calls for a bank to have all of its investment assets in very long term maturities is known as the ________________________.

Question 21

Stripping a security eliminates prepayment risk.

Question 22

________________ are instruments that are closely related to CMOs that also partition the cash flow from a pool of mortgage loans or mortgage-backed securities into multiple maturity classes in order to reduce the cash-flow uncertainty of investors.

Question 23

________________ are a type of municipal bond that are backed by the full faith and credit of the issuing government.

Question 24

Marketable notes and bonds sold by agencies owned by the government or sponsored by the government are known as _______________.

Question 25

Bank income from loans is usually taxable.

Question 26

________________ are time deposits of fixed maturity issued by the world's largest banks,headquartered in financial centers around the globe.The heart of this market is in London.

Question 27

Investment securities are expected to help stabilize a financial institution's income.

Question 28

A(n)________________ is a picture of how market interest rates differ across loans and securities of varying times to maturity.

Question 29

A short-term IOU offered by major corporations that is of short maturity (most of these lOUs mature in 90 days or less)is known as a CMO.

Question 30

A security issued by the federal government with greater than 10 years to maturity at the time of issue is called a(n)_______________.

Question 31

Investment securities are expected to "dress up" a bank's balance sheet,according to the textbook.

Question 32

Interest income and capital gains from a bank's portfolio of investment securities are taxed in the United States as ordinary income.

Question 33

Eurocurrency deposits that some banks purchase as investments generally carry higher market yields than domestic time deposits issued by comparable-size U.S.banks.

Question 34

Prepayment risk on securitized assets generally increases when interest rates rise.

Question 35

________________ are a type of municipal bond that are paid only from certain stipulated sources of funds.

Question 36

Banks may invest in municipal bonds issued by smaller local governments and claim 80 percent of deductions for tax purposes on the interest amount of funds borrowed to purchase these securities.These bonds are known as ____________ bonds.

Question 37

According to the textbook,a majority of securities held in U.S.banks' investment portfolios are state and local government bonds.

Question 38

Investments in securities provide diversification for a bank's assets because most loans come from the local areas served by a bank's offices.

Question 39

A lending institution that sells lower-yielding securities at a loss in order to reduce current taxable income,while simultaneously purchasing higher-yielding new securities in order to boost future returns is doing a(n)_______________.

Question 40

________________ is the risk that loans will be terminated or paid off ahead of schedule.This is a particular problem with home mortgages and other consumer loans that are pooled and used as collateral in securitized assets.

Question 41

Call risk refers to the right of debt collectors to call in the loans in advance of maturity and get an early repayment.

Question 42

Stripped mortgage-backed securities fully protect investors from having to reinvest their income at lower interest rates.

Question 43

When a bank irrevocably guarantees a commercial paper issue,the bank's credit rating substitutes for the borrower's credit rating.

Question 44

An important investment security popular with banks that must,by law,mature within one year from the date of issue and which has a high degree of safety and marketability is the:

A)Treasury bill.
B)Treasury note.
C)FNMA note.
D)bankers' acceptance.
E)Eurodollar CD.

Question 45

A bank's promise to pay the holder a designated amount of money,on a designated future date,and often used in international trade is known as a(n):

A)promissory guarantee.
B)discount security.
C)bankers' acceptance.
D)in-the-money option.
E)accretion note.

Question 46

One investment maturity strategy,called the front-end loaded policy,requires that the bank put all of its investment portfolio in long-term securities.

Question 47

Treasury bills are the long term debt obligations issued by the federal government.

Question 48

Commercial paper is a short-term debt instrument issued by major banks.

Question 49

Business risk is the risk that a bank may experience a cash shortage and will have to sell some of its investments securities.

Question 50

One investment maturity strategy popular among smaller institutions is the ladder or spaced-maturity policy.It is popular because it does not take much expertise to implement.

Question 51

Bankers' acceptances are considered to be among the safest of all money market instruments.

Question 52

Interest rate risk is the risk financial institutions face due to changes in market interest rates.

Question 53

Stripped mortgage-backed securities make maturity matching of bank assets and liabilities easier to accomplish than do most other investment securities that banks buy.

Question 54

The yield to maturity is the discount rate that equates a security's purchase price with the stream of income expected until it is sold to another investor.

Question 55

An eligible acceptance is one that can be used as collateral for borrowing from the Federal Reserve Banks.

Question 56

Treasury notes and bonds are issued by the federal government and are coupon paying instruments.

Question 57

The principal risk banks face from investing in structured notes is credit (default)risk.

Question 58

Inflation risk is the possibility that the purchasing power of interest income and repaid principal from a security or loan will be eroded by rising prices for goods and services.

Question 59

The principal risk to a financial institution buying CMOs is market risk.

Question 60

Lower interest rates increase the present value of all projected cash flows from a loan-backed security resulting in a rise in its market value.

Question 61

Which of the following is not one of the capital market instruments?

A)U.S.Treasury notes
B)Corporate notes and bonds
C)U.S.Treasury bonds
D)Municipal bonds
E)Commercial paper

Question 62

The most aggressive investment maturity strategy that calls for the bank to continually shift the maturities of its securities in response to changes in forecasts of interest rates and other economic conditions is known as:

A)barbell strategy.
B)rate expectations approach.
C)front-end loaded policy.
D)ladder approach.
E)None of the options is correct.

Question 63

_____________ is the method by which banks can provide a safeguard for the deposits of governmental units.

A)Hedging
B)Loan sale
C)Pledging
D)Securitization
E)Window dressing

Question 64

Which of the following would not be considered a bank-qualified municipal security?

A)A Columbia County general obligation bond to modernize the county fire department
B)A Bucks County general obligation bond to build a new sewer plant
C)A City of San Marcos general obligation bond to pay for street repairs
D)A City of Chicopee general obligation bond to pay for a new city jail
E)A Treasury bond to finance government debt

Question 65

A security where the interest payments and the principal payments are sold separately is called:

A)a Treasury note.
B)an accretion.
C)a structured note.
D)a stripped security.
E)None of the options is correct.

Question 66

A bond has six years to maturity and has a coupon rate of 7.5 percent.Coupon payments are made annually and the bond has a face value of $1,000.The bond is currently selling in the market for $1,127.What is the yield-to-maturity on this bond?

A)7.5 percent
B)5 percent
C)11.5 percent
D)2.5 percent
E)None of the options is correct

Question 67

Which of the following statements is (are)correct regarding duration?

A)In comparing two bonds with the same yield to maturity and the same maturity,a bond with a higher coupon rate will have a longer duration.
B)In comparing two loans with the same maturity and the same interest rate,a fully amortized loan will have a shorter duration than a loan with a balloon payment.
C)The duration will always be shorter than the maturity for all debt instruments.
D)All of the options are correct.
E)B and C

Question 68

Suppose a bank has found bank-qualified municipal bonds which have a nominal gross rate of return of 8 percent and that it can borrow funds needed for this purchase at a rate of 6.25 percent.The bank is in the 35 percent tax bracket.What is the net after-tax return on this bond?

A)5.20 percent
B)3.5 percent
C)1.75 percent
D)0 percent
E)None of the options is correct

Question 69

Banks are generally not allowed to invest in speculative grade bonds.What kind of risk is this designed to limit?

A)Liquidity risk
B)Business risk
C)Credit risk
D)Operational risk
E)Interest rate risk

Question 70

A bond has eight years to maturity and a coupon rate of 6.5 percent.Coupon payments are made annually and the bond has a face value of $1,000.This bond is currently selling in the market for $862.What is the yield-to-maturity on this bond?

A)6.5 percent
B)10 percent
C)8.5 percent
D)9 percent
E)None of the options is correct

Question 71

A bond has eight years to maturity and a coupon rate of 6.5 percent.Coupon payments are made annually and the bond has a face value of $1,000.The bond is currently selling in the market for $862.If this bond is sold at the end of four years for $1046 (ex-interest),what is the holding period return on this bond?

A)6.5 percent
B)12 percent
C)9 percent
D)6 percent
E)None of the options is correct

Question 72

In recent years security dealers have assembled pools of federal agency securities whose interest yield may be periodically reset based on what happens to a stated interest rate,or may carry multiple coupon rates that are periodically adjusted;the foregoing describes a:

A)financial futures contract.
B)revenue-anticipation note.
C)zero coupon instrument.
D)structured note.
E)None of the options is correct.

Question 73

Mortgage prepayment risk:

A)is higher on high interest rate mortgages.
B)is felt most dramatically when interest rates rise.
C)is eliminated by the use of mortgage backed securities.
D)is eliminated by the purchase of a stripped mortgage obligation.
E)All the options are true.

Question 74

An investor can invest in either a tax-exempt security that pays 5%,or a taxable corporate security of comparable risk and maturity that pays 8%.At what marginal tax rate will the investor be indifferent between these two securities?

A)25.0%
B)32.5%
C)37.5%
D)57.5%
E)62.5%

Question 75

Pools of mortgages put together,either by a government agency or by a private investment banking corporation,to raise more loanable funds for the issuer are known as a(n):

A)accretion bond.
B)participation certificate.
C)CMO.
D)stripped security.
E)commercial paper.

Question 76

Principal roles that a financial institution's investment portfolio plays include which of the following?

A)Income stability
B)Geographic diversification
C)Hedging interest rate risk
D)Backup liquidity
E)All of the options are correct

Question 77

A bank replaces 5-year corporate bonds with a coupon rate of 9.75 percent with 5-year municipal bonds with a coupon rate of 7 percent.The bank is in the 35 percent tax bracket and these bonds have the same default risk.What is the most likely reason the bank changed from the corporate to the municipal bonds?

A)Liquidity risk
B)Business risk
C)Credit risk
D)Tax exposure
E)Interest rate risk

Question 78

A $1,000 bond has three years to maturity and has a coupon rate of 15 percent.Coupon payments are made annually.The bond is currently selling in the market for $1,072 and has a yield-to-maturity of 12%.What is the duration of this bond?

A)3 years
B)1 year
C)1.92 years
D)2.45 years
E)2.64 years

Question 79

Which of the following is true of Treasury bills?

A)Interest on Treasury bills is not exempt from state income taxes.
B)Interest on Treasury bills is exempt from federal income taxes.
C)Treasury bills pay a lower pre-tax yield than comparable corporate securities.
D)All the options are true.
E)None of the options is correct.

Question 80

Fluctuations in the timing of cash-flows arising out of an underlying pool of securitized assets is referred to as:

A)income risk.
B)prepayment risk.
C)liquidity risk.
D)capital risk.
E)None of the options is correct.