Download True/False Questions

Chapter 1
Introduction
Chapter 1
True/False Questions
1. Primary markets are markets where users of funds raise cash by selling securities to funds suppliers.
Answer: True Page: 4 Level: Easy
2. Secondary markets are markets used by corporations to raise cash by issuing securities for a short time
period.
Answer: False Page: 6 Level: Easy
3. In a private placement, the issuer typically sells the entire issue to one or only a few institutional buyers.
Answer: True Page: 4 Level: Easy
4. The NYSE is an example of a secondary market.
Answer: True Page: 6 Level: Easy
5. The NASDAQ is an example of an over the counter market.
Answer: True Page: 2,6-7 Level: Easy
6. Money markets are the markets for securities with an original maturity of 1 year or less.
Answer: True Page: 7 Level: Easy
7. Eurodollar bonds are dollar denominated bonds issued outside the United States.
Answer: True Page: 20 Level: Easy
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8. Financial intermediaries such as banks often have assets that are riskier than their liabilities.
Answer: True Page: 16 Level: Easy
9. As of 2001, the dollar amount of outstanding money market securities was substantially greater than the
dollar amount of capital market securities.
Answer: False Page: 8 Level: Easy
10. A transaction that involves the exchange of currencies at a specified date in the future at terms agreed
upon today is known as a forward foreign exchange transaction.
Answer: True Page: 10 Level: Medium
11. An individual buying an AT&T corporate bond in the secondary market is an example of a direct
finance.
Answer: True Page: 12 Level: Medium
12. A bank incurs credit risk when its loans have a longer maturity than its deposits.
Answer: False Page: 18 Level: Easy
Multiple Choice Questions
13. The best example of a foreign exchange spot transaction is
A) Buying stock in an IPO
B) Selling your AT&T bond through your broker
C) Purchasing shares of Fidelity Magellan Mutual Fund
D) Trading your dollars for yen at today's rate
E) Promising to trade your dollars for British pounds in one month
Answer: D Page: 10 Level: Easy
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Chapter 1
Introduction
Use the following to answer questions 14-15:
IBM creates and sells additional stock to the investment banker, Morgan Stanley. Morgan Stanley then resells
the issue to the U.S. public.
14. This transaction is an example of a(n)
A) Primary market transaction
B) Asset transformation by Morgan Stanley
C) Money market transaction
D) Foreign exchange transaction
E) Forward transaction
Answer: A Page: 5 Level: Easy
15. Morgan Stanley is acting as a(n)
A) Asset transformer
B) Asset broker
C) Government regulator
D) Foreign service representative
Answer: B Page: 5 Level: Medium
16. As measured by total assets, the largest three private U.S. intermediaries are:
A) banks, thrifts and insurers
B) banks, insurers and investment companies
C) insurers, thrifts and pension funds
D) Securities dealers, thrifts and banks
E) Mortgage companies, investment companies and pension funds.
Answer: B Page: 13 Level: Medium
17. Advantages of putting your money in a bank deposit instead of directly buying capital market securities
typically include
A) Delegated monitoring
B) Better liquidity
C) Less price risk
D) All of the above
E) None of the above
Answer: D Page: 14 Level: Easy
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18. A bank that makes a two year loan in yen and funds it with 6 month Eurodollar deposits incurs
A) Foreign exchange risk
B) Interest rate risk
C) Liquidity risk
D) All of the above
E) None of the above
Answer: D Page: 10,14 Level: Medium
19. New Age Banking (NAB) recently invested heavily in Internet technology in order to offer on line
services to corporate and individual customers. So far, only two corporate customers and very few
individuals have begun using their Internet services. In addition, NAB lost an entire corporate payroll
last month. These are examples of:
A) Credit risk and market risk
B) Country risk and insolvency risk
C) Technological risk and operational risk
D) Liquidity risk and interest rate risk
E) None of the above
Answer: C Page: 19-20 Level: Medium
20. _________ and __________ allow a financial intermediary to offer safe, liquid liabilities such as
deposits while investing the depositors money in riskier, illiquid assets.
A) Diversification ; high equity returns
B) Price risk ; collateral
C) Free riders ; regulations
D) Monitoring ; diversification
E) Primary markets ; foreign exchange markets
Answer: D Page: 15-16 Level: Medium
21. Depository institutions include:
A) Banks
B) Thrifts
C) Finance companies
D) All of the above
E) A and B only
Answer: E Page: 12 Level: Medium
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Chapter 1
Introduction
22. Match the intermediary with the characteristic that best describes its function.
I. Provide protection from adverse events
II. Pool funds of small savers and invest in either money or capital markets
III. Provide consumer loans and real estate loans funded by deposits
IV. Accumulate and transfer wealth from work period to retirement period
V. Underwrite and trade securities and provide brokerage services
1. Thrifts
2. Insurers
3. Pension funds
4. Securities firms and investment banks
5. Mutual funds
A) 1, 3, 2, 5, 4
B) 4, 2, 3, 5, 1
C) 2, 5, 1, 3, 4
D) 2, 4, 5, 3, 1
E) 5, 1, 3, 2, 4
Answer: C Page: 12 Level: Medium
23. As of 2001, in dollar terms, U.S. investors held over ___________ trillion in foreign financial assets and
foreign investors held over __________ trillion in U.S. financial assets.
A) $7.6 ; $6.5
B) $6.5 ; $7.6
C) $3.2 ; $5.2
D) $8.1 ; $5.5
E) $5.5 ; $8.1
Answer: E Page: 21 Level: Medium
24. Financial intermediaries (FIs) can offer savers a safer, more liquid investment than a capital market
security, even though the intermediary invests in risky illiquid instruments because:
A) FIs can diversify away some of their risk
B) FIs closely monitor the riskiness of their assets
C) The federal government requires them to do so
D) Both a) and b)
E) Both a) and c)
Answer: D Page: 15-16 Level: Easy
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25. Households are increasingly likely to both directly purchase securities (perhaps via a broker) and also
place some money with a bank or thrift to meet different needs. Match up the given investor's desire
with the appropriate intermediary or direct security.
I. Money likely to be needed within 6 months
II. Money to be set aside for college in 10 years
III. Money to provide supplemental retirement income
IV. Money to be used to provide for children in the event of death
1. Depository institutions
2. Insurer
3. Pension fund
4. Stocks or bonds
A) 2, 3, 4, 1
B) 1, 4, 2, 3
C) 3, 2, 1, 4
D) 1, 4, 3, 2
E) 4, 2, 1, 3
Answer: D Page: 12 Level: Medium
26. Which one of the following is a capital market instrument?
A) Federal funds
B) Treasury bills
C) Commercial paper
D) Common stock
Answer: D Page: 8,9 Level: Easy
27. Which of the following are money market instruments?
A) Federal funds
B) Treasury bills
C) Commercial paper
D) 4 year maturity corporate bond
E) A, B and C are money market instruments
Answer: E Page: 7-8 Level: Easy
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Chapter 1
Introduction
28. The Securities Exchange Commission (SEC) does not
A) Decide whether a public issue is fairly priced
B) Decide whether a firm making a public issue has provided enough information for investors to
decide whether the issue is fairly priced
C) Require exchanges to monitor trading to prevent insider trading
D) Attempt to reduce excessive price fluctuations
E) Monitor the major securities exchanges
Answer: A Page: 9 Level: Medium
29. Many households place funds with financial intermediaries (FIs) because many FI accounts provide
A) Lower denominations than money market securities
B) Better liquidity and less price risk than direct securities
C) Shorter maturities than direct securities
D) All of the above
E) None of the above
Answer: D Page: 15 Level: Easy
30. In the U.S., savings institutions must concentrate their assets in __________ lending.
A) mortgage
B) commercial
C) consumer
D) government
E) money market
Answer: A Page: 18 Level: Easy
31. Depository institutions (DIs) play an important role in the transmission of monetary policy from the
Federal Reserve to the rest of the economy because
A) Loans to corporations are part of the money supply
B) Bank and thrift loans are tightly regulated
C) U.S. DIs compete with foreign financial institutions
D) DI deposits are a major portion of the money supply
E) Thrifts provide a large amount of credit to finance residential real estate
Answer: D Page: 17-18 Level: Difficult
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32. According to a recent SIA survey, what percentage of retail stock transactions will be conducted online
by 2003?
A) 30%
B) 40%
C) 50%
D) 60%
E) 70%
Answer: C Page: None Level: Medium
Chapter 2
True/False Questions
1. The real interest rate is the increment to purchasing power that the lender earns in order to induce him or
her to forego current consumption.
Answer: True Page: 47 Level: Medium
2. At a peak in economic activity the term structure usually switches from a downward slope to flat.
Answer: False Page: 54 Level: Medium
3. A monthly interest rate of 1% is equivalent to a 12% annual interest rate with annual compounding.
Answer: False Page: 26-27 Level: Medium
4. In simple interest calculations the interest earned is never added to the principle.
Answer: True Page: 26-27 Level: Easy
5. Cash flows of $500 in one month, $500 in 3 months and $500 in 6 months comprise an annuity.
Answer: False Page: 28 Level: Easy
6. You just won a lottery that has a present value of $20 million. However, you will actually receive 20
annual installment payments over the next 20 years, beginning in one year. If the interest rate is greater
than zero you can expect each installment to be less than $1 million.
Answer: False Page: 32 Level: Difficult
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Chapter 1
Introduction
7. Everything else equal, the present value of a given future cash flow will increase if you use a higher
interest rate while the future value of a given amount of cash received today will decrease if you use a
higher interest rate.
Answer: False Page: 34 Level: Easy
8. Holding everything else equal, for a given N year annuity, the higher the interest rate the greater the
future value of the annuity and the lower the present value of the annuity.
Answer: True Page: 33-34 Level: Medium
9. If you buy a single payment security you will receive interest in 6 months and at maturity.
Answer: False Page: 36-37 Level: Easy
10. Everything else equal, a bond equivalent yield will be greater than an effective annual yield
Answer: False Page: 32-37 Level: Easy
11. The household sector is the largest supplier of loanable funds.
Answer: True Page: 37-38 Level: Easy
12. The greater is household wealth, the greater the amount of loanable funds they demand, ceteris paribus.
Answer: False Page: 40 Level: Easy
13. An increase in the perceived riskiness of investments would cause a movement up along the supply
curve.
Answer: False Page: 42 Level: Medium
14. Ceteris paribus, a decline in the government budget deficit would tend to increase U.S. interest rates.
Answer: False Page: 40 Level: Medium
15. When the quantity of a financial security supplied or demanded changes at every given interest rate in
response to a change in a factor, this causes a shift in the supply or demand curve.
Answer: True Page: 41 Level: Medium
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16. An increase in loan origination fees by all banks would shift the demand for funds up and to the left.
Answer: False Page: 38 Level: Medium
17. 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.
Answer: True Page: 45 Level: Medium
18. The risk that a security cannot be sold at a predictable price with low transaction costs at short notice is
called default risk.
Answer: False Page: 47 Level: Easy
19. The nominal rate less the DRP is the real rate.
Answer: False Page: 48 Level: Medium
20. Default risk premiums on investment grade debt typically increase during economic slowdowns.
Answer: True Page: 48-49 Level: Easy
21. Everything else equal, the interest rate on a callable bond will be less than the interest rate on a
convertible bond.
Answer: False Page: 51-52 Level: Easy
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Chapter 1
Introduction
22. The term structure of interest rates is the relationship between interest rates on bonds similar in terms
except for maturity.
Answer: True Page: 52-53 Level: Easy
23. The unbiased expectations hypothesis of the term structure posits that long term interest rates are
unrelated to expected future short term rates.
Answer: False Page: 54-55 Level: Medium
24. The traditional liquidity premium theory states that long term interest rates are greater than the average
of expected future interest rates.
Answer: True Page: 56 Level: Medium
25. According to the market segmentation theory short term investors will not normally switch to
intermediate or long term investments.
Answer: True Page: 57 Level: Easy
Multiple Choice Questions
26. An investment pays, $950 in one year, X amount of dollars in two years and $450 in 3 years. The total
present value of all the cash flows (including X) is equal to $2000. If it is 9%, what is X?
A) $817.16
B) $749.68
C) $780.95
D) $927.86
E) $600.00
Answer: D Page: 34 Level: Difficult
Response: X = [2000 – (950/1.09) – (450/1.093)]*1.092
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27. An annuity and an annuity due that have the same number of payments also have the same present value
if r = 10%. Which one has the higher payment?
A) The annuity has the higher payment
B) The annuity due has the higher payment
C) They both must have the same payment since the present values are the same
D) There is no way to tell which has the higher payment
E) An annuity and an annuity due cannot have the same present value
Answer: A Page: 34 Level: Medium
28. A 10 payment annual annuity has its first payment in 6 years. The investment has a current value today
of $50,000. What is the payment amount (to the penny) if the interest rate is 12%?
A) $15,364.55
B) $8,849.21
C) $14,490.25
D) $17,651.20
E) $15,595.33
Answer: E Page: 32 Level: Difficult
Response: 50,000* 1.125 = Pmt  PVIFA(12%,10 yrs)
29. You borrow $95 today for six and a half weeks. You must repay $100 at loan maturity. What is the
effective annual rate on this loan?
A) 50.73%
B) 40.00%
C) 32.33%
D) 27.95%
E) 37.93%
Answer: A Page: 34 Level: Difficult
Response: (100 / 95)(52 / 6.5)
30. If M > 1 and you solve the following equation to find i: PV * (1 + (i/M))M*N = FV, the i you get will be
A) The bond equivalent yield
B) The EAR
C) The TOE
D) The EYE
E) The rate per compounding period
Answer: A Page: 35-36 Level: Difficult
31. An annuity and an annuity due with the same number of payments have the same future value if r =
10%. Which one has the higher payment?
A) They both must have the same payment since the future values are the same
B) There is no way to tell which has the higher payment
C) An annuity and an annuity due cannot have the same future value
D) The annuity has the higher payment
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Chapter 1
Introduction
E) The annuity due has the higher payment
Answer: D Page: 32-34 Level: Difficult
32. You go to the Wall Street Journal and notice that yields on almost all corporate and Treasury bonds have
decreased. The yield decreases may perhaps be explained by which one of the following:
A) A decrease in U.S. inflationary expectations
B) Newly expected decline in the value of the dollar
C) An increase in current and expected future returns of real corporate investments
D) Decreased Japanese purchases of U.S. Treasury Bills/Bonds
E) Increases in the U.S. Government budget deficit
Answer: A Page: 47-48 Level: Medium
Use the following to answer questions 33-34:
YIELD CURVE FOR ZERO COUPON BONDS RATED AA
Maturity YTM
Maturity YTM
Maturity YTM
1 year
8.00%
7 year
9.15%
13 year
10.45%
2 year
8.11%
8 year
9.25%
14 year
10.65%
3 year
8.20%
9 year
9.35%
15 year
10.75%
4 year
8.50%
10 year
9.47%
16 year
10.95%
5 year
8.75%
11 year
9.52%
17 year
11.00%
6 year
8.85%
12 year
9.77%
18 year
11.25%
There are no liquidity premiums.
33. To the nearest basis point what is the expected interest rate on a one year AA zero coupon bond
purchased eight years from today?
A) 9.47%
B) 10.15%
C) 9.41%
D) 10.56%
E) 0.12%
Answer: B Page: 58-59 Level: Difficult
Response: (1.09359 / 1.09258) -1
34. You just bought a 17 year maturity Xerox corporate bond rated AA with a 0% coupon. Find the
expected rate of return (to the nearest basis point) on the bond if you expect to sell the bond in 6 years
(watch out for rounding error).
A) 11.00%
B) 8.85%
C) 12.39%
D) 9.80%
E) 9.92%
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Answer: B Page: 58-59 Level: Difficult
35. According to the liquidity premium theory of interest rates
A) Long term spot rates are higher than the average of current and expected future short term rates.
B) Investors prefer certain maturities and will not normally switch out of those maturities.
C) Investors are indifferent between different maturities if the long term spot rates are equal to the
average of current and expected future short term rates.
D) The term structure must always be upward sloping.
E) Long term spot rates are totally unrelated to expectations of future short term rates.
Answer: A Page: 56 Level: Difficult
36. An increase in income tax rates
A) Will decrease the savings rate
B) Will decrease the supply of loanable funds
C) Will increase interest rates
D) All of the above
Answer: D Page: 37-38 Level: Medium
37. Upon graduating from college this year you expect to earn $25,000 per year. If you get your MBA, in
one year you can expect to start at $35,000 per year. Over the year, inflation is expected to be 5%. In
today's dollars, how much additional (less) money will you make from getting your MBA (to the
nearest dollar) in your first year?
A) -$2,462
B) $8,333
C) $8,750
D) $9,524
E) $10,000
Answer: B Page: 47 Level: Difficult
Response: (35,000 / 1.05) - 25,000
38. Investment A pays 8% simple interest for 10 years. Investment B pays 7.75% 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).
A) $2,500.00
B) -$2,500.00
C) $1,643.32
D) $3,094.67
E) -$3,094.67
Answer: E Page: 26 Level: Difficult
Response: [10000 + (800  10)] – [10000  1.077510]
39. If a $10,000 par T-Bill has a 9.5% discount and a 180 day maturity, what is the price of the T-Bill?
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A)
B)
C)
D)
E)
Introduction
$9,050
$9,525
$9,532
$9,675
None of the above
Answer: B Page: 35-36 Level: Easy
Response: 9525=10,000  [1-(0.095*180/360)]
40. A 90 day T-Bill is selling for $9,825. The par is $10,000. The EAR on the T-Bill is
A) 7.00%
B) 7.22%
C) 7.29%
D) 7.42%
E) 7.54%
Answer: D Page: 35-36 Level: Medium
Response: (10,000 / 9825)(365 / 90) – 1
41. Suppose that $10 million face value commercial paper with a 270 day maturity is selling for $9.5
million. What is the EAR on the paper?
A) 5.26%
B) 7.11%
C) 7.32%
D) 9.45%
E) None of the above
Answer: E Page: 36-37 Level: Medium
Response: {10 mill / 9.5 mill}365 / 270 – 1 = 7.18%
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42. A $1 million jumbo CD is quoting a 6.25% interest rate on 180 day maturity CDs. How much money
could you withdraw in 180 days if you invest in the CD?
A) $1,000,000
B) $1,062,500
C) $1,031,250
D) $1,030,822
E) None of the above
Answer: C Page: 35-36 Level: Medium
Response: 1 mill  [1 + (0.0625  180/360)]
43. An investor wants to be able to buy 4% more goods and services in the future in order to induce her to
invest today. During the investment period prices are expected to rise by 2%. Which statement(s)
below is/are true.
I. 4% is the desired real rate of interest
II. 6% is the approximate nominal rate of interest required
III. 2% is the expected inflation rate over the period
A) I only
B) II only
C) III only
D) I and II only
E) I, II and III are true
Answer: E Page: 47 Level: Difficult
44. Classify each of the following in terms of their effect on interest rates (increase or decrease):
I. Perceived risk of financial securities increases
II. Near term spending needs decrease
III. Future profitability of real investments increases
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
Answer: E Page: 38-39 Level: Difficult
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Introduction
45. 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) 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
Answer: D Page: 38-39 Level: Difficult
46. Inflation causes the demand curve for loanable funds to shift to the _____ and causes the supply curve to
shift to the _____.
A) Right; right
B) Right; left
C) Left; left
D) Left; right
Answer: B Page: 45 Level: Medium
47. An individual desires to earn a real return of 3%. Prices are expected to rise over the investment period
by 4%. The investor has a federal tax rate of 28% and state and local tax rate of 6%, what is the
investor's expected after tax rate of return?
A) 7.006%
B) 10.61%
C) 5.04%
D) 4.62%
E) 6.58%
Answer: D Page: 47,48,51 Level: Medium
Response: (0.04 + 0.03)  [1 – (0.28 + 0.06)]
Chapter 3
True/False Questions
1. If interest rates increase, the value of a fixed income contract decreases and vice versa.
Answer: True Page: 63 Level: Easy
2. At equilibrium a security's required rate of return will be less than its expected rate of return.
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Answer: False Page: 63-64 Level: Easy
3. If a security's realized return is negative it must have been true that the expected return was greater than
the required return.
Answer: False Page: 63-64 Level: Medium
4. If the present value of a security's cash flows is below its current market price the security is
undervalued.
Answer: False Page: 63-64 Level: Easy
5. The required rate of return is the interest rate that equates the current market price of the bond with the
present value of all future cash flows received.
Answer: False Page: 64 Level: Medium
6. A bond with an 8% coupon and a 10% required return will sell at a premium to par.
Answer: False Page: 68 Level: Easy
7. A bond with a 10% coupon and an 8% required return will sell at a discount from par.
Answer: False Page: 66-67 Level: Easy
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8. Discount bonds are poorer buys than premium bonds.
Answer: False Page: 68 Level: Easy
9. The duration of a four year maturity 10% coupon bond is less than four years.
Answer: True Page: 69-71 Level: Easy
10. The longer the time to maturity the lower the security's price sensitivity to an interest rate change, ceteris
paribus.
Answer: False Page: 70-71 Level: Easy
11. The greater a security's coupon the lower the security's price sensitivity to an interest rate change.
Answer: True Page: 70-71 Level: Easy
12. For a given interest rate change, a 20 year bond's price change will be twice that of a 10 year bond's
price change.
Answer: False Page: 69 Level: Medium
13. Any security that returns a greater percentage of the price sooner is less price volatile.
Answer: True Page: 71 Level: Easy
14. Duration is the elasticity of a security's value to small coupon changes.
Answer: False Page: 73-74 Level: Medium
15. A coupon bond with a 3.5 year duration has the same price volatility as a 3.5 year maturity zero coupon
bond.
Answer: True Page: 78-80 Level: Medium
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16. The lower the level of interest rates, the greater is a bond's price sensitivity to interest rate changes.
Answer: True Page: 83-84 Level: Difficult
Multiple Choice Questions
17. The interest rate used to find the fair present value of a financial security is the
A) Expected rate of return
B) Required rate of return
C) Realized rate of return
D) Realized yield to maturity
E) Current yield
Answer: B Page: 63 Level: Easy
18. A security has an expected return greater than its required return. This security is
A) Selling at a premium to par
B) Selling at a discount to par
C) Selling for more than its FPV
D) Selling for less than its FPV
E) A zero coupon bond
Answer: D Page: 63-64 Level: Medium
19. A bond that you held to maturity had a realized return of 8%, but when you bought it, it had an expected
return of 6%. If no default occurred, which one of the following must be true?
A) The bond was purchased at a premium to par
B) The coupon rate was 8%
C) The required return was greater than 6%
D) The coupons were reinvested at a higher rate than expected
E) The bond must have been a zero coupon bond
Answer: D Page: 63-64 Level: Medium
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20. You would want to purchase a security if P _____ FPV or Err _____ rrr.
A)  , 
B)  , 
C)  , 
D)  , 
Answer: C Page: 63-64 Level: Difficult
21. A 6 year annual payment corporate bond has a market price of $1050. It pays annual interest of $100
and its required rate of return is 9%. By how much is the bond mispriced?
A) $0.00
B) Overpriced by $5.14
C) Underpriced by $5.14
D) Overpriced by $11.32
E) Underpriced by $11.32
Answer: B Page: 63-64 Level: Medium
Response: FPV = 100  PVIFA[r%,6yrs] + 1000  PVIF(r%,6 yrs) = $1044.86
22. A 10 year corporate bond pays $75 interest semiannually. What is the bond's price if the required return
is 7%?
A) $1175.32
B) $1181.47
C) $1035.53
D) $1052.97
E) $1222.18
Answer: C Page: 67 Level: Medium
Response: 1 = 37.50  PVIFA(3.5%,20) + 1000  PVIF(3.5%,20)
23. A corporate bond has a coupon rate of 10% and a required return of 10%. This bond's price is
A) $924.18
B) $1000.00
C) $879.68
D) $1124.83
E) Not possible to determine from the information given
Answer: B Page: 66 Level: Easy
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24. A 10 year annual payment corporate coupon bond has an expected return of 11% and a required return
of 10%. The bond's market price is
A) Greater than its FPV
B) Less than par
C) Less than its Err
D) Less than its FPV
E) $1000.00
Answer: D Page: 66-67 Level: Medium
25. An 8 year annual payment corporate bond has a required return of 10% and a 9% coupon. Its market
value is $15 over its FPV. What is the bond's Err?
A) 10.11%
B) 9.85%
C) 9.71%
D) 10.23%
E) 8.73%
Answer: C Page: 67-68 Level: Difficult
Response: FPV = 946.65 = 90  PVIFA(10%,8yrs) + 1000  PVIF(10%,8yrs) ; (946.65+15) = 90 
PVIFA(Err,8yrs) + 1000  PVIF(Err,8yrs), trial and error or calculator
26. Corporate Bond A returns 5% of its cost in PV terms in each of the first five years and 75% of its value
in the sixth year. Corporate Bond B returns 8% of its cost in PV terms in each of the first five years and
60% of its cost in the sixth year. If A and B have the same required return, which of the following is/are
true?
I. Bond A has a bigger coupon than Bond B
II. Bond A has a longer duration than Bond B
III. Bond A is less price volatile than Bond B
IV. Bond B has a higher FPV than Bond A.
A) III only
B) I, III and IV only
C) I, II and IV only
D) II and IV only
E) I, II, II and IV are all true
Answer: D Page: 76 Level: Difficult
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Saunders, Financial Markets and Institutions, 2/e
Chapter 1
Introduction
27. A corporate bond returns 6% of its cost (in PV terms) in the first year, 5% in the second year, 4% in the
third year and the remainder in the fourth year. What is the bond's duration in years?
A) 3.68 years
B) 2.50 years
C) 4.00 years
D) 3.75 years
E) 3.88 years
Answer: A Page: 76 Level: Medium
Response: 3.68 = (6%  1) + (5%  2) + (4%  3) + (85%  4)
28. If an N year security recovered the same percentage of its cost in PV terms each year the duration would
be
A) N
B) 0
C) N/2
D) N!/N2
E) None of the above
Answer: C Page: 74-75 Level: Difficult
29. The _____ the coupon and the _____ the maturity; the _____ the duration of a bond, ceteris paribus.
A) Larger, longer, longer
B) Larger, longer, shorter
C) Smaller, shorter, longer
D) Smaller, shorter, shorter
E) None of the above
Answer: E Page: 79 Level: Difficult
30. A 4 year maturity 12% coupon annual payment corporate bond with a required rate of return of 12% has
a duration of (years):
A) 3.05
B) 2.97
C) 3.22
D) 3.71
E) 3.40
Answer: E Page: 74-76 Level: Medium
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31. A decrease in interest rates will
A) Decrease the bond's FPV
B) Increase the bond's duration
C) Lower the bond's coupon rate
D) Change the bond's payment frequency
E) Not affect the bond's duration
Answer: B Page: 74-76 Level: Medium
32. A 10 year maturity coupon bond has a 6 year duration. An equivalent 20 year bond with the same
coupon has a duration
A) Equal to 12 years
B) Less than 6 years
C) Less than 12 years
D) Equal to 6 years
E) Greater than 20 years
Answer: C Page: 79 Level: Easy
33. A six year maturity bond has a five year duration. Over the next year maturity will decline by 1 year
and duration will decline by
A) Less than one year
B) More than one year
C) 1 year
D) N years
E) N/(N-1) years
Answer: A Page: 78-80 Level: Medium
34. A bond has a 6% required return. Interest rates are projected to rise 25 basis points. The bond's
duration is 5 years. What is the predicted price change?
A) –1.18%
B) 4.71%
C) 1.25%
D) –1.25%
E) 1.18%
Answer: A Page: 82-83 Level: Medium
Response: -5  (+0.0025/1.06)
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Saunders, Financial Markets and Institutions, 2/e
Chapter 1
Introduction
35. Convexity arises because
A) Bond's pay interest semiannually
B) Coupon changes are the opposite sign of interest rate changes
C) Of Federal Reserve policy
D) Present values are a nonlinear function of interest rates
E) The professor said so
Answer: D Page: 84 Level: Medium
36. The duration of a 180 day T-Bill is (in years)
A) 0.493
B) 0.246
C) 1
D) 0
E) Indeterminate
Answer: A Page: 80 Level: Easy
Response: 180/365
37. For large interest rate increases, duration _____ the fall in security prices and for large interest rate
decreases, duration _____ the rise in security prices.
A) Overpredicts, overpredicts
B) Overpredicts, underpredicts
C) Underpredicts, overpredicts
D) Underpredicts, underpredicts
E) None of the above
Answer: B Page: 82 Level: Medium
Chapter 4
True/False Questions
1. Federal Reserve interest rate decisions can be vetoed by the U.S. President or the Congress.
Answer: False Page: 88 Level: Easy
2. The FOMC is responsible for supervising and regulating depository institutions and foreign exchange
traders.
Answer: False Page: 91 Level: Easy
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3. Four seats on the FOMC are allocated to Federal Reserve Bank presidents on an annual rotating basis.
Answer: True Page: 91 Level: Easy
4. The discount rate is usually set about 50 basis points above the target Fed Funds rate.
Answer: False Page: 91 Level: Easy
5. There are 10 Federal Reserve Districts throughout the U.S., each one headed by a Federal Reserve Bank.
Answer: False Page: 93 Level: Easy
6. The major asset of the Federal Reserve is currency outside banks, and the major liability is U.S.
Treasury securities.
Answer: False Page: 94 Level: Medium
7. All nationally charted banks are required to join the Federal Reserve System, state chartered banks may
choose to join the Federal Reserve or not.
Answer: True Page: 93-94 Level: Easy
8. Federal Reserve Board members are appointed by the U.S. President and confirmed by the Senate for a
non-renewable 14 year term.
Answer: True Page: 95 Level: Easy
9. If the FOMC wished to generate faster economic growth, they could issue a policy directive to the
Federal Reserve Board Trading desk to purchase U.S. government securities.
Answer: True Page: 99-101 Level: Medium
10. Open market operations are the purchase and sale of U.S. government and federal agency securities.
Answer: True Page: 96 Level: Easy
Multiple Choice Questions
11. The primary policy tool used by the Fed to meet its monetary policy goals is:
A) Changing the discount rate
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Saunders, Financial Markets and Institutions, 2/e
Chapter 1
B)
C)
D)
E)
Introduction
Changing reserve requirements
Devaluing the currency
Changing bank regulations
Open market operations
Answer: E Page: 99 Level: Easy
12. The Federal Reserve System is charged with
A) Regulating securities exchanges
B) Conducting monetary policy
C) Providing payment and other services to a variety of institutions
D) Setting bank prime rates
E) Both B and C
Answer: E Page: 89 Level: Easy
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13. The _______________ is a nationwide network that electronically process credit and debit transfers of
funds.
A) Fedwire
B) ACH
C) CHIPS
D) NASDAQ
E) SWIFT
Answer: B Page: 92 Level: Easy
14. The _____________ is a network linking over 6000 banks with the Federal Reserve that is used to
transfer deposits and make loan payments between participants.
A) Fedwire
B) ACH
C) CHIPS
D) NASDAQ
E) SWIFT
Answer: A Page: 92 Level: Easy
15. Ceteris paribus, if the Fed was targeting the quantity of money supplied and money demand dropped the
Fed would likely ______________. If the Fed was instead targeting interest rates and money demand
dropped the Fed would likely _______________.
A) increase the money supply, do nothing.
B) do nothing, decrease the money supply.
C) decrease the money supply, do nothing.
D) do nothing, increase the money supply.
E) increase the money supply, decrease the money supply.
Answer: B Page: 97 Level: Difficult
16. Which of the following is the major monetary policy making body of the U.S. FRS?
A) FOMC
B) OCC
C) FRB bank presidents
D) U.S. Congress
E) Group of ten
Answer: A Page: 99 Level: Easy
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Saunders, Financial Markets and Institutions, 2/e
Chapter 1
Introduction
17. The major liability of the Federal Reserve is
A) U.S. Treasury securities
B) Depository institution reserves
C) Currency outside banks
D) Vault cash of commercial banks
E) Gold and foreign exchange
Answer: C Page: 96 Level: Medium
18. The major asset of the Federal Reserve is
A) U.S. Treasury securities
B) Depository institution reserves
C) Currency outside banks
D) Vault cash of commercial banks
E) Gold and foreign exchange
Answer: A Page: 97-98 Level: Medium
19. Given the current economic conditions in Japan, the Bank of Japan is likely to engage in
A) Contractionary monetary policy
B) Expansionsary monetary policy
C) Zero inflation monetary policy
D) Fiscal spending to improve the economy
E) Cutting the government budget deficit.
Answer: B Page: 116 Level: Medium
Response: The answer to this question may change as Japanese economic conditions change.
20. The fed funds rate is the rate that
A) Banks charge for loans to corporate customers
B) Banks charge to lend foreign exchange to customers
C) The Federal Reserve charges on emergency loans to commercial banks
D) Banks charge each other on loans of excess reserves
E) Banks charge securities dealers to finance their inventory
Answer: D Page: 98 Level: Medium
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21. The discount rate is the rate that
A) Banks charge for loans to corporate customers
B) Banks charge to lend foreign exchange to customers
C) Banks charge each other on loans of excess reserves
D) Banks charge securities dealers to finance their inventory
E) The Federal Reserve charges on loans to commercial banks
Answer: E Page: 101 Level: Medium
22. The Fed has traditionally offered three types of discount window loans. _____ credit is offered to small
institutions with demonstrable patterns of financing needs, _____ credit is offered for short term
temporary funds outflows, and _____ credit may be offered to institutions with more severe liquidity
problems.
A) Seasonal; extended; adjustment
B) Extended; adjustment; seasonal
C) Adjustment; extended; seasonal
D) Adjustment; seasonal; extended
E) Seasonal; adjustment; extended
Answer: E Page: 103 Level: Medium
23. Federal Reserve discount window loans must be _____.
A) Fully collateralized
B) Over collateralized
C) Partially collateralized
D) Uncollateralized
Answer: B Page: 105-106 Level: Easy
24. A decrease in reserve requirements could lead to a(n)
A) Increase in bank lending
B) Increase in the money supply
C) An increase in the discount rate
D) Both A and B
E) Both A and C
Answer: D Page: 105-107 Level: Medium
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Saunders, Financial Markets and Institutions, 2/e
Chapter 1
Introduction
25. Bank A has an increase in deposits of $10 million dollars and reserve requirements are 10%. Bank A
loans out 90% of the increase. This amount winds up deposited in Bank B. Bank B lends out 90%, and
this amount winds up deposited in Bank C. What is the total increase in deposits resulting from these
three banks?
A) $10.00 million
B) $19.00 million
C) $22.33 million
D) $27.10 million
E) $30.00 million
Answer: D Page: 106-107 Level: Medium
Response: 10 + (10  0.90) + (9  0.90)
26. The Fed changes reserve requirements from 10% to 8%, thereby creating $450 million in excess
reserves. The total change in deposits (with no drains) would be
A) $486 million
B) $5.625 billion
C) $0.489 billion
D) $3.795 billion
E) None of the above
Answer: B Page: 106-107 Level: Medium
Response: (1/0.08)  $450 mill
27. If the Fed wishes to stimulate the economy it could
I. Buy U.S. government securities
II. Raise the discount rate
III. Lower reserve requirements
A) I and III only
B) II and III only
C) I and II only
D) II only
E) I, II and III
Answer: A Page: 99-105 Level: Medium
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28. Currently the Fed sets monetary policy by targeting
A) The Fed funds rate
B) The prime rate
C) The level of nonborrowed reserves
D) The level of borrowed reserves
E) The stock market
Answer: A Page: 98 Level: Easy
29. If the Federal Reserve were to buy dollars by selling yen the result would be to _____ the supply of U.S.
dollars and _____ the exchange rate in terms of the number of yen per U.S. dollar.
A) Increase, lower
B) Increase, raise
C) Decrease, lower
D) Decrease; raise
Answer: D Page: 114-115 Level: Medium
30. From October 1983 to July 1993 the Federal Reserve targeted
A) Fed funds rate
B) Borrowed reserves
C) Nonborrowed reserves
D) M1
E) M3
Answer: B Page: 110 Level: Medium
Chapter 5
True/False Questions
1. The money market is necessary because for most entities cash inflows do not occur in the same pattern
as cash expenses.
Answer: True Page: 121 Level: Easy
2. Money markets exist to help reduce the opportunity cost of holding cash balances.
Answer: True Page: 121 Level: Easy
3. The majority of money market securities are low denomination, low risk investments designed to appeal
to individual investors with excess cash.
Answer: False Page: 122-123 Level: Easy
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Saunders, Financial Markets and Institutions, 2/e
Chapter 1
Introduction
4. Most money market securities are initially sold to individual investors.
Answer: False Page: 122 Level: Easy
5. Commercial paper, negotiable certificates of deposit and bankers acceptance rates are all quoted as
discount yields.
Answer: True Page: 138-140 Level: Medium
6. Commercial paper is a short term obligation of the U.S. government.
Answer: False Page: 134 Level: Easy
7. T-Bills have no default risk and virtually no liquidity risk, so their rate of return is the riskless time value
of money.
Answer: True Page: 124 Level: Easy
Saunders, Financial Markets and Institutions, 2/e
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8. In the T-Bill secondary market the ask yield will normally be less than the bid yield.
Answer: True Page: 126-27 Level: Difficult
9. The largest secondary money market in the U.S. is the secondary market for T-Bills.
Answer: True Page: 126 Level: Easy
10. The bond equivalent yield of a T-bill will be greater than its discount yield.
Answer: True Page: 129-130 Level: Medium
Multiple Choice Questions
11. Money market securities must have which of the following characteristics?
I. Low trading costs
II. Little price risk
III. High rate of return
IV. Life greater than one year
A) I and III
B) II and IV
C) III and IV
D) I and II
E) I, II and III
Answer: D Page: 122-123 Level: Easy
12. Money market securities exhibit which of the following?
I. Large denomination
II. Maturity greater than one year
III. Low default risk
IV. Contractually determined cash flows
A) I, II and III
B) I, III and IV
C) II, III and IV
D) II and IV
E) I, II, III and IV
Answer: B Page: 121-122 Level: Medium
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Saunders, Financial Markets and Institutions, 2/e
Chapter 1
Introduction
13. A repo is in essence a collateralized
A) Banker's acceptance
B) Certificate of deposit
C) Fed funds loan
D) Commercial paper loan
E) Eurodollar deposit
Answer: C Page: 132 Level: Medium
14. A short term unsecured promissory note issued by a company is
A) Commercial paper
B) T-Bills
C) Repurchase agreement
D) Negotiable CD
E) Banker's acceptance
Answer: A Page: 134 Level: Easy
15. A time draft payable to seller of goods, with payment guaranteed by a bank is
A) Commercial paper
B) T-Bills
C) Repurchase agreement
D) Negotiable CD
E) Banker's acceptance
Answer: E Page: 139 Level: Easy
16. In the T-Bill auction process the competitive bidder is guaranteed a _____ and a noncompetitive bidder
is guaranteed a _____.
A) Minimum price; maximum price
B) Maximum price; minimum price
C) Maximum price; given quantity
D) Minimum price; maximum quantity
E) None of the above
Answer: C Page: 124-125 Level: Medium
Saunders, Financial Markets and Institutions, 2/e
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17. A dealer is quoting a $10,000 face 60 day T-Bill quoted at 3.22 bid, 3.14 ask. You could buy this bill at
_____ or sell it at _____.
A) $9,947.67 , $9,946.33
B) $9,678.00 , $9,686.00
C) $9,686.00 , $9,678.00
D) $9,946.33 , $9,947.67
E) None of the above
Answer: A Page: 129 Level: Medium
Response: Buy at 10,000  [1-(0.031460/360)] ; Sell at 10,000  [1-(0.032260/360)]
18. Rates on federal funds and repurchase agreements are stated
A) On a bond equivalent basis with a 360 day year
B) On a bond equivalent basis with a 365 day year
C) As a discount yield with a 360 day year
D) As an EAR
E) As a discount yield with a 365 day year
Answer: A Page: 130,134 Level: Medium
19. The discount yield on a T-Bill differs from a bond equivalent yield (BEY) because
A) The discount yield is a percentage of face value instead of price
B) A 360 day year is used on the discount yield instead of 365 days
C) The discount yield is without compounding, the BEY is with compounding
D) Both A and B
E) A, B and C are all reasons for the difference
Answer: D Page: 128-130 Level: Medium
20. The typical spread on prime quality commercial paper and medium grade commercial paper has been
about ______ basis points.
A) 200
B) 22
C) 33
D) 86
E) 12
Answer: B Page: 136 Level: Medium
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Saunders, Financial Markets and Institutions, 2/e
Chapter 1
Introduction
21. The rate of return on a repo is
A) Determined by the rate of return on the underlying collateral
B) Strongly affected by the current Fed funds rate at the time of the repo
C) Determined at the time of the repo
D) A and C
E) B and C
Answer: E Page: 134 Level: Medium
22. All but which one of the following statements about commercial paper is true? Commercial paper
A) Is an unsecured short term promissory note
B) Has a maximum maturity of 270 days
C) Is virtually always rated by at least one ratings agency
D) Has no secondary market
E) Carries above prime interest rates
Answer: E Page: 134-135 Level: Medium
23. A negotiable CD
A) Is a bank issued transactions deposit
B) Is a registered instrument
C) Is a bank issued time deposit
D) Has denominations ranging from $50,000 to $10 million
E) Pays discount interest
Answer: C Page: 138 Level: Medium
24. A 90 day $1 million CD has a 4% annual rate quote. If you buy the CD, how much will you collect in 90
days?
A) $1,040,000
B) $1,009,863
C) $1,000,000
D) $1,015,012
E) $1,010,000
Answer: E Page: 139 Level: Medium
Response: $1 mill  [1 + (0.04  90/360)]
Saunders, Financial Markets and Institutions, 2/e
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25. A banker's acceptance is
A) A time draft drawn on the exporter's bank
B) A method to help importers evaluate the creditworthiness of exporters
C) A liability of the importer and the importer's bank
D) An add on instrument
E) For greater than 1 year maturity
Answer: C Page: 140 Level: Medium
26. The most liquid of the money market securities are
A) Commercial paper
B) Banker's acceptances
C) T-Bills
D) Fed funds
E) Repurchase agreements
Answer: C Page: 141 Level: Easy
27. In dollars outstanding the largest money market security is
A) Commercial paper
B) Banker's acceptances
C) T-Bills
D) Fed funds
E) Repurchase agreements
Answer: A Page: 145 Level: Medium
28. The international version of the fed funds rate is called
A) LIBOR
B) The repo rate
C) The Euro rate
D) International dollar rate
E) The exchange rate
Answer: A Page: 146 Level: Easy
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Saunders, Financial Markets and Institutions, 2/e
Chapter 1
Introduction
29. LIBOR is generally _____ the Fed funds rate because foreign bank deposits are generally _____ than
domestic bank deposits
A) Greater than; less risky
B) Less than; more risky
C) The same as; equally risk
D) Greater than; more risky
E) Less than; less risky
Answer: D Page: 146 Level: Medium
30. A U.S. exporter sells $50,000 of furniture to a Latin American importer. The exporter requires the
importer to obtain a letter of credit. When the bank accepts the draft the exporter discounts the 90 day
note at a 6% discount. What is the exporter's true effective annual financing cost (EAR)?
A) 6.00%
B) 6.18%
C) 6.32%
D) 6.24%
E) 6.45%
Answer: C Page: 140-141 Level: Difficult
Response: 50,000  [1 – (0.0690/360)] = 49,250 ; (50,000/49,250)(365 / 90) – 1
Saunders, Financial Markets and Institutions, 2/e
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