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Dr. Nilufer

The concept of ________ is based on the common-sense notion that a dollar paid to you in the future is less valuable to you than a dollar today.

A) present value

The present value of an expected future payment ________ as the interest rate increases.

A) falls

An increase in the time to the promised future payment ________ the present value of the payment.

A) decreases

With an interest rate of 6 percent, the present value of $100 next year is approximately

C) $94.

If a security pays $55 in one year and $133 in three years, its present value is $150 if the interest rate is

B) 10 percent.

To claim that a lottery winner who is to receive $1 million per year for twenty years has won $20 million ignores the process of

D) discounting the future.

A credit market instrument that provides the borrower with an amount of funds that must be repaid at the maturity date along with an interest payment is known as a

A) simple loan.

A credit market instrument that requires the borrower to make the same payment every period until the maturity date is known as a

B) fixed-payment loan.

Which of the following are true of fixed payment loans?

B) Installment loans and mortgages are frequently of the fixed payment type.

A fully amortized loan is another name for

B) a fixed-payment loan.

A credit market instrument that pays the owner a fixed coupon payment every year until the maturity date and then repays the face value is called a

C) coupon bond.

A ________ pays the owner a fixed coupon payment every year until the maturity date, when the ________ value is repaid.

C) coupon bond; face

The ________ is the final amount that will be paid to the holder of a coupon bond.

C) face value

When talking about a coupon bond, face value and ________ mean the same thing.

A) par value

The dollar amount of the yearly coupon payment expressed as a percentage of the face value of the bond is called the bond's

A) coupon rate.

If a $5,000 coupon bond has a coupon rate of 13 percent, then the coupon payment every year is

A) $650.

An $8,000 coupon bond with a $400 coupon payment every year has a coupon rate of

A) 5 percent.

All of the following are examples of coupon bonds except

B) U.S. Treasury bills

A bond that is bought at a price below its face value and the face value is repaid at a maturity date is called a

D) discount bond.

A ________ is bought at a price below its face value, and the ________ value is repaid at the maturity date.

D) discount bond; face

A discount bond

B) pays the bondholder the face value at maturity.

Examples of discount bonds include

A) U.S. Treasury bills.

Which of the following are true for discount bonds?

B) The purchaser receives the face value of the bond at the maturity date.

The interest rate that equates the present value of payments received from a debt instrument with its value today is the

C) yield to maturity.

Economists consider the ________ to be the most accurate measure of interest rates.

C) yield to maturity.

For simple loans, the simple interest rate is ________ the yield to maturity.

C) equal to

If the amount payable in two years is $2420 for a simple loan at 10 percent interest, the loan amount is

C) $2000.

For a 3-year simple loan of $10,000 at 10 percent, the amount to be repaid is

D) $13,310.

If $22,050 is the amount payable in two years for a $20,000 simple loan made today, the interest rate is

A) 5 percent.

If a security pays $110 next year and $121 the year after that, what is its yield to maturity if it sells for $200?

B) 10 percent

The present value of a fixed-payment loan is calculated as the ________ of the present value of all cash flow payments.

A) sum

Which of the following are true for a coupon bond?

A) When the coupon bond is priced at its face value, the yield to maturity equals the coupon rate.

The price of a coupon bond and the yield to maturity are ________ related; that is, as the yield to maturity ________, the price of the bond ________.

D) negatively; rises; falls

The yield to maturity is ________ than the ________ rate when the bond price is ________ its face value.

B) greater; coupon; below

A $10,000 8 percent coupon bond that sells for $10,000 has a yield to maturity of

A) 8 percent.

Which of the following $1,000 face-value securities has the highest yield to maturity?

C) A 12 percent coupon bond selling for $1,000

Which of the following $5,000 face-value securities has the highest yield to maturity?

D) A 12 percent coupon bond selling for $4,500

Which of the following $1,000 face-value securities has the highest yield to maturity?

A) A 5 percent coupon bond with a price of $600

Which of the following $1,000 face-value securities has the lowest yield to maturity?

A) A 5 percent coupon bond selling for $1,000

Which of the following bonds would you prefer to be buying?

A) A $10,000 face-value security with a 10 percent coupon selling for $9,000

A coupon bond that has no maturity date and no repayment of principal is called a

A) consol.

The price of a consol equals the coupon payment

D) divided by the interest rate.

The interest rate on a consol equals the

D) coupon payment divided by the price.

A consol paying $20 annually when the interest rate is 5 percent has a price of

C) $400.

45) If a perpetuity has a price of $500 and an annual interest payment of $25, the interest rate is

B) 5 percent.

The yield to maturity for a perpetuity is a useful approximation for the yield to maturity on long-term coupon bonds. It is called the ________ when approximating the yield for a coupon bond.

A) current yield

The yield to maturity for a one-year discount bond equals the increase in price over the year, divided by the

A) initial price.

If a $10,000 face-value discount bond maturing in one year is selling for $5,000, then its yield to maturity is

D) 100 percent.

If a $5,000 face-value discount bond maturing in one year is selling for $5,000, then its yield to maturity is

A) 0 percent.

A discount bond selling for $15,000 with a face value of $20,000 in one year has a yield to maturity of

D) 33.3 percent.

The yield to maturity for a discount bond is ________ related to the current bond price.

A) negatively

In Japan in 1998 and in the U.S. in 2008, interest rates were negative for a short period of time because investors found it convenient to hold six-month bills as a store of value because

D) the bills were denominated in large amounts and could be stored electronically.

The ________ is defined as the payments to the owner plus the change in a security's value expressed as a fraction of the security's purchase price.

C) rate of return

Which of the following are true concerning the distinction between interest rates and returns?

A) The rate of return on a bond will not necessarily equal the interest rate on that bond.

The sum of the current yield and the rate of capital gain is called the

A) rate of return.

What is the return on a 5 percent coupon bond that initially sells for $1,000 and sells for $1,200 next year?

D) 25 percent

What is the return on a 5 percent coupon bond that initially sells for $1,000 and sells for $900 next year?

C) -5 percent

The return on a 5 percent coupon bond that initially sells for $1,000 and sells for $950 next year is

C) 0 percent.

Suppose you are holding a 5 percent coupon bond maturing in one year with a yield to maturity of 15 percent. If the interest rate on one-year bonds rises from 15 percent to 20 percent over the course of the year, what is the yearly return on the bond you are holding?

C) 15 percent

If the interest rates on all bonds rise from 5 to 6 percent over the course of the year, which bond would you prefer to have been holding?

A) A bond with one year to maturity

An equal decrease in all bond interest rates

B) increases the price of a ten-year bond more than the price of a five-year bond.

An equal increase in all bond interest rates

D) decreases long-term bond returns more than short-term bond returns.

Which of the following are generally true of bonds?

A) The only bond whose return equals the initial yield to maturity is one whose time to maturity is the same as the holding period.

Which of the following are generally true of all bonds?

B) Even though a bond has a substantial initial interest rate, its return can turn out to be negative if interest rates rise.

The riskiness of an asset's returns due to changes in interest rates is

D) interest-rate risk.

Interest-rate risk is the riskiness of an asset's returns due to

A) interest-rate changes.

Prices and returns for ________ bonds are more volatile than those for ________ bonds, everything else held constant.

B) long-term; short-term

There is ________ for any bond whose time to maturity matches the holding period.

A) no interest-rate risk

The ________ interest rate is adjusted for expected changes in the price level.

A) ex ante real

The ________ interest rate more accurately reflects the true cost of borrowing.

B) real

The nominal interest rate minus the expected rate of inflation

A) defines the real interest rate.

When the ________ interest rate is low, there are greater incentives to ________ and fewer incentives to ________.

C) real; borrow; lend

The interest rate that describes how well a lender has done in real terms after the fact is called the

A) ex post real interest rate.

The ________ states that the nominal interest rate equals the real interest rate plus the expected rate of inflation.

A) Fisher equation

If the nominal rate of interest is 2 percent, and the expected inflation rate is -10 percent, the real rate of interest is

D) 12 percent.

In which of the following situations would you prefer to be the lender?

B) The interest rate is 4 percent and the expected inflation rate is 1 percent.

In which of the following situations would you prefer to be the borrower?

D) The interest rate is 25 percent and the expected inflation rate is 50 percent.

If you expect the inflation rate to be 15 percent next year and a one-year bond has a yield to maturity of 7 percent, then the real interest rate on this bond is

D) -8 percent.

If you expect the inflation rate to be 12 percent next year and a one-year bond has a yield to maturity of 7 percent, then the real interest rate on this bond is

A) -5 percent.

If you expect the inflation rate to be 4 percent next year and a one year bond has a yield to maturity of 7 percent, then the real interest rate on this bond is

C) 3 percent.

The interest rate on Treasury Inflation Protected Securities is a direct measure of

A) the real interest rate.

Assuming the same coupon rate and maturity length, the difference between the yield on a Treasury Inflation Protected Security and the yield on a non-indexed Treasury security provides insight into

D) the expected inflation rate.

Assuming the same coupon rate and maturity length, when the interest rate on a Treasury Inflation Protected Security is 3 percent, and the yield on a non-indexed Treasury bond is 8 percent, the expected rate of inflation is

B) 5 percent.

Duration is

C) the average lifetime of a debt security's stream of payments.

Comparing a discount bond and a coupon bond with the same maturity,

B) the discount bond has the greater effective maturity.

The duration of a coupon bond increases

A) the longer is the bond's term to maturity.

All else equal, when interest rates ________, the duration of a coupon bond ________.

A) rise; falls

All else equal, the ________ the coupon rate on a bond, the ________ the bond's duration.

B) higher; shorter

If a financial institution has 50% of its portfolio in a bond with a five-year duration and 50% of its portfolio in a bond with a seven-year duration, what is the duration of the portfolio?

C) 6 years

An asset's interest rate risk ________ as the duration of the asset ________.

B) decreases; decreases

Depositors lack of information about the quality of bank assets can lead to ________.

A) bank panics

"The fact that banks operate on a ""sequential service constraint"" means that"

"C) depositors arriving first have the best chance of withdrawing their funds.

Depositors have a strong incentive to show up first to withdraw their funds during a bank crisis because banks operate on a

B) sequential service constraint.

Because of asymmetric information, the failure of one bank can lead to runs on other banks. This is the

D) contagion effect.

The contagion effect refers to the fact that

D) the failure of one bank can hasten the failure of other banks.

During the boom years of the 1920s, bank failures were quite

C) common, averaging about 600 per year.

To prevent bank runs and the consequent bank failures, the United States established the ________ in 1934 to provide deposit insurance.

A) FDIC

"The primary difference between the ""payoff"" and the ""purchase and assumption"" methods of handling failed banks is"

"B) that the FDIC guarantees all deposits when it uses the ""purchase and assumption"" method."

Deposit insurance has not worked well in countries with

A) a weak institutional environment.

When one party to a transaction has incentives to engage in activities detrimental to the other party, there exists a problem of

A) moral hazard.

Moral hazard is an important concern of insurance arrangements because the existence of insurance

A) provides increased incentives for risk taking.

When bad drivers line up to purchase collision insurance, automobile insurers are subject to the

B) adverse selection problem.

Deposit insurance is only one type of government safety net. All of the following are types of government support for troubled financial institutions except

A) forgiving tax debt.

Although the FDIC was created to prevent bank failures, its existence encourages banks to

A) take too much risk.

A system of deposit insurance

A) attracts risk-taking entrepreneurs into the banking industry.

The government safety net creates ________ problem because risk-loving entrepreneurs might find banking an attractive industry.

A) an adverse selection

Since depositors, like any lender, only receive fixed payments while the bank keeps any surplus profits, they face the ________ problem that banks may take on too ________ risk.

D) moral hazard; much

Acquiring information on a bank's activities in order to determine a bank's risk is difficult for depositors and is another argument for government ________.

A) regulation

The existence of deposit insurance can increase the likelihood that depositors will need deposit protection, as banks with deposit insurance

A) are likely to take on greater risks than they otherwise would.

In May 1991, the FDIC announced that it would sell the government's final 26% stake in Continental Illinois, ending government ownership of the bank that it had rescued in 1984. The FDIC took control of the bank, rather than liquidate it, because it believed that Continental Illinois

C) was too big to fail.

If the FDIC decides that a bank is too big to fail, it will use the ________ method, effectively ensuring that ________ depositors will suffer losses.

D) purchase and assumption; no

"Federal deposit insurance covers deposits up to $100,000, but as part of a doctrine called ""too-big-to-fail"" the FDIC sometimes ends up covering all deposits to avoid disrupting the financial system. When the FDIC does this, it uses the"

"B) ""purchase and assumption"" method."

The result of the too-big-to-fail policy is that ________ banks will take on ________ risks, making bank failures more likely.

D) big; greater

A problem with the too-big-to-fail policy is that it ________ the incentives for ________ by big banks.

A) increases; moral hazard

The too-big-to-fail policy

C) treats large depositors of small banks inequitably when compared to depositors of large banks.

Regulators attempt to reduce the riskiness of banks' asset portfolios by

A) limiting the amount of loans in particular categories or to individual borrowers.

A well-capitalized financial institution has ________ to lose if it fails and thus is ________ likely to pursue risky activities.

B) more; less

A bank failure is less likely to occur when

D) a bank has more bank capital.

The leverage ratio is the ratio of a bank's

C) capital divided by its total assets.

To be considered well capitalized, a bank's leverage ratio must exceed ________.

C) 5%

Off-balance-sheet activities

C) generate fee income but increase a bank's risk.

The Basel Accord, an international agreement, requires banks to hold capital based on

A) risk-weighted assets.

The Basel Accord requires banks to hold as capital an amount that is at least ________ of their risk-weighted assets.

B) 8%

Under the Basel Accord, assets and off-balance sheet activities were sorted according to ________ categories with each category assigned a different weight to reflect the amount of ________.

D) 4; credit risk

The practice of keeping high-risk assets on a bank's books while removing low-risk assets with the same capital requirement is know as

C) regulatory arbitrage.

Banks engage in regulatory arbitrage by

A) keeping high-risk assets on their books while removing low-risk assets with the same capital requirement.

Because banks engage in regulatory arbitrage, the Basel Accord on risk-based capital requirements may result in

D) increased risk taking by banks.

One of the criticisms of Basel 2 is that it is procyclical. That means that

A) banks may be required to hold more capital during times when capital is short.

Overseeing who operates banks and how they are operated is called ________.

A) prudential supervision

The chartering process is especially designed to deal with the ________ problem, and regular bank examinations help to reduce the ________ problem.

B) adverse selection; moral hazard

The chartering process is similar to ________ potential borrowers and the restriction of risk assets by regulators is similar to ________ in private financial markets.

A) screening; restrictive covenants

Banks will be examined at least once a year and given a CAMELS rating by examiners. The L stands for ________.

B) liquidity

The federal agencies that examine banks include

A) the Federal Reserve System.

Banks are required to file ________ usually quarterly that list information on the bank's assets and liabilities, income and dividends, and so forth.

A) call reports

Regular bank examinations and restrictions on asset holdings help to indirectly reduce the ________ problem because, given fewer opportunities to take on risk, risk-prone entrepreneurs will be discouraged from entering the banking industry.

B) adverse selection

The current supervisory practice toward risk management

C) evaluates the soundness of a bank's risk-management process.

Regulations designed to provide information to the marketplace so that investors can make informed decisions are called

A) disclosure requirements.

With ________, firms value assets on their balance sheet at what they would sell for in the market.

A) mark-to-market accounting

During times of financial crisis, mark-to-market accounting

A) requires that a financial firms' assets be marked down in value which can worsen the lending crisis.

Consumer protection legislation includes legislation to

A) reduce discrimination in credit markets.

An important factor in producing the subprime mortgage crisis was

A) lax consumer protection regulation.

Competition between banks

A) encourages greater risk taking.

Regulations that reduced competition between banks included

A) branching restrictions.

The ________ that required separation of commercial and investment banking was repealed in 1999.

B) the Glass-Steagall Act.

Which of the following is not a reason financial regulation and supervision is difficult in real life?

D) Financial institutions are not required to follow the rules.

Who has regulatory responsibility when a bank operates branches in many countries?

A) It is not always clear.

The collapse of the Bank of Credit and Commerce International, BCCI, showed the difficulty of international banking regulation. BCCI operated in more than ________ countries and was supervised by the small country of ________.

A) 70, Luxembourg

Agreements such as the ________ are attempts to standardize international banking regulations.

A) Basel Accord

The Basel Committee ruled that regulators in other countries can ________ the operations of a foreign bank if they believe that it lacks effective oversight.

A) restrict

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