FIN 310 Final Exam Dr. Smith CSU Questions With
Complete Solutions
active monetary policy correct answers an active monetary
policy reflects actions taken by the Fed to adjust money supply
in order to affect economic conditions.
Activity in the secondary market for T Bills correct answers
The secondary market for Treasury bills is very active, which
makes Treasury bills more attractive because it enhances their
liquidity. Financial institutions that have previously purchased
Treasury bills can sell these securities in the secondary market
whenever they need cash.
Adjustable Rate Mortgages correct answers Allows the
mortgage interest rate to adjust to market conditions. (Exhibit
9.4)Contract will specify a precise formula for this
adjustment.Some ARMs contain a clause that allow the
borrower to switch to a fixed rate within a specified period.
After Tax Yield correct answers Yat= Ybt(1-T)
helps to determine which bond is more valuable to invest in
Allocation of IPO shares correct answers The lead underwriter
may rely on a group (called a syndicate) of other securities firms
to participate in the underwriting process and share the fees to
be received for the underwriting.
are corporate bonds taxed on interest earned? correct answers
Yes
,are municipal bonds taxed on interest earned? correct answers
No
Are variable-rate bonds attractive to investors who expect
interest rates to decrease? Explain. Would a firm that needs to
borrow funds consider issuing variable-rate bonds if it expects
interest rates to decrease in the future? Explain. correct answers
investors expect interest rates to decrease, they would avoid
variable-rate bonds because the return to the investors would be
tied to market interest rates. The investors would prefer fixed-
rate bonds if interest rates are expected to decrease
.If a firm expects that interest rates will decrease, it may
consider issuing variable-rate bonds, because the interest paid on
the bonds would decline over time with the decline in market
interest rates.
Assessing interest rate differentials among countries correct
answers The risk-free foreign interest rates are determined by
supply and demand for funds in their local currency. Inflationary
expectations affect the risk-free interest rate. Thus, the
difference in interest rates between the countries with very high
interest rates versus low interest rates is primarily attributed to
risk-free rate differentials. The credit risk premium is typically
higher in the countries with very high interest rates, but that is
not the primary reason for the large difference between countries
with very interest rates versus low interest rates.
Assume an expectation of lower interest rates in the future arises
quite suddenly. What would be the effect on the shape of the
,yield curve? Explain. correct answers The demand for short-
term securities would decrease, placing downward (upward)
pressure on their prices (yields). The demand for long-term
securities would increase, placing upward (downward) pressure
on their prices (yields). If the yield curve was originally upward
sloped, it would now be more horizontal (less steep). If it was
downward sloped, it would now be more steep.
Assume that inflation is expected to decline in the near future.
How could this affect future bond prices? Would you
recommend that financial institutions increase or decrease their
concentration in long-term bonds based on this expectation?
correct answers since lower inflation normally causes a decline
in interest rates (other things being equal), financial institutions
would benefit if they increase their concentration of long-term
bonds before this occurs.
because lower inflation (lower interest rate) means an increase
in bond prices which would be best especially if the portfolio
could grow
Assume that the Fed's primary goal is to reduce inflation. How
can it achieve its goal? What is a possible adverse effect of such
action by the Fed (even if it achieves this goal)? correct answers
TO cure inflation, the Fed may use a restrictive monetary policy,
which will reduce economic growth and inflationary pressure. A
possible adverse effect is an increase in the unemployment rate.
Assume the yield curve experiences a sudden shift, such that the
new yield curve is higher and more steeply sloped today than it
was yesterday. If a firm issues new bonds today, would its bonds
, sell for higher or lower prices than if it had issued the bonds
yesterday? Explain. correct answers a higher and steeper yield
curve implies that long-term bond yields have increased. The
firm would have to sell the bonds for lower prices to entice
investors with a high yield today.
Balloon payment mortgages correct answers Requires only
interest payments for a three-to five-year period. At the end of
this period, the borrower must pay the full amount of the
principal (the balloon payment).
Based on what you know about repurchase agreements, would
you expect them to have a lower or higher annualized yield than
commercial paper? Why? correct answers repurchase
agreements with a similar maturity as commercial paper would
likely have a slightly lower yield, since they are typically backed
by Treasury securities.
Beige Book correct answers The Beige book is a consolidated
report of regional economic conditions in each of the 12
districts. This book is sent to FOMC members before their
meeting so that they are updated on regional conditions before
they decide on monetary policy.
Bond pressure affects correct answers selling bonds: downward
pressure on bond prices (demand is now lower)
purchasing bonds: upward pressure on bond prices (demand is
now higher)
Bond Price Elasticity correct answers the sensitivity of bond
prices to changes in the required rate of return (interest rates)
Complete Solutions
active monetary policy correct answers an active monetary
policy reflects actions taken by the Fed to adjust money supply
in order to affect economic conditions.
Activity in the secondary market for T Bills correct answers
The secondary market for Treasury bills is very active, which
makes Treasury bills more attractive because it enhances their
liquidity. Financial institutions that have previously purchased
Treasury bills can sell these securities in the secondary market
whenever they need cash.
Adjustable Rate Mortgages correct answers Allows the
mortgage interest rate to adjust to market conditions. (Exhibit
9.4)Contract will specify a precise formula for this
adjustment.Some ARMs contain a clause that allow the
borrower to switch to a fixed rate within a specified period.
After Tax Yield correct answers Yat= Ybt(1-T)
helps to determine which bond is more valuable to invest in
Allocation of IPO shares correct answers The lead underwriter
may rely on a group (called a syndicate) of other securities firms
to participate in the underwriting process and share the fees to
be received for the underwriting.
are corporate bonds taxed on interest earned? correct answers
Yes
,are municipal bonds taxed on interest earned? correct answers
No
Are variable-rate bonds attractive to investors who expect
interest rates to decrease? Explain. Would a firm that needs to
borrow funds consider issuing variable-rate bonds if it expects
interest rates to decrease in the future? Explain. correct answers
investors expect interest rates to decrease, they would avoid
variable-rate bonds because the return to the investors would be
tied to market interest rates. The investors would prefer fixed-
rate bonds if interest rates are expected to decrease
.If a firm expects that interest rates will decrease, it may
consider issuing variable-rate bonds, because the interest paid on
the bonds would decline over time with the decline in market
interest rates.
Assessing interest rate differentials among countries correct
answers The risk-free foreign interest rates are determined by
supply and demand for funds in their local currency. Inflationary
expectations affect the risk-free interest rate. Thus, the
difference in interest rates between the countries with very high
interest rates versus low interest rates is primarily attributed to
risk-free rate differentials. The credit risk premium is typically
higher in the countries with very high interest rates, but that is
not the primary reason for the large difference between countries
with very interest rates versus low interest rates.
Assume an expectation of lower interest rates in the future arises
quite suddenly. What would be the effect on the shape of the
,yield curve? Explain. correct answers The demand for short-
term securities would decrease, placing downward (upward)
pressure on their prices (yields). The demand for long-term
securities would increase, placing upward (downward) pressure
on their prices (yields). If the yield curve was originally upward
sloped, it would now be more horizontal (less steep). If it was
downward sloped, it would now be more steep.
Assume that inflation is expected to decline in the near future.
How could this affect future bond prices? Would you
recommend that financial institutions increase or decrease their
concentration in long-term bonds based on this expectation?
correct answers since lower inflation normally causes a decline
in interest rates (other things being equal), financial institutions
would benefit if they increase their concentration of long-term
bonds before this occurs.
because lower inflation (lower interest rate) means an increase
in bond prices which would be best especially if the portfolio
could grow
Assume that the Fed's primary goal is to reduce inflation. How
can it achieve its goal? What is a possible adverse effect of such
action by the Fed (even if it achieves this goal)? correct answers
TO cure inflation, the Fed may use a restrictive monetary policy,
which will reduce economic growth and inflationary pressure. A
possible adverse effect is an increase in the unemployment rate.
Assume the yield curve experiences a sudden shift, such that the
new yield curve is higher and more steeply sloped today than it
was yesterday. If a firm issues new bonds today, would its bonds
, sell for higher or lower prices than if it had issued the bonds
yesterday? Explain. correct answers a higher and steeper yield
curve implies that long-term bond yields have increased. The
firm would have to sell the bonds for lower prices to entice
investors with a high yield today.
Balloon payment mortgages correct answers Requires only
interest payments for a three-to five-year period. At the end of
this period, the borrower must pay the full amount of the
principal (the balloon payment).
Based on what you know about repurchase agreements, would
you expect them to have a lower or higher annualized yield than
commercial paper? Why? correct answers repurchase
agreements with a similar maturity as commercial paper would
likely have a slightly lower yield, since they are typically backed
by Treasury securities.
Beige Book correct answers The Beige book is a consolidated
report of regional economic conditions in each of the 12
districts. This book is sent to FOMC members before their
meeting so that they are updated on regional conditions before
they decide on monetary policy.
Bond pressure affects correct answers selling bonds: downward
pressure on bond prices (demand is now lower)
purchasing bonds: upward pressure on bond prices (demand is
now higher)
Bond Price Elasticity correct answers the sensitivity of bond
prices to changes in the required rate of return (interest rates)
