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Sample Test

Money, Banking, and the Financial System, 3e (Hubbard/O’Brien)

Chapter 3   Interest Rates and Rates of Return

 

3.1   The Interest Rate, Present Value, and Future Value

 

1) Suppose Matt’s New Cars issues a bond in which they’ll need to pay $10,000 in one year, which includes 4% interest. How much will they receive for the bond?

1.   A) $9,600

2.   B) $9,615

3.   C) $10,000

4.   D) $10,400

 

 

2) Though Treasury bonds may have little default risk, what type of risk exists when current interest rates are low?

1.   A) price risk

2.   B) refinancing risk

3.   C) interest-rate risk

4.   D) present value risk

 

3) Which of the following will lead to a higher interest rate on a loan?

1.   A) lower inflation

2.   B) lower opportunity cost

3.   C) increased perceived risk of default

4.   D) reduced likelihood of borrower not paying the loan

 

4) The key to present value calculations is that they

1.   A) are appropriate only for funds in the same time period.

2.   B) provide a common unit for measuring funds at different times.

3.   C) provide accurate answers only in a low-inflation environment.

4.   D) provide accurate answers only in a high-inflation environment.

 

 

5) Compounding refers to

1.   A) the calculation of interest rates after the compounding effect of taxes has been allowed for.

2.   B) the paying back of both interest and principal during the life of a fixed-payment loan.

3.   C) the process of earning interest on both the interest and the principal of an investment.

4.   D) the increased value of an investment that arises from the payment of periodic interest.

 

 

6) If you deposit $500 in a savings account at an annual interest rate of 5%, how much will you have in the account at the end of five years?

1.   A) $392

2.   B) $550

3.   C) $625

4.   D) $638

 

7) If you deposit $10,000 in a savings account at an annual interest rate of 6%, how much will you have in the account at the end of three years?

1.   A) $8,396

2.   B) $10,600

3.   C) $11,800

4.   D) $11,910

 

8) $1 received n years from now has a value today of

1.   A) ($1 + i)/i.

2.   B) $1/(1 + i).

3.   C) ($1 + i)n/i.

4.   D) $1/(1 + i)n.

 

 

9) At an interest rate of 6%, how much will need to be invested today to have $10,000 in 5 years?

1.   A) $5,000

2.   B) $7,473

3.   C) $10,000

4.   D) $13,382

 

10) At an interest rate of 3%, what is the present value of $1,000 to be received five years from now?

1.   A) $850

2.   B) $863

3.   C) $1,159

4.   D) $1,667

 

 

11) If the annual interest rate is 8%, what would you expect to pay for a bond paying a lump sum of $10,000 in ten years?

1.   A) $4,632

2.   B) $9,259

3.   C) $10,000

4.   D) $21,589

 

12) If the annual interest rate is 9%, what would you expect to pay for a bond paying a lump sum of $10,000 in two years?

1.   A) $8,200

2.   B) $8,417

3.   C) $10,000

4.   D) $11,881

 

13) The price of a financial asset equals the

1.   A) future value of all payments.

2.   B) sum of all payments.

3.   C) present value of all future payments.

4.   D) difference between the future value and present value of all payments.

 

 

14) What are three reasons that banks charge interest on loans?

.

 

15) Suppose you put $500 in your savings account and earn 4% interest per year. How much will you have in your account after two years? Be sure to round off to the nearest cent.

 

16) Suppose you had $1,000 and were deciding between two investments. One pays 5% a year for two years while the other pays 8% the first year and 2% the second year. Which investment would provide a higher return?

17) Suppose you have two clients who need your services for two years. One agreed to pay you $50,000 one year from now and another $50,000 in two years while the other paid $35,000 after one year, but $65,000 after two years. Assuming an interest rate of 10%, which one has a higher present value? Round off to the nearest dollar.

 

1) Simple loans and discount bonds differ from coupon bonds and fixed-payment loans in that

1.   A) interest on simple loans and discount bonds is taxable, while interest on coupon bonds and fixed-payment loans is not.

2.   B) interest on coupon bonds and fixed-payment loans is taxable, while interest on simple loans and discount bonds is not.

3.   C) interest rates on simple loans and discount bonds are generally higher than interest rates on comparable coupon bonds and fixed-payment loans.

4.   D) interest on simple loans and discount bonds is paid in a single payment, while issuers of coupon bonds and fixed-payment loans make multiple payments of interest and principal.

 

 

2) Debt instruments are also called

1.   A) equities.

2.   B) credit market instruments.

3.   C) prospectuses.

4.   D) units of account.

 

3) A debt instrument represents

1.   A) an ownership claim by the purchaser on the issuer.

2.   B) a promise by a borrower to repay principal plus interest to a lender.

3.   C) an attempt by a borrower in default to restore his or her credit.

4.   D) a nontaxable asset, owned primarily by large corporations.

 

 

4) Issuers of coupon bonds

1.   A) make a single payment of principal when the bonds matures, but multiple payments of interest over the life of the bond.

2.   B) make a single payment of interest and principal.

3.   C) make multiple payments of principal, but a single payment of interest.

4.   D) make a single payment of principal at the time the bond is issued and multiple payments of interest over the life of the bond.

 

 

5) A simple loan involves

1.   A) interest payments from the borrower to the lender periodically during the life of the loan.

2.   B) no payment of interest by the borrower to the lender.

3.   C) payment of interest by the borrower to the lender only at the time the loan matures.

4.   D) payment only of principal by the borrower to the lender at maturity.

 

6) The amount of funds the borrower receives from the lender with a simple loan is called the

1.   A) principal.

2.   B) equity.

3.   C) claim.

4.   D) collateral.

 

7) The total payment to a lender for a one-period simple loan is

1.   A) (P + i)n.

2.   B) P + i.

3.   C) i(1 + i).

4.   D) P(1 + i).

 

 

8) Suppose First National Bank makes a one-year simple loan of $1,000 at 7% interest to Harry’s Restaurant. At the end of one year Harry’s Restaurant will pay First National

934.             A) $934.58.

935.             B) $1,007.

936.             C) $1,070.

937.             D) $1,700.

 

9) The most common type of simple loan is a(an)

1.   A) automobile loan from a bank.

2.   B) mortgage loan from a bank.

3.   C) commercial loan from a bank.

4.   D) corporate bond.

 

10) A discount bond resembles a simple loan in that

1.   A) the interest on neither is taxable.

2.   B) the borrower repays in a single payment.

3.   C) both represent assets to the borrowers who issue them.

4.   D) both have par values greater than their face values.

 

11) A discount bond involves

1.   A) interest payments from the borrower to the lender periodically during the life of the loan.

2.   B) payment by the borrower to the lender of the face value of the loan at maturity.

3.   C) no payment of principal by the borrower to the lender.

4.   D) payment of interest by the borrower to the lender every six months during the life of the loan.

 

12) Which of the following is NOT a discount bond?

1.   A) a U.S. savings bond

2.   B) a U.S. Treasury bill

3.   C) a U.S. Treasury note

4.   D) a zero-coupon bond

 

 

13) A coupon bond involves

1.   A) interest payments from the borrower to the lender periodically during the life of the loan and payment by the borrower to the lender of the face value of the loan at maturity.

2.   B) interest and principal payments from the borrower to the lender periodically during the life of the loan.

3.   C) periodic payments by the borrower to the lender that include both principal and interest.

4.   D) periodic payments by the borrower to the lender that include principal, but not interest.

 

 

14) The coupon rate is the

1.   A) annual coupon payment divided by the face value of the bond.

2.   B) annual coupon payment divided by the market value of the bond.

3.   C) difference between the face value of the bond and its par value.

4.   D) coupon paid every 6 months divided by par value.

 

15) Which of the following is a coupon bond?

1.   A) a U.S. savings bond

2.   B) a U.S. Treasury bill

3.   C) a U.S. Treasury note or bond

4.   D) a zero-coupon bond

 

 

16) Which of the following is NOT true of a fixed payment loan?

1.   A) The borrower is required to make regular periodic payments to the lender.

2.   B) The payments made by the borrower include both interest and principal.

3.   C) The borrower is left with a substantial unpaid principal at the maturity of the loan.

4.   D) A home mortgage is an example of fixed payment loan.

 

 

17) Which of the following is a fixed payment loan?

1.   A) a home mortgage

2.   B) a U.S. Treasury bill

3.   C) a U.S. Treasury note

4.   D) a zero-coupon bond

 

18) Which of the following is NOT a fixed payment loan?

1.   A) a home mortgage

2.   B) a car loan

3.   C) a U.S. Treasury note

4.   D) a student loan

 

19) Suppose a coupon bond with a par value of $1,000 is currently priced at $950 and has a coupon of $40. Which of the following is TRUE?

1.   A) current yield > coupon rate

2.   B) current yield < coupon rate

3.   C) Coupon rate has risen.

4.   D) Coupon rate has declined.

 

20) When the price of a coupon bond increases

1.   A) the coupon rate declines.

2.   B) the coupon rate increases.

3.   C) the current yield declines.

4.   D) the current yield increases.

 

21) The current yield is equal to

1.   A) the coupon divided by the market price of the bond.

2.   B) the yield to maturity, if the bond is a coupon bond.

3.   C) the coupon divided by the par value of the bond.

4.   D) the market price of the bond divided by its par value.

 

 

22) A coupon bond has an annual coupon of $75, a par value of $1,000, and a market price of $900. Its current yield equals

7.   A) 7.50%.

8.   B) 8.33%.

9.   C) its yield to maturity.

10.                D) Not enough information has been provided to calculate the current yield for this bond.

 

23) Which of the following is NOT fixed on a coupon bond?

1.   A) coupon

2.   B) coupon rate

3.   C) market price

4.   D) par value

 

24) Which of the following is fixed on a coupon bond?

1.   A) coupon rate

2.   B) current yield

3.   C) market price

4.   D) yield to maturity

 

 

 

25) Which of the following involves payment of part of the face value or principal prior to maturity?

1.   A) fixed-payment loan

2.   B) coupon bond

3.   C) discount bond

4.   D) simple loan

 

 

26) Which of the following is NOT a fixed-payment loan?

1.   A) mortgage

2.   B) car loan

3.   C) student loan

4.   D) corporate bond

 

27) Which of the following is a consequence of extending the payback period of a student loan from 10 to 30 years?

1.   A) higher monthly payments

2.   B) more interest paid over the life of the loan

3.   C) faster payoff of principal

4.   D) lower monthly payments initially, but higher monthly payments in the future

 

 

28) Suppose a firm receives $975 for a discount bond with a face value of $1,000 to be repaid in one year. What is the amount of interest on the bond? What is the interest rate on the bond? Report a percentage with two decimal places.

 

29) Suppose a bond has a coupon of $75, face value of $1,000, and current price of $1,100. What is the coupon rate? What is its current yield? Report a percentage with two decimal places.

 

30) Suppose a bond has a coupon of $40, face value of $1,000, and current price of $950. What is the coupon rate? What is its current yield? Report a percentage with two decimal places.

31) How do payments on a fixed-payment loan differ from a coupon bond?

 

1) Suppose Matt’s New Cars issues and sells a one-year discount bond for $9,259 and repays $10,000 at maturity. The interest rate on this bond would be

2.   A) 2.6%.

3.   B) 7.41%.

4.   C) 8%.

5.   D) 10%.

 

 

2) The yield to maturity is equal to

1.   A) the interest rate at which the present value of an asset’s returns is equal to its price today.

2.   B) the face value or par value of a coupon bond.

3.   C) any payments received from an asset at the date the asset matures.

4.   D) interest rate on the asset minus any taxes owed on the interest received.

 

 

3) For simple loans, the yield to maturity

1.   A) is always less than the specified simple interest rate.

2.   B) is always greater than the specified simple interest rate.

3.   C) is always equal to the specified simple interest rate.

4.   D) may be less than, greater than, or equal to the specified simple interest rate, depending on the maturity of the loan.

 

4) What is the yield to maturity on a simple loan that requires payment of $500 plus $30 in interest one year from now?

5.   A) 5.3%

6.   B) 6%

7.   C) 6.38%

8.   D) Not enough information has been provided to determine the answer.

 

 

5) The yield to maturity on a new one-year discount bond equals

1.   A) (FV- P)/P.

2.   B) (D – FV)/P.

3.   C) (FV – P)/FV.

4.   D) (P – FV)/FV.

 

6) A one-year discount bond with a par value of $5,000 sold today, at issuance, for $4,750 has a yield to maturity of

2.   A) 2.50%.

3.   B) 5.00%.

4.   C) 5.26%.

5.   D) 9.75%.

 

 

7) A one-year discount bond with a par value of $1,000 sold today, at issuance, for $943 has a yield to maturity of

4.   A) 4.30%.

5.   B) 5.70%.

6.   C) 6.04%.

7.   D) 9.43%.

 

8) On a coupon bond, the yield to maturity

1.   A) always equals the coupon rate.

2.   B) equates the present value of all the bond’s payments to its price today.

3.   C) increases when the market price of the bond increases.

4.   D) equals the coupon payment divided by the current price of the bond.

 

 

 

9) What is the price of a coupon bond that has annual coupon payments of $85, a par value of $1,000, a yield to maturity of 10%, and a maturity of three years?

211.             A) $211.38

212.             B) $898.84

213.             C) $962.70

214.             D) $1,255.00

 

 

10) What is the price of a coupon bond that has annual coupon payments of $75, a par value of $1,000, a yield to maturity of 5%, and a maturity of two years?

43.                A) $1,043.08

44.                B) $1,046.49

45.                C) $1,000.00

46.                D) $1,150.00

 

 

11) What is the yield to maturity of a consol with a coupon of $85 and a price of $944.44?

5.   A) 5.56%

6.   B) 8.50%

7.   C) 9.00%

8.   D) Not enough information has been provided to determine the answer.

 

12) If i is the yield to maturity of a fixed-payment loan

1.   A) the value of the loan today equals i times the sum of the values of all the loan payments.

2.   B) i equals the present value of the loan payments.

3.   C) the value of the loan today equals the sum of the values of the loan payments.

4.   D) the value of the loan today equals the present value of the loan payments discounted at rate i.

 

 

13) If the current price of a bond is greater than its face value

1.   A) an investor will receive a capital gain by holding the bond until maturity.

2.   B) the yield to maturity must be less than the coupon rate.

3.   C) the coupon rate must be less than the current yield.

4.   D) the coupon rate must be equal to the current yield.

 

 

14) Unless otherwise indicated, when economists or investors refer to the interest rate on a financial asset, they are referring to the

1.   A) current yield.

2.   B) coupon rate.

3.   C) yield to maturity.

4.   D) prime rate.

 

15) Which of the following represents the equation that would be used to determine the yield to maturity of a three-year fixed payment loan of $1,400 which has payments of $500 per year?

1.   A) $1,400 = $500/(1 + i) + $500/(1 + i)2+ $500/(1 + i)3

2.   B) $1,400 = $500/(1 + i)3

3.   C) i = (1,400-500)/1,400

4.   D) $1,400 = $500/(1 + i) + $500/(1 + i)2+ $500(1 + i)3+ 1,400/(1 + i)3

 

16) Which of the following represents the equation that would be used to determine the yield to maturity of a corporate bond with a face value of $1,000, price of $1,100, coupon rate of 5%, and maturity in three years?

1.   A) $1,100 = $1,500/(1 + i)3

2.   B) $1,100 = $500/(1 + i) + $500/(1 + i)2+ 1,000/(1 + i)3

3.   C) $1,100 = $500/(1 + i) + $500/(1 + i)2+ 500/(1 + i)3

4.   D) $1,100 = $500/(1 + i) + $500/(1 + i)2+ 1,500/(1 + i)3

 

 

17) What is the yield to maturity of a perpetuity with a coupon of $40 and a price of $800?

 

18) A one-year discount bond has a face value of $1,000 and price of $880. What is the yield to maturity on the bond? Report using percentages with two decimal places.

 

19) A one-year discount bond has a face value of $1,000 and a price of $925. What is the yield to maturity on the bond? Report using percentages with two decimal places.

 

3.4   The Inverse Relationship Between Bond Prices and Bond Yields

 

1) A bond’s price and its yield to maturity are inversely related because

1.   A) discounting future payments at a higher rate reduces the present value of the payments.

2.   B) discounting future payments at a higher rate increases the present value of the payments.

3.   C) an increase in the yield to maturity will lower a bond’s coupon rate and hence its price.

4.   D) a fall in a bond’s price will lower its par value and hence its yield to maturity.

 

2) An speculator who buys a fifty-year corporate bond

1.   A) must be expecting to still be alive in fifty years.

2.   B) is subject to substantial reinvestment risk.

3.   C) is probably expecting market interest rates to increase in the future.

4.   D) is probably expecting market interest rates to decrease in the future.

 

 

3) Which of the following types of mortgage loans became more common during the housing boom of the early-to-mid 2000s?

1.   A) those with flawed credit histories

2.   B) thirty-year, fixed-rate mortgages

3.   C) prime mortgages

4.   D) those with down payments of at least 20%

 

 

4) Banks who held mortgage-backed securities “took a bath” during the financial crisis of 2007-2009 due to

1.   A) rising yields in secondary markets which led to a decline in the price of mortgage-backed securities.

2.   B) falling yields in secondary markets which led to a decline in the price of mortgage-backed securities.

3.   C) their inability to issue new mortgages.

4.   D) more rapid pre-payment of mortgages.

 

 

5) A capital gain occurs when the

1.   A) coupon rate increases.

2.   B) current yield increases.

3.   C) price of an asset increases.

4.   D) yield to maturity increases.

 

6) The bid price for a bond is

1.   A) the minimum price that you are allowed to bid for a bond that is being auctioned by the government.

2.   B) the maximum price that you are allowed to bid for a bond that is being auctioned by the government.

3.   C) the price that you will receive from a securities dealer if you sell the bond.

4.   D) the price that you must pay a securities dealer to purchase a bond.

 

7) With respect to U.S. Treasury bills

1.   A) the bid price is always greater than the asked price.

2.   B) the asked price is always greater than the bid price.

3.   C) the bid price is only greater than the asked price if investors expect interest rates to decline in the future.

4.   D) the asked price is only greater than the bid price if investors expect interest rates to decline in the future.

 

8) If, while you are holding a coupon bond, its market price falls, you can be sure that

1.   A) the coupon payment you are receiving must have been reduced.

2.   B) the interest rate on other similar bonds must have fallen.

3.   C) the interest rate on other similar bonds must have risen.

4.   D) the par value of the bond must have declined.

 

 

9) If, while you are holding a coupon bond, the interest rates on other similar bonds fall, you can be sure that

1.   A) the coupon payments on your bond will fall.

2.   B) the market price of your bond will rise.

3.   C) the market price of your bond will fall.

4.   D) the par value of your bond will rise.

 

 

10) What is the yield on a discount basis for a U.S. Treasury bill that has a face value of $10,000, has a price of $9,500, and will mature in 180 days?

5.   A) 5.00%

6.   B) 5.25%

7.   C) 10.00%

8.   D) 10.67%

 

 

11) In comparing the yield to maturity on a Treasury bill with the yield on a discount basis on the same bill, we can say that the yield to maturity

1.   A) will always be greater than the yield on a discount basis.

2.   B) will always be less than the yield on a discount basis.

3.   C) will always be equal to the yield on a discount basis, provided the holding period is the same as the number of years to maturity.

4.   D) rises whenever the yield on a discount basis falls.

 

 

12) Which of the following will result in a decrease in the price of an existing corporate bond?

1.   A) lower expectations of inflation

2.   B) new bonds issued at a lower interest rate

3.   C) increased default risk

4.   D) all of the above

 

13) As the housing bubble began to burst in 2006-2008, investors would only buy mortgage-backed securities at high yields to compensate for higher perceived default risk. As a result

1.   A) banks suffered significant capital losses as the value of their holdings of mortgage-backed securities declined.

2.   B) funds available for mortgages increased.

3.   C) bank profits rose as they earned higher interest on mortgages.

4.   D) the price of mortgage-backed securities tended to rise due to the higher yields.

 

14) How long does it take prices of securities to adjust so as to eliminate arbitrage profits?

1.   A) seconds

2.   B) hours

3.   C) days

4.   D) months

 

 

15) A corporation issues a three year bond with a coupon of $50 and a face value of $1,000. Immediately after being issued, market interest rates decline to 4%. What is the price of the bond? Report your answer to the nearest dollar.

16) A corporation issues a three-year bond with a coupon of $50 and a face value of $1,000. A year later, market interest rates have declined to 4%. What is the price of the bond a year after it was issued? Report your answer to the nearest dollar.

 

17) Explain the process by which prices of securities adjust so as to eliminate arbitrage profits.

3.5   Interest Rates and Rates of Return

 

1) The rate of return is equal to the

1.   A) sum of the coupon rate and the current yield.

2.   B) yield to maturity.

3.   C) sum of the current yield and the actual rate of capital gain or loss.

4.   D) sum of the current yield and the expected rate of capital gain.

 

2) What is the rate of return on a bond with a coupon of $55 that was purchased for $900 and sold one year later for $950?

5.   A) 5.56%

6.   B) 6.11%

7.   C) 11.67%

8.   D) 12.43%

 

 

3) Which of the following statements about the rate of return is NOT correct?

1.   A) The total rate of return may be greater or less than the current yield.

2.   B) The total rate of return may be greater or less than the rate of capital gain.

3.   C) The total rate of return may never be negative.

4.   D) The total rate of return is greater than the coupon, holding everything else constant.

 

 

4) The rate of return is equal to

1.   A) the coupon rate plus the rate of capital gains.

2.   B) the coupon rate plus the current yield.

3.   C) the current yield plus the rate of capital gains.

4.   D) the coupon rate multiplied by the rate of capital gains.

 

5) If the current price of a bond is equal to its face value

1.   A) there is no capital gain or loss from holding the bond until maturity.

2.   B) the yield to maturity must be greater than the current yield.

3.   C) the current yield must be greater than the coupon rate.

4.   D) the coupon rate must be greater than the yield to maturity.

 

 

6) If the current price of a bond is less than its face value

1.   A) an investor will receive a capital gain by holding the bond until maturity.

2.   B) the yield to maturity must be less than the current yield.

3.   C) the coupon rate must be greater than the current yield.

4.   D) the coupon rate must be equal to the current yield.

 

7) For a specific change in the yield to maturity

1.   A) the shorter the time until a bond matures, the greater will be the change in its price.

2.   B) the longer the time until a bond matures, the greater will be the change in its price.

3.   C) the longer the time until a bond matures, the greater will be the change in its par value.

4.   D) the shorter the time until a bond matures, the greater will be the change in its coupon rate.

 

 

8) If an investor is certain that market interest rates will decline in the future, which of the following will she be most likely to purchase?

1.   A) a six-month government bill

2.   B) a two-year government note

3.   C) a ten-year government bond

4.   D) a fifty-year government bond

 

9) What is the rate of return on a bond with a coupon of $38 payable in one year that was purchased for $950 and sold one year later for $931?

1.   A) 2%

2.   B) 4%

3.   C) 6%

4.   D) 19%

 

10) Interest-rate risk can best be characterized as the risk that

1.   A) you could have earned a higher interest rate if you waited to purchase a bond.

2.   B) fluctuations in the price of a financial asset in response to changes in market interest rates.

3.   C) you could have gotten a lower interest rate if you waited to lock in a mortgage.

4.   D) short-term interest rates may exceed long-term interest rates.

 

 

11) U.S. Treasury bonds

1.   A) carry no risk of default and are therefore not risky investments.

2.   B) have constant yields to maturity and are therefore not risky investments.

3.   C) have constant coupon rates and are therefore not risky investments.

4.   D) are subject to fluctuations in their market prices and are therefore risky investments.

 

 

12) Why isn’t the current yield a good indicator of holding a bond?

1.   A) It doesn’t account for the yield to maturity.

2.   B) It doesn’t account for capital gains or losses.

3.   C) It doesn’t account for the coupon.

4.   D) It assumes that the current price equals its par value.

 

13) How can a bond have a negative rate of return?

1.   A) if the current yield is greater than the coupon rate

2.   B) if the current yield is less than the coupon rate

3.   C) if the rate of capital loss exceeds the current yield

4.   D) if the rate of capital gains is less than the current yield

 

 

14) Suppose you purchase a bond with a coupon of $30 for $1,025. You sell it one year later for $1,050. What rate of return did you earn? Report a percentage with two decimal places.

 

15) Suppose you purchase a bond with a coupon of $50 for $1,010. You sell it one year later for $900. What rate of return did you earn? Report a percentage with two decimal places.

3.6   Nominal Interest Rates Versus Real Interest Rates

 

1) The expected real interest rate approximately equals

1.   A) the nominal interest rate minus the tax rate.

2.   B) the nominal interest rate minus the expected rate of inflation.

3.   C) the nominal interest rate plus the expected rate of inflation.

4.   D) the yield to maturity on a coupon bond held to maturity.

 

2) Which of the following is the correct expression for the approximate expected real interest rate?

1.   A) r = i + πe

2.   B) r = i – πe

3.   C) r = i/πe

4.   D) r = iπe

 

 

3) A sustained decrease in the price level is known as

1.   A) inflation.

2.   B) disinflation.

3.   C) reflation.

4.   D) deflation.

 

 

4) Nominal interest rates are higher than real interest rates as long as

1.   A) expected inflation is positive.

2.   B) the government taxes interest income.

3.   C) inflation is expected to decline in the future.

4.   D) long-term interest rates are higher than short-term interest rates.

 

 

5) Why may investors buy a Treasury bill with a negative real interest rate?

1.   A) fear of rising inflation

2.   B) concern about high yields on other bonds

3.   C) fear of default by the U.S. government

4.   D) concern about the high default risk of alternative investments

 

6) Suppose you have a fixed-rate mortgage with a nominal interest rate of 6% and the expected annual inflation rate over the life of the mortgage is 2%. What is the expected real interest rate?

1.   A) 3%

2.   B) 4%

3.   C) 8%

4.   D) 12%

 

 

7) A borrower and a lender agree on a mortgage interest rate. If inflation turns out to be less than expected

1.   A) the actual real interest rate will exceed the expected real interest rate.

2.   B) the actual real interest rate will be less than the expected real interest rate.

3.   C) the actual nominal interest rate will be higher than expected.

4.   D) the actual nominal interest rate will be less than expected.

 

 

8) Which type of bond would you purchase if you expected higher rates of inflation during the life of the bond?

1.   A) Treasury bond

2.   B) TIPS

3.   C) corporate bond

4.   D) municipal bond

 

9) How are TIPS adjusted for inflation?

1.   A) The interest rate is adjusted for inflation during each period.

2.   B) The principal is adjusted once the bond reaches maturity.

3.   C) The principal is adjusted for inflation each period.

4.   D) The interest rate is adjusted once the bond reaches maturity.

 

10) Which group is hurt by inflation being less than expected?

1.   A) holders of TIPS

2.   B) lenders of fixed-rate mortgages

3.   C) borrowers with fixed-rate mortgages

4.   D) all of the above

 

 

11) If the real interest rate is 2% and expected inflation is 2%, the nominal interest rate is

1.   A) 0%.

2.   B) 1%.

3.   C) 2%.

4.   D) 4%.

 

12) If the real interest rate is -1.4% and the nominal interest rate is 0.6%, expected inflation equals

1.   A) -2%.

2.   B) -0.8%.

3.   C) 0.8%.

4.   D) 2%.

 

 

Money, Banking, and the Financial System, 3e (Hubbard/O’Brien)

Chapter 4   Determining Interest Rates

 

4.1   How to Build an Investment Portfolio

 

1) Investors value liquidity in an asset because

1.   A) liquid assets tend to have high rates of return.

2.   B) liquid assets incur lower selling costs.

3.   C) liquid assets incur lower tax liabilities.

4.   D) whereas liquid assets have high information costs, their low risk offsets this.

Answer:  B

Diff: 2     Page Ref: 98

Topic:  portfolio choice

Objective:  Discuss the most important factors in building an investment portfolio

*:  Recurring

AACSB:  Reflective Thinking

 

2) A portfolio is a

1.   A) brokerage house specializing in the trading of common stock.

2.   B) brokerage house specializing in the trading of corporate bonds.

3.   C) measure of the risk involved with a holding a particular asset.

4.   D) collection of assets.

Answer:  D

Diff: 1     Page Ref: 93

Topic:  portfolio choice

Objective:  Discuss the most important factors in building an investment portfolio

*:  Recurring

AACSB:  Reflective Thinking

 

3) Economists believe that as a saver’s wealth increases, the saver will generally

1.   A) increase his or her holdings of all assets proportionately.

2.   B) increase the fraction of wealth held as cash.

3.   C) increase the fraction of wealth held as common stock.

4.   D) decrease the fraction of wealth held as corporate bonds.

Answer:  C

Diff: 2     Page Ref: 94

Topic:  portfolio choice

Objective:  Discuss the most important factors in building an investment portfolio

*:  Recurring

AACSB:  Reflective Thinking

 

 

4) As wealth decreases, which of the following is likely to account for a smaller fraction of a saver’s portfolio?

1.   A) stocks

2.   B) corporate bonds

3.   C) cash

4.   D) U.S. government securities

Answer:  C

Diff: 2     Page Ref: 94

Topic:  portfolio choice

Objective:  Discuss the most important factors in building an investment portfolio

*:  Recurring

AACSB:  Reflective Thinking

5) As wealth decreases, which of the following is likely to account for a larger fraction of a saver’s portfolio?

1.   A) corporate stock

2.   B) corporate bonds

3.   C) U.S. government securities

4.   D) checking account balance

Answer:  D

Diff: 2     Page Ref: 94

Topic:  portfolio choice

Objective:  Discuss the most important factors in building an investment portfolio

*:  Recurring

AACSB:  Reflective Thinking

 

6) The average investor must weigh the benefits of liquidity against

1.   A) the high taxes generally levied on liquid assets.

2.   B) the lower returns on liquid assets.

3.   C) the high transactions costs involved in disposing of liquid assets.

4.   D) the greater variability in the nominal returns on liquid assets.

Answer:  B

Diff: 2     Page Ref: 98

Topic:  portfolio choice

Objective:  Discuss the most important factors in building an investment portfolio

*:  Recurring

AACSB:  Reflective Thinking

 

 

7) Why do CDs have lower rates of return than stocks?

1.   A) CDs are much riskier investments than stocks.

2.   B) CDs are less risky than stocks.

3.   C) CDs are not taxed while stocks’ returns are taxable.

4.   D) CDs are not as liquid as stocks.

Answer:  B

Diff: 2     Page Ref: 95

Topic:  portfolio choice

Objective:  Discuss the most important factors in building an investment portfolio

*:  Recurring

AACSB:  Reflective Thinking

 

8) Which of the following can best be characterized as a “Black Swan” event?

1.   A) decline in stock prices due to a recession

2.   B) rising market interest rates as the Fed tightens monetary policy

3.   C) a financial crisis causing credit to dry up

4.   D) an individual firm unexpectedly filing for bankruptcy

Answer:  C

Diff: 2     Page Ref: 97-98

Topic:  portfolio choice

Special Feature:  Making the Connection: Will a Black Swan Eat Your 401(k)?

Objective:  Discuss the most important factors in building an investment portfolio

AACSB:  Reflective Thinking

9) In an article, “Preparing for the Next Black Swan” (Wall Street Journal, Aug 21, 2010), the point is made that diversification may be insufficient in protecting one’s portfolio during a “Black Swan” event. Why may this be TRUE?

1.   A) Virtually all asset classes may decline at the same time.

2.   B) Investors may be unable to buy different assets during a “Black Swan” event.

3.   C) Some assets may rise while others decline during a “Black Swan” event.

4.   D) Black Swan events are surprises and thus one cannot prepare for such an event.

Answer:  A

Diff: 2     Page Ref: 97-98

Topic:  portfolio choice

Special Feature:  Making the Connection: Will a Black Swan Eat Your 401(k)?

Objective:  Discuss the most important factors in building an investment portfolio

AACSB:  Reflective Thinking

 

 

10) Suppose there’s a 50% chance of a stock rising by 20% and a 50% chance of it falling by 20%. What is the expected rate of return on the stock?

1.   A) -20%

2.   B) 0%

3.   C) 10%

4.   D) 20%

Answer:  B

Diff: 2     Page Ref: 94-95

Topic:  portfolio choice

Objective:  Discuss the most important factors in building an investment portfolio

*:  Recurring

AACSB:  Analytical Thinking

 

11) Suppose there’s an 80% chance of a stock rising by 20% and a 20% chance of it falling by 40%. What is the expected rate of return on the stock?

1.   A) -40%

2.   B) -20%

3.   C) 8%

4.   D) 16%

Answer:  C

Diff: 2     Page Ref: 94-95

Topic:  portfolio choice

Objective:  Discuss the most important factors in building an investment portfolio

*:  Recurring

AACSB:  Analytical Thinking

 

12) As a person’s wealth increases, which of the following portfolio holdings is likely to increase the least?

1.   A) checking account

2.   B) stocks

3.   C) money market fund

4.   D) bonds

Answer:  A

Diff: 2     Page Ref: 94

Topic:  portfolio choice

Objective:  Discuss the most important factors in building an investment portfolio

*:  Recurring

AACSB:  Reflective Thinking

 

13) Suppose there’s an 80% chance of a stock rising by 20% and a 20% chance of it falling by 40%. Which type of investor would prefer an investment with a guaranteed return of 5%?

1.   A) risk loving investor

2.   B) risk neutral investor

3.   C) risk averse investor

4.   D) Risk is not relevant in this example.

Answer:  C

Diff: 2     Page Ref: 94-95

Topic:  portfolio choice

Objective:  Discuss the most important factors in building an investment portfolio

*:  Recurring

AACSB:  Analytical Thinking

 

14) Given that most investors tend to be risk averse

1.   A) no one buys risky assets.

2.   B) there’s a trade-off between risk and return.

3.   C) low risk assets provide the best return.

4.   D) it must be a superior strategy compared to one that is risk loving.

Answer:  B

Diff: 2     Page Ref: 96

Topic:  portfolio choice

Objective:  Discuss the most important factors in building an investment portfolio

*:  Recurring

AACSB:  Reflective Thinking

 

15) Which of the following financial assets has both the highest risk and highest return for the period of 1926-2015?

1.   A) small company stocks

2.   B) large company stocks

3.   C) corporate bonds

4.   D) Treasury bills

Answer:  A

Diff: 1     Page Ref: 97-98

Topic:  portfolio choice

Special Feature:  Making the Connection: Will a Black Swan Eat Your 401(k)?

Objective:  Discuss the most important factors in building an investment portfolio

AACSB:  Reflective Thinking

 

 

16) Which best describes the relationship between the cost of acquiring information and return?

1.   A) A high return must compensate for a high cost of acquiring information.

2.   B) A higher cost of information corresponds with a low return.

3.   C) A low cost of acquiring information corresponds with a high return.

4.   D) A higher return results in a lower cost of acquiring information.

Answer:  A

Diff: 1     Page Ref: 98

Topic:  portfolio choice

Objective:  Discuss the most important factors in building an investment portfolio

*:  Recurring

AACSB:  Reflective Thinking

17) Since all assets typically do NOT move together, how can investors typically reduce risk?

1.   A) purchase only the best performing assets

2.   B) diversify one’s portfolio across different asset classes

3.   C) avoid poor performing assets

4.   D) actively manage one’s portfolio

Answer:  B

Diff: 1     Page Ref: 99

Topic:  portfolio choice

Objective:  Discuss the most important factors in building an investment portfolio

*:  Recurring

AACSB:  Reflective Thinking

 

18) Risk that is common to all assets of a certain type is referred to as

1.   A) systematic risk.

2.   B) unsystematic risk.

3.   C) idiosyncratic risk.

4.   D) structural risk.

Answer:  A

Diff: 1     Page Ref: 99-100

Topic:  portfolio choice

Objective:  Discuss the most important factors in building an investment portfolio

*:  Recurring

AACSB:  Reflective Thinking

 

 

19) Suppose that you own $10,000 worth of stock in General Motors. Adding stock in which of the following companies would be least likely to reduce the risk in your portfolio?

1.   A) Google

2.   B) Walmart

3.   C) Ford

4.   D) General Electric

Answer:  C

Diff: 1     Page Ref: 99

Topic:  portfolio choice

Objective:  Discuss the most important factors in building an investment portfolio

*:  Recurring

AACSB:  Reflective Thinking

 

20) Which combination of assets represents the most diversification?

1.   A) holding corporate and Treasury bonds

2.   B) holding shares of Google and Yahoo

3.   C) holding shares of Google and Microsoft

4.   D) holding shares of Google along with Treasury bonds

Answer:  D

Diff: 2     Page Ref: 99

Topic:  portfolio choice

Objective:  Discuss the most important factors in building an investment portfolio

*:  Recurring

AACSB:  Reflective Thinking

21) Which is the best example of idiosyncratic risk?

1.   A) a financial crisis

2.   B) a lawsuit because the corporation produced a faulty product

3.   C) a recession

4.   D) rising interest rates

Answer:  B

Diff: 1     Page Ref: 100

Topic:  portfolio choice

Objective:  Discuss the most important factors in building an investment portfolio

*:  Recurring

AACSB:  Reflective Thinking

 

 

22) An investor who desires the ability to have quick and easy access to cash would prefer to hold which type of asset?

1.   A) risky

2.   B) liquid

3.   C) tax free

4.   D) any form of bond

Answer:  B

Diff: 2     Page Ref: 98

Topic:  portfolio choice

Objective:  Discuss the most important factors in building an investment portfolio

*:  Recurring

AACSB:  Reflective Thinking

 

23) The wealth of most people declined as a result of the financial crisis of 2007-2009. As a result, which asset most likely became a larger portion of their portfolio?

1.   A) bonds

2.   B) stocks

3.   C) house

4.   D) checking account

Answer:  D

Diff: 2     Page Ref: 94

Topic:  portfolio choice

Objective:  Discuss the most important factors in building an investment portfolio

*:  Recurring

AACSB:  Reflective Thinking

 

24) An investor who bases the decision to buy an asset solely on the expected return of an asset is considered to be

1.   A) risk loving.

2.   B) risk averse.

3.   C) risk neutral.

4.   D) risk avoiding.

Answer:  C

Diff: 2     Page Ref: 96

Topic:  portfolio choice

Objective:  Discuss the most important factors in building an investment portfolio

*:  Recurring

AACSB:  Reflective Thinking

 

25) Which of the following assets had both the lowest average annual return and lowest risk between 1926 and 2015?

1.   A) small company stocks

2.   B) large company stocks

3.   C) long-term corporate bonds

4.   D) U.S. Treasury bills

Answer:  D

Diff: 2     Page Ref: 97-98

Topic:  portfolio choice

Special Feature:  Making the Connection: Will a Black Swan Eat Your 401(k)?

Objective:  Discuss the most important factors in building an investment portfolio

AACSB:  Reflective Thinking

 

26) Which type of investor is most likely to have a diversified portfolio?

1.   A) risk averse

2.   B) risk loving

3.   C) risk neutral

4.   D) risk tolerant

Answer:  A

Diff: 2     Page Ref: 96, 99

Topic:  portfolio choice

Objective:  Discuss the most important factors in building an investment portfolio

*:  Recurring

AACSB:  Reflective Thinking

 

27) Diversification is most effective in reducing

1.   A) market risk.

2.   B) systemic risk.

3.   C) idiosyncratic risk.

4.   D) all forms of risk.

Answer:  A

Diff: 2     Page Ref: 99

Topic:  portfolio choice

Objective:  Discuss the most important factors in building an investment portfolio

*:  Recurring

AACSB:  Reflective Thinking

 

 

28) In November 2012, HP claimed that they had weak earnings due to questionable accounting by a company that they had taken over. This is an example of

1.   A) market risk.

2.   B) systemic risk.

3.   C) idiosyncratic risk.

4.   D) liquidity risk.

Answer:  A

Diff: 2     Page Ref: 99

Topic:  portfolio choice

Objective:  Discuss the most important factors in building an investment portfolio

*:  Recurring

AACSB:  Reflective Thinking

29) If you think that there is a 75% chance of a stock increasing by 8% and a 25% change of it falling by 20%, what is the expected return on the stock? Report using percentages with two decimal places.

Answer:  The expected return is (0.75 × 8%) + (0.25 × -20%) = 1.00%.

Diff: 2     Page Ref: 95-96

Topic:  portfolio choice

Objective:  Discuss the most important factors in building an investment portfolio

*:  Recurring

AACSB:  Analytical Thinking

 

30) Suppose you are risk averse and you are deciding between two investments. One has a guaranteed return of 5% while the second has a 50% chance of a 10% return and a 50% chance of a 0% return. Which investment would you choose? Why?

Answer:  The second investment has an expected return of (0.5 × 10%) + (0.5 × 0%) = 5%. Since the two investments have the same expected return and you are risk averse, you choose the first investment.

Diff: 3     Page Ref: 95-96

Topic:  portfolio choice

Objective:  Discuss the most important factors in building an investment portfolio

*:  Recurring

AACSB:  Analytical Thinking