Q&A Hero

Q: A 30-year Treasury bond as a face value of $1,000, price of $1,200 with a $50 coupon payment. Assume the price of this bond decreases to $1,100 over the next year. The one-year holding period return is equal to: A. -9.17%.B. -8.33%.C. -4.17%.D. -3.79%.

Q: A $1,000 face value bond, with an annual coupon of $40, one year to maturity and a purchase price of $980 has a: A. current yield that equals 4.00%.B. coupon rate that equals 4.08%.C. current yield that equals 4.08% and a yield to maturity that equals 6.12%.D. current yield that equals 4.08% and a yield to maturity that equals 4.0%.

Q: A $1000 face value bond, with one year to maturity that sells for $950 and has a $40 annual coupon has a: A. current yield and yield to maturity of 4.00%.B. yield to maturity that equals the current yield.C. coupon rate of 4.00% and a current yield that is below this.D. current yield of 4.21%.

Q: Which of the following is not a reason why the yield to maturity can differ from the current yield? A. Because the yield to maturity considers the capital gain/loss.B. Because the current yield focuses only on the coupon payment and the purchase price.C. Because most bonds are not purchased for face value.D. Because the current yield moves in the opposite direction from price.

Q: If a bond's purchase price equals the face value the: A. coupon rate equals the current yield, which is less than the yield to maturity.B. current yield equals the yield to maturity, which exceeds the coupon rate.C. coupon rate equals the yield to maturity, which equals the current yield.D. coupon rate does not equal the current yield, which does not equal the yield to maturity.

Q: When the current yield and the coupon rate are equal, the bond is: A. purchased at a discount.B. purchased at a price that equals the face value.C. a zero-coupon bond.D. purchased at a price that exceeds its face value.

Q: In calculating the current yield for a bond the: A. coupon payment and purchase price is all that is needed.B. present value of the capital gain/loss is ignored.C. present value of the final payment is the only important consideration.D. present value of the coupon payments is the only important consideration.

Q: In calculating the current yield for a bond the: A. coupon payment is ignored.B. present value of the capital gain/loss is ignored.C. present value of the final payment is the only important consideration.D. present value of the coupon payments is the only important consideration.

Q: A $1,000 face value bond purchased for $965.00, with an annual coupon of $60, and 20 years to maturity has a: A. current yield and coupon rate equal to 6.22% and a coupon rate above this.B. current yield equal to 6.22% and a coupon rate below this.C. coupon rate equal to 6.00% and a current yield below this.D. yield to maturity and current yield equal to 6.00%.

Q: A $1,000 face value bond purchased for $965.00, with an annual coupon of $60, and 20 years to maturity has a: A. current yield equal to 6.22%.B. current yield equal to 6.00%.C. coupon rate equal to 6.22%.D. yield to maturity and current yield equal to 6.00%.

Q: The current yield of a bond: A. is another term for the coupon rate.B. is another term for the yield to maturity.C. equals zero for a zero-coupon bond since these bonds have no coupon payments.D. is the difference between its future value and its present value.

Q: Suppose a saver is looking for the opportunity to make a very large return in a very short period of time. Would you recommend diversification for this individual?

Q: Explain why insurance companies may find themselves at times having to refuse business.

Q: What is the difference between standard deviation and value at risk? Consider the difference between purchasing a one-year bank CD compared with purchasing a homeowner's insurance policy. Which scenario do you believe is more likely to consider value at risk over standard deviation? Explain.

Q: Apply the definition of risk provided in the textbook to an individual's decision to purchase a car insurance policy. Suppose that the individual has two possibilities: no accident ($0 gain/loss) and accident (-$30,000 loss). If the probability of an accident is lower than the probability of an accident occurring (say the probability of an accident is 10%), then why do people buy car insurance? How is this related to the concept of value at risk and the time horizon of investment decisions?

Q: How are the decisions of government policy makers, such as the Federal Reserve, related to risk and an individual investor's portfolio?

Q: Consider an individual who plans to buy a new home. He has two options: (i) pay for mortgage insurance (that insures the lender in case the borrower defaults), or (ii) pay the lender a higher interest rate for the mortgage. Describe how these two options are related to the concept of risk premium and the lender's aversion to risk. Why does the interest rate on the mortgage differ in these two options?

Q: You study horse racing avidly and discover for this year's Kentucky Derby you think you have the field pretty well figured out. In fact, you calculate the expected return and it is the same as the expected return you are getting from the stock market. Is this investment in the race valuable to you?

Q: Considering leverage, can you explain why a mortgage lender would want borrowers to have larger down payments, and when the borrower doesn't the mortgage lender may require mortgage insurance?

Q: Explain the rapid rise in popularity of mutual funds.

Q: Explain why a company offering homeowners insurance policies would want to insure homes across a wide geographic area.

Q: Briefly explain the difference between idiosyncratic risk and systematic risk. Provide an example of each.

Q: Why isn't it correct to say that people who are risk averse avoid risk?

Q: What would be the impact of leverage on the expected return and standard deviation of purchasing an asset with 10% of the owner's funds and 90% borrowed funds?

Q: You buy an asset for $2500. The asset will return $3300 half of the time and $2700, the other half. The expected return is 20%(a gain of $500) and the standard deviation is 12%($300). How would using $1,250 of borrowed funds change the expected return and standard deviation specifically?

Q: What would be the standard deviation for a $1000 risk-free asset that returns $1,100?

Q: An investment with a large spread between possible payoffs will generally have: A. a low expected return.B. a high standard deviation.C. a low value at risk.D. both a low expected return and a low value at risk.

Q: Risk-free investments have rates of return: A. equal to zero.B. with a standard deviation equal to zero.C. that are uncertain, but have a certain time horizon.D. that exhibit a large spread of potential payoffs.

Q: An investor puts $2,000 into an investment that will pay $2,500 one-fourth of the time; $2,000 one-half of the time, and $1,750 the rest of the time. What is the investor's expected return? A. 12.5%B. $250.00C. 6.25%D. 3.125%

Q: An investor puts $1,000 into an investment that will return $1,250 one-half of the time and $900 the remainder of the time. The expected return for this investor is: A. $1,075B. 5.0%C. 7.5%D. 15.0%

Q: Suppose that Fly-By-Night Airlines Inc., has a return of 5% twenty percent of the time and 0% the rest of the time. The expected return from Fly-By-Night is: A. 10%.B. 0.1%.C. 0.2%.D. 1.0%.

Q: If an investment has a 20%(0.20) probability of returning $1,000; a 30%(0.30) probability of returning $1,500; and a 50%(0.50) probability of returning $1,800; the expected value of the investment is: A. $1,433.33B. $1,550.00C. $2,800.00D. $1,600.00

Q: Another name for the expected value of an investment would be the: A. mean value.B. upper-end value.C. certain value.D. risk-free value.

Q: If an investment will return $1,500 half of the time and $700 half of the time, the expected value of the investment is: A. $1,250.B. $1,050.C. $1,100.D. $2,200.

Q: The expected value of an investment: A. is what the owner will receive when the investment is sold.B. is the sum of the payoffs.C. is the probability-weighted sum of the possible outcomes.D. cannot be determined in advance.

Q: If the probability of an outcome is zero, you know the outcome is: A. more likely to occur.B. certain to occur.C. less likely to occur.D. certain not to occur.

Q: If a fair coin is tossed, the probability of coming up with either a head or a tail is: A. ½ or 50 percent.B. Zero.C. 1 or 100 percent.D. Unquantifiable.

Q: If the probability of an outcome equals one, the outcome: A. is more likely to occur than the others listed.B. is certain to occur.C. is certain not to occur.D. has unquantifiable risk.

Q: Inflation presents risk because: A. inflation is always present.B. inflation cannot be measured.C. there are different ways to measure it.D. there is no certainty regarding what inflation will be in the future.

Q: Which of the following is true? A. Investments with higher risk generally have a higher expected return than risk-free investments.B. Investments that pay a return over a longer time horizon generally have less risk.C. Investments with a greater variance in the size of the future payoff generally pay a lower expected return.D. Risk-free investments are the best benchmark for measuring the risk of all investment strategies.

Q: When measuring the risk of an asset: A. one must measure the uncertainty about the size of future payoffs.B. it is necessary to incorporate uncertainties that are not quantifiable.C. one must remember that the concept of risk applies only to financial markets, not to financial intermediaries.D. one cannot use other investments to evaluate the asset's risk.

Q: Uncertainties that are not quantifiable: A. are what we define as risk.B. are factored into the price of an asset.C. cannot be priced.D. are benchmarks against which quantifiable risks can be assessed.

Q: All other factors held constant, an investment: A. with more risk should offer a lower return and sell for a higher price.B. with less risk should sell for a lower price and offer a higher expected return.C. with more risk should sell for a lower price and offer a higher expected return.D. with less risk should sell for a lower price and offer a lower return.

Q: Which of the following would not be included in a definition of risk? A. Risk is a measure of uncertainty.B. Risk can always be avoided at no cost.C. Risk has a time horizon.D. Risk usually involves some future payoff.

Q: What matters more: having a credit card with a low rate or paying off your balance as quickly as possible? Explain.

Q: Explain the suggestion that people may have their own "personal discount rate" and how that may affect decisions about borrowing and other financial matters.

Q: Explain why countries that have volatile inflation rates are likely to have high nominal interest rates.

Q: During the early 1980s, the U.S. economy experienced an increase in interest rates quoted on U.S. Treasury debt, business loans, and mortgages. At the same time the inflation rate gradually declined more than expected. What happened to ex ante versus ex post real interest rates during this period? Use the Fisher equation to support your answer.

Q: Is the obtaining of a car loan a primary or secondary market transaction?

Q: Can a financial instrument be bought and sold in both a primary and secondary financial market? Explain.

Q: How do financial markets pool and communicate the information regarding issuers of financial instruments in a convenient way?

Q: Explain how the introduction of asset-backed securities has allowed investors to take advantage of higher returns from loans that most investors could never make on their own.

Q: Consider a typical individual who owns the following financial instruments: A life insurance policy for $250,000; a certificate of deposit for $10,000; homeowner's and auto insurance policies; $50,000 in a mutual fund, and $150,000 in her pension fund at work. Which of these are instruments used primarily as stores of value and which are being used to transfer risk?

Q: Standard & Poor's sells information to investors; this is their primary business. Is this an example of a financial intermediary? Explain.

Q: What evidence is there that the transaction costs involved with the buying and selling of stocks is low?

Q: Describe what is likely to happen to the average price of a share of stock if the stock markets decide to close every Friday and Monday to provide workers at the exchanges with longer weekends.

Q: A high school basketball player decides to bypass college and go right into the NBA, (the National Basketball Association). Describe the risk the individual is taking and a contract that might transfer the risk.

Q: What are the four fundamental characteristics that determine the value of a financial instrument?

Q: Why are options referred to as derivative instruments?

Q: Financial intermediaries include each of the following, except: A. the New York Stock Exchange.B. credit unions.C. savings banks.D. commercial banks.

Q: Derivative markets exist to allow for: A. allow for the transfer of risk.B. direct transfers of common stocks for bonds.C. cash receipts from the sale of bonds.D. reduced information asymmetry.

Q: Financial intermediaries handle a larger flow of funds than do primary markets primarily because financial intermediaries: A. have a government-provided monopoly.B. have government-regulated prices, so there is little competition.C. can lower transaction costs and increase liquidity for savers.D. do not have to worry about information asymmetry.

Q: Financial intermediaries pool funds of: A. many small savers and provide it to a few large borrowers.B. few large savers and provide it to many small borrowers.C. few large savers a few large borrowers.D. many small savers and provide it to many borrowers.

Q: Small savers would rather use financial institutions than lend directly to borrowers because: A. financial institutions will offer the savers higher interest rates than the savers could obtain directly from borrowers.B. lenders wouldn't want to deal with small savers.C. it allows them to diversify risk.D. the liquidity is lower with financial institutions but the return is higher.

Q: Non-depository institutions would include all of the following except: A. finance companies.B. pension funds.C. insurance companies.D. credit unions.

Q: Nondepository institutions: A. do not serve as intermediaries.B. only serve as brokers.C. only transform assets.D. do not accept deposits.

Q: Which of the following are depository institutions? A. Credit unionsB. Mutual fundsC. Pension fundsD. Insurance companies

Q: All of the following are depository institutions, except: A. commercial banks.B. credit unions.C. insurance companies.D. savings banks.

Q: An insurance company is an example of a financial institution that: A. transfers risk.B. acts as a broker.C. serves as a depository institution.D. sells derivative securities.

Q: Financial institutions: A. raise the level of transaction costs relating to borrowing/lending.B. can lower the information asymmetry involved with borrowing/lending.C. decrease the liquidity to savers.D. are required for all financial transactions.

Q: Countries that lack well-defined property laws and legal structures: A. have large secondary financial markets because the primary markets do not exist.B. will not develop as fast economically as counties with clear property rights and a formal legal system.C. will have much lower transaction costs associated with any level of lending.D. will not have any financial markets at all.

Q: Well-run financial markets: A. keep transactions costs high to benefit brokersB. prevent the widespread pooling of informationC. ensure that resources are allocated efficientlyD. are usually the result of little or no government regulation

Q: Money markets are where trades occur for: A. stocks.B. bonds of all maturities.C. derivatives.D. short-term bonds issued by both governments and private companies.

Q: Debt instruments that have maturities less than one year are traded in the: A. primary market exclusively.B. bond markets exclusively.C. bond market if they are already in existence.D. money market.

Q: Equity markets are markets: A. of U.S. Treasury bonds.B. for AAA rated bonds.C. for stocks.D. for either stocks or bonds.

Q: Which of the following is not true of over-the-counter markets? A. Traders are linked by computer.B. Dealers buy and sell only for their customers.C. Trading does not take place in one physical location.D. Traders are willing to buy and sell stocks and bonds at posted prices.

Q: Over-the-counter (OTC) markets: A. employ specialists to minimize price volatility.B. are centralized exchanges but you must be a dealer to be part of an exchange.C. only deal in the stocks of companies with over $100 million in capital.D. are networks of security dealers linked electronically.

Q: The New York Stock Exchange (NYSE) originated as: A. a decentralized electronic market made up of dealers all over the world.B. an example of a centralized exchange.C. a financial market where nearly 100 million shares of stock are traded every business day.D. the only centralized stock exchange in the world.

Q: An over-the-counter (OTC) market is: A. made up of dealers who only sell government bonds.B. an example of a centralized market.C. made up of dealer who buy and sell only for their own accounts.D. made up of dealers who buy and sell for their customers and for their own accounts.

Q: Which of the following is likely to be a primary financial market transaction? A. You cash the check your grandmother sent you for your birthday.B. You call a broker and purchase bonds for your retirement fund.C. A city issues bonds to finance new road construction.D. A supermarket needs to borrow the funds for a second location and takes out a loan from a commercial bank to pay for it.