BAFI 341 Chapters 1-5 practice quiz questions

Ch 1 True/False: Money is anything accepted by anyone as payment for services or goods.

TRUE

Ch 1 True/False: Interest rates are determined in the bond markets.

TRUE

Ch 1 True/False: A stock is a debt security that promises to make periodic payments for a specific period of time.

FALSE

Ch 1 True/False: Monetary policy affects interest rates but has little effect on inflation or business cycles.

FALSE

Ch 1 True/False: The government organization responsible for the conduct of monetary policy in the United States is the U.S. Treasury.

FALSE

Ch 1 True/False: Interest rates can be accurately described as the rental price of money.

TRUE

Ch 1 True/False: Holding everything else constant, as the dollar weakens vacations abroad become less attractive.

TRUE

Ch 1 True/False: In recent years, financial markets have become more stable and less risky.

FALSE

Ch 1 True/False: Financial innovation has provided more options to both investors and borrowers.

TRUE

Ch 1 True/False: A financial intermediary borrows funds from people who have saved.

TRUE

Ch 1 True/False: From 2001 to 2008, the dollar depreciated substantially.

TRUE

Ch 1 True/False: From 2007 to 2009, the U.S. economy was hit by the worst financial crisis since the Great Depression.

TRUE

Ch 1 True/False: Holding everything else constant, as the dollar strengthens foreigners will buy more U.S. exports.

FALSE

Ch 1 True/False: In a bull market stock prices are rising, on average.

TRUE

Ch 1 True/False: In a bear market stock prices are rising, on average.

FALSE

Ch 1 True/False: Financial institutions are among the largest employers in the country and frequently pay very high salaries.

TRUE

Ch 1 True/False: Different interest rates have a tendency to move in unison.

TRUE

Ch 1 True/False: Financial markets are what makes financial institutions work.

FALSE

Ch 1 True/False: In recent years, financial markets have become more risky. However, only a limited number of tools (such as derivatives) are available to assist in managing this risk.

FALSE

Ch 1 True/False: Although the internet has changed many aspects of our lives, it hasn't proven very useful for collecting and/or analyzing financial and economic data.

FALSE

Ch 1 True/False: Currency fluctuations have limited impact on imports and exports.

FALSE

Ch 1 True/False: Currency conversions take place in the foreign exchange market.

TRUE

Ch 1 True/False: Financial crises typically only affect financial institutions.

FALSE

Ch 1 True/False: The financial crises of 2007-2009 was caused by high default rates in subprime residential mortgages.

TRUE

Ch 1 True/False: The most important financial institution in the financial system is the Federal Deposit Insurance Corporation.

FALSE

Ch 1 Essay: Have interest rates been more or less volatile in recent years? Why?

Interest rates have been quite volatile over the long run. T-bill rates were about 1% in the early 1950s, climbed to roughly 15% around 1980, then fell to near zero after 2008 and stayed very low through about 2016 and again in 2020-2021, before rising sharply in 2022. The swings come from changes in inflation, the business cycle, central bank (Fed) policy, and financial crises. Rates are also tied to the risk and inflation expectations built into financial markets, so any shock to those moves rates.

Ch 1 Essay: Why should consumers be concerned with movements in foreign exchange rates?

• Exchange rates change the price of foreign goods, imports, and foreign travel.
• A strong dollar makes imports and vacations abroad cheaper; a weak dollar makes them more expensive.
• They also affect U.S. jobs and prices: a strong dollar hurts export industries and firms competing with imports.

Ch 1 Essay: How does the value of the dollar affect the competitiveness of American businesses?

When the dollar strengthens, U.S. goods become more expensive to foreign buyers, so exports fall and U.S. firms have a harder time competing against imports. This hurts exporters and import-competing industries. When the dollar weakens, U.S. goods are cheaper abroad, which boosts exports and competitiveness, though imported inputs and consumer goods get more expensive.

Ch 1 Essay: What is monetary policy and who is responsible for its implementation?

Monetary policy is the management of the money supply and interest rates. It affects interest rates, inflation, and the business cycle. In the United States it is carried out by the central bank, the Federal Reserve System (the Fed), not the U.S. Treasury.

Ch 1 Essay: What are financial intermediaries and what do they do?

Financial intermediaries (banks, insurance companies, mutual funds, pension funds, etc.) borrow funds from savers and then lend or invest them with borrowers. By doing this they reduce transaction costs, provide liquidity services, share risk, and reduce problems from asymmetric information. Intermediation is the primary way funds move from lenders to borrowers.

Ch 1 Essay: What is money?

Money is anything that is generally accepted as payment for goods and services or in the repayment of debts. It serves as a medium of exchange, a unit of account, and a store of value.

Ch 1 Essay: How does a bond differ from a stock?

• Bond: a debt security. The issuer promises to make interest (coupon) payments and repay the principal at maturity. Bondholders are lenders.
• Stock: an equity security representing an ownership claim on the firm's earnings and assets. Stockholders receive dividends (not guaranteed) and are paid after debt holders.
• Stocks carry more risk but offer a claim on the firm's upside.

Ch 1 Essay: Why is the stock market so important to individuals, firms, and the economy?

• Individuals: stock prices affect personal wealth and retirement savings, and large swings change how much people feel able to spend.
• Firms: companies raise funds by selling stock, and the stock price influences investment and financing decisions.
• Economy: it helps channel funds to productive uses and receives the most media attention because of its effect on wealth and spending.

Ch 1 Essay: What is the central bank and what does it do?

The central bank is the government institution responsible for monetary policy and for overseeing the banking system. In the U.S. it is the Federal Reserve System. It manages interest rates and the money supply (for example through open market operations, the discount rate, and reserve requirements) to promote stable prices and economic growth, and it acts as a lender of last resort in a crisis.

Ch 1 Essay: If you are planning a vacation to Europe, do you prefer a strong dollar or weak dollar relative to the euro? Why?

A strong dollar. When the dollar is strong, each dollar buys more euros, so hotels, meals, and travel in Europe cost less in dollar terms. A weak dollar makes the same vacation more expensive.

Ch 1 Essay: How has the stock market performed since 2000?

Using the DJIA from the slides: about 11,000 in 2000 and 2005, about 10,000 in 2010, about 18,000 in 2015, about 28,900 in 2020, and about 31,500 in 2022. So the market was roughly flat for the first decade (with big drops after the dot-com bust and during the 2007-2009 crisis) and then rose strongly.

Ch 1 Essay: Briefly explain why cryptocurrency does not satisfy the conditions to be considered money.

• It is not generally accepted as a medium of exchange; few merchants take it.
• Its price is highly volatile, so it is a poor store of value and unit of account.
• It is not issued or backed by a government or central bank, and prices are still quoted in dollars or other national currencies.

Ch 1 Essay: What is the difference between a stock and a bond?

A stock is equity: an ownership claim on the firm's residual earnings, with uncertain dividends and no maturity. A bond is debt: a contractual promise to pay interest and repay principal at maturity. Bondholders have priority over stockholders if the firm fails, so bonds are generally less risky.

Ch 2 True/False: Every financial market allows loans to be made.

FALSE

Ch 2 True/False: Most people's involvement with the financial system is through financial intermediaries rather than financial markets.

TRUE

Ch 2 True/False: A critical function of financial markets is an efficient allocation of capital.

TRUE

Ch 2 True/False: Financial securities are assets for the entity that sells them.

FALSE

Ch 2 True/False: When financial markets break down it can lead to political instability.

TRUE

Ch 2 True/False: The New York Stock Exchange is an example of a primary market.

FALSE

Ch 2 True/False: Equity represents an ownership interest in a firm and entitles the holder to the residual cash flows.

TRUE

Ch 2 True/False: The capital market is a financial market in which only short-term debt instruments (generally those with an original maturity of less than one year) are traded.

FALSE

Ch 2 True/False: Many common stocks are traded over the counter, although a majority of the largest corporations have their shares traded at organized stock exchanges.

TRUE

Ch 2 True/False: Many common stocks are traded at organized exchanges, although a majority of the largest corporations have their shares traded over the counter.

FALSE

Ch 2 True/False: A debt security is long-term debt if its maturity is greater than 10 years.

TRUE

Ch 2 True/False: Corporations that issue new securities to raise capital now conduct more of this business in financial markets in Europe and Asia than in the U.S.

TRUE

Ch 2 True/False: Currently, over 80% of the new issues in the international bond market are Eurobonds.

TRUE

Ch 2 True/False: American investors pay attention to only the Dow Jones Industrial Average.

FALSE

Ch 2 True/False: A bond denominated in euros and issued in a country that uses the euro as its currency is an example of a Eurobond.

FALSE

Ch 2 True/False: Eurocurrencies are foreign currencies deposited in banks that are outside of the home country.

TRUE

Ch 2 True/False: An example of direct financing is if you were to lend money to your neighbor.

TRUE

Ch 2 True/False: Liquidity services are services that make it easier for customers to conduct financial transactions.

TRUE

Ch 2 True/False: A financial intermediary's risk-sharing activities are also referred to as asset transformation.

TRUE

Ch 2 True/False: The process of financial intermediation is also known as direct finance.

FALSE

Ch 2 True/False: Through economies of scale, financial intermediaries can lower the cost of information production for each service by applying one information resource to many different services.

FALSE

Ch 2 True/False: Adverse selection refers to those with high credit risks, being most aggressive in their search for funds.

TRUE

Ch 2 True/False: One of the most important stock market indexes is the FTSE 100.

TRUE

Ch 2 True/False: A mutual fund is not a depository institution.

TRUE

Ch 2 True/False: A pension fund is not a contractual savings institution.

FALSE

Ch 2 True/False: "Thrift institutions" include savings and loan associations, mutual savings banks, and credit unions.

TRUE

Ch 2 True/False: The government agency that insures each depositor at a commercial bank, savings and loan association, or mutual savings bank up to a loss of $100,000 per account ($250,000 for individual retirement accounts) is the Securities and Exchange Commission (SEC).

FALSE

Ch 2 True/False: In the U.S., financial intermediaries are restricted in what they are allowed to do and what assets they can hold.

TRUE

Ch 2 True/False: Unlike regulations in other countries, there are very few federal regulations governing who is allowed to set up a financial intermediary.

FALSE

Ch 2 Essay: Distinguish between direct financing and indirect financing.

Direct finance: borrowers get funds directly from lenders in financial markets by selling securities (claims on their future income or assets). Example: lending money to a neighbor or buying a bond. Indirect finance: a financial intermediary borrows funds from lender-savers and then makes loans to borrower-spenders. The intermediary issues its own claims (like deposits) to savers.

Ch 2 Essay: Why is it so important for an economy to have fully developed financial markets?

• They channel funds from lender-savers to borrower-spenders with productive investment opportunities, giving an efficient allocation of capital.
• This supports higher production, efficiency, and economic growth.
• They also improve consumer well-being by letting people time purchases better.
• When markets break down, the result can be poverty and even political instability.

Ch 2 Essay: Distinguish between primary markets and secondary markets.

Primary market: where new security issues are sold to initial buyers, typically with an investment bank underwriting the offering. The issuing firm receives the money. Secondary market: where previously issued securities are resold (e.g., NYSE, Nasdaq). Firms get no money from it, but it provides liquidity and establishes a price for the securities. Brokers and dealers operate here.

Ch 2 Essay: Distinguish between money markets and capital markets.

Money markets trade short-term debt instruments (original maturity under one year). They are more liquid and less risky, and prices fluctuate less. Capital markets trade longer-term debt (maturity over one year) and equities (which have no maturity), such as stocks, bonds, and mortgages.

Ch 2 Essay: Describe how over-the-counter markets work.

In an OTC market, dealers at different locations hold inventories of securities and stand ready to buy and sell. They are linked by computer and phone networks rather than a central trading floor, and competition among dealers keeps prices similar. The best example is the market for Treasury securities.

Ch 2 Essay: What are some of the differences between an organized exchange and an over-the-counter market?

• Exchange: trades happen at a central location, usually with listing requirements; the NYSE is an example.
• OTC: decentralized; dealers at various locations quote prices and trade with buyers and sellers.
• Many stocks trade OTC, but most of the largest corporations list on organized exchanges.

Ch 2 Essay: Why do corporations that issue new securities to raise capital now conduct more of this business in financial markets in Europe and Asia than in the United States?

• New technology in foreign exchanges has made them more competitive.
• U.S. regulation became tighter after 9-11.
• The risk of lawsuits is greater in the U.S.
• Sarbanes-Oxley increased the cost of being a U.S.-listed public company. As a result, markets like London and Hong Kong compete with U.S. markets.

Ch 2 Essay: What are some of the major foreign stock exchanges? Is following their returns important to U.S. investors? Why or why not?

Major foreign indexes and exchanges include the FTSE 100 (London), DAX (Frankfurt), CAC 40 (Paris), Nikkei 225 (Tokyo), Hang Seng (Hong Kong), and the Strait Times (Singapore). Yes, following them matters: the U.S. no longer dominates world markets, foreign markets offer investment and diversification opportunities, and events abroad can move U.S. markets and firms.

Ch 2 Essay: Why are financial intermediaries so important to an economy?

Intermediation is the main way funds get from savers to borrowers, and it is a larger source of finance than securities markets. They matter because they:

• reduce transaction costs (expertise and economies of scale) and provide liquidity services
• share risk and allow diversification
• reduce asymmetric information problems (adverse selection and moral hazard)
• exploit economies of scope.

Ch 2 Essay: What are adverse selection and moral hazard?

Adverse selection: occurs before the transaction. The borrowers most likely to produce a bad outcome (high credit risks) are the ones most eager to get a loan; in insurance, unhealthy people most want coverage. Moral hazard: occurs after the transaction. Once a borrower has the funds (or a person has insurance), they have an incentive to take on undesirable or risky activities, making repayment less likely.

Ch 2 Essay: Why can a financial intermediary's risk-sharing activities be described as asset transformation?

Intermediaries create and sell assets with lesser risk (like deposits or shares) to one party in order to buy riskier assets (like loans or stocks) from another party. In effect, risky assets are turned into safer assets for investors. They also pool assets to diversify.

Ch 2 Essay: Discuss the different types of depository institutions.

Depository institutions accept deposits and make loans.

• Commercial banks: the largest intermediary, fund with checkable, savings, and time deposits and make business, consumer, and mortgage loans; most diversified portfolios.
• Thrifts: savings and loan associations and mutual savings banks (mainly mortgages), and credit unions (mainly consumer loans). Mutual savings banks and credit unions are owned by depositors.

Ch 2 Essay: Discuss the different types of investment intermediaries.

• Finance companies: raise funds by selling commercial paper, bonds, and stock and lend to consumers and small businesses.
• Mutual funds: sell shares to investors and buy diversified portfolios of stocks and bonds.
• Money market mutual funds: sell checkable-like shares and buy safe, liquid short-term instruments.
• Hedge funds: large minimum investments, few regulations, invest across many assets.
• (Investment banks advise firms, underwrite securities, and act as dealers.)

Ch 2 Essay: List some of the depository institution regulatory agencies of the U.S. and their primary roles.

• Office of the Comptroller of the Currency: charters and examines federally chartered banks and thrifts and restricts their assets.
• FDIC: insures deposits (up to $250,000 per depositor per bank), examines insured banks.
• Federal Reserve System: examines member banks and sets reserve requirements.
• NCUA: charters and examines federally chartered credit unions.
• State banking and insurance commissions: charter and examine state-chartered institutions and restrict branching.

Ch 2 Essay: What is the primary role of the Securities and Exchange Commission (SEC)?

The SEC regulates organized exchanges and financial markets. It requires corporations issuing securities to disclose information about their sales, assets, and earnings, and it restricts insider trading. This reduces adverse selection and moral hazard and makes markets more efficient.

Ch 3 True/False: A bond's current market value is equal to the present value of the coupon payments plus the present value of the face amount.

TRUE

Ch 3 True/False: Discounting the future is the procedure used to find the future value of a dollar received today.

FALSE

Ch 3 True/False: The current yield is the best measure of an investor's return from holding a bond.

FALSE

Ch 3 True/False: Unless a bond defaults, an investor cannot lose money investing in bonds.

FALSE

Ch 3 True/False: The current yield is the yearly coupon payment divided by the current market price.

TRUE

Ch 3 True/False: The current yield goes up as the price of a bond falls.

TRUE

Ch 3 True/False: A bond with a 5% coupon has a yield to maturity of 5%.

FALSE

Ch 3 True/False: The concept of present value tells you that a dollar in the future is not as valuable to you as a dollar today because you can earn interest on this dollar. Therefore, nominal interest rates can never be negative.

FALSE

Ch 3 True/False: The current yield and the coupon rate are the same thing.

FALSE

Ch 3 True/False: When a lender makes a simple loan the lender provides the borrower with an amount of funds, which must be repaid to the lender at the maturity date along with an additional payment for the interest.

TRUE

Ch 3 True/False: The real interest rate is equal to the nominal rate minus inflation.

TRUE

Ch 3 True/False: Because their interest and principal payments are adjusted for changes in the price level, the interest rate on TIPS provides a direct measure of a real interest rate.

TRUE

Ch 3 True/False: The real interest rate is actually the ex ante real interest rate because it is adjusted for actual changes in the price level.

FALSE

Ch 3 True/False: Prices for long-term bonds are more volatile than for shorter-term bonds.

TRUE

Ch 3 True/False: When the real interest rate is low, there are greater incentives to borrow and fewer incentives to lend.

TRUE

Ch 3 True/False: The difference between the ex ante interest rate and the ex post interest rate is known as the Fisher effect.

FALSE

Ch 3 True/False: When the real interest rate is high, there are greater incentives to borrow and fewer incentives to lend.

FALSE

Ch 3 True/False: An indexed bond is a bond whose interest and/or principal payments are adjusted for changes in the price level.

TRUE