Markets & Institutions Final Exam Kuan Liu

Treasury bills are capital market instruments

True or False

False

Capital market's main need is to satisfy finance long-term loans

True or False

True

Money market instruments are traded through dealer-broker networks in the secondary market.

True or False

True

In a T-bill auction, issues of T-bills are allocated to bidders who offer

A. highest premiums over par

B. highest volumes of orders

C. highest discounts from par

D. lowest discounts from par

D. lowest discounts from par

A T-bill trades at a 10% discount from par and has 36 days to maturity. The discount yield of the T-bill is

A. 1.39%

B. need more information

C. 1.19%

D. 1.00%

D. 1.00%

Discount yield = ((Par-Price)/Par)(360/Days to maturity)100%

Discount yield = 10%*(360/36) = 1.00%

A T-bill trades at a 20% discount from par and has 73 days to maturity. The bond-equivalent yield of this T-bill is

A. 1.25%

B. 1.01%

C. need more information

D. 0.99%

A. 1.25%

Bond-equivalent yield = ((Par-Price)/Price)(365/Days to maturity)100%

The T-bill trades at a 20% discount from par, meaning the price is 80% of par. ((100-80)/80)x(365/73) = 1.25

A STRIPS T-note is no longer subject to interest rate risks.

True or False

False

Credit Default Swaps can be used as insurance against default risks.

True or False

True

Securitization helps diversify borrower-specific default risk in the capital market.

True or False

True

Securitization does help diversify borrower-specific default risk in the capital market by pooling various debts into tradable securities, spreading the risk across a broader investor base.

Tranches of an ABS re-distribute default risks among investors.

True or False

True

Tranches of an ABS redistribute default risks among investors by offering different levels of risk and return within the same security

The yield curve for AA rated corporate bonds should plot

A. below that of T-bonds but above that of AAA-rated corporate bonds

B. below that of T-bonds and below that of AAA-rated corporate bonds

C. above that of T-bonds and below that of AAA-rated corporate bonds

D. above that of T-bonds and above that of AAA-rated corporate bonds

D. above that of T-bonds and above that of AAA-rated corporate bonds

Consider an ABS that contains three zero-coupon bonds of $100 face value. Each bond has a 5% probability of default. Assume that three bonds are independent from each other. If the ABS are sliced into three tranches: tranches A, B, and C. Each tranche has a $100 face value. What is the probability of tranche A suffering a loss?

A. 0.0125%

B. 0.25%

C. 0.5%

D. 1%

A. 0.0125%

0.05 X 0.05 X 0.05 = .000125

In an Asset-Backed Security (ABS) structure, losses are typically allocated to the tranches starting from the lowest tranche to the highest-rated tranche. Assuming this structure, tranche A, being the most senior tranche, would suffer a loss only if all three bonds default

The yield of a 10-year STRIPS T-note is 1% annually while the yield of a 10-year regular T-note is 5% annually. If the actual inflation rate is 3%, what will happen to the yield of the 10-year STRIPS T-note's yield?

A. increase to 2%

B. stay at 1%

C. decrease to 0.5%

D. increase to 3%

A. increase to 2%

Which of the following financial assets is subject to the largest amount of inflation risk?

A. A 30-day commercial paper

B. A 30-day T-bill

C. An overnight repo

D. A 5-year T-note

D. A 5-year T-note

Interest payments of a mortgage are computed based on a constant principal balance.

True or False

False

Adjustable-rate mortgages alleviate interest rate risk for lenders by transferring it to borrowers.

True or False

True

Mortgages in a mortgage-backed security are no longer subject to prepayment risk.

True or False

False

Mortgage-backed securities are more liquid than individual mortgages.

True or False

True

Mortgages are more likely to be refinanced when

A. interest rates are increasing

B. interest rates are decreasing

C. interest rates stay the same

D. the Fed increases the fed funds rate target

B. interest rates are decreasing

Which of the following is not a reason for banks to use the Originate-to-Distribute (OTD) mortgage business model?

A. Recover initial investment in mortgages faster

B. Avoid bearing prepayment and default risks of mortgages

C. Increase interest earned from lending mortgages

D. Increase number of mortgages they are able to supply

C. Increase interest earned from lending mortgages

Which of the following is a conventional mortgage?

A. A mortgage issued by the Federal Housing Administration (FHA)

B. A mortgage issued by the Veteran Administration (VA)

C. A conforming mortgage

D. A mortgage issued by the U.S. Department of Agriculture (USDA)

C. A conforming mortgage

The role of the Federal Home Loan Mortgage Corporation (Freddie Mac) in mortgages securitizations is to

A. make home loans to low-income individuals

B. purchase conforming mortgages from mortgage originators

C. purchase FHA insured mortgages from financial institutions

D. purchase mortgages created by VA

B. purchase conforming mortgages from mortgage originators

Which of the following type of mortgages are designed to help retirees with cash flows during retirement?

A. fixed-rate mortgages

B. adjustable-rate mortgages

C. balloon mortgages

D. reverse mortgages

D. reverse mortgages

Jumbo loans are a typing of conforming loan

True or False

False

The yield-to-maturity of a four-year T-note is 5%. The yield-to-maturity of a four-year TIPS T-note is 1.5%. What is the expected annual inflation rate for the next four years?

A. 3.5%

B. 3.0%

C. 2.0%

D. 2.5%

A. 3.5%

5% = 1.15% + Expected inflation rate

5%-1.5% = 3.5%

Anakin Inc. is currently priced at $42.92 per share, and the firm's revenue is expected growth by 3% annually in the future. The stock pays a $1.25 dividend per share this year. What is the cost of equity capital of this firm?

A. 4.5%

B. 6.0%

C. 5.0%

D. 3.5%

B. 6.0%

1.25 (1+0.03 / 42.92) +0.03 = 0.599

X 100% = 6%

Stocks X, Y, and Z are initially priced at $45/share, $55/share, and $82/share, respectively. They are used to construct a price-weighted index with a base value of 100. One year later the prices of the three stocks are $40\share, $56/share, and $83/share, respectively. What is the value of the price-weighted index after one year?

A. 90.25

B. 85.71

C. 98.35

D. 100

C. 98.35

Step 1 - calculate the initial price total price of the three stocks: $45+$55+$82 =$182

Calculate the new total price: $40+$56+$83 = $179

New index value (new total price/initial total price) X base value

($179/$182) X 100 = 98.35

Stocks A, B, and C are initially priced at $20 per share. The shares outstanding for A, B, C are 25, 15, and 5, respectively. They are used to construct a market value-weighted index with a base value of 100. One year later the prices of the three stocks become $30/share, $20/share, and $20/share, respectively. What is the market value-weighted index after one year?

A. 111.11

B. 100.88

C. 165.68

D. 127.78

D. 127.78

Calculate the initial total market value of the three stocks.

(25 x $20) + (15 x $20) + (5 x $20) = $900

Calculate the new total market value of the three stocks after one year.New total market value =

(25 × $30) + (15 × $20) + (5 × $20) = $1,150

Calculate the new value of the market value-weighted index.

New index value = (New total market value / Initial total market value) × Base value

New index value = ($1,150 / $900) × 100 = 127.78

True/False: Treasury notes and bonds are money market instruments.

False

Treasury notes and bonds are long-term securities. Therefore, they are both capital money market instruments

True/False: A STRIPS securities is no longer subject to interest rate risks

False

STRIPS securities make it easier for investors to immunize against interest rate risks. However, a STRIPS security itself is still exposed to interest rate risks.

True/False: A TIPS security's yield is in real terms

True

The purpose of a TIPS is to strip inflation's effect on security yields

A "repo" transaction is essentially:

A. An unsecured short-term loan

B. An option transaction

C. Riskless

D. A secured short-term loan

D. a secured short-term loan

Which of the following is NOT one of money market instrument features:

A. Small denominations

B. Low default risk

C. Low price risk

D. High liquidity

A. Small denominations

True/False: Mortgage interests are computed on the declining principal.

True

True/False: Credit Default Swaps can be used as an insurance against risks associated with Mortgage-Backed Securities.

True

True/False: Adjustable-Rate Mortgages alleviate interest rate risks for lenders by transferring them to the borrowers

True

A contract designed to use the equity in a home for retirement income without making any required payments is called a(n):

A. Rollover mortgage

B. Reverse mortgage

C. Adjustable-rate mortgage

D. Home equity loan

B. reverse mortgage

Suppose 7-day fed funds trade at 1.65 percent annually. What is the yield on fed funds on a bond-equivalent basis?

1.67%

0.0165(365/360) X 100

A firm raised $999,450 by issuing a 30-day commercial paper with $1,000,000 face value. What is the bond equivalent yield on this commercial paper?

Bond equivalent yield = par-price x 365 / days to maturity x 100%

Bond equivalent yield = $1,000,000 - $995,450 / $995,450 x 365/30 x 100% = 5.56%

The OTD model helps prompt the supply of residential mortgages

True or False

False? I have no idea