Academic Year 2010-11 30006 FINANCIAL MARKETS AND INSTITUTIONS (BIEMF 17 and 18) GENERAL EXAM February 07,

7, 2010 NAME: SURNAME: MATRICULATION NUMBER: SIGNATURE: __________________________________ __________________________________ __________________________________ __________________________________

Report answers of Multiple Choices here. Be aware some questions have NO (E) reply!!! Question 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 A A A A A A A A A A A A A A A A B B B B B B B B B B B B B B B B C C C C C C C C C C C C C C C C D D D D D D D D D D D D D D D D E E E E E E E E E E E E E E E E

MULTIPLE CHOICE QUESTIONS (1 point each) 1. In which of the following situations would you prefer to be making a loan?
A) The nominal interest rate is 9 percent and the expected inflation rate is 7 percent B) The nominal interest rate is 4 percent and the expected inflation rate is 1 percent C) The nominal interest rate is 13 percent and the expected inflation rate is 15 percent D) The nominal interest rate is 25 percent and the expected inflation rate is 50 percent

2. The Fisher equation states that:

A) B) C) D) E) the nominal interest rate equals the real interest rate plus the expected rate of inflation the real interest rate equals the nominal interest rate less the expected rate of inflation the nominal interest rate equals the real interest rate less the expected rate of inflation both A and B of the above are true both A and C of the above are true

3. When the default risk on corporate bonds decreases, other things equal, the demand curve for corporate bonds shifts to the _________ and the demand curve for Treasury bonds shifts to the _________.
A) right; right B) right; left C) left; left D) left; right

4. If the Federal Reserve wants to drain reserves from the banking system, it will:
A) purchase government securities B) raise reserve requirements C) sell government securities

5. The security with the longest maturity is a Treasury:

A) note B) bond C) bill 6. The concept of adverse selection helps to explain A) why collateral is not a common feature of many debt contracts. B) why large, well-established corporations find it so difficult to borrow funds in securities markets. C) why financial markets are among the most heavily regulated sectors of the economy. D) all of the above. 7. The free-rider problem A) occurs when people do not pay for information take advantage of the information other people have to pay for. B) suggests that the private sale of information will only be a partial solution to the lemons problem. C) prevents the private market from producing enough information to eliminate all the asymmetric information that leads to adverse selection. D) all of the above. 8. If a bank has more rate-sensitive assets than rate-sensitive liabilities, then a(n) _________ in interest rates will _________ bank profits. A) increase; reduce B) increase; increase C) decline; increase D) decline; not affect

9. Duration analysis involves comparing the average duration of the bank's _________ to the average duration of its _________ A) securities portfolio; non-deposit liabilities. B) loan portfolio; non-deposit liabilities. C) loan portfolio; rate-sensitive liabilities. D) rate-sensitive assets; rate-sensitive liabilities. E) assets; liabilities. 10. What should a bank manager do if she feels the bank holds too much capital? A) Increase dividends to reduce retained earnings B) Issue stock C) Slow asset growth (retire debt) or sell securities. D) All of the above E) only A and C 11. Referring to Table A below, First National Bank has an income gap of _________. Table A: First National Bank

A) B) C) D)

0 +30 -30 60

12. One problem of the too-big-to-fail policy is that it _________ the incentives for _________ by big banks. A) reduces; moral hazard B) increases; moral hazard C) reduces; adverse selection D) increases; adverse selection 13. Tasks that investment bankers perform when acting as underwriters to sell securities to the public include: A) pricing the security. B) preparing the filings required by the Securities and Exchange Commission. C) arranging for the security to be rated. D) all of the above. E) only A and B of the above. 14. A typical venture capital firm has a _________ number of investors who each contribute a _________ amount of money to the fund. A) large; small B) small; large C) large; large D) small; small

15. Most mutual funds are structured in two ways. The most common structure is a(n) _________ fund, from which shares can be redeemed at any time at a price that is tied to the asset value of the fund. A(n) _________ fund has a fixed number of nonredeemable shares that are traded in the over-thecounter market. A) closed-end; open-end B) open-end; closed-end C) no-load; closed-end D) no-load; load E) load; no-load 16. Insurance companies' attempts to minimize adverse selection and moral hazard explain which of the following insurance practices? A) Gender-neutral premiums B) Flat-rate premiums C) Restrictive provisions D) All of the above E) Only A and B of the above

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PROBLEMS 1. The current yield on a $6,000 (FV), 10 percent coupon bond selling for $5,000 is (2 points): A) 5%
B) 10% C) 12% D) 15%

2. A stock currently sells for $25 per share and pays $0.24 per year in dividends. What is an investor's valuation of this stock if she expects it to be selling for $30 in one year and requires 15 percent return on equity investments (cost of equity, Ke) (2 points)? A) $30.2
B) $26.3 C) $26.1 D) $27.7

3. Government economists have forecasted one-year T-bill rates for the following five years, as follows (4 points):
Year 1 2 3 4 5 1-year rate 4.25% 5.15% 5.50% 6.25% 7.10%

You have liquidity premium 0.25% for the next two years and 0.50% thereafter. Would you be willing to purchase a four-year T-bond at a 5.75% interest rate? Solution: Your required interest rate on a 4-year bond Average interest on 4 one-year bonds Liquidity Premium (4.25% 5.15% 5.50% 6.25%)/4 0.5% 5.29% 0.50% 5.79% At a rate of 5.75%, the T-bond is just below your required rate.

4. What is the yield on a $1,000,000 municipal bond with a coupon rate of 8%, paying interest annually, versus the yield of a $1,000,000 corporate bond with a coupon rate of 10% paying interest annually? Assume that you are in the 25% tax bracket (2 points):.
Solution: Municipal bond coupon payments equal $80,000 per year. No taxes are deducted; therefore, the yield would equal 8%. The coupon payments on a corporate bond equal $100,000 per year. But you only keep $75,000 because you are in the 25% tax bracket. Therefore your after-tax yield is only 7.5%

5. Option strategies (5 points) Suppose two options on same stock: Put: Strike price K1=$11.50; Cost= $0.10 Call: Strike price K2=$12.00; Cost= $0.10 A traders strategy is as follows: Buy call, Buy Put. a. The initial cost of the strategy is: ___________________________________ b. Construct a table that shows the profit and payoff of the strategy. c. Draw the diagram of the profit in function of the spot price of the underlying asset.