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2nd Year
FINANCIAL INSTITUATIONS
Mid-term Revision (chapter 1, ,7)
Summary chapter (1, 7)
Chapter 1: An Overview of Financial Markets and
Institutions
Financial markets can be formal or informal
The financial system provides the mechanism by which funds
can be transferred between these groups and from suppliers
(SSUs) to users of funds (DSUs).
Financial claims ( IOU) are contracts related to the transfer
of funds from surplus spending units to deficit spending units.
Financial claims are issued by DSUs (liabilities), and
purchased by SSUs (assets).
Marketability: Ease with which a financial asset may be
sold to another SSU.
"underwriting spread" is the difference between the
investment banker's purchase price and sale price.
Brokers : don't actually buy or sell securities . they only
execute their clients' transactions at the best possible price.
Dealers: "make markets" for securities
The bid-ask Spread : represent the dealer gross profits.
ASK Price > Bid Price
The lower interest rates, the more willing businesses are to
make expenditures on real investments and vice Vera.
Consumers whose transactions are small in dollar amount
(retail transactions) find that the intermediation market is
most cost effective
Thrift institutions focus more on real estate loans, savings
deposits, and time deposits.
Credit union Not-for-profit and tax – exempt
Casualty claims are not as predictable as death claims.
Retirement benefits replace paychecks (at least partly
Mutual Funds provide intermediated access to various
capital markets
Money Market Mutual Funds (“MMMFs”) a mutual funds
that invest in money market securities which are short-term
securities with low default risk , limited check-writing.
Finance Companies : Make loans to consumer and small
business but do not take deposits
Federal Agencies : Issue “agency securities” backed by
government and lend at sub-market rates for favored social
purposes (support agriculture and housing)
Primary markets claims are first issued , Secondary
markets claims are resold and repriced.
Organized Exchanges Physical trading floor ,OTC
Markets: virtual ,online
Spot Markets: immediate pricing, immediate delivery.
“Futures” contracts: standardized as to amounts, forms, and
dates; trade on organized exchanges
“Forward” contracts: individualized between parties with
particular needs
Options markets : writer grants owner some exclusive right
for some certain time Puts (options to sell) Calls (options to
buy)
Foreign exchange Markets : Any currency is convertible to
any other at some exchange rate ( Forex)
Money markets: wholesale markets for short-term debt
instruments resembling money itself.
Capital markets: where “capital goods” are permanently
financed through long-term financial instruments.
Chapter 7 : Money Markets
Characteristics of Money Market Instruments:-
o Low default risk , Short maturity , High marketability
Low transactions costs
Money Characteristics
market
instruments
1.U.S Sold on discount basis.
Treasury Maturities up to one year.
Bills Minimum denomination is usually $10,000.
Free Default Risk
Auctioning New Bills
Competitive Bids (Specify price and quantity
desired).
Noncompetitive Bids (Specify quantity only)
2.Federal Farm credit agencies Housing credit agencies
Agencies Government-owned agencies (Explicit Guarantee)
Securities , Government-sponsored agencies (implicit
guarantee)
Greater default risk
lower marketability
Yields are higher than T-Bills
3.Federal Short-term interbank loans
Funds (Fed SSU Bank : (federal funds sold)
Fund) DSU Bank : (federal funds purchased).
Most are one-day (over-night loan)
unsecured loans.
4.Repurchase Sale of security with agreement to buy it back later
agreement at a higher price
(Repo) Securities serve as collateral.
The interest rate on a repo is lower than the fed
funds rate, since it is backed up by a security
5.Commercial Unsecured corporate debt .
Paper Maturities are 1 to 270 days.
Large denominations -- $100,000 and up
Sold at a discount from par
Over 95% of issues are in the top two rating
categories.
Backup lines of credit from banks support or
guarantee quality
6.Negotiable Large time deposits (> $100,000), maturity less than
Certificates of six months
Deposit Issued at face value, interest is based on a 360-day
year
Interest rates depend on the issuing bank’s
creditworthiness.
Lower rate for strong banks like center banks
Higher rate for less strong banks like regional
banks
Yields are higher than on T-Bills
higher credit risk
lower marketability
higher taxability
7.Bankers' Mostly relate to international trade
Acceptance Time draft - order to pay in future.
Direct liability of bank.
Discounted in market to reflect yield.
Standard maturities of 30, 60, or 90 days -max of
180.
Importer's bank writes irrevocable letter of credit for
exporter
Importer's bank accepts draft (liability to pay) and
creates a banker's acceptance (BA).
Auctioning New Bills
Competitive Noncompetitive
Specify price and quantity All non-competitive bids
desired. accepted before the award
Minimum $10,000 & in of any competitive bids
multiples of $5,000 above Specify quantity only.
$10,000. Maximum $5,000,000.
Mostly professionals - Mostly individuals & small
dealers & banks. investors.
Note that :-
More Risk , more Return
No physical securities: only record entries.
Book-entry record keeping.
Issuer of the money market instrument consider it liability
, and the investor who purchase this instrument consider it
as assets.
Pricing Treasury Bills
A. The bank discount rate, yd , is
Note that : The discount yield is always lower than the bond
equivalent yield on the same security.
TRUE/FALSE QUESTIONS
(T) 1. The purpose of the financial system is to bring savers and borrowers
together.
(T) 4. Investment bankers help deficit spending units (DSUs) bring new
primary security issues to market.
(F) 6. Most banks are considered systemically risky under the 2010 Dodd
Frank bill.
(F) 8. Finance companies take small consumer deposits and make large
consumer loans.
(T) 10. Direct finance requires a more or less exact match of preferences
between DSUs and SSUs
(F) 11. In the modern financial system, there must be an equal number of
DSUs and surplus spending units (SSUs) in a period.
(T) 14. Depository intermediaries issue claims that are for the most part
highly liquid.
(T) 15. A household is a surplus spending units when income for the period
exceeds spending.
(F) 16. A surplus spending unit (SSU) must hold a claim until its scheduled maturity.
(T) 17. Pension funds transfer spending power from the work period to the
retirement period.
(T) 18. SSUs may prefer intermediated financing to direct financing if they
are seeking liquidity and safety for their investments.
(T) 19. Commercial banks often lend to businesses in direct financial
markets.
(F) 20. “Futures contract” and “forward contract” are identical terms.
(T) 22. Households are the major source of funds to the financial system.
(F) 23. Secondary markets are important because they provide funds directly
to deficit spending units (DSUs).
(F) 24. Primary markets were created to offer liquidity and ways for
investors to alter the risk of their portfolios.
(T) 26. The money market provides short-term liquidity; the capital market
finances long-term corporate growth.
(T) 27. Private placements are the simplest form of direct finance.
(T) 29. Money markets have a greater variety of investors than borrowers.
(F) 30. Every asset is someone else’s liability, but not every liability is someone
else’s asset.
(T) 33. The money market is a dealer market, not an exchange, and has no
specific location.
(T) 35. The money market is a market where liquidity is bought and sold.
(T) 36. Life insurance liabilities are generally more predictable than property
and casualty insurer claims.
(F) 37. Federal funds are the funds provided by the Federal Government for domestic
corporations for long-term growth.
(F) 38. Dealers bring buyer and seller together; brokers make a market.
(F) 39. OTC markets are not very important any more.
(T) 40. When a stock is listed on an exchange, members may trade it on the
floor of the exchange.
(T) 41. Primary markets are markets where users of funds raise cash by
selling securities to funds suppliers.
(F) 42. Privately placed securities are usually sold to one or more investment
bankers and then resold to the general public.
(T) 43. Financial institutions such as commercial banks typically have assets that are
riskier than their liabilities.
MULTIPLE CHOICE QUESTIONS
(c) 4. When the financial system has achieved a high degree of efficiency,
a. Borrowers are able to finance at the highest possible cost.
b. Surplus spending units are able to receive the lowest return on their
savings.
c. Transaction and intermediation costs are low.
d. Lenders will have a limited choice of financial investments.
(a) 15. All but one of the following is a comparative advantage of financial
intermediaries:
a. exploit moral hazard in lending relationships.
b. ability to achieve economies of scale.
c. ability to reduce transaction costs.
d. ability to reduce information asymmetry.
(a) 16. Which of the following would tend to hold the most corporate bonds as a
percent of investments?
a. life insurance company
b. credit union
c. mutual savings bank
d. commercial bank
(d) 17. All but one of the following is a standard characteristic of financial
claims:
a. They are recognized on two balance sheets.
b. They are intangible assets.
c. They are IOU's traded for funds.
d. They represent ownership of real assets.
(a) 18. Money market mutual funds are a strong competitor for
a. depository institutions.
b. the stock market.
c. finance companies.
d. the real estate market.
(d) 19. All of the following are terms for or examples of financial claims
except
a. bonds.
b. money.
c. loans.
d. commodities.
(c) 22. During 2008, Bob and Nancy Gutierrez expect total income of about
$225,000 and are budgeting total expenditures of about $180,000. For
this budget period, the Gutierrez family is most specifically a(n)
a. deficit spending unit (DSU)
b. business entity
c. surplus spending unit (SSU)
d. government entity
(c) 23. The ease with which a financial claim can be resold is its
a. quality.
b. risk.
c. marketability.
d. perpetuity.
(c) 24. The flow of funds from saving to investment through direct financing
involves
a. the saver holding the lender's IOU.
b. two separate contracts.
c. the lender holding the borrower's IOU.
d. several different financial institutions.
(a) 25. Intermediation, or ____ financing, involves ___ financial claim(s)
linking surplus spending unit (SSU) and deficit spending unit (DSU) .
a. indirect; two
b. direct; two
c. indirect; one
d. direct; one
(b) 28. A sale of an entire security issue to one investor or a small group of
investors is
a. a dealer arrangement.
b. a private placement.
c. an underwriting.
d. intermediation financing.
(b) 31. Second Security Bank accepts ten 6 month deposits of $5,000 each
and uses the money to make a 6 month $50,000 loan to a business. This is an
example of
a. maturity intermediation
b. denomination intermediation
c. currency transformation
d. credit risk diversification
(a) 32. Third National Bank accepts a 1 month deposits of $5,000 and uses
the money to make a 6 month $5,000 loan to a business. This is an example
of
a. maturity intermediation
b. denomination intermediation
c. currency transformation
d. credit risk diversification
(c) 33. Acting as matchmaker and earning a commission, the ______ is an
important component in supporting direct financial markets.
a. dealer
b. investment banker
c. broker
d. seller
(d) 34. All but one describes a dealer involved in direct financial market:
a. provides liquidity to sellers
b. buys and sells from inventory
c. earns return from securities holdings
d. transforms claims
(a) 35. All but one of the following is associated with investment banking:
a. Taking deposits.
b. Marketing new issues of securities.
c. Underwriting securities.
d. Completing regulatory paperwork and providing consulting services.
(d) 36. Which of the following are typical transaction costs in making a
loan?
a. Credit evaluation of the lender
b. Cost of monitoring the loan
c. Cost of creating the loan document
d. All of the above
(a) 37. Most of the financial claims issued by U.S. financial intermediaries
are purchased by
a. the household sector.
b. the business sector.
c. the government sector.
d. the foreign sector
(d) 38. The best synonym for “financial intermediation” is
a. direct finance
b. investment banking
c. market making
d. transformation of claims
(b) 39. An S&L taking short-term deposits and financing local land
development is engaging in
a. speculation.
b. maturity intermediation.
c. securities trading
d. currency transformation
(c) 40. Bank credit risk diversification occurs when
a. adding loans to the portfolio increases the liquidity of the loan
portfolio.
b. loans are sold to other banks
c. adding loans to the portfolio decreases the variability of the loan
portfolio.
d. bank loans are repaid by the borrowers.
(c) 41. Currency transformation is an important service because
a. most surplus spending units (SSUs) want to invest in more than one
currency
b. all financial institutions operate internationally
c. few ordinary investors care to hold claims denominated in foreign
currency, but many DSUs need foreign currency claims
d. Deficit spending units (DSUs) can’t export unless they borrow in the
currency of the importing country
(d) 42. A commercial bank provides liquidity when it
a. pays the check written by a deposit customer.
b. redeems a savings deposit upon demand.
c. makes a loan fulfilling a loan commitment.
d. All of the above.
(b) 44. The only “deposit-type” institutions that do not operate for profit are
a. thrift institutions
b. credit unions
c. pension funds
d. commercial banks
(a) 45. Credit unions are _____ institutions; pension funds are _______
institutions.
a. depository; contractual
b. contractual; depository
c. federal ; money market
d. depository; depository
(b) 46. The financial institution that is the largest issuer of commercial paper
is
a. commercial banks.
b. finance companies.
c. property-casualty insurance companies.
d. pension funds.
(d) 47. Which of the following is not a debt security?
a. corporate bonds.
b. U.S. Government securities.
c. federal agency securities.
d. common stock.
(c) 48. Federal agencies issue high quality securities and invest primarily in claims
issued by
a. businesses that are “too big to fail”.
b. the U.S. Treasury to finance government deficits.
c. agricultural or housing-related sectors which have limited access to
private credit.
d. foreign governments
(a) 49. Money market instruments and capital market instruments differ appreciably
in
a. maturity
b. liquidity
c. safety of principal
d. all of the above
(d) 50. Potential effects of yield fluctuations on security prices and
reinvestment income represent
a. credit risk.
b. liquidity risk.
c. foreign exchange risk.
d. interest rate risk.
(a) 64. Which of the following statements about the money market is true?
a. The money market is a dealer market linked by efficient
communications systems.
b. Money market transactions are seldom over $1 million.
c. Market transactions include more primary than secondary market
trades.
d. Most money market transactions are still conducted by mail.
(a) 65. Which of the following may be a liability of a nonfinancial business?
a. commercial paper
b. Federal Funds
c. Treasury securities
d. agency securities
(d) 66. Federal Funds are typically
a. Treasury deposits.
b. Federal Reserve assets.
c. commercial bank deposits at the Federal Reserve.
d. overnight loans settled in immediately available funds.
(d) 67. The money market is important because
a. it is the world's liquidity market.
b. it is the market in which the Fed conducts monetary policy.
c. the federal government finances most of its credit needs in the money
market.
d. all of the above
(b) 73. Which of the following institutions provides risk protection from
events such as automobile accidents?
a. finance company
b. property and casualty insurer
c. pension fund
d. mutual fund
(b) 74. The diagram below is a diagram of the
a. secondary markets
b. primary markets
c. money markets
d. derivatives markets
e. commodities markets
(c) 75. Match the financial institutions with the characteristic that best describes its
function.
I. Pool funds of small savers and invest in either money or capital markets
II. Provide economic protection from adverse events
III. Provide consumer loans and real estate loans funded by deposits
IV. Underwrite and trade securities and provide brokerage services
V. Accumulate and transfer wealth from work period to retirement period
1. Credit unions
2. Insurance companies
3. Pension funds
4. Securities firms and investment banks
5. Mutual funds
a. 1, 3, 2, 5, 4
b. 4, 2, 3, 5, 1
c. 5, 2, 1, 4, 3
d. 2, 4, 5, 3, 1
e. 5, 1, 3, 2, 4
(e ) 76. Secondary markets help support primary markets because secondary markets
a. offer primary market purchasers liquidity for their holdings
b. reduce the cost of trading the primary market claims
c. help investors diversify portfolios
d. update the price or value of the primary market claims
e. all above
CHAPTER 7
TRUE-FALSE QUESTIONS
(F) 3. Treasury bills are sold on an add-on basis, with interest paid separately at
maturity.
(F) 4. Treasury bills are the least marketable among money market securities.
(T) 5. Commercial banks act as dealers and are major investors in Treasury
securities.
(F) 6. For large corporations, commercial paper is a more expensive but more stable
alternative to bank borrowing.
(T) 7. Finance company commercial paper is more likely to be placed directly than
corporate commercial paper.
(F) 8. The Federal Funds market is not available to smaller, regional banks.
(T) 9. Bankers' acceptances are used primarily for financing international trade.
(T) 11. Individual investors are typically indirect investors in money markets.
(T) 12. The money market is a dealer market rather than an exchange and has no
specific location.
(T) 13. Money market borrowers are small in number compared to money market
lenders.
(T) 14. The money market is a market where liquidity is bought and sold.
(T) 15. One would expect commercial banks to hold more money market investments
than pension funds.
(T) 16. Federal Reserve open market operations, reserve requirement changes, and
discount rate policy directly impact interest rates in the money market.
(F) 17. Dealers bring buyers and sellers together; whereas brokers make a market.
(T) 18. The higher yields of federal agency securities relative to T-bills are attributed
mostly to the lower marketability of agency securities.
(T) 19. Commercial banks are important indirect guarantors of some commercial
paper.
(F) 20. Interest arbitrage keeps the interest rates of the many money market securities
identical.
(T) 21. The money market provides liquidity for deficit spending units (DSUs); the
capital market provides opportunities for capital growth for DSUs.
(F) 22. Competitive bids in T-bill auctions require the bidder to specify only the
quantity of bills desired.
(T) 23. Non-competitive bidders in the U. S. Treasury security auctions pay the
weighted average price of all accepted competitive bids.
(F) 24. Reverse repos are contracts that require a firm to sell securities with the
agreement to buy them back in a short period at a higher price.
(F) 25. Money market securities provide low denominations, low default risk
investments and are designed to appeal to individual investors with excess
cash.
(T) 26. Fed funds are short term unsecured loans while repos are short term secured
loans.
MULTIPLE-CHOICE QUESTIONS
(e) 2. Investors in the money markets are generally willing to take which of the
following risks?
a. default risk
b. interest rate risk
c. liquidity risk
d. all of the above
e. none of the above
(d) 3. Small investors are likely to invest in the money market through ____.
a. directly; commercial paper
b. locally; their credit union
c. indirectly; negotiable CDs
d. indirectly; money market mutual funds
(a) 4. Which of the following statements about the money market is true?
a. The money market is a dealer market linked by efficient
communications systems.
b. Money market transactions are seldom over $1 million.
c. Money market investments bear substantial default risk.
d. Most money market transactions are conducted by mail.
e. All of the above statements are true.
(c) 8. The most common money market instrument utilized in the Fed's open
market operations is
a. Federal Funds.
b. commercial paper.
c. Treasury bills.
d. Agency securities.
(e) 11. Which of the following statements about agency securities is true?
I. All agency debt is explicitly guaranteed by the federal government.
II. All agencies are owned by the federal government.
III. Agency securities usually have yields of 3 to 20 basis points below
Treasury bills.
a. I only
b. I and II only
c. I, II and II
d. II and III only
e. I, II and III are all incorrect.
(b) 12. Which of the following money market instruments would typically be used
to finance international trade?
a. a Treasury bill
b. a banker's acceptance
c. commercial paper
d. a negotiable CD
(b) 15. In 2015 the money market security with the largest dollar amount outstanding
was
a. commercial paper.
b. fed funds and repos.
c. negotiable CDs.
d. Treasury bills.
(c) 16. Which of the following money market securities is backed by specified
collateral?
a. negotiable CDs
b. T-bills
c. repurchase agreements
d. commercial paper
(a) 19. Large industrial U.S. corporations act as lenders in the money market by
a. investing excess cash balances.
b. issuing negotiable CDs.
c. issuing commercial paper.
d. issuing agency securities.
(d) 20. Banks invest in government securities for a variety of reasons except
a. income.
b. safety.
c. to obtain marketable collateral.
d. high relative yield.
(b) 21. Which of the following money market instruments is not sold on a discount
basis?
a. commercial paper
b. negotiable certificates of deposit
c. Treasury bills
d. banker's acceptances
e. All of the above instruments are sold on a discount basis.
(e) 22. A time draft drawn on and accepted by a commercial bank that orders to pay
a specified amount of money to the bearer on a given date is called a
_______
a. letter of credit
b. negotiable certificate of deposit
c. banker's certificate of support
d. reverse repurchase agreement
e. banker’s acceptance
(a) 23. Which of the following money market rates is studied closely for indicators
of changes in Federal Reserve monetary policy?
a. Federal Funds
b. Treasury bills
c. commercial paper
d. banker's acceptances
(d) 24. When a firm issuing commercial paper uses a backup line of credit, it _____.
a. increases the credit risk for investors and raises the cost to borrow.
b. decreases the credit risk for investors and decreases the cost to borrow.
c. increases the credit risk for investors and decreases the cost to borrow.
d. decreases the credit risk for investors and raises the cost to borrow.
(c) 25. What is the bank discount yield on a $100,000 face value T-bill priced at
$97,500, maturing in 181days?
a. 2.50%
b. 4.84%
c. 4.97%
d. 5.10%
e. 5.17%
(b) 26. The bank discount rate (ask) on a 91-day T-bill is 5.35%. What is the price
of the $1000 T-bill?
a. $976.40
b. $986.48
c. $981.20
d. $989.45
(c) 27. The bank discount rate (ask) on a 71-day T-bill is 4.86%. What is the bond
equivalent yield on the T-bill?
a. 4.86%
b. 4.92%
c. 4.98%
d. 5.14%
(d) 28. Calculate the bond equivalent yield on a 52-day T-bill selling for 98.555% of
its face value.
a. 10.85%
b. 10.75%
c. 10.54%
d. 10.29%
(c) 29. Which of the following yield calculations on a Treasury bill provides the best
comparison yield for competing coupon-bearing securities of the same maturity?
a. bank discount rate
b. CD equivalent rate
c. bond equivalent rate
d. the prime rate.
(a) 30. The T-bill rate quoted by the Federal Reserve banks is the
a. bank discount rate.
b. the true rate.
c. effective annual rate.
d. bond equivalent rate.
e. the primary rate
(b) 33. Purchasing a T-bill via a computerized account without actually receiving the
securities is achieved through a _______ Account.
a. Direct Purchase
b. Treasury Direct
c. Fed Purchase
d. Federal Benefit
(a) 34. Federal agency securities have higher yields than Treasury securities because
a. they are less marketable than Treasury securities.
b. they have higher exchange rate risk than Treasuries.
c. they are more affected by interest rate risk.
d. they don’t pay interest and Treasuries do.
e. Federal agency securities actually have lower yields than Treasury securities.
(b) 35. If the yield curve is sharply upward sloping which of the following would
likely have the highest yield?
a. 90 day T-bills
b. 90 day commercial paper rates
c. The federal funds rate
d. The overnight repo rate
(e) 37. A bank agrees to buy T-bills from a securities dealer for $997,250, and
promises to sell the securities back to the dealer in 4 days for $997,575. The
yield on this reverse repo for the bank is:
a. 3.00%
b. 2.97%
c. 2.91%
d. 2.86%
e. 2.93%
(a) 38. A firm buys $1,000,000 of a 30-day commercial paper issue for $995,450.
The bond equivalent yield on this commercial paper is:
a. 5.56%
b. 5.46%
c. 5.49%
d. 5.54%
(d) 43. The fed funds rate is very important to the economy because:
a. it measures the return on the most liquid of all the financial assets traded
b. it is closely related to the conduct of monetary policy
c. it impacts the amount of excess reserves in the banking system
d. all of the above
(b) 44. Usage of banker’s acceptances in the U.S. first became popular after the year
____.
a. 1865
b. 1913
c. 1929
d. 1933
(e) 45. Which of the following do not participate in the money markets?
a. commercial banks
b. the Federal Reserve
c. U.S. Treasury dealers
d. corporations
e. All of the above participate in the money markets.
(c) 46. A dealer is quoting a 180-day T-Bill with a face value of $10,000 that
is quoted at 3.75 bid, 3.60 ask. This bill can be bought at
________ or can be sold at ________.
a. $9,879.23; $9,864.36
b. $9,864.36; $9,859.23
c. $9,820.00; $9,812.50
d. $9,802.50; $9,787.50
(a) 47. A 90 day $3 million jumbo CD has a 5.75% annual rate quote. If you
purchase the CD, how much will you collect in 90 days?
a. $3,043,125
b. $3,045.678
c. $3,062,877
d. $3,063,750
(a) 48. Which of the following money market instruments faced a crisis in
during the 2007-2009 recession?
a. Asset backed commercial paper
b. Banker's acceptances
c. T-Bills
d. Federal funds and repos
(a) 49. You spent $9,675 to buy a Treasury bill with a par of $10,000 and you
sold it 180 days later for $9,875. What was the effective annual rate
on this transaction?
a. 4.24%
b. 4.39%
c. 4.45%
d. 4.52%
(c ) 50. If a $10,000 par T-Bill has a 2.75% discount quote and a 180 day
maturity, what is the price of the T-Bill to the nearest dollar?
a. $9,625
b. $9,706
c. $9,863
d. $9,927