BA 426 Fall 2011 Midterm II Practice Questions

This document is broken into two parts. The first part contains questions that I have made. The second, starting on page 7 contains questions from the books test bank.

NOTE: I dont have any calculations in this yet, but there will be some. I will add examples once I have written the exam.

1. Why should borrowers match the term (maturity) of their borrowing to the life of the asset for which they are financing? Theoretically, the one should match financing term with the life of an asset. If the asset has a short life and the financing is long-term, then one is paying off the asset long after its useful life. And in that case, if market interest rates were to decline during the period of payment, the borrower would still be locked into the higher rates. If the borrower financed long-term assets with short-term debt, then as it refinances as the note comes due, it is subjecting itself to the chance that rates will be higher, thus reinvestment risk. 2. True or False: Long-term borrowers should match the term (or maturity) of their borrowing to the life of the asset to reduce the risk that interest rates will move out of favor.

3. How does time fit with the classifications of the Capital Markets and the Money Markets? Capital markets are where securities with maturities greater than 1 year are bought and sold Money markets are where securities with maturities 1 year or less are bought and sold 4. Considering the capital markets and the money markets, which holds greater reinvestment risk and which holds greater interest rate risk?

Capital market Interest rate risk Money markets Reinvestment risk

5. What is the primary purpose of the Money Market from an investors perspective?
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BA 426 Fall 2011 Midterm II Practice Questions

To warehouse surplus funds waiting for need or for a productive use. To reduce the opportunity cost of lost interest income.

6. The three primary capital markets are: Bond, equity and mortgage 7. Please match the capital markets with the types of securities bought and sold in that market, referencing their respective numbers. They may be used multiple times. Security Type Notes Fixed Income Common Stock Preferred Stock Subordinated Debt Graduated Payment Mortgages Capital Market ______1,2,5_______ Bond Market

1. 2. 3. 4. 5. 6.

______3,4_________ Equity Market

_____6,5__________ Mortgage Market

8. Please match the capital markets with the characteristics of that market, referencing their respective numbers. They may be used multiple times. Characteristic 1. Long term collateralized loan 2. Percentage ownership 3. Defined maturity 4. No maturity 5. Defined investor return 6. Undefined investor return 7. Investor return via principal and interest 8. Investor return via dividends and/or price appreciation 9. Amortized principal and interest 10. Borrowers: businesses 11. Borrowers: businesses & governments 12. Borrowers: businesses, governments & individuals 13. Residual claimant Capital Market _3,5,7,11___Debt Market

__2,4,6,8,10,13____Equity Market

__1,3,5,7,9,12___Mortgage Market

BA 426 Fall 2011 Midterm II Practice Questions

9. If you were to hold a TIPS (Treasury Inflation-Protected Security) and inflation increased, what would happen to the interest rate and what would happen to the principal? The interest rate stays the same. The face value changes according to the CPI.

10. What is the maturity for the following U.S. government securities? Treasury Bills: 1, 3 and 6 month and 1 year Treasury Notes: 2,3,5, 7 and 10 years Treasury Bonds: 20 and 30 year

11. True or False Corporate bonds have their payments amortized. 12. True or False. The Student Loan Marketing Association (Sallie Mae) is a government sponsored agency authorized to issue bonds that essentially guaranteed by the U.S. government.
I am putting this in the practice exam as an example of a type of question, but also to use the opportunity to update everyone. I wont do the same on the exam. False: the text book has not been updated. From Wikopedia and consistent with Sallie Maes web site: SLM Corporation (NYSE: SLM; commonly known as Sallie Mae; originally the Student Loan Marketing Association) is a publicly traded U.S.[2] corporation whose operations are originating, servicing and collecting on student loans.[3] Managing more than $180.4 billion in debt for more than 10 million borrowers, the company primarily provided federally guaranteed student loans originated under the Federal Family Education Loan Program (FFELP).[4] It now provides private student loans.The Student Loan Marketing Association was originally created in 1972 as a government-sponsored enterprise (GSE) and began privatizing its operations in 1997, a process it completed at the end of 2004 when Congress terminated its federal charter, ending its ties to the government

The book describes GSEs as having the government not explicitly guaranteeing agency bonds, though most investors feel that the government would not allow the agencies to default. Yet Freddie Macs FAQ on its web site states: Are FreddieNotes securities guaranteed by the federal government?

BA 426 Fall 2011 Midterm II Practice Questions

No. FreddieNotes securities are obligations of Freddie Mac only. FreddieNotes securities, including any interest on FreddieNotes securities, are not guaranteed by, and are not debts or obligations of, the United States or any agency or instrumentality of the United States other than Freddie Mac. 13. How would the payments schedules for a typical mortgage loan and a typical corporate bond differ? The mortgage loan is amortized, with principal payments incorporated into each payment, and periodic interest payments based on the remaining principal. The corporate bond pays off the principal at maturity, and interim payments are merely principal

14. The Bond Buyer, Tuesday, October 25, 2011: The Maricopa County School District No. 69 is asking voters next week to approve $203 million of general obligation bonds to renovate and maintain its 45 schools. What is meant by this? The voters are asked whether or not they want $203 million more debt issued that will be paid off by the general credit, or taxing authority, of the county. Extra Credit: Here is a quote from a blog, BondView from September 3.
Harrisburg, PA Bond Default Notice The US Congress and the SEC are currently grilling CEOs of Moodys and S&P about the future of the ratings agency model. One problem is the inherent flaws due to conflicts of interest. Stale data is another. For example, Harrisburg, PAs incinerator bonds are in financial default. So why does Moodys and S&P have those same defaulted bonds rated highly at AA3 and AAA? Sure the bonds are insured but it seems Harrisburg has real problems that dont jive with a top credit rating. Do you think that the next time Harrisburg tries to raise money the marketplace will agree with their wallets that these bonds deserve a AAA rating? Uhhhh No.

If this is actually so, why might the rating agencies give such a high rating? Probably a combination of factor, but it is related to the expectation of payment. Primarily, there is some implied guarantee by another entity (The State of PA is working on this...) Providing additional support is bond insurance (which will cover some of the default).

BA 426 Fall 2011 Midterm II Practice Questions

15. Freddie Mac has the following credit ratings for its debt. Please explain why the differences exist between the types of debt.

Senior Long-Term Debt: AAA Aaa AAA Subordinated Debt BBB+/Watch Positive Aa2 AA-

Senior is first to be paid, thus has a lower risk that subordinated, which, in the event of default, is junior, or paid after the Senior obligations are taken care of. 16. What is the role of the Designated Market Maker in the trading of stocks on the New York Stock Exchange? The DMM is assigned specific companies securities for which it is responsible for executing buy and sell orders of others. It is responsible for keeping the market for these assigned securities fair and orderly.

17. True or False Supplemental Liquidity Providing Firms, such as Goldman Sachs and Barclays Capital, purchase and sell securities each day to provide liquidity. They are trading for their own accounts, not for others. 18. Name two significant differences of the Over The Counter Market as compared to organized exchanges. No physical trading floor, rather over the phone/computer Market Makers are buying and selling, versus trading for others

19. What is the role of Circuit Breakers on the NYSE? To reduce volatility, a pause in trading is made to allow market participants to assimilate information. 20. Name one benefit to banks resulting from the increasing role of Mortgage aggregators. By selling the loan, or merely just originating the loan, the banks do not have money tied up in a long-term mortgage, and may use their loanable funds for other purposes. 21. Why is a mortgage down payment considered a means to reduce moral hazard. The more the homeowner has invested money in the house, the less likely the homeowner will be willing to lose the money invested should he/she face financial difficulties.

BA 426 Fall 2011 Midterm II Practice Questions

22. The three primary factors that determine a borrowers mortgage rate are: The term, the discount points paid, and the long term interest rates

23. Competition for mortgage borrowers led to new products, often quite risky for the lender. Please provide one example of how an Interest Only or a No Documents mortgage can be risky. Example: Interest only: the borrower does not build equity in the home. If the housing market values decline, the borrower has financial incentive to continue paying the interest for the higher-valued house. Example: No-Doc: With no requirements to submit proof of income, assets, jobs, the credit quality of the borrower is unknown, and it is not a factor in the approval processthus the risk of default is not known and therefore higher. 24. You are provided with the following information about various types of mortgages. Please match the mortgage type with the description that bests fits that mortgage type. Mortgage type A. Fixed Mortgage d B. Adjustable Rate Mortgage Description Given a borrowers expectations that income will increase, the loan has escalating payments. This helps borrowers qualify for their mortgage. A 2nd loan, junior to the first. Often used to refinance a home at a higher value than the first or for a line-ofcredit secured by the home. Recently used to eliminate the down payment. Conventional or insured loan with an unchanging interest rate. Borrower receives payments instead of making payments, with the lender receiving the mortgaged asset at death or at sale. For retirees. Payments start like a conventional loan, often for the first two years, but then increases. This reduces the life of the loan. A loan with a rate that will change according to changes in a specific market rate. Usually the high and low are capped to protect the borrower and lender, respectively.

C. Reverse Annuity Mortgage D. Graduated Payment Mortgage E. Growing Equity Mortgage F. Second Mortgage

BA 426 Fall 2011 Midterm II Practice Questions

Selected Questions from Test Bank Questions These can be good just to judge your overall knowledge. And for goodness sake, cover the answer as you go!! 9) Which of the following are true statements about participants in the money markets? A) Large banks participate in the money markets by selling large negotiable CDs. B) The U.S. government and corporations borrow in the money markets because cash inflows and outflows are rarely synchronized. C) The Federal Reserve is the single most influential participant in the U.S. money market. D) All of the above are true. E) Only A and B of the above are true. Answer: D 10) The most influential participant(s) in the U.S. money market A) is the Federal Reserve. B) is the U.S. Treasury Department. C) are the large money center banks. D) are the investment banks that underwrite securities. Answer: A 11) The Fed is an active participant in money markets mainly because of its responsibility to A) lower borrowing costs to encourage capital investment. B) control the money supply. C) increase the interest income of retirees holding money market instruments. D) assist the Securities and Exchange Commission in regulating the behavior of other money market participants. Answer: B 13) The primary function of large diversified brokerage firms in the money market is to A) sell money market securities to the Federal Reserve for its open market operations. B) make a market for money market securities by maintaining an inventory from which to buy or sell. C) buy money market securities from corporations that need liquidity. D) buy T-bills from the U.S. Treasury Department. Answer: B

14) Finance companies raise funds in the money market by selling A) commercial paper. B) federal funds. C) negotiable certificates of deposit. D) Eurodollars.
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BA 426 Fall 2011 Midterm II Practice Questions

Answer: A 17) Which of the following is the largest borrower in the money markets? A) commercial banks B) large corporations C) the U.S. Treasury D) U.S. firms engaged in foreign trade Answer: C 20) Suppose that you purchase a 91-day Treasury bill for $9,850 that is worth $10,000 when it matures. The security's annualized yield if held to maturity is about A) 4 percent. B) 5 percent. C) 6 percent. D) 7 percent. Answer: C 21) Suppose that you purchase a 182-day Treasury bill for $9,850 that is worth $10,000 when it matures. The security's annualized yield if held to maturity is about A) 1.5%. B) 2%. C) 3%. D) 6%. Answer: C 24) If your noncompetitive bid for a Treasury bill is successful, then you will A) certainly pay less than if you had submitted a competitive bid. B) certainly pay more than if you had submitted a competitive bid. C) pay the average of prices offered in other noncompetitive bids. D) pay the same as other successful noncompetitive bidders. Answer: D 25) Federal funds A) are short-term funds transferred between financial institutions, usually for a period of one day. B) actually have nothing to do with the federal government. C) provide banks with an immediate infusion of reserves. D) are all of the above. E) are only A and B of the above. Answer: D 26) Federal funds are A) usually overnight investments. B) borrowed by banks that have a deficit of reserves. C) lent by banks that have an excess of reserves.
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BA 426 Fall 2011 Midterm II Practice Questions

D) all of the above. E) only A and B of the above. Answer: D 28) The Federal Reserve can influence the federal funds interest rate by buying securities, which ________ reserves, thereby ________ the federal funds rate. A) adds; raising B) removes; lowering C) adds; lowering D) removes; raising Answer: C 34) A negotiable certificate of deposit A) is a term security because it has a specified maturity date. B) is a bearer instrument, meaning whoever holds the certificate at maturity receives the principal and interest. C) can be bought and sold until maturity. D) all of the above. E) only A and B of the above. Answer: D 35) Negotiable certificates of deposit A) are bearer instruments because their holders earn the interest and principal at maturity. B) typically have a maturity of one to four months. C) are usually denominated at $100,000. D) are all of the above. E) are only A and B of the above. Answer: E 38) A banker's acceptance is A) used to finance goods that have not yet been transferred from the seller to the buyer. B) an order to pay a specified amount of money to the bearer on a given date. C) a relatively new money market security that arose in the 1960s as international trade expanded. D) all of the above. E) only A and B of the above. Answer: E

39) Banker's acceptances A) can be bought and sold until they mature. B) are issued only by large money center banks. C) carry low interest rates because of the very low default risk.
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BA 426 Fall 2011 Midterm II Practice Questions

D) are all of the above. E) are only A and B of the above. Answer: D 42) Money market transactions A) do not take place in any one particular location or building. B) are usually arranged purchases and sales between participants over the phone by traders and completed electronically. C) are both A and B of the above. D) are none the the above. Answer: C 1) Money market securities are short-term instruments with an original maturity of less than one year. Answer: TRUE 2) Money market securities include Treasury bills, commercial paper, federal funds, repurchase agreements, negotiable certificates of deposit, banker's acceptances, and Eurodollars. Answer: TRUE 13) Commercial paper securities are unsecured promissory notes, issued by corporations, that mature in no more than 270 days. Answer: TRUE 19) The Treasury accepts noncompetitive bids in ascending order of yield until the accepted bids reach the offering amount. Answer: FALSE

6) What are the main characteristics of money market securities?

5) The primary reason that individuals and firms choose to borrow long-term is to reduce the risk that interest rates will ________ before they pay off their debt. A) rise B) fall C) become more volatile
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BA 426 Fall 2011 Midterm II Practice Questions

D) become more stable Answer: A 7) A firm will borrow long-term A) if the extra interest cost of borrowing long-term is less than the expected cost of rising interest rates before it retires its debt. B) if the extra interest cost of borrowing short-term due to rising interest rates does not exceed the expected premium that is paid for borrowing long-term. C) if short-term interest rates are expected to decline during the term of the debt. D) if long-term interest rates are expected to decline during the term of the debt. Answer: A

Why do governments never issue stock? Answer: Because they cannot sell ownership claims.

14) Individuals and households frequently purchase capital market securities through financial institutions such as A) mutual funds. B) pension funds. C) money market mutual funds. D) all of the above. E) only A and B of the above. Answer: E 15) (I) There are two types of exchanges in the secondary market for capital securities: organized exchanges and over-the-counter exchanges. (II) When firms sell securities for the very first time, the issue is an initial public offering. A) (I) is true, (II) false. B) (I) is false, (II) true. C) Both are true. D) Both are false. Answer: C 19) (I) The coupon rate is the rate of interest that the issuer of the bond must pay. (II) The coupon rate is usually fixed for the duration of the bond and does not fluctuate with market interest rates. A) (I) is true, (II) false. B) (I) is false, (II) true.
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BA 426 Fall 2011 Midterm II Practice Questions

C) Both are true. D) Both are false. Answer: C 21) Treasury bonds are subject to ________ risk but are free of ________ risk. A) default; interest-rate B) default; underwriting C) interest-rate; default D) interest-rate; underwriting Answer: C 24) (I) To sell an old bond when interest rates have risen, the holder will have to discount the bond until the yield to the buyer is the same as the market rate. (II) The risk that the value of a bond will fall when market interest rates rise is called interest-rate risk. A) (I) is true, (II) false. B) (I) is false, (II) true. C) Both are true. D) Both are false. Answer: C 27) (I) In most years, the rate of return on short-term Treasury bills is below that on the 20-year Treasury bond. (II) Interest rates on Treasury bills are more volatile than rates on long-term Treasury securities. A) (I) is true, (II) false. B) (I) is false, (II) true. C) Both are true. D) Both are false. Answer: C 29) Which of the following statements about Treasury inflation-indexed bonds is not true? A) The principal amount used to compute the interest payment varies with the consumer price index. B) The interest payment rises when inflation occurs. C) The interest rate rises when inflation occurs. D) At maturity, the securities pay the greater of face value or inflation-adjusted principal. Answer: A 32) The bond contract that states the lender's rights and privileges and the borrower's obligations is called the A) bond syndicate.
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BA 426 Fall 2011 Midterm II Practice Questions

B) restrictive covenant. C) bond covenant. D) bond indenture. Answer: D

33) Policies that limit the discretion of managers as a way of protecting bondholders' interests are called A) restrictive covenants. B) debentures. C) sinking funds. D) bond indentures. Answer: A 34) Typically, the interest rate on corporate bonds will be ________ the more restrictions are placed on management through restrictive covenants, because ________. A) higher; corporate earnings will be limited by the restrictions B) higher; the bonds will be considered safer by bondholders C) lower; the bonds will be considered safer by buyers D) lower; corporate earnings will be higher with more restrictions in place Answer: C 36) (I) Restrictive covenants often limit the amount of dividends that firms can pay the stockholders. (II) Most corporate indentures include a call provision, which states that the issuer has the right to force the holder to sell the bond back. A) (I) is true, (II) false. B) (I) is false, (II) true. C) Both are true. D) Both are false. Answer: C 40) Long-term unsecured bonds that are backed only by the general creditworthiness of the issuer are called A) junk bonds. B) callable bonds. C) convertible bonds. D) debentures. Answer: D 41) A secured bond is backed by A) the general creditworthiness of the borrower. B) an insurance company's financial guarantee.
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BA 426 Fall 2011 Midterm II Practice Questions

C) the expected future earnings of the borrower. D) specific collateral. Answer: D 42) Financial guarantees A) are insurance policies to back bond issues. B) are purchased by financially weaker security issuers. C) lower the risk of the bonds covered by the guarantee. D) do all of the above. E) do only A and B of the above. Answer: D 44) Corporate bonds are less risky if they are ________ bonds and municipal bonds are less risky if they are ________ bonds. A) secured; revenue B) secured; general obligation C) unsecured; revenue D) unsecured; general obligation Answer: B

45) Which of the following are true for the current yield? A) The current yield is defined as the yearly coupon payment divided by the price of the security. B) The formula for the current yield is identical to the formula describing the yield to maturity for a discount bond. C) The current yield is always a poor approximation for the yield to maturity. D) All of the above are true. E) Only A and B of the above are true. Answer: A 47) Which of the following are true for the current yield? A) The current yield is defined as the yearly coupon payment divided by the price of the security. B) The current yield and the yield to maturity always move together. C) The formula for the current yield is identical to the formula describing the yield to maturity for a discount bond. D) All of the above are true. E) Only A and B of the above are true. Answer: E 50) The current yield on a $5,000, 8 percent coupon bond selling for $4,000 is A) 5%.
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BA 426 Fall 2011 Midterm II Practice Questions

B) 8%. C) 10%. D) 20%. E) none of the above. Answer: C 51) When an old bond's market value is above its par value, the bond is selling at a ________. This occurs because the old bond's coupon rate is ________ the coupon rates of new bonds with similar risk. A) premium; below B) premium; above C) discount; below D) discount; above Answer: B 11) Debentures are long-term unsecured bonds that are backed only by the general creditworthiness of the issuer. Answer: TRUE

13) A financial guarantee ensures that the lender (bond purchaser) will be paid both principal and interest in the event the issuer defaults. Answer: TRUE 1) What is the purpose of the capital market? How do capital market securities differ from money market securities in their general characteristics?

2) What is a bond indenture?

3) What role do restrictive covenants play in bond markets?

4) What is the difference between a general obligation bond and a revenue bond?

4) (I) Preferred stockholders hold a claim on assets that has priority over the claims of common stockholders. (II) Bondholders hold a claim on assets that has priority over the claims of preferred stockholders. A) (I) is true, (II) false. B) (I) is false, (II) true.
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BA 426 Fall 2011 Midterm II Practice Questions

C) Both are true. D) Both are false. Answer: C 6) The riskiest capital market security is A) preferred stock. B) common stock. C) corporate bonds. D) Treasury bonds. Answer: B 9) Securities not listed on one of the exchanges trade in the over-the-counter market. In this exchange, dealers "make a market" by A) buying stocks for inventory when investors want to sell. B) selling stocks from inventory when investors want to buy. C) doing both of the above. D) doing neither of the above. Answer: C 11) Which of the following statements about trading operations in an organized exchange is correct? A) Floor traders all deal in a wide variety of stocks. B) In most trades, specialists match buy and sell orders. C) In most trades, specialists buy for or sell from their own inventories. D) The SuperDOT system is used to expedite large trades of over 100,000 shares. Answer: B 15) 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 a 15 percent return on equity investments? A) $30.24 B) $26.30 C) $26.09 D) $27.74 Answer: B Is the stock over-valued or under-valued at the $25.00 per share price? Under-valued 19) In the generalized dividend valuation model, a stock's value depends only on A) its future dividend payments and its future price. B) its future dividend payments and the required return on equity.
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BA 426 Fall 2011 Midterm II Practice Questions

C) its future price and the required return on investments on equity. D) its future dividend payments. Answer: B

20) Which of the following is not an element of the Gordon growth model of stock valuation? A) the stock's most recent dividend paid B) the expected constant growth rate of dividends C) the required return on investments in equity D) the stock's expected future price Answer: D 21) According to the Gordon growth model, what is an investor's valuation of a stock whose current dividend is $1.00 per year if dividends are expected to grow at a constant rate of 10 percent over a long period of time and the investor's required return is 11 percent? A) $110 B) $100 C) $11 D) $10 E) $5.24 Answer: A On the following two questions, think of the Gordon Growth Model. 23) Holding other things constant, a stock's value will be highest if its dividend growth rate is A) 15%. B) 10%. C) 5%. D) 2%. Answer: A 25) Holding other things constant, a stock's value will be highest if the investor's required return on investments in equity is A) 20%. B) 15%. C) 10%. D) 5%. Answer: D 31) (I) The market price of a security at a given time is the highest value any investor puts on the security. (II) Superior information about a security increases its value by reducing its risk. A) (I) is true, (II) is false. B) (I) is false, (II) is true.
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BA 426 Fall 2011 Midterm II Practice Questions

C) Both are true. D) Both are false. Answer: B I didnt cover this specifically in class, but it is a good point: 32) The main cause of fluctuations in stock prices is changes in A) tax laws. B) errors in technical stock analysis. C) daily trading volume in stock markets. D) information available to investors. E) total household wealth in the economy. Answer: D 2) In over-the-counter markets, dealers increase the liquidity of thinly traded securities. Answer: TRUE 1) How do corporate stocks differ from bonds?

2) How do common stocks differ from preferred stocks?

3) How do over-the-counter markets differ from organized exchanges?

4) What is the role of specialists on a stock exchange?

1) Which of the following are important ways in which mortgage markets differ from the stock and bond markets? A) The usual borrowers in the capital markets are government entities and businesses, whereas the usual borrowers in the mortgage markets are individuals. B) Most mortgages are secured by real estate, whereas the majority of capital market borrowing is unsecured. C) Because mortgages are made for different amounts and different maturities, developing a secondary market has been more difficult. D) All of the above are important differences. E) Only A and B of the above are important differences. Answer: D 3) Which of the following are true of mortgages? A) A mortgage is a long-term loan secured by real estate. B) A borrower pays off a mortgage in a combination of principal and interest payments
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BA 426 Fall 2011 Midterm II Practice Questions

that result in full payment of the debt by maturity. C) Over 80 percent of mortgage loans finance residential home purchases. D) All of the above are true of mortgages. E) Only A and B of the above are true of mortgages. Answer: D 5) Which of the following are true of mortgage interest rates? A) Interest rates on mortgage loans are determined by three factors: current long-term market rates, the term of the mortgage, and the number of discount points paid. B) Mortgage interest rates tend to track along with Treasury bond rates. C) The interest rate on 15-year mortgages is lower than the rate on 30-year mortgages, all else the same. D) All of the above are true. E) Only A and B of the above are true. Answer: D 8) Typically, discount points should not be paid if the borrower will pay off the loan in ________ years or less. A) 5 B) 10 C) 15 D) 20 Answer: A 10) Which of the following reduces moral hazard for the mortgage borrower? A) collateral B) down payments C) private mortgage insurance D) borrower qualifications Answer: B 13) During the early years of an amortizing mortgage loan, the lender applies A) most of the monthly payment to the outstanding principal balance. B) all of the monthly payment to the outstanding principal balance. C) most of the monthly payment to interest on the loan. D) all of the monthly payment to interest on the loan. E) the monthly payment equally to interest on the loan and the outstanding principal balance. Answer: C 18) (I) Conventional mortgages are originated by private lending institutions, and FHA or VA loans are originated by the government. (II) Conventional mortgages are insured by private companies, and FHA or VA loans are insured by the government.
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BA 426 Fall 2011 Midterm II Practice Questions

A) (I) is true, (II) false. B) (I) is false, (II) true. C) Both are true. D) Both are false. Answer: B 22) A borrower with a 30-year loan can create a GEM by A) simply increasing the monthly payments beyond what is required and designating that the excess be applied entirely to the principal. B) converting his ARM into a conventional mortgage. C) converting his conventional mortgage into an ARM. D) converting his conventional mortgage into a GPM. Answer: A

23) Which of the following are useful for home buyers who expect their income to rise in the future? A) GPMs B) RAMs C) GEMs D) Only A and B are useful. E) Only A and C are useful. Answer: E 26) Second mortgages serve the following purposes: A) they give borrowers a way to use the equity they have in their homes as security for another loan. B) they allow borrowers to get a tax deduction on loans secured by their primary residence or vacation home. C) they allow borrowers to convert their conventional mortgages into GEMs. D) all of the above. E) only A and B of the above. Answer: E 34) The Federal Housing Administration (FHA) A) was set up to buy mortgages from thrifts so that these institutions could make more loans. B) funds purchases of mortgages by selling bonds to the public. C) provides insurance for certain mortgage contracts. D) does all of the above. E) does only A and B of the above. Answer: C

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BA 426 Fall 2011 Midterm II Practice Questions

41) A loan for borrowers who do not qualify for loans at the usual market rate of interest because of a poor credit rating or because the loan is larger than justified by their income is A) a subprime mortgage. B) a securitized mortgage. C) an insured mortgage. D) a graduated-payment mortgage. Answer: A 43) Which of the following terms are found in mortgage loan contracts to protect the lender from financial loss? A) collateral B) down payment C) private mortgage insurance D) all of the above Answer: D 44) What factors are used in determining a person's FICO score? A) past payment history B) outstanding debt C) length of credit history D) all of the above Answer: D 1) Down payments are designed to reduce the likelihood of default on mortgage loans. Answer: TRUE 2) Discount points (or simply points) are interest payments made at the beginning of a loan. Answer: TRUE 8) Adjustable-rate mortgages generally have lower initial interest rates than fixed-rate mortgages. Answer: TRUE 15) Mortgage-backed securities are marketable securities collateralized by a pool of mortgages. Answer: TRUE 18) Subprime loans are those made to borrowers who do not qualify for loans at the usual market rate of interest because of a poor credit rating or because the loan is larger than justified by their income. Answer: TRUE 5) Evaluate the advantages and disadvantages, from both the lender's and borrower's perspectives, of fixed-rate and adjustable-rate mortgages.
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BA 426 Fall 2011 Midterm II Practice Questions

9) What are the benefits and side effects of securitized mortgages? 10) Discuss the pros and cons of a subprime market for residential mortgages in the U.S. --------------------------------- Material not covered as of 10/24/2010----------------------------------4) When the value of the dollar changes from 0.50 to 0.75, the pound has ________ and the dollar has ________. A) appreciated; appreciated B) depreciated; appreciated C) appreciated; depreciated D) depreciated; depreciated Answer: B 6) When the exchange rate changes from 1.0 euros to the dollar to 0.8 euros to the dollar, the euro has ________ and the dollar has ________. A) appreciated; appreciated B) depreciated; appreciated C) appreciated; depreciated D) depreciated; depreciated Answer: C 13) The starting point for understanding how exchange rates are determined is a simple idea called ________, which states that if two countries produce an identical good, the price of the good should be the same throughout the world no matter which country produces it. A) Gresham's law B) the law of one price C) purchasing power parity D) arbitrage Answer: B 15) The ________ states that exchange rates between any two currencies will adjust to reflect changes in the price levels of the two countries. A) theory of purchasing power parity B) law of one price C) theory of money neutrality D) quantity theory of money Answer: A 17) In the long run, a rise in a country's price level (relative to the foreign price level) causes its currency to ________, while a rise in the country's relative productivity causes its currency to ________.
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BA 426 Fall 2011 Midterm II Practice Questions

A) appreciate; appreciate B) appreciate; depreciate C) depreciate; appreciate D) depreciate; depreciate Answer: C

18) If the 2005 inflation rate in Britain is 6 percent, and the inflation rate in the U.S. is 4 percent, then the theory of purchasing power parity predicts that, during 2005, the value of the British pound in terms of U.S. dollars will A) rise by 10 percent. B) rise by 2 percent. C) fall by 10 percent. D) fall by 2 percent. E) do none of the above. Answer: D 22) Increased demand for a country's ________ causes its currency to appreciate in the long run, while increased demand for ________ causes its currency to depreciate. A) imports; imports B) imports; exports C) exports; imports D) exports; exports Answer: C 27) If the French demand for American exports rises at the same time that U.S. productivity rises relative to French productivity, then, in the long run, A) the euro should appreciate relative to the dollar. B) the dollar should depreciate relative to the euro. C) the dollar should appreciate relative to the euro. D) it is not clear whether the euro should appreciate or depreciate relative to the dollar. Answer: C

30) The expected return on dollar deposits in terms of foreign currency is the ________ the interest rate on dollar deposits and the expected appreciation of the dollar. A) product of B) ratio of C) sum of D) difference in Answer: C 32) If the interest rate on dollar deposits is 10 percent, and the dollar is expected to appreciate by 7 percent over the coming year, the expected return on dollar deposits in terms of the foreign currency is A) 3 percent.
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BA 426 Fall 2011 Midterm II Practice Questions

B) 10 percent. C) 13.5 percent. D) 17 percent. E) 24 percent. Answer: D 58) The foreign exchange market A) is organized as an over-the-counter market in which several hundred dealers stand ready to buy and sell deposits denominated in foreign currencies. B) is very competitive. C) functions no differently from a centralized market. D) all of the above. Answer: D 57) Forward exchange rates A) involve the immediate exchange of bank deposits. B) involve the exchange of bank deposits at some specified future date. C) involve the immediate exchange of imports and exports. D) none of the above. Answer: B 60) In the long run, ________ affect the exchange rate. A) relative price levels B) tariffs and quotas C) productivity D) all of the above. Answer: D Regardless of what you know about the subprime crisis, you can think through this one. 63) With the start of the subprime financial crisis in August 2007, the dollar ________ in value against the euro as the Fed lowered interest rates. By December of 2008, with the financial crisis spreading throughout Europe, foreign central banks cut their interest rates, leading to a ________ in the value of the dollar relative to the euro. A) rose; further increase B) rose; decline C) declined; rise D) declined; further decline Answer: C

1) The foreign exchange market is organized as an over-the-counter market in which deposits denominated in foreign currencies are bought and sold. Answer: TRUE

5) Discuss the relationship between changes in domestic real and nominal interest rates and
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BA 426 Fall 2011 Midterm II Practice Questions

exchange rates.

6) What are some of the long-run determinants of the exchange rate?

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