Chapter 2 Self Study Questions
Indicate whether the sentence or statement is true or false.
If an individual investor buys and sells existing stocks through a broker, these are primary market
If the Federal Reserve tightens the money supply, other things held constant, short-term interest rates will be
pushed upward, and this increase probably will be greater than the increase in rates in the long-term market.
The fact that a percentage of the interest income received by one corporation is excluded from taxable income
has encouraged firms to use more debt financing relative to equity financing.
If the tax laws stated that $0.50 out of every $1.00 of interest paid by a corporation was allowed as a
tax-deductible expense, it would probably encourage companies to use more debt financing than they
presently do, other things held constant.
Financial asset markets deal with stocks, bonds, mortgages, and other claims on real assets with respect to the
distribution of future cash flows.
The yield curve is downward sloping, or inverted, if the long-term rates are higher than the short-term rates.
American depository receipts are foreign stocks that sell in American stock exchanges and are denominated in
If you have information that a recession is ending, and the economy is about to enter a boom, and your firm
needs to borrow money, it should probably issue long-term rather than short-term debt.
The two reasons most experts give for the existence of a positive maturity risk premium are (1) because
investors are assumed to be risk averse, and (2) because investors prefer to lend long while firms prefer to
An investor with a six-year investment horizon believes that interest rates are determined only by
expectations about future interest rates, (i.e., this investor believes in the expectations theory). This investor
should expect to earn the same rate of return over the 6-year time horizon if he or she buys a 6-year bond or a
3-year bond now and another 3-year bond three years from now (ignore transaction costs).
The existence of an upward sloping yield curve proves that the liquidity preference theory is correct, because
an upward sloping curve necessarily implies that firms must offer a maturity risk premium in order to induce
investors to lend for longer periods.
Suppose financial institutions, such as savings and loans, were required by law to make long-term, fixed
interest rate mortgages, but, at the same time, were largely restricted, in terms of their capital sources, to
deposits that could be withdrawn on demand. Under these conditions, these financial institutions should prefer
a "normal" yield curve to an inverted curve.