MT 1 Spring 08

MT 1 Spring 08 - Version A Student name Business 171a...

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Unformatted text preview: Version A Student name' - Business 171a Spring 2008 Midterm Examination 1 Instructions and notes: I. Please put your name on BOTH the scantron and this exam. If your name is missing from either, you will receive ZERO on the final exam — no exception and no changes afterwards. II. This is a closed—book, closed-notes exam. Do not consult others. You may use a calculator. III. There is one correct answer to each problem. Multiple answers receive zero point. IV. FI=financial institution; Fed=Federal Reserve System; YTM = yield to maturity V. Unless specified otherwise, a. investors maximize their net worth (i.e., they are “rational”) and firms maximize their common shareholders’ net worth. all markets are efficient. firms are typical of the industry in which they operate. approximations should be rounded to 2 digits after the decimal, a debt security has a face (par) value of $1,000 9.0-9.3 1. A US bank is holding European euros (€) in its portfolio. Suppose that the current exchange price is 1 = € 0.8. What would add to the bank’s income? (5 the euro to rise in value to $1 = (=3 0.9 ‘ip (b) the euro to rise in value to $1 = € 0.7 (c) the euro to fall in value to $1 = € 0.9 (d) the euro to fall in value to $1 = € 0.7 2. Maturity intermediation means (a) FIs lending funds to borrowers (b) FIs borrowing funds from lenders ' c FIs (e.g., banks) opening checking accounts for clients =©None of above \ 3. Regarding interest rates on T-bills: (a) The current rate is around 2%—3% (b) The current rate is around 8%-9% (mostly because of the sub-prime issue) , lower than any time in the past 25 years (c The T—bill rate is always the same as the Fed funds rate a ‘ he current rate is around 4%-5%, not much higher than any time in the past 25 years fix ,3 i/ : e : k; 4. 5. 7. fidyNone of the above ‘ . T - relationship between bond price and the rate of interest: ,' ) You are offered $5,000 today or $6,000 in 2 years. If you can invest your funds at 10% per year, which alternative is better (assume no taxes)? (a) Take $5,000 today since a “bird in the hand is better than two birds in the bushes” b Take $6,000 in 2 years since it has a higher FV @ake $5,000 today since it has the higher PV ) Both (b) and (c) (e) None of the above You can invest in a 2-year bond that costs $980; you will receive coupons in 1 year and in 2 years, respectively, and you sell the bond at maturity (the day you receive the second coupon). The coupon rate is 10%. You require a rate of return of r = 8% on this bond. The appropriate formula to use to decide whether you should buy this bond or not is (a) Bond value = 39— + 801+_110209 1.10 (b) Bond value = E + 1.08 100+980 _ 0 i 1‘“ .r/l r .r 1 100CIT\ (1 + r)2 100 ———+ 1+r (c) §80 = hey move in opposite directions and convex They move in the same directions and convex (c) They move in opposite directions along a straight line (d) None of the above Consider the various influences on the overall market rate of interest. (a) “When there is more willingness to borrow, interest rates tend to rise K(®\Z.I'When the risk of default by issuers of bonds rises, interest rates tend to rise When the risk of default by issuers of bonds rises, interest rates tend to fall Both (a) and (b) (e) Both (a) and (c) 8. When economic conditions in the US improve relative to conditions elsewhere in the world, the risk of default elsewhere rises as compared to the risk in the US, resulting in lower interest rates 9. A bond has a coupon rate of 8% paid semiannually at year-end, and YTM of 10%; you expect to keep the bond for exactly 1 year and sell it for $980 at that time; the bond has a face value of $1,000. What is the market price of this bond? (a) $963.27 $1000.00 g6?) 1/ $980.00 ‘ (d) $963.64 (e) $879.34 y/W7 e observe the current rate on one-year loan to be 6% and the rate on two-year loan to be 7%. What is the market expect that the one-year loan to be next year (under the Unbiased Expectations Theory)? [note: you may use the model that was presented in the Feb-14 lecture r 6.5% A I . - r: / r .V .0 % $3M ~ C 0) Some figure between 6% and 7%, but cannot be determined more precisely A 3;; "\I (d) Cannot be determined at all since it is a future rate {0% 4'64 V ‘ e plot of yield to maturity of expected interest rates against maturity ow much you can earn by investing in stocks versus bonds 0 he relationship between spot interest rates and expected interest rates (as; e plot of yield to maturity of spot interest rates against maturity ' e) None of the above 12. Everything else the same, bonds that have shorter maturities are more sensitive to interest rate .i iations than bonds that have longer maturities. rue ) False l 13. Right now inflation, based on one of several measures, is 2.5% and the market expects inflation to average 4% between now and next year. The return on a one-year security is expected to be 6% over the next year. What is the aggroximate real return you expect on this security? (a) 3.5% (b) 8.5% : IQJTQE‘QL (c) 10% n e 1r“ (0 n ‘4 + .14 14. A bond pays interest annually its coupon rate of 8% (and it has just paid its latest coupon) with a par value of $1,000. The bond has 2 years left to mature and its yield to maturity is 9%. The current market price of this bond is .L $ 1,000 $ 982.41 c) since we do not have the required rate of return on this bond its market price cannot be determined 15. Data suggest that in the recent past (say, the past 20-25 years) (a) Short-term interest rates have generally been less volatile than long-term rates b Short—term interest rates have generally been as volatile as long-term rates hort—term interest rates have generally been more volatile than long-term rates 16. Data suggest that the recent past (say, the past 20-25 years) a Short-term interest rates have generally been at about the same level as long-term rates / (b Short-term interest rates have generally been lower than long-term rates (c) Short-term interest rates have generally been higher than long-term rates 17. A company has issued various bonds with different maturities and coupon rates. They all have the same face value of $1,000. Bond A matures in 5 years, has coupon rate of 8% with a yield to maturity (YTM) of 8%. Bond B matures in 7 years, has coupon rate of 9% and YTM = 9%. Bond C matures in 12 years with a coupon rate of 11% and YTM = 11%. (a) Bond A has a lower market price than Bond B which, in turn, has a lower market price than Bond C i ‘ 11 these bonds sell at the same market price c Bond C has a lower market price than Bond B which, in turn, has a lower market price than Bond A (brim c\_ A r sat at. {vii . 18. You buy a bond for $921.73. The bond pays interest of $100 at the end of year 1 and another $100 at the end of year 2, at which time you sell it for $980. The (annualized) rate of return you “ expect to earn on this investment is approximately 10.20%. g (511;: f A “t i “a... (a True 4/ / ‘~ I, ‘y M; W“: m..- alse “ v/ 01% “ B i ‘ 2 ‘* ‘1‘ ' 19. What is the duration of a 2-year bond that pays an annual coupon rate of 10% and has a current “(‘2 \ yield to maturity of 11%? 4) // (a) 2 years / (b) 1.91 years , (c) Cannot be calculated since we don’t have the required rate of return V A 20. Consider two bonds A and B. Both have the same YTM and the same maturity. But A pays a coupon rate of 8% while B pays a coupon rate of 12%. / (a) Bond B has the longer duration (b) _ Without knowing the exact YTM we cannot determine the bonds’ durations (0) Without knowing the exact maturities we cannot determine the bonds’ durations ((1) Bond A has the longer duration A (g/ 21. There is a zero~coupon bond that matures in 5 years. 2 ' (a) Its duration is exactly 5 years (b) Its duration is shorter that 5 years but cannot be determined exactly without know its YTM (c) All we can say is that its duration would be longer if it had a lower YTM (d) All we can say is that its duration would be longer if it had a higher YTM 22. Duration is (a) the time until the investor recovers the price of the bond in today's dollars b the responsiveness (elasticity) of a security's value to (small) coupon changes @he responsiveness (elasticity) of a security's value to (small) interest rate (YTM) changes ) greater than the maturity for deep discount bonds and less than the maturity for premium bonds , I .x/ 23. Bond A has duration 3 years; Bond B has duration 3.2 years. (a) If interest rates rise, Bond A’s price falls by a greater percentage than the fall in the price of B \ (b) If interest rates rise, Bond A’s price falls by a smaller percentage than the fall in the price of B (c) Interest rates have nothing to do with duration; coupon rates do ((1) The percentage changes in bond prices have nothing to do with duration 24. Denomination intermediation is when (a) You have $1,000 to invest and you open 4 savings account and deposit $250 in each (b) When banks borrow small amounts from small investors and find other borrowers to lend small amounts to (c FIs can better bear the risk of borrowing and lending that individual small investors one of the above v ng the instruments traded in capital markets are N ’ ommon stocks, preferred stocks, and corporate bonds (b) US government notes and bonds, and corporate bonds (c) All US government securities ((1 All of the above nly (a) and (b) 26. If consumers find owning homes more attractive than before, the result would be a lower overall market rate of interest. (a True (b False 27. We observe the current one-year US Government security rate to be higher than the current two- year US Government security. What can be inferred about the one-year US Government security rate expected one year from now? m" Next year’s one—year rate will be lower than the current two-year rate m ext year’s one-year rate will be higher than the current one—year rate I M 2/ Next year’s one—year rate will be higher than the current two-year rate {fix ext year’s one-year rate will be lower than the current one—year rate s x; Q\ 28. You check the Wall Street Journal and notice that yields on almost all corporate and Treasury bonds have decreased. The yield decreases may perhaps be explained by which one of the . Wing A decrease in U.S. inflationary expectations ) An increase in current and expected future returns of real corporate investments c ‘ ecreased Japanese purchases of U.S. Treasury Bills/Bonds creases in the U.S. Government budget deficit 29. The future value in 3 years of $1,000 received today if your investment pays 6% compounded anually is ,i ,000 (1-.06)33 if“ 3 " z (b) 1.06(1,000) 50;? ~ (c) 1,000(6%)3 +1,000 (d) (1.06) 3/ 1,000 30. was discount yield is lower than the bond equivalent yield. as: ‘ fl ‘ . rue (b) False \‘J 31. The federal funds rate refers to ' a The rate of interest on funds the federal government lends to banks he rate of interest on fundsthe federal reserve lends to banks (c) The rate of interest On funds the federal government pays on its borrowings fiom other countries (Cy) None of the above ...
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This note was uploaded on 09/08/2010 for the course BUS 171A at San Jose State.

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MT 1 Spring 08 - Version A Student name Business 171a...

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