f09 bus171a midterm2

f09 bus171a midterm2 - Version A Name(please print Business...

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Unformatted text preview: Version A Name (please print) . Business 171a Professor Reza Fall 2009 San Jose State University mm; Instructions and notes: 1. Please put your name on BOTH the scantron and this exam and return both. If your name is missing from either, you will receive ZERO on the exam — no exception and no changes afterwards. 11. Please put your test VERSION on the scantron. If the version is missing, your exam will be assigned a version at random and corrected; the result will not be changed. III. This is a closed-book, closed-notes exam. Do not consult others. You may use only a calculator. IV. There is one correct answer to each problem. Multiple answers receive zero point. V. Unless specified otherwise, approximations should be rounded to 2 places after the decimal. Unless specified otherwise, a debt security has a face (par) value of $1,000 VI. Unless specified otherwise, assume that a. investors maximize their net worth (i.e., they are “rational”) and firms maximize their common shareholders’ net worth. b. all markets are efficient. c. firms are typical of the industry in which they operate. d. both firms and individuals are residents of the United States, and are interested in profits, wealth and consumption in terms of the US $. e. Earnings on municipal bonds are exempt from income tax; earnings on all other bonds are taxable 1'. Return includes both interest/dividend and capital gain (or loss) P—P i—i Duration:-'—°/ ‘ 0 PO 1+io , Po =initial price; P, =fina1 price; i0 =initial interest rate; i 1 =final interest rate [0,N = LN + [(10.1 + [:2 + [:3 + ...+ [ileuv )J/ N; [0,»; = N—period spot rate; [0.1 = one-year spot (current) rate; I f 2 = one-year forward (expected) rate for one year from now; and so on; I ;,_l ’ N = one- year forward (expected) rate between year N—l and year N. L N = liquidity premium for an N—year bond. The Expectations Theory is when L N = 0 1. The Federal Reserve System is a government entity a. a part of the US Treasury Department b. an administrative unit of the US Congress c. an Administrative unit reporting the US President d. that reports directly to the Council of Economic Advisors e. none of the above 1 :30 Version A 1 ExamZ iFal] 2009 2. While the Executiv W , a responsible for monetary policy. a. True b. False _. iscal policy, the Fed is independently 3. When the potential borrowers who are the most likely to default are the ones most actively seeking a loan, is said to exist a. Fraud b. Adverse selection c. Asymmetric information d. Moral hazard 4. You check the Wall Street Journal and notice that yields on almost all corporate and Treasury bonds have decreased. The yields decrease may best be explained by which one of the following A decrease in US. inflationary expectations An increase in current and expected future real returns of corporate investments Decreased Japanese purchases of US. Treasury securities Increases in the US. Government budget deficit Both (c) and (d) 9999‘!» 5. In the past year the Fed has increased the money supply by buying bonds from the private sector. This has a. Shifted the bond demand curve to the left and lowered interest rates b. Shifted the bond supply curve to the right and increased the price of bonds c. Shified the bond demand curve to the right and increased the price of bonds d. Both (b) and (c) 6. You have a bond that you intend to sell in 7 months. It promises to pay $50 in 1 year, $60 in 2 years, and $1065 in 3 years (when it matures). The required rate of return on this bond is 8%. How much cash will you have when you sell the bond in 7 months? a. $1,058.58 . 60 mr b. $943.17 A + 7 «7. 4' 733 c. $986.48 1.6% ' | - 3f @ $31533 qtmwslw 4’me'b QZI®AL 7. If interest rates are volatile and you want to reduce the volatility of your bond investment, which bond would you prefer to hold? Bonds with maturity of a. ten years b. twenty years m it $321; 7°13 .lh 7 We.) 1:30 Version A 2 ExamZ —Fall 2009 8. A bond has duration D I 10 years. It is currently yielding anYI'M = 2%; what is the percentage change in the market price of the bond if its YTM rises to 4%? -. a. Since we don‘t know the price of the bond prior to the change in YTM, we cannot determine the percentage change in its price ® All we can say is that its price would change c. Its price would fall by approximately 19.61 % d. Its price would rise by approximtely 19.61% 9. if you expect interest rates to fail, you would prefer to invest a. In long-term bonds because their price is less sensitive to interest rates b. In short-term bonds because their price is less sensitive to interest rates c. In short-term bonds because their price is more sensitive to interest rates (1. In long-term bonds because their price is more sensitive to interest rates 10. When stock prices become more uncertain, the demand curve for bonds shifts to the and the rate of interest a. Right; rises 13. Left; falls c. Right; falls d. Left; rises 1 1. The current yield on a bond that pays its coupon once a year is a. Coupon payment divided by its face value b. Coupon payment divided by its current price c. Rate of return divided by its current price :1. Rate of room divided by its face value 12. 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 A has the longer duration b. Bond B has the longer duration c. Without knowing the exact YTM we cannot determine the bonds‘ durations d. Without knowing the exact maturities we cannot determine the bonds‘ durations [:30 Version A 3 Emu-D2 iFall 2009 1:30 V‘exsiun A Eran-4:2 —Fall 2009 13.‘ Gonlsider corporate bonds versus US Treasury bonds. If corporate bonds become {relatively} . “510:1 ‘ l’sio shift in demand for Treasuries, and the riskpremium on corporate bonds may b. 3:32;: for US Treasuries shifts to the right, increasing the risk premium on corporate c. fifijnd for US Treasuries shifis to the lefiz, increasing the risk premium eta-corporate d. :Dilggnd for US Treasuries shifts to the right, reducing the risk premium on corporate on 5 M. A tax—free municipal bond has YTM= m while a corporate bond has YTM = c ; if the marginal tax rate is t the equilibrium yields will be m = c (H I] c = m [1- t} c = m [1".w r) m = c (1- t) none of the above 9999*!» 15. Ifthe tax rate on interest on corporate bonds is reduced, tax-free municipal bonds yields a. Will rise b. Will fail us. Will not change 16. Your bank offers to pay you 5% on a one-year CD if you buy the CD today; alternatively, the bank will pay you 6% per year on a two-year CD if you buy it today. Both are zero-coupon CDs. This implies that the (approximate) one-year forward rate for next year is :1. Less than 5% h. 7% c. 11 % d. 6% e. Between 5% and 6% 17. There is a one-year zero-coupon CD with an interest rate of 4%; upon maturity the proceeds are reinvested in another one-year zero-coupon CD with an interest of 3%. To be as attractive an investment, a two-year zero-coupon CD has to offer you (approximately) a. 3.5% per year b. 7% per year c. 3% per year (I. 4% per year 18. Consider zero-coupon bonds whose par values and market prices are the same. The borrowing and lending market interest rates are the same: spot one-year rate (one-year bond) 1 7%; spot r rave-year rate (two-year bond) = 6.5% per year; one-year forward rate for next year = 6.5%. Given these rates. can you earn a riskless profit without investing your own fimds, assuming that Expectations Theory holds true? (Assume no risk of default and forward rate is certain) 9 Yes: sell the two—year bond, use the proceeds to buy the one-year bond. After one year, use the proceeds from this one-year bond to lend next year at the forward rate and end up earning 0.5325% b. Yes: sell the two—year bond, use the proceeds to buy the one-year bond. After one year. use the procwds from this one~year bond to lend next year at the forward rate and end up earning 0.500036 . c. No: there is no way to make money without investing your own funds in the l 3. 7 f, circumstance described here. i}. ”(5'26" 19‘ Risk premiums on corporate bonds {relative to Treasury securities) are usually pro-cyclical — they rise during expansions and fall during recessions. a. True in. Fall 20. Holding everything else the same, if a corporation‘s earning rise, then the delimit risk on its (previously issued} bonds will and the expected return on those bonds will a. Decrease; increase b. Increase; decrease c. Decrease; decrease d. Increase; increase 2]. According to the Expectations Theory 3. Interest rate on long-term bonds will exceed the average of short-term spot and forward rates b. Bond investors prefer short—term to long—term bonds c. Interest rates on bonds of different maturities move together over time d. All of the above e. Only (a) and (b) 22. Consider long term bonds and compare two situations: interest rate at 3% rising to 4%, versus interest rate at 10% rising to 11%. A consequence of convexity on bond return is that a. The capital loss is greater when interest rate is 10% and rises to 11% b. The capital loss is the same since interest rate changes by 1 percentage point in both situations (2. The capital loss is greater when interest rate is 3% and rises to 4% [-30 Version A 5 Emmi 7Fall 2009 23. When investing in bonds, if your objective is to reduce the risk of interest rate changes , you would select bonds a. With lo'ng duration b. With short dut'ation c. With low coupon rates but long maturity 24. The Liquidity Premium Theory assumes that bonds of different maturities are perfect substitutes. a. True b. False 25. According to the Expectations Theory a. When the yield curve is downward-sloping, short-term rates are expected to remain relatively stable in the future b. Investors have strong preference for short-term relative to long—term bonds, explaining why yield curves typically slope upward c. When the yield curve is upward-sloping, short-term rates are expected to rise in the future .- d. All of the above e. Only (a) and (b) 26. The controls the discount rate, and controls the open market operations a. Fedora] Open Market Committee; Board of governors b. 12 Federal Reserve Banks; Federal Open Market Committee a. Board of Governors and the 12 Federal Reserve Bans; Federal Open Market Committee d. Board of governors; Federal Open Market Committee 27. Assets on the Balance sheet of the fed include Government securities and currency in circulation Government securities and (discount) loans (Discount) loan-s and reserves Currency in circulation and reserves Both (a) and (b) sup-99's a. Increases assets of , : . . - . . no and increases assets-ofthe Fed b. Decreases asSets of .=, . . lie and increases assets of the banking system I creases assets of the banking system and increases w - of the Fed 1:30 Version a 6 Examfl erlI 21109 29. [f the Fed wants to expand reserves in the banking system, it a. Sells governmerit securities h. Buys governmeht securities c. Raises the discount rate to member banks d. Raises reserve requirements 30. The federal funds rate is the interest rate a. On loans ofreserves from one bank to another b. On loans from the Fed to a bank {3. 0n government securities the Fed holds :1. On government secm'ities banks hold 3 l. Ifthe Fed buys $100 in securities from the banking system, the following happens, assuming a 10% reserve ratio: Banks’ total reserves rise by $100: banks can lend out $110, but must hold 511 in reserves. 5.. True h. False 32. The Fed can control either the money supply or interest rates, not both. a. True 13. False 33. “TIPS" are a. Zero-coupon bonds constructed fi'om corporate bonds b. The coupons and the principals of US Treasuries are split apart (i.e., separated from each other) and sold individually c. US Treasuries that protect the investor against inflation :1. None of the above 34. The way the US Treasuries that protect investor against inflation works is to a. Reset the interest rate to match the rate of inflation in. Reset the principal to match the rate of inflation e. Reset both the interest rate and the principal to match inflation 1:30 Version A Examl -Fal120t]9 35. A bond with a par value of 51,000 with an annual coupon has one year to maturity. Its current yield is 7.0% and its current YTM = 9%. What is the current market price of this bend? a. 1,000 ' 5 930.39 c. 968.176 d. 1,070 36. Comparing various types of bonds issued by the same company with the identical maturities and coupon rates. In general, a. Ordinary callable debentures have higher YTM than noncallable debentures b. Ordinary callable debentures have lower-YTM than noncallable debentures c. Ordinary nnncallable debentures have higher YTM than noncallable sinking fund debentures d. Both (a) and (c) e. Both (b) and (c) 37. The basic characteristics of money market securities include a. Low default risk b Usually large denominations c. Maturity at issue time of 1 year or less d. All of the above e Only {a} and (c) 33. The Chairman of the Fed is 3.. Tim Geitbner b. Alan Greenspan c. Larry Summer d. Ben Bemanke e. Oliver'Williamson 1:30 Version A 8 Exam! eFall 3909 m0: WJVHWHDD HDHLNVSS 0 NOBJNVOS‘ODQ-I. (alarm: 'JH'W‘H 'xum‘nmx mm M1 2n] Manama ammu‘nr ,— Nou 03510 SJHJ 933:1 -—.- iImHZI Mlfl IL“ in“ HHIAJBS JEUJ [115" D I|||||||||l||l||l|||||||l||||||||||I|||||l|l|l||||l _A fififl‘dGMhmM-i n )- u SUBJECTIVE SCOHE INSTRUCTOR USE ONLY (A: :A: .:01 :B: :c: :A: EB: 36-: 11 EB: EC: 12 It: :3: :c: 13 an: -I- :c: 14 :Aj re: 15 Cfljgtc: 16 cm w-B- cc: 17 Ill :3: EC: 13 It! 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