Chapter 2 – An Overview of the Financial System
An example of economies of scale in the provision of financial services is
a) Spreading the cost of writing a standardized contract over many borrowers
b) Investing in a diversified collection of assets
c) Spreading the cost of borrowed funds over many customers
d) Providing depositors with a variety of savings certificates
The primary assets of a finance company are:
a) Corporate stocks and bonds (these are their liabilities)
c) Consumer and business loans
d) Municipal bonds
Adverse selection is a problem associated with equity and debt contracts arising from
a) The borrower’s lack of incentive to seek a loan for highly risky investments
b) The borrower’s lack of good options for obtaining funds
c) The lenders inability to legally require sufficient collateral to cover a 100 percent loss on defaults
d) The lender’s relative lack of info about the borrower’s potential returns and risks of his investment activities
Chapter 3 – What is Money?
The evolution of the payments system from barter to precious metals then to fiat money then to cheques can be best understood as a consequence of:
Innovation that reduced costs of exchanging goods and services
Which statement accurately describes the two measures of the money supply? the two measures do not always move together; they cannot be used interchangeably by policymakers
An electronic payments system has not completely replaced the paper payments system bc of all of the following reasons except
a) Security concerns
b) Privacy concerns
c) Transportation costs (this is actually an advantage)
d) Expensive equipment is necessary to set up terminals
Chapter 4 – Understanding Interest Rates
The price of a coupon bond and the YTM are negatively related; that is, as the YTM rises, the price of the bond falls.
The YTM is greater than the coupon rate when the bond price is below its face value. (makes the coupon bond less desirable so then the price will be below the face value)
A $10,000 8% coupon bond that sells for $10,000 has a YTM of 8%.
If a 10k facevalue discount bond maturing in one year is selling for 5k, then its YTM is
I = (F – P) / P = (10k – 5k) / 5k = 100%
What is the return on a 5% coupon bond that initially sells for $1k and sells for $900 next year?
RET = C/P + (P2-P)/P = 5% + (900-1000)/1000 = 5% - 10% = -5%
If the interest rates on all bonds rise from 5 to 6% over the course of the year, which bond would you prefer to have been holding?
a) A bond with 1 year to maturity
b) A bond with 10 years to maturity
c) A bond with 5 years to maturity
d) A bond with 20 years to maturity
**the longer the maturity, the bigger the price drop
Chapter 5 – Behaviour of Interest Rates
If stock prices are expected to drop dramatically, then, other things equal, the demand for stocks will decrease and that of treasury bills will increase
Reduces expected return of stocks when the prices drop… you can redistribute your wealth in stocks or t-bills so you're going to choose t-bills
The demand curve for bonds has the usual downward slope, indicating that at lower prices of the bond, everything else equal, the quantity demanded is higher.
The supply curve for bonds has the usual upward slope, indicating that as the price rises, ceteris paribus, the quantity supplied increases.
Increase in liquidity of bonds results in a rise in demand for bonds and the demand curve shifts to the right
During a business cycle expansion, the supply of bonds shifts to the right as businesses perceive more profitable investment opportunities while the demand for bonds shifts to the right as a result of the increase in wealth generated by economic expansion.
A lower level of income causes the demand for money to decrease and the interest rate to decrease, everything else held constant (this is the liquidity framework. About money demand not bonds. So it’s the one