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Study On The Financial Environment And Financial Markets Finance Essay

1. Which of the following statements is most correct?

a. The NYSE does not exist as a physical location; rather it represents a loose collection of dealers who trade stock electronically.

b. An example of a primary market transaction is buying 100 shares of Wal-Mart stock from your uncle.

c. Capital market instruments include long-term debt and common stock.

d. Statements b and c are correct.

e. Statements a, b, and c are correct.

Financial markets Answer: d Diff: E

2. Which of the following statements is most correct?

a. If an investor sells 100 shares of Microsoft to his brother-in-law, this is a primary market transaction.

b. Private securities are generally less liquid than publicly traded securities.

c. Money markets are where short-term, liquid securities are traded, whereas capital markets represent the markets for long-term debt and common stock.

d. Statements b and c are correct.

e. All of the statements above are correct.

Financial markets Answer: c Diff: E N

3. Which of the following statements is most correct?

a. Money markets are markets for long-term debt and common stocks.

b. Primary markets are markets where existing securities are traded among investors.

c. A derivative is a security whose value is derived from the price of some other “underlying” asset.

d. Statements a and b are correct.

e. Statements b and c are correct.

Capital market instruments Answer: b Diff: E N

4. Which of the following is an example of a capital market instrument?

a. Commercial paper.

b. Preferred stock.

c. U.S. Treasury bills.

d. Banker’s acceptances.

e. Money market mutual funds.

Financial transactions Answer: c Diff: E N

5. You recently sold 200 shares of Disney stock to your brother. This is an example of:

a. A money market transaction.

b. A primary market transaction.

c. A secondary market transaction.

d. A futures market transaction.

e. Statements a and b are correct.

Primary market transactions Answer: e Diff: E

6. Which of the following are examples of a primary market transaction?

a. A company issues new common stock.

b. A company issues new bonds.

c. An investor asks his broker to purchase 1,000 shares of Microsoft common stock.

d. All of the statements above are correct.

e. Statements a and b are correct.

Risk and return Answer: d Diff: E

7. Your uncle would like to limit his interest rate risk and his default risk, but he would still like to invest in corporate bonds. Which of the possible bonds listed below best satisfies your uncle’s criteria?

a. AAA bond with 10 years to maturity.

b. BBB perpetual bond.

c. BBB bond with 10 years to maturity.

d. AAA bond with 5 years to maturity.

e. BBB bond with 5 years to maturity.

Interest rates Answer: c Diff: E

8. Which of the following statements is most correct?

a. If companies have fewer productive opportunities, interest rates are likely to increase.

b. If individuals increase their savings rate, interest rates are likely to increase.

c. If expected inflation increases, interest rates are likely to increase.

d. All of the statements above are correct.

e. Statements a and c are correct.

Interest rates Answer: b Diff: E

9. Which of the following is likely to increase the level of interest rates in the economy?

a. Households start saving a larger percentage of their income.

b. Corporations step up their plans for expansion and increase their demand for capital.

c. The level of inflation is expected to decline.

d. All of the statements above are correct.

e. None of the statements above is correct.

Cost of money Answer: c Diff: E N

10. Which of the following is likely to lead to an increase in the cost of funds?

a. Companies’ production opportunities decline, leading to a decline in the demand for funds.

b. Households save a larger portion of their income.

c. Households increase the amount of money they borrow from their local banks.

d. Statements a and b are correct.

e. Statements a and c are correct.

Financial transactions Answer: d Diff: M

11. If the Federal Reserve sells $50 billion of short-term U.S. Treasury securities to the public, other things held constant, what will this tend to do to short-term security prices and interest rates?

a. Prices and interest rates will both rise.

b. Prices will rise and interest rates will decline.

c. Prices and interest rates will both decline.

d. Prices will decline and interest rates will rise.

e. There will be no changes in either prices or interest rates.

Financial transactions Answer: d Diff: M

12. Which of the following statements is most correct?

a. The distinguishing feature between spot markets versus futures markets transactions is the maturity of the investments. That is, spot market transactions involve securities that have maturities of less than one year whereas futures markets transactions involve securities with maturities greater than one year.

b. Capital market transactions only include preferred stock and common stock transactions.

c. If General Electric were to issue new stock this year it would be considered a secondary market transaction since the company already has stock outstanding.

d. Both dealers in Nasdaq and “specialists” in the NYSE hold inventories of stocks.

e. Statements a and d are correct.

Interest rates Answer: b Diff: M

13. Assume interest rates on long-term government and corporate bonds were as follows:

T-bond = 7.72% A = 9.64%

AAA = 8.72% BBB = 10.18%

The differences in rates among these issues were caused primarily by

a. Tax effects.

b. Default risk differences.

c. Maturity risk differences.

d. Inflation differences.

e. Statements b and d are correct.

Inflation rate Answer: d Diff: E

14. Suppose that the annual expected rates of inflation over each of the next five years are 5 percent, 6 percent, 9 percent, 13 percent, and 12 percent, respectively. What is the average expected inflation rate over the 5-year period?

a. 6%

b. 7%

c. 8%

d. 9%

e. 10%

Expected interest rates Answer: c Diff: M

15. You are given the following data:

k* = real risk-free rate = 4%.

Constant inflation premium = 7%.

Maturity risk premium = 1%.

Default risk premium for AAA bonds = 3%.

Liquidity premium for long-term T-bonds = 2%.

Assume that a highly liquid market does not exist for long-term T-bonds, and the expected rate of inflation is a constant. Given these conditions, the nominal risk-free rate for T-bills is , and the rate on long-term Treasury bonds is .

a. 4%; 14%

b. 4%; 15%

c. 11%; 14%

d. 11%; 15%

e. 11%; 17%

ANSWERS AND SOLUTIONS

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