STUDY QUESTIONS

1.Bonds that are sold in a foreign country and are denominated in a currency other than that of
the country in which it is sold are known as
A) foreign bonds.
B) Eurobonds.
C) equity bonds.
D) country bonds.
Answer: B

2. An example of economies of scale in the provision of financial services is

A) investing in a diversified collection of assets.
B) providing depositors with a variety of savings certificates.
C) hiring more support staff so that customers don't have to wait so long for assistance.
D) spreading the cost of writing a standardized contract over many borrowers.
Answer: D

3. Economies of scale enable financial institutions to

A) reduce transactions costs.
B) avoid the asymmetric information problem.
C) avoid adverse selection problems.
D) reduce moral hazard.
Answer: A

4. Conflictsof interest are a type of ________ problem that can happen when an institution
provides multiple services.
A) adverse selection
B) free-riding
C) discounting
D) moral hazard
Answer: D

5.The primary assets of a pension fund are

A) money market instruments.
B) corporate bonds and stock.
C) consumer and business loans.
D) mortgages.
Answer: B

6. Recent financial innovation makes the Federal Reserve's job of conducting monetary policy
A) easier, since the Fed now knows what to consider money.
B) more difficult, since the Fed now knows what to consider money.
C) easier, since the Fed no longer knows what to consider money.
D) more difficult, since the Fed no longer knows what to consider money.
Answer: D
7. A ________ is bought at a price below its face value, and the ________ value is repaid at
the maturity date.
A) coupon bond; discount
B) discount bond; discount
C) coupon bond; face
D) discount bond; face
Answer: D

8. The yield to maturity is ________ than the ________ rate when the bond price is ________
its face value.
A) greater; coupon; above
B) greater; coupon; below
C) greater; perpetuity; above
D) less; perpetuity; below
Answer: B

9. The ________ is below the coupon rate when the bond price is ________ its par value.
A) yield to maturity; above
B) yield to maturity; below
C) discount rate; above
D) discount rate; below
Answer: A

10. A$10,000 8 percent coupon bond that sells for $10,000 has a yield to maturity of
A) 8 percent.
B) 10 percent.
C) 12 percent.
D) 14 percent.
Answer: A

11. Which of the following $5,000 face-value securities has the highest yield to maturity?
A) a 6 percent coupon bond selling for $5,000
B) a 6 percent coupon bond selling for $5,500
C) a 10 percent coupon bond selling for $5,000
D) a 12 percent coupon bond selling for $4,500
Answer: D

12. Which of the following bonds would you prefer to buy?

A) a $10,000 face-value security with a 10 percent coupon selling for $9,000
B) a $10,000 face-value security with a 7 percent coupon selling for $10,000
C) a $10,000 face-value security with a 9 percent coupon selling for $10,000
D) a $10,000 face-value security with a 10 percent coupon selling for $10,000
Answer: A
13. The interest rate on a consol equals the
A) price times the coupon payment.
B) price divided by the coupon payment.
C) coupon payment plus the price.
D) coupon payment divided by the price.
Answer: D

14. If a perpetuity has a price of $500 and an annual interest payment of $25, the interest rate
is
A) 2.5 percent.
B) 5 percent.
C) 7.5 percent.
D) 10 percent.
Answer: B

15. Suppose you are holding a 5 percent coupon bond maturing in one year with a yield to
maturity of 15 percent. If the interest rate on one-year bonds rises from 15 percent to 20
percent over the course of the year, what is the yearly return on the bond you are holding?
A) 5 percent
B) 10 percent
C) 15 percent
D) 20 percent
Answer: C

16. Pricesand returns for ________ bonds are more volatile than those for ________ bonds,
everything else held constant.
A) long-term; long-term
B) long-term; short-term
C) short-term; long-term
D) short-term; short-term
Answer: B

17. In the United States during the late 1970s, the nominal interest rates were quite high, but
the real interest rates were negative. From the Fisher equation, we can conclude that expected
inflation in the United States during this period was
A) irrelevant.
B) low.
C) negative.
D) high.
Answer: D

18. Assuming the same coupon rate and maturity length, the difference between the yield on a
Treasury Inflation Indexed Security and the yield on a nonindexed Treasury security provides
insight into
A) the nominal interest rate.
B) the real interest rate.
C) the nominal exchange rate.
D) the expected inflation rate.
Answer: D

19. Comparing a discount bond and a coupon bond with the same maturity
A) the coupon bond has the greater effective maturity.
B) the discount bond has the greater effective maturity.
C) the effective maturity cannot be calculated for a coupon bond.
D) the effective maturity cannot be calculated for a discount bond.
Answer: B

20. Allelse equal, the ________ the coupon rate on a bond, the ________ the bond's duration.
A) higher; longer
B) higher; shorter
C) lower; shorter
D) greater; longer
Answer: B

21. An asset's interest rate risk ________ as the duration of the asset ________.
A) increases; decreases
B) decreases; decreases
C) decreases; increases
D) remains constant; increases
Answer: B

22. Factorsthat can cause the supply curve for bonds to shift to the right include
A) an expansion in overall economic activity.
B) a decrease in expected inflation.
C) a decrease in government deficits.
D) a business cycle recession.
Answer: A

23. When the inflation rate is expected to increase, the ________ for bonds falls, while the
________ curve shifts to the right, everything else held constant.
A) demand; demand
B) demand; supply
C) supply; demand
D) supply; supply
Answer: B

24. When the economy slips into a recession, normally the demand for bonds ________, the
supply of bonds ________, and the interest rate ________, everything else held constant.
A) increases; increases; rises
B) decreases; decreases; falls
C) increases; decreases; falls
D) decreases; increases; rises
Answer: B

25. Everything else held constant, when the government has higher budget deficits
A) the demand curve for bonds shifts to the left and the interest rate rises.
B) the demand curve for bonds shifts to the left and the interest rate falls.
C) the supply curve for bonds shifts to the right and the interest rate falls.
D) the supply curve for bonds shifts to the right and the interest rate rises.
Answer: D

26. Ifprices in the bond market become more volatile, everything else held constant, the
demand curve for bonds shifts ________ and interest rates ________.
A) left; rise
B) left; fall
C) right; rise
D) right; fall
Answer: A

27. In the figure above, a factor that could cause the supply of bonds to shift to the right is
A) a decrease in government budget deficits.
B) a decrease in expected inflation.
C) a recession.
D) a business cycle expansion.
Answer: D

28. In the figure above, a factor that could cause the demand for bonds to decrease (shift to the
left) is
A) an increase in the expected return on bonds relative to other assets.
B) a decrease in the expected return on bonds relative to other assets.
C) an increase in wealth.
D) a reduction in the riskiness of bonds relative to other assets.
Answer: B

29. Inthe figure above, the price of bonds would fall from P1 to P2 when
A) inflation is expected to increase in the future.
B) interest rates are expected to fall in the future.
C) the expected return on bonds relative to other assets is expected to increase in the future.
D) the riskiness of bonds falls relative to other assets.
Answer: A

30. Inthe figure above, a factor that could cause the demand for bonds to shift to the right is
A) an increase in the riskiness of bonds relative to other assets.
B) an increase in the expected rate of inflation.
C) expectations of lower interest rates in the future.
D) a decrease in wealth.
Answer: C

31. Inthe figure above, the price of bonds would fall from P2 to P1 if
A) there is a business cycle recession.
B) there is a business cycle expansion.
C) inflation is expected to increase in the future.
D) inflation is expected to decrease in the future.
Answer: B

32. InKeynes's liquidity preference framework

A) the demand for bonds must equal the supply of money.
B) the demand for money must equal the supply of bonds.
C) an excess demand of bonds implies an excess demand for money.
D) an excess supply of bonds implies an excess demand for money.
Answer: D

33. The bond supply and demand framework is easier to use when analyzing the effects of
changes in ________, while the liquidity preference framework provides a simpler analysis of
the effects from changes in income, the price level, and the supply of ________.
A) expected inflation; bonds
B) expected inflation; money
C) government budget deficits; bonds
D) government budget deficits; money
Answer: B
34. Inhis Liquidity Preference Framework, Keynes assumed that money has a zero rate of
return; thus
A) when interest rates rise, the expected return on money falls relative to the expected return
on bonds, causing the demand for money to fall.
B) when interest rates rise, the expected return on money falls relative to the expected return
on bonds, causing the demand for money to rise.
C) when interest rates fall, the expected return on money falls relative to the expected return
on bonds, causing the demand for money to fall.
D) when interest rates fall, the expected return on money falls relative to the expected return
on bonds, causing the demand for money to rise.
Answer: A

35. If
there is an excess demand for money, individuals ________ bonds, causing interest rates
to ________.
A) sell; rise
B) sell; fall
C) buy; rise
D) buy; fall
Answer: A

36. A business cycle expansion increases income, causing money demand to ________ and
interest rates to ________, everything else held constant.
A) increase; increase
B) increase; decrease
C) decrease; decrease
D) decrease; increase
Answer: A

37. When the price level ________, the demand curve for money shifts to the ________ and
the interest rate ________, everything else held constant.
A) falls; right; rises
B) rises; right; falls
C) falls; left; rises
D) rises; right; rises
Answer: D

38. When the Fed ________ the money stock, the money supply curve shifts to the ________
and the interest rate ________, everything else held constant.
A) decreases; right; rises
B) increases; right; falls
C) decreases; left; falls
D) increases; left; rises
Answer: B
39. In the liquidity preference framework, a one-time increase in the money supply results in a
price level effect. The maximum impact of the price level effect on interest rates occurs
A) at the moment the price level hits its peak (stops rising) because both the price level and
expected inflation effects are at work.
B) immediately after the price level begins to rise, because both the price level and expected
inflation effects are at work.
C) at the moment the expected inflation rate hits its peak.
D) at the moment the inflation rate hits it peak.
Answer: A

40. Of the four effects on interest rates from an increase in the money supply, the one that
works in the opposite direction of the other three is the
A) liquidity effect.
B) income effect.
C) price level effect.
D) expected inflation effect.
Answer: A

41. When the growth rate of the money supply increases, interest rates end up being
permanently lower if
A) the liquidity effect is larger than the other effects.
B) there is fast adjustment of expected inflation.
C) there is slow adjustment of expected inflation.
D) the expected inflation effect is larger than the liquidity effect.
Answer: A

42. When the growth rate of the money supply is increased, interest rates will fall immediately
if the liquidity effect is ________ than the other money supply effects and there is ________
adjustment of expected inflation.
A) larger; fast
B) larger; slow
C) smaller; slow
D) smaller; fast
Answer: B

43. Ifthe liquidity effect is smaller than the other effects, and the adjustment to expected
inflation is immediate, then the
A) interest rate will fall.
B) interest rate will rise.
C) interest rate will fall immediately below the initial level when the money supply grows.
D) interest rate will rise immediately above the initial level when the money supply grows.
Answer: D

44. The riskiness of an asset is measured by

A) the magnitude of its return.
B) the absolute value of any change in the asset's price.
C) the standard deviation of its return.
D) risk is impossible to measure.
Answer: C

45. Inthe figure above, illustrates the effect of an increased rate of money supply growth at
time period 0. From the figure, one can conclude that the
A) Fisher effect is dominated by the liquidity effect and interest rates adjust slowly to changes
in expected inflation.
B) liquidity effect is dominated by the Fisher effect and interest rates adjust slowly to changes
in expected inflation.
C) liquidity effect is dominated by the Fisher effect and interest rates adjust quickly to
changes in expected inflation.
D) Fisher effect is smaller than the expected inflation effect and interest rates adjust quickly to
changes in expected inflation.
Answer: C

46. The figure above illustrates the effect of an increased rate of money supply growth at
time period T0. From the figure, one can conclude that the
A) liquidity effect is smaller than the expected inflation effect and interest rates adjust quickly
to changes in expected inflation.
B) liquidity effect is larger than the expected inflation effect and interest rates adjust quickly
to changes in expected inflation.
C) liquidity effect is larger than the expected inflation effect and interest rates adjust slowly to
changes in expected inflation.
D) liquidity effect is smaller than the expected inflation effect and interest rates adjust slowly
to changes in expected inflation.
Answer: C

47. The figure above illustrates the effect of an increased rate of money supply growth at time
period T0. From the figure, one can conclude that the
A) Fisher effect is dominated by the liquidity effect and interest rates adjust slowly to changes
in expected inflation.
B) liquidity effect is dominated by the Fisher effect and interest rates adjust slowly to changes
in expected inflation.
C) liquidity effect is dominated by the Fisher effect and interest rates adjust quickly to
changes in expected inflation.
D) Fisher effect is smaller than the expected inflation effect and interest rates adjust quickly to
changes in expected inflation.
Answer: A

48. The figure above illustrates the effect of an increased rate of money supply growth at time
period T0. From the figure, one can conclude that the
A) liquidity effect is smaller than the expected inflation effect and interest rates adjust quickly
to changes in expected inflation.
B) liquidity effect is larger than the expected inflation effect and interest rates adjust quickly
to changes in expected inflation.
C) liquidity effect is larger than the expected inflation effect and interest rates adjust slowly to
changes in expected inflation.
D) liquidity effect is smaller than the expected inflation effect and interest rates adjust slowly
to changes in expected inflation.
Answer: D

49. The ________ the returns on two securities move together, the ________ benefit there is
from diversification.
A) less; more
B) less; less
C) more; more
D) more; greater
Answer: A
50. The spreadbetween the interest rates on bonds with default risk and default-free bonds is
called the
A) risk premium.
B) junk margin.
C) bond margin.
D) default premium.
Answer: A

51. Abond with default risk will always have a ________ risk premium and an increase in its
default risk will ________ the risk premium.
A) positive; raise
B) positive; lower
C) negative; raise
D) negative; lower
Answer: A

52. Other things being equal, an increase in the default risk of corporate bonds shifts the
demand curve for corporate bonds to the ________ and the demand curve for Treasury bonds
to the ________.
A) right; right
B) right; left
C) left; right
D) left; left
Answer: C

53. A(n) ________ in the riskiness of corporate bonds will ________ the price of corporate
bonds and ________ the yield on corporate bonds, all else equal.
A) increase; increase; increase
B) increase; decrease; increase
C) decrease; increase; increase
D) decrease; decrease;decrease
Answer: B

54. Which of the following long-term bonds has the highest interest rate?
A) corporate Baa bonds
B) U.S. Treasury bonds
C) corporate Aaa bonds
D) municipal bonds
Answer: A

55. Which of the following securities has the lowest interest rate?
A) junk bonds
B) U.S. Treasury bonds
C) investment-grade bonds
D) corporate Baa bonds
Answer: B
56. The spreadbetween interest rates on low quality corporate bonds and U.S. government
bonds
A) widened significantly during the Great Depression.
B) narrowed significantly during the Great Depression.
C) narrowed moderately during the Great Depression.
D) did not change during the Great Depression.
Answer: A

57. During the Great Depression years 1930-1933 there was a very high rate of business
failures and defaults, we would expect the risk premium for ________ bonds to be very high.
A) U.S. Treasury
B) corporate Aaa
C) municipal
D) corporate Baa
Answer: D

58. The collapse of the subprime mortgage market

A) did not affect the corporate bond market.
B) increased the perceived riskiness of Treasury securities.
C) reduced the Baa-Aaa spread.
D) increased the Baa-Aaa spread.
Answer: D

59. Ifyou have a very low tolerance for risk, which of the following bonds would you be least
likely to hold in your portfolio?
A) a U.S. Treasury bond
B) a municipal bond
C) a corporate bond with a rating of Aaa
D) a corporate bond with a rating of Baa
Answer: D

60. A decrease in the liquidity of corporate bonds, other things being equal, shifts the demand
curve for corporate bonds to the ________ and the demand curve for Treasury bonds shifts to
the ________.
A) right; right
B) right; left
C) left; left
D) left; right
Answer: D

61. A(n) ________ in the liquidity of corporate bonds will ________ the price of corporate
bonds and ________ the yield on corporate bonds, all else equal.
A) increase; increase; decrease
B) increase; decrease; decrease
C) decrease; increase; increase
D) decrease; decrease; decrease
Answer: A

62. An increase in the liquidity of corporate bonds will ________ the price of corporate bonds
and ________ the yield of Treasury bonds, everything else held constant.
A) increase; increase
B) reduce; reduce
C) increase; reduce
D) reduce; increase
Answer: A

63. Adecrease in the liquidity of corporate bonds will ________ the yield of corporate bonds
and ________ the yield of Treasury bonds, everything else held constant.
A) increase; increase
B) decrease; decrease
C) increase; decrease
D) decrease; increase
Answer: C

64. Everything else held constant, if the tax-exempt status of municipal bonds were eliminated,
then
A) the interest rates on municipal bonds would still be less than the interest rate on Treasury
bonds.
B) the interest rate on municipal bonds would equal the rate on Treasury bonds.
C) the interest rate on municipal bonds would exceed the rate on Treasury bonds.
D) the interest rates on municipal, Treasury, and corporate bonds would all increase.
Answer: C

65. Municipal bonds have default risk, yet their interest rates are lower than the rates on
default-free Treasury bonds. This suggests that
A) the benefit from the tax-exempt status of municipal bonds is less than their default risk.
B) the benefit from the tax-exempt status of municipal bonds equals their default risk.
C) the benefit from the tax-exempt status of municipal bonds exceeds their default risk.
D) Treasury bonds are not default-free.
Answer: C

66. Everything else held constant, an increase in marginal tax rates would likely have the
effect of ________ the demand for municipal bonds, and ________ the demand for U.S.
government bonds.
A) increasing; increasing
B) increasing; decreasing
C) decreasing; increasing
D) decreasing; decreasing
Answer: B
67. Everything else held constant, a decrease in marginal tax rates would likely have the effect
of ________ the demand for municipal bonds, and ________ the demand for U.S.
government bonds.
A) increasing; increasing
B) increasing; decreasing
C) decreasing; increasing
D) decreasing; decreasing
Answer: C

68. Everything else held constant, if income tax rates were lowered, then
A) the interest rate on municipal bonds would fall.
B) the interest rate on Treasury bonds would rise.
C) the interest rate on municipal bonds would rise.
D) the price of Treasury bonds would fall.
Answer: C

69. The Obama administration increased the tax on the top income tax bracket from 35% to
39%. Supply and demand analysis predicts the impact of this change was a ________ interest
rate on municipal bonds and a ________ interest rate on Treasury bonds, all else the same.
A) higher; lower
B) lower; lower
C) higher; higher
D) lower; higher
Answer: D

70. The term structure of interest rates is

A) the relationship among interest rates of different bonds with the same maturity.
B) the structure of how interest rates move over time.
C) the relationship among the term to maturity of different bonds.
D) the relationship among interest rates on bonds with different maturities.
Answer: D

71. A plot of the interest rates on default-free government bonds with different terms to
maturity is called
A) a risk-structure curve.
B) a default-free curve.
C) a yield curve.
D) an interest-rate curve.
Answer: C

72. Differences in ________ explain why interest rates on Treasury securities are not all the
same.
A) risk
B) liquidity
C) time to maturity
D) tax characteristics
Answer: C

73. The typical

shape for a yield curve is
A) gently upward sloping.
B) mound shaped.
C) flat.
D) bowl shaped.
Answer: A

74.When yield curves are downward sloping

A) long-term interest rates are above short-term interest rates.
B) short-term interest rates are above long-term interest rates.
C) short-term interest rates are about the same as long-term interest rates.
D) medium-term interest rates are above both short-term and long-term interest rates.
Answer: B

75. An inverted yield curve

A) slopes up.
B) is flat.
C) slopes down.
D) has a U shape.
Answer: C

76. According to the expectations theory of the term structure, the interest rate on a long-term
bond will equal the ________ of the short-term interest rates that people expect to occur over
the life of the long-term bond.
A) average
B) sum
C) difference
D) multiple
Answer: A

77. If
bonds with different maturities are perfect substitutes, then the ________ on these bonds
must be equal.
A) expected return
B) surprise return
C) surplus return
D) excess return
Answer: A

78. Ifthe expected path of one-year interest rates over the next five years is 4 percent, 5
percent, 7 percent, 8 percent, and 6 percent, then the expectations theory predicts that today's
interest rate on the five-year bond is
A) 4 percent.
B) 5 percent.
C) 6 percent.
D) 7 percent.
Answer: C

79. If the expected path of 1-year interest rates over the next four years is 5 percent, 4 percent,
2 percent, and 1 percent, then the expectations theory predicts that today's interest rate on the
four-year bond is
A) 1 percent.
B) 2 percent.
C) 3 percent.
D) 4 percent.
Answer: C

80. Ifthe expected path of 1-year interest rates over the next five years is 1 percent, 2 percent,
3 percent, 4 percent, and 5 percent, the expectations theory predicts that the bond with the
highest interest rate today is the one with a maturity of
A) two years.
B) three years.
C) four years.
D) five years.
Answer: D

81. According to the expectations theory of the term structure

A) the interest rate on long-term bonds will exceed the average of short-term interest rates that
people expect to occur over the life of the long-term bonds, because of their preference for
short-term securities.
B) interest rates on bonds of different maturities move together over time.
C) buyers of bonds prefer short-term to long-term bonds.
D) buyers require an additional incentive to hold long-term bonds.
Answer: B

82. According to the segmented markets theory of the term structure

A) the interest rate on long-term bonds will equal an average of short-term interest rates that
people expect to occur over the life of the long-term bonds.
B) buyers of bonds do not prefer bonds of one maturity over another.
C) interest rates on bonds of different maturities do not move together over time.
D) buyers require an additional incentive to hold long-term bonds.
Answer: C

83. Akey assumption in the segmented markets theory is that bonds of different maturities
A) are not substitutes at all.
B) are perfect substitutes.
C) are substitutes only if the investor is given a premium incentive.
D) are substitutes but not perfect substitutes.
Answer: A
84. The segmented markets theory can explain
A) why yield curves usually tend to slope upward.
B) why interest rates on bonds of different maturities tend to move together.
C) why yield curves tend to slope upward when short-term interest rates are low and to be
inverted when short-term interest rates are high.
D) why yield curves have been used to forecast business cycles.
Answer: A

85. According to the liquidity premium theory of the term structure

A) bonds of different maturities are not substitutes.
B) if yield curves are downward sloping, then short-term interest rates are expected to fall by
so much that, even when the positive term premium is added, long-term rates fall below short-
term rates.
C) yield curves should never slope downward.
D) interest rates on bonds of different maturities do not move together over time.
Answer: B

86. The additional incentive that the purchaser of a Treasury security requires to buy a long-
term security rather than a short-term security is called the
A) risk premium.
B) term premium.
C) tax premium.
D) market premium.
Answer: B

87. According to the liquidity premium theory of the term structure, a flat yield curve indicates
that short-term interest rates are expected to
A) rise in the future.
B) remain unchanged in the future.
C) decline moderately in the future.
D) decline sharply in the future.
Answer: C

88. According to the liquidity premium theory of the term structure, a downward sloping yield
curve indicates that short-term interest rates are expected to
A) rise in the future.
B) remain unchanged in the future.
C) decline moderately in the future.
D) decline sharply in the future.
Answer: D

89. According to the liquidity premium theory, a yield curve that is flat means that
A) bond purchasers expect interest rates to rise in the future.
B) bond purchasers expect interest rates to stay the same.
C) bond purchasers expect interest rates to fall in the future.
D) the yield curve has nothing to do with expectations of bond purchasers.
Answer: C

90. Ifthe yield curve is flat for short maturities and then slopes downward for longer
maturities, the liquidity premium theory (assuming a mild preference for shorter-term bonds)
indicates that the market is predicting
A) a rise in short-term interest rates in the near future and a decline further out in the future.
B) constant short-term interest rates in the near future and a decline further out in the future.
C) a decline in short-term interest rates in the near future and a rise further out in the future.
D) a decline in short-term interest rates in the near future and an even steeper decline further
out in the future.
Answer: D

91. Ifthe yield curve slope is flat for short maturities and then slopes steeply upward for
longer maturities, the liquidity premium theory (assuming a mild preference for shorter-term
bonds) indicates that the market is predicting
A) a rise in short-term interest rates in the near future and a decline further out in the future.
B) constant short-term interest rates in the near future and further out in the future.
C) a decline in short-term interest rates in the near future and a rise further out in the future.
D) constant short-term interest rates in the near future and a decline further out in the future.
Answer: C

92. Ifthe yield curve has a mild upward slope, the liquidity premium theory (assuming a mild
preference for shorter-term bonds) indicates that the market is predicting
A) a rise in short-term interest rates in the near future and a decline further out in the future.
B) constant short-term interest rates in the near future and further out in the future.
C) a decline in short-term interest rates in the near future and a rise further out in the future.
D) a decline in short-term interest rates in the near future and an even steeper decline further
out in the future.
Answer: B

93. The ________ of the term structure of interest rates states that the interest rate on a long-
term bond will equal the average of short-term interest rates that individuals expect to occur
over the life of the long-term bond, and investors have no preference for short-term bonds
relative to long-term bonds.
A) segmented markets theory
B) expectations theory
C) liquidity premium theory
D) separable markets theory
Answer: B

94. According to this theory of the term structure, bonds of different maturities are not
substitutes for one another.
A) segmented markets theory
B) expectations theory
C) liquidity premium theory
D) separable markets theory
Answer: A

95. The ________ of the term structure states the following: the interest rate on a long-term
bond will equal an average of short-term interest rates expected to occur over the life of the
long-term bond plus a term premium that responds to supply and demand conditions for that
bond.
A) segmented markets theory
B) expectations theory
C) liquidity premium theory
D) separable markets theory
Answer: C

96. An inverted yield curve predicts that short-term interest rates

A) are expected to rise in the future.
B) will rise and then fall in the future.
C) will remain unchanged in the future.
D) will fall in the future.
Answer: D

97. A ________ yield curve predicts a future increase in inflation.

A) steeply upward sloping
B) slight upward sloping
C) flat
D) downward sloping
Answer: A

98. Stockholders are residual claimants, meaning that they

A) have the first priority claim on all of a company's assets.
B) are liable for all of a company's debts.
C) will never share in a company's profits.
D) receive the remaining cash flow after all other claims are paid.
Answer: D

99. Inthe one-period valuation model, an increase in the required return on investments in
equity
A) increases the expected sales price of a stock.
B) increases the current price of a stock.
C) reduces the expected sales price of a stock.
D) reduces the current price of a stock.
Answer: D
100. Using theone-period valuation model, assuming a year-end dividend of $1.00, an
expected sales price of $100, and a required rate of return of 5%, the current price of the stock
would be
A) $110.00.
B) $101.00.
C) $100.00.
D) $96.19.
Answer: D

101. Using the Gordon growth formula, if D1 is $1.00, ke is 10% or 0.10, and g is 5% or 0.05,
then the current stock price is
A) $10.
B) $20.
C) $30.
D) $40.
Answer: B

102. Using the Gordon growth model, if D1 is $.50, ke is 7%, and g is 5%, then the present
value of the stock is
A) $2.50.
B) $25.
C) $50.
D) $46.73.
Answer: B

103. In the Gordon Growth Model, the growth rate is assumed to be ________ the required
return on equity.
A) greater than
B) equal to
C) less than
D) proportional to
Answer: C

104. Increaseduncertainty resulting from the global financial crisis ________ the required
return on investment in equity.
A) raised
B) lowered
C) had no impact on
D) decreased
Answer: A

105. The view that expectations change relatively slowly over time in response to new
information is known in economics as
A) rational expectations.
B) irrational expectations.
C) slow-response expectations.
D) adaptive expectations.
Answer: D

106. The major criticism of the view that expectations are formed adaptively is that
A) this view ignores that people use more information than just past data to form their
expectations.
B) it is easier to model adaptive expectations than it is to model rational expectations.
C) adaptive expectations models have no predictive power.
D) people are irrational and therefore never learn from past mistakes.
Answer: A

107. In rational expectations theory, the term "optimal forecast" is essentially synonymous
with
A) correct forecast.
B) the correct guess.
C) the actual outcome.
D) the best guess.
Answer: D

108. An expectation may fail to be rational if

A) relevant information was not available at the time the forecast is made.
B) relevant information is available but ignored at the time the forecast is made.
C) information changes after the forecast is made.
D) information was available to insiders only.

109. Which of the following types of information most likely allows the exploitation of a profit
opportunity?
A) financial analysts' published recommendations
B) technical analysis
C) hot tips from a stockbroker
D) insider information
Answer: D

110. Sometimes one observes that the price of a company's stock falls after the announcement
of favorable earnings. This phenomenon is
A) clearly inconsistent with the efficient markets hypothesis.
B) consistent with the efficient markets hypothesis if the earnings were not as high as
anticipated.
C) consistent with the efficient markets hypothesis if the earnings were not as low as
anticipated.
D) consistent with the efficient markets hypothesis if the favorable earnings were expected.
Answer: B

111. You read a story in the newspaper announcing the proposed merger of Dell Computer and
Gateway. The merger is expected to greatly increase Gateway's profitability. If you decide to
invest in Gateway stock, you can expect to earn
A) above average returns since you will share in the higher profits.
B) above average returns since your stock price will definitely appreciate as higher profits are
earned.
C) below average returns since computer makers have low profit rates.
D) a normal return since stock prices adjust to reflect expected changes in profitability almost
immediately.
Answer: D

113. The efficient markets hypothesis indicates that investors

A) can use the advice of technical analysts to outperform the market.
B) do better on average if they adopt a "buy and hold" strategy.
C) let too many unexploited profit opportunities go by if they adopt a "buy and hold" strategy.
D) do better if they purchase loaded mutual funds.
Answer: B

114. The efficient markets hypothesis suggests that investors

A) should purchase no-load mutual funds which have low management fees.
B) can use the advice of technical analysts to outperform the market.
C) let too many unexploited profit opportunities go by if they adopt a "buy and hold" strategy.
D) act on all "hot tips" they hear.
Answer: A

115. If
a market participant believes that a stock price is irrationally high, they may try to
borrow stock from brokers to sell in the market and then make a profit by buying the stock
back again after the stock falls in price. This practice is called
A) short selling.
B) double dealing.
C) undermining.
D) long marketing.
Answer: A

116. Loss aversion can explain why very little ________ actually takes place in the securities
market.
A) short selling
B) bargaining
C) bartering
D) negotiating
Answer: A

117. Ifa mutual fund outperforms the market in one period, evidence suggests that this fund is
A) highly likely to consistently outperform the market in subsequent periods due to its
superior investment strategy.
B) likely to under-perform the market in subsequent periods to average its overall returns.
C) not likely to consistently outperform the market in subsequent periods.
D) not likely to outperform the market in any subsequent period.
Answer: C
118. The number and availability of discount brokers has grown rapidly since the mid-1970s.
The efficient markets hypothesis predicts that people who use discount brokers
A) will likely earn lower returns than those who use full-service brokers.
B) will likely earn about the same as those who use full-service brokers, but will net more
after brokerage commissions.
C) are going against evidence suggesting that full-service brokers can help outperform the
market.
D) are likely to outperform the market by a wide margin.
Answer: B

119. Of thefollowing sources of external finance for American nonfinancial businesses, the
least important is
A) loans from banks.
B) stocks.
C) bonds and commercial paper.
D) loans from other financial intermediaries.
Answer: B

120. Which of the following is NOT a benefit to an individual purchasing a mutual fund?
A) reduced risk
B) lower transactions costs
C) free-riding
D) diversification
Answer: C

121. The problem faced by the lender that the borrower may take on additional risk after
receiving the loan is called
A) adverse selection.
B) moral hazard.
C) transactions costs.
D) diversification.
Answer: B

122. The free-rider problem occurs because

A) people who pay for information use it freely.
B) people who do not pay for information use it.
C) information can never be sold at any price.
D) it is never profitable to produce information.
Answer: B

123. External financing by ________ should be more important in developing countries than
in industrialized countries because information about private firms is more difficult to collect
in developing countries.
A) financial intermediaries
B) bonds
C) stock
D) direct lending
Answer: A

124. That only large, well-established corporations have access to securities markets
A) explains why indirect finance is such an important source of external funds for businesses.
B) can be explained by the problem of moral hazard.
C) can be explained by government regulations that prohibit small firms from acquiring funds
in securities markets.
D) explains why newer and smaller corporations rely so heavily on the new issues market for
funds.
Answer: A

125. Tools to help solve the adverse selection problem in financial markets include all of the
following EXCEPT
A) diversification.
B) government regulations to increase information.
C) the use of financial intermediaries.
D) the private production and sale of information.
Answer: A

126. Since they require less monitoring of firms, ________ contracts are used more frequently
than ________ contracts to raise capital.
A) debt; equity
B) equity; debt
C) debt; loan
D) equity; stock
Answer: A