Practice Questions #1

Disclaimer: These practice questions are not comprehensive, nor are they intended to be. They are a strict subset of questions on the subject matter for which you are responsible.

Identifications:

Security / financial instrument
Financial intermediary
Factors of production
CPI
GDP deflator
Debt
Equity
Direct finance
Indirect finance
Maturity
Short/medium/long term debt instruments
Commercial paper
Repurchase agreement
Default
Mortgages
Convertible bonds
Eurobond / Eurodollar
Transaction costs
Adverse selection
Primary / secondary markets
Money / capital market instruments
T-Bills / T-Bonds
CD
Banker's acceptances
Fed Funds
Collateral
Mortgage-backed securities
Municipal bonds
Financial intermediation
Asymmetric information
Moral hazard
Regulation Q
Reserve requirements
Liquidity
Hyperinflation
Fiat money
Euro
ACH
CHIPS / SWIFT
Fedwire
EMOP
Monetary aggregates (M1, M2, etc.)
Coupon bond
Par value
Coupon rate
Discount bond
Present value
Yield to maturity
Simple interest rate
Consol
Current yield
Discount yield
Rate of return
Real interest rate
Fisher equation
Interest-rate risk
Default risk
Reinvestment risk
TIPS
Indexed bonds
Loanable funds (framework)
Business cycle
Fisher effect
Liquidity preference framework
Opportunity cost
Income effect
Price-level effect
Seignorage
Float
Electronic check truncation
Competitive devaluation

True/False/Uncertain:

1. Determinants of bond demand:
a. An increase in wealth increases the demand for bonds.
b. An increase in the expected interest rate increases the demand for bonds.
c. An increase in expected inflation increases the demand for bonds.
d. An increase in the riskiness of bonds relative to other assets increases the demand for bonds.
e. An increase in the liquidity of bonds relative to other assets increases the demand for bonds.

2. Determinants of bond supply:
a. A decrease in the profitability of other investments decreases the supply of bonds.
b. A decrease in the government budget deficit decreases the supply of bonds.

3. Interest-rate determinants:
a. An increase in income decreases the interest rate.
b. An increase in the price level decreases the interest rate.
c. An increase in money supply decreases the interest rate.
d. The effect of an increase in the rate of money growth will have a definite effect in the interest rate in the long run.

4. If the real interest rate increases people have incentive to increase their expenditures.

5. If the real interest rate increases people have incentive to increase their holdings of bonds.

6. Bond questions:
a. Volatility for long-term bonds is higher than that for short-term bonds.
b. The return of a bond is equal to the interest rate on that bond.
c. Current yield and yield to maturity are fancy names for the same thing, i.e. the interest rate.
d. The return on a bond will not necessarily equal the interest rate on that bond.
e. Bonds with a maturity that is as short as the holding period have no interest-rate risk.
f. Discount yield understates yield to maturity, and this understatement is increasing in maturity.

7. Diversification is always beneficial to the risk-averse investor.

8. Financial intermediaries increase the costs to borrowers and thereby diminish the amount of investment and capital formation in the economy.

Short Essays:

1. Discuss the importance of the interest rate to individuals; in particular, comment on how changes in the interest rate affect income allocation.

2. What is the relationship between interest rate risk and maturity?

3. Is the real interest rate as defined by the Fisher equation an accurate measure of the effective cost of borrowing for U.S. individuals and corporations?

4. What is the difference between current yield and yield to maturity for consols?

5. What are two benefits and one cost of indexed bonds? (Hint: the cost has to do with income taxes)

6. Under what circumstances does the yield to maturity equal the coupon rate of a coupon bond?

7. What is the relationship between the yield to maturity and the price of a coupon bond?

8. If mortgage rates rise from 5% to 10% but the expected rate of increase in housing prices rises from 2% to 9%, are people more or less likely to buy houses?

9. In Keynes' liquidity preference analysis, what two factors cause the demand curve for money to shift? How do these effects work?

10. What is the liquidity effect of an increase in the money supply? The income effect? Price-level effect? Expected-inflation effect?

11. Equity share of total assets vs. real-estate share
a. Does stock ownership figure much more importantly in the household portfolios of most Americans than it did in the past?
b. Why are the Flow of Funds Accounts statistics potentially misleading, with respect to this question?
c. Why has equity value held by households surpassed real estate value?
d. What might you expect the lice-cycle path of real estate assets as a fraction of total assets to look like? What does it actually look like, and why?
e. What is the probably cause for the real-estate share being so high for most households? What are the principal attendant risks? What are possible remedies?

12. Foreign $ holdings
a. Where is most of the U.S. currency, and why?
b. What are three policy implications of increased foreign holdings of U.S. currency?

13. Direct vs. indirect finance
a. What are they, which is more important, and why?

14. Money
a. How do the monetary aggregates relate to the amount of "money" in the economy?
b. Is money creation a tax?

15. EMOPs
a. What are the benefits of EMOPs?
b. Why are we not likely to move to a cashless society any time soon?

16. European Monetary Union
a. What are the costs of EMU?
b. What are the benefits?
c. Critically assess the wisdom of the Euro, comparing the costs and benefits from unification.

17. How can financial intermediaries shoulder more risk than an individual household or corporation?