chapters 6-10.pdf

Saunders, Financial Markets and Institutions, 2/e 57

Chapter 6

True/False Questions

1. Treasury notes have original maturities from 1 to 10 years and Treasury bonds have original maturities

of 10 years or more.

Answer: True Page: 153 Level: Easy

2. A callable bond is one where the issuer is required to retire a certain amount of the outstanding bonds

each year to ensure that all the bond principle is paid by final maturity.

Answer: False Page: 173 Level: Easy

3. Of the three major sectors of bond issuers, corporations have the greatest dollar value of bonds

outstanding.

Answer: True Page: 152 Level: Medium

4. “On the run” Treasury notes and bonds are newly issued securities and “off the run” Treasuries are

securities that have been previously issued.


5. Bonds that give the bondholder the opportunity to purchase common stock at a prespecified price up to a

specified date are called convertible bonds.

Answer: False Page: 171-172 Level: Medium

6. The dirty price plus accrued interest is called the clean price of the security.


7. Accrued interest owed to the bond seller increases as the next coupon payment date approaches


Chapter 6 Bond Markets


8. Revenue bonds are backed by the full revenue of the municipality.


9. Tax exempt bonds pay lower interest rates than taxable bonds because of their tax advantage.


10. An unsecured bond that has no specific collateral other than the general creditworthiness of the issuing

firm is called a debenture.


11. Municipalities are liable for repayment of industrial development bonds in the event the corporation

cannot repay.

Answer: False Page: 166 Level: Medium

12. Bond ratings use a classification system to give investors an idea of the amount of default risk associated

with the bond issue.


13. Bonds rated below Baa by Moody's or BBB by S&P are junk bonds.


14. Euro bonds are bonds denominated in the issuer's home currency, but are issued outside their home

country.


15. Dollar denominated bonds issued in the U.K. are called Bulldog bonds.


Multiple Choice Questions


16. The largest component of the U.S. National Debt is

A) T-Bills

B) T-Bonds

C) State and local government securities

D) U.S. Savings Bonds

E) None of the above

Answer: E Page: 153 Level: Medium

17. A T-Bond with a $1000 par is quoted at 98:20 Bid, 98:24 Ask. The clean price for you to buy this bond

is

A) $986.25

B) $987.50

C) $982.00

D) $982.40


Answer: B Page: 159-160 Level: Medium

18. The quoted ask yield on a 15 year $1000 par T-Bond with a 6% semiannual payment coupon and a price

quote of 104:12 is

A) 6.00%

B) 5.60%

C) 5.57%

D) 2.81%

E) 2.78%

Answer: C Page: 158-159 Level: Medium

Response: $1,043.75 = $30 PVIFA(r%,30) + $1,000 PVIF(r%,30 yrs)

19. A Treasury security in which periodic coupon interest payments can be separated from each other and

from the principal payment is called a

A) STRIP

B) T-Note

C) T-Bond

D) G.O. Bond

E) Revenue Bond

Answer: A Page: 155 Level: Easy



20. An 18 year T-Bond can be stripped into how many separate securities?

A) 18

B) 19

C) 36

D) 37

E) 38

Answer: D Page: 155-156 Level: Easy

21. A life insurer owes $50,000 in 5 years. To fund this outflow the insurer wishes to buy strips that mature

in 5 years. The strips have a $2,000 face value per strip and pay a 7% EAR. How much must the

insurer spend now to fully fund the outflow?

A) $10,000

B) $25,000

C) $42,675

D) $35,649

E) $39,877

Answer: D Page: 157-158 Level: Easy

Response: (2000 / 1.075) (50,000 / 2000)

22. The January 1, 2002 ask yield on a Treasury strip maturing in 6 years is 4.99%. If the face value is

$1000,what should be the quoted cost of the strip today (use annual compounding)?

A) 70:00

B) 74:20

C) 74:63

D) 74:16

E) 74:12

Answer: B Page: 158 Level: Medium

Response: $1,000 /(1.0499)6 = $746.25

23. Which one of the following bonds is likely to have the highest required rate of return, ceteris paribus?

A) AAA rated noncallable corporate bond with a sinking fund.

B) AA rated callable corporate bond with a sinking fund

C) AAA rated callable corporate bond with a sinking fund

D) High quality municipal bond

E) AA rated callable corporate bond without a sinking fund

Answer: E Page: 175-176 Level: Difficult

24. On June 1, 2000 you purchase a $10,000 par T-Note that matures in 5 years. The coupon rate is 6% and

the price quote is 98:6. The last coupon payment was May 1, 2000 and the next is November 1, 2000

(184 days total). The accrued interest is


A) $75.35

B) $101.00

C) $50.54

D) $40.65

E) $35.67


25. On September 1, 2000 an investor purchases a $10,000 par T-Bond that matures in 15.67 years. The

coupon rate is 6% and the investor buys the bond 60 days after the last coupon payment (120 days

before the next). The ask yield is 7%. The dirty price of the bond is:

A) $9,045.63

B) $9,157.47

C) $9,145.63

D) $9,200.02

E) $9,000.10

Answer: B Page: 159-160 Level: Difficult

Response: 300 PVIFA(3.5%,31.34) + 10,000 PVIF(3.5%,31.34) = 9057.47 ; 300 (60/180) = 100 ;

9057.47 + 100 = 9157.47

26. Interest income from Treasury securities is _____, and interest income from municipal bonds is always

_____.

A) Exempt from federal taxes; exempt from all taxes

B) Taxable at the state level only; exempt from state taxes only

C) Taxable at federal level only; exempt from federal taxes

D) Taxable at the state level; taxed at the federal level

E) Totally tax exempt; exempt from state taxes

Answer: C Page: 164 Level: Medium



27. An investor is in the 28% federal tax bracket, pays an 8% state tax rate and 2% in local income taxes.

For this investor a municipal bond paying 6% interest is equivalent to a corporate bond paying _____

interest

A) 15.79%

B) 8.33%

C) 9.38%

D) 9.68%

E) 8.47%

Answer: D Page: 164 Level: Medium

Response: 0.06 / [1 – (0.28 + 0.08 + 0.02)]

28. An investor is trying to decide between a muni paying 6% or an equivalent taxable corporate paying

7.5%. What is the minimum marginal tax rate the investor must have to consider buying the municipal

bond?

A) 80.00%

B) 20.00%

C) 25.00%

D) 66.67%

E) 33.33%


Response: 1 – (0.06 / 0.075)

29. Standard revenue bonds are

A) Backed by the full taxing authority of the municipality

B) Collateralized by the earnings from a specific project

C) Bonds backed by mortgages

D) Backed by the U.S. Treasury

E) Always offered with a best efforts offering

Answer: B Page: 165 Level: Easy

30. When an investment banker purchases an offering from a bond issuer and then resells it to the public this

is known as a

A) Rights offering

B) Private placement

C) Firm commitment

D) Best efforts

E) Standby offering

Answer: C Page: 167 Level: Easy

31. The entire contract between the bondholders and bond issuer is called the _____.


A) Covenant

B) Debenture

C) Indenture

D) Denture

E) Monitor


32. Which of the following is/are true about callable bonds?

I. Must always be called at par

II. Will normally be called after interest rates drop

III. Can be called by either the bondholder or the bond issuer

IV. Have higher required returns than non-callable bonds

A) I and II only

B) II and IV only

C) III and IV only

D) I, II and III only

E) I, II, III and IV are true


33. Bonds collateralized with tangible, non-real estate property are called

A) Debentures

B) Indentures

C) Subordinated debentures

D) Mortgage bonds



34. Convertible bonds are

A) Bonds that give the bondholder the right to purchase stock at a preset price without giving up the

bond

B) Bonds in which the issue matures (converts) a little each year

C) Bonds collateralized with certain types of automobiles

D) Bonds that allow the issuing company to require bondholders to purchase stock in exchange for the

bond





35. A holder of Rainbow Funds convertible bonds with a $1,000 price can convert the bond to 20 shares of

common stock. The stock is currently priced at $44/share. By what percent does the stock price have to

rise to make conversion potentially attractive?

A) 10.00%

B) 14.73%

C) 11.11%

D) 13.64%

E) 10.69%

Answer: D Page: 172 Level: Difficult

Response: [(1000 / 20) / 44] – 1

36. With respect to private placements of bonds, which of the following is correct?

I. Issuers of privately placed bonds tend to be less well known than public bond issues

II. Interest rates on privately placed debt tend to be higher than for similar public issues

III. Purchasers of privately placed debt have assets of at least $100 million

IV. Once bonds have been privately placed, the original buyers must hold the bonds until maturity

A) I only

B) I and III only

C) I, II and III only

D) I, III and IV only

E) I, II, III and IV


37. Which of the following statements about Euro bonds is/are true?

I. The issuer chooses the currency of denomination

II. Spreads on firm commitment offers are lower for Euro bonds than for U.S. bonds

III. Euro bonds typically have denomination of $5,000 and $10,000

IV. Euro bonds are bearer bonds

A) I and II only

B) I, III and IV only

C) II, III and IV only

D) II and III only

E) I, II, III and IV are true



38. Brady bonds are sometimes converted to _____ when the issuer's credit rating improves.

A) Samurai bonds

B) Zombie bonds

C) Bulldog bonds

D) Sovereign bonds

E) Phoenix bonds


39. Bearer bonds are bonds

A) With coupons attached that are redeemable by whoever has the bond

B) Where the registered owner automatically receives bond payments when scheduled.

C) In which the issue matures on a series of dates

D) Issued in another currency other than the bond issuer's home currency

E) Issued in a different country other than the bond issuer's home country


Chapter 7


1. The largest category of mortgages by dollar volume is multi-family mortgages.


2. A mortgage is a loan backed by real property.


3. Approximately 60% of residential mortgages are now securitized.


4. The secondary market for mortgages influences the accept/reject decision in originally granting a

mortgage.


5. Federally insured mortgages are called conventional mortgages.




6. The duration of a balloon payment mortgage is less than the duration of a fully amortized 30 year fixed

rate mortgage.

Answer: True Page: 191-192 Level: Medium

7. A borrower using a conventional mortgage will have to put up at least a 20% down payment or purchase

private mortgage insurance.


8. Discount points are paid to reduce the down payment required.

Answer: False Page: 193-194 Level: Easy

9. The required down payment on a FHA Loan can be as small as 3%.


10. A common rule of thumb is to not refinance your mortgage unless interest rates decline by at least 2

1/2%.



11. Rank the following types of mortgages by amount outstanding from largest to smallest.

I. Home mortgages

II. Multifamily mortgages

III. Farm mortgages

IV. Commercial mortgages

A) I, II, III, IV

B) I, II, IV, III

C) II, I IV, III

D) IV, II, III, I

E) I, IV, II, III



12. The process of packaging and/or selling mortgages which are then used to back publicly traded debt

securities is called

A) Collateralization

B) Securitization

C) Market capitalization

D) Stock diversification

E) Mortgage globalization


13. A _____ placed against mortgaged property ensures that the property cannot be sold (except by the

lender) until the mortgage is paid off.

A) Collateral

B) Lien

C) Habeas corpus

D) Down payment

E) Writ of certiorari


14. If a borrower makes a 20% down payment on a conventional mortgage they will be required to obtain

A) FHA insurance

B) VA insurance

C) Private mortgage insurance

D) GNMA payment guarantees


Answer: E Page: 189-190 Level: Easy

15. Mortgage payments are _____ on a 15 year fixed rate mortgage than on a 30 year fixed rate mortgage,

and _____ is paid on a 15 year mortgage than on a 30 year mortgage, ceteris paribus

A) Lower; less interest

B) Lower; less principal

C) Higher; less interest

D) Higher; more principal

E) Higher; more interest


16. With a fixed rate mortgage the _____ bears the interest rate risk and with an ARM the ______ bears the

interest rate risk.

A) Borrower; lender

B) Borrower; borrower

C) Lender; lender

D) Lender; borrower



E) Federal government; pool organizer

Answer: D Page: 192-193 Level: Medium

17. The schedule showing how monthly mortgage payments are split into principle and interest is called

a(an):

A) Securitization schedule

B) Balloon payment schedule

C) Graduated payment schedule

D) Amortization schedule

E) Growing equity schedule

Answer: D Page: 195 Level: Easy

18. You purchase a $200,000 house and you pay 20% down. The interest rate is 7% and there are 360

monthly payments. What is the monthly payment?

A) $1,330.61

B) $1,074.49

C) $1,064.48

D) $1,327.34

E) $933.33


Response: 0.80*$200,000 = Pmt PVIFA(0.07/12, 360 months]

19. A borrower took out a 30 year fixed rate mortgage of $130,000 at an 8% annual rate. After five years,

he wishes to pay off the remaining balance. Interest rates have by then fallen to 7%. How much must

he pay to retire the mortgage (to the nearest dollar)?

A) $134,963

B) $118,657

C) $72,766

D) $123,591

E) $114,042


Response: $130,000 = Pmt PVIFA(0.08/12, 360 months] ; Pmt = $953.89 ; PV = $953.89

PVIFA(0.08/12, 300 months]


20. A homeowner could take out a 15 year mortgage at a 6.5% annual rate on a $125,000 mortgage amount,

or she could finance the purchase with a 30 year mortgage at a 7.0% annual rate. How much total

interest over the entire mortgage periods could she save by financing her home with the 15 year

mortgage (to the nearest dollar)?

A) $103,387

B) $140,625

C) $92,457

D) $113,786

E) $77,899

Answer: A Page: 198 Level: Difficult

Response: 125,000 = Pmt PVIFA(0.065/12, 180 months] ; Pmt of 1,088.88 180 = 195,999 ; 125,000

= Pmt PVIFA(0.07/12, 360 months] ; Pmt of 831.63 360 = 299,386 ; 299,386 – 195,999 = 103,387

Use the following to answer questions 21-22:

A homeowner can obtain a $150,000 thirty year fixed rate mortgage at a rate of 7.5% with zero points or at a

rate of 7.0% with 2 points.

21. If you will keep the mortgage for 30 years, what is the net present value of paying the points (to the

nearest dollar)?

A) $18,313

B) $13,667

C) $7,646

D) $5,631

E) $4,646

Answer: E Page: 199 Level: Difficult

Response: No Points: $1,048.82 = $150,000 / PVIFA(0.075/12, 360 months] ;

Pay Points: $997.95 = $150,000 / PVIFA(0.07/12, 360 months] ; $1,048.82 – $997.95 = $50.87 ;

[$50.87 PVIFA(0.07/12, 360 months)] – (0.02150,000) = $4,646.15



22. How long must the owner stay in the house to make it worthwhile to pay the points if the payment

saving is invested monthly?

A) 5,40 years

B) 3.33 years

C) 6.04 years

D) 4.91 years

E) More than 30 years


Response: $3,000 points cost = $50.87 payment savings PVIFA(0.07/12, N) ; N = 72.49 months / 12 =

6.04 years

23. A _____ may be used by a borrower who wants to pay off a mortgage more quickly than a standard

mortgage.

A) Second mortgage

B) GPM

C) ARM

D) Automatic Rate Reduction Mortgage

E) GEM


24. A _____ is used to purchase a more expensive home than for which the borrower could otherwise

qualify.

A) Second mortgage

B) GPM

C) ARM

D) Automatic Rate Reduction Mortgage

E) GEM


25. A _____ mortgage is primarily used when interest rates are high in order to allow borrowers who could

not otherwise obtain mortgages to do so.

A) SAM

B) RAM

C) GEM

D) ARM

E) Automatic Rate Reduction Mortgage

Answer: A Page: 200 Level: Medium

26. A _____ is used to help retired people receive monthly income in exchange for the equity in their home.


A) SAM

B) Equity Participant Mortgage

C) RAM

D) PLAM

E) GEM


27. Which of the following statements about mortgage markets is/are true?

I. Mortgage companies service more mortgages than they originate.

II. Servicing fees typically range from 2% to 4%.

III. Most mortgage sales are with recourse.

IV. The government is involved in the residential mortgage markets.

A) I, III and IV only

B) II, III and IV only

C) I, II and IV only

D) II and III only

E) I and IV only

Answer: E Page: 201-202 Level: Medium

28. Which of the following statements about GNMA is/are true?

I. GNMA provides timing insurance.

II. GNMA creates pools of mortgages and issues securities.

III. GNMA insures only FHA, VA and FmHA loans.

IV. GNMA requires that all mortgages in the pool have the same interest rate.

A) I, II , III and IV are true

B) I, III and IV only


D) II, III and IV only

E) III and IV only




29. A $25,000 face value GNMA pass-through quote sheet lists a spread to average life of 103, PSA of 220,

and a price of 101-09. This means that

I. The pass-through yield is 103 basis points above the comparable maturity Treasury bond

II. The pass-through is being prepaid more quickly than normal

III. The pass-through is priced at $25,272.50

A) I, II and III are correct

B) I and II only

C) I and III only

D) II and III only

E) III only


30. The advantage of a CMO to an investor over a pass-through is

A) The CMO increases the predictability of the period over which cash flows will be received

B) The CMO reduces credit risk

C) The CMO is not taxable and the pass-through is taxable

D) CMO rates of return are guaranteed

E) All of the above

Answer: A Page: 207-208 Level: Medium

31. An IO holder benefits from _____ than expected prepayments, and a PO holder benefits from lower than

expected _____.

A) Lower; prepayments

B) Higher; prepayments

C) Lower; interest rates

D) Higher; interest rates


Answer: C Page: 209-210 Level: Difficult

32. A MBB differs from a CMO or a pass-through in that

I. The MBB does not result in the removal of mortgages from the balance sheet.

II. A MBB holder has no prepayment risk.

III. Cash flows on a MBB are not directly passed through from mortgages.

A) I, II and III

B) I and II only

C) II and III only

D) I and III only

E) I only


Chapter 8



1. The lead bank in the syndicate that negotiates with the issuing company on behalf of the syndicate is

called the originating house.


2. An order to buy shares of stock at a specified price or better is called a market order.


3. The NYSE defines the simultaneous buying and selling of 15 or more different stocks with a total value

of at least $1 million dollars to be block trading and such trades are subject to trading curbs.


4. A long term investor in a high marginal tax bracket will normally prefer a dollar of capital gain to a

dollar of dividend yield.


5. In the event of bankruptcy a firm's janitor must be paid all the salary owed him before stockholders

receive anything.


6. At year end a firm has assets of $100 and debts due of $120. The stockholders must pay an additional

$20 out of their own pocket.


7. In cumulative voting, a stockholder who owns 51% of the shares can be assured of the ability to elect the

entire board of directors.




8. In straight voting, a stockholder who owns 51% of the shares can elect the entire board of directors.


9. Preferred stockholders have a claim senior to common stock but junior to bondholders.

Answer: True Page: 224-225 Level: Easy

10. A market order is normally executed in 15 minutes or less but the buyer has three days to actually pay

for the stock.


11. Preferred stock is generally a costlier source of funds than bonds.


12. The smallest stock price change is currently 1/16th.


13. Firms with both common and preferred stock are called dual class firms.


14. If the stock markets are weak form efficient, stock prices reflect all historic public information about a

firm.


15. IPOs are sometimes sold via a rights offering.




16. You buy a stock for $14 per share and sell it for $18 after you collect a $1.00 per share dividend. Your

pre-tax capital gain yield is _____ and your pre-tax dividend yield is _____.

A) 28.57% ; 7.14%

B) 35.71% ; 0.00%

C) 21.42% ; 5.55%

D) 22.22% ; 5.55%

E) 27.78% ; 6.32%


17. Common stocks typically have which of the following that bonds do not have:

I. Voting rights

II. Fixed cash flows

III. Set maturity date

IV. Tax deductibility of cash flows

A) I only

B) I, II and IV only


D) IV only



18. You buy a stock for $10 per share and sell it for $12 after holding it for slightly over a year and

collecting a $0.50 per share dividend. Your ordinary income tax rate is 28% and your capital gains tax

rate is 20%. Your after-tax rate of return is _______.

A) 18.1%

B) 19.6%

C) 25.0%

D) 20.2%

E) 17.4%


Response: [(($12-$10) (1-0.20)) + ($0.50 (1-0.28))] / $10 = $1.96 / $10 = 19.6%



19. An investor has a 38% ordinary income tax rate and a 20% long term capital gains tax rate. The investor

holds stock in a firm that could pay its usual $1 per share dividend or reinvest the cash in the firm. The

stock price is currently $25 per share. If the firm does not pay the dividend the share price will rise. If it

pays the dividend the share price will stay the same. By how much must the share price rise if the

dividend is not paid in order to make the investor indifferent between receiving the dividend or not?

A) $2.00

B) $0.59

C) $1.55

D) $1.97

E) $2.50

Answer: C Page: 221 Level: Difficult

Response: 2 * (1 - 0.38) = Change in share price * (1 - 0.20)

20. With _________ voting, all directors up for election are voted on by the shareholders at the same time in

one general election.

A) Straight

B) Participating

C) Nonparticipating

D) Proxy

E) Cumulative


21. If all preferred dividend payments that have been missed must be paid before any common stock

dividend can be paid the preferred stock is called _____ preferred stock.

A) Cumulative

B) Participating

C) Nonparticipating

D) Voting

E) Dual class



22. In the year 2000 about 20% of the shares of the top one hundred non-U.S. companies (ranked by sales)

were owned by U.S. residents. Most of these stocks were held in the form of _________________.

A) Foreign direct investment

B) ADRs

C) Proxies

D) GRDs

E) Brady bonds


23. If the net proceeds are greater than the gross proceeds in an underwritten offering

A) The investment banker made a profit on the spread

B) The issuing company underpriced its securities

C) The issue fails to occur

D) The SEC rescinds the issue



24. The preemptive right is designed to

A) Allow management to diffuse stock ownership any voting power

B) Allow managers to preempt a stock offering if they do not like the terms of the deal

C) Allow existing shareholders the right to sell their existing shares before the new offer

D) Allow existing shareholders to buy shares of the new offering if they desire



25. The NASDAQ automatic order execution system for individual traders placing buy or sell orders of

1000 or fewer shares is called the

A) ECN Network

B) SOE System

C) NASDAQ/AMEX Joint Program

D) Instinet Network

E) E*Trade Online Program




26. The preliminary version of a security offer that is circulated to potential buyers before SEC approval

(registration) is obtained is called a

A) Final prospectus

B) Shelf registration statement

C) Due diligence draft

D) Waiting period offer

E) Red herring prospectus

Answer: E Page: 231 Level: Easy

27. A shelf registration allows firms the opportunity to avoid the normal _____ day waiting period by

allowing preregistration of securities for up to _____ years.

A) 20 day; 2 years

B) 10 day; 1 year

C) 15 day; 3 years

D) 20 day; 1 year

E) 30 day; 2 year

Answer: A Page: 231-232 Level: Medium

28. Which of the following is/are true about specialists?

I. Investment banks generally cannot be specialists

II. Specialists are used by the NASDAQ system

III. Market and limit orders are transacted at specialist posts, but the specialist's 'own

account' orders are executed elsewhere

IV. Specialists help maintain continuous trading

A) I, II and III only

B) I and IV only


D) I only

E) III only


29. Market orders are generally executed in less than _____ and settled in _____.

A) 15 minutes; 3 days

B) 1 hour; 1 week

C) 30 minutes; 2 days

D) 30 minutes; 3 days

E) 45 minutes; 4 days



30. A stock has a P/E ratio of 95. If earnings don't grow the investor must wait how long to recover their

investment?

A) 20 years

B) 45 years

C) 60 years

D) 95 years



31. In terms of volume of trading and market value of firms traded the ________ is the largest U.S. stock

market. In terms of number of firms traded the ___________ is the largest in the U.S.

A) NYSE ; NYSE

B) NASDAQ ; NYSE

C) NYSE ; AMEX

D) NYSE ; NASDAQ

E) NASDAQ ; AMEX


32. On the NASDAQ system, the inside quotes are the

A) Lowest ask and lowest bid

B) Lowest bid and highest ask

C) Highest bid and highest ask

D) Highest bid and lowest ask



33. NYSE listing has traditionally benefited a firm by

A) Improving the stock's price

B) Generating increased publicity for the firm

C) Providing easier access to primary market capital

D) B and C only

E) A, B and C




34. Which of the following indices are value weighted?

I. NYSE Composite

II. S&P500

III. NASDAQ Composite

IV. Dow Jones Industrial Average

A) I, II, III and IV

B) I only

C) II only


E) I, II and III only

Answer: E Page: 242-243 Level: Easy

35. The largest holder of common stock ($) is

A) Pension funds

B) Households

C) Mutual funds

D) Brokers and dealers

E) Life insurance firms


Chapter 9


1. If a foreign currency appreciates, that country's goods and services become relatively more expensive

for U.S. buyers.


2. A U.S. firm agrees to import textiles from Hong Kong and pay in 90 days. The invoice requires

payment in Hong Kong dollars. The U.S. importer could hedge this currency risk by buying the HK

dollar forward.


3. The principle currency futures market in the U.S. is the IMM in Chicago.



4. London is the largest center for trading foreign exchange.


5. If you can convert 150 Swiss francs to $90 the exchange rate is 1.67 francs per dollar.


6. If the dollar is initially worth 120 yen and then the exchange rate changes so that the dollar is now worth

115 yen, the value of the yen has depreciated.


7. If the euro per yen ratio falls the value of the yen has risen.




8. If the U.S. has inflation of 3% and Europe has inflation of 5%, the value of the Euro should increase,

ceteris paribus.


9. A U.S. bank has £12 million worth of loans and £10 million worth of deposits in Britain. The bank

would benefit from a drop in the value of the pound against the dollar.


10. A country with a current account surplus is importing more goods and services than they are exporting.



11. Foreign exchange trading in 2001 averaged about _____ per day.

A) $101 million

B) $1.1 billion

C) $101 billion

D) $1.1 trillion

E) $101 trillion


12. In 2001, the U.S. imported goods and services worth about _____________ and exported about

_________ leading to a current account ____________.

A) $1.3 trillion ; $1.6 trillion ; deficit

B) $1.3 trillion ; $1.6 trillion ; surplus

C) $1.3 trillion ; $1.3 trillion ; balance

D) $1.6 trillion ; $1.3 trillion ; deficit

E) $1.6 trillion ; $1.3 trillion ; surplus



13. A U.S. investor has borrowed pounds, converted them to dollars and invested the dollars in the U.S. to

take advantage of interest rate differentials. To cover the currency risk the investor should

A) Sell pounds forward

B) Buy dollars forward

C) Buy pounds forward

D) Sell pounds spot



14. A U.S. firm has £50 million in assets in Britain. They could hedge this risk by

A) Buying pounds forward

B) Selling pounds forward

C) Borrowing pounds

D) Both B and C would hedge the risk

E) Both A and C would hedge the risk

Answer: D Page: 268-269 Level: Difficult

15. A U.S. bank made converted $1 million to Swiss francs to make a Swiss franc loan to a valued corporate

customer when the exchange rate was 1.5 francs per dollar. The borrower agreed to repay the principle

plus 5% interest in 1 year. The borrower repaid Swiss francs at loan maturity and when the loan was

repaid the exchange rate was 1.4 francs per dollar. What was the bank's rate of return?

A) 6.00%

B) -11.67%

C) 7.14%

D) -2.00%

E) 12.50%


Response: {[($1 mill*((SFr 1.5/$)*1.05) / SFr 1.4/$] / $1 mill} – 1



16. A Japanese investor can earn a 1% annual interest rate in Japan or about 4% per year in the U.S. If the

spot exchange rate is 115 yen to the dollar at what one year forward rate would an investor be indifferent

between the U.S. and Japanese investments?

A) ¥110.58

B) ¥116.15

C) ¥111.68

D) ¥118.42

E) ¥112.45

Answer: C Page: 272 Level: Difficult

Response: ($1 * ¥115 * 1.01) / 1.04

17. An investor starts with $1 million and converts them to 0.65 million pounds which are then invested for

one year. In a year the investor has 0.6695 million pounds which she then converts to dollars at an

exchange rate of 0.63 pounds per dollar. The U.S. dollar annual rate of return earned was _____.

A) 3.00%

B) 6.27%

C) 4.45%

D) 5.69%

E) 4.38%


Response: [(0.6695 mill pounds / 0.63) / $1 million] –1

18. Banks net foreign exposure is equal to

A) Net foreign assets

B) Net FX bought

C) Net foreign assets + Net FX bought

D) Assets – liabilities



19. If a firm has more foreign currency assets than liabilities, and no other foreign currency transactions, it

has

A) Positive net exposure

B) Negative net exposure

C) Fully balanced position

D) Zero net exposure



20. The levels of foreign currency assets and liabilities have _____ in recent years and the level of foreign

currency trading has _____.

A) Increased; increased

B) Decreased; decreased

C) Increased; decreased

D) Decreased; increased

E) Decreased; stayed the same


21. The dominant supplier of foreign exchange to retail customers in the U.S. is

A) Bank America

B) Citigroup

C) Chase

D) Wells Fargo

E) Deutschebank


22. If parity holds and the annual German nominal interest rate is 5% and the U.S. annual nominal rate is

3% and real interest rates are 2% in both countries, then inflation in Germany is about _____ than in the

U.S.

A) 1% higher

B) 2% higher

C) 1% lower

D) 4% lower

E) 2% lower


23. At the beginning of the year the exchange rate between the Brazilian Real and the U.S. dollar is 2.5

Reals per dollar. Over the year Brazilian inflation is 16% and U.S. inflation is 2%. If parity holds, at

year end the exchange rate should be _____ dollars per real.

A) 2.9070

B) 0.3509

C) 2.8498

D) 0.3749

E) 0.3440


Response: (1 / 2.5) - [0.14 * (1 / 2.5)]



24. The sum of the capital account plus the current account is equal to

A) The trade deficit

B) The current account balance

C) Zero

D) GDP – PDI

E) Net foreign investment


25. The U.S. currently has a merchandise trade _____, a service trade _____, and a capital account _____.

A) Surplus, deficit, deficit

B) Deficit, surplus, surplus

C) Deficit, surplus, deficit

D) Deficit, deficit, surplus

E) Surplus, surplus, deficit


26. Government budget deficits and merchandise trade deficits generally require either a very large service

account surplus or require

A) A large amount of U.S. foreign aid

B) A decline in U.S. interest rates

C) A capital account deficit

D) Americans to net borrow from foreigners


27. A capital account surplus implies that

A) The U.S. net borrowed money from overseas and/or net sold U.S. assets to foreigners

B) U.S. investors purchased more foreign capital assets than foreigners purchased U.S. capital assets

C) More goods were exported than imported

D) The U.S. net repaid its foreign debts

E) U.S. foreign aid exceeded net unilateral transfers



28. A current account deficit implies that

A) More goods and services are exported than are imported

B) The country borrowed from abroad more than it loaned, and/or sold off some of its assets

C) There is excessive consumption of foreign financial assets

D) The value of the dollar will rise

E) The country is going bankrupt

Answer: B Page: 275 Level: Difficult

29. Which of the following are likely to lead to an appreciation of the U.S. dollar (ceteris paribus)?

I. Higher real U.S. interest rates

II. Lower U.S. inflation

III. Higher U.S. productivity

IV. Higher nominal U.S. interest rates

A) I, II, III and IV

B) I, II and III only

C) I, III and IV only


E) II and III only


30. You can buy or sell the £ spot at $1.60 to the pound. You can buy or sell the pound 1 year forward at

$1.62 to the pound. If U.S. annual interest rates are 4%, what must be the one year British interest rate if

interest rate parity holds?

A) 4.00%

B) 5.25%

C) 2.75%

D) 3.33%

E) 5.65%

Answer: C Page: None Level: Difficult

Response: ($1.62 - $1.60)/$1.60 = 1.25% appreciation in the pound. 4% - 1.25% = 2.75%

Chapter 10


1. Credit derivatives generally provide a means to hedge against an increase in default risk on a loan.


2. Forward contracts are marked to market daily.




3. Futures or option exchange members who take positions on contracts for periods longer than a day are

called floor brokers.


4. The seller of a T-bond futures contract priced at 101-16 at the time of sale agrees to deliver $100,000

face value Treasury bonds in exchange for receiving $101,500 at contract maturity.


5. A negotiated agreement between a buyer and seller (with no third party involvement) to exchange a non-

standardized asset for cash at some future date, with the price set today is called a forward agreement.


6. An immediate delivery versus payment agreement is a spot agreement.


7. Options on the S&P500 index are examples of European stock index options.


8. In a futures contract if funds in the margin account fall below the initial margin requirement, a margin

call is issued.


9. You would expect the price quote for a put option to be at least $10 if the put had an exercise price of

$40 and the underlying stock was selling for $50.


10. A clearinghouse backs the buyer's and seller's position in an forward contract.


11. American options can only be exercised at maturity.



12. The buyer of a call option immediately pays the premium to the call option writer.


13. Writing a put option results in a potentially limited gain and a potentially unlimited loss.


14. The buyer of a put option on stock benefits if the underlying stock price rises.


15. An in the money American call option increases in value as expiration approaches, but an out of the

money American call option decreases in value as expiration approaches.





16. The most recent derivative security innovations are

A) Foreign currency futures

B) Interest rate futures

C) Stock index futures

D) Stock options

E) Credit derivatives

Answer: E Page: 278 Level: Easy

17. By convention, a swap buyer on an interest rate swap agrees to

A) Periodically pay a fixed rate of interest and receive a floating rate of interest

B) Periodically pay a floating rate of interest and receive a fixed rate of interest

C) Swap both principle and interest at contract maturity

D) Back both sides of the swap agreement

E) Act as the dealer in the swap agreement


18. An increase in which of the following would increase the price of a call option on common stock, ceteris

paribus?

I. Stock price

II. Stock price volatility

III. Interest rates

IV. Exercise price

A) II only

B) II and IV only





19. Which of the following is true?

A) Forward contracts have no default risk

B) Futures contracts require an initial margin requirement be paid

C) Forward contracts are marked to market daily

D) Forward contract buyers and sellers do not know who the counterparty is

E) Futures contracts are only traded over the counter


20. A professional futures trader who specializes in buying or selling futures contracts for multiple days or


weeks is called a

A) Scalper

B) Day trader

C) Position trader

D) Specialist

E) Hedger


21. You have agreed to deliver the underlying commodity in 90 days. Today the underlying commodity

price rises and you get a margin call. You must have

A) A long position in a futures contract

B) A short position in a futures contract

C) Sold a forward contract

D) Purchased a forward contract

E) Purchased a call option on a futures contract


22. You find the following current quote for the June T-Bond contract: $100,000; Pts 32nd, of 100%

You went long in the contract at the open. Which of the following is/are true?

I. By the end of the day your margin account would be increased

II. 45,348 contracts were traded that day

III. You agreed to deliver in June $100,000 face value T-Bonds in exchange for $88,875

IV. You agreed to purchase in June, $100,000 face value T-Bonds in exchange for $89,500

A) I, II and III only


C) I and III only

D) I and IV only

E) IV only


Open High Low Settle Open interest 89-16 89-16 88-22 88-28 45,348



23. A contract that gives the holder the right to sell a security at a preset price only immediately before

contract expiration is a(n).

A) American call option

B) European call option

C) American put option

D) European put option

E) Knockout option


24. A higher level of which of the following variables would make a put option on common stock more

valuable, ceteris paribus?

I. Stock price

II. Stock price volatility

III. Interest rates

IV. Exercise price

A) II only

B) II and IV only





25. A speculator may write a call option on stock with an exercise price of $15 and earn a $3 premium if

they thought

A) The stock price would stay at or above $15

B) The stock volatility would increase

C) The stock price would rise above $18

D) The stock price would stay at or below $18

E) Both A and B could be true


26. You have taken an option position and if prices drop you could go bankrupt, but if prices rise you might

get a small gain. You have

A) Bought a call option

B) Bought a put option

C) Written a call option

D) Written a put option


Answer: D Page: 292 Level: Difficult

27. You have taken an option position and if prices drop you could lose a fixed small amount of money, but


if prices rise your gain rises with it, You have

A) Bought a call option

B) Bought a put option

C) Written a call option

D) Written a put option



28. In a bull market which option positions make money?

I. Buying a call

II. Writing a call

III. Buying a put

IV. Writing a put

A) I and II

B) I and III

C) I and IV

D) II and III

E) I and IV


29. The higher the exercise price the _____ the value of a put and the _____ the value of a call.

A) Higher; higher

B) Lower, lower

C) Higher, lower

D) Lower, higher


30. The largest type of derivative market in the world is the

A) Futures market

B) Forward market

C) Swap market

D) Options market

E) Credit derivatives market




31. A stock has a spot price of $35. Its May options are about to expire. One of its puts is worth $5 and one

of its calls is worth $5. The exercise price of the put must be _____ and the exercise price of the call

must be _____.

A) 30, 40

B) 35, 35

C) 40, 30

D) 25, 45

E) One cannot tell from the information given


32. An agreement between two parties to exchange specified periodic cash flows in the future based on

some underlying instrument or price is a/an

A) Forward agreement

B) Futures contract

C) Interest rate collar

D) Option contract

E) Swap contract


33. An investor has unrealized gains in 100 shares of Amazin stock upon which they do not wish to pay

taxes. However, they are now bearish upon the stock for the short term. The stock is at 64 and he buys

a put with a strike of 65 for $200. At expiration the stock is at $61. What is the net gain or loss on the

entire stock/option portfolio.

A) $200.00

B) -$100.00

C) -$300.00

D) -$200.00



Response: [($61 - $64) * 100] + (($65 - $61)*100) - $200

34. New futures contracts must be approved by

A) The CFTC

B) The SEC

C) The Warren Commission

D) The NYSE

E) The Federal Reserve

Answer: A Page: 283-284 Level: Easy

35. A(n) _____ is a succession of forward contracts on interest rates between two parties.


A) Collar

B) Interest rate swap

C) Currency swap

D) Swaption

E) Credit swap


36. A bank with short term floating rate assets funded by long term fixed rate liabilities could hedge this risk

by

I. Buying a T-bond futures contracts

II. Buying options on a T-bond futures contract

III. Enter into a swap agreement to pay a fixed rate and receive a variable rate

IV. Enter into a swap agreement to pay a variable rate and receive a fixed rate

A) I and III only


C) II and IV only

D) III only

E) IV only

Answer: B Page: Various Level: Difficult

37. The swap market's primary direct government regulator is (the)

A) SEC

B) CFTC

C) NYSE

D) WTO

E) Nobody




38. A bank with long term fixed rate assets funded with short term rate sensitive liabilities could do which

of the following to limit their interest rate risk?

I. Buy a cap

II. Buy an interest rate swap

III. Buy a floor

IV. Sell an interest rate swap

A) I and II only

B) III only

C) I and IV only

D) II and III only

E) III and IV only

Answer: A Page: 302,306-307 Level: Difficult

39. An interest rate floor is designed to protect an institution from

I. Falling interest rates

II. Falling bond prices

III. Increased credit risk on loans

IV. Swap counterparty credit risk

A) I and IV

B) II and III

C) I and III

D) II and IV

E) I only


40. An interest rate collar is

A) Writing a floor and writing a cap

B) Buying a cap and writing a floor

C) An option on a futures contract

D) Buying a cap and buying a floor



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